Watsco, Inc. (NYSE: NYSE:WSO) reported a record-breaking third quarter in 2024, with unprecedented sales and net income figures. The company experienced mid-single-digit sales growth in October, driven by unit increases. E-commerce platforms performed robustly, with sales surpassing $2.5 billion, and the OnCall Air digital platform alone generating $1.2 billion, marking a 22% increase from the previous year.
Watsco is also gearing up for the A2L systems transition in 2025, which is projected to further elevate sales numbers. Despite facing inventory challenges, the company is committed to enhancing inventory turnover and operational efficiency. The recent hurricanes had a minimal impact on the business, with an expected increase in repair-related sales. Management remains optimistic about the future, targeting a long-term gross margin of 30%.
Key Takeaways
- Watsco achieved record sales and net income in Q3 2024.
- October sales grew in the mid-single digits, propelled by unit increases.
- E-commerce sales exceeded $2.5 billion; OnCall Air digital platform sales hit $1.2 billion, up 22% year-over-year.
- The company is preparing for the A2L systems transition in 2025, anticipated to boost sales.
- Inventory challenges exist, but focus remains on improving turnover and efficiency.
- Minimal impact from hurricanes Helene and Milton, with an uptick in repair-related sales expected.
- Management aims for a long-term gross margin of 30%.
Company Outlook
- Watsco plans to invest in growth and partnerships with OEMs to regain market share.
- The company is preparing for new product launches in the upcoming year.
- A transition to A2L products is expected, potentially leading to complete system replacements.
Bearish Highlights
- Inventory levels have increased due to pre-buy of 410A refrigerant.
- Lingering impacts are expected in Q4, although conditions are anticipated to improve next year.
- The replacement of 120 million installed units presents a challenge for system upgrades and price increases.
Bullish Highlights
- Ductless product sales saw double-digit increases year-to-date.
- The company's technology platform is a differentiator in attracting entrepreneurial partnerships.
- There is strong demand in the light commercial sector, maintaining double-digit growth.
Misses
- While overall units are up 5% year-to-date, ducted units have remained flat.
- Some recent pricing reductions in the commercial sector due to increased availability.
Q&A Highlights
- Executives discussed the complexity of pricing strategies and the influence of market factors.
- The company confirmed visibility into OEM pricing for a new product line, with most manufacturers having released prices.
- Upcoming A2L refrigerant transition may lead to consumer "sticker shock" due to system-wide changes.
- Executives noted the impact of recent hurricanes on business and the support for affected employees.
In conclusion, Watsco's recent earnings call showcased the company's strong performance and strategic planning for future growth. With a focus on technological advancements and market opportunities, Watsco is poised to maintain its leadership in the HVAC industry. The company's executives remain confident in their ability to navigate market challenges and leverage their robust platform to drive further success.
InvestingPro Insights
Watsco's record-breaking third quarter performance in 2024 is reflected in its robust financial metrics. According to InvestingPro data, the company boasts a market capitalization of $17.7 billion, underscoring its significant presence in the HVAC distribution industry. The company's revenue for the last twelve months as of Q3 2024 stands at $7.47 billion, with a modest growth of 2.83% over the same period.
Watsco's commitment to shareholder value is evident in its dividend policy. An InvestingPro Tip highlights that Watsco has raised its dividend for 11 consecutive years, demonstrating a consistent focus on returning value to shareholders. This is further supported by the current dividend yield of 2.32% and a notable dividend growth of 10.2% over the last twelve months.
The company's profitability remains strong, with an operating income margin of 9.77% for the last twelve months as of Q3 2024. This aligns with management's optimistic outlook and their target of achieving a long-term gross margin of 30%. Currently, the gross profit margin stands at 26.66%, indicating room for improvement as the company pursues its strategic initiatives.
Investors should note that Watsco is trading at a P/E ratio of 37.35, which could be considered high. This valuation may reflect the market's confidence in Watsco's growth prospects, particularly with the upcoming A2L systems transition and the company's strong position in e-commerce sales.
Another InvestingPro Tip reveals that Watsco holds more cash than debt on its balance sheet, which provides financial flexibility to invest in growth opportunities and navigate market challenges, such as the inventory issues mentioned in the earnings call.
