Watsco, Inc. (WSO) Earnings Call Transcript & Summary

Okay. Good afternoon, everyone. Welcome to the Watsco presentation. I'm Ryan Merkel from William Blair Research Department. Before we begin, I need to remind you that a complete list of disclosures and [ conflicts of interest ] is available on our website. With us today is Barry Logan, Senior Vice President. We also have Rick Gomez, Director of Corporate Development. Watsco is the largest distributor of HVAC and refrigeration equipment in North America, operating over 600 branches and serving over 300,000 customers. With that, Barry, let me turn it to you for some opening remarks, and then we can dive into the Q&A.

Thank you very much. I am -- as I mentioned it right earlier, I'm in my dining room camped out, and it's nice to have short salad while I talk to you today. I did put on a collared shirt just for record, just [ a forward mention. ] It's nasty and high humidity and severe outside. So it's a good way to be today. Again, I'm Barry Logan from Watsco. My 28th year doing this. I think we've been doing the William Blair growth conference for probably at least 20 years. And so we appreciate always being invited, and it's a usual circumstance of doing it through video. So glad you're here. Watsco is a distribution company. We sell air-conditioning, heating products throughout North America, $4.5 billion company. We were zero 31 years ago. We really developed a strategy of first buying good companies, keeping families involved, keeping their leaders involved, keeping the names, keeping the culture, keeping the substance, really that built businesses, and then challenge those families after they sold the business to us to grow their business. So first 10 years, we did that. We built a billion dollar business after 10 years from 0. In another 10 years, we built a second billion dollars of revenue through largely the same aspects of culture. And we became multibrand manufacturers, multi-OEM -- I'm sorry, multibrand distributors, multi-OEM distributors, which was a new concept at the time in 2008, '09. And during the financial downturn, we were fortunate to have Carrier and United Technologies approach us about buying their factory network. We said yes, but let's do it over a period of time. And over a period of time, we became a joint venture partner with them, and doubled the size of our company. And -- so this nice progression of building a network today, it's around 15% or so, a little less than 15% of the overall market. We still have about 20 states where we do not operate at all. We still are not representative of all the OEMs that we would like to represent as a matter of diversity. So we limit ourselves to North America. We still limit our thinking to HVAC and refrigeration. In markets where we are, I think, farther along the curve of maturity, we have north of 30%, 40% market share in some markets. So if we apply any of that math to a $35 million, $40 million HVAC market, we can be a considerably bigger company, which is our intention. In recent years, we developed, really, a new thought process for the industry, and that is how do we bring technology and modern tools, modern processes, both to our own business. How do we modernize our business through technology? And our other choice was, how do we modernize our customers' experience in this industry. So we chose to do the latter. We started with our customer first. How do we modernize all of our relationships, all of our interactions, all of our services to help our customer. How do we help them first. Then long term, we'll think about how that helps us. So we developed really a suite of technologies to help, again, our contractor customer really behave differently every day. I use the term A Way of Life. How do we help our customers' way of life and their daily activities? And every homeowner that has air-conditioning, every business that has air-conditioning or heating has to have it. It's not going to go anywhere, it's not going to be impacted by the economy. That requirement, that necessity doesn't change and nor does the contractor who is the one licensed to do the services for that group of users. So that was our priority, was customer first, and I know we'll speak to as we get through the call. The second priority was -- but still a priority was, how does it help us? How do we improve the cost of our operations? How do we improve the cost to serve customers? How do we get efficiencies over time? How do we evolve our own processes to be faster, better, cheaper in a sense of operating our business? So those are really the 2 priorities. And then the third priority became, and is, how do we help homeowners and businesses actually get these services. It's an $80 billion market at the consumer level. How do we help the average homeowner with a better experience that will matter to us and to our customer, and ultimately, the OEM that we support? So if we can actually devise strategies and technologies and processes that go all the way through the channel, it's a very interesting thing. And we also have always said, we're double the size of our next competitor. We're probably 3 or 4x the size of our fifth largest competitor. And there are 1,300 total independent distributors in the country. And as we drag our OEMs into the technology world, and we have, as we drag our customer into it, as we push more on the consumer, more and more of those independent distributors that are generationally owned and have been around for 30, 40, 50 years, how can we influence them to join our network, join our culture and pull them into it as well? So last year, we