Good morning, and welcome to the Watsco First Quarter 2022 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Albert Nahmad, CEO and Chairman. Please go ahead..

Good morning, everyone. Welcome to our first quarter earnings call. And as she said, this is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, who is the President and Paul Johnston, Barry Logan and Rick Gomez.

Now, before we start our cautionary statement as usual, 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. Well, now that that's over.

Let me report that we had another exceptional quarter. New records were set on virtually every measurement of performance. Earnings per share jumped 109% to a record $2.90 per share. Sales grew 34% to a record $1.52 billion and operating income increased 109% to a record $171 million.

Gross margins expanded, and that along with improved operating efficiencies, led to record operating profit as well as operating margins, which expanded 400 basis points to a record 11.2%. Now this is important. The sales growth was strong and consistent across all markets and product groups.

Also, noted is the companies that we acquired during the past year also performed at record levels. The reason we like that is that we believe that shows once again, that Watsco is a great home for family-owned businesses. We sustain their culture, invest in people and provide technology to secure and build upon their very great legends.

Also, please note that the quarter’s results are all the more impressive giving the strong comparison from a year-ago. Year-ago was very strong and this year is even stronger. While it's early in the year, we are encouraged by this terrific start and by current demand trends.

Let me say that again, we are encouraged by terrific start and by current demands trends. And we think that 2022 should be another record year for Watsco. Looking beyond sales and profits is important to highlight some of the important catalysts going on both in the short-term and the long-term and we emphasize as we always do with the long-term.

The industry is still experiencing inflationary pressures and OEMs have recently announced additional price increases. As you can see from our results, we are capturing price in the marketplace, given the reliance and necessity of HVAC products in homes and businesses.

Looking forward to next year, energy efficiency mandates enacted a few years ago are now in effect and they will raise the minimum standard for base efficiency systems beginning in 2023. So the government is very involved in raising efficiency mandates or efficiency of ratings through mandates.

Now we are working closely with our OEM partners to transition inventory ahead of next year. Historically, energy efficiency mandates provides us the opportunity for a richer sales mix of high-efficiency systems. And importantly, our customers have greater value to offer and – to end users in replacing and upgrading older systems.

We have the same expectations going forward. Federal mandates are also in place that would ultimately phase-out the current high GWP refrigerants used in millions of systems throughout the country. 10% reduction in these refrigerants is in effect now that's mandated by the government.

A 30% reduction is scheduled for 2025 with a further reduction in 2030 – a further 30% reduction in 2030. OEMs are actively developing new products to incorporate the lower GWP refrigerants, and those products are expected to be launched in the next couple of years.

And as a result of that, today's cost of refrigerants used to repair older systems has risen sharply and so to as a cost of repairing and maintaining older system. Forgive my slight cold, please.

Working with our contractor customers, we see the opportunity for homeowners and businesses to upgrade systems that will cover over time more efficient – I should say that over time will be both more efficient and environmentally friendly. That's a nice thing that's coming to our industry.

In terms of our commercial markets, we believe there is potential for greater infrastructure upgrades and climate change capital spending along with an increased focus on indoor air quality.

Although it is likely that this trend will take years to play out, Watsco’s organic sales growth rate for commercial products accelerated during the first quarter to 29%. That's 29% growth in commercial products in the first quarter.

Longer-term, there are other potential catalysts, expansion of federal state, or local programs to help fund the purchase of high-efficiency systems, we see that happening. The trend towards electrification and the adoption of heat pump systems to replace fossil-fuel powered heating systems that like gas furnaces.

And the second half – and the second phase-out to even lower GWP refrigerants is on the books in 2029. This information emphasizes Watsco's significant role in the drive to lower CO2 emissions. According to the Department of Energy, heating and air conditioning accounts for roughly half of U.S. household energy consumption.

As such, replacing HVAC systems at a higher efficiency is a meaningful action that a homeowner can take to reduce energy consumption and carbon footprint over time. We offer a broad variety of systems to go well beyond the minimum standards that can exceed 20 SEER.

