Watsco, Inc. (WSO) Q4 2023 Earnings Report, Transcript and Summary

Good morning, and welcome to the Watsco Fourth Quarter 2023 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Albert Nahmad, Chairman and CEO. Please go ahead.

Thank you, and good morning, everyone. Welcome to our fourth quarter earnings call. This is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, Watsco's President; and Paul Johnston, Barry Logan and Rick Gomez. Now before we start, our cautionary statement, as always, this conference call has forward-looking statements as defined by the SEC laws and regulations that are made pursuant to safe harbor provisions of these various laws. Ultimate results may differ materially from forward-looking statements. Now, Watsco delivered strong results in 2023 despite some market conditions which were somewhat inevitable after two extraordinary years in 2021 and 2022. While reflecting in the year's results, I am proud of the accomplishments we delivered. We achieved market share gain in markets we serve. We further scaled Watsco's industry-leading technology platforms. We had a successful start driving down long-term productivity gains. I should say, we had a successful start driving long-term productivity gains. We expanded our network and product offerings by acquiring great businesses through our scale, and we fortified our balance sheet through inventory reduction and generated record fourth quarter cash flow. And once again, shareholders will receive a meaningful dividend increase in 2024, which is in April 2024. This is Watsco's 50th consecutive year of paying dividends. 2023 was also a year of immense change in virtually all equipment products transition to new [indiscernible] systems. In collaboration with our OEM partners, Watsco introduced new products and SKUs for over 25 brands of HVAC systems. Our teams executed well, and thanks to our scale and speed to market. We are confident that we gained share. We also trained thousands of customers on new products and our digital pilot library was updated with approximately 500,000 new SKUs. In this spring we will begin the next regulatory transition to new A2L products with lower GWP refrigerants. These regulatory transitions are positive for our industry and are good for Watsco's business. They offer meaningful value to homeowners and businesses to upgrade systems that are more efficient and better for the environment. Watsco's residential unit volumes, although still down, stabilized during the second half of 2023. Commercial end markets remain strong across all markets. Our commercial business continued to grow at a healthy rate, and our backlog of products extends well into next year. Sales of ductless systems, an increasingly important component of our business grew double digits in the year, and offset declines in conventional residential business. SG&A as a percentage of sales on a same-store basis decreased for the year, indicating progress in driving more productivity across the company. We believe we are in early innings of a long-term opportunity to meaningfully improve productivity and overall efficiencies. We have challenged our leaders and provided them with tools and data to implement change. And most importantly, we possess an entrepreneurial culture to execute change in a responsible way. Over the past year, we expanded our network through acquisitions with three terrific business joining the Watsco family, collectively their annual sales are around $200 million. These businesses will retain their culture, leadership teams and uniqueness in the market, consistent with our long-term practice of honoring and sustaining great legacies. Our industry remains highly fragmented, and we will continue to pursue other great companies to grow scale in our $60 billion North American market. We believe Watsco's technology advantage, market-leading scale and the strength of our balance sheet are all great reasons to join the Watsco family. Now before getting to Q&A, as always, I want to emphasize that our core focus remains on the long term. We believe our scale, the quality of our balance sheet and unique culture will continue to drive long-term growth and performance. We have an immense technology advantage, and we invested -- investing to grow that advantage. Watsco's broad array of products and brands is also a competitive advantage that allows us to serve contractors in any environment. And finally, our industry is fortunate to benefit from important regulatory and industry catalysts that should positively influence Watsco's performers in the years ahead. With that, let's go on to Q&A.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Tommy Moll with Stephens Inc. Please go ahead.

Good morning, Al. Thank you for taking my questions.

You bet.

I wanted to start on gross margins, no big surprise there. Your fourth quarter -- your fourth quarter gross margin percentage was a little bit below the long-term aspirations that have been discussed recently. So it's a two part question really. One is just if you could unpack any of the factors there for us in the fourth quarter? And then if we think about the art of the possible going forward to start this year, is there a pathway near term, you can define that how you want, near term to recovering and moving back towards those longer-term aspirations in the high 20s or maybe 30?

Very good question. As you know, I've stated earlier that eventually, our aspiration is 30%, and we have a ways to go. So I'm going to ask Barry Logan and Paul Johnston to deal with current events.

