Good morning, and welcome to the Watsco Third quarter 2020 earnings conference call. I would now like to turn the conference over to Albert Nahmad, Chairman and Chief Executive Officer. Please go ahead, sir.
Good morning, everyone. Welcome to Watsco's third 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, Executive Vice President. Before we start, our cautionary statement. 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. Before I report, let me first wish that you and your families are healthy and safe. On to our report. Watsco just completed an outstanding third quarter. EPS grew 25% to a record $2.76. Records were set for sales, gross profit, operating profit, operating margins, and net income.
These results were driven by strong growth in our U.S. residential HVAC equipment business, which grew 19% during the quarter, and from operating efficiencies achieved throughout our network as evidenced by the nominal change in SG&A. Homeowners clearly are investing in their homes as HVAC replacement sales have remained strong from early summer through today. We also believe that greater adoption of our Watsco technologies has contributed to our results and led to gains in market share. Our best indication of this impact are 2 simple metrics. First, customers that use Watsco technologies are growing at a much faster rate than non-users. Second, we are experiencing minimal attrition among active users on a year-over-year basis. Now, keeping this in mind, we continue to invest in our platforms and to drive for greater adoption by more customers. Here are some examples of our progress.
Weekly users of our mobile apps have grown 31% since last year with over 100,000 downloads. E-commerce transactions have grown by 19% this year to nearly 1 million online orders, which is about a billion and a half dollars at an annual rate at the moment. Our annualized e-commerce sales run rate is 32% versus 29% at the end of last year. In certain markets, the use of e-commerce is over 50%. Our dockside pickup services have expanded to more locations and now include non-contact payment functionality. This technology has only been available for a few months, and already over 12,000 orders were fulfilled during the quarter by more than 2,000 unique users. Two of our newer innovative platforms have gained momentum. We call them OnCall Air and the second one, Credit for Comfort.
These platforms provide digital connectivity for contractors and homeowners when making proposals and buying and financing replacement systems. Contractors using our, what we call OnCall Air platform, provided digital proposals to over 39,000 households during the quarter and generated $114 million in sales, nearly double that of last year. Our Credit for Comfort platform processed double the number of digital financing applications, resulting in an 87% increase in third-party funded loans. Investments in inventory management software have also benefited us this year with inventory turns improving 25 basis points over last year and of course, contributing to cash flow and operating efficiency. All of this is exciting, but we believe Watsco's technology are only scratching the surface of their full potential. As always, feel free to schedule a Zoom call with us, and we can further explain our technology and progress.
We also strengthened Watsco's balance sheet this quarter. We generated record operating cash flow of $373 million, which is far away a record for the year so far, and we have no debt at this time. Importantly, we have the capacity to make almost any size investment to grow in our business. I always like to comment that we're in a $40 billion industry, of which we are only $5 billion, so we have lots of room for growth. Finally, one more very important thought. Our results are a testament to the efforts of our teams across the Watsco network. We deeply appreciate their commitment. With that, A.J., Paul, Barry and I are happy to answer your questions.
We will now begin the question-and-answer session. The first question comes from Joshua Pokrzywinski of Morgan Stanley. Please go ahead.
Morning, Josh.
Hello.
Mr. Pokrzywinski, your line is open. Are you accidentally muted on your side, sir? Okay. We'll go on to the next questioner, and he can return to the queue. Oh, I see some activity. Oh, he disconnected. Okay. We'll go to Brett Linzey from Vertical Research Partners. Please go ahead.
Hey, good morning, everyone.
Good morning.
Hey. Wanted to start with just the sales trends, 10% growth in HVAC equipment, 19% in the U.S. resi products. What was the big driver in that category? Everything excluding equipment, where did you see the strength?
Why don't we turn to our Paul Johnston for that answer?
Yeah, I'd like to make sure I understand. Everything but equipment?
Just, the total U.S. resi sales, you know, up much stronger than the equipment. What was the big driver kind of, you know, ex equipment? What categories drove that?
Oh, no, you misunderstood. Go ahead, Paul. Explain that.
Yeah. Resi is equipment. It's, it's gas furnaces, coils, air handlers, split systems for residential. It's included in the total equipment.
Right. Right. Okay.
I think increase that came in equipment. That's what we're trying to say.
Got it. Just a follow-up to that. Did you see any mixed benefit in terms of the gross margin line, you know, from kinda strength in the other categories versus just the equipment side?
Paul?
