Ready to go. Okay. Thanks for coming back here. We have Barry and Rick from Watsco. Maybe Barry, I'll just let you kind of intro a bit. I know you guys have a very consistent and simple message. You know, maybe we can get into what you're seeing out there and the business strategy and where you're going. Thanks again for joining us. Always good to talk.
Sure. Thank you. I'm glad we're here. We're just talking, it's been 20 years being here, so I try to remember what I said 20 years ago and see if it came true or not. I think it did. Again, Watsco is a distribution business, over $7 billion in revenue. We've been a public company since the 1960s. Our CEO got there when it was doing $3 million, $0.80 stock price. Through culture, through hard work, through consistency, through sustained culture, we built the largest business in our industry. But yet we're only about 10%-15% of our industry, and we're still not in 50 states, we're still not in all markets, we still don't have fully representative market share in all markets. We're still building the company.
We sell HVAC products and refrigeration products to contractors 95% of the time. I make the distinction about contractors 'cause that's really who sells products in this industry. It's the contractor that goes into a home or business, it's their pricing, their erector set, their recommendation, their prescription, their technical know-how that sells you something once every 10 or 15 years.
The contractor is the central theme in this industry, in our view, and our job is to help them every single minute of the day through product, through product knowledge, through convenient locations, through product depth, through multiple brands, through technology, through friendship, through taking them on fishing trips, through advancing their own technologies and how they sell products to a point now we have technology that helps them actually sell you a product in your home through a point of sale type device. Revolutionary in many respects in this industry. As I said, despite all of the long-term view of what we've done, total shareholder return for 30 years around 17% compounded for 30 years, we still have a lot to do. Our largest market is Florida. Our largest market share is in Florida.
If I imagined and dreamt a bit what we've done in that market, we would be a $15 billion-$20 billion business or more in just North America. The only thing I'll also cover is Rick has been with us how long now? You wanna get accurate?
Almost nine years.
We've known each other almost 20 years. If you came to Miami and met our inner circle of our corporate office, we've all been together 10, 20, 30 years. If you went and visited all of our business units, you'd find continuity like that in our marketplace. We've been through major changes of OEMs, major changes of ownership of OEMs, major changes in the market, major changes in customer types, and yet we've consistently performed well. We do that through an equity culture. Watsco has about 150 key leaders that own restricted stock. It's an odd that I'm even mentioning it, but this is a cultural discussion. If you decide to invest for a long time, you know who you're investing in.
Our culture for equity is 150 key people running our businesses, running our markets, developing technology for our business, and the vesting period is over someone's career. My first grants were in 1997, 10,000 shares at $8. It vested last year when I turned 62. I waited that long, and to say that we have 150 people where the average age is more like 45 that have on average 17 years to vest, and if they quit, they lose it. If they get fired, they've lost it. Yet, 92% of the shares we've ever granted either vested or remain unvested, only 8% forfeited over almost a 29-year period.
Hmm.
The idea of continuity and I like it when companies say, "We're aligned with our shareholders." For maybe 3-5 years you are. I can look in the mirror and tell you that our leadership team across all Watsco, not just the corporate office, is aligned for a very long period of time with our shareholders, and we're something we're proud of. I'll leave it at that, and I'm sure you have questions.
Yeah. Maybe just stepping back and from a longer term perspective, you guys have really done a lot on the technology front to, you know, innovate around customer service and everything, fulfillment. Maybe just touch on the technology you guys are investing in and how it differentiates you versus the competition in local markets.
Sure. Go ahead, Rick.
Yeah. Quick state of the union on technology. I mean, this has been a 15-year journey in the company, and it started very simply with data on everything we sell, on all our customers, on a host of different things. Today, we have the industry's largest repository of PIM. PIM is incredibly valuable. As we're fond of saying, it's the most important asset that's not on our balance sheet, actually. That is the gating item to everything else that follows from that technology on that technology stack. PIM was kind of the first endeavor, then getting, you know, real-time actionable data about markets and customers and products in the hands of our business unit leaders through a very sophisticated BI platform was the next step.
