Good day, and welcome to the Watsco 4th Quarter 2020 Earnings Conference Call. All participants will be in listen only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Albert Nahmad, CEO.
Please go ahead.
Good morning, everyone. Hope everyone is healthy and safe, and welcome to Watsco's 4th quarter earnings call. This is Al Nahmad, Chairman and CEO and with me is A. J. Nahmad, President Paul Johnston, Executive Vice President and Barry Logan, also Executive Vice President.
Now as we normally do before we start, here is our cautionary statement. The conference call has forward looking statements as defined by SEC laws and regulators 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 our financial report. Wascua produced another record year with sales, net income and earnings per share reaching record levels. We generated record cash flow of $534,000,000 during the year, well in excess of our goal of generating cash flow greater than net income.
This further strengthened our balance sheet, which is now debt free and provides us the capacity to make almost any size investment to grow our business. We also announced this morning a 10% increase in our annual dividend to $7.80 per share. That reflects our confidence in our business. 2020 results were driven by steady growth with market share gains in our U. S.
Residential HVAC equipment business, which grew 10% for the year and 17% during the Q4. Homeowners continue to invest in their homes as replacement sales at higher efficiencies remain strong from early summer through today. Looking long term, we see opportunity to be a significant participant and contributor in efforts to address climate change. Sales of high efficiency products have long been a component of our business and have grown steadily in our sales mix over the past decade. This is an interesting data point.
There are over 110,000,000 installed HVAC systems in the United States, many of which are operating under old efficiency standards that resulted for the user in higher energy use and cost to them. It's important to note we will explore and evaluate impactful opportunities to make progress in our marketplace. We believe the combination of Watsco's technology platforms, industry leading scale, access to capital, customer relationships and unrivaled OEM relationships provide a strong foundation and long term benefit for all stakeholders involved. We also continue to invest in our industry leading technology platforms, leading to greater adoption, new customer acquisition and market share gains. User growth on Watsco's e commerce platform, a good indicator of overall tech adoption, was up 20% during 2020.
This is important as sales growth rates for customers that are active users up pace growth rates of non users. Also customer attrition among active users is a fraction of non users, another good indicator of effectiveness. Now some more detailed examples of our progress. Weekly users of our mobile apps increased 27% in 2020 with over 120,000 downloads. The number of e commerce transactions grew 20% this year to 1,200,000 online orders.
Our annualized e commerce sales run rate is 33% versus 31% at the end of last year. In certain markets, it's over 50%. Our curbside or dockside pickup services expanded to more locations and now includes no contact payment functionality. The technology has only been available since this summer and already over 22,000 orders were fulfilled by more than 3,000 unique users. 2 of our newer innovative platforms gained momentum in 2020.
We call them On Call Air and Credit for Comfort. These platforms help digitize the relationship between contractors and homeowners when buying and financing replacement HVAC systems. OnCallAir is growing exponentially. Contract has provided digital proposals to over 109,000 hospitals using the tool during last year and generated nearly $350,000,000 in gross merchandise value for our customers, an 89% increase over last year. And Credit for Comfort processed 40% more digital financing applications in 2020 versus 2019, resulting in more than 180% increase in 3rd party funded loans.
This tool helps homeowners afford much needed HVAC systems. Investments in inventory management software have also benefited the company, yielding lower inventory, improved turns and contributing to our record cash flow and operating efficiency. These examples are exciting and we believe it's still early in terms of reaching the full potential of our technology investments. As always, feel free to schedule a Zoom call with us and we can further explain our technology and its progress. Now one very important thought as we end this prepared remarks.
Our 2020 results are a testament to the efforts of our valued employees across the Watsco network. We deeply appreciate their commitment. With that, AJ, Paul, Barry and I are happy to answer your questions. Elizabeth?
We will now begin the question and answer session. The first question today comes from Stephen Volkmann of Jefferies. Please go ahead.
Good morning, Stephen.