First quarter sales of high-efficiency systems rose above the minimum standard through 31%, outpacing the 26% growth rate for the residential equipment. Based on estimates validated by independent sources, Watsco averted 11.4 million metric tons of CO2e emissions since January 1, 2020 through the sale of high-efficiency HVAC systems.

This kind of information and more information is available on our website, including sources and assumptions used to support the estimates. Simply put, there is a lot going on and we love our industry.

But again, we believe entrepreneurial culture, custom-focused technologies, scale, access to capital and leadership positions provide unique advantages in our industry. We are fortunate to serve a large and growing population of contractors and technicians with the industry's most innovative technology.

Our annual run rate for e-commerce sales now exceeds $2 billion, and we can see that our active technology users continue to grow at a faster rate. Let me say that again, e-commerce users of Watsco technology, at least the e-commerce platform are growing at a faster rate than those that do not do e-commerce with us.

OnCall Air, that’s one of our tech developments, a Watsco digital sales platform used by contractors and CreditForComfort, which extends credit to the end user continues to expand.

Contractors presented quotes to approximately 45,000 households during the quarter, a 40% increase and generated $160 million worth of sales for our customer, a 59% increase over last year. The information presented today is only some of what is going on in terms of technology initiatives.

As we said before, if you have any interest on learning more, let us know. We will schedule time with A.J. and his team. We believe we are transforming the industry, and we are always happy to share more about our progress. With that, let's now go on to Q&A..

We will now begin the question-and-answer session. [Operator Instructions] And our first question will come from Tommy Moll of Stephens. Please go ahead..

Good morning, Tom..

Good morning, Al, and thanks for taking my questions..

Of course..

So an 18% increase in residential average unit selling prices. You called out that's a combination of pure price plus beneficial mix. And I think on both of those points, there's a nexus to some of the technology investments you've made.

Can you help us understand that nexus?.

Well, that's a very good question.

Barry, A.J.?.

Hey. Good morning, Tom. Well, first, the pricing actions are always built on the costs that's coming in the door. As we receive a higher cost, we pass on higher prices. And that's elementary school stuff that's gone on for 25 years, of course, cause and effect.

The technology discussion is on the pricing – is a pricing system that's been in place now for a couple of years and is more mature today than two years ago and more useful today than two years ago.

When you start to see the pricing actions play out with all the movement that's going on across really all product lines, not just equipment, 18% is just equipment. This has been a discussion across 150 product lines, 600 vendors, and the administration of pricing is much different today than again, it was two years ago.

So not quite answering your question maybe, but just get a sense that this is not business as usual with this added layer of pricing technology that we have in place..

And on the mix side. Sorry, go ahead..

Is that you, Rick?.

No, it’s A.J. I'll say what Barry is saying slightly differently is you have to think about the scale of what we're talking about with these price increases and the number of customers would deal with and the number of products it touches and the number of geographies.

We have received hundreds of different pricing actions from our 1,000 plus manufacturers, and we sell those products to 100,000 contractors across 671 locations. The administration of that those changes and nearly every contractor by the way, buys products from us at different prices. The administration of that can be overwhelming.

And what we have now with our technology tools allows us not only to administer that quickly, efficiently and accurately, but it also provide – we can get that done so quickly that it gives us time to put intelligence and analytics to work to optimize pricing by customer, by geography, by product, et cetera, so that we can really make a difference in the market as well..

Thank you. That's all helpful context.

I guess to consider the other side here, demand destruction, I'm curious for any insight on, so in an environment where you have realized substantial price and looking at your numbers, I don't think there's any sign today of significant or any demand destruction on the end user side, but it's got to be something that's on everyone's minds.

And so I'm just curious for any insight or opinions you might offer there?.

Barry?.

Yes. Sure. Well, again, this is not unprecedented. Several years ago, when products went from 10 SEER to 13 SEER, there were probably 15%, 20% price increases then just because the products. We didn't see the demand destruction then. As you suggest, I don't think we're seeing it now.