For readers interested in a more comprehensive analysis, InvestingPro offers additional tips and insights. Currently, there are 11 more InvestingPro Tips available for Watsco, providing a deeper understanding of the company's financial health and market position.
Full transcript - Watsco Inc (WSO) Q3 2024:
Operator: Good day and welcome to the Watsco Third Quarter 2024 Earnings Conference Call. Please note that today's event is being recorded and all participants will be in a listen-only mode. [Operator Instructions]. After today's presentation there will be an opportunity to ask questions. [Operator Instructions]. Also, please be aware that today's call is being recorded. I would now like to turn the call over to Albert Nahmad, CEO of Watsco. Please go ahead sir.
Albert Nahmad: Good morning. Welcome to our third quarter earnings call and this is Albert Nahmad, Chairman and CEO and with me is A.J Nahmad, President; Paul Johnston, Barry Logan and Rick Gomez. Before we start, our usual 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 produced record sales and net income for the quarter. Our markets have shown signs of stability and the fourth quarter is off to a good start with October sales up mid-single digits driven by meaningful unit growth. Let me say that again. October sales are up mid-single digits and driven by meaningful unit growth. We also believe we have gained share based on industry data and shipment trends. We have also generated record cash flow this year and our balance sheet remains in pristine condition to enable investments in growth. As communicated in our press release, we are in recovery mode with one of our primary OEMs, a fairly large supplier of equipment to us. We are collaborating with them and co-investing to make the needed investments to regain business and add new customers. Moving on, we continue to make investments in the industry's most innovative technology platforms for HVAC contractors. Greater adoption and use of our platforms by a growing number of contractors has helped produce market share gains. Annualized E-Commerce sales now exceed $2.5 billion and our active users continue to grow faster than non-users. OnCall Air, which is Watsco's digital sales platform, continue to expand and generate growth for contractor customers. Thus far in 2024, OnCall Air Contractors presented close to approximately 258,000 households, a 17% increase and generated $1.2 billion of sales for our contractors. That's a 22% increase over last year. We are also leveraging our technology platforms to optimize the launch of the new federally mandated A2L systems beginning in 2025. Historically, regulatory change has been good for our industry and good for our business. In 2023, energy efficiency mandates went into effect, providing contractors the ability to upgrade older systems with higher efficiency systems. The trend to electrification of fossil fuel heating has driven increased sales of heat pump systems which are both sold at higher average unit prices than conventional alternative systems. The growing penetration of ductless HDA systems is also made a catalyst for growth as they provide homeowners and businesses a more energy efficient alternative to conventional assistance. And now the A2L transition is upon us and we look forward to the opportunity. Turning to our balance sheet, we have a strong cash position, no debt to support, and that supports most of our investment we choose to make. Although we have produced record cash flow this year, we are still not satisfied with our inventory turns. We are working with our OEM community and continuously improving our methodology to improve our inventory turns. We have also made progress improving operating efficiency across our network as evidenced by the modest change in SG&A year-over-year. But there is more to do. In summary, we operate in a great industry and in attractive geographical markets. We have a proven entrepreneurial culture that empowers local leaders. We possess the industry's most innovative technology platforms for HVAC contractors. We have leading scale and product diversity, particularly in high growth market. And finally, our balance sheet and access to capital enables future investments in our highly fragmented industry. As always, if you have an interested in learning more, please visit Miami and see us. We are transforming an industry and we enjoy telling you about it. With that, let's now go on to Q&A.
Operator: We will now begin the question-and-answer session. [Operator instructions]. At this time we will take our first question which will come from David Manthey with Baird. Please go ahead.
Albert Nahmad: Morning, Dave.
David Manthey: Hey Al. Good morning everyone. First question I have to ask is about the hurricanes, particularly Helene, which hit us pretty hard here in Tampa. Could you talk about the negatives and potential unwinding positives you might see from Helene and or Milton?
Albert Nahmad: Well, let's see if we can get one of us to tell you at least what he thinks. You want to take that, Paul?
Paul Johnston: Sure, I can get it started and then somebody else can pick up. But yeah, we had our branches shut down for a couple days for Helene and then we also had them shut down for another couple days with Milton. Most everything is back to normal now and obviously we're seeing an initial rush at least of repair components that are going out the door in October. Milton came through so quickly. It really didn't impact us as severely as the other storm. However, when you get up into the North Carolina, Georgia area, a lot more severe damage was done and we've. Yeah, it slowed us down, but it didn't really impact our sales that dramatically, more or less.