Yes. Thanks, Al. good morning, Tommy. We've said all year long with some of the moving pieces with gross profit and also said two years ago or so now, the aspiration -- short-term aspiration was 27%. And so, if I just focus on the year for a second, Tommy, just some important things to be grounded in looking at the year's performance and then I'll address the quarter and the shorter-term perspective. But for the year, the 27.4% million is what was achieved. And it's -- obviously, it's better than it was two years ago, two years ago, historically, and a lot of the moving pieces that we've talked about to drive and sustain that higher margin, obviously, are in place as we look at the year's perspective. If we look at a 60 business day perspective, which is the fourth quarter, in the off season, some of those variables have a greater impact in the short term. So that would be my first bias I would try to talk about is we're talking about 60 business days in the off-season in the fourth quarter and some of the moving pieces are more acute because of benefits of a year ago, not so much what's happening short term. So if I unpack that a bit and not be quite as abstract about it, we have about $16 million of benefit in the prior year from pricing gains, from weighted average cost gains, from inflationary gains, however you want to define it, which is roughly 100 basis points in the year ago quarter. Some of that is equipment, a greater proportion is not equipment as there was a lot of inflation going on in some of our non-equipment products a year ago like refrigerant, like copper tubing, like steel products and probably 40 other product lines where an year later, those benefits are not there. So that's 100 basis points. That's $16 million of consequence. And if I look forward to 12 months, instead of back 12 months, if I look forward 12 months, I don't expect there to be that kind of headwind in those products, let's say, a year from now. And it's just one of those things that as the numbers are larger in the fourth quarter, the acuteness is higher, $16 million would not be as material to a second or third quarter. It's more material to a fourth quarter. So that's probably the biggest impact in the quarter if you look at things on a year-over-year basis. There are some other moving pieces, which we've talked about. One is that equipment products in fact, have a lower gross margin than non-equipment products. So in the quarter, you see a mix difference between the growth rate of equipment, which was pretty flat. Non-equipment, which was down. So that's algebra that affects the margins in the quarter by 20, 30 basis points, I would say. And there are some other smaller things that aren't worth kind of going through. The bigger picture is this idea of inflationary gains that occurred a year ago. With less inflation, there's less inventory gains to come by. And if we look in the next 12 months, I would expect a much smoother water, much more -- less volatility in terms of this dynamic. I think we need to get beyond the first quarter to clearly see that if I look forward the next 12 months. But I would say a greater feeling of stability versus the volatility that you've been seeing this year. Paul, anything you would add to that?

Barry, you've really covered a lot of ground there, yes. Obviously, there's going to be some price changes that we're going to see in some of the commodities, especially refrigerant. We should start seeing some uptick in refrigerant pricing as we -- as we've got the 30% reduction in allocations coming into effect January 1. Too early in the season to have really seen those yet in the first quarter, but obviously, those are expected. Secondly, we're also seeing some recovery in steel. We're seeing some recovery in some of the other products that we sell. So price increases are still occurring in the non-equipment side of the business, and we expect those to stabilize and perhaps grow as the year -- as the demand picks up during the year.

Thank you both for those helpful answers. As a follow-up, I wanted to pivot to a volume conversation and knowing that you won't give guidance, I'll try to frame it in a way that provides for a constructive discussion. If we look at the trends for unitary HVAC systems in the year you just concluded, down, I think it was 8% in your material this morning that you provided. I think we would agree that's an abnormal type trend. And so I'm just curious, if you look to 2024, is there anything abnormal that you see anything worth calling out now? Or does it feel more like a normal kind of environment off that lower base from last year?

And it's a great question. By the way, some of the OEMs, particularly large ones -- now 30% unit volume drop in the fourth quarter. And we're pleased that we're doing a hell of a lot better than that. Paul, do you want to take a shot?

Yes. The obvious elephant in the room is going to be the -- how fast the transition goes to the A2L product, which is being discussed in -- among the OEMs is a perhaps a 10% to 15% increase or a lift in price and each one of the OEMs, obviously, has a different implementation schedule. So it's not going to be a full year implementation that we're going to see on that. We're going to see some start coming in, in the second quarter and beyond. So I think that's going to be one of the things that's going to drive an increase. Secondly, obviously, a reduction in mortgage rates always helps. People buying existing homes although they don't intend to replace the air conditioning system, that's really when they're at the prime period where they would do a replacement is within the first 90 to 180 days after acquiring an existing home. So I think there's some good news out there. We don't -- I can't forecast out exactly how that's going to overlay into the entire year. But I think there's some positive things that we're going to be seeing as the year goes on.

