Good day and welcome to the Watsco Fourth Quarter 2024 and Year End Earnings Call. All participants will be in listen-only mode. Please note, this event is being recorded. I would now like to turn the conference over to Albert Nahmad, Chairman and CEO. Please go ahead.

Good morning. This earnings call features A.J. Nahmad, President of Watsco; Paul Johnston; Barry Logan; and Rick Gomez. Now, before we start, our cautionary statement mentions that this conference call has forward-looking statements as defined by SEC laws and regulations that are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements. Now, on to the call. Watsco had a terrific, emphasis on terrific, fourth quarter to close out a strong year. We achieved record sales, expanded margins, improved operating efficiency, and generated record earnings and cash flow. Market conditions continue to improve, which led to a 14% growth in equipment sales and 16% growth in residential products. Our financial position is stronger than ever, and we are happy to announce today an 11% dividend increase to $12 per share. Looking forward, we are optimistic about our opportunities ahead of us. First, the transition to next-generation A2L products is well underway. The new A2L products provide the opportunity to upgrade the installed base of existing equipment to systems that are more efficient and environmentally-friendly. We also made the transition that influences 50% to 60% of our sales. We are making investments to train our customers, leverage our technology advantage, and transition close to $1 billion in inventories to aggressively take advantage of this opportunity. Second, our technology platforms have gained momentum. Our community of active users of Watsco mobile apps has expanded to over 64,000 users. E-commerce sales during the quarter increased 16%, outpacing overall growth rates and now represents 35% of our annual sales, which totals $2.6 billion in aggregate. OnCall Air, our digital sales platform for contractors, presented approximately 313,000 proposals to homeowners, generating $1.5 million in gross merchandise value, a 25% increase. There is no question that our technology investments have contributed to our performance and provide us an immense competitive advantage. And the importance of these investments will only grow with time. Finally, we believe our strong financial position is also an important differentiator. We have the ability to invest in big opportunities to accelerate growth and gain market share. In January 2025, we completed our 70th acquisition since 1989. There are many great family businesses in our industry that we believe offer compelling reasons for them to join forces with us. As always, and I emphasize this, our focus is on the long-term. We have a great deal more to accomplish and we welcome any of you to visit and spend time with our team in Miami to learn more. With that, let's turn to the Q&A.

We will now begin the question-and-answer session. The first question comes from David Manthey with Baird. Please go ahead.

Morning Dave.

Yes. Hey, Al. Good morning. First question is with double-digit unit growth in residential versus 16% reported, I guess that implies mid-single-digit price/mix. Was A2L a driver of that uptick? And just a general update when do you expect to be fully transitioned to the new technology? And it seems like channel feedback is 8% to 10% pricing. Is that consistent with how you're thinking about things?

Let's turn to Paul Johnston for that answer.

Yes. In the fourth quarter, no, we really didn't have much of an impact on A2L. We were 90%-plus on the 410A. Pricing actions, yes, 8% is what was previously announced with the tariffs coming online from the White House. It seems like there's going to be some more pricing actions from the manufacturers that are going to be announced here shortly. So, we're going to start seeing more single-digit price increases.

Dave, regarding your question about unit growth, I'm not entirely following your math. To clarify, we observed an increase in residential products for the quarter. Specifically, when we talk about unit growth, it relates to how AHRI assesses equipment growth, specifically unitary products and compressor bearing units. For Watsco across all markets, unit growth was up 16% for the quarter, with an additional 3% from pricing. Domestically, the unit growth is actually a bit stronger. There is also some price and mix influence driven by significantly stronger unit growth. As Paul mentioned, A2L had a minimal impact this quarter, but we expect a greater influence as we move into 2025.

Yes. Thanks for that, Barry, that's encouraging. And just one quick one, kind of on a tangent. Could you talk about Watsco Ventures' ownership position in HouseCall Pro? Could you scale that for us and just give us an update there?

A.J.?