I think the fundamentals are simple to understand, which is people don't live without our products. They won't live without our products. There's a health quotient. There's a comfort. If it's a business, it has to be in business. So I think the necessity of our products has always been a great fundamental for the industry.

The other is that it's really a product with 10, 15, 20-year life. You don't buy these things twice a week. You buy them once every 10 or 15 years. And when you do, you're upgrading the efficiency of your dinosaur that you do own in your home.

And contractor collaboration and contractor skill, I think has improved to a point where the recommendation and the installation, and really the overall aptitude for high-efficiency is playing out. Obviously, we're helping that with some of our technology as well, but I think that's the life cycle that has been in place now for a long time.

And I think if your real question is at what point does consumer sensitivity matter on price? You'll notice in the press release, we talked about selling 29 different brands of equipment.

So the diversity and the price points and the features and benefits, and the waterfront that we cover is very comforting because that's part of – it's ultimately part of an equation, right, is how well the consumer spends money on these things. And I'm glad we're the most diverse player in the industry to be in that position..

And there is an ROI, the consumer that buys high-efficiency equipment saves electricity costs 10 to 15 years, if there is a return on that investment..

Thanks a lot. I appreciate it, and I'll turn it back..

The next question comes from Jeff Sprague of Vertical Research Partners. Please go ahead..

Good morning, Jeff..

Thank you. Hey, good morning, everyone. Addition to the revenues, the margins pop-out here. I wonder if we could just kind of dig into that a little bit more and obviously you get leverage on the year-over-year growth. But kind of looking at the sequentials, right, your revenue in Q1 is similar to Q4 as it usually is.

And really prior to last year, we tended to see gross margins in Q4 and Q1 being quite similar, but we've got half the step function change happening here. So maybe you could just unpack that for us.

I'm guessing, it's price on top of price would be my initial guess, but maybe you could provide a little bit of perspective on how to think about the gross margins here in the quarter and what it pretends for the year?.

Paul?.

Well, yes, it is a little bit of price upon price increase. We had price increases at the end of the fourth quarter that range from 8% to 12%. And then we've had a secondary announcement of price increases that are coming in April and May. So I think the prices have continued to move up.

And as the prices continue to move up, obviously, our gross margin goes up with it..

And could we just touch on inventories a little bit here? Obviously, there's a lot of price and mix I would assume going on in the inventories as you report them. Is there any particular disconnect there in inventories relative to what you see playing out in Q2, and there was a comment about transitioning inventory with the OEMs.

I just wonder if you could elaborate on what you meant there and how you see that playing out over the balance of the year?.

Okay. If you take the first question, obviously the inventory dollars are up and we look at a reflection of how many units do we have and are we set for these season. And the answer to that right now is we're in very good shape on the inventory to be able to carry us through it to the second quarter and obviously the stronger third quarter.

What we're facing is a transition of pretty much all of our SKU as they relate to outdoor heating – outdoor heat pumps and cooling products that will go into effect January 1, 2023, as we indicated. However, we're going to be doing a transition earlier than that.

We're going to try to start moving the new products in late third quarter, early fourth quarter, so that we will have a smooth transition into 2023. Obviously when that occurs, we're going to see another step up in cost and price because the price of the new products at the higher efficiency ratings is going to be higher..

But you're anticipating selling the newer equipment also in the back half of the year, not just stocking it in preparation for 2023, is that right?.

No. We definitely look forward to selling it in the back half of the year..

Great. Thank you..

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

Good morning, Jeff..

Hey, good morning. So I just wanted to get on back on gross margins. I mean, you guys have had a huge step up from kind of three, four years and 24.5. And then we step up again. And I'm just wondering, any anomalies in this 1Q.

And if we start to see this inflation kind of normalize, which doesn't seem to be, but where you think you ultimately fall out, given the combination of kind of price cost arbitrage versus your structural changes?.

That's a very good question. I think both Barry and Paul should answer them..

