Watsco, Inc.

Hello, good day, and welcome to the WESCO Incorporated Third Quarter Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then 1 on a touch-tone phone. To withdraw your question, please press star, then 2. Please note this event is being recorded. I would now like to turn the conference over to Albert Named, Chairman and CEO. Please go ahead.

Good morning, everyone. Welcome to our third quarter earnings call. And this is Al Namit, Chairman and CEO. And with me is AJ, President of Watsco, Paul Johnston, Barry Logan, and Rick Gomez. Before we start our normal 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 in the forward-looking statement. I am pleased to report that Watson generated healthy earnings and record cash flow despite a very challenging market environment. As we all know, 2025, a year of significant transition to next-generation equipment containing A2L refrigerants. The transition affected roughly 55% of products sold and influence most every aspect of our business. Regulatory changes have historically been good for our business and good for our customers. In the long term, we expect this transition to be no different. The transition is substantially complete, and we look forward to operating a far simpler business in 2026. Throughout all of the volatility, we are satisfied that our earnings are largely intact Our balance sheet remains strong and our technology advantages remain immense. We certainly expect the volatility to be as temporary and will ease as the transition concludes. We operate in a great industry with strong long-term fundamentals and have the industry's most accomplished leadership team, all with long-term focus to keep building on our success. Turning now to our third quarter results. Sales declined 4% in total and 3% in the U.S. While unit volumes remain subdued, we achieved double-digit pricing gains on the new products with growth in sales for both non-equipment and commercial refrigeration products. We again improved gross margins, which expanded 130 basis points to 27.5%. As we have expressed before, we have several ongoing initiatives to enhance gross margins with long-term goals of exceeding 30%. Operating expenses increased 5%, reflecting a measure of ongoing inefficiency tied to the product transition, as well as new and acquired locations. With the product transition largely behind us, we expect SG&A performance to improve from here. We continue to fortify our balance sheet, reducing inventories and overall working capital. We generated record third quarter cash flow of $355 million, an incremental opportunity in the fourth quarter as we close out the year. We remain fundamentally positive and optimistic about our position in the industry and our ability to generate growth. Our balance sheet has a healthy cash position and no debt, providing us with opportunity to invest in most any size growth opportunity. This includes the capacity to co-invest with our OEM partners as well as heading to 2020 as we head into 2026. We also continue to invest in innovation and technology that separates us from our competitors. We have made long-term progress in driving adoption. I should say we have made terrific progress in driving adoption. For example, e-commerce penetration continues to grow and accounts for 34% of our sales and up to 60% to 70% in certain U.S. markets. Let me say it again. e-commerce penetration continues to grow, and it counts for 30%, 34%, I should say, of our sales at up to 60% to 70% in certain U.S. markets. The number of contractors and technicians engaged with our mobile apps now stands at 72,000 users and grew an impressive 18%. That means that 72% – I should say 72,000 of our customers are using our technology. The annual run rate of sales through OnCallAir, our digital selling platform for contractors, saw a 19% increase in the gross merchandise value of products sold through the platform and reaching $1.7 billion over the last 12 months. We are also making next generation investments to enhance our competitive position. For example, we are developing new technology aimed at capturing more sales from the institutional customer. We are accelerating the use of pricing optimization tools to make progress toward 30% plus gross margin target. We have launched a new initiative to compete and grow sales in the highly fragmented equipment non-equipment, I should say, non-equipment market, which today is roughly 30% of our sales. And we have begun to harness the power of artificial intelligence, both internally and externally, offering potential to further transition our customer experience, improve operating efficiency, and create new data-driven growth strategies. Our technology investments are making a big difference, and we believe The impact will only grow with time. We look forward to sharing more during our upcoming investor meeting in Miami in December. I can't wait to see and meet you all this December. These investments, along with our scale, entrepreneurship, culture, and capacity to invest are unmatched in our industry.

With that, let's turn to Q&A.

We will now begin the question and answer session. To ask a question, you may press star, then one on your touchtone phone. If you are 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 two. At this time, we will pause momentarily to assemble our roster.

The first question comes from Tommy Moll of Stevens.

Go ahead, please.