Yes, Watsco does not have an ownership in HouseCall Pro. We have a commercial relationship, which we've enjoyed with them for a very long time and have both benefited from. The flagship in Watsco Ventures portfolio is OnCall Air, which is our homegrown software and our homegrown business called OnCall Air, which helps the contractor sell at the home. And that's being used at scale now and continues to grow about $1.5 billion worth of our customer sales to their customers. Now, we're powered through that platform and customers are that are using it, they're growing faster, they're winning more deals, they're higher margin deals, they're higher ticket deals, and it's a win-win-win for everybody. But to answer your original question, Watsco does not have any investment in HouseCall Pro.

Okay, that's great. Thank you very much.

The next question comes from Tommy Moll with Stephens. Please go ahead.

Morning Tommy.

Morning Al and thanks for taking my question. First question is if you look at your inventory position today, what's the best guess on when you've run down that 410A currently on the balance sheet and should fully transition to the new product? I mean, it will depend on the weather and other factors, but what's a reasonable outlook there?

Paul, Barry, do you want to take a shot at that?

Go ahead, Paul.

Yes. We've been working with our subsidiaries to try to make sure that we sell through the 410A and do a reasonable transition into the A2L. And at the present time, what we're looking at is probably by the beginning of the second quarter, we should be pretty much running our 410 down to almost nothing, and we should be almost fully engaged with A2L. It's not to say that we're not going to still have 410 products. We still will have 410 products probably throughout the year, but the big transition is probably going to occur in the second quarter.

I would agree with that. I'll just also add, I don’t know just to clarify, our position is that whether the regulation says it specifically or there's noise around it is that we want to be through selling and three of our 410 inventory by the end of 2025, and we fully expect to do that. And that's in large part because of the scale and the power of Watsco. It's a good time to be the size that we are because our business units can help each other. There's a lot of data surrounding what's where in terms of inventory and what products need to be moved and they can help each other out and clear out what needs to be cleared out in time.

Well said. I have a follow-up question. As you begin to increase the volume of A2L sales, what impact should we expect on the gross margin percentage, especially considering the positive mix effect? Additionally, as you implement this in the market, how are you assisting your customers in communicating the benefits of the product to the end users? We are all ready for significant price and mix increases, but ultimately, these discussions happen at the kitchen table. How are you supporting your customers in these discussions as we move forward? Thank you.

I mean, that's what we do no matter what are the changes. That's our job. Maybe some more specifics, Paul, Barry?

Yes. We provide extensive training to our customers to get them ready for the transition to the new refrigerant. As you know, it's got slight flammability to it, so it has to be handled in a little bit different manner. And it's got other components that are going to be on the product that aren't on the 410. So, a lot of training has gone in prior to the introduction of the product. As far as the gross profit movement, you'll see the gross profit dollars probably go up but because it's a brand-new product, you're not going to see so much the gross profit percentage move up that much to start with. It's going to be a more expensive product than the 410A product and we expect that to be somewhere in the neighborhood of 8% to 10%.

Thank you.

Yes, to add to that, we needed to upgrade our entire database of product information, which has been done for all the new products. The process of matching products, fitting them, and even managing permits for new products is now all digital. This represents about 35% of total Watsco and is likely closer to 45% or 50% of our residential business. Our digital platform is easing the transition for customers in how they buy, specify, and correlate products. Last time, we didn't have these tools at scale, which is crucial now. Regarding OnCall Air, those customers enrolled in the program are now using tools that shape how they learn about, see, and experience these new products. The timing is excellent; I only wish the user community for OnCall Air was ten times larger. This program represents $1.5 billion of products that consumers are seeing digitally for the first time. There is momentum, which is part of the story. On gross profit, to add to what Paul said, it's an algebraic equation influenced by higher costs, and maintaining the same margin would be beneficial for business. One of our other technologies is a pricing platform aimed at enhancing margins where possible and informing our teams on performance. This is a more abstract point, but it's an opportunity we recognize with our new pricing technology.

