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

Great. Hello again. Sorry for the delay. This is the Watsco presentation. I'm Ryan Merkel from William Blair's 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 at williamblair.com. With us today is Barry Logan, Senior Vice President. Watsco is the #1 distributor of HVAC and refrigeration products in North America, operating over 650 locations and serving over 300,000 contractors. I think we'll skip opening remarks, and we'll dive right into Q&A.

So Barry, first off, can we just get your view on the consumer and the state of the HVAC industry?

Sure. Again -- well, first, if I owe you guys 8 minutes, just call, then I'll spend at least 8 minutes with you.

Fair enough.

No, the state of the consumer. Well, again, it's been really almost -- since this time last year, there's been this kind of very consistent progression of demand. Once contractors felt comfortable kind of going into backyards and closets and then attics and basements and dealing with issues because the machines are machines. They don't know what was going on. If they break or need repair or service or replacement, the barrier was not the machines, the barrier was the comfort level of homes and contractors working together, so to speak. And so that started playing out in a positive way a year ago. There has actually been no change, absolutely no dip, no variation in the consistency over the last year. And I think, in March, we said that overall, residential was up 18% on a 12-month basis. And again, things are strong. So there is 2 things going on from our point of view. A homeowner awareness. The machines are breaking at the same rate they would have otherwise. They're not breaking faster, they're breaking at the exact same rate. But I think there is some thought and some awareness and some meaningfulness going into decision-making. Just as everything in the home right now probably has a similar amount of altered discretion going on in terms of what do we do, what do we spend, what do we invest in, how much money do we have, how much credit do we have. And part of that either the idea that Home Depot is up 20%, 30% in sales as well. It's a very similar dynamic, I'm sure. And so you have some inflation going on, which may be a small fragment of that. But the other thing you have is contractor confidence really is at an all-time high from what we can tell, people we talk to, the creditworthiness of what we're seeing. The mix -- the product mix has always been a leading indicator of contractor confidence, walk in and saying, here's what you should do. Here's what you need. Here is what I would do, if I were you. Here's what it cost. Here's how we can help you finance it. That seems to be just riding a wave at this point. And so, yes, that's the good news is we're already in May, beginning to have lapped some of what we were seeing. And I'll say it again, to some extent, early on here in the summer that the trends remain very strong. So I think the state of the consumer, Ryan, is still this greater awareness, greater commitment to do something and the contractor's willingness to play its merchant side and recommend those products. And of course, we're doing some things internally to bring value to that equation, something we didn't do as much a year or 2 ago, but now a very valuable part of our technology is bringing those products in a more professional way to the homeowner.

Right. Okay. Sounds perfect. So the follow-up that I have is, one of your competitors said that stay at home and work from home is causing people to run the AC units more. And then on the margin, they're replacing more than fixing. What do you think about that? Is there some truth to that?

Well, we try to determine with data if the first part is true. Are people running their machines longer? Are they breaking faster? So the only people that really have that data other than anecdotal data or people like Nest, who are actually measuring it, and Honeywell and ecobee, which are some of the people we represent. And thermostats, that is not IoT device, it's actually measuring usage. So we asked them the question, what are you seeing? And they said, a little bit more, but it's not like this material thing that seems to be a phenomenon. And I think if people are spending more time at home, and then they're simply more aware of what's going on in their home and have a chance to make a decision of what they should be using and having health-wise, comfort-wise, utility-wise. Yes, I think there's been a greater awareness of what they should be doing. I don't think from what -- at least that one data stream, it doesn't seem like they're breaking faster. But the idea of repairing versus replacing, there is some truth to it, I think. Again, because contractors at the end of the day are the ones really recommending the solution. Our OEMs do not recommend a solution to Ryan at his home, the contractor is doing that. And that recommendation confidence level, I think there is truth to maybe that replacing is going on more often because there is a value to it and awareness to it, but maybe it was not as important as it was pre-COVID.

Right. And the data seems to be bearing that out. I mean you look at AHRI shipments like I do. I know HARDI is a small part of the industry, but some of the numbers are just really, really strong. So I guess time will tell. So the other question I'm asking everyone, Barry, is just comment on if you're seeing any supply shortages of equipment or parts, and if there's been any impact to your business.