Generally. Let me just say generally that if -- I've obviously seen industry weakness as an opportunity for us. there are highly leveraged distributors in the business, and there are distributors that don't have the -- perhaps the balance sheet to deal with tougher times. We see that as an opportunity to join -- have them join us with their culture. We provide capital, we insisted they keep their culture and their organization and we provide tools that no one else has -- so I'm sort of well, I don't -- would not be very excited to have market industry data decline. If it happens, I'm also looking at opportunity to bring more wonderful companies to do partnership with us. Go ahead, Paul.

I was just going to add about the unit data. I listened to the question, and I asked myself the question about units. Do we feel better or worse? That would be my simple way of asking that question. And so the first half of 2023 units were down, I think, in the teens. And second half of the year, I think it's -- units are down 2% or 3%. So I think we feel better about units than worse. Of course, the crystal ball is -- needs to play out next selling season in April to September when our business multiplies in size. But I think generally speaking, things again seem more stable as opposed to being volatile.

Thank you all. I appreciate the insight. And I will turn it back.

The next question comes from Ryan Merkel with William Blair. Please go ahead.

Hi everyone. Good morning. My first question was on price and the outlook for '24. What do you think in price will contribute given what you've seen from the OEMs?

We have that information. Barry, Paul?

Yes, we've seen price increases announced already in the year on the existing equipment, and they range basically from 4% to 6%. So the equipment prices have already been announced. They're going to be further supplemented again by the introduction, as I indicated in the last question, with the A2L introduction. And so we're going to probably see some additional lift there. A lot of speculation around how big of a lift that's going to be, so nobody has really disclosed anything on their anticipated price outside of that wide range that I think you all have heard 10% to 15%. On the other products that we sell, we're also seeing, as I indicated, increased prices pretty much all of the copper products and all of the metal products that we sell and we experienced some softness on some of the insulation products last year. Those appear to be stabilized now and we should start seeing those products not have any sort of price degradation in 2024. How much all that is going to add up to? I think it's still a little bit of a question mark as far as being able to put a percentage against that against total sales, I think it will be clear in the second quarter as we start seeing what the rollout prices are going to look like for the A2L.

Okay. Got it. And then I wanted to ask on SG&A. You've taken some actions there. Anything you can quantify for us in terms of how much is coming out in '24 or what your kind of aspiration is for SG&A growth in '24 either way?

Mr. Logan?

Good morning Ryan. Well, first, again, there's two sides to that equation. And they're all -- it's all being driven again through the field, through our stores, through our regions, through our business unit leaders in terms of -- in their 2024 plans, reducing SG&A. And when I say reduced SG&A, it's not just cutting SG&A, it's finding out the opportunities for productivity after what had been also two years of wildness in terms of SG&A growth. Talk about the business performance of 2021 and 2022. It was also a very unproductive period of adding SG&A to serve what was going on. So that's what we're looking to improve and to some extent, simply get back to a little bit more normalized conditions in terms of how the branches operate and so on. So this kind of single-digit declines that you're seeing, Ryan, is a composite of two things. In recent quarters, it's variable expenses coming down 10%, 15% fixed cost inflation moderating, but still there's inflation in fixed costs like rent, for example. So it's probably a slow grind or better improvement from what you've been seeing in the last few quarters? This is, again, not restructuring the corporation. This is improving the daily expenses, the daily productivity. But in that kind of better progress from what we've been seeing in the last few quarters is our expectation. I'll have to leave it at that.

Okay. Fair enough. Thank you.

The next question comes from David Manthey with Baird. Please go ahead.

Good morning David?

Mr. Manthey, your line is open. Please go ahead with your question. Is it muted accidentally?

Got it. Yeah, hey. Good morning Al, good morning everyone. Can you hear me now?

Yes. Please go ahead, sir.

So I'm going to stay on the gross margin topic, if I can here. Were there adjustments in the fourth quarter that hit gross margin disproportionately hard. Barry, you're kind of saying the year-over-year comparison looking back and then looking forward, are you implying that the gross margin a year from now, give or take, will be in the range that it was this year? Or was there something unusual in this fourth quarter that might affect that comparison?

