Watsco, Inc. (NYSE:WSO) Q1 2024 Earnings Call Transcript

Watsco, Inc. (NYSE:WSO) Q1 2024 Earnings Call Transcript April 24, 2024

Watsco, Inc. misses on earnings expectations. Reported EPS is $2.17 EPS, expectations were $2.26. Watsco, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning, and welcome to the Watsco First Quarter 2024 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] I would now like to turn the conference over to Al Nahmad, Chairman and CEO. Please go ahead.

Al Nahmad: Thank you. Good morning, everyone. Welcome to our first quarter earnings call. And this is Al Nahmad, Chairman and CEO. And with me is A.J. Nahmad, President; Paul Johnston, Barry Logan and Rick Gomez. Now, before we start, I will state our cautionary statement as usual. 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 performance. Watsco delivered good results despite softer market conditions. As a reminder, the first quarter is traditionally the low season for sales in our industry. Although it is early, we are encouraged by the improved sales trends in April ahead of the summer selling season.

We believe our technology, breadth of brands and products and the expansion of our network have generated market share gains. Our balance sheet strengthened during the quarter through a combination of record cash flow and an equity raise using our ATM program. And once again, we boosted our annual dividends by 10% to $10.80 per share beginning April of 2024. This year marks Watsco’s 50th consecutive year of paying dividends. Now, commentary and highlights on the quarter. Although residential equipment unit demand remains low, our price realization, a richer sales mix of heat pumps as well as high-efficiency products and new locations contributed to record sales in the quarter. Commercial end markets experienced growth and our backlog of projects remained healthy.

Sales of ductless systems, an increasingly important component of our business, grew and offset declines in the conventional ductless residential business. Gross margins performed well and are consistent with our near-term target of 27%, though we believe higher margins are achievable over time. Turning to expenses. SG&A increased 2% on an adjusted same-store basis. Variable SG&A expenses were lower for the fourth consecutive quarter and our teams across Watsco have implemented a number of actions to improve efficiency and reduce SG&A. And to that end, we have equipped leaders with the necessary tools and data to improve productivity and most importantly of all, we possess an entrepreneurial culture to execute change in a responsible way. Since the beginning of last year, we expanded our network through acquisition with three — through acquisitions with three terrific businesses joining the Watsco family.

Collectively, their aggregate sales are approximately $200 million per year and more importantly, they expand Watsco’s reach into new markets. These businesses will retain their culture, their leadership, and teams and uniqueness in the market, which is consistent with our long-term practice of sustaining great legacy and investing to drive additional growth. Our industry remains highly fragmented, and we will continue to pursue other great companies to grow scale in our $64 billion North American market. Watsco’s technology advantage, industry-leading scale, equity culture and the strength of our balance sheet are all great reasons to join the Watsco family. And finally, before getting into Q&A, as always, I want to emphasize that our focus remains on the long term.

Our balance sheet is strong, and we stand ready to invest in the right growth opportunity. We have an immense technology advantage, and we are investing to grow that advantage. Watsco’s broad array of products and brands is also a competitive advantage that allows us to serve contractors in most any environment. And we are also fortunate to operate in an industry that benefits from regulation changes and fundamental catalysts that will play out in the years ahead. With that, let’s go out to Q&A.

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Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Our first question today is from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Jeff Hammond: Hey, good morning.

Al Nahmad: Hi, Jeff. How are you doing?

Jeff Hammond: Doing great. Well, I’ll ask first about this equity raise. Just wondering why now and does it signal some kind of imminent M&A coming or what’s just the rationale?

Al Nahmad: Well, it’s an opportunity that we had from an institution that has a reputation for being a long-term holder. And we wanted to have them engage with us for the long term because that’s a reputation. That’s all it is.

Jeff Hammond: Okay. And then one of the things we were picking up in our channel checks is repair, replace, kind of shifting more to repairs, kind of consumers struggle with higher rates, et cetera and the increased cost. Just wondering what you’re seeing on that end?

Al Nahmad: Paul?

Paul Johnston: Yeah, we’re really not — excuse me, we’re really not seeing a lot of repair pickup in the first quarter. And we saw a little bit on the motor side, but not on the compressor side. The weather just wasn’t there to really institute any real change in the market dynamics right now.