Yes. Thanks. Good morning, Jeff. Yes. I mean, first there were price increases in the first quarter – effective in the first quarter, as Paul mentioned. There is a benefit as we turn that inventory and what is a small – relatively small quarter.

So just to balance the discussions, if we look back sequentially in the fourth quarter, 27.3 I think was the margin and this quarter, 29 and change. So there is a benefit that showed up this quarter really, and what is a slight quarter for that, that the benefit of that. It doesn't account for the entire increase, but I'll say a good part of it.

So that's something that is, I wouldn't call it anomalies, not the right word. That is something that is more material in early first quarter. And as Paul mentioned, there are more price increases on the horizon.

They won't have the same level of benefit and basis points, but they will have a benefit, that trend will continue we think for the rest of the year. But again, don't just fall in love with the algebra that this is a structural change in how we manage pricing. First of all, you've heard that story.

Second of all, we absolutely work with our OEMs to invest in our business. And when we invest in our business, the economics between us and the OEM is something that improves, and you can see that in the SG&A by the way.

Part of the counterbalance to higher gross profit is sitting in our SG&A expenses through investments we're making to grow the business long-term.

And our parts and supplies business, which we don't talk a lot about because we're not asked about it very much, that is where we see the disproportionate level of gross profit improvement along the lines of the technology gains that we're seeing with pricing..

Okay. That's real helpful. Oh, go ahead..

And as we said, we've got a price increase dropping into this quarter, and I reasonably assured that we're going to have another price increase with the introduction of the new product in Q4.

And some of the products that we sell that Barry mentioned, when we get into the supply side and all the accessories, some of those have got some long-term price advantages, which are going to continue to repeat.

Refrigerant is going to become short as the government has restricted the amount of GWP type refrigerants that can be produced, it's created a supply issue, which is going to be long-term at least for the next 10 years. So there's a lot of things out there, a lot of pieces, as Barry always puts a lot of moving parts out there.

But I think from a price standpoint, I think it's going to be pretty much sustainable for the rest of the year..

Then I think a direct consequence to gross profit margin is product mix. As we move to higher efficiency, that does bring a higher gross profit margin. As we expand our parts and supplies business that does increase our gross profit margin in addition to what Paul and Barry has already said..

Okay. Very helpful guys. Just kind of a housekeeping.

One, I'll ask on non-equipment, what price was relative to what you said on equipment? And then just any color on growth rates in the international and commercial piece?.

Well, on the non-equipment side, yes, we've seen price increases less on the part side than we have on some of the supplies. Some of the supplies as I indicated with the refrigerant, refrigerant is moving rapidly upwards. However, on the parts side, what we're seeing is, we're seeing a strong demand.

At the same time, as we're seeing a strong demand for the equipment side and pricing actions there are lower than they are on the equipment..

And Jeffrey, to answer your question, I've said this now for a few quarters. I think the overall same-store growth rate of 25% is within 1% be it commercial, or I'm sorry, be it domestic or international..

And how about the….

The geographic markets are very consistent..

And how about commercial growth?.

Yes. We mentioned that on a call, 29%..

Okay. Sorry about that. Okay. Thanks guys..

The next question comes from Nigel Coe of Wolfe Research. Please go ahead..

Good morning, Nigel..

Thanks. Good morning. I hope you're feeling – you feel better. Sounds like you are suffering with a cold. So on the mix side, I'm not sure you called out the – broke out the 18% on residential between pure price and a mix. So just wondering if you just maybe just flesh that out a little bit.

And really the context of the question is consumers get hit with a lot of inflationary pressures across the board. And at these times you sometimes see a mix down towards more value brands, value products and then maybe a bit more of a pair.

Doesn't seem like that's [indiscernible], but I'm just wondering, number one, what was mix in the quarter? And secondly, are you seeing any signs of that kind of behavior coming through?.

Not really, we're not really seeing any real change in the way we're – way the brands are reacting to it, all of the brands, all the OEMs we represent are experiencing up sales, up sales which pretty much are normal across the board. As Barry indicated, when we started the call, most consumers only make this purchase every 10 to 15 years.