Today, that BI platform probably has 4,000 or 5,000 users across the company. There's not a decision or a thought or a debate had around the company that doesn't involve a critical evaluation of the data behind all of it and all of which augments the intuition of the leadership that is there. It doesn't supplant intuition. It doesn't supplant, you know, the human. It augments the decision-making capability of that human. Those things enabled then a digital ecosystem that we're very, very proud of. We think it's the industry's best ecosystem for a contractor to basically do everything within their entire business infrastructure.
From the moment you walk onto a home and you've got to assess warranty, you need help repairing or replacing a system, you need help with a wiring diagram, you need to check inventory or price, you need to build an AHRI match-up, you need an AHRI certificate. All these are things that used to entail manual touch points that are now digital processes in our mobile ecosystem, digital ecosystem, such that there's about 75,000 contractors, average weekly users that are doing this with us. There is a definite value in the form of growth and reduced attrition that comes when our customers become tech-enabled.
The next layer of that technology stack is what Barry was starting to mention, which is what if we can influence the trajectory of growth at our customer level? In other words, not just make it easy for them to engage and interface with us, but can we actually help improve their outcomes when they're at the proverbial kitchen table? That's what OnCall Air is. That's what now drives, you know, $1.8 billion or so of gross merchandise value through the platform. We're now, for the first time ever, you know, the only distributor fully integrated that can say we have a view as to what's going on at the kitchen table, and we have a view as to what's going on really throughout all the parts of that contractor's business.
Everything I've just described is kind of the existing stack, and now we're adding to that. We spent a good few hours in our Investor Day in December outlining some new initiatives, all of which are absolutely rooted in the tech stack that's been developed. Now the goal is to keep improving upon it, keep adding feature and functionality to it, widen the moat that already exists for us, and we like where we're headed over a 3, 5, 10-year period there.
Now, what's been interesting is we used to do 7 million-8 million transactions, field another several million phone calls, all the contractors calling up and saying, "What do I do? How do I do this? Do you have it? What's my price? What?" You know? We had an 8-hour business. I mean, before technology, we had an 8-hour business because that's when the phones were answered. Just having a 24-hour business where anything can happen digitally has grown the business. It's grown the margin of the business. It's reduced attrition in the business, which has a great value. In my investor 30-year career, plus career, no one's ever asked, "How much attrition do you suffer every year in your business?" Start asking that question. I think it's a great question.
How much business do you give up each year so for you to grow 5% or 6%? How much attrition do you overcome? In the technology stack, where it's now over almost 40% of our volume, it's de minimis versus a probably 8% or 10% historical average. 40% of our business has virtually no attrition. That makes growth rates long term easier to come by. That's one of the values of what we're doing, and it's by far we have markets that are 70%, 80% e-commerce driven, so we're far from maturity in that respect. But it's been interesting and we dragged our OEMs into this.
We dragged a lot of our customers into this, still developing and still expanding in adoption. I think it's been a profound change in the industry.
Is there anything on the AI front that's making its way into that stack?
Yeah. I mean, I just kinda have fun with AI. Again, 10 years ago, you called our store and said, "I need a motor. I'm not sure which motor. Can you tell me which motor, and then tell me if you have it, what my price is, and is it under warranty?" The grumpy old man behind our counter would put you on hold for 20 minutes while they found out. Now a mobile device has all that data, is linked to all of that data, and I can find those answers in under 5 minutes in my pajamas on Sunday night, and AI is gonna accelerate that. AI is gonna say, "This is the serial number of the machine I'm working on. What motor do I need?
Where can I get it, and how do I install it?" You know, we call it Ask Al in deference to our long-term CEO. You'll ask Al, and Al will give you the answers and we'll log that in Salesforce. We'll save that customer service level thinking and outcome and it builds a database further for inferences and answers in AI. That would be one example.
