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Watsco is the largest distributor of air-conditioning, heating, and refrigeration equipment for both commercial and residential use in the U.S. Founded more than 60 years ago in Miami, Watsco in 2023 acquired Gateway Supply Co., a South Carolina plumbing and HVAC distributor. Albert H. Nahmad has served as the company’s CEO since 1972.

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Watsco (WSO): Company Profile, Stock Price, News, Rankings

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Watsco

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Day, and welcome to the Watsco Second Quarter of twenty twenty five Earnings Conference Call. All participants will be in a listen only mode for the duration of the call. After today's presentation, there will be an opportunity to ask questions. Please also note that this event is being recorded today. I would now like to turn the conference over to Albert Naumann, CEO and Chairman. Please go ahead.

Good morning, everyone. Welcome to our second quarter earnings call. This is Al Naumet, Chairman and CEO. And with me is A. J.

Naumet, President Paul Johnston Barry Logan and Rick Gomez. Before we start, our normal cautionary statement. This conference call has forward looking statements as defined by SEC laws and regulations and are made pursuant to the Safe Harbor provisions of these various laws. Ultimate results may differ materially from the forward looking statements. Watsco delivered healthy second quarter results in a soft market conditions.

I should say, in soft market condition. 2025 marks a year of significant product transition to next generation equipment containing a two l refrigerants. The transition affects roughly 55% of our historical product sales. The trip this transition affects our inventories, our supply chain, staffing levels in our branches, and other aspects of our business. Regulatory changes have historically been good for our business and good for our customers.

We expect that transition to be no different than has happened in the past. The changes are substantial and complete and we'll look forward to operations as simpler business in 2026. Let me turn to second quarter highlights. Sales declined 4%, like the double digit pricing gains for the new equipment, offset by lower volumes. We had a late start to the summer season.

Sales for residential new construction and international markets remain subdued. On the plus side, Watsco achieved record gross profit margins. Our performance yielded an increase in EBIT and expanded EBIT margins despite lower sales. Our results benefited from OEM pricing actions. Our pricing technology platform called PriceFX also contributed.

Gross margins remain a focus. There is much potential to improve over time. SG and A increased 6% as we incurred extra cost during the transition. We also added 10 new locations from recent acquisitions. Our balance sheet remains solid.

We have a strong cash position and no debt. We continue to invest in innovation and technology to separate us from our competitors. Watsco's technology journey began fifteen years ago, and we have made terrific progress. Example, ecommerce continues to grow and is now a $2,500,000,000 business or 34% of our sales. Mobile apps have now 70,000 users and grew 17% versus last year.

The annual volume of products sold through OnCallAir, which is our digital selling platform for customer contractors, increased 19% to $1,600,000,000. It's a great assist to our customers. But we're not standing still in terms of ideas and making further investments. We are building on or adding new initiatives to drive growth and to delight our customers. Examples include, a new technology driven sales platform being developed to capture larger national customers.

We're talking about national customers here. This would be incremental to Watsco's core replacement vehicles and is expected to be launched in 2026. We have accelerated adoption of our pricing platform, price, FX is the name of it. Our goal is to reach 30% gross profit margin. We have launched an initiative to grow the parts and supply segment of our business, which today is roughly 30% of sales and can be a much larger can be much larger over time.

And we launched two AI platforms, one internal and one external to harness our data. Artificial intelligence offers the potential to further transform our customer experience, improve operating efficiency, and create new data driven growth strategies. This is an exciting time, and these are just a few of the many initiatives underway. Now we will expand on these themes at an investor event in Miami, which will occur after temperatures have dropped a bit. Stay tuned for additional details.

Finally, we believe our culture of innovation along with our scale entrepreneurial culture and capacity to invest are unmatched in our industry. With that, let's turn to q and a.

We will now begin the question and answer session. To ask a question, you may press star then one on your touch tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. And if at any time your question has been addressed and you would like to withdraw it, And our first question here will come from Ryan Merkel with William Blair. Please go ahead with your question.

Hey, good morning, everyone. Good morning.

So my first question is just on volumes in the quarter were a little bit worse than I was expecting. I know you mentioned weather, A2L, new construction. Would just love to hear from you what happened there? And then more importantly, are you seeing trends improve in July?

I'm going to ask both Paul and Barry to respond to that.