Jeff Hammond: Okay. And then just finally, Al, you mentioned April being better. Maybe put a little more context around what you’re seeing.

Al Nahmad: Yeah, sure. I’ll let Barry answer that.

Barry Logan: Good morning, Jeff. Yeah, again, it’s been a nice pickup and it’s in the — I would call it, characterize it as the high-single-digit range that includes the new branches. If I look at things on a same-store basis, it’s in the mid-single-digits is how I’d put it and unit growth thus far in the month.

Jeff Hammond: Okay. Thanks so much, guys.

Al Nahmad: Sure.

Operator: The next question is from Tommy Moll with Stephens Inc. Please go ahead.

Tommy Moll: Good morning.

Al Nahmad: Hello, Tommy.

Tommy Moll: Good morning, Al. Thank you for taking my questions.

Al Nahmad: Of course.

Tommy Moll: So, believe it or not, I’m not going to start on gross margin today. I wanted to focus on SG&A.

Al Nahmad: Well, we hope we haven’t let you down on gross margin.

Tommy Moll: No, no. But on the SG&A point, I think even if we strip out the $5 million in change of non-recurring items that you called out, that expense item did grow faster on a same-store basis versus the top line. And I know driving leverage there has been a priority over the past year or so. So what can you tell us about what you saw in the first quarter and how you think that might unfold going forward?

Al Nahmad: Mr. Logan?

Barry Logan: Good morning, Tommy. Yeah, well first, it is the first quarter, and a lot of actions were taken in terms of streamlining the branch and the headcount and, again, the general conditions that leaders went out and did. They tended to take those actions at the beginning of this year as opposed to before the holidays. So that makes common sense. And again, that’s part of the mindset is to start the year with that kind of momentum going on. So much of that played out in February and March. And I would expect the rest of the year — the remainder of the year to reflect some reductions in some of our major categories. Transportation, freight, logistics were down in the quarter. That’s been consistent now for several quarters. On the headcount side, which is the largest of the contributors to SG&A, I think you’ll see some results from what was done for the remainder of the year.

Tommy Moll: That’s helpful. Thank you. And I guess a question just on the A2L transition here. What is the State of the Union you can offer there in terms of how you’re thinking about managing inventory for this year and maybe even into next year where there will be some portion of the market on the 410A still and then another portion on the A2L. Just what can you tell us about the strategy here? Thank you.

Al Nahmad: That’s a good one for you, Paul.

Paul Johnston: Okay. Well, it’s going to be an interesting time. We’re still waiting to hear from the EPA whether or not there’s going to be all the sell-through that people anticipate with the old 410A units. Will they be allowed as components? So that’s kind of a fly in the ointment right now. Right now, what we’re looking at is probably to start incorporating the A2L units, probably third and fourth quarter, we’ll probably see some sales pickup in the first and second quarter of 2025. I think it’s going to be a phase-down, phase-up between the two product lines. Right now, it’s a question mark as far as when each one of the manufacturers that we represent is going to be introducing their A2L products.

Tommy Moll: And then in the midst of all of that, is it fair to say just from a turns perspective, you may need to run that a little higher than typical as you get into the middle or back half — middle part or back half of this year?

Paul Johnston: Yes, it would be contrary to what Mr. Nahmad would like, but yes, we’re probably going to have some lower turns as we transition from the old 410 over to the new A2L product. We’re going to see how much of that we can mitigate, but definitely there’s going to be some uptick in inventory.

Tommy Moll: Okay. Thank you very much. I’ll turn it back.

A.J. Nahmad: Can I — this is A.J. Just if I can add one more piece of color there, speak to our culture a little bit and being a little more conservative. One thing we will not do which some other maybe smaller independent distributors may do is speculate and take huge positions either way on the 410A product or the 454 product, our job is to meet the market and meet the expectations of our customers. We’re not trying to speculate for some short-term giant swing one way or the other, so — because we are long-term players.

Al Nahmad: That’s a good point.

Tommy Moll: Thank you. Appreciate the context.

Operator: The next question is from Jeff Sprague with Vertical Research. Please go ahead.