Hi, good morning, guys. Thanks for taking my question. I guess maybe just to kick off, I mean, obviously, 2020 was an extraordinary year in lots of ways in terms of the stay at home spending and your market share gains and improvements in e commerce, etcetera. But of course, that sets us up for what is potentially a difficult comparison in 2021, especially as the year progresses. So I'm wondering, Al, maybe you can give us your thoughts about how you think the market will kind of be unveiled in 2021 relative to the opportunities for continued growth?
Well, I'll start with an answer and then I'll turn to Paul Johnson to talk about the industry. I'll talk about ourselves. I think that we will we are set up to continue to grow over a number of years. We've talked about technology adoption. We've talked about our financial strength, which allows us to continue our active M and A program.
We have a lot of things we can do to continue our growth regardless of what happens to the industry. And we feel very confident in that statement. Paul, you want to talk about the market?
Yes. The market in 2021, it's tough to make a comparison obviously to 2020 because we had so many ups and downs and ebbs and flows and inventory issues and such. However, I think it's fair to say that the industry will remain strong during the year. New construction remains strong. Replacement demand, we're still seeing that following through.
It's where we ended last year. We're beginning this year on the right footing. I think there's another phenomenon out there that's helping and changing the replacement dynamics and that is we're seeing homeowners stay in their homes for longer periods and I don't mean because of the pandemic. I mean they're not flipping houses as they were in the early 2000s. We're seeing them stay in their homes 13, 14 years, which is a good indicator that when something does happen to your air conditioning system, you're probably going to replace it as opposed to repair it.
You'd have more of a tendency to repair if you're planning to sell your home. So I'm bullish on that. Secondly, I'm also bullish on the idea that we have markets where we have very good market share and we have markets where our market share isn't as high as we think it should be. So we still have market share gains that we're striving for and going for, and we have great partners working with us on the OEM side to help make that happen.
Good, Paul.
Okay. Thanks so much. And my house is we're going on year 2020 actually, so I get your point. Quick follow-up, if I could. I was really surprised by the inventory levels.
You guys just did a really good job of keeping that under wraps as we ended the year. And I'm curious whether that's just more the strong demand in the industry and you might have even preferred that you've added to your inventory management?
That's a great question. Let me turn to A. J. For the answer. J.
Juvekar:] Sure. It's a combination of all of the above. There were supply chain constraints in the industry. There was strong demand and our technology enabled us to fill customer orders and take market share and show sales growth in that environment as well as gave us new insight and tools to attack what we call non performing inventory, inventory that's probably been on our shelves for too long. So with more detail and more talent focused on it, we were able to move some of that old product out of the network as well.
So it's a mix and a confluence of all three factors. And certainly those efforts are going to continue going into 2021 and beyond.
Okay. Can
I add one more thing to that and that is that A? J. Did a great job of not only getting the technology that we needed with the system side of it. So we had a visibility all the way through to what the inventory should be. But also we were able to fortunately for us before the pandemic add people from different walks of life in purchasing and inventory management systems.
People from retail, from different commodities mixed in with our group of people that knew the HVAC industry. So I think it bode well once we got into the pandemic that our people had varied backgrounds and capabilities and were able to work hand in glove with our OEMs and our other suppliers to make sure that we had a proper cadence of inventory receipts.
You're so right, Paul. We use technology as really shorthand. It's really people, process and technology. Technology just enables great people to put in great processes and create change and increase profitability.
Yes. Just to add a layer of numbers to it, the reduction year over year was around 120,000,000 dollars which is pretty astounding number. And I think part of the question is how much of that is temporary versus permanent, right? We cut through kind of cut through the conversations and more than well more than half, I would say, is permanent reduction from the point of view of technology and recalibrating how our stores actually operate in sock products and reorder products with products. So, it's certainly more than half and is I would call it a permanent reduction.
That's perfect. Thank you, guys.
You bet.
The next question is from David Manthey of Baird. Please go ahead.