Barry Logan: Just to add to that, I've said for many years growing up in Florida and being in Watsco for 32 years that hurricanes typically disrupt local markets and may not have an impact on the whole market. And the reverse is true. If there's business opportunity, it's good for those markets and not necessarily material for the, the national scale. I think the most obvious question and thought is that, when they talk about $10 billion, $20 billion, $30 billion of insurance investment that follows these things. A portion of that always is our industry, be it equipment or non-equipment. The materiality of that needs to play out sometime this year or next year obviously, but and that's how I've characterized it, at least over time.
David Manthey: Okay, so. But even though Florida is clearly your biggest market and Helene in particular ripped up the whole coast, you're saying it's fairly immaterial and we shouldn't view the mid-single digit growing up growth in October as just a temporary snapback from storm activity is what you're saying?
Paul Johnston: Absolutely not. No, it's a -- nothing is that material relative to helium and either disruption in the last week of the quarter or to a benefit for the first part of October, as very indicated, when the insurance kick. The insurance is going to kick in within the Next, let's say 30 to 90 days. So we really don't see equipment sold. What we see is the motors sold, the compressors, that type of. To start with.
David Manthey: Got it. Okay, thanks. Great. Yeah, thanks for that. And then on the gross margin came in a little bit light. I know you had a reason for that here that you discussed with one of your major OEMs, but just medium term you still feel good about 27%.
A.J. Nahmad: This is A.J I'll jump in. The answer is yes in the short term and the ambition is much higher than that. I think we've talked about publicly. One day we'd like to achieve 30%. So our engines are revved up and we very much have a focus on gross margins and we're investing there and have high expectations.
Barry Logan: I think in the analysis, Dave, there's obviously the magic words are price and mix and price overall was pretty consistent this quarter. So that's not really a discussion item. Mix is where the variations are so far this year and for this quarter. And the word mix is a broad term really. There's customer mix, there's geographic mix, there's product mix, there's end market mix, there's brand mix, so a little bit of weight in those factors. If I spent 20 minutes explaining to you what I just said, a little bit of weight on margin this quarter. But those are short term conversations. And I think if you consider the A2L transition in front of us, if I look forward, it's really an opportunity to basically re-price and go to market with what will essentially be 60% new products over the next 12 months. So our OEMs who listen to this call, along with all of you, this is a very critical stage where we're making tremendous investments. Inventory is going to completely cycle a year over the next 12 months. And pricing, marketing features and benefits mix, overall mix, is going to be critical over the next 12 months to drive margin. I think one of the messages we tried to convey in the press release and I'll convey now is, and somebody will ask this question is where are we in terms of unit volumes and stability and things like that? And year to date, unit volumes are positive in the quarter, they're overall positive for our selling season. Overall positive and positive. To the extent that it's kind of conventional growth rates in units, I look at a longer term average. So if I try to consider stability as well as the opportunity in front of us, that's where we have some optimism in what we're doing.
Operator: Thank you. And our next question will come from Tommy Moll with Stephens. Please go ahead.
Tommy Moll: Good morning. Yes, sir. And thank you for taking my questions. I wanted to start on some of the co-investment you described in the press release this morning alongside one of your OEM partners. And it's a two part question here. First part is where you did call it out this morning with substantial detail. Did something change since last quarter that prompted the enhanced discussion on this item? And then as you look forward, is there anything you can do to calibrate our expectations about how this ought to progress and ultimately fade? Thank you.
Albert Nahmad: Terrific question. Who wants to answer? Paul Barry, A.J. rick. Rick.