Jeff Sprague: Hey, thanks. Good morning, everyone. Hey, I wanted to come back to inventory again if I could. Just from my historical vantage point, it still looks a touch high in Q1 relative to, I guess, my estimate of full-year sales and maybe that may differ from what you’re planning. But anything else going on there? You’ve got some new distributors, I’m sure, as a role. It doesn’t sound like the 454B stuff is impacting you, but perhaps it is. Just any other color on kind of where your inventories stand today relative to how the year might play out.

Al Nahmad: I’m going to give you a…

Paul Johnston: Go ahead.

Al Nahmad: Okay, Paul. I was just going to give a big picture and then turn to you. I agree with you that the inventory may be slightly higher and we’re not going to stop until we achieve the goals that we had set for that. But more — but in more detail, Paul, you want to deal with that?

Paul Johnston: Yeah, it’s — a lot of it is pricing that we’re seeing in the marketplace. We had a price increase in April — excuse me, we had a price increase in February and another one in March from various manufacturers. We’ve seen copper go up to $4.50 a pound. So we’ve seen a lot of upward thrust as far as our cost is concerned. As far as the number of units that we have — outdoor units that we have in inventory, that’s actually down year-over-year. So we feel like we’re managing our inventory. It’s a little bit tough out there right now with the price increases.

Al Nahmad: Yeah. And I’ll add there was some, I guess, on the margins — opportunistic buying that our business units took advantage of. So that — and as a result of, I’d say, some smoothing out of supply chain, which has been chaotic for the last three years in COVID, I believe our business units feel that they are very well prepared for the busy summer selling season as far as inventory goes. They’ve got the right mix of products and they’ve got a healthy quality of inventory. So the expectation is that as the selling season begins and runs its course, we should be well positioned to take care of our customers and move products.

Paul Johnston: Yeah, I’ll just say this, I think a year ago in this call, we lamented one of our major vendors and not being in a strong inventory position for the season and lamented about lost sales and so on. And obviously a year later, the channel for that particular vendor has filled in a very good competitive condition. It grew nicely in the early stage of the year here and there’s a lot more work to do, but that’s also an inventory position. If you look at a year-over-year basis, that contributes to some of our current position.

Jeff Sprague: And then on just price — OEM price, obviously on 454B, there’s going to be a different price regime. But on kind of like-for-like product, do you see kind of a bias for kind of OEMs to be looking for more than one increase during the year? As you noted, copper is moving up or we’ve kind of gotten to something like a little bit more normal on kind of like-for-like units in terms of what’s going on with OEM price increases?

Paul Johnston: Well, we’re just starting to see the prices roll in from the OEMs on the new A2L products. So I would say we’re going to see one price increase on the A2L products and then, I think that’s going to be probably it for the year. I’m hoping.

Al Nahmad: Yeah, the like-for-like products are going away, right? I mean, the 410A products will not be sold to us again next year?

Paul Johnston: Right.

Jeff Sprague: And just one other one from me. These kind of Oxbox branded products, you just address how significant, if at all this is to your strategy in particular and the interest in the channel in these products and how they’re selling through?

Paul Johnston: There’s — like every market there’s a good, better, best selection of products out there. And Oxbox generally fits the value portion of that market. So that’s where I think Trane has got that product positioned right now. We’ve got a number of other products such as Payne, some of our ICP products, some of our private label products that compete in that marketplace. And it’s a market segment.

Barry Logan: Yeah, I was going to emphasize that. It’s a crowded space, the value segment. There are a lot of brands that are sold in the market. Watsco itself sells probably half a dozen brands in that segment. And so it’s a crowded space and it is a way for an OEM to diversify its price points in the market. But again, it’s a crowded space.

Jeff Sprague: Okay, great. Thank you for the color. I appreciate it.

Operator: The next question is from Dave Manthey with Baird. Please go ahead.

Al Nahmad: Good morning, Dave.

Dave Manthey: Thank you. Good morning, Al. Hi. Hi, everyone.

Al Nahmad: I think you have a cold.

Dave Manthey: Yeah, first question is on the non-recurring SG&A, just what was that? And then second, on the 27% gross margin, anything about that that makes you more or less positive about hitting 27% for the full year?