Well, yeah, we had some moderate growth in the parts and supply side of our business, which we indicated a little heavier on the parts side, you know, mid-single digits. That obviously is an enhancement to our gross profit. That mix did help a bit. Yes.
Okay. All right. Great. I'll leave it there and pass it on. Thanks a lot.
Sure.
The next question comes from Jeff Hammond of KeyBanc Capital Markets. Please go ahead.
Hello, Jeff.
Hey, good morning. Just on the equipment side, can you remind us what the mix is of, you know, kind of the on the equipment side of the U.S. residential versus, I guess, would be the drags would be commercial and international?
Paul?
Yeah. Barry, why don't you handle that as far as you know, what is offshore versus onshore?
Sure, Jeff. You're on the right track. The largest part of our equipment business is the U.S. residential business by far. To a lesser extent, there's commercial U.S. and there's international, which has a slant toward the commercial applied market. That core business of ours, which is residential U.S., is what is up 19% this quarter. The commercial U.S. market is recovering, but it is still not, you know, anywhere near the growth rate obviously of residential. International is what has been more impacted than anything else. You'll find some of our international data in our 10-Q when we file it.
That's a market where it is much tilted towards the commercial market and, and those markets have been more impacted than anything else we operate. I have to say that from a profit perspective, from an EBIT perspective, actually our international business is up this quarter from a profit perspective. Although the sales have been impacted, they've done a great job with managing the business and actually are more profitable this quarter internationally.
Okay, great. Can you just, you know, I guess a couple questions. One, on inventory levels, just kind of where do you see your inventory levels? Are they too low for the demand environment or about right? Do you still have some restocking to do? Just speak to, you know, a lot of discussion about IAQ, what you're doing there, what you're seeing there, what you're doing to kind of broaden that in light of the increased interest there.
As you heard earlier, we do have investments in inventory management software that's considerably helping us to maintain and grow revenues with less investment in inventory. Maybe more color can be provided by Barry or Paul.
Yep.
Yeah.
Either one, jump in.
I'd say first on, first on the inventory, Paul, you have layers to this, but big picture, we started the year, early this year, talking about inventory being something we wanna improve inventory turns from 4 to 5. It was a very straightforward goal, a very straightforward math calculation to say what that's worth in cash flow. That's before any of the disruptions or any of the noise of supply chain discussions that we've had. We started the year with that in mind as a strong source of cash flow, as well as a, obviously, an operational efficiency that can be gained through our 600 locations that we operate. That's been an initiative before any of this noise.
Paul, you can comment on the current state of what's going on with the supply chain and so on.
Yeah. The supply chain, you know, rapidly recovered. You know, in the September timeframe, it pretty much got back into a normal flow, and we started seeing inventory flowing again. You know, we're not really experiencing the big stock-outs. We'd have some spotty issues with inventory on the supply chain side, but for the most part, I think the OEMs have recovered nicely. As far as our inventory levels, we were able to not only use the technology that we've invested in to improve the inventory turns, but we were also able to improve the quality of our inventory. Now we're able to analyze, you know, by branch, by division, by product line, by SKU, exactly the types of inventories that we need to have in place.
It's been a wonderful investment that we've made in it. I think the dividends that we're gonna receive from it are gonna be paying back over the next several years.
A.J., a little color on the technology involved in this inventory?
I think, Paul, your last point was important in that it's not just the amount of inventory or even the turns of the inventory, but it's the quality of the inventory. That is absolutely a function of the technology that we're using and the people, the teams that are using them. That's been a major focus and there's been major achievements there. Also, given the constraints and supply with all the demand going on, it's important to note how great of a job our teams in the field did finding products to get our customers filled or their orders filled so they could sell product. That was really a Herculean effort and we're proud of them.
It sounds like inventories have kind of normalized and the lower year-on-year is maybe a function largely of some of the internal changes. Can you just talk about IAQ? You know, how big is it for you guys? Is it moving the needle? Is it something you're excited about, you know, given kind of the COVID, you know, dynamic and, you know, it just seems to be a lot of people talking about it.
It definitely is an important piece of our business now. You know, historically, you know, as you know, IAQ has been something we always talk about, but I think definitely the pandemic, you know, made it into a frontline product area. It's growing very rapidly, you know, 2, 3 times, you know, what it was in prior year. Excited about all the new products that we're putting in with putting in new lights, you know.
UV light, yeah.
Yeah. UVC lights, air cleaners, filtration, you know, the entire gambit is growing rapidly. It's been very good, and I think it's sustainable.
Yeah.