Thank you all. I'll turn it back.

The next question comes from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Morning Jeff.

Hey good morning guys. Just back to fourth quarter, I mean, very strong unit growth. I'm just wondering if you can unpack what's kind of easy comps? What's kind of this supplier issue, lapping the supplier issue? And then was there any evidence that contractors were taking 410A that would have impacted the fourth quarter? And then just last, any kind of change in optimism around just underlying demand? Thanks.

Yes, Jeff, this is Rick. I can address the initial part of your question regarding unit trends and what we observed within our customer base. In terms of comparisons, during the fourth quarter of last year, we reported a decline of approximately 4%. However, when we analyze units organically over the two-year span, we see an increase of around 12%. This suggests that the growth is not solely reliant on comparisons; we are witnessing strong underlying demand, effective new customer acquisition, and we anticipate some market share gains that will become apparent in future data. The next query pertains to whether some of this demand stems from the contractor channel holding more inventory than usual. To provide some insights, it's essential to understand that the typical contractor operates as a small business, often as an owner-operator with a limited number of trucks. They typically lack large storage facilities and do not invest extensively in inventory or working capital because they rely on us, the distributor, for just-in-time inventory. Generally, they maintain days of inventory rather than months. Additionally, if contractors were actively purchasing, we would expect to see a spike in sales in December. However, our analysis showed consistent growth throughout the entire fourth quarter, with October performing as strongly as December. This observation does not support the idea of an excess inventory in the market. Furthermore, when reviewing trends among our largest customers, those with the capacity to buy forward and maintain inventory, the data does not indicate any significant increase in purchasing. Finally, our own inventory supports this perspective. Beyond the financial figures reflected on the balance sheet, the number of units in our inventory has remained stable and flat compared to two years ago. Therefore, we have minimal evidence suggesting that contractors are carrying substantial inventory beyond what we manage in the distribution channel, and there is nothing to raise concerns about potential growth rates for 2025.

Okay, great color. No, go ahead.

I feel like beating up the dead horse some more, Jeff. You mentioned about recovery of business from one of our OEMs who had issues a year ago. There is recovery, but that's not what's driving the growth that you see. It's a component of it, but it's not anywhere near the principal reason. And one of the principal reasons that I want to emphasize, Rick said, is new customer growth. We really have seen progress, either technology or whatever market share generation concepts we are doing. The greatest component of growth this quarter is new customers. So, I want to say those words like next year and feel like we have a really progressive trend going in that direction, but we saw that this quarter for sure and we've seen it year-to-date.

Okay. Thanks. Great color, guys. Your balance sheet is in great shape. Just maybe talk about the M&A environment. It does seem like private equity has been more present in the space. Just what are you guys seeing in your pipeline, et cetera and the ability to get stuff done?

Go ahead, Barry.

Yes, David, this is a familiar situation that you've heard throughout my career. There are still easily 50 to 100 families that own businesses valued at $100 million or more. We have always aimed to develop personal and multigenerational relationships with these families, many of whom are now in their second or third generation. The stability of the past one or two years, particularly after the wild earnings fluctuations during COVID, allows us to assess valuations better. Now that we have some time to reflect, it gives us confidence to invest and understand how these businesses should perceive their valuation. Private equity still shows interest, but it’s not as prominent now compared to the COVID period when valuations were excessively high. Currently, things appear to be more business as usual, but we’ll see how it evolves. Our primary focus remains on building strong relationships and being present when families are ready to make decisions, and we feel optimistic about the positive activities happening in this area.

Thanks a lot.

The next question comes from Damian Karas with UBS. Please go ahead.

Morning David.

Hey, good morning Al. Nice work in the quarter.

Thank you.

I guess the one area that's maybe just a little bit stagnant still is the non-equipment sales. Could you maybe give us a little bit color around what you're seeing in that area of the business?

Paul?