So there isn't really a recognition on their part as far as what is the manufactured suggested list price of a carrier versus a goodman versus a train. So it really hasn't impacted that at all..

Okay.

And then what would you say is the mix component of that 18%?.

Yes. Nigel, it’s not something we break out in that sense..

Okay. That's fair. And then on the inventory side, I think the message from Jeff's question was that there is a bit of 14 SEER kind of stocking up preps ahead of the deadline.

Would you expect to continue to build inventory kind of ahead of seasonality into the mid part of the year and then set us through, I mean, how should we think about that?.

Well, first let me say that the OEMs are still supply challenged and we do have more orders because the demand is still very high.

Barry or Paul on that?.

Yes. We're not going to build up inventory. This is not a traditional change over that we had when we went from 10 SEER to 12 SEER and then to 14 SEER. So we're going to be tailing off very quickly on the straight cool units.

We're going to be bringing those down, focusing once again on what is environmentally good and also can be sold through and is grandfathered and that is the heat pumps.

So this is not going to be a situation where the industry will be building up low efficiency or standard efficiency 14 SEER products in anticipation of some sort of a bridge where they can undercut the price of the new product when it's introduced in the fourth quarter and first quarter of next year..

Okay. Great. I'll leave it there. Thanks. Thanks, guys..

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

Good morning, Ryan..

Good morning, guys. Great quarter. I was hoping we could start high level.

What is the outlook that you guys have for resi unit growth in 2022? I know the guys over at [Hardy] are thinking flattish, but after this quarter, it feels like that might be a little conservative?.

Go ahead, Paul..

We normally don't get into what we forecast for the marketplace, but the marketplace obviously right now is very strong and we're adapting to that, new construction, which is a small piece of our business, but it's still an important piece of our business, continues to be very, very strong. Don't see that tailing off.

But the replacement demand, we feel pretty good about it right now, but a lot of the elements trying to predict replacement demand are tied to things that we don't control, the weather and all those things..

Yes. But we still see very strong demand..

Yes..

Yes. We haven't seen a change yet in the demand equation..

And some of it, if you look through it, we disclosed in the press release a bit of a discussion on ductless systems for example, both residential, commercial. The growth rate of that product group was up 45% in the quarter. And if I strung together three or four years, the compound growth rate is well in excess of any overall industry growth rate.

So what's the story of ductless for example, and part of it is our own investment and skill and capability and – of growing those product lines, a big part of it also is the acceptance of those products in homes and businesses.

So we're competing today with VRF products in a way that we didn't probably even three or four years ago, to mention 10 years ago.

So they're always more going on than just what's the market doing, and that would be an example of something that's becoming more material that's important and interesting and gets beyond just what is the market doing?.

Yes. Got it. Okay. As a follow-up, I'm getting asked about inflation and rising interest rates and how that might impact replacement rates.

What's been the history there during a period of rising rates? Should we be thinking about replacement rates falling at some point in the coming quarters? Or is that not in the – you're not pretty – just quite yet?.

Yes. I think Barry says it best. Yes..

Yes. Well, first I think again, you have consumers that won’t live without the products. And then the question is what do they spend when they're faced with a replacement? And contractor – the contractor relationship is what matters most in that regard, right.

So again, having access to the brands and the products and efficiencies that may solve any equation is what we're after. If you were a factory operated location with a single brand in your warehouse, you have a different feeling that day than I think what we have where we're servicing a broad group of price points and contractor types and so on.

Just my pitch for independent distribution. But I think at the end of the day, the consumer is going to figure it out. Our job is to help them figure it out. And contractor relationships are integral to that. Financing becomes integral to that.

That's something that we're investing in and ramping up and long-term we'll have the most elegant solution we believe in the industry for financing. And again, in past events, past recessions, let's say if we saw a trade between a 20 SEER unit and a 16 SEER unit, yes, there's price sensitivity, but it's really not material at the end of the day.

These are not discretionary purchases..

Very helpful guys. I'll pass it on. Thanks for the color..