Yeah, revenues were not as strong as we anticipated going into Q2. What we saw was kind of a lumpy picture in the marketplace where April came in strong, May ended up being very weak, mainly because of the weather patterns in the North. And then in June, they came back again. And it was pretty much RNC is probably our residential new construction is probably down 15% to 20%. Replacement is still holding fairly strong.

We didn't really see a lot of repair in the beginning of the quarter, which we saw towards the end of the quarter and continues into July, but not enough to offset the unit sales that were certainly down.

Yeah, I'll comment on that. Also on one of the exposures we talked about in the first quarter that repeated itself in the second quarter was our international, which is Mexico. Mexico is probably the most volatile market. It's a small part of our business, but a big contributor from a margin point of view. Mexico was down, well, let's put it this way, it cost us about $0.10 a share in the quarter, $0.02 0 a share year to date.

In June it grew and July it's grown since then. So I'll take kind of one market that's been irritating, which seems to be a lot better in the last couple of months. As far as July goes, Ryan, I would say it's better. August is bigger than July in our forward looking commentary. So if I say that July is better than what we saw in June, that's okay, but it needs to extend itself and extrapolate itself as the year goes on.

The good news is that in general, what we can control is margin, pricing and the wherewithal of our business to support all these new products in the market with our customers. I'm glad we have our balance sheet to do that with because it's been a pretty extraordinary product change this year. You can see the building of inventories, that's a customer focused effort to help our customers get going in this market. The margin speaks to capturing new pricing on, as we say, over half the products we sold we sell. We had to capture price inflation since that price and and get off on the right track in margins and needless to say that's been accomplished.

So we like what we can control. We'll be patient about what we can't control. And and I think also maybe this is more of a 2026 discussion. But, you know, the the entire industry, every OEM we sell products for have been through an extreme product cycle probably for the last two or three years. And at what point does that serenity, you know, play itself out in terms of growth and market share development and product expansion, the blocking and tackling that I think particularly good for us and that we're good at.

So maybe that's more of a a next year event, but we're kinda looking forward to it quite honestly.

Yeah. That's fair. Okay. Since you mentioned gross margin, was the other, you know, metric that was really strong this quarter. My sense is it's both price cost and initiatives.

But my question is, I don't want us to extrapolate that 29% into the back half. So just how sustainable is that? Was 2Q kind of temporary due to price cost timing?

Yeah. Yeah. Think there is obviously an algebraic benefit to margin when OEMs raise prices. In in April and May, we talked last quarter that OEMs had faced some inflationary realities going on with tariffs and raw materials and so on. On top of the like for like price increase on the new product, they introduced inflationary pricing early in the quarter.

That clearly helped build a bigger margin this quarter and the benefit of that kind of slides off into the third and fourth quarter. But I'm the one that probably three years ago talked about 27% as a floor, as a benchmark. And I stand by that obviously. And if I say now 27% plus, would expect that for the last half of the year, but we won't have the benefit of those pricing actions that you see in the first half of this year. So somewhere in between would be my conjecture and the market will play out and determine what it is, but so I think I think we have a chance to beat our benchmark and but not have the benefit that we saw as extraordinarily this quarter in in terms of pricing.

Just want to add. I mean, this is AJ. Just real quickly. I mean, there are there is the benefit from the OEM price increases, but also the efforts we're making on our price optimization and the leadership of those teams and the pricing teams, that's also working.

So it's a combination of both. But we continue to put points on the board in terms of the pricing efforts that we're taking internally.

Yeah. I'll add that as we move our product mix, which I mentioned in the opening statements, towards parts and supplies, and that's what we're focused on with our technology, That, by its nature, carries a higher margin than equipment sales. So our product mix, hopefully, sometime later this year or into next year, will improve margins too because parts and supplies carry higher margin.

And our next question will come from Brett Linzey with Mizuho. Please go ahead.

Hey, good morning. Yes, maybe just a follow-up on that last point there. So if you could maybe just unpack the year over year gross margin contribution, is there any way to delineate that between the pricing optimization tools versus the parts mix versus some of that raw pricing just in the marketplace in the quarter?

That's an interesting question. Who wants to deal with that?

Yeah, Brett, I'll take a stab at that. This is Rick. This is a directional because there's, you know, a lot of art and a lot of science to this as well. And but it's not all science. So when we look at the quarter, there was and when we look at the year as well, consistent.

