Prepared remarks
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 is A.J. Nahmad, President of Watsco; Paul Johnston; Barry Logan; and Rick Gomez. Now, before we start, our cautionary statement is as follows: 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 represent 35% of our annual sales, which is a number of $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 with 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.
Questions and answers
We will now begin the question-and-answer session. The first question comes from David Manthey with Baird. Please go ahead.
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 sure I fully understand your calculations. To clarify, we saw residential product growth for the quarter, and if we examine the details carefully, unit growth correlates with how AHRI measures equipment growth, specifically unitary products and compressor bearing units. Across Watsco and all markets, this grew by 16% for the quarter, with an additional 3% from pricing. Domestically, unit growth is even stronger. There's also some price and mix influence, driven by significantly stronger unit growth. Additionally, as Paul mentioned, A2L had a minimal impact this quarter, with a more noticeable influence expected as we approach 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 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, I would say, probably 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 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 run more of the A2L volumes through, what impact, if any, should we consider regarding the gross margin percentage, especially with the mix tailwind? Additionally, as you implement this in the marketplace, how are you assisting your customers in explaining the product benefits to the end users? We are all expecting significant price/mix increases, but ultimately, this discussion happens at the kitchen table. How are you supporting your customers in these discussions as we move forward? Thanks.
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 have upgraded our entire database of product information for the new products. The way products are matched and fit, as well as how permits can be obtained for new products, is now a digital experience. This accounts for about 35% of total Watsco and likely closer to 45% or 50% of our residential business. Our digital platform is facilitating the transition for customers in how they buy, specify, and add related products. Previously, we didn't have these tools at this scale, and that makes a significant difference. We've discussed OnCall Air, and for customers enrolled in that program, these tools are shaping how consumers learn about and experience new products. The timing is excellent, and while I wish the OnCall Air user community were ten times larger, there is $1.5 billion of products that consumers are seeing digitally for the first time. There is momentum in this area. Regarding gross profit, as Paul mentioned, if we apply the same margin, it benefits the business. Additionally, we have a pricing platform designed to enhance our margins when possible and to inform our teams on how that's progressing. This highlights one of the opportunities we see with the implementation of 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 first part of your question regarding unit trends and what we observed within the customer base. Looking at the comparisons, in the fourth quarter of last year, we reported a decline of about 4%. However, when examining units on an organic basis over the two-year period, we saw an increase of around 12%. This improvement is not solely due to favorable comparisons; it indicates strong underlying demand and significant new customer acquisition, as well as some market share growth that we expect to be reflected in future data. Now, regarding whether the contractor channel is holding more inventory than usual, I have a couple of points to share. First, it's important to recognize that an average contractor operates as a small business, often as an owner-operator with just a handful of trucks. They do not typically have large facilities for storing inventory and usually avoid investing heavily in inventory and working capital.
We act as their just-in-time inventory partner, and they generally maintain days’ worth of inventory rather than months. Moreover, if contractors were purchasing more, we would expect to see a spike in December, but we experienced consistent growth throughout the fourth quarter, with October performing just as well as December. This trend does not strongly suggest that there’s excess inventory present. Next, we analyzed the trends among our largest customers, who would have the capacity to buy in advance and hold inventory, yet there’s nothing in the data that indicates significant bulk purchasing. Lastly, looking at our own inventory situation, the numbers reflect a balanced and unchanged level compared to two years ago. Therefore, we do not observe substantial evidence of contractors carrying additional inventory beyond what we hold in the channel, nor do we have concerns regarding 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 we've encountered throughout our careers. There are still easily 50 to 100 families that own businesses valued at $100 million or more. We've always aimed to know these families personally and maintain multigenerational relationships, many of which have evolved over two or three generations by now. The stability we've experienced over the past year or two, especially during COVID when we saw significant increases in earnings, raises the question of whether valuations also fluctuated wildly. Now that we have a couple of years of data, we have a clearer understanding of the current landscape, which instills confidence in our investment decisions. This reflects the reality of how these businesses should assess their valuations. Private equity remains interested, but it's less of a driving force compared to the wild valuation swings during COVID, when opinions were more divided. Currently, things feel more routine, but we'll continue to monitor the situation. As always, our priority is to build strong relationships and be ready to assist families when they want to explore opportunities. We're pleased to see some promising activity in that area today.