Yes, good question. Well, a year from now, again, we'll have a completely different blend of new products a year from now. I would expect that to be a margin opportunity a year from now. There are no adjustments or funk that had hit this quarter that I would call out as being material or even important to talk about or even immaterial to talk about, really nothing that stands out. So yes, I think going back to the algebra of price and inflation and the seasonality and so on, again, I would expect as we get into season, we have pricing actions in our pocket. We have new products being introduced. And I would say, a continuance of the technology that we've been using to improve margin. And as far as a year from now and next fourth quarter, again, I think there's an opportunity to improve margin, but nothing that penalized this quarter in a particular way that would be important.

Okay. And yes, I appreciate you indulging us on all this quarterly conversation, which I don't think historically we would have done here. But Barry, you also said we need to get through the first quarter and you were kind of talking again about that year-to-year comparison, if you were down a couple of hundred basis points in the fourth quarter year-to-year because of all the items you mentioned, and then we look to the first quarter, that would put us in a range in the what, the 26.5%, 27% range. Just trying to understand the cadence, again, knowing there's a lot of moving parts there. Is there anything in the first quarter unusual that we should think about their relative to your comments, Barry?

Yeah, I think the pricing actions of the OEMs are pushed out a little bit into the late first quarter, early second quarter, if I look at things comparatively to last year. So you can read into that comment and in terms of modeling, you can consider the comment. So sequentially, I think, again, there're going to be certainly better margin in the first quarter versus a year ago, you have to consider my comment about the timing of some of the pricing actions that we're describing.

That's a good point, Barry, because instead of a January 1 price increase, most everybody went February 1, March 1. So it's a little bit of a lag to Barry's point.

A top 10 vendor that went April 1 instead of January 1. So some of this -- the benefit will push a little bit later into 2024 than simply January 1.

Great. Thanks very much guys.

The next question comes from Brett Linzey with Mizuho. Please go ahead.

[Multiple Speakers] Just want to come back to the inventory. So you took another $208 million out of the system. I believe that was a little bit ahead of your initial plan. But maybe you could just speak to your assessment of inventory levels as we begin to move into the selling season? Are there more actions that need to be taken, largely complete? How are you thinking about that?

Well, I'll give you a big picture of it is that we do want and we'll work on higher inventory turns. So I do expect to have our inventory produce more cash flow as it turns. And the science that we use is to do that, is being implemented. It's a very long process, longer than I expected. But eventually, what you'll see is lower investment in inventory and higher returns when compared to sales.

Yes, absolutely. This is Paul. Historically, it's been a four plus turn industry. And obviously, during the pandemic and the supply team is disruption, everybody got lost in the mid- to low 3s. And so now as we strive to get back to the four turns, obviously, we're going to have a reduction in inventory. Right now, we're seeing better cooperation and better lead times coming out of our OEMs pretty much across the board. And as those lead times improve, obviously, that gives us a better position to not have to stock as much inventory. So that's one thing that's happening. Secondly, Watsco has got an unusual position on inventory in each one of our operating units manages inventory. So there's not one big central headquarter directive that gets into the inventory. We manage it in much smaller blocks with each one of the operating units actually functioning against their vendors, what they need to have in stock and inventory. Plus Watsco invested during -- before the pandemic. We invested heavily in the technology it takes to manage inventory, putting in new inventory management systems. It gives us daily management reviews so that we can identify what we have on hand, what we have on order, by region, by district, by branch. So a lot more visibility than you'd find in a normal distribution company.

Yes, that's great. And then just shifting to the non-equipment versus equipment trends as well as in the second half being a little better than first half. I guess it doesn't suggest there's a meaningful retrenchment in the consumer on the replacement side. Is there anything in terms of high efficiency mix or credit metrics or things that you're watching internally that would suggest there's a step down here in 2024 early in the year?

Take a stab on the equipment side. The -- as we indicated a year ago, and we went to the higher efficiency minimums that were regulated by the government, we expected there to be a compression around the entry-level product. And we went from around 65% of the minimum efficiency products up to around 85%. So we've definitely seen more product coming out. It's higher-efficient product than what we had before, but it has distorted the industry a little bit towards the minimum efficiency as opposed to high efficiency.

And it's a good question on credit. It's not asked often enough, frankly. So we -- obviously, our accounts receivable represents contractor credit giving the average contractor about $10,000 a month and a credit line essentially. And so if you look at our cash flow statement, which is published in the press release, you'll see bad debt is actually down about 20% this year. So there's no obvious indication of change in the quality of the portfolio. It's roughly 10, 11 basis points of bad debt and again, compare that against any peer or any kind of other distribution model you can find, it's in a very favorable position. So credit is not something we're seeing a risk. It's how we serve customers and again, so far, so good from an economic point of view.