Good morning, David.
Hey, good morning. Hi,
everyone. It's not too cold where you are.
No, in Tampa.
That's the heat of the Super Bowl.
Yes. We're absolutely fine, actually a little warm yesterday in the 80s. But as always, hoping you can disaggregate the organic equipment growth units versus price mix there and then your outlook for 2021 as it relates to pricing?
Jerry, you want to take a shot?
Sure. Well, David, first, if you look at the full year, which I think is a responsible way to look at it, the residential business up 10%. Almost all unit growth, very little price if any, a slight benefit on mix, but mostly unit growth this year. And for the quarter, again, I would say a very similar circumstance, almost all unit growth, almost no price and a slight amount of mix benefit.
Okay. And with copper and steel and everything being up, should we expect that 2021 we could actually see a positive impact there?
Well, there are 2 groups in that discussion. There's what the OEMs make products and what their cost inputs are, right? So almost all the OEMs already announced pricing actions, price increases for 2021 and that will flow through the inventory cycle and into the season this year. So I don't think we're ready to call it, it's a crystal ball, but there has been pricing announced and we'll see how that sits through the market this year. We do sell non equipment products that consist of metals, right?
And there is inflation going on in that and those prices have been increasing and accounts for some of the 4th quarter's benefit that you see in the non equipment growth. You're more encyclopedic than me about that, but I think it's some helpful price increases heading into 2021.
Correct. Got
it. Okay. And just to stay on that theme of the other HVAC products, assuming there was some volume there, I know you had a major initiative that you're working on. And I'm assuming that some of that growth was early returns from that program. Could you just talk about the trends that you're seeing and the early returns from the initiative relative to other HVAC products?
I guess we can take a shot at it, Paul, with that.
Yes. I don't think a lot of it was from the early parts of our initiative. I just think a lot of it was a little bit of pent up demand with some of the equipment spotting that we had that equipment wasn't available, so people had to repair their product, had to repair a furnace. That's been probably the tightest market for everybody right now. As far as price increases, a lot of the steel and copper prices that Barry mentioned did occur in the Q4.
They had a benefit, but really not material in the overall scheme of Watsco's revenues for the quarter. I think more of that's going to bleed into perhaps in the first and second quarter of this year. We'll have a better idea for what's going to happen price wise with those commodities.
The next question is from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.
Good morning, Jeff. Hey, good morning everyone.
Just on a good color on the U. S. Res HVAC. Can you just kind of update us on whether it be the quarter or full year, what you saw from the businesses outside the U. S, which still seem to be a headwind and then just commercial trends 4Q and into 2021?
Barry? Hey, Jeff. Well, first, the U. S. Market, we speak to that pretty directly in the press release.
Our other international our international business is really split into 2 other whole, Canada grew its sales and profits in 2020. So that is Latin America. That's where in our Latin American business, which we do publish in our 10 ks. You can glean some data from it. That's mostly a commercial business and that's the business that went down in sales and profits this year, probably to the tune of about $0.20 a share if I look at the full year.
So when we speak about our results, again, put a placeholder for Latin America, which we expect a recovery this year and after costing us about $0.20 this year. Again, largely a commercial market and like you're seeing in everyone's discussion, commercial market is improving, but still lagging and 2021 could be a year of recovery that can have some benefit, we'll wait and see it and talk about it if it happens. But that gives you a sense for 2020.
Okay, that's helpful. And then just on the SG and A line, can you just talk about maybe puts and takes as you think about that into 2021, certainly good incrementals, very good incrementals in the back half. But it seems like a lot of companies tamped down costs in 2Q and then demand kind of came back quickly. So just how are you thinking some of those tamp down costs or temp costs start to come back and impact SG and A? Thanks.
Go ahead, Barry.