There's about 50 to 60 basis points of gross margin enhancement that we can attribute to that raw selling margin, which is basically the day to day job of a distributor in the market is what are you buying for and what are you selling for. And so gross margins would have been in the high 27s absent any of that inflation and the inflation helps, but it's not something that you can underwrite perpetually obviously. So that's what it's amounted to. By the way that's been pretty consistent. If I look back maybe two or three years in the data, We've been at that, we can aggregate and say that there's been about 200 basis points of gross margin expansion attributable to this pricing optimization and bringing more technology to how we price.

Keep in mind that complexity of price in the industry is something that generally benefits a distributor. What I mean by that is that virtually every SKU has a different price to every customer. And so to imagine that we are optimized, well, it's the opposite. We're far from optimized. And that's why we think there's so much room still to go.

And oh, by the way, just to finish the thought is that during that period of time, we've also gained market share. We have about 200 to two fifty basis points of incremental market share over that three year period, if I measure it. So that's mainly attributable to all the technology. And my point there is that, everything that we're doing on the technology side with margin, has not borrowed from customer acquisition and market growth at the end.

That's very helpful. I appreciate that. And then just a follow-up on the cylinder shortage. It sounds like you guys think it abates by the second half. I know some of the peers think it does persist into the second half.

Maybe what was the impact you think in the quarter from shortage situation? And then are you assuming that some of that does carry into H2?

I think, as Paul, what we had was we had an allocation situation where we were being allocated refrigerant. What the OEMs did was they came through and did an overcharge in the unit so that they didn't require as much field installation type refrigerant. So it's become less and less of a concern as time goes on, as our allocations continue to increase. We feel good that sometime in August we should be off of allocation. And I think it was very irritating.

It was very disturbing that we had to go through that. But I don't think that really is the total cause of why the market was slower than what it was.

Yeah. Just an editorial on that. I you know, the like for like skews that we're selling now, a two l versus the prior is is is the 10% difference in price. And a speed bump on the canisters or refrigerant is that a speed bump. And so the transition itself, if we look forward again to that word serenity I used earlier, we're looking forward to it.

And our next question will come from Tommy Malt with Stephens. Please go ahead with your question.

Good morning, Alan. Thanks for taking my questions.

I wanted to start on inventory. Maybe you could characterize for us the investment there versus what you would have expected to need for the transition? Just in dollar terms, is it about what you would have soft circled or maybe a little elevated? Anything you can do to frame that for us and then also how you think it might trend over the next couple quarters?

Well, the honest answer is that it's more than we had hoped for and some of that is because we expected not to have the unusual demand, industry demand, the lower industry demand, we peaked at about $2,000,000,000. But we are now very focused on what to do about it and we've lost, in terms of inventory investment, dollars 200,000,000 so far in the third quarter. We're down to 1,800,000,000.0 And plus this transition of product, you have to have the old and you have to have the new on the equipment side. And we'll transition out of the old before the end of the year and that will help reduce the inventory investment. That's a very good question.

I'm very dedicated to increasing our inventory turn, and it's been a rough time to do that, but I think that.

Yeah, on a raw number basis, we had double inventory. We had about 5% of the total inventory was $410 and then we had the more expensive A2L product in there. So we probably had a 15% rise just between what we had and $410 left over and what we experienced when we had price increase. The balance of it is exactly what Al said. The demand just wasn't there to be able to take the inventory back down.

That you're going to see come down at the end of the third quarter.

Thank you both. As a follow-up, wanted to ask about the M and A environment and pipeline. It hasn't gotten a ton of airtime lately, but how can you characterize that for us?

That's a very good question. We are eager, eager to see what owners of distribution businesses in HVAC are going to do with this existing very soft market. They may do nothing. They may continue or they may say, well now it's time to do something in terms of an M and A. And of course, we have a great reputation with independent distributors because the way we treat sellers, we're careful about relationship built continuing post acquisition with the existing leadership of the business acquired.

So I can't say it's gonna happen but I'm sure hoping we have a very, very strong balance sheet and we could take advantage of opportunities as they come. And I cannot, I can only tell you that, well, I can't disclose it, but there is one that I think without disclosing much more than that, that is of size and we'll see how that turns out. It's still under study.

Yeah, would say rest assured we're having as many of those conversations as we can. We're super ambitious and we have the balance sheet to support anything we want if we can manage to muster up. Hopefully it can be an exciting period in M and A.

And our next question will come from David Manthey with Baird. Please go ahead.