Barry Logan: Didn't mean to leave you out, Rick. Yeah, I think, I mean, I'll go first and just add to it because it's an important point and in our collaborative spirit you'll get Insight into how we look at These discussions internally, I wouldn't say anything critically changed in the third quarter as an isolated event. We felt it's needed to kind of reconcile where we are year to date. A year ago we talked about disruptions and whatever the range of revenue was, $150 million, $200 million of revenue at the time, you have to go back and look at the disclosures. But a year later, the idea of recovering that business, growing volume, growing market share, re-establishing market share. These are markets like Florida, Texas, California that are huge markets, Carolinas as well. And there is a collaboration, there is a co investment. We use that term intentionally in the press release where we work with our OEM partner and try to figure this out. And this is the scorecard year to date, business and unit growth has outpaced overall growth rates for sure for that particular product group it better. And when we talk about pricing, there's more to it than just the price on the product. There's again the mix of those products. And I'm not going to give too much competitive detail in this discussion in answering you. And the other is incentives that we chose to put on the street to not just get somebody back buying more from us, but getting new customers at the same time. In other words, play offense with this opportunity. And that is a shared cost and a shared experience with our OEM. But we thought it was important to go ahead and kind of reconcile that scorecard year to date. And that's what we've done. Now as far as extent, as far as lingering impact, which is the second part of your question, there's some lingering impact, needless to say, in the fourth quarter and that dissipates, I would believe more so next year when again all the new ATL products will come in. And we are kind of truly working on today a complete set of economics for those new products with all of our OEMs. And it's a chance to kind of recalibrate those economics looking forward.
A.J. Nahmad: Yeah, I'll just stress that our OEM partner here is truly a partner. They're a long time relationship. I think it's a successful partnership now. It has been, it will be. This is absolutely a collaboration with them and it's nice to have such a wonderful partner.
Tommy Moll: Anyone else before we move on here? All right. I also wanted to ask about inventory and any pre buy dynamics we may be seeing. Al, you talked about hoping to improve inventory turns and I did note that inventory dollars were up versus the second quarter, which is atypical. But is some of that just the 410A pre buy that we're seeing. And what's the view there at this point?
Paul Johnston: Yeah, it is.
Albert Nahmad: Yep, go ahead.
Paul Johnston: Yeah, it is, it is the inventory pre buy on the 410 as each one of the OEMs has come up with a program to at least fill in for the 410 that they have to be able to manufacture and be completed by the end of the year and so some of them have asked if they could move the inventory quickly into our inventory so that we can be ready for at least the first quarter selling the 410A that should taper down at the same time that's tapering down. We're going to be bringing in the A2L inventory. So I don't see much of a fluctuation in the next quarter with our inventory.
Rick Gomez: Yeah, Tommy, I would just add to that, that when we most OEMs have had their last call and those products are starting to get received. And so I think as you look forward to Paul's point about, the next quarter or two, the seasonality around inventory probably looks different over the next quarter or two as we go through this transition. And then it probably picks up its normal seasonal cadence sometime middle of next year once 410 diminishes as a percentage of shipments and sell through. Really. And a 2L becomes just a greater proportion of sales in our balance sheet as well. Makes sense and I appreciate the insight. Thanks all.
Operator: And our next question will come from Ryan Merkle with William Blair. Please go ahead.
Ryan Merkle: Hey everyone. Good morning. Just wanted to ask, on October to start, you said meaningful unit growth improvement and then mid-single digit growth. Can you just clarify, what pricing is? Because my assumption was pricing is still kind of running up maybe 3, 4. So how do we bridge the mid-single digits if volumes are popping back positive?
Barry Logan: Yeah, I'll cover that. So let's be careful. Let's be careful. I'll give it to you in a spoon fed way because this is like critical data. I'm not going to comment as much on specifics for October other than to say what we've said which is it's, meaningful unit growth. But let's just be analytical about it and then we can talk the business side of it. So for the quarter overall units were up 4% and that includes both ducted products which actually declined 1% and ductless products which were up double digits. So it's a year to date trend. It's probably an 18 month trend where our investments in ductless is paying off very well. Mitsubishi and Gree & Carriers brands and. And other brands that we sell in ductless have been doing very well, both domestic and international. So there's a bit of a story inside of that number. That's our investment, our business units doing well with ductless products. If I stick to. What is more curious, maybe for the group is the ducted product, and we're interested in all of it. But deducted product volumes were down 1% and price was down 1% in ducted products. And again, that has nothing to do with deflation or average selling prices. In terms of, price risk, that is mix. That's what I'm alluding to earlier in the call, where if I look at brand mix, customer mix, and market mix, there's a little bit of a weight in price this quarter. For the year, for year to date, units are up 5% and unitary pricing is up 1%. Induction pricing is up 1%. And that's kind of like makes sense to me because the OEMs launched pricing earlier in the year. I think they've all kind of said about the same thing about it. And this is a year where price has not contributed really anything to the equation. And honestly, I'm quite glad our gross margins kind of look the way they look in the absence of any price. And we know that's going to change.