All right. Appreciate the color. I will pass along.

Next question comes from Jeffrey Sprague with Vertical Research. Please go ahead.

Good morning, Jeffrey.

Good morning, Al. Good morning everyone. Thanks for the time. Hey just kind of back on price. Just wonder what, if anything, you make of the OEMs kind of going later and kind of not at the same time. Is there sort of a message here of kind of price fatigue in the market do you think? Is there a game theory or something we should be thinking about?

I don't think it's that diabolical. I think it's just a natural progression of how they intend to roll out their new product introduction on the A2L and if you listen to each one of the OEMs on their public broadcast, you find that they each are putting out a different variety of products at different times during the year. And I think it has more to do with their engineering and their manufacturing plants and all that, that goes into rolling out the product.

Yes, interesting. Makes sense. And then just kind of back to the replacement question I was asked kind of at least obliquely a couple of different ways. Al, in your opening, you kind of talked about the inevitability of after a year like 2023 here. If we do go back to just that kind of old school demographic replacement [indiscernible] into the whole 15-year life and all that argument. We're echoing against 2009 right now, right? So that math could argue for another soft replacement year. I just wonder your thoughts on that and kind of what you're seeing in repair versus replace?

Well, our guru and that is Paul Johnson.

Oh my God. Start with the repair versus replace. It's is fourth quarter, first quarter, which is not the time when you're going to see a lot of repair going on out there. You don't have your air conditioners working, you have your heat pumps and your gas furnaces, which your gas furnaces are generally a lower repair item. So to date, we're not declaring that there's any trends that we've been able to identify and repair versus replace. Will it occur when the temperature goes up, we'll wait and see and find out. The other part of your question was what?

Just the underlying health of replacement demand based on kind of where the installed base is and sort of the age of the installed base.

The age of the installed base is newer than it's probably ever been since I've been around, which is a long time. But obviously, the mix of the installed base is changing. Gas furnaces generally have a lifetime. You can make a gas furnace last 25, 30 years, whereas a straight cool unit, I think the industry has said, it's around 15, 16 years. Heat pumps are something that are growing as a percentage of the total business. And those generally don't have as long a lifetime. Remember, they're not just operating in the wintertime, they're operating in the summertime also. So you've got more hours being packed on to that piece of equipment. What that's going to do to the overall mix of installed base out there right now. I think that's going to be one of the questions that we'll be able to look at probably in the next year or so. But replacement pull up, I figured that we probably had 2.5 million to 3 million units were pulled up troughing the pandemic. They were installed perhaps prematurely, perhaps not. Trying to get some data around that to see what the geography was of those replacements? Was it North or was it south? Where people were actually replacing equipment. A lot of data coming in, a lot of data that needs to be analyzed to answer that question properly.

Paul, I think you said something [indiscernible] This is A.J. In your 40 years in this industry, this is probably a dynamic period for the space as there's ever been between -- I mean all these questions are pointing to all the different in outs and change in paradigm between the supply chain, changing again the OEMs going with different pricing, different times, the change of rates of pricing going up and inflation, the inventory and the change to the A2L products coming out. There's so many different things going on in the industry today, which creates a lot of noise. But I have to say that I think Watsco is very well positioned. Our inventory has come down. The quality of our inventory has gone up as far as lower excess and slow and damaged inventory. Pricing, Barry, you covered a lot of it. What I think you left out was the key fundamental block there is that our transaction margin or as I think it's been written structural margin going in the right direction for 2023. I think there's more momentum around that in 2024. I think we're doing a good job. Our leaders and our teams in the field are doing a good job managing expenses given all the craziness in the space and the balance sheet. The balance sheet being without any debt well positioned for any opportunity that comes our way. So I guess my point is then in a crazy industry in a crazy time, I like where we sit and I like our performance, and I remain very optimistic about the year and the future.

Thank you for the perspective.

And I think that's well said.

I agree.

The next question comes from Joe Ahlersmeyer with Deutsche Bank. Please go ahead.

Good morning, Joe.

Hi, everybody. Thank you for taking my questions. I think right after your last call. There was a rule by the EPA interpreting the AIM Act, just wondering if you have any thoughts on the impact of that rule as it relates to the dates around the transition?

Yes, it doesn't change the dates of the transition. All it really did was change the sell-through process. Originally, the AIM Act out and indicated that you had to see selling any 410A product at the end of the year. The EPA came out with that with what you're talking about and has a one year sell-through now. The units have to be manufactured and produced in 2024. The date for building anymore is December 31 of this year, and then there's a 12-month sell-through.