Hey, good morning. I was wondering if you had any thoughts on consumer preference during this product transition. Like, are you continuing to see a premium on the R410 systems? And then as people are buying the a two l, are they gravitating to one end or the other of the good, better, best tier?

That's an interesting question. I wonder who our team can respond to that. Paul, are you the one, Paul? You always are.

Yeah, the industry really hasn't popped as far as high efficiency product. It's still at the entry level. I mean, we're at basically using the old SEER rating. We're at above 15 SEER for minimum efficiency. So it's high efficiency product.

So we really haven't seen a change in the direction of the industry. It's still very much sliding along the idea that it's going to be whatever the minimum efficiency is. And that represents probably 85% of the market. That has not changed. And then when you get into the brands that we're selling, the brands have been consistent throughout the year and they continue to hold steady.

We're seeing the Carrier brand and the Rheem brand and the Goodman brands all doing their job and holding up their share of the business. We're not seeing a migration to a lower branded product, no.

Just to add to that for the fun of it, If I look at brands, products, markets, customers, geographies, North and South, East and West, and we're selling close to 20 brands, the first half of the year is very consistent amongst that collection of data points. So nothing stands out Dave and I don't think this has been disruptive to what kind of the baseline products being sold is going on.

Yeah. The exciting anomaly though, and I think it's in our press release, is on call error. When our customers are using the tool that we've created for them, which we call a sales engine, they are selling high efficiency systems at a much higher rate, like the inverse amount. Meaning, I think it's like 70 or 75% of the time, a contractor is selling using Encolair. They're selling high efficiency systems.

So when we can help influence that through that tool, that's powerful because the consumer gets a better product, the contractor makes a bigger ticket, as do we. So it's a win win win.

It sounds good. Thanks for all the color there. My follow-up, it's the first time we've seen other do better than the equipment in a long time. And as Paul said, the residential new construction is not helping, I assume all the ductwork and thermostats and things in the other category. So should we not read into this that there's a stronger fix versus replace trend this quarter?

Or is it, I don't know, commodities or I'm just making this up, any thoughts on that?

It's pretty small. You take a look at the entire marketplace, you just take compressors, The normal demand for compressors in The U. S. Is about 1,200,000.0 to $1.3 And the balance of them go warranty because you have a five and a ten year warranty on most of the equipment. You take a look at the equipment side, it's seven to 8,000,000 units.

So for the offset of a down market on the unit side through additional parts, yes, it's going to help our gross margin. But no, it's not going to help the top line. It's not going help your revenue line. The ratio is just too great between what parts represent versus equipment. Are we seeing an uptick?

Yes, we started seeing an uptick in June, which historically is the month in which you're going to see that up. It's continued into July, but we really haven't seen a radical increase in units. We've seen an increase in dollars more than we have units.

Now let's not mislead either. Our sales in the new quarter are not they're pretty flattish, small incremental, low digit increase. They're not it's nothing that does not signify a a major double digit increase yet.

When we talked about unit growth of compressors and coil, things like that, year to date is single digit. It's not, you know, it was not an avalanche of transition to that. It could be us just selling more compressors in the market. And I think you heard Carrier talk yesterday very directly about that and they're talking to, you know, 150 independent distributors when they're answering your question to that. So it's obviously an opportunity to sell more parts but the wholesale trend is not something that I think is quite in the numbers yet.

Well, and somebody mentioned earlier the m and a. We're very eager to do more m and a. Sometimes opportunities arise when you have these kind of markets. I'm sure hoping for it. Are we shut down again?

Our next question will come from Jeff Hammond with KeyBanc Capital Markets. Please go ahead.

Hey, good morning, everyone. Is this real Al or or AI Al?

It's a combination. You you have to you have to have to figure it out. You see?

Just to clarify on the on the flattish sales comment, was that parts for July, or is that overall?

And then just on back to inventories, can you just, you know, maybe talk about, you know, where you wanna ultimately get your turns to? I know you were kinda running four and a half turns a year, you know, pre COVID and pre all these regulatory changes, and now you're kinda three to three and a half. You know, kinda where you see that happening over and over what time frame?

Well, first of all, let me compliment you on the data. You're right about those turns. I'd like I'm not I'm not gonna put a time limit on this, but I'd like to get to five. At some point in time, given all the the technology we're investing in, I'd like to get to five.

Watsco (WSO) Q2 2025 Earnings Call Transcript

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