Okay
being the industry leader and having the scale that we have, when new products roll out from new companies, whether they're startup or mature companies, we often get the call first as a distribution partner. We're getting first look at a lot of these products.
Okay. Thanks for the color, guys.
Jeff, what I would add just in to AJ, you know, what we talked about before on platforms and technology and people and execution. IAQ is now part of every single, you know, recommendation in our platform called OnCall Air. OnCall Air is this, you know, presentation platform that contractors give to homeowners to sell them solutions. Again, that would be an example where old school, a contractor may or may not present that feature or benefit, may or may not add it to the collection of things he's doing. Now it's embedded in the technology, embedded in the presentation, embedded in the proposal that's being given.
Yeah
Just looking at a future state, that kind of thing is very important.
A.J., why don't you explain more in lay language what the OnCall Air does?
Sure. OnCall Air is a business that we've built that has a software tool that is sold on a SaaS basis to contractors to help them sell in the house. It replaces the yellow carbon copy pieces of paper that they previously used to write proposals on. It is a full digital interactive experience with lots of product information and videos about the product offering. Enables contractors to sell with a good, better, best offering and all those add-ons and accessories and recommendations that Barry was hinting at are embedded in the tool. Consumer financing options are embedded in the tool.
It's basically a modern sales platform designed purely for HVAC contractors, and the contractors that are using it are growing faster, they're creating bigger tickets, they're closing more deals, and it's off to a tremendous start.
Thank you.
It's also, you know, using all the product data that we've curated for the last five years, where it's not just a sales platform, it's an information platform of all the products, all the data, all the SKUs, all the connectivity to e-commerce to allow for fulfillment. It's really a, I think, again, a terrific platform.
You know, really, you know, going to that future state of how things can be sold, in the home.
Remind me, AJ, how many SKUs do we have in terms of data?
Yeah, in our product information management system now, we've mastered about 800,000 SKUs in the industry.
Thanks a lot, guys.
Yeah. Yeah.
The next question comes from Chris Dankert of Longbow Research. Please go ahead.
Good morning.
Hey, morning, Al. Morning, guys. Thanks for taking my question. I guess first off, congrats on the U.S. res growth. Really impressive. If I'm remembering correctly, I mean, your fulfillment metrics are typically, you know, mid to high 90s, very strong. I guess with that kind of a spike in demand from, you know, flattish to up almost 20%, was there any dip in your ability to fill, or was the team pretty well able to keep up with the needs of the customers there?
That's a great question, and all the OEMs were stressed. From our observation is they kept up with us as best they could, as they did with other distributors. Yes, did we lose a little bit of sales? Probably. Overall, I think they kept up with us and as I said, with other distributors as well. They're working hard. They're not messing around here. They know this is an opportunity, so they run hard. Anybody wanna add color to that?
Yeah.
Yeah. Yeah.
Oh, go ahead.
I mentioned it earlier, there's a Herculean effort in the field, where there was product shortages, our teams found ways to fill orders anyway. There's a lot of warehouse transfers going on. There was a lot of helping contractors find if they were looking for product A, but we didn't have enough of it, you know, we could substitute with product B and get them a competitive price. There's a lot of little wins like that helped kept our customer fulfilled.
Our OEMs, like Al said, came through magnificently. We were working with them daily. We had conversations with all of our major OEMs on a daily basis, talking to what our needs were, where our needs were, and they really jumped through hoops to be able to help us fill, you know, open orders where we had spot shortages. It was very well done.
Thanks for the color there, guys. I got to imagine being able to keep up with customers this quarter it's gotta breed a lot of goodwill. so nice work.
Well said. I agree with that, you know.
Just one quick update. You know, any update on VRF, the size for you today, what the growth looks there? Is it meaningful for you at the moment?
Yeah, it's not a material size in our market. The VRF isn't by itself. You know, the general, you know, duct-free split market is becoming larger and larger each year and continues to grow in, you know, in the low 20s%. VRF, we had a good quarter for VRF. It did grow. It kind of suffered in the second quarter, a little bit of a similar situation that you had with all commercial product, 'cause that's generally where VRF goes. It did have a down tick to it, a recovery because most of the jobs that we have with VRF are long-term jobs that are forecast out, you know, six, eight, nine months.
Gotcha. Gotcha. Well, thanks so much for the color, guys. Appreciate it.
Sure.
Next question comes from David Manthey of Baird. Please go ahead.
Hi, Dave.
Hey, Al. Good morning, everyone.
Hey, David.