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

Good morning, David..

Hey. Good morning, everyone. Question on the price differential as it relates to SEER ratings. I think in the past, it's been fairly linear with efficiency.

Is the price differential between 14 SEER to 15 SEER or something in that mid single-digit range today?.

It’s actually – the 15 SEER is not – is a product line, but is not a material seller in the industry. So it actually jumps from a 14 SEER to 16 SEER. So the 14 SEER and 16 SEER would be the largest segments of the market today. And it's a double-digit difference between 14 SEER to 16 SEER..

Yes. Okay. That's helpful. And then, I know we've talked about this on past calls, the success that you're having in selling other HVAC products, that segment used to lag equipment, and lately you've been seeing similar even better growth in a lot of cases.

Are you ready at this point to talk about what's driving that? I mean, is it incentives? Is it training, technology? What are the key drivers behind the better results you've seen there lately?.

Paul?.

I guess, I'm not understanding exactly what products you're talking about..

Well, I'm talking about – so you've got your report equipment, and then there's other HVAC products, and I'm saying other as a segment historically used to lag the equipment because you sort of swung between the new construction related stuff, the duct work, and the thermostats and things, and then the repair parts.

So it used to always lag equipment. Lately, it's been growing much better.

And I'm just trying to understand what the drivers there? Is it something you're doing or is it just consumer demand? What's the issue there?.

I would say it's a combination of two things. One, yes, we are driving that business that has been a business, which has to your point lagged. And now we're driving that business with better availability, better arrays of products in the branches.

So we have the right availability at the right spot and that's been a technology drive that we've had with our inventory management systems.

Secondly, we've actually put people in place, who are in that supply type business, who are in that non-equipment business, who know it and have done it successfully for other people, and they're doing it for us now. So I think we're gaining our fair share of that.

We're looking at attachment rates as far as how many units, how many pieces of equipment we sell and with that, how much of the other products should be going with them. So I think it's a great effort and something that we're very focused on..

I would add. That’s getting the pricing right too, that's another extension of our pricing optimization is that in many cases, we’ve been – we’re so focused on selling equipment to our customers, selling non-equipment was not their thought.

Well now, with the tools, we think that the pricing, right and pricing profile is right for the customers, and then market digitally through our e-commerce and e-mails and mobile push notifications making customers aware that we sell these products, they're well priced competitively.

And also we have a private label offering and non-equipment parts and supplies that is also an effective tool to take some share in the market with those products..

Dave, this is Rick. I would add just a fourth or fifth layer to that, which is that, three years ago, if you want to use that as a benchmark, we did not have the number of users today on our mobile apps and in our e-commerce platform that we do today. And we've said for a long time, that line items per order through that channel are higher.

The incremental line items are not equipment. They tend not to be big ticket stuff, they tend to be accessories. So for instance, this quarter we grew supplies 34% and the more contractors we aggregate on our mobile apps and through our e-commerce channel, the more we kind of have better start going forward..

Good point..

All right. Thanks everyone. Appreciate the detail..

The next question comes from Josh Pokrzywinski of Morgan Stanley. Please go ahead..

Hi. Close enough. We all know – we all know what's going on..

You must feel for that Josh..

Yes. And it never gets old. Good morning, guys. So just on the gross margin commentary, I understand there's kind of a lot of factors there, but I guess conversely also an awful lot of daylight between 24% and I guess nearly 30%.

Maybe to ask it a little differently, if you guys were in this kind of like 26% to 27% type range where you were at last year, if I said you were there two years from now, would you be happy with that, would you be disappointed because it didn't go up further and like 1Q was a little bit more anomalous, like how would that fit with you?.

I don't understand the question.

What do we think about our gross profit margin?.

Gross margins grow 26% to 27% long-term, is that good or bad?.

Well, we hope to do better than that. We haven't expressed that before, but what we think is with the investments that we're making, we should be able to do considerably better than what we've done in the past with the gross profit margin considerably better.