Morning, Tom. Morning. Morning, Alan. Thanks for taking my questions. Of course. I want to start with a question on the repair versus replace dynamic. It's been a couple quarters in a row now where your non-equipment business trends have been well ahead of the equipment trends. You've obviously been very disciplined on pricing for the new equipment, and so I'm curious, is the simplest explanation here just that we're seeing some price elasticity among homeowners, or is there something else you might call out? I'm going to let Paul Johnson respond to that.

Yeah, you know, it's not a repair versus replace. It's repair and replace. I think we said that on the last call. What we've seen is the larger dealers that have salespeople generally don't sell compressors and motors. They generally sell the equipment side. And what we see with the people that don't have an in-home salesperson is they will repair the unit. So we see a dichotomy there amongst our customers. Also, there's a geographic spread where if you're in Illinois or, excuse me, Pennsylvania, and you've got an 11-year-old unit in your house, you're generally going to repair it and not replace it. It's got a 20-year life. In Florida, Texas, where you've got a shorter life, I think generally you're going to replace it with a piece of equipment. So it's really difficult to put your finger exactly on where and who is creating a repair versus replace market.

And just some data behind that. When we say non-equipment, there are really two things that are not equipment, parts and supplies. That may be a more direct way of calling that category something, parts and supplies. So parts basically is 8% of Watska's revenues, parts. And supplies, everything else, is over 20% of Wattsco's revenues. So just in the scope of the bandwidth of that discussion, parts will never substitute what's happening in the replacement market in that discussion. The data just isn't there to support that. So at the end of the day, it's the consumer that's spending... $8,000, $10,000, $12,000 on a pair of new machines for their home. As Paul's suggesting, where we see in the Sun Belt, that's a more frequent purchase and a more ordinary purchase and a more necessity purchase. And we do see some differences as we go north of the Sun Belt. So we do like it that Watts goes 75% in the Sun Belt in that respect. But it's really, I think... More of the crux of the answer is built on what are consumers spending on their homes right now? And that's probably the bigger orientation to this than whether we're selling more compressors or not versus the replacement market.

Yep. As a follow-up, maybe we'll address the elephant in the room here. Maybe just take it on directly. Yesterday, Carrier mentioned that their October distributor movement was down 30% and that they expect something like down mid-20s for November and December. Does all that sound reasonable enough in terms of what you have seen or expect to see for your equipment business this quarter? And should we think of that in terms of volumes or sales?

Well, that's a very good question.

And I don't think we're out of the woods yet, so there's some merit to that. Who wants to add more to that? Is it you, Paul, or AJ?

Yeah, I think it's pretty much in line. You've got to remember that the shipment data that you're seeing was up last year as a lot of the OEMs were shipping all that 410 in. So the shipment data coming out of HRI really isn't going to be indicative of what's going on in the market. But when you look at the actual unit sales, you know, without the price increase, I think they're pretty much in line with what the market is showing. Now, that's going to vary from region to region. Once again, we're seeing some real strength in certain parts of the country and we're seeing definite weaknesses in others, you know, and so it's not across the board.

But in aggregate, we are not seeing increase in demand. No. It's the fourth quarter. In aggregate, it's still below this time last year. Now, this time last year, it was an extraordinary quarter. But nevertheless, we're seeing that and we're dealing with it. We're getting more productive in our operations and more efficient. given the lower volumes that temporarily are lower. And we are adjusting to the circumstances.

Tommy, just to clarify one aspect of that is that the 20% to 30% is unit volumes, not sales dollars. I want to be clear about that.

I mean, just to nod a little bit of therapy about it, just to be, again, very direct about it, so we're clear. A year ago, fourth quarter, unit volumes for Wasco were up almost 20%, between 15% and 20%. And a year later, the variance is going to be exposed to that comparable, right? And then after the fourth quarter is when things started to become... I would say less extreme in that regard. So I think the fourth quarter a year ago is still in the context of the transition started. The 410A availability was at its peak. The contractors, builders, national accounts, whoever it was, was drawing on distribution for 410A because they could get it. And it's really the last of the cyclical things in this discussion, I think, about the transition is the fourth quarter. Now, it's the smallest quarter of the year. It's off-season, and there obviously is noise in the fourth quarter this year, but it really doesn't bear a resemblance as we go forward into next year as a consequential trend, I would say. It's more about the comp a year ago than whether the market has changed any at all in the last 20 days.