Relative to all of the comments you had here on stockouts, do you think that manufacturer shortfalls were positive or negative in the third quarter? I mean net-net, did Watsco miss out on sales, or did they actually benefit from shortfalls that other distributors may have been experiencing and you picked up some contractor business that you may not have had before? Do you have a feel for that?
Well, I don't think that OEMs discriminated for us as opposed to their other customers. I don't believe that.
Yeah.
I think they worked hard for all their customers.
Well, I'm thinking between brands too, Al.
What?
Yeah. I'm thinking between brands. You know, if one brand was out and that contractor would switch over to something that you had in stock. Do you think you saw it in there or anything measurable?
I don't Paul, do you wanna take a shot?
Yeah, that's, you know, that's a great question and one that would have to do a lot of forensics to try to identify exactly what the impact of it was. You know, right now, I would not say that it really had a big impact because, you know, we were obviously going hand in mouth with our inventory, so it became very, very difficult for us to go out and reach out and take somebody else's customer, if you will, and provide inventory to them when we were trying to maintain the growth of our customers in the market.
I think that's well said, yeah.
Yeah, a little bit more time, I think, under our belt, I think we'll have a better feel on that.
Okay, fair enough. Then second on the other HVAC products, if I heard you right, Paul, I think you said that the parts business was up mid-single, which I guess would imply the supplies being something lower than that to get to the +2 overall. I'm just confused on why that would be, given that we're seeing such a strong push in the new residential construction market. I guess a bigger picture question for all of you is that in that other HVAC products business, do you envision a world where that can grow? It seems like it's been flat or down forever because of this offsetting factor between parts and supplies. Is there a world where that can grow on a more regular basis?
Definitely. Yeah, that is a marketplace that we have a strong focus on as far as, you know, what are the dynamics of where we can make that market grow. Of course, a lot of that is gonna be market share, it's gonna be product availability, it's gonna be using our technology to be able to replenish dealer stocks in a more rapid economical manner for the dealer. There are a number of different efforts that we can get into to make that market grow again.
Dave, I think you're spot on. Being the largest distributor dealing with a 1,000 vendors, we believe that we're able to negotiate, due to our volume buying, as good of prices as anybody, and we believe that should help us gain share. We think that we have more work to do in order to get the growth rates going. Certainly don't think it's gonna stay at proportionally at this level. I'm very hopeful that parts and supplies will increase as a percentage of our overall business. Some of the things we're doing, with our OEMs, I think will assist that.
Right.
In other words, don't count us out on parts and supplies.
Yeah. No. I was gonna say something. Stay tuned. You know, that's a new major data-driven initiative that we're just kicking off now in earnest, and that'll be kind of a next generation effort on parts and supplies.
All right. Sounds good.
I just to like add another layer that if needed, it's probably not needed, but I feel like saying it anyway is there is no, I think, big macro dynamic, David, where parts are suddenly becoming a solution. You know, the equipment growth rates have been too consistent and through today, as we said in the opening comments, that, you know, that consistency is through today. I think what we're alluding to is this is a market share game for parts and supplies also. And, you know, we have probably 15 competitors in Miami selling parts and supplies, and it's the most fragmented part of our industry is distributors that sell parts and supplies.
Where AJ is alluding to as well, is this can become a technology play in a far different advanced way than what's being done historically, and it's an opportunity for us.
Great. Well, we'll watch for that. Thanks very much, guys.
That was much more eloquent than me, Barry. Well done.
Well, Barry is a very eloquent speaker.
He is.
In every way.
The next question comes from Stephen Volkmann of Jefferies. Please go ahead.
Morning, Steve.
Good.
Good morning, everybody. Barry, if I can pick on your elegance again for a moment.
You don't miss a beat, do you?
Well, you said something I thought was interesting earlier. Many things obviously that I thought were interesting, but one specifically was that the IAQ is now sort of part of all of these OnCall Air, you know, proposals that come through. Is it possible to ballpark how much of the add-on? Would that be like 10% of the project or 20 or 50? I just really have no idea.
Yeah, it's certainly not 50. The OnCall Air concept that differs from the historical, you know, sales process is giving the homeowner a good, better, best solution, which includes IAQ. It's not just adding IAQ. It's adding a bundle. It's selling higher efficiencies. The fact that consumer financing can then make those higher efficiencies and larger bundles more affordable is part of the holy grail of what we're trying to create here. I wouldn't say IAQ adds, you know. Paul, you may know.
Yeah.