Understood. And I think there was also some consternation around what constituted manufacturing and if that could actually apply to things that were charged in the field, wondered if you had any thoughts on that? And then over -- like bigger picture, though, does this actually change the time frame over which the OEMs are taking the actions that they're taking. Just any thoughts there?

No, it doesn't really change. The manufacturers have had to plan for this transition for the last several years. So it did not change the way that they're going to flow this through. They had to get their manufacturing processes in order. They had to change their plant, get their vendors lined up. There was no real change in direction based upon that ruling. They still have to stop manufacturing all 410A units at the end of the year. I think what you were referring to had more to do with what was a component? Was the outdoor unit a component and hence, it could be replaced. That question is still a little bit up in the air. There's still some fuzziness around that so that subsequent to the sell-through period, can you still install a 410 outdoor unit or indoor unit as a repair component? That has not been clarified yet.

Okay. Understood. And if I may, I don't think I heard earlier what your commercial HVAC sales were year-over-year relative to residential -- and if you have any thoughts on where commercial can go in the year ahead?

Well I did comment that commercial is very strong, and then we have backlog for at least a year. Can you add anything more to that, Barry or Paul?

I mean for the year, commercial was up in the teens. So I think that's been the trend all year long. The fourth quarter was near double digits and leave it at that, residential down a little bit.

And looking forward?

And I was going to say, and for the quarter, for the sake of the algebra, we had one less selling day in the quarter, so you can adjust for that if you choose to. Sorry, what was your question?

Just the outlook for commercial?

Again, we don't measure backlog in the same proportions as the OEM to make large quantities of large commercial but like we said, I think, in the release or in the commentary, the backlog is still strong. We haven't seen much variation in trend. And so not a reason to think that there will be.

Yes. And most of our commercial unitary products go at once. It's a replacement demand. So there is no backlog.

I always remember to put it in perspective, commercial for us is about 15% of what we do. Between 15% and 20% of what we do

The next question comes from Jeff Hammond with KeyBanc Capital Markets Inc. Please go ahead.

Hey, good morning guys. So I heard a bunch of different things on gross margin. I wanted to come back to that. It sounds like transaction margin moving in the right direction. You got these kind of headwinds that carry over maybe 1Q, 2Q. Just mean maybe level set us on how you think about gross margins for 2024. Is that kind of 27% margin doable or do we kind of run a little bit below that given some of the moving pieces?

You better take that Barry. Barry and Paul, do you want to deal with that?

Yes, I'll handle it. Well, first, I want to go back to the transaction margin. A.J. mentioned that, and it's important to emphasize that I think so for the year, which I really want to speak about the year. In the year, the headwind in terms of all this noise about weighted average cost gains and inflation and so on. That headwind in 2023 was about 120 basis points. And that's what we expect that to diminish greatly, importantly as we get into 2024. The margin gain, the selling margin gain in the year was 70 basis points. So the -- that transactional margin that we make by improving pricing, improving everything we do relative to price and margin did improve in 2023. So the question for 2024 is can that continue? Can that trend continue? And then some of the other noise diminishes, I would say, has largely diminished. So to answer your question, we're going to stick with 27% of the goal for next -- for 2024. And there's some good momentum in the selling margin and some of these other pricing action discussions we're having will have to play out as we think in the second, third quarter, especially for that to play out. But I think it's where we stand today.

Including the transition to the A2L products, that will be -- have to see how that plays out in the market as well.

And just to clarify, the non-equipment down six, did you have negative price in there where there were some actually real disinflation around whether it be refrigerant or copper steel?

I don't -- go ahead Barry.

Go ahead, Paul. You got it.

I don't think there was much of the way of a deflation that was really occurring there. Yes, we had a couple of product areas where -- we did see some price degradation, but it stabilized and came back. But I just think it was overall demand. And we just saw a slowdown in demand on those products.

Okay. And then just last one. On the -- Barry, you talked about kind of being a merchant and you've got pricing kind of a little bit later but you're also kind of managing dry down inventory. So how should we think about kind of buying ahead of price increases to be a merchant versus managing inventories lower as you go into the selling season? Thanks.