Sure. I think that last, that last one summarizes the barriers of pacing. Our pacing and the industry pacing is roughly the same. The COP changes in Q4.

Thank you all for the insight. I'll turn it back.

Rick, is there something you want to add with the work you've done?

Yeah, I think, I mean, obviously it's been a fluid market and one of the noisiest years in our industry in recent memory. And by the way, with all that noise, our earnings are largely intact. And I think that says a lot about the resiliency of our business model and of distribution in general. But if we step back, you know, let's – and examine kind of the big macro factors. We don't have influence over interest rates. We can't influence consumer sentiment or new housing completions or existing home sales. These are all things that impact the unit movement numbers that everyone is focused on. But we have control and we have influence over many other things. We have control over how many customers we serve, and that's been growing steadily over time. We have influence over our margins, and that too has steadily improved with more upside to go, we think. We have control over our expenses, and we're taking steps to improve efficiencies with the product transition now largely behind us. We control our inventory and as you can see we made great progress to improve working capital and cash flow in the quarter. We have influence on how we partner with OEMs and we're right now developing aggressive growth strategies with our key partners for next year. We control our balance sheet and of course it's never been stronger. And we control our technology, which is, I think, the most important competitive advantage we have, and with more innovation being introduced right now in real time to help future growth. So even as we navigate this admittedly fluid industry dynamic, I think we've done a great job of acting on the things within our control, and we will continue to do so.

Thank you all. I'll turn it back.

The next question comes from Ryan Merkel of William Blair. Go ahead, please.

Morning, Ryan. Hey, morning, all. I want to follow up on the fourth quarter. Could you just comment on what you've seen quarter to date in terms of total sales? It's soft. Okay. Gotcha. So, yeah, it sounds like your biggest supplier is talking about Units down 30%. It sounds like you don't totally disagree with that.

No, no, we're not. We're not in that arena of softness. Not even close. It's single-digit. It's probably mid-single-digit so far in revenue.

Okay, that's helpful. Okay, so mid-single-digit decline. And then I'm curious...

In the single digit now, and maybe a little bit higher in the start of the quarter, I would say more accurately, is it a very, what is it, 5%, 10% in that area?

Yeah, I would give that a range. It's October. It's not the rest of the year. But in that 5% to 10% range decline in dollars is how I'd characterize it.

Okay. All right. That's Not too different than I think most of us were expecting. And then I'm curious, if you talk about the third quarter, the shape of the quarter, it sounded like July started off kind of flat, right, year over year. And then from what I heard, August was really rough. September was also tough. So two-part question, is that what you saw? And then what do you think the reason is that, you know, the unit volume just fell off so much in August and September?

Barry, Paul, you want to deal with that?

I don't know. Barry, do you want to grab that one?

Because contractors installed fewer systems? I don't know what. Yeah. Yeah, I mean, again, if we consider the number of units that did decline, put it in a unit number, and then ask the question, what are the components of the unit decline? New construction is the largest component of that discussion. We can see it in, we can see our customers, we can see the special pricing we give, we can count the number of units we sell into new construction. And it was down, as a percentage, down the most in that overall discussion. And I don't know offhand if that got worse in August and September. That's a little granular for my brain this morning. But that's the largest component of the discussion. So if interest rates or home building activity or existing home sales get generated in the forward period over the next 12 months, That's an opportunity because that is the largest component of both the quarter and the year-to-date decline in units. And on terms of the replacement market and everything else, there's always a measure of consumer discretion, always, when a contractor walks in and says, this thing will cost you $10,000, $12,000. Right? And to the extent the consumer is either tighter or worried or credit crunched or more paralyzed in some way about spending $10,000, $12,000 or more on something, it's going to affect. Did that get worse in August and September? It looks like it. Is it permanent or temporary? Is it long-term or short-term? We'll see. At least in our industry's history, it's never long-term. It's always a short-term dynamic. But anyways, just some big picture thoughts on that.

Okay, I appreciate it.

I know that's kind of a hard question to answer, so I appreciate you entertaining it. I'll pass it on. Thanks.

