Watsco, Inc.

Good morning and welcome to the Watsco second quarter 2023 earnings call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero on your telephone keypad. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Albert Namid, Chairman and CEO. Please go ahead.

Good morning, everyone. Welcome to our second quarter earnings call. And this is Al Namid, Chairman and CEO. And with me is A.J. Namid, the President, Paul Johnston, Barry Logan, and Rick Gomez. Now, 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. Watsco delivered a solid quarter against a challenging backdrop. It was the second strongest quarterly performance in our history which is about 50 years, only surpassed by last year's record-breaking second quarter when sales were up 15% and earnings per share was up 33% last year. Our teams executed very well to generate this quarter's results, which came with considerable challenges, including product availability, as mentioned in our press release. The product shortages are a consequence of an immense product transition that is playing out this year following the step up of minimum efficiency standards mandated across the United States. Approximately 60% of the equipment we are selling today represents new or revamped products. Pricing capture and margins consistency have done well, as evidenced by our gross margin performance for the quarter and the year to date. We are converting inventory and balancing our product offerings across our footprint. We have trained thousands of customers on the new products. We have updated our digital library to include all of the new products, adding over 400,000 new SKUs since the start of the year. The transition, however, has been uneven. One of our primary OEM partners was disproportionately impacted, affecting product availability of higher efficiency systems and therefore affecting our sales. We estimated a second sales impact of $75 million to $80 million, as much as $125 million for the six-month period ended June 30th. The reality is all of our OEM partners have been affected to some measure, and all are working to improve supply chain and help us meet the needs of our customers. As we mentioned, beyond the tough comps and supply chain issues, the arrival of a hot summer weather was delayed this year as evidenced by the decline in cooling degree days. Cooling degree days is measured by the U.S. government, so we have a lot of information as to demand for cooling systems during the year. Summer has now arrived, and current business conditions are encouraging. Apart from the product transition, which largely affected our residential business, other facets of the business are performing very well. Our commercial business continues to grow strong, double digits this quarter, and our backlog of projects extends into next year. Sales of ductless systems, an increasingly important component of our business, also grew double just during the quarter. We saw the continued trend of gas furnaces converting towards heat pumps, which we sell at higher average selling prices. Gross margins held firm this quarter at 28.1, reflecting our disciplined mindset around price and continued progress on our investment in earth. pricing technology. We also exhibited good SG&A discipline this quarter and we are optimistic about driving more operating efficiencies across our network as we move through the years. Through the year, I should say. And of course, our balance sheet remains strong with little net debt at the peak of our seasonality. As always, the financial position provides us flexibility to invest in virtually any opportunity and as we continue to grow and scale in a very fragmented $50 billion plus North American market. We continue to look for acquisitions. Wattsco is a great home for entrepreneurs in our space. We sustain cultures, invest in people, and provide technology to secure and build on their great legacies. Looking beyond the short term, Our press release provides critical details that support Watsco's long-term growth trajectory. We have immense technology advantage, and we are investing to grow with that advantage. Our mobile platforms and e-commerce channels have increased customer engagement, reduced attrition, created market share gains, and supported our margin expansion in recent years. Watsco's broad array of products and brands It's a competitive advantage that allows us to serve contractors in any environment. We have a leading market share position in some built markets that provide stability and high growth rates over time. In addition, there are several important regulatory and industry catalysts that are developing. For example, the introduction of higher efficiency standards for HVAC equipment for HVAC equipment has taken a full effect this year, providing price and sales mix benefits. New refrigerant standards historically has made it harder to repair existing systems and benefits our sales of replacement systems. In other words, whenever they change the refrigeration mandates, it makes it very difficult to repair what you've got, so they generally go and buy a replacement system. The phase-out of current refrigeration began last year, and the launch of new equipment that conforms to the new refrigerant standards is scheduled in 2025. We also see continued progress toward electrification and greater adoption of heat pumps, which higher average selling prices. Finally, we expect the Inflation Reduction Act's enhanced tax credit and consumer incentives to help upgrade HVAC systems in the years ahead. All of these catalysts will benefit the industry in the coming years, and we certainly believe our scale, technology, and financial strength positions us to capture these market opportunities. With that, let's go on to questions and answers.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you're using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Ryan Merkle with William Blair. Please go ahead.