Another example today is we get tens of thousands of calls that run to voicemail. AI will listen to the voicemails, prioritize them, translate them, know the sentiment of the voice that was spoken, knows who to send it to, knows what product it might be. It's gonna get smarter. It's not, you know, it's not mature, but that would be another customer service-driven example of AI that we have going on. In addition to building code and building a marketing, you know, message for a product group, something like that. But the more customer-driven, customer-focused thing is where AI will have a big impact. Just accelerating from grumpy old man to something much more accelerated.
Are you seeing any more, I guess, intelligence at the consumer level from AI? You know, are you seeing a little more contact on that front, maybe poking around?
Yeah, I'm trying to think of how.
A bit more?
I'm trying to think of how would we know. Yeah. If somebody said, "Well, I heard Trane is a good brand. Is it?" You know, before, if you Googled Trane, you would get-
Yeah
68 Trane paying, you know, dealers in your neighborhood, which wouldn't help you very much, you know?
Right.
I'm sure, you know, searching for information is obviously something we're all doing. I don't know what the outcome is. It's an interesting question.
I mean, I was at the Lennox Investor Day a couple weeks ago. They talked about their brand apparently getting more recognition in their data, that people are learning more about the brands, doing a little more research themselves.
Yeah, I think that's fair. I think we're doing that on most anything these days. What's the catalyst or the outcome that flows from it? I don't know. That's an interesting question.
Yeah. He thought it was positive because obviously you want your brand to be out front. I mean, in my view, the lack of transparency for the consumer and the OEM has always been a positive for this industry. Puts a lot of control in the channel, which is good for you guys, good for the contractors ultimately.
Yeah, I mean, we're, but, you know, Rick mentioned OnCall Air, where we have this engine, this point-of-sale engine that's helping a contractor inform the consumer of good, better, best energy efficiencies or sound or noise or air filtration, just something that upgrades the system beyond the base level. Maybe this is part of the answer then is, in that platform where there is more information, the higher efficiency sales are close to 70% of volume.
Mm.
Where the industry is at best 80% base level efficiency and 20% high-end. Well, the high end is the concentration that we're seeing with a better informed, you know, end customer. ASPs on OnCall Air are considerably higher, as a result, and we're helping the contractor itself, you know, do that. Maybe there's something to a better informed buyer will pay more for something.
Speaking of high efficiency and technology, what are you guys seeing on heat pumps and ductless these days versus the traditional ducted unitary cube?
Yeah. I think we're I mean, if I step back, we've been in a period of, you know, intense regulatory and product transitions the last 3-4 years, and it's nice to be able to take a deep breath, and it's nice to be able to work with your primary OEM partners and have that, you know, innovation discussion, have that, you know, where should the industry be from a product perspective over a 5-10-year period. You know, heat pumps are still critically important. They're almost a mainstay now in a lot of residential new construction application. Everything that's ductless is obviously heat pump.
That's a trend that I think will be, you know, secular and up to the right, as and particularly as those products get even better at heating in lower ambient temperatures, which they have gotten over the last 3 to 5 years. We're seeing great adoption there in regions that, you know, normally don't have much heat pumps, like the Northeast, like the Midwest, where you tend to have harsher climates. The performance of those systems is now better than it's ever been, and it's becoming a more perfect substitute, and the contractor feels now more confident in therefore making that part of their bundle and their solution set to the homeowner.
On the ductless side, you know, we take a little bit of pride in our performance with ductless. We helped, from a distribution perspective, pioneer its introduction into the U.S. many years ago. We were early adopters of ductless. One of our business unit leaders in the Northeast, you know, describes it this way. He said, "Well, the rest of the world can't all be wrong. There's something to this." He said that 20-25 years ago. Today, you know, ductless, depending on how you count, is probably 12%-15% of the industry. It's more like 20% of Watsco if I include commercial. We're, I think, over-indexed ductless. It has outperformed ducted in virtually every period over the last 10-12 years.
We don't see that slowing down. That too is becoming, I think, a closer substitute for what would be a traditional, you know, system in a home. All of those things are up and to the right. We cheer for it and we root for it. I think what gives us a little bit of confidence is that we're now at a point where you can work with OEMs in a more direct way to say, "Here's what it should look like. Here's how we can go to market. Let's do this. Let's do that." Neither OEM nor distributor nor contractor have to worry about massive product transitions for the next several years. That should be a good environment to proliferate both a little bit more.