Ryan Merkle: We know that's going to evolve from here. And I welcome anybody else's color. Okay, well, yeah, that's helpful. That explains it then. And then just back to gross margins. Can we bridge 3Q back to 27%? It sounds like parts and supplies were down, so there's a mix element that's occurring. And then you also, you didn't quantify for the quarter, but this co investment. So just can we get back to 27% or what are the pieces?
Albert Nahmad: Go ahead, Rick.
Rick Gomez: Yeah, Ryan, I think you heard AJ Say the answer is yes, and I think there's an upward bias to that over time. But let me try and start with. I think the most important layer of margin, which we haven't talked about and has been consistent is our transactional margin, our invoice margin, which is the most basic form of margin that any distributor can have before you get to mix. And to Barry's point earlier, that transactional margin is constant versus last year in a year where there's been relatively no contribution to price at all in our gross margin. That is a testament to some of the pricing technology that's been deployed and It's a testament to the work that our field leaders are doing on this subject. So then, so what do we bridge if transactional margin is constant and consistent with last year? And it's those four basic elements of mix that we've talked about. It's firstly, a difference in growth rates between equipment and non equipment that will always weigh on your overall margin to some extent. Secondly, within equipment it is a difference in growth rates between residential and commercial. Residential has been in that low single mid, single digit type environment and commercial has been higher. We like that because we have profit dollars to account for that higher growth rate. But it does weigh and influence your overall mix. Thirdly, and particularly in the third quarter, in a seasonal period, you tend to have a little bit more residential new construction than you have add on replacement. Right. It's a time where the builder channel gets a lot of things done and that tends to weigh a little bit. And it has been true that for the last year or two the residential new construction end market has been outpacing add on replacement. You can look at the, the housing completion data to tell you that. And then lastly is this element of customer mix which is, the hardest one to untangle in some ways. But if you just simply segment your customer base, you do see differences in growth rates. And what we see in our data is that larger, more progressive, more tech enabled customer is growing faster than his or her counterpart that is smaller and less sophisticated. So not to write a whole paragraph about it, but those are the three or four elements of mix that explain and help contextualize a year date margin profile that looks different. I go back to where I started, which is the key point in all of this, is that transactional margin, same customer, same product, is very consistent with last year.
Operator: And our next question will come from Jeff Hammond with Keybank Capital Markets. Please go ahead.
Jeffrey Hammond: Hey, good morning everyone. Just on the A2L, new product introductions, just what kind of pricing are you seeing relative to kind of this, 10 to 15%. And as you talk with your major OEM partners, just address kind of their readiness, so there's no kind of hiccups as you transition.
Paul Johnston: Yeah, I can, cover part of that. And that is that, among all of the OEMs that we talk to, everybody is ready. As a matter of fact, one OEM has started their launch in the fourth quarter and we've actually taken equipment in and started selling a 2L. When it comes to the pricing, the pricing has been consistently, in the double digit, low double digit range, it's been around, 8% to 10%, some pricing a little bit higher. But we're going to have to wait until probably the second quarter for that to be adjusted to find out exactly where that price settles. It's an unusual situation for each of the OEMs because it's a total new product line that's going to be offered. And it's an unusual situation also that the consumer is going to have to buy a system now as opposed to in the past when we've sold the 410 product, they could just install the outdoor unit. And now you're not going to be able to do that. Technically, you're supposed to replace the indoor and the outdoor unit both. So it's not just the raising of the price. It's also the idea that we're going to be selling more systems and less single unit replacements once the A2L becomes firmly lodged. And that's going to be spread out over all. 120 million units that are installed out there right now will at some point have to be replaced, all at various times. But it seems to us that it's a wonderful opportunity not only for the price increase, but also for the system.