The next question comes from David Mancy of Baird. Go ahead, please.

Morning, David. Morning, Al. Thank you. I feel like I'm in a parallel universe here. It's been 25 years coming to Watchco. This is the closest I've come to hearing guidance. It's pretty amazing. But as long as we're talking about it, the minus 5% to 10% revenue declines in the fourth quarter, we're talking about equipment only there, correct?

No, we did not get guidance. We did not give guidance. We gave a percentage of what we see thus far in the quarter in October.

But in equipment, Barry, right?

No, that's overall. No, that's overall.

Overall. Okay, fair, fair. Okay. All right. And then... You know, if you believe in the normalization theme here, you have a lot of cash, no debt, healthy dividend. You've always invested organically as needed. The stock seems to be on sale here. Is there a thought about allocating some of your cash hoard to more aggressive share repurchase at these levels?

That's an excellent question. And I've thought about it. We've thought about it. But on the other hand, the softness in the industry creates perhaps opportunities for us to do more acquisitions. Because I would say when we compare our financial strength to others, we're at the top of the heap. And there may be some distributors that finally want to venture with us, either in a joint venture or sell to us altogether. We don't know, but we have to remain open to the possibility that we may be able to step up our acquisition activity. I don't know that it's going to happen, but we have to be ready to do that. And we will. We will use our capital to acquire more distributors if we have that opportunity.

Yep. I appreciate that, Al. Okay. Thank you.

The next question comes from Jeffrey Sprague of vertical research partners. Go ahead, please.

Morning, Jeffrey. Hey, good morning, Al. Good morning, everyone. I just want to come back to inventories. It was nice to see that sequential step down in Q3. I just want to think about where we end the year. Obviously, a lot of that depends on things that you said you can't control, like end demand and the consumer and all those sorts of things. But what is your view at this point in time of sort of how you end the year, how close to normal inventories you might be, you know, as you obviously then start to pivot the focus into 2026?

Well, I would say that maybe a general reply as a state criminal, a specific fourth quarter reply. We want to increase our inventory terms. And that effort will continue into the fourth quarter and in the future. So we're going to get better at inventory turns. And that's our goal. So I think I've answered your question. That is a focus. And we certainly have the capability with our technology to do something about it. And we're doing it, as you can tell. The inventory is coming down, and it's coming down again in the fourth quarter. And the turns are slightly increasing. I'm trying to create more cash for us, and we like that.

Yeah, I like more cash, too. There's really two curiosities, and the one you're asking about is will our distribution channel at Watsco be in a more conventional position, right? And that's really almost an OEM orientation that that then asks the question, you know, has the inventory been reset in line with some kind of, you know, so that you understand what I'm saying. Yes, absolutely. And so, yeah, there's a lot of progress in the third quarter, more progress in the fourth. You could look analytically, where are we today versus history, and answer the question, and I can help you with that. But what I was saying is how does inventory affect us looking forward? What if we had five inventory turns instead of four? What would that do to our return on invested capital? What would that do to our real estate? What would that do to our cash flow? What would it do to the overall handling and load that we carry in our stores if we had less inventory and better turns? What if we had better technology with our OEMs to replenish our stock every day? Those are the things we are focused on while trying to reduce inventory by the end of the year. And you can understand that it's a longer-term perspective from our point of view. And while we're just trying to get the year-end inventory in line to have, frankly, a strong hand, a strong capital base to flow into next year. And so I think we said last quarter we were targeting $500 million of reductions by year end. And second quarter or third quarter was $350 million of that. I think we can improve on the $500 million target. It's a slower time of year to say that. But by the end of the year, I think inventories will be near historical levels versus the size of our company.

But let me say again, yeah, when we say inventory turns, we are presently at about 3.6, 3.7. We want to be a lot better than that. Very use of numbers, but he was just throwing numbers out there. I'm giving you more specific numbers. So we have an opportunity to significantly improve inventory turns, which also significantly increases our cash flow and becomes a more productive part of our business with higher inventory turns. And we have the ability to get our manufacturers to participate in that because generally we're the largest customer and we have the largest impact on the markets. And that's what we're doing with them and with our own technology to do better with what we have to achieve the higher terms. But I like it. I like higher terms and I like higher cash flow. I mean, we're at 600 million cash flow right now in the bank. I'd like to see that number get larger because I'd like to have the ability to do almost any transaction that comes our way. And I don't like going into debt for it. I'd like to have the capacity to do what we need to do with the cash we have.