Yes. I think the whole supply chain has gotten only better since last fall. Last fall was when I think there was this gap in the demand flow that we were seeing out of our stores versus what we were receiving into our stores in replenishment. Lead times pushed out. Lead times is really the key measurement in this discussion. We're pushing out 60 days and somewhat uncertain at that level. Today, they could have come back in line. Not quite to what is typical, which is typically 30 days, but near 30 days. And I would say, it's far improved, Ryan. We're not seeing either the shortages or the stress that we saw, let's say, 6 months ago.

Okay. And as a follow-up, this is a loaded question for you, Barry. You'll probably dodge it, but which OEMs have been able to keep up production? And which ones are having problems?

Well, we don't represent all 7 primary OEMs. So I can't handicap all of them for you. It's good public knowledge between Carrier, Rheem and Goodman. They would be our top 3 manufacturers for air-conditioning equipment. Manitowoc for food service. To a lesser extent, Trane is a -- provides us product in some of our markets. Again, I wouldn't say there is a distinction at this point to make. Goodman has caught up. They chose to prioritize large customers last fall. I don't think we really missed very much in terms of the Goodman relationship. They chose to concentrate on the largest partners, which we're one, and I think we worked through with them pretty well. So I don't think anyone is at a -- well, a disruptive kind of place right now. I think everyone is still catching demand, but that's a nice problem to have. It's not like the supply chain is disrupted in some way.

All right. Then the other top question. Obviously, you're seeing a lot of inflation, both in the equipment and some of the parts and supplies. Have you been able to push price to cover these cost increases? Are you confident that you'll have positive price/cost or at least neutral price/cost in 2021?

Answer is, yes. I mean we reported in the first quarter with the early season -- or the pre-season price increases. We yielded about 2% price increase for us in equipment. And obviously, that -- there is no thought that, that doesn't carry through the rest of the year. Incremental equipment price increases are coming online in June and July, depending on which OEM. And again, the answer is always, we'll see about the secondary price increase flowing through. But -- and then parts and supplies, things like sheet metal products that we sell, copper tubing, refrigerant have had inflation going on, especially in the spring. And yes, I mean, the price goes up. Our cost catches up. So there is a period of time we're actually making a little bit of a higher spread on our products that neutralizes and flattens out as the year goes on. But what we call selling margin, which is strictly our markup on products we sell, has been positive since the beginning of the year. So I don't see any particular gap or risk in price/cost at this point.

Right. That's great to hear. So in a post-COVID world, Barry, how is Watsco thinking differently about its business strategy?

Well, it's interesting. There is probably 2 concepts there. First is the customer experience that we were looking to revolutionize the last 3 years has only either meant more to those that are using the technology, and we see almost no attrition in those -- that user community. We see higher growth rates, which means that they're either growing at a faster rate against their competition or we're getting more of their business every day, 1 of 2 things, which is -- and there is no attrition. We're not having to kind of fill the bucket back up from what we might lose year-to-year. So the idea that we invented this stuff a few years ago and now we're seeing some real benefits in the user community is a gratifying thing and a valuable plan. And then -- so the concept is, what we're contemplating every day is, how do we double the number of users. How do we go beyond where we are, not just in incremental steps, but in bigger jumps. And is that investing in more salespeople, is it creating more training programs, is it -- how do we influence the usage. And of course, in the middle of the summer, where it's gangbusters, that's harder to do. So in the off season, as we get out of the season this year, the next incremental jump-in and adoption is something we're going to focus on. And not just because it's good to do, it addresses a lot of the concerns people still have post-COVID. The other is, I think every company, including William Blair, is probably thinking about this. What does your cost structure look like after 12 months of weirdness, right? After 12 months of austerity in some way or thinking about what you really need to do and should do, what's the scope of cost that you really can have going forward. So at the branch level, we're spending time really understanding that. And we've already seen the benefit of austerity in our SG&A, and how you make that either permanent or culturally different going forward is what all of us are challenged to think about.

Okay. I want to dig in on your app a little bit and really your broader technology suite, but the app, I think, is central. Just talk about what you offer the contractor and how does it improve their business.