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 of 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 indicates 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 will add a few points. Within Watsco, we operate various business units. As with any portfolio, we have some units that are performing exceptionally well, currently at or around a 30% margin. This isn’t just an aspirational figure; it reflects what we observe within our network. Like any portfolio, our goal is to enhance both maturity and overall capabilities to achieve even higher margins. In the near term, we've encountered some challenges this year, particularly related to a vendor recovery that impacted us by about 30 basis points, which we anticipate recovering and hopefully surpassing in future periods. This is part of our operational costs for the year, and we are moving forward. Additionally, we continue to focus on improving our pricing and technology. We invite anyone interested to come visit us for a deeper understanding of our strategies, as it's more than just a brief comment during a call.
Our objective is to foster a culture of using technology to better price every product we sell, which remains a long-term goal. In the short term, this has an impact at the basis point level, but moving forward, we aim for percentage point improvements. Product mix is another factor; this year, we've faced some headwinds with our equipment growth lagging behind our non-equipment growth, which has likely affected us by around 20 basis points. I want to emphasize Paul's sentiment: if both sectors can grow together, it would definitely enhance our margins, especially in the short run.
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 think the trend was specific to the fourth quarter. We saw this trend develop throughout the year. If you look back to this time last year, the market was somewhat unstable, moving sideways. These are typically the types of markets where we perform very well and gain market share. The trend built throughout the year and became more pronounced in the fourth quarter. However, the overall annual trend is quite consistent, showing the highest revenue contribution from new customers that we've recorded in many years. As for what these customers look like, it's a good question; they all have unique characteristics. We have a strong presence among large contractors, but we primarily aim to attract mid-tier contractors, where our non-equipment offerings tend to resonate strongly. In this segment, the variety and depth of our inventory are crucial. Our technology can significantly impact these contractors, and A.J. can elaborate on this. Our technology effectively equips smaller operations with the same tools and sophistication that our largest customers benefit from, which is a significant advantage over time.
Yes, to elaborate further, I want to be intentionally vague to protect some competitive discussions we need to be cautious about. Historically, a significant part of our network focused on large customers, substantial dealers, and well-known brands that have been central to our business for a long time. To expand that business, we had to meet the needs of the many contractors in local markets. When we mention collaborating with OEM partners, we’re looking at how to reach segments of the market we are not currently serving. This requires investment in inventory, pricing, and programs to meet those needs. While I am being general, this has been a process ongoing for about one to two years. We aim to maintain this momentum as it is contributing to increased market share and sales revenue across locations at a healthy margin.
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 a chance to create value for customers instead of just continuing to sell the same products every year. Each situation like this comes with opportunities. Our sales team is motivated, and our technology supports this change. The positive momentum generated by such changes is a chance for growth, but it requires investment. We believe our competitive edge comes from making those investments and harnessing that energy during this transition. That's how I would evaluate the situation.
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. Glad to hear you all. Just wonder what your final verdict, if there is one, is on the notion of pre-buy. And the reason I ask it so simplistically is, your inventories do not look unusual in any historical light and you just made a pretty convincing case that the dealer channel is not up to their eyeballs. So, when you look back at this and kind of all the ink that's been spilled on pre-buy and what it might be, like, do you have kind of a final view on what actually happened?
What actually happened? Who wants that one?
Sounds like a Rick question to me.
Thank you, Paul. I'll attempt to address that, Jeff. Yes, I believe some of the OEMs have tried to quantify this. However, that calculation tends to lean more towards art than science. If we consider what they've quantified and assume an average selling price for an outdoor unit, it amounts to 2% or 3% of the 9.5 million to 10 million systems sold annually. The question is whether this occurred in certain areas. Perhaps it did. But does it fundamentally change the competitive landscape or growth expectations for the year? I don't believe so.
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 have indicated that our sales and inventory are primarily 410A. We have delayed the purchase of the A2L product until the first quarter of this year and into the second quarter as well. Essentially, our focus has been on 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.
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.