acquired 3 businesses that I think the youngest of which was 50 years old. We acquired a business last year that was 93 years old -- that is 93 years old. And this idea of bringing a community of legacy distribution companies into our family of thinking and long-term thinking is what our -- really, our M&A mindset is today, is how do we not just buy companies, how do we bring what are largely these regional dominant family legacy businesses into this broad technology thinking that we're doing. Last year, we've had a few takers. And in fact, we asked one of the families to write our annual report in 2019. On Watsco's website, it's got to be a rare occurrence to have an acquired company's family write your annual report for you, and we chose to do that to really communicate our strategy as well as -- and maybe inspire others to do that. And Rick and I are making the rounds here in the spring time to do just that, and wish us luck because it's the way we can build our network much larger over a long period of time. So those are some broad strokes. Inevitably, we'll get the question about current state of the world. And again, I've said this for many years, air-conditioning and heating happens to be mechanical equipment. The precise number that we're going to break as we speak, no influence from anything relative to the physics of these machines breaking. So the variable is not the number of units that we might have the opportunity to sell. The question is, what will they -- what will somebody pay for them? What will contractors recommend? What will consumers ultimately do? And in April, we talked about the business being impacted by shutdowns, close downs of, really, markets. Our stores never closed. Our phones never stop being answered. Our [ sale ] never stopped talking to customers. And as I said, the same number of machines were breaking. So despite some short-term disruption, ever since the -- really, the end of April, we've seen this progression, this migration of business that momentum occurring June, July, August is what matters in our summertime performance. From a timing point of view, if we were going to dig a hole, I'd rather it be dug in April than in June, July or August because now we are seeing that momentum. We are seeing, especially in markets where the sun is shining and it's nasty outside, we're seeing some instant gratification with retrieval of business. And of course, that's all short-term stuff. The long-term over the course of the rest of the year needs to play out, but we feel better today than we did a month ago, and better than we did a week ago in that regard. So -- but, again, it's still early in the season to fully feel like a recovery is there, but from a point of view of momentum, it's been pretty strong. Technology, the last phase of our discussion, and then Ryan, we can move on to some Q&A, is we -- every company has thoughtfully wondered about what do I need to change, what do I need to -- what have I been putting off, what maybe sacred cows have I protected for too long? I think all companies are going through that self-awareness campaign to evaluate performance. So have we. At least I -- we'll be the ones that fully admit it, and looking at every costs, looking at every process, looking at every mindset that creates cost, we evaluated, and I think we've been aggressive without being foolish. We've been medium to long-term thinking, versus short term, but we are going through that process. Our costs will be lower this quarter. How to sustain those cost reductions play out will depend largely on what our business is doing. But we certainly use this as a way to improve our cost structure in a more accelerated way than we might have otherwise. I think most businesses are thinking that way, and we have as well. The other acceleration that we've had in mind is, how do we teach, train and coach our customers on an accelerated basis, all this technology. So it's not just for users that wanted to use it, but the users that were curious about it that could now jump on the bandwagon. So we've done a lot of training, a lot of engagement. We've accelerated our touchless experience, which is all on the road map. Curbside-type pickups, drive buys where contractors don't even get out of the truck. Touchless payment, which is a -- which would be a new concept in this industry to actually allow customers to pay for things without even taking a credit card or cash out of the wallet. Again, all in this idea of not just safety, but efficiency. How do we get customers in and out in a few minutes versus 20, 30 minutes? And if we do 7 million transactions a year, we're saving them time and ourselves time as well as addressing kind of the safety realities that we're operating in. So that customer engagement is now tracked. We've launched, this year, a sales force type platform to not just keep a score, but keep track and bring data to all of our customer engagement, the number of calls, the follow ups, the reasons for the follow-ups, the structure of how we address customer engagement has evolved this year, even more so in recent weeks. And that data is also shared with the manufacturers that we represent. So they're more engaged at a detailed level and organized fashion than they ever have been. So there's a lot going on, and we're seeing some of the benefits, I believe. This is a time where I think if you're a multibrand, multi-OEM, multi-location, diverse and technology, we have a chance to gain some market share where this adversity becomes something to our advantage. So we'll see how that plays out, but those would be my thoughts to get started.