Great. Well, thank you for that very thorough answer. I'll pass the baton and give somebody else an opportunity. Appreciate it. See you in December.

Good. I'm glad you're coming.

Our next question comes from Chris Snyder of Morgan Stanley. Go ahead, please.

Hello, Chris. Thank you. Hey, good morning. Thank you, guys. I wanted to follow up on some of that inventory conversation. It seems like you guys believe you'll be at a roughly more normalized level to exit the year. But I guess my question is, should we expect the normal kind of typical business ramp in inventories from year end into Q2 that we've seen you guys do historically? Or could that be more muted, you know, just kind of given the inventory backdrop? Thank you.

Well, that's an interesting question. And I can only say that we're trying to get better in the management of our inventory. So history is not... is not dependable what we're going to do as we go forward this year. I think, I think whatever we've done in the past, we'll do better. We'll do better. Go ahead, Paul.

Yeah. Think about the last, you know, five, six years in, in our industry, we've had, we had the change in industry standards on efficiency. Then we had the change in refrigerant come at us. Then we had, you know, we had the pandemic. It hasn't been normal, uh, on a lead time basis with our OEMs for the last four, five, six years. So for us to get back to normal again, as Barry was talking about, means that we order something and we get it within four to six weeks. And we don't have lead times that extend out beyond that and that the manufacturers can go ahead and supply us in a timely manner. And that's how you adapt your inventory to get to a five turn.

And we're trying to get cooperation from the manufacturer to do better in deliveries.

Right.

Whatever they have to do to deliver much quicker with less lead time. And that's part of the effort. And because of who we are and our size, they listen to us. I hope. I'm hoping.

But I think they will. Thank you. I appreciate that. Maybe to follow up on price, you know, the OEMs that have reported so far, you know, talked about an expectation of incremental price in 26. You know, maybe a bit of a surprise given what seems like affordability challenges and just overall headwinds facing the consumer. You know, I guess, you know, what is your thoughts on that? And do you feel like just given the balance sheet and maybe the absorption headwinds that they're facing, do you feel like that gives you guys better ability to push back or negotiate than years past? Um, thank you.

Well, I couldn't get how to begin to answer that question. That's a tough question. We're, we're a good customer of our manufacturers and I, I like to think that we can, uh, They will listen, and we will listen to them. We like to get along with our manufacturers, and I don't know how to answer that any better than that.

Bottom line, though, when you look at the average transaction out there, our value content to the contractor is generally about 30% to 40%. So if it's a $12,000 installation, the amount of product that we're selling is going to be in the, let's say, $3,000 to $4,000 range. So a price increase at that point is going to increase, let's say they go up, you know, pick a number. If they go up $100, you know, it's not going to be a major transaction halt to the consumer. So I really don't know what we're facing from the OEMs yet. And until we do, you know, we can't react to it.

Thank you. I appreciate that perspective.

The next question comes from Mitch Moore of KeyBank Capital Markets.

Go ahead, please.

Hey, everyone. Good morning.

Good morning. I know most of the industry is already in those entry-level baselines to your products, but I was just wondering if you could talk about mix in the quarter, just maybe if you could flesh out if you're seeing consumers trade down to lower-tier products.

Yeah, that's been occurring all year long. Anytime you have a change in product, everything always has migrated to the base model. The base model today is 15.3 SEER. In the south, that's a very efficient piece of equipment that I wouldn't call base anymore. I'd call it almost high-efficiency equipment. So it's been pretty steady. The data we have only covers two quarters on the industry. So first and second quarter, we're fairly flat as far as the SEER ratings. It's always higher on heat pumps than it is on straight cool.

The exception and exciting thing going on in our business is that we can help our customers sell up, particularly through on-call air. I think we're approaching, not I think, we are approaching close to $2 billion of our customer sales going through that tool. And the most amazing statistic is that over 70% of the sales that occur are higher than the minimum efficiency standard. So where the rest of the industry is selling 85% minimum standard on on-call air, it's over 70% above minimum standard. The more of that we can do, the better for everybody in the channel.