It's not just adding 10% or whatever the % might be. It's presenting this bundle in a, in a, in a very, you know, connected way with the homeowner that's gonna respond to it differently than if a contractor happens to remember it when he's writing down on paper on a Office Depot form, you know? A far different sales process is really what it's about.
There are various layers of IAQ. IAQ is not just one product. You know, you've got a number of different products you can, you can tier into the, to the installation. A baseline installation would be, you know, if you use just minimum IAQ products, it'd be probably around 10% of the install price. Could go as high as 25%-30%.
Okay, great. That's helpful.
Just one more thing on that. In OnCall Air, right, no longer just a static proposal. It's a digital interactive sales experience. Just like buying online when we all buy, when we all shop online on Amazon and others, we're seeing other products that might make sense in this purchase. That happens in the OnCall Air experience. It also happens in our, in our B2B e-commerce as our customers shop on our websites. Fascinating statistic. The line items per invoice on our online stores, meaning our subsidiaries websites, is 30% higher than offline sales. That's a number that's stayed true for a while.
Great. That's great. Thanks so much. My actual question I was gonna ask originally was more on the SG&A side. Very impressive SG&A control in the quarter here, I guess flat or on a same store sales basis. Just how do we think about that going forward? I assume there's probably some costs that are gonna kinda creep back in as the world opens up. How should we think about that?
I've warned Barry that he will answer that, so let's give it a shot.
Again, every distributor has two things they're managing in SG&A obviously, the fixed cost that you would like to lower over time. The variable costs that you don't mind spending because they're usually they're driven by sales or margin growth. We're no different. The key this year has been to get costs, fixed costs down. How do we take some of the latent costs in our, not just rent and facilities, but any measure of latent cost in our stores down? That's where we've been accomplishing the most this year. You know, rent and facilities, for example, was lower year-over-year on 6% higher sales would be an example. Some of the fixed payroll, where we're examining really the technology benefits that might come.
This has been obviously a climate to address some of those costs and then try to push for the permanence of them as they go into next year. I don't have a great analytic for you to say X amount of fixed costs have been reduced and will stay permanent. Culturally, there's not 1 of our 30 regional presidents that hasn't taken to task their own local cost structure to accomplish that. The variable costs will be driven by sales. There will be more commissions, there will be more performance-based comp. There will be more delivery costs, as the business is growing the way it is, and that's obviously embedded in our 3rd quarter performance where you see SG&A flat. We have growth in variable, we have offsetting reductions in fixed.
Again, culturally, it's a huge effort to go on to sustain this, because they can be more permanent than temporary benefits, especially on the fixed cost side.
Yeah, I'll add to that. On the variable cost side, well, SG&A, the third-biggest bucket of all of our SG&A is freight. That's the cost of moving product into our locations, between our locations, and out of our locations to our customers. We fill orders. I hate to be a broken record on technology, but we now have new technology that exposes more data and enables more optimization around how we do all of that, how we bring the product in, how we deliver it to our customers, just making smarter decisions day by day, transaction by transaction, of which we do 7 million plus a year, to optimize costs and gain efficiencies. Early innings of that.
A.J., is there enough of that technological opportunity to offset the general increase in logistics costs that we're seeing broadly?
I would say TBD, you know?
Okay, good.
Yeah, that's the goal, right? Is to be ever more efficient.
Yeah, the largest cost of that, of that discussion is delivering products from one of our 600 stores within 10, 15 miles of where it sits. That activity-based cost used to be largely a branch manager figuring it out every day. Then with technology, how do we help, you know, empower, enable, and change the game of how that local process is done, all this moving inventory around, then it becomes embedded in the inventory optimization project that we have going on. As we said in the call, scratching the surface, yet some of that scratching is having an impact on results.
Yeah.
Thank you, guys.
Sure.
Next question comes from Ryan Merkel of William Blair & Company. Please go ahead.
Morning, Ryan.
Hey, morning, all. First off, the resi growth also very impressive in my view. This is probably hard to answer, but I'm just wondering about sustainability. You know, what level of growth can continue? I have to imagine there was some, you know, pent-up demand, you know, that deferred work from 2 Q that got done in 3 Q. I don't know, it's hard to answer, but what do you think?
Well, I would say that your conclusion is correct. It's very hard to answer. It started in the third quarter. It has not tailed. I mean, the growth rate, there is growth going on at the start of the fourth quarter. How long that'll be sustained is hard to say. We'll just have to see. Well, our game plan is if we can't get it from industry growth, we're gonna get it from share growth. We're gonna use the advantage of our technology. Unless somebody can add to that, Barry Logan, Paul Johnston, A.J. Nahmad?