And for all the reasons you're starting to hear, the wave of higher efficiency, the government is stimulating it. We had a peak at some bill. I don't know if it's going to actually pass, but they're going to incentivize consumers to buy higher efficiency systems.

Our own ability to merchandise parts and supplies is growing, by the time our e-commerce is booming. I mean, there are a lot of things that we're doing in order to raise that gross profit margin..

Okay..

I am not stuck to the 24% of the past. I am stuck. There's something that's going up, absolutely..

I completely agree. And Josh, if you know us, we are never satisfied, right? The whole mission of the company is to always continuously improve on everything we do in all of our results. So there is no level at which we're satisfied. We're always shooting for more..

Okay. And then just thinking about 1Q, I think seasonally has a lot of things that can move around and maybe not a massive barometer for the year.

But the levels of activity that contractors are seeing today is that an early start to the season, is it catch up on stuff that couldn't get done last year because either labor or equipment itself was less available.

Like, how should we think about what's going on today relative to kind of when you get into the real bulk of the season, like, is this 2021 kind of deferral activity that you've made up here?.

Paul?.

I don't think there's any real way of knowing Josh. I would say this, no one tends to replace their system ahead of time. They think it's going to break in April. So let's go ahead and get it done in February. I just don't think that's ever a consequence.

I think in our experience, the shoulder season is a very good indicator of how the consumer is behaving. It's a time where there is maybe more discussion going on instead of an emergency situation like in July. So if price and margin and yield in terms of gross profit has improved over the last six months and they have.

Let's look at things over six months in the shoulder season. I think that speaks well to what the consumer is doing..

Yes. I agree with that Barry. I don't think we have any way of knowing, what motivates the consumer at this time. Historically, what we've looked at is about 80% of the units are replaced because of an emergency situation. The units down and I need hot or cold air.

About 20% of the consumers buy because they plan the purchase ahead of time to what Barry is talking right now. And I don't – I really can't foresee if there's been a real major change in that dynamic..

Great. Helpful detail guys..

The next question comes from Steve Tusa of JP Morgan. Please go ahead..

Good morning, Steve..

Hey, good morning.

Sorry, what did you mean when you said the heat pumps are grandfathered in?.

The heat pumps, you can continue selling the current heat pump into next year..

And that doesn't change going forward or is that just you can sell them, you can take them in inventory and sell them out that there's still a step up required on the heat pumps?.

There will be a step up required on the heat pumps, but any inventory that you have is grandfathered and can continue to be sold for the next year..

Got it.

Even in the south?.

Even in the south..

Yes. Steve [indiscernible]. The government is very interested in moving away from gas furnaces because of the emissions, so heat pumps solves – the electrification through heat pumps solves a lot of those issues..

Right. I feel, I recall in the past, you guys talking about targeting a 10% operating margin at one point, I don't know if you ever kind of put in print, but you had talked about that. Obviously you're kind of blowing through that today. I mean is this – is there a time where you'll say you guys can do low double-digit, 15%.

I mean is that kind of what this trajectory looks like for the next couple years?.

Well, that's our goal to increase the EBIT margin for sure..

Okay..

We work tirelessly at that, our profitability, and yes, I think those numbers are possible..

Okay.

And then just one last one, what is total – what was total price capture for the total company for the quarter?.

See, we only report on the equipment, so at 18%..

Okay. I had to try. Thanks guys. Appreciate it..

[Operator Instructions] And our next question will come from Chris Dankert of Loop Capital. Please go ahead..

Good morning..

Hey. Good morning, guys.

Again, to circle back to gross margin because it was just kind of such an impressive number here, I guess it would be fair to characterize, you guys finally hitting whether it's critical mass in kind of the adoption of the business intelligence tools and the operational efficiency tools, is that part of what's really driving this uptake, obviously price-on-price goes a long way.

But it sounds like your commentary really is pointing to, hey, these efficiency tools have finally hit a point where it is at least a substantial driver of that gross margin improvement and thus is durable, is that the fair way to characterize it?.