Well said, AJ. Can you explain OnCallAir? Yes, OnCallAir is... There may be some new people on this call.

Sure. OnCallAir is a technology initiative. It's actually a business we created in our Wasco Venture subsidiary and has created a piece of software that's really a sales engine for our contractors or our customers. So a customer like AJ PD and Cooling be it on-call or a customer, and use our software to sell in the kitchen house. And it's loaded up with all of our data about all the products we sell, our customers' pricing, our inventory, everything you could ever want in terms of creating a world-class, professional, sophisticated proposal or proposals for homeowners as a contractor or building owners as contractors attempt to sell their wares. our customers that use it are winning more jobs. They're higher ticket jobs. They're higher margin jobs. And like I just said, they're more often than not selling higher efficiency systems than the base tier as well. So it's growing. It's growing fast. And it's just a win-win-win for everybody in the channel. Very good.

Great. That's super helpful. And then, obviously, record gross margins here in the third quarter. Just wondering if you could unpack the moving pieces within that. Maybe just how much was mixed benefits from the other HVAC products versus some carryover OEM pricing? Thanks.

This is Rick. I can help you with that answer a little bit. There's two or three contributors there that help and that feel good and sustainable. The first is we had growth in non-equipment. And as a category, as a basket, that non-equipment business has higher gross margins. So that is a a mixed benefit in our gross margin. There was some carryover benefit from springtime OEM pricing actions. And then the third most structural, most interesting aspect of it is that We've talked about the pricing optimization tools that are maturing and getting better every day in the field. AI is making that even better today. And transactional margins were very resilient in a down market and actually slightly up. So we take some comfort in that and it feeling and being somewhat resilient or to us feel somewhat permanent and structural, whatever word you want to use, and those are the large contributors to the margin expansion.

By the way, let me just say this. We don't want to provide information to our competitors they can use for us, so be careful with how much detail we answer these things.

Go ahead, AJ. Thank you. I was just going to say, you know, the way you said that, Rick, and what you said earlier about controlling what we can control, it's important to reiterate that we're a long-term company. I mean, I know this is a third quarter call, but our job is to invest and to steer the business for the long-term health and continuous improvement of this business. You heard us talk about that in our inventory, right? We talked a little bit about what it means in this quarter and next quarter, but really we're talking about how do we get to five turns. What does that mean for our business in the medium and long term? The pricing, there's noise, there's OEM changes and so forth, but what are we doing to improve our paradigm as a selling organization to structurally increase our margins over the long term? It's true of our technology niches, helping our customers digitize their businesses so they can be more efficient as well as we can be more efficient and we can all move the efficient frontier out and to the right. So, you know, I understand these questions are very much focused on this quarter and next quarter, but our business is focused on the long term as well as the short term. Well said.

Great. Thanks, guys.

Our next question comes from Steve Tusa of J.P. Morgan. Go ahead, please.

Steven.

Good morning.

As I say, Miami, como estas?

Molto bene?

That's very good.

I don't know.

I was in Italy this summer. I could tell.

Never a real language guy, unfortunately.

You did good.

But I do talk HVAC. I talk the HVAC language. I'm just curious. When you survey your contractors... what are they saying about like what their volumes are down or are they, I mean, I would assume they're down if this is what kind of like what you guys are seeing, but like what, what is the actual, like, uh, I don't know what you call it. Um, act like, like of activity for, for the contractors, like at the ground level.

I'm not sure I understand your question.

Well, you know, are your contractor customer sales down or are they like, like, you know, is it, Because Lennox mentioned something about contractors having inventory. I think Carrier kind of reinforced that yesterday. So there's this kind of narrative that there was some inventory sitting at contractors, or should we assume that your sales are kind of in line with what they're seeing on the ground level?

Some contractors may have inventory, but that's going to be a very large contractor. It's got a warehouse there. You know, we sell to almost 100,000 different contractors across the country. So it's, you know, if you're talking to the large contractor, yeah, they could have inventory, but I don't think it's ever going to be a meaningful amount of inventory.