I think, you know, when the industry numbers are all added up, you know, I mean, obviously there's gonna be an anomaly in shipment data coming out of the industry association in Q3, where the industry is gonna show this huge bubble of growth. When you put it all together, you know, we're gonna have to look at it at year-end as far as what the actual growth in equipment sales were for the year. I think going forward then, you know, the pent-up demand from second quarter that pushed into the third quarter, you know, we're still seeing, as Al Nahmad said, some of that in the October timeframe. It's a crystal ball outlook, you know, as far as, you know, what's gonna occur in 2021.
I think when everything is added up, it's gonna look like a pretty normal year for the industry.
I think what you're also saying is the first half industry shipments were probably below where they should have been in the second half is in somewhat in terms of catching up.
Right. Right.
That's why the annual, you know, the annual won't be necessarily out of line.
Ryan, I tried to kind of You know, this is a good question. I looked through that. I think you have to look at things on a year-to-date basis and smooth things out and then ask the question. Year-to-date, the U.S. residential market, our business is up 8% and there's virtually no price in that. That's simply machines breaking the same number we're going to break no matter what is going on in the economy or COVID. Machines don't know. You have an 8% growth rate largely driven by, you know, a healthy replacement market, contractor confidence to go in and install the right thing or upgrade the right thing and get the work done.
That type of growth rate is above average, but not so far out in, you know, out in space that it doesn't seem, you know, sustainable. 'Cause again, I think homeowner, contractor, distributor, even OEM is feeling this kind of health in the market. If stay at home added something, fine. I think in big picture, 8%, sustaining itself, is not out of the question or out of the ordinary. Some of the short term choppiness, you need to look through it, I think.
Yeah. Okay. That's a good answer. That context helps.
Just one more point there. Whether it comes from industry growth or share gain, I'll tell you one more detail, is that our growth rate to new customers is higher than it's ever been. Meaning we have more sales to more new customers, we can attribute that to a number of factors. We have more customers buying more product from us than ever.
Yeah. It speaks to share gain on top of whatever the market gives you, which I think will be pretty good.
Absolutely.
Okay.
Absolutely.
I'm gonna come at the SG&A again, you know, because you had troubles the last couple years leveraging SG&A, then here this quarter, right, it was incredibly strong. You know, based on your answer to the prior question, it sounds like you've taken fixed costs down. You've got this technology that's now, you know, making you more efficient. My question is, should we look at this as an inflection point or as the new normal? I mean, have we turned a corner, and now, you know, assuming the top line is there, you're gonna start delivering more consistent SG&A leverage?
Well, I would say that first I'm going to comment on what you've said for the last 2 years. We've reported over and over again that we were doing, for more than that time, significant investments in our technology. I don't think that's going to stop. It may even increase because we do think it's a competitive edge to do what we're doing. Obviously some of that's being offset by other efficiencies that are occurring. Barry, my SG&A extra?
Yeah. First, Ryan, Al's right. I mean, $30 million of technology spending today didn't exist, you know, 5, 6 years ago, and that's 50 basis points of EBIT margin. We could have built an elaborate pro forma EBIT calculation for everyone. We didn't do that. Instead, we just tell people, "This is the right way to do it," and execute it. Obviously the rate of increase in that spending has diminished as things are maturing. Al's right, we will spend more. This is a good time to talk about it. It's very clear that sales margin, share, efficiency, other technologies that we're building beyond the customer-facing stuff has started to have an impact. I think is it an inflection point? That's a nice big cliché to ponder.
I think the basic question is it having an impact? The answer is yes, it clearly is. Culturally, when you talk about new normal, again, I go back to the 30 leaders across Watsco's footprint. There isn't one of the 30 that isn't looking at their business differently because of their actions this year and because the technology is just beginning to really influence all aspects of their locations and their business.
Okay. Yeah, very encouraging. Thanks, thanks for the answers.
You bet.
The next question comes from Brendan McCann of Morgan Stanley. Please go ahead.
Morning, Brendan.
Hey, Al. It's actually Josh. Sorry for the.
Morning, Josh.
Oh my God. An alias. An alias.
I had to sneak in because I was embarrassed about missing it the first time. Thanks for taking the question. I guess a few things that maybe I missed 'cause of the of joining a little late. I guess first, just given the healthy end to the season, at some point every consumer kind of throws in the towel on summer and says like, "I can wait until next year for some of this stuff," especially if the contractor can't get there for a while.