All right. Who is going to volunteer for that one? Barry, Paul, A.J..

This is A.J. I mean, Barry said it early in the call is that some portion of this is structural. There is price-on-price, like you said, but there is structural as well and business intelligence and moving our customers purchasing to online and all the other things that are happening in terms of our analytics and our process improvements and so forth.

Those are structural and again, we're never satisfied. We are always seeking to continuously improve on these dimensions and they should result in higher gross margins and higher EBIT margins over time. That's been the plan and yes, I think we are absolutely seeing some of that today..

And you'd have to say A.J., we still have a lot of runway on..

Oh my gosh..

And being able to implement these all the way through, so that's where I get excited..

Maybe we're in the second inning now out of the first inning..

Okay. That makes sense. Again, like I said, it seems like it has been, since 2017 for a lot of these programs, it seems like all of a sudden you're certainly hitting a stride on some of them.

So I mean, maybe you said there's a lot of runway, where do you see the most runway going forward? Is there a particular program? Is it just integration? Is it just driving adoption? How do we think about these tools going forward and what they can do?.

You mean to quantify that?.

I mean, if you want to – that'd be great. I was more thinking qualitative..

We always invite you and others to spend some time with us and really understand or start to understand the scope and the scale of what we're talking about with all these programs. And we'll spend three hours together and maybe scratch the surface and you can understand the breadth of it. That might be a way to answer your question though..

That's a very good answer. .

Yes. And I would say that the tease of that is this that, the e-commerce [indiscernible] any customer anywhere period, not large or small, not north or south, but any customer we believe should be on the platform. And so to the extent we have, let's say $100,000 customer that somebody else's $1 million customer.

How do we get access to that book of business through the technology? How do we get that adoption going? How do we make a material dent and what is a smaller customer and make them larger customers? So that's my tease is if you spend the two or three hours with A.J. and team, you'll understand how that's being done..

And I could add one more thing. And that is with all the labor shortages that everybody's experiencing, including in the HVAC industry, we also forget that our technology improves the efficiency of the mechanic in the field, improves his productivity so that he can perform more jobs.

So it becomes more and more relevant that we're able to improve the performance of our customer. That's a benefit that you can't just get from any location except for a Watsco location..

That's an excellent segue, I guess, to my follow-up here.

I mean, adding 600 heads in the past year, I guess, how do we think about hiring going forward? Are you finding decent availability of labor? Just any comments on kind of how we think about headcount from here would be great?.

Well, we're very decentralized and very entrepreneurial. Those decisions are made locally. Of course, if we open a new branch, which we are constantly doing, we'll add to the headcount. So that's a – and something that's always in motion.

We can't quantify to you what – whether we're going to have 50 new employees because we don't decide that at the corporate level, we let the people know what's going on in the field beside that, but we certainly are growing branches and employees..

It's not something that your regional managers have been saying, hey, this is really an impediment to growth at this point, clearly.

You're finding the people you need?.

No, I wouldn't go that far. We do have issues with sufficient help, but as I said, we're very decentralized and local leaders do what they have to do with compensation. We have a pretty good corporate program for health insurance and retirement we think.

Those are things that we can do at our level, but at the local level that's done because they understand what they need to do. And they do it. We do have people leave, but it's not yet become as you can tell by the performance something that's hurting us..

Yes. Absolutely..

We like that. Yes..

Yes. Clearly not that big an issue, but glad to hear that, I mean, it sounds like you're – the guys in the field are making the choices they need to, so we'll listen. Thanks so much for the color guys and really congrats on the quarter..

Thanks. Come visit us.

I mean, just imagine, just to finish that thought, can you imagine what a factory branch does in order to beat the question that you've just raised? How do they going to decide what to pay and how are they going to decide who to hire and how many to hire that's coming from somebody in as corporate? What's a better model?.

Good question. Thanks again, guys..

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

Well, thanks guys. I really appreciate your interest in our company. I think we have shown you that we can perform well and we believe very strongly we're going to continue to perform well. So I'll see at the next conference call. Bye now..

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