Jeffrey Hammond: Okay, and then just a quick follow on that. Can you just remind us that the multiplier effect, as you do the matched versus the standard, and then just maybe just touch on M&A environment. It seems like, the PE has gotten more crowded in this space. And just what you're seeing in general
Rick Gomez: I can tackle the M&A piece here. I mean, it's. Look, Jeff, there's always more M&A to do. There's no way to predict it or to think about a cadence of it. And I would say that, private equity was a lot more prevalent in the space the last two years. That has subdued a little bit of late. And this is still bigger picture and longer term, a very fragmented industry. And I think what a lot of you all from the outside don't see as it relates to M&A is two things. One is that we're very focused on partnering with the right entrepreneurs. And that's different from consolidating an industry. That cultural element of M&A is very, very important. We want the right entrepreneurs who will embrace our technology, embrace our growth spirit and our equity culture to help transform their business. So it's very much a Cultural discussion oftentimes more so than a financial discussion. And then the second thing that I would point to that, I hope leads to incremental opportunity going forward is today, our technology platform and our M&A discussions are essentially one and the same. You know, we've always had access to capital, we've always had scale, we've always had great vendor relationships, we've always had an equity culture. Those things have been constant for 35 years since we've been in distribution. What's different today and what has been different over the last five years is we've invested in this technology platform that I think now is well better understood, if not well understood out in the market. And it's leading to more and more discussions with long term prospects. So my job is to help lead some of that. And so I can speak to it with some pride. And we want more of it. Absolutely. But I will also point out that as a $7.5 billion company now, we have a whole lot of internal levers at our disposal too, to grow. And we're not dependent on M&A to grow profitably in the future.
A.J. Nahmad: Rick, this is A.J. i think what you said about these being cultural discussions more than financial discussions is so true. And it runs both ways where it really has to be a good fit for these are often multifamily, I'm sorry, multigenerational family businesses that we're saying, come be part of our multi generational family business and you be you guys with your leadership team and your branding and your customers and your teams, but do it under our umbrella and use all of our resources. And those resources are capital. It's equity to recruit and retain great people and these technologies which are all about helping you grow and helping your customers grow, because that's what we are all about, a long term sustainable growth for the business. And those families and the leaders of those families that have joined our business over the last five, 10 years are really going back forever. They are thriving in that environment, they are happy, they are still running the business, they are motivated and they're growing in many cases faster than our, if you would call legacy businesses, if you will. So it has to be a fit. And when it is a fit, they seem to be home runs, which is what we're going for.
Operator: [Operator instructions] Our next question will come from Patrick Baumann with JP. Morgan. Please go ahead.
Patrick Baumann: Good morning, Al. How are you? It's hot and humid. Yeah, it's actually warmer up here than it is usually for this time of year. Just wanted to maybe quickly go back to something Barry said on units. I think he said year to date up. Was that a total unit comment or was that. I assume duct did is not up that much. Right. Just maybe clarify that if you could?
Barry Logan: Yeah, yeah, I should, I should clarify that. So duct did is flat in units year to date and overall is up 5%. Which would suggest that this is up double digits.
Patrick Baumann: That's helpful.
Barry Logan: And then just to be like, even more refined, we mentioned this in the press release. If I look at our selling season, so I'm really looking at joint performance of our seasonal business, let's join together second third quarter. So there's no push and pull, aspect to it, to the analysis. So for the season, second third quarter combined ducted units are up 3% and overall up 5%. So when we talk about stability, that's the frame of mind.
Patrick Baumann: Okay, helpful. And then are you, have you guys been. I think we talked about inventory earlier. You expect it to be stable through the end of the year, is your view. That is the channel restocking currently in terms of inventory?
Paul Johnston: Yeah, the channel right now is picking up 410 equipment which they'll pick up in November, December and January. And so yes, that it's not restocking. It's. It's kind of a pull forward, if you will, into, it's first quarter sales, fourth quarter shipments. It'll turn into first quarter, second quarter sales.
A.J. Nahmad: Right, right. Yeah, that I think the industry and included are bringing into our barns for the large part. Bringing into our Barns what we'll sell 410A products will sell through the first quarter. And as that is being sold through, we can't replenish them with the 410A unit. So we'll replenish them with the 8L units.
Patrick Baumann: Helpful. And then one for you on margin, on the gross margin side, normally there's like a lift, I think from seasonality in the fourth quarter because the mix, which I guess hurt you in the third quarter typically improves somewhat. Is that reasonable to assume this year or are there factors like that, OEM investment collaboration that holds that back in the year end?