Do you feel like you're having a longer than normal season that maybe stretches out into months that you normally don't talk about, cooling demand or potentially some level of, you know, I know it's not a backlog industry, but you know, a backlog of broken stuff out there waiting for attention, as we get into the spring of next year?
I'll take a shot at the first half of October, strong demand. Will that be sustained? I don't know. First half of October, we got smiles on our face.
Got it.
Maybe it's because we're gaining share, maybe because the industry is doing better. It's hard to say, but I like it.
Any sense from what you guys been seeing on contractor lead times that would maybe kind of speak to like, hey guys, just can't get to the job site fast enough?
I think most of that would have been completed in the during September.
Yeah.
You know, any sort of backlog that the contractor would have had. I don't think that's an issue right now.
Yeah, Josh, I would just to add to it, I would say that if 80% of what we do is in the Sun Belt, and it is-
Right.
You know, people aren't gonna wait till next spring.
Right.
I think we've always been, and to the extent will always be this, you know, kind of real time way of looking at us in terms of our sales and our seasonality. I don't think we see the deferrals. I think where we see deferrals right now is the commercial market that's built a backlog waiting for jobs, waiting for money, waiting for contractors to fulfill backlog in a commercial market. I would say that's the only part of our business where that might be true for next year.
Got it.
I don't think it was-
That's more financial than anything else, right?
Yeah.
What was that? I didn't-
Josh?
Paul, let him say what he was gonna.
Yeah.
What'd you say, Josh?
I was just saying that the commercial comment would be more of a financial decision, not like residential just saying, "Well, I'm not using my air conditioner, so I don't need to.
That's right. Yeah. Although the indoor air quality is a big theme now of the commercial as well. Carrier, for example, has introduced equipment. It's used in the applied world for buildings and that sort of thing. Very useful to attack on the threat of the virus.
Paul, you had something?
Yeah, I think, you know, we're putting together some additional data, you know, on. One of the, one of the things I keep hearing is that people had more replacement jobs because people were staying at home, so they were running their air conditioning longer. I guess that sounds good on paper. I wanna get underneath that and find out really if the data proves that correctly. You know, were the runtimes actually longer in the Sun Belt? As Barry said, 80% of our business is in the Sun Belt. Were they actually longer in the Sun Belt because people were home and not at work or in school? I think the jury's out on that a little bit right now.
Got it. That's helpful. Then just shifting gears entirely, any observation that you would have, Al, or revisitation that you would have on the dividend policy or payout? Obviously you guys have a pretty high dividend payout right now, with any potential changes to the statutory tax rate, does that color your thinking, or is that something that would be revisited if taxes were to go up?
That's an easy one. We have consistently followed the principle that we will share our growth with the stockholders, have a history of doing that year after year for a number of years. We see no reason not to continue that, no reason at all, especially given that we have no debt and strong cash flow. I would say that we're going to sustain what we've been doing in the past, unless there's something that comes up that I'm unaware of. Right now, it looks pretty good to do that.
Okay.
Don't forget, cash flow is, has been, to a large extent, a little greater than earnings, and that gives us additional opportunity to do more for our stockholders.
Understood. Thanks.
We have a question from Steve Tusa of JPMorgan. Please go ahead.
Hi, Steve.
Hey, guys. Good morning.
Morning.
Great, great performance this year, managing some of these, supply constraints, spotted supply constraints, and big numbers on the sell-through, for sure.
Thank you.
I'm just curious though, when you guy You know, Barry mentioned kind of the +8 this year. Sounds like, you know, I guess you're thinking the market kind of grew a bit below that, obviously, if you're taking market share. +8 is still a pretty big number to call kind of a normalized growth rate. If people aren't running their machines longer, or harder, i.e., kind of shortening the useful lives, for an installed base that's kind of grown, you know, low to mid-single digits, maybe in the 4%-4% range, how do you kind of get to a higher normalized kind of number than that? What is I guess, what's changed?
That's a good question. Barry, sustain your 8% idea. Well, I mean, Steve, just to be philosophical, then I'll actually answer your question. There are two things that happened this year that are interesting and frankly surprised me. One is that, you know, we have another year where the mix of high efficiency is growing. If there is a consumer risk this year, it's not evident in the mix of products we're selling. It's a positive and it speaks to the homeowner-contractor relationship as that's playing out. Secondly is
Is that about a point? Do you think mix is about a point? I think Lennox said mix was about a point. Is that about right?
That's maybe a little strong, but rounded, that's probably fine.
Okay. Okay.
The other I think it's probably a little high, but that's.