Yes, I think you're seeing a couple of things happening there. One, we've got a lot of that business that is driven by commodities, copper, refrigerant, steel. I think we're going to see a pop perhaps in steel and a pop in copper, refrigerant still has been slow. When you get into the parts business, which is what it takes to actually install a unit or repair a unit in the field, we saw a definite increase. In fact, we had a double-digit increase in parts which indicate that there could be kind of a dual action going on in the industry right now where we've actually seen parts sales go up at the same time, we're seeing equipment sales go up. So, outside of the commodity portion, I would have to say we're very pleased with what we're seeing in the aftermarket right now also.

Great, that's really helpful. And my follow-up, I know you guys are absolutely delighted in talking about gross margins. But I wanted to kind of just hear your confidence in the path to getting back to 27% or higher when that might be. And I'm just curious if any of these new customers that, Barry, you talked about driving a lot of the growth, if you expect that to have any kind of meaningful impact on your profitability as you bring some of these new customers into the mix?

Well, you may or may not have heard that our aspiration is a 30% gross profit margin. And we think we're going to add a lot of value to our customers to achieve that in products or services. So, we aspire more than we presently have. And do we have a time period on that? No. But we think it's possible and we have the tools and the means to get there, probably better than anybody else. Do you want to add anything to that?

Certainly, I’d like to add some details. Within Watsco, we operate multiple business units, and as with any portfolio, we have some units that outperform others. Our top-performing business units are currently approaching a 30% margin. This is not an unrealistic figure; it reflects what we observe in our network, and just like any portfolio, we aim to enhance both maturity and overall capability for higher margins. In the short term, we did face some challenges this year, which we discussed last quarter regarding recovery with one of our vendors, affecting us by about 30 basis points. We anticipate recovering this and potentially improving in the future. This is part of the business landscape we navigated this year. Additionally, our ongoing efforts in leveraging technology for pricing across our products is a vital aspect of our long-term strategy. We invite anyone interested to visit us to gain a deeper understanding beyond just this call. While in the short term, we are looking at basis points, in the long term, we aim for percentage points. The product mix also played a role this year, causing a slight headwind, likely around 20 basis points, due to the growth of our equipment compared to the stability of our non-equipment offerings. I share Paul's view that if both segments grow together, it will positively impact margins, particularly in the near term.

Appreciate your time. Good luck with everything.

Thank you.

Thank you.

The next question comes from Ryan Merkel with William Blair. Please go ahead.

Morning Ryan.

Morning. I want to go back to the fourth quarter, the new customer growth being the big driver. Why all of a sudden in the fourth quarter did you see this? And then who are these customers? Are these more tech-forward contractors that appreciate your technology or is there anything similar about these customers?

Barry?

Rick, go ahead.

Yes, Ryan. I don’t recall the last part of your question, but the trend wasn’t limited to the fourth quarter; it gradually developed throughout the year. Looking back to this time last year, it was a somewhat unpredictable market. Those types of markets generally favor us and allow us to gain market share. We noticed this trend building over the year, and it became more evident in the fourth quarter. However, the annual trend is quite similar, showing the highest revenue contribution from new customers since we began tracking that metric many years ago. As for who these customers are, each is unique, much like snowflakes. We have a strong representation among large contractors, but we also aim to target mid-tier contractors where our non-equipment offerings often resonate more effectively. The depth and variety of our inventory are crucial here, and our technology can significantly impact those contractors. We often hear that our technology effectively equips smaller operations with the same tools and sophistication that our largest customers enjoy, which is a vital contribution over time, I believe.

To add some depth, and while intentionally being abstract to protect certain competitive discussions, I would like to highlight that a significant part of our network has historically focused on large customers and name brand dealers. To grow this business, it was essential to cater to the many contractors in local markets. When we collaborate with OEM partners, we approach them to identify market segments that aren't being addressed, emphasizing the need for investments in inventory, pricing, and programs to service that market. This strategy has been developing over the past year or two, and we aim to maintain this momentum as it contributes to increased market share and sales revenue at a good margin for every location.