Thanks for that. Why don't I just hone in on what you said about near-term trends you're thinking about? Are you seeing some momentum? Is it that the harsh states or the harsh restrictions opening up? Is that the main driver in your opinion of improved sales? Or is it equally as important that the consumer is letting the HVAC contractor into their home again?

I think in the Sun Belt where we saw -- summer began a few weeks ago, it was a matter of necessity, but the services play out either in your home or in your backyard. And the contractor needed to instill confidence in the homeowner to do that. They're all better at it. They're all -- I think it's -- again, there is a bigger health crisis of people try to live out air-conditioning in Florida. Maybe not bigger, but the trade-off is not good. So I think we did not see the volatility in the Sun Belt as much as the North tier point. But where we're seeing recovery is also in the Sun Belt in terms of growth rates. The West Coast would be an example of that. California, Arizona and Nevada, where temperate climate until the last few weeks. And people maybe could kind of put things off or maybe they didn't turn their machine on in April or May. But when it got hot out there, it was a light switch, and there was instant impact and instant gratification for being in this industry in that market. Northeast has been the more peculiar one. First, it was, I think, snowing in Boston 3 weeks ago, for God sake. And it is a little bit higher commercial component to our industry and our business in that market. We disclosed last year, the Northeast is about a $700 million market for us, put things in context. And again, the closings, the job site impact, the fact that it was winter until, I think, 6 weeks ago, a month ago, again, in recent days, in recent -- probably the last couple of weeks, again, more instant gratification as the sun has come out. I can't speak to the Midwest or the Pacific Northwest. It's not our -- we're not in those markets, but that Philadelphia to Boston corridor has woken up as the sun has come out and some of the restrictions on job sites on the commercial side have eased. So again, all that can feel better, sustaining that through what would be our typical -- through the third quarter selling season, we'll see. But as I said, we're happier than we felt a month ago.

Thanks for that. And let me follow-up with a question on pricing. Has the channel stayed disciplined? Is there any movement, one way or the other?

We're not seeing any big impacts on pricing. The pricing and kind of the economic equation was set earlier in the year. It feels fairly disciplined through the channel at this point. We -- the OEMs who can react to price or create pricing in a market, I think, has stayed really disciplined. I don't think there's been a reason to -- for it to become volatile. And I think my other comment earlier about what does the consumer decide to pay for a new system. It's not our doing, it's not the OEMs discipline. It's -- what is the contractor able to accomplish in the home without losing the job. So I don't think we see discounting really ever as a risk in a replacement market. What we can see is mix, what brand will they install, what level of extended warranty might they offer, what pushes the consumer to say yes. And the contractor is the one largely making that decision. Our job is to support that, to support all the brands, all the price points, all the decision making that might go on. And that's where we feel very good because in all of our locations, we have multiple brands, we have multiple price points, not everyone does. And so again, I think it's a good chance for us to gain some share.

Okay. You talked a little bit earlier about technology. You're a few years into it, as it relates to e-commerce. What have you seen over the past couple of months? Has the COVID and the health crisis boosted e-commerce sales?

They have. So there is 2 -- really 2 critical metrics. And the first is, just how many contractors are using all the tools of our mobile platform, not just e-commerce. The idea was to get more and more customers using it every day because we see very little year-over-year attrition for those that are using it. Whether they're using it for e-commerce or finding products or getting a price or looking at the warranty, whatever the functionality might be. So at the end of last year, we were around 17,000 active users. Now it's over 25,000. And it's hard to know what it would have been without this stuff going on, but we've made a very concerted effort with our sales force, with our store personnel who can be more engaged in that respect with customers right now because they're not all driving around bringing coffee and doughnuts to their customers. They're engaged in different ways. And again, we digitized that engagement process to also know what's going on and track it. So that's where we're seeing the benefit, is more users. On the e-commerce use itself, again, we're pushing into the 35% range versus around the short of 30% at the end of last year. That's more of a productivity, feel-good thing in terms of knowing that ease of use, ease of doing business, convenience in new business is increasing. And at the end of the day, though, it's the user community that we're looking to really expand because two things are true, looking at the data. Last year, our user community grew over 10% with us, and our same-store sales were around 4% or 5%. So the user community does grow at a faster rate, and there is almost no attrition year-over-year in that community. So if we had fun with those variables over the next 3 or 4 years, it's exciting for us, to be honest. So the other part of the engagement with customers is expanding, our platforms that actually go into the home without going into the home. So there is a platform called OnCall Air, which is our proposal software that's almost a contractor develop a point-of-sale capability on an iPad or on a -- now on a Zoom screen. I could talk a homeowner through a proposal I'm making for their house on Zoom, show them the good, better, best, show them the choices they need to make, have them sign it, have them prosecute a warranty on it or finance it. That's another layer of technology more recently is leasing in a consumer financing tool into that virtual technology. All things that used to happen with paper and pen and kitchen table. So we're pushing more and more of our contractors to, again, not just use the technology, but make it part of their business, make it part of their daily life. And our take is, the more we do, the more -- again, the more growth and the more stickiness that happens over periods of time.