I mean, I've talked to contractors in Northeast that are of size and they're doing great. I've talked to small ones in Texas that are closing up shop. I mean, it is all over the map, which as you imagine, since like Paul said, we're, at such scale with 100,000 customers across the company. There's not one story. There's thousands. But obviously, the industry overall is down.

As far as this institutional channel, which is, I think, the large contractors, how big is that now as a percentage of the market if housing and home builders are like 20%-ish? Is that institutional channel? How big is that now, the consolidators on the contractor side?

It would be a guess on our part, yeah. It would be a guess on our part, yeah.

Barry, what do you have there? I think you estimated that for me once.

Yeah, I mean, it's two separate conversations, Steve. There's the contractors that do work for the builder community, and that is not necessarily a consolidator or some kind of what we're targeting as institutional contractors. And if housing is 10%, 15% of the market, I'll believe those contractors are 10%, 15% of the market. But the focus of what we're talking about is mega contractors that are primarily replacement-driven that have a multitude of locations throughout the U.S. And their fragmentation of who they buy from is extreme. So we're trying to develop the thought of, how to bring productivity and scale to that relationship. And I certainly think that segment is under 10% of the market, but it is growing. And this isn't just cooked up in a lab. This is customers coming to us and asking if we can help them with this.

I think you said that right, Barry. It's under 10%, but it's an important and growing segment. Their buying is fragmented. including amongst the Watco companies, fragmented. So what we're developing is a single solution for them to buy all their needs from all of our businesses. That's under development now and will come to market early next year. But the conversations we have with those institutional-type contractors and the consolidators of what the prospect of this thing is is very exciting to them and therefore very exciting to us.

Got it. And then just one last one for you on pricing. Anything in the environment that you're seeing where maybe there's an OEM that's trying to get rid of some inventory or something, any kind of late-season rebate activity or discounting activity you're seeing on a like-for-like basis price-wise?

Whatever we're seeing is not material. No, it's not. Okay.

Okay. Thanks a lot.

The next question comes from Nigel Coe of Wolf Research. Go ahead, please.

Morning, Nigel. Thanks. Good morning. Good morning. Please don't test my language skills. My Spanish isn't very good. By the way, I think this is the first time you guys have done a formal investor event, so this is one we can't miss. So looking forward to that, guys.

Where are you coming from, Nigel?

New York. Yeah. So don't be fooled by the accent.

You had me fooled. You did have me fooled. I was going to guess Ireland.

Ireland. Well, yeah. I'm actually Welsh, but close enough. So I want to go back. I'd really love to get your perspective on the customer behavior and why it changed so dramatically. And You know, it seems to me a coincidence or maybe not a coincidence that it's happening at the time where we're seeing this A2L transition. And I'm just wondering if the kind of the cost of a full replacement system versus a partial is a factor that contractors are highlighting to you. And within that question, I'm just wondering if you're seeing the same sorts of trends for the R32 products, you know, Douglas or Goodman. Are those kind of sell-through dynamics better than what we're seeing for 454B?

Yeah, it's, Paul, yes, you are seeing a difference, you know, as far as performance. The A2L product, you've got to replace the coil inside as well as the outdoor unit. You can't just replace the outdoor unit because you have to have the sniffing device to be able to tell if there's a leak, and then you have to have the switch to turn on the blower fan. So that brought the price up. But it also increased the cost to the consumer to, you know, replace an entire system. When you look at ductless products, ductless products, you know, continue to grow. You know, there's new products out there that are side discharge. And, you know, they have a tendency to get into the higher efficiency levels with a coil inside and they're ducted. So, yeah, we've seen some changes in the duct-free market, which have enhanced our sales.

But, Nigel, yes, the price of the H2O machines or equipment or solutions are higher, but I don't believe that's the full reason that there's a slowdown in the industry. I think that's much more about the record, or I believe close to record, lows in consumer confidence, record lows in the trading of homes and building of new homes, the tariffs creating, I would say, uncertainty for many homeowners of what their cost of living is going to be. So I just think there's less activity in terms of people investing in their homes, HVAC included, especially coming off a period where they invested a lot in their homes when they were living at home all day long during the COVID times. So while yes, it's true that there's more price in the machines. I just don't believe it's that clear of an elasticity conversation. I think much more macro influences are having an impact.