Paul Johnston: I think we should see some lift with the mix. As we get into the colder season, we start seeing more furnaces, more heat pumps, which have obviously higher margins to them and higher volumes. So without knowing what the weather is going to be in the fourth quarter I would say yes.
Operator: And our next question will come from Nigel Coe with Wolfe Research. Please go ahead
Nigel Coe: Good morning, guys. Thanks for the time. I think this is meant to be a cold winter according to the pharmaceutical. So if that's true, then it should be a little bit of help for you guys. I know you cut a lot of ground. I don't want to retread ground we've already taken. Just on the gross margin, seems like there was a bit of lapping of price from earlier this year and you talked about mix and, and some OEM support. Is there more discounting going on, especially at the higher tier levels? Is that a factor at all in some of the gross margin pension?
Barry Logan: I think if you listen to Rick's comments, as a composite, we look at the most important metric, which is does the transactional margin have any material change to it? The answer was no. So I don't think, I'm not saying neutral is exactly what we want, but it means there's not been a risk factor relative to deflation, let's say at really any level of product group. So I think it's more subtle and the mix of it. And I think again, Paul, you have a good insight into this. But the higher tier systems, the 16, 18, 20 plus year systems, really only came into existence in our inventory sometime late last year and has not really been a factor, if you will, in the sales process this year. I think the movement of energy efficiency mandates that happened in last year kind of condensed, the base layer into a much more broad part of our business now.
Albert Nahmad: And Paul, maybe you have some perspective.
Paul Johnston: Yeah, it happens every time we've gone through a change in standards with the federal government and that is there's a compression where a greater percentage of the industry moves towards standard efficiency. And with this last energy efficiency change, they basically increase the efficiency to roughly 15 seers from 14 seer.
Nigel Coe: And so when they did that, we definitely saw a compression where the high efficiency equipment shrunk as far as a meaningful size in the marketplace. Okay, that's helpful. Thanks guys. And then just a couple of quick ones here. Just on the A2L transition, obviously you've been through many of these transitions before. When you compare this to the 10 seer, 13 seer, 22 to 14, do you think the contractors, the end customers, are ready for this transition? And obviously you're very close to those guys. You provide a lot of training, support, etc. Are they ready for this?
Paul Johnston: I think the consumer is probably not ready for this. They don't really understand what's going to be coming at them. As you indicated earlier, it's going to be a system change out, not just an outdoor change out. And that's going to be a bit of a sticker shock, I think, for some of the consumers once they see what the pricing is going to look like. So it's more than just the 10% price increase. It's also the entire system. The contractors themselves, I think they're going to pretty easily go through the transition. The only real change in the units is going to be on the inside. You're going to have a detector that's going to detect any sort of leak in the refrigerant into the home. And then if it detects that there is a leak, it's going to turn the blower motor off. So it's not going to contaminate all the indoor air.
Nigel Coe: That's the biggest change. Outside of that, the refrigerant itself is going to have a different component in it than the old refrigerant did, but it's still the base component in both refrigerants. The 454 as well as the 32A is still 32A. So it's going to be the same. The same refrigerant that we've had with 410A, basically. Okay.Okay. It sounds like it's not going to be a big deal?
A.J. Nahmad: Yes. I'll just add that it's our job to help them get ready from a technology perspective, product perspective, from a business and selling perspective from. And then support them with helping them figure out what product they need and getting technical support and et cetera, et cetera. And we do that at a scale and with a technology background that I think is unparalleled in the space and sets us apart.
Nigel Coe: And I think there's a big reason why customers or contractors choose to do business with a lot of companies. Okay. Okay. And then just a quick one, as I may. Obviously great news about October up mid-singles, and I know you said no more details on that, but I've got to say I'm a little bit surprised with the hurricane's impact in Florida and the southeast. I know you've got some extra days selling in October, so is there some benefit from selling days in October offset and some of the hurricane impact, or am I off base there?