Yeah, I think things happen more slowly than disruptively. What's happened slowly in the last 10, 20 years is ductless has grown share in the overall market. For one reason, the contractors accept it in increasing numbers. That's ultimately what drives the industry, not necessarily even what we want to do or what an OEM is trying to do. It's whether their contractor will go sell it or not, and that's what's been benefiting that segment of the market. If it is more efficient or if it's more economic and more efficient, it still has to be accepted by the contractor as a reputational risk they have to go carry into the market. That's what's been, again, a slow change, not a drastic change.
Da-
For us, I mean, we obviously Carrier's largest customer. It's a segment of what we buy and resell with Carrier. We're one of Daikin's largest. We're Mitsubishi's largest. We're Gree's largest in the ductless space, and so very well represented and as I said, as Rick said, a bit of a driver for that segment and helping the contractor go do something with it because it's also replaced a lot of window units. It's also been added to a lot of homes up north that didn't have central air conditioning, and the practical answer was ductless air conditioning. I don't think it's necessarily been a substitute for the ducted product. It's been a complement to what the installed base has become now and again driven by the contractor acceptance.
Daikin was here yesterday and talked about their side discharge hybrid ducted product. It's effectively a smaller side discharge that plugs into the kind of your ductwork. Lennox introduced something two weeks ago, or at least talked more about it a couple weeks ago. Everybody seems to be coming out with a product that is more applicable to a replacement application. Are you guys seeing that resonate in the channel as well?
Yes. Mitsubishi will follow, and there'll be a Carrier version that will follow, and it'll be a new product. Not a brand-new product, but, you know, we expect it to be something that does grow because, again, going back to the contractor, it's not necessarily cheaper. It's not lower margin. It's not a commodity. It's a specialized product, specialized control, specialized installation. It's not like a drop-in, and you walk away from it. There's some technology to it. Again, if it offers higher efficiency at a reasonable price, contractors will want to figure out and sell it. There will be a family of products, a family of brands. I'm not sure there's a big head start by any one party. But it's.
We like it 'cause it's something complementary to what we can sell and service and train and add to our technology and as Rick said, we helped pioneer it in the first place. It's, you know, it's again something that will happen deliberately. It won't happen all at once, but it'll be a good ingredient in the industry to have something new to sell. Should help the replacement market if somebody has a dinosaur that they're sitting on, that's highly inefficient, made 15 years ago and usurping power, and a contractor says, "Well, listen, this is gonna change your life. You don't hear these things. They're quiet.
You know, it's twice as efficient, and here's your local utility rebate check that helps you pay for it. That'll be the kind of things that will lift the tide a bit, I think, across all manufacturers of that stuff. It's not just one or two.
I waited more than 20 minutes to ask about how the quarter's going, which isn't I pat myself on the back for. You guys had talked about, you know, on your earnings, a negative quarter to date trend at that point. What are you guys seeing kind of quarter to date today, and how are the indications? Obviously, it's very early.
Yeah
What are the indications looking like on sell-through and your unit sales?
Yeah. I think, again, honestly, when we talked in February about January and February, it's the smallest, most inconsequential, least time of year to make an inference and so nothing's changed about, you know, what's in the rearview mirror with January and February. March is a bit of a view into maybe how the season is starting and a little bit of a view of. Your question is, are we in a valley of death still, to use your term, right? It sounds so severe, a valley of death. Not a valley. It's a valley of death, you know.
I gotta market.
It's not that. The question is the momentum that we see on the surface of the industry, and the answer is yes. I think I won't call it entire momentum because it's not May, it's March. I would say.
Yeah
you know, very early in the vision of this answer, there's positive things, and we kind of expected that. We didn't know if it would occur, but we're seeing absolute progress in that respect.
Are you guys up, like, in March, or is it just, you know, kinda like trending more towards flat?
We're seeing absolute progress in that respect.
Okay. Got it. All right. That's incrementally positive. That would be total sales, or that's a unit kind of unit sales commentary?