Okay. That's great, Kyle. Thanks, guys.

I just want to add something for everyone's sake in this because I think part of this discussion is where is the contractor in this and How are their businesses doing? Someone asked, you know, is there a correlation between what a contractor would feel and what we're feeling and so on? And I said this many quarters through my career. No one ever asks about credit. You know, we give contractors $800 million in accounts receivable, and we know the credit quality, you know, every second of the day. In the recession... For example, we had 10% of that portfolio over 90 days past due. Today it's 1.2%. Last year at this time it was 1.2%. Credit quality has not changed at all. It's not, you know, that 1.2% is as low as any year in the last 10 years. So if I look at, you know, the pure credit quality of our customer as maybe a leading indicator of some kind, The quality is very high.

Okay, that's great, Kala. And then my follow-up, and I know we're running out of time here, but my follow-up is, you know, everyone tracks the Hardy data inter-quarter, and it just seems very disconnected from, well, it doesn't seem, it is very disconnected from what we're seeing from you and obviously your OEM partners. Any perspective on that would be helpful.

Yeah. Okay. I think there's a great deal of difference there. You know, one, if you take a look at the OEMs themselves who don't report to Hardy, you've got, what, 50% of train sales goes through their company-owned stores, 70% of Lenox, 70% of Goodman. Carrier pushes, what, over 40%, 45% of their sales through Wattsco. We don't report to that. So, you know, it's a different reporting group. I think it's going to be a little bit more commercial refrigeration. I think it's going to be a little bit more on the repair side, perhaps. Excuse me. And it tends to be generally more of a northern-based report than the south. So geographically, I don't know how it's spread, and I don't know if they have a consistency every month or quarter. as far as who's reporting to it. So, you know, the only index that we really can use is the HRI data.

Paul, why don't you comment also, which we generally do not comment, but the weather this season?

Yeah, the weather was, you know, it was hot in Florida like it always is, and it was hot in Texas like it generally is, but, you know, we had the recooling days that were not I'm really on target, you know, for the entire year, especially the peak part of the year, which is, you know, May and June, you know, when people are thinking about putting in a new air conditioner. But if the weather doesn't get hot, they don't. So it's been just an odd year. I just wish I could put both arms around it and explain it better. But it's a very difficult situation to explain.

Barry said it on last quarter's call. We look forward to getting back to some harmony, hopefully in 2022. Amen.

All right, guys. Appreciate the comment.

Thanks a lot. And the word was serenity, by the way. Serenity, yeah. Thank you.

Better word.

Serenity now.

But in the meantime, we're getting stronger. Our balance sheet's getting stronger. Our technology capabilities are getting better. We're not... feeling sorry for ourselves that the industry has slowed down. We're doing something about it. We're getting stronger.

Our next question comes from Steve Tusa of J.P. Morgan. Go ahead, please.

Hey, guys. Sorry.

We're very proud.

Steve Tusa twice.

I believe the term is serenity now and sanity later. I believe that's what they say. Sorry, on that point about this year being an unusual year, so as you kind of stand today, I know the crystal ball is pretty clouded, but, like, do you view this as kind of, like, abnormally low, and then next year you bounce from a sell-through perspective, or, you know, there's just not enough visibility to kind of call that as you move into next year?

Do we think this year's been unusual? Yes. Demand is unusual. Do we think we'll get normal next year? I would like to think so, but who am I to predict what the weather's going to do and the other circumstances that create demand? So that's an unknown. But are we stronger now and will we be stronger next year? Yes. All I can do is control what we do. We're going to get stronger and better no matter what's going on with demand because that's who we are. We're going to build up our capabilities to do much more things that our competitors can do, innovating in technology and building our task position to perhaps do more M&A. I'd like to do more M&A. So whatever comes, comes. We'll be ready for it.

Yep. Control to control, Wolf. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Albert Ahmed for any closing remarks.

Well, this was fun today. I enjoyed it. We have a great team here in Wattsville and Miami, and I certainly hope as many of you can come to Miami in December, please do. We'll welcome you with open arms. In any event, thanks for your interest in Wattsville.

Bye-bye now.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.