Okay, that's helpful. And then it sounds like the improved volume growth, at least is continuing into the first part of the year. And I guess my question is, in the press release, you mentioned A2L, there's an incremental growth opportunity and share gain opportunity. Can you unpack what you mean by that?

I believe that any new product presents the chance to create value for customers instead of just selling the same items year after year. Each moment like this brings new opportunities. Our sales team is motivated, and our technology is in place. This kind of change generates a positive energy that we can harness, but it requires investment. We believe our competitive advantage comes from making those investments and channeling that energy into this transition. That's how I would approach it.

And on the pricing side, you're going to see a lift in price. The product has a higher cost. You're going to be installing an indoor and outdoor. You can't just replace the outdoor unit and not replace the indoor unit. All the safety devices for the refrigerant are on the indoor unit and have to be replaced and they can't be field installed. So, we're definitely going to see a definite uptick in revenue dollars and gross profit dollars from that.

All right, makes sense. Thanks. I'll pass it on. Best of luck.

The next question comes from Jeff Sprague with Vertical Research. Please go ahead.

Morning Jeff.

Good morning everyone. I'm glad to hear from you all. I would like to know your final opinion, if there is one, regarding the concept of pre-buy. The reason I ask is quite straightforward; your inventory levels do not appear unusual compared to historical data, and you have made a strong case that the dealer channel is not overwhelmed with stock. Given all the discussions surrounding pre-buy, do you have a conclusive perspective on what actually transpired?

What actually happened? Who wants that one?

Sounds like a Rick question to me.

Thank you, Paul. I'll give it a try, Jeff. Some of the OEMs have attempted to quantify this, but I would say that the calculations involved are more of an art than a science. However, if we take what they have quantified and assume an average selling price for an outdoor unit, it would represent about 2% or 3% of the 9.5 million to 10 million systems sold annually. The question is whether this occurred in specific instances, and perhaps it did. But I don’t believe it fundamentally changes the competitive landscape or growth strategy for the year.

Yes, interesting. That those seem to be the takeaway. And then as it relates to your own inventories, as I indicated, they look pretty normal to me. But would they be mostly 410A in your reported inventories as we see it or there's now a balanced mix there as you prepare for the new year?

We indicated that our sales primarily consist of 410A, and our inventory is largely 410A as well. We have essentially delayed the purchase of the A2L product until the first quarter and into the second quarter of this year. Overall, it has predominantly been 410A.

Yes. And maybe I'll just say that what we said our goal was, was for a harmonious transition from the old products to the new. And I think so far, we've had pretty good success on that scale of harmony.

And it sounds like you're getting kind of a market signal from the OEMs that have tariffs happen, obviously, they're going to want to push through price. Would you expect this to be sort of almost a mechanical immediate reaction sort of tariffs go into place, day one, prices move up in concert with that?

You're definitely going to see a price increase with what has been already announced as far as tariffs in China. Most of the ductless product and a lot of the side discharge product comes from China directly. So, until the manufacturers can adjust the location of the manufacturing of those products, I think you're definitely going to see an uptick in pricing.

I was referring more to maybe Mexico risk, any thoughts on that?

Mexico, we don't have a clue yet. What's going to happen if that's going to satisfy President Trump or it's not going to satisfy him is something that only he knows, I believe. So, once we identify that, that obviously would be a big mover as far as what the pricing action would be if we put a 25% tariff down there.

Yes, thanks for the remarks. Appreciate it.

The next question comes from Brett Linzey with Mizuho. Please go ahead.

Hey good morning. Yes, just one more on this price/mix dynamic and specifically gross margins. So, you talked about the high single-digit to double-digit price/mix this year on new units, but also some of this additional tariff pricing. Is there any way to think about how that drops through mix versus incremental pricing on gross margin percent for Watsco?