Both.
Both. Okay.
Yeah, I mean, just to level set it for everyone's sake, I mean, price has been something, you know, of debate and discussion. Really in our careers, there's three things that add to price. There's inflation and normal GDP-like pressures that our OEMs have to pass through the channel. If that's average 2% or 3% because GDP is 2% or 3%, that's what it is. There's a regulatory. We have that going on. The OEMs announced price increases March 1st. It'll be some subset of that, you know, and pricing, we're seeing it. It'll be captured. We're not paranoid about it. There's regulatory changes that add to price.
Coming into this year, for our equipment business, we're probably sitting on, I would guess, 5% or 6% price just by showing up in the mix of the new products. Now, that does not affect all of Watsco, it affects 55% of Watsco, so do the algebra. This year, price and mix and regulatory change is positive overall. The key ingredient is what, you know, is the unit environment going to be a usual market year or the valley of death? Well, it's not the valley of death. Whether it's a conventional growth market, again, I've told you there's progress. We're a lot smarter in May, June, and July in the middle of the season, and obviously, you know, that's what's important.
How are you approaching the inventories at this stage?
Go ahead.
Thoughtfully. You know, it's been what my answer earlier about a very hectic 3-5 years on product transitions has meant a very hectic 3-5 year period on inventory as well, and some inefficiency that crept into inventory. Just to level set everyone, you know, pre-COVID, pre-supply chain disruptions, pre product transitions, not that long ago, we would turn inventory around 4x . We're now in the low 3xs, so in our minds, we've got some work to do to get back there. That doesn't necessarily mean tactically taking a sledgehammer to inventory. That puts you know, customers and market share at risk, and so a distributor shouldn't just take a blanket approach to that. Our goal from here, you know.
Well, let me go back to last year. We peaked last year at about $2.1 billion of inventory. That wasn't a reported number. That's actually what we peaked at during the course of the year. My technical way of describing that is we chopped a lot of wood the second half of last year to get the company's inventory position to be as well-calibrated as it could be to start the year so that there's no overhang, there's no, you know, debate, and there's no, you know, more sizable work to do on inventory this year, and let demand tell us what we should do with inventory from here on out.
That's a slightly abstract answer for Steve, but our goal would be a distributor should always measure their inventory not in dollars, but in relation to demand and therefore turns. What we'd like to do is have more inventory as needed and carry slightly less inventory throughout the course of a year such that we're improving our turns and we're improving our cash flow along the way. I think the tactical reaction to inventory that needed to happen took place largely in the back half of last year. From here on out, what we would love to do is grind out incremental improvement towards our ultimate goal of being, you know, a 5x inventory company that will unlock north of $500 million of cash flow.
That doesn't mean I have to own less inventory to get there. It just means that I'm smarter with inventory throughout the year and managing it throughout a seasonal business, and that's the goal. The other quick comment I'll make is that over these X number of years that I've described, and certainly before that, we have been investing in technology and tooling and humans to be a better distributor and to manage inventory better. As I said, now with some of the noise of the product transition behind us, that technology can now show its mettle. You know, we talked about AI earlier.
like, a limitless possibility to AI around inventory and pricing and margin, and that's like a whole 'nother frontier that we're gonna get to in short order. I think the summary of the long-winded answer is the tactical work around inventory I think is largely behind us. We'll let demand tell us what it should look like, and over a X number of year period, we'd like to take it from somewhere in the low 3xs to 5 x of inventory.
Effectively inventory normal in the context of sales today and should trend normally with demand as kind of the season approaches. Is that the way we should think about it at a high level?
I think we're closer to that steady state reality, yes.
Yeah. Okay. Just on pricing, you mentioned the OEMs have obviously all come out. There will be a percentage of that. How does that for you guys, what's the timing on that and how that plays through into your gross margin?
Well, if the OEM announces a price increase March 1st, we tell our customers, "March 1st, our selling price is going to increase." We may actually even attach the OEM's letter to that dealer so they see evidence of it.
Right.