Yes. Again, three factors, I think, in the answer, Jeff, to kind of unbuttal it. So 2020, you're right, an early spring reaction to all the knives that were falling, helping with cost reduction and provoking cost reduction for good reasons. 2nd, what was interesting, the need to deal with double digit demand thereafter for the next 8 months. So certainly some costs needed to come back into the equation as 2020 played out.
And then 3rd, technology. What did we do? Can we do? Can we continue to do relative to technology, which is one of the whole outcomes of technology is to improve cost, especially the efficiency gain of all the technology that's intended in that. So that's nice and abstract answer.
If I look at 2021, I would say this, half of our SG and A are people. And commission growth, growth in incentive pay, we want that to happen. We would expect that to happen next year. And so there will be SG and A increases, for example, in that category. Rent, which is about 15% of SG and A, is, I think, flat this year.
That's an accomplishment. Our teams went to the landlords and dealt with the realities of what was going on in the market and this year's rent was flat, what that was otherwise intended to or likely to increase. I think some of those savings will be kept and sustained into next year. So if I try to summarize it without another 10 minutes of explanation, we would see some SG and A growth next year, just in the realities of what happened in 2020. We are making investments in our distribution network in 2021 with people and locations.
And we see the opportunity. We have really OEM partnership in many of those efforts, And we're going to go out and expand our network some next year and there'll be some SG and A growth for that. Otherwise, technology will help pinch those increases. And again, I would expect not the same performance, but a moderate increase next year. Okay.
Thanks for the color, guys.
The next question is from Chris Dankert of Longbow Research. Please go ahead.
Good morning, Chris.
Hey, good morning, guys. Thanks for taking the question. I guess just kind of looking into 2021, I mean, great, great performance on the gross margin in the back half of '20, definitely got things stabilized. I guess, Latin America is a moving piece. I know there's some mix dynamics going on.
But how do we think about gross margin into the New Year? Just any puts and takes you'd call out anything to kind of bear in mind besides just the typical pricevolume mix?
Well, it's something that we're focused on and whatever improvements you saw this year or last year, I should say, we continue to believe this year will show improvement as well because of our focus and because of the ability to do something about it through our own internal systems and approach to the marketplace.
I do assume Latin America was a piece of kind of what the headwind was kind of late 2019, early 2020 though?
2019, 2020. Barry, if you understand that, go ahead and answer it.
Yes. Go ahead. Ask your question again. So what's the what are you going to?
Yes, sorry. So the gross margin is kind of on a year over year basis in the latter half of twenty nineteen, early half of twenty twenty, we're facing some year over year headwinds. I'm just curious how much Latin America was playing a role in that gross margin decline earlier in 2020?
No, not at all. The margins internationally look like the U. S. Margins, gross margins. So there's no how's your brother effects, the mix of some sort.
It's really the blocking and tackling of getting pricing in the market. It's technology. There's a big pricing initiative going on to improve how we price our products to go to market. And we talked earlier about inflation and there's a lack of inflation in 2020. The opportunity of inflation might help, we'll see.
We don't know until we get into the season, but those are the larger moving pieces.
Got it. Got it. All right.
And then I guess something we haven't touched on lately, just any update on Russell Sigler either in terms of investments being made there, kind of what's required in terms of investments, the likelihood of kind of further consolidation of ownership, just anything you can share there would be great.
Well, we can't share much. We're in a minority position and we're very supportive of anything they want from us. And that's all I can say. We don't we have no idea what their intentions are in terms of divesting more ownership.
Yes, even in terms of, I mean, how are they pulling on some of the technology tools, Are they fully integrated in terms of how they can use on call air, that type of thing?
What we can tell you is that we're very pleased with their performance all across.
Understood.
Yes.
Thanks so much guys.
The next question is from Jeff Sprague of Vertical Research. Please go ahead.
Good morning, Jeff. Hey, good morning, everyone. Thanks for the question. I guess maybe somewhat following up on that last point, I just wonder if you could speak a little bit to what you are seeing in the potential M and A landscape. And I imagine there's a little bit of tug of war, business is good, so perhaps people aren't eager to sell.