I want to emphasize that any increase related to A2L should be approached with caution. If an OEM raises a product's cost by 8% or 10%, and we adjust our selling price accordingly, it does not inherently result in a gain in gross margin. It's important to distinguish between pricing strategies and the associated margin benefits. As mentioned in our press release, 50% to 60% of our business is influenced by A2L. We've noted that over half of our business is still based on 410A in the early part of the year, but this shifts as we move into the latter half. You can evaluate this trend over the next four quarters. Furthermore, the inflation-related price increase that Paul discussed will also play a role in the gross margin and pricing benefits, which may come into effect during the last three quarters of the year. However, this is not the current situation, as it's more relevant for the second quarter and beyond.

Correct.

Okay, got it.

Brett, to add to that quickly, there's a strong emphasis on gross margin in this discussion. However, a more direct and equally significant aspect is the ability to utilize your SG&A base effectively. As a result, the ultimate advantage is likely to be seen in EBIT margin over time, since some components of SG&A won't respond to these changes in the near term. This presents a more compelling opportunity for profit margin at the operating level compared to the gross margin level.

Okay, got it. Yes, I appreciate that. And then just last one for me. So, there's this ongoing debate on repair versus replace, doesn't look apparent that you've seen a big step down in replacement to repair. But anything in the parts or the component data that's ticked up at all that would maybe inform that or suggest that is the case but it does look pretty resilient. But just any thoughts there?

Well, we've already indicated that we saw both parts and unit sales go up double-digit. So, we're seeing both of them occur at the same time. We're not seeing a repair versus a replace. It's repair and replace. And will that continue throughout the year? We'll have to wait and see.

Got it. Appreciate the insights.

Our next question comes from Steve Tusa with JPMorgan. Please go ahead.

Morning Tusa.

Hi good morning.

How are you Steve?

Good, how are you? Love it when the CEO and Chairman reads the forward-looking statements, that is quite unique, so thank you for that. Just on the kind of how we're trending into this year. Thanks for all the color on like pre-buy, etc. Are you guys seeing anything on the refrigerant side, any volatility in price there to speak of and how this may be trending differently than what happened with R22 to 410A?

Yes. Paul, you deal with that, please.

Yes, we're not really seeing the price of 410 spike yet, no. We have not seen any great movement there. And that's what I indicated earlier with the issue that we're having with commodities, is we're not seeing any sort of uptick. If that's what you're talking about on the 410 side. Obviously, when we get to 454, if any 454 is used in repair during the year, that will be a higher price than the 410.

Are you experiencing any availability or price issues with the aftermarket refrigerant needed to charge or top off the system in the field?

We are currently experiencing some availability issues, which are not related to refrigerant but rather to the containers. It is specifically about the availability of containers, as a special container is required to handle the 454 or the 32A refrigerants.

Got it. And then regarding the reestablishment of that supplier that had the issue last year, my understanding is that the volumes are significantly up this quarter. Can you clarify how much that may have contributed to the volume number?

Yes, Steve, again, it's competitive data, I think. So, I want to be careful with it. But that vendor in general is somewhat less than 10% of total Watsco in terms of sales, product sales. I mean that brand sale. So, in context, it can only be a portion of the current quarter's growth.

You mentioned that you can't simply replace the outdoor unit and that a complete replacement is necessary. Can you explain the cost difference for the consumer between this full replacement and just replacing the outdoor unit?

We haven't sold enough to really come up with a good number on that. It's going to be a higher price, obviously, because you're selling an indoor unit. You've got the indoor unit that has to have the sensor as well as a switch to be able to turn on the airflow in the event of a leak. And so you've got more cost on the indoor than you did on the 410 units. Maybe by the second quarter, we'll be able to provide you with more information as far as what the delta difference is. We know it's going to be more, though.

Right. And you don't think the contractor eats that, do you?

No, I do not.

This concludes our question-and-answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks.

Thanks again for your interest. We look forward to a great year and we appreciate your following us and all the best. Bye, bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.