Barry Logan: Yeah, again, Nigel, it's something we track down to dollars and cents in terms of hurricane impact. And we had like the last two or three days of the quarter, and we had, three or four days for Milton this quarter. So I think if we have any pickup, it's been offset by disruption with Milton. And again, in relative terms, not that material of an event. I think with the destruction that is obvious in these markets, there's a business opportunity that will flow once insurance money flows. Nothing is immediate, but the word destruction I'm using purposely because that's what has gone on in those markets, there will be that opportunity once dollars flow.
A.J. Nahmad: I also just want to report quickly just an important point. We have a lot of employees that we're in the path of these storms and very happy to say that everybody is safe and accounted for and those who have destruction in their homes or problems that we could help with, we are helping to the best of our ability. We care very much about our team members and we're very thankful everybody came out on skate, relatively speaking.
Operator: And our next question will come from Steve Tusa with JP Morgan. Please go ahead.
Stephen Tusa: Senor Tusa, how are you? Hey, good morning. Sorry, just to follow up to Pat's question, got a little bit late on the call here. Do you have complete visibility into, all the OEMs pricing for a 2L product at this stage? Is there anybody that's, playing a little more close to the vest than others? Not just your suppliers, but kind of across the industry?
Paul Johnston: Yeah, we have visibility into every manufacturer's pricing. There's only one or two that right now have not really fully released their pricing. I think it's not that they're trying to be coy or sly about how they release their pricing. I just think that their timing is probably just a little bit off. But for the most part, we've got most of the pricing in. And Steve, is that pricing going to hold throughout this entire transition? That's the question we ask.
Stephen Tusa: Do you think customers are looking at it as a bit of similar to a list price increase? I think Most of the OEMs are pitching it as cost push, which is just inevitable versus hey, here's the new price, and then let the negotiations begin. Or how are most of them looking at it?
Paul Johnston: I think most of them are very serious about this price, because they are adding costs or adding two new components to the system itself. So due to that, I think that, I think the pricing will probably be closer to the, the 8% to 10% range than the 15, but I think it's going to hold around 10%. That's why it's.
Stephen Tusa: Yeah. So the 8 to 10 is kind of a bit of a discount to what they had previously said.
Paul Johnston: I think a little bit, but not that much. We'll have to wait and see and find out. Yeah, All I got is opinion right now, you know.
Barry Logan: Yeah. I want to remind you, I mean, maybe that maybe you're asking that question from an OEM perspective, but from our perspective, if we buy, say, $25 million of one SKU from an OEM, and the price is, quoted to us, we're reselling that $25 million at maybe 1,000 different prices depending on the customer, the market, the end market. You know, there's variations, obviously on our selling price and more ironically, there's variations on our buy price depending on the intended, again, customer or end market. So this is an art form, more so than just strict analysis. And when we allude to technology that's helping us do that and raising margin over the last four or five years, that's where technology has played its role, is in that snowflake management, if you will. We have a much more gifted capability than we had three or four years ago. And in this transition, it's another chance to accomplish the same thing. And if we need to react to a market condition, we have our OEMs react to our cost. So that fluidity is why this is hard to predict. But I can tell you why it's benefited us in the last three or four years.
Stephen Tusa: Right. And I guess your point is that, like, to take 10% or whatever and like, stick it into a model and a spreadsheet, like, it's a lot more complicated than that.
Paul Johnston: A lot more complicated than that. As Barry alluded to all the variable price, I wish it was as simple as that, but it's not as simple as that because you do have the different market segments and you got originality to the pricing.
Stephen Tusa: Got it. One last one for you. Just on the light commercial side, everybody's had a pretty good 3Q. One of your peers said it's a little bit slower in the fourth quarter. Any signs of weakening there on the back of fundamentals in the next year for, like, commercial?
Paul Johnston: I think as the availability of the commercial product improved, I think we saw some reduction in some of the pricing. But as far as the demand, the demand has remained fairly strong. We're still up double digit. Yep.
Operator: Great. All right, thanks, guys. As usual. Thanks for details. All right, guys, and this concludes our question and answer. Session. I'd like to turn the conference back over to Albert Naumann for any closing remarks.
Albert Nahmad: Once again, it's always good to communicate to all of you. And we hope you'll be here for the next quarter. Numbers and performance. So thank you for your interest in our company. And as we said earlier, it's winter. Why don't you come down to Miami and see us for yourself? Bye. Bye.
Operator: The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
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