So e-commerce is going to get a boost from COVID. Any other long-term tailwinds for Watsco or the HVAC industry in a post-COVID world?

Yes. I think in the commercial market, there is a lot of rhetoric about endurer quality and filtration and air treatment and so on. I mean those products have been around for much of my career, and there were kind of add-ons or -- that were made. And probably most new schools, new hospitals, new whatever are built with those as integrated into it. What about the 10,000 schools that don't have it? So I think in the commercial market, the OEMs, in particular, are devising ways to make those products more ubiquitous, to make them -- and where we sell those products, we'll partner with our OEMs and our customers to push those products. I think that's a longer-term prospect because when you're talking about retrofitting systems or engineering something into a current system which has a timeline to it. But the good news is, it's something new to sell. They're not commodities. They're things that we can make a good market as we [indiscernible]. Residentially, I think, again, they're into our quality product list, and we'll sell more of them. It's a smaller ticket today than -- relative to the full system, but it's an opportunity, right? I think commercial -- the commercial market is where the bigger opportunity is.

Okay. And then why don't we talk about M&A for a minute? When do you see M&A activity picking up? And then has this crisis pushed sellers to come to the table?

Well, it did pick up last year. Obviously, we did a few good transactions, and we don't report how many conversations we had that didn't flow all the way through because people were still thinking about what they wanted to do with us. So we entered this year with, I would say, the momentum of good conversations of people that we, in earnest, were talking to, I think the COVID stuff doesn't paralyze that. I think it pushes it more into later this year when both us and these companies feel like there is a comfort level in terms of business trends. They're absolutely not going to wait 50 years to sell us in a middle of weakness nor do we necessarily want to buy something in weakness. We'd rather buy when we're comfortable, and when they're comfortable. It mitigates risk thereafter. So again, to be more direct, some good targets, some good discussions, I think it will play out one way or the other as we get through this, not during the current cycle. Not during -- no one's desperate to sell. Good companies are trying to find opportunities in this, not sell their company and weakness. And those that have been weakened by it may not be good companies to acquire. And maybe in those markets, we talk to our OEMs, we -- and find ways to maybe expand our product network or brand network in ways that might be helpful in terms of expanding the presence, and we're doing some of that, too.

We have about one minute left. Why don't I just ask about international markets, which were a little softer in 1Q? Can you just give us an update there on the outlook?

Sure. Well, to be clear, our international market is Canada. That's the biggest one, about $250 million out of our $4.5 billion, about 5% or so. Mexico and exporting products to Latin America is the rest, and it's about an equal sized amount, around $200 million, $250 million. I would say, it's improved from the first quarter, but the domestic market is still recovering faster. We have largely commercial markets or as -- I should say, a bigger proportion of commercial markets internationally. And again, the commercial business overall has been, I think, more impacted in the U.S. and internationally. And we also have a stronger U.S. dollar, which means U.S.-made products are more expensive in those markets. And we have a certain amount of inflation that has to be dealt with. And so for those reasons, the international market is probably in a slower recovery mode, but it's better than what we saw in the first quarter.

Perfect. Well, guys, we're out of time. Thank you so much for participating in our conference. Talk to you soon.

Thank you, Ryan. I appreciate it very much. Bye for now.