Yes, I mean is it more direct question whether we're buying Ford in some way and beating the price increase and so on. I'm not going to, again, publicly say what we do in terms of competing for -- but it's not a practice that we entertain on scale. I think we look at it here and there. We look at it market by market. At no time do we look at Watsco as a scaled company and say, let's buy Ford. And it's not something that really is a responsible thing to do in that sense. So I think in markets we consider it and certain brands we consider it, but nothing on scale that would be remarkable, Jeff.

Yes, I would say we are emerging, but we don't bet the ranch, and we take a risk-adjusted approach to [indiscernible].

Plus, Jeff, I think you've got the phase-in, phase-out of we're going to be phasing out of 410, phasing into the A2L product. So I think right now, we'll buy we'll buy a product that we need when we need it.

Was there a follow-up, Mr. Hammond?

No. I'm all set. Thank you.

Thank you. [Operator Instructions] The next question comes from Steve Tusa with JP Morgan. Please go ahead.

Good morning. How are you? So just to get the math down on the kind of resi unit sell-through, it looks like if we kind of parse that between light commercial and resi, that was down roughly 10% for the year, the resi stuff -- on units? It was down 8%, including commercial?

We don't really -- I mean, we don't include commercial in our unit volume discussion, Steve, [Multiple Speakers].

Okay. That's great. And I guess, just thinking about the gross margin, I mean, there's just such a wide gulf between what you did this quarter and what you did last first quarter. Can you just give us -- and you mentioned the price increases are coming a little bit later. Can you just give us any flavor for like where that 1Q might land in this whole construct on gross margin?

I would say without constituting official guidance, I think I tried to say it earlier, which is something sequentially better than the fourth quarter, start looking at things more sequentially than year-over-year. It takes some of the year ago volatility out. So an improvement sequentially from what you saw this quarter into the first quarter.

Right. So not up year-over-year, but something better than the fourth quarter?

That's correct.

Yes, okay. That's helpful. And I guess this whole discussion on pricing, are you assuming that the non-A2L products that you get price on those? I mean you're making it sound like the degree of price you get will depend on what kind of A2L product you sell. Are you assuming some lift on the non-A2L equipment? And then secondarily, if like there is some pushback in the channel, are you kind of prepared to ask your OEMs to kind of help you guys maintain or gain share in this market with price?

Those are all great questions of what if. Obviously, we keep in mind of some contact with our OEMs, and we'll be -- we'll be ready to make any sort of a judgment that is required to be competitive in the marketplace. We're not going to lose our competitiveness. And our OEMs certainly are not of that vein either. So yeah, we'll be working with them on that. One thing that makes the A2L introduction unusual, if you remember when we went from the 410A to the R-22, 410A was introduced five or six years before we transitioned over to -- transition out of the R-22. So you had a price basis that gradually was inserted over that six year period before we actually implemented the transition. This time, we're not going to have that. So I think there's a lot of question marks around exactly how this price can be set. And will the price go up or will be said too low, will it be so too high. And so that's a what if that -- I guess I'm not smart enough to answer.

Yes, I think it's more of a when, not if because I think different customer segments will adopt the new products sooner and then others and the prices will shake out as all this transpires and it's not going to happen in Q1. We know that. And so really the summer that we'll see how it works out in the market.

But -- are you assuming capture on the older -- are you assuming price capture on the non-A2L? Or is most of the price lift from the A2Ls?

We have not assumed the price that there's going to be captured on the 410. [indiscernible] We've got the price increase so far for the 410. It's not anticipated that we're going to be able to price that up against the A2L. I don't think anybody is assuming that.

Against the A2L. I'm just saying like-for-like relative to where the price was in '23 for the non-A2L, like do you assume year-over-year capture if A2L wasn't happening would you assume year-over-year capture on the 410A type product?

Certainly. With the price increases that we have, yes, of course. [Multiple Speakers]

Yes, I want to be really clear about that. So Paul mentioned earlier, if we range it out across really -- we sell six OEMs products on the ductive side, probably another six on the ductless side and the range of price consistently across the group is between 4% and 6% as we said earlier. Your question is, do you expect to yield any of that in 2024? And the answer is yes. To what extent time will tell, but we certainly do not see outliers and if there's a competitive need in the market or customer type or an application, OEMs will always be asked to participate and react to what's going on in the market. But on whole, on scale, we do expect price capture 410A.

And then sorry, I just got one more. The call usually ends early, so hopefully, I'm not taking up anybody's time here. But the 2.5 million to 3 million units you mentioned, what's kind of the math on that? And can you just explain that, what you meant by that, the 2.5 million to 3 million units that you're calculating is being installed at the peak?