Yeah
My feeling. The other thing that no one ever asks about is contractor credit. You know, when we sell $5 billion of stuff to contractors, 80% of it is on credit. We have to wait 30 days to get our money, and it's the best, one of the best leading indicators of how our contractors' health is.
Oh, we're gonna collect it. Yeah. Okay, Barry, I know where you're going.
Yeah. We see, you know, we see almost the lowest default rate, lowest bad debt, lowest kind of.
Yeah
risk factors in credit than we have seen. Again, it does speak to the idea that contractors are active and closing deals, and if we're helping them through our technology, great. It does speak, I think, to the industry, and to our contractor relationships, I think, in terms of health of that end market and how homeowners are reacting to what's going on when something breaks or if something needs to get replaced and so on. I don't know if that adds to 8%, Steve. Market share gains, I think, will prove out this year, adding to that 8%. I feel like that momentum is only getting started for longer term body of work we're doing with our OEMs right now.
It may be, you know, time will tell, but I think that you can't underestimate the health of what's going on with the contractor-homeowner relationships that are out there.
That's been, you said, you're kind of implying that that was not something that pre-pandemic, it was kind of, you know, normal, and that this has gotten better post-pandemic?
Yes.
It's amazing that, you know, an 8% unemployment rate means better, you know, consumer credit behavior. Interesting.
Well, but Steve-
This whole thing's pretty interesting.
Steve, also remember, our customer is the homeowner, and the unemployment rate is much lower with homeowners than it is with people who are renters.
Right. Right. That.
There is facts there.
No, that makes sense.
The second thing that we mentioned on, you know, really gaining market share is a combination of two things. One, it's acquiring new customers, but also, as AJ indicated, with some of our new technology, we've reduced the attrition rate of existing customers.
Right.
It's a combination of the two, reduce attrition and grow new customers, that yields you a higher return as far as share of market.
Right. Right. I guess to that point, I mean, you know, what changed for you guys on that front? I mean, you know, when you just compare factually kind of your growth rates versus the market, they weren't that great, you know, ahead of the pandemic, heading into the pandemic. I mean, did you kind of turn on something here where, you know, because of the e-commerce dynamic, like, you know, people went to you guys 'cause you had the technology ready and, you know, was there something that kind of flipped for you guys specifically? Because I think the supply constraints in the industry, on net probably would have hurt you guys because one of the major players that supplies you guys, I heard, was, you know, kind of out.
That shouldn't have helped you. Was there something that kind of flipped for you guys specifically here in the last couple quarters?
We're just great leaders, what can I tell you?
Other than, of course, great management. Yeah. Other than that.
We, you know, sometimes I think that, Steve, that you underestimate the earlier investments we were making and which was affecting growth rates of earnings. You maybe others were more, too short-term orientated. We didn't mind because we're in it for the long term, and so we may have been hurt by the recent growth rates in recent years. You know, we're starting to get a payback in what we do, and I'm optimistic that we'll do even better. What the industry will do, I have to say that being home because of the virus and having, in some cases, record heat, did not hurt demand.
Yeah. That,
It was a very hot summer, and most of us are staying home. We don't go to restaurants. We don't go to movies. We don't go to supermarkets. That means you're using cooling more than you normally would, and wear and tear on equipment does create needs for repairs and replacements.
Right. How much was One last one for you. Pretty big difference between the resi growth rate in equipment and your total equipment growth rate. Resi's obviously a big piece of that. How much was kind of commercial down for you guys?
Paul or Barry?
Yeah. The commercial in the U.S. is down, I would say right at double digits. Again, a slight improvement over where the second quarter was. International is the larger impact and component, which is where we sell, not the contractors internationally, but also other distributors.
Right.
There's some channel, some changes in the channel, you know, internationally. Again, I will report what our international component looks like, in our 10-Q in a couple days.
Sorry, one last quick one. What was price for you guys on that equipment growth rate for this quarter? Are you seeing any of these OEMs that may have had supply issues, get, you know, a little more aggressive as far as trying to kind of regain that market share so far?
No, really, we have not seen price on the equipment side, no, we have not seen price be a big change in the market dynamics.
Will they increase prices in the new year?
Well-
It might be your question. It's hard to say, but my prediction would be they will.
Yep. Yep. Just like every year. Okay.
Yep.
Thanks a lot, guys. 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.
Well, thanks for paying attention to our company. We think we're the best in the industry and will continue to be. We look forward to the next quarter to report our progress. In the meantime, stay healthy, stay safe. Thanks again. Bye.
Bye. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.