Some negotiation for, you know, will occur with, let's say, large customers that say, you know, "Can we do better than that?" We'll do better than that, and then we'll get a different cost for that customer. We're through that interplay now and we'll have a better sense of what was actually achieved in pricing over the next couple of months. I'm just saying, I'll say so far so good. That helps our gross margin algebraically in the short term because my selling price increased in advance of my weighted average cost increasing. I would say this year is more, that's happening as we speak, where last year it was more of a May 1st on. A little bit of push and pull in the timing of it, but nothing that is remarkably disruptive to margin.
I think we have 10 other variables we're managing to improve margin, not just that one. Those are all things we've been kind of achieving. I don't expect anything again disruptive with margin. I think the question is can we block and tackle through these, you know, through those 10 variables and do that well, and margin will be fine this year.
You said basically the guide for 2025, if you will, is flat with 2026. The guide is flat with 2025?
Yeah. We don't guide, but the thought would be that we can sustain what we achieved last year. If our equipment business grows at a remarkable rate, equipment has a lower margin than our non-equipment business. That'll be an algebraic difference that I'll accept. Our, you know, it's not one variable. The mix of our business is a major variable. We'll explain that as we go and educate as we go. You know, some of the worry is commodities and deflation and some kind of overarching competitive, you know, price risk. You know, you've heard me for 20 years, Steve. We don't consider that a major risk because the industry hasn't, like, behaved like that historically.
I think the manufacturers are under too much pressure to sustain margin in what are also very highly volatile markets for them and where absorption is also a significant you know variable for them that's going on. I think the sanity and sanctity and consistency of pricing is there this year and that doesn't mean it's simple. It means it's more stable than unstable.
How does that work if you know, we had a few contractors on the panel yesterday. They all talked about negotiating directly with the OEMs. How does that work if they have a direct negotiation with the OEM? You guys get paid some sort of like, you know, fulfillment margin on that? Who ultimately, you know, how do you guys get paid on that, if you will? 'Cause you're not setting the price.
Sure.
They're setting the price, right? The OEMs.
Sure. We negotiate a margin. We sell the product.
Mm-hmm.
We invoice the product. We are not just selling equipment to those guys. We're selling a whole market basket of maybe 80 product lines to those guys, and their technicians don't buy 100 systems today. They buy one system today with 14 other things that go with it from us.
Right.
The OEMs are not in theory selling the product to these guys. They're reacting to a price need. Our cost is then adjusted to what it needs to be to make an acceptable margin when we pass those products through the channel.
Right
to them.
Right.
That's been done that way with builders for my entire career. That's what's been done with national accounts my entire career, warranty companies, and there's always been a segment of the market that is price negotiable, if you will.
Yep.
Thankfully, cost is negotiable in those situations for us, and we share in the merchant risk of that with the OEM. It's not all our risk. It's not all the OEM. I'm also getting to sell 15 other line items that support that business from a profit perspective. The cost to serve is less 'cause I'm not gonna send that guy on a trip to Portugal if he buys enough from us. He's not asking for that.
Right.
He's not, you know, it's a different cost to serve for that business as well and we support it.
One more for you. Pathway to 30% gross margin, is that still a, you know, a longer term target for you guys?
Yeah, go ahead.
Building blocks.
It is. We just made it public, and so it better be, and operationally it is. The biggest driver along that journey to get us there is we've invested in pricing technology that is very sophisticated, and it is helping us enhance our transactional margins and what we, you know, we've. A good bit of the margin trajectory and the margin profile of Watsco over the last 3-4 years and the gains that have been achieved have been driven by that pricing optimization technology.
I don't like the word structural, but I think it's very durable, and I think when I look at where we are in that journey of internal adoption of that technology and how many customers is it influencing, how many businesses is it influencing, how many SKUs is it touching, we're in the middle innings of that journey which is to say that there's still room to go and 30% is absolutely a target and absolutely achievable.
Okay. That's it. Thanks, guys. Really appreciate the time.
Thank you very much, everybody.
Thank you very much.
Appreciate it.
Thanks, Steve.
Come to Miami and visit.