But by the same token, it does seem like the technology changes maybe are kind of increasing the pressure on some of the smaller guys. So just the state of play there, should we expect other M and A to happen in 2021, maybe some color on the activity in your pipeline?
Well, I'll make a general statement and then Barry who leads our M and A can provide more information. Watsco is an acquirer and that's part of our overall strategy. We have a $5,000,000,000 revenue and a $40,000,000,000 industry. So our share has a lot of room to grow and we use our balance sheet to support M and A. And we are active and we do think there's no promise, but we do think we'll have M and A this year.
And I do think that the reputation for our culture for a different kind of an acquirer, we're not disruptive, we're supportive. And all the other things that we add, the capital, the equity for the key people in their organization, our 401 which is our donations are in Watsco shares. That sort of thing is culturally attractive, I believe. And as I said, lots of opportunities since we're only $5,000,000,000 out of the $40,000,000,000 And now some of them are very small, but it doesn't matter to us. We just try to bring in people that want to continue working and continue building what they have with our support.
And Barry?
Yes, Jeff. Just first, Jeff, welcome back. Yes, two things I think to remind everyone of is the focus of M and A is kind of the regional superpower businesses that are in this industry. We're not attempting to roll up a fragmented industry. We're focused on the largest of targets that will drive growth and share and then platforms to build on and invest in.
The second, I think big picture fundamentally is we would rather invest in businesses when they're growing and reaching greater strength. We're not turnaround experts. We're not looking for a dip in the market to buy. We're looking to invest in strengthening businesses. So I think this environment after everyone has been through a lot this year, net net is stronger now than it was a year ago.
So I would say that presents us opportunity and certainly gives us confidence in where the good businesses are. But having said that, for 2021, I'll never be able to predict a thing other than to say some of the targets that were technology discussions were the reason for the discussion along with performance. I think that rekindling of that effort can happen now that we're through some of the weirdness. And again, the foundations are stronger today than they were a year ago. So I would expect some great conversation, whether there's great transactions or not is still to be seen, but
There's going to be great transaction, Barry.
Get off the
fence, sir. We're very optimistic about that. No guarantees, but we're very optimistic.
Next question is from Steve Susa of JPMorgan. Please go ahead.
Hello, Steve.
Hey, guys. How's it going?
Good, good. Come visit.
I'd love to. It's a little snowy up here. Question for you on carriers that their backlog in residential was up 3x year over year. Backlog is not typically the type of thing we talk about in residential, especially not in December. Did you guys get out in front of some of these price increases or availability concerns and order a bunch that they'll deliver to you guys in the first half here?
What a question. Who wants to volunteer for that answer?
I will. It's no, we did not do huge pre buys. We did several buys just to make sure that we were refilling the inventory that we lost that we still had a deficit in, very selective. One thing that we did during the entire pandemic is even when everybody else was canceling orders, we maintained the cadence of putting in orders and maintained our order board throughout the entire pandemic. And so we really didn't we had shortages, yes, but we didn't have these yo yo type inventory movements like a lot of people did.
So we feel that we finished the year in good shape on inventory. Yes, we have a concern going into 2021 that we'll be able to maintain that status, but we're working diligently with our OEMs on a daily and weekly basis to make sure that we're getting the fulfillment we need on what we have on order.
Yes. I guess that wouldn't be an inventory, right? If it was backlog for them, that's something they would kind of ship to you guys in the first half or whatever.
Yes.
So I mean, are they it's kind of unusual that you'd be allowed to just like place a paper order and get terms and they would essentially be holding whatever whip they have or finished goods they have. So none of that activity?
Like I said, we've got our orders, we put our orders in the way we always have. We have a pre buy like we always do. We're not trying to be unusual here.
Most of
the manufacturers, I think, continued building product during the off season where they normally wouldn't have shutdowns. I think that was pretty much universal across the OEMs.