Well, if you look at 2019 as your baseline at roughly 8.5 million units. And then we zoomed up to [indiscernible] we stayed above 10 million in 2023, the industry shipments fell back down to 2019 a little bit ahead. So if you take a normal, let's say, 2% or 3% growth rate that the industry historically has had put that against where we were in 2019 and take the delta.

Got it. Okay. Great. So that pull forward, you're saying like kind of the opposite end?

Yes, that looked like a pull forward to me. Like I indicated to you, one, we've got to look at it geographically because you have longer life spans, obviously, in Michigan than you do in Miami, Florida.

Right, right. Okay. Great. Thank you so much.

The next question comes from Damian Karas with UBS. Please go ahead.

Good morning, Damian.

Hey, good morning, everyone. I have a follow-up question on inventory. I know you talked about normalizing back to kind of four to five turns over time. Just curious if you're anticipating though, later this year, maybe having to go in a restocking mode as the 454B equipment becomes available and then basically, you kind of get your last call on getting that 410A? And related to that, I'm just curious if there's any incremental cost that you might expect just as you're kind of managing the legacy versus the A2L inventory buckets? Or can you do that pretty efficiently?

I think we -- each one of our operating units is developing plans for what we call phase in phasing in the A2L products and phasing out the 410 products. We have -- and obviously, we have a safeguard that we mentioned earlier with the AIM Act where we can sell the 410A all the way through next year. But each one of our operating units is working on that plan so that -- we want to be able to hit our inventory targets. We want to be able to hit the demands of the marketplace and our contractors. And we want to be able to do it in a very logical format so that it's not disruptive to the business and it's not creating additional overhead for us.

Okay. Got it. Thanks. And then kind of a follow-up question to a comment you made, Barry, about you sell six OEM products on the ductive side, six on the ductless side, I mean it does [indiscernible] there's a lot of kind of newer players trying to make moves in the US market, particularly in key pumps and some of these alternative electric high-efficiency solutions. Would you guys foresee working with more equipment vendors over time or you pretty kind of satisfied and set in your existing relationships and product breadth?

Are you satisfied?

It's like a -- I want to give like a half hour answer to that honestly. I mean I don't think we look at our portfolio of brands and say, do we have enough or too much. I don't think we can even consider that kind of notion. We look at the markets themselves. So where we've acquired great businesses, we've acquired a great carrier distributor in Chicago three years ago. We acquired a great green distributor in Louisiana a few years ago. the acquisition campaign is somewhat indifferent to brand. It's focused on who are the dominant players in markets and over time, building incredible franchises on top of the credible franchise that owners have built, so I would say that from that growth perspective and if you ask me, can Watsco double in size, the answer is yes, and we would do it that way. And oddly enough, ironically enough, the brands are relatively indifferent to that strategy. because we're trying to grow share in markets and legacies and that's what we've done, right? I mean we were a $1 billion company 20 years ago. We're a $7 billion company now, and we know we can double the size of Watsco in that same kind of way of growing over the long term. Now if your question is very short term and kind of the puzzle pieces that we operate today, we're not going to be satisfied unless market share is well above average end markets. And we're going to find either build on relationships we have and add brands, with carrier, I don't think people really appreciate it, but we sell seven, eight different brands that carrier makes and we don't have all of carrier brands in all of our carrier locations, and that's an opportunity that we talk about in terms of how to bring more density to those brands and those stores. And we've added -- there are niche products and manufacturers that operate in niches that we've added to our network. This ductless that we've added to our network. We have a private label that's grown over time. So very interesting question with a very long-tailed answer

I'll say this is that we're never satisfied. That's part of our culture. We're very ambitious. We're always wanting to grow, always want to move up and to the right. It's an exciting time in the industry as key pumps have gained traction and regulation, frankly, and the changing markets are creating product innovation for the first time I think in a long time, and it's exciting. And that innovation is not only coming from new entrants, but it's also coming from our OEM partners with products that they've brought to market or that they will bring to market it's fun and exciting with the improvement and enhancements in the technology that's coming into the product and it will be fun to take in the market as well.

Really appreciate the color. Best of luck, guys. And Barry, I'll make sure I follow up, so you can give you the full 30-minute response.

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

Thanks for your interest in our company. We much appreciate it. And we believe that we have an enormous future ahead of us, and we hope you'll be with us along the way. Bye-bye.

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