Did you speaking of the OEMs, I think it's pretty clear that Goodman lost some share, whether it was their fault or not. Are you seeing any kind of do you expect any kind of swings? I mean, you pretty much serve them all. So it's not like it's a negative or a positive for you guys either way. Do you see any kind of swings back this year between the guys that kind of won and lost in 2020?
I guess that's the $100 question that everybody has. Will the dealers go back to the brands that they were loyal to that they couldn't get availability or they lost and they went to other brands. And I guess that's what everybody's marketing plans are all about is being able to maintain the share gains that they picked up in prior year.
And then just one last one. I've noticed Goodman's acquiring a few distributors recently. I think it's been selective and mostly around their Daikin brand. And we also understand Ferguson is kind of looking to be a bit more aggressive here. They put out some pretty publicly aggressive targets.
Anything you've noticed on kind of around the block, if you will, about a little bit of an increase in competition?
Competition is always strong. And the one you mentioned in others, it's a very fragmented industry that we think we have advantages that others don't have. And we've had that for a number of years as evidenced by the growth that we've had. I don't see any reason why that's not going to continue. I think we're actually getting stronger.
I'm more optimistic about the future than anything we've done in the past. We're on a roll.
Right. Clearly, the digital stuff has worked out for you guys. Took a crap out of it.
Yes, it has. And it's just beginning.
Yes, great. Thank you so much. Appreciate the question.
To that end, this is A. J. Going back a question to the market share, which ties right into what the conversation was now, is that we saw huge new growth in new customers buying from the Watsco Companies, which is exciting. And at the same time, we're seeing all time low attrition rate of customers. So I think what that tells you is that customers are finding it's very good to buy product from the Watsco Companies.
We're good partners to these contractors. We try to make it easy for them to do business with us. We try to help them grow their businesses and that's getting more and more valued and appreciated.
Right. So it sounds like A. J. Is up for a raise now.
Well, agree with that.
Thanks guys.
Good to talk to you.
The next question is a follow-up from Chris Dankert of Longbow Research. Please go ahead.
Hi, Chris.
Hey, guys. Just one more from me. I guess, we talked about your inventory, OEM inventory, let's go down one level. I mean, what are you seeing at the customer level? I mean, are they still stocking a bit more than normal, still kind of skittish about being able to get product on time?
Just what are you hearing back from customers and what their inventory position looks like?
Paul, why don't you take that?
Yes. Most of the dealers and contractors that we do business with really don't maintain any inventory, just base inventory in parts and supplies. So that really isn't an issue. Some of the larger contractors do carry some inventory, but it's they really rely on the most part, the industry relies on the distributors supply inventory. Do we think there's some contractors who may have been concerned about the shortages of last year and they're trying to put some inventory in place?
Yes, I think there is some of that happening. To what extent, I really wouldn't have a read on that right now.
Yes. Thanks so much. It also remains true, the vast majority of our customers rely on us for their inventory. Yes, that's right.
Yes. I mean, an example, we have a 100 business unit that we'll call Baker is probably pushing $1,000,000,000 in in terms of revenue as part of Watsco. I would say 99.9% of what they sell today was ordered within the last 6 hours. None of their customers are out, talking, drawing from inventory and replenishing with us. If I said de minimis, that's overstating it.
That's 95% of the mark. I mean, dealers carry motors and capacitors and some linesets and copper tubing, refrigerant, but generally not equipment.
Got it. Yes, thanks so much.
This concludes our question and answer session. I would like to turn the conference back over to Albert Nahmad for any closing remarks.
Well, thanks for lifting and I'll talk to A. J. About his raise. We appreciate your interest. I just want to give you the confidence level that I have that we're really on a roll here.
I think we're very strong and going to get stronger. I think business is solid at the start of the year and I hope that continues. And take us up on our offer, call us about learning more about the technology initiative. It's a game changer. And other than that, I wish you all to stay safe and stay healthy.
And we'll talk at the next quarter. Bye bye now.