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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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Hello, good day and welcome to the Watsco Inc third quarter conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch tone phone. To withdraw your question, please press star then two. 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.

Good morning everyone. Welcome to our third quarter earnings call and this is Albert Nahmad, Chairman and CEO, and with me is A.J., President of Watsco, Paul Johnston, Barry Logan, and Rick Gomez. Before we start our normal cautionary statement, this conference call has forward-looking statements as defined by SEC laws and regulations that are made pursuant to the safe harbor provisions of these various laws. Ultimate results may differ materially from the forward-looking statements. I am pleased to report that Watsco Inc. generated healthy earnings and record cash flow despite a very challenging market environment. As we all know, 2025 is a year of significant transition to next-generation equipment containing A2L refrigerants. The transition affected roughly 55% of products sold and influenced most every aspect of our business. Regulatory changes have historically been good for our business and good for our customers.

In the long-term, we expect this transition to be no different. The transition is substantially complete and we look forward to operating a far simpler business in 2026. Throughout all of the volatility, we are satisfied that our earnings are long staying intact, our balance sheet remains strong, and our technology advantages remain immense. We certainly expect the volatility is temporary and will ease as the transition concludes. We operate in a great industry with strong long-term fundamentals and have the industry's most accomplished leadership team, all with long-term focus to keep building our success. Turning now to our third quarter results, sales declined 4% in total and 3% in the U.S. While unit volumes remain subdued, we achieved double-digit pricing gains on the new products with growth in sales for both non-equipment and commercial refrigeration products. We again improved gross margins, which expanded 130 basis points to 27.5%.

As we have expressed before, we have several ongoing initiatives to enhance gross margins for long-term goals of exceeding 30%. Operating expenses increased 5%, reflecting a measure of ongoing inefficiency tied to the product transition as well as new and acquired locations. With the product transition largely behind us, we expect SG&A performance to improve from here. We continue to fortify our balance sheet, reducing inventories and overall working capital. We generated record third quarter cash flow of $355 million. Incremental opportunity in the fourth quarter as we close out the year, we remain fundamentally positive and optimistic about our position in the industry and our ability to generate growth. Our balance sheet has a healthy cash position and no debt, providing us with opportunity to invest in most any size growth opportunity. This includes the capacity to co-invest with our OEM partners as well as heading to 2020.

As we head into 2026, we also continue to invest in innovation and technology that separates us from our competitors. We have made terrific progress in driving adoption. For example, e-commerce penetration continues to grow and accounts for 34% of our sales and up to 60% to 70% in certain U.S. markets. Let me say it again, e-commerce penetration continues to grow and accounts for 34% of our sales at up to 60% to 70% in certain U.S. markets. The number of contractors and technicians engaged with our mobile app now stands at 72,000 users and grew an impressive 18%. That means that 72,000 of our customers are using our technology. The annual run rate of sales through OnCall Air, our digital selling platform for contractors, saw a 19% increase in the gross merchandise value of products sold through the platform and reaching $1.7 billion over the last 12 months.

We are also making next-generation investments to enhance our competitive position. For example, we are developing new technology aimed at capturing more sales from the institutional customer. We are accelerating the use of pricing optimization tools to make progress toward 30%+ gross margin target. We have launched a new initiative to compete and grow sales in the highly fragmented non-equipment market, which today is roughly 30% of our sales. We have begun to harness the power of artificial intelligence both internally and externally, offering potential to further transition our customer experience, improve operating efficiency and create new data-driven growth strategies. Our technology investments are making a big difference and we believe the impact will only grow with time. We look forward to sharing more during our upcoming investor meeting in Miami in December.

I can't wait to see and meet you all this December. These investments, along with our scale, entrepreneurship culture, and capacity to invest, are unmatched in our industry. With that, let's turn to Q&A.

We will now begin the question-and-answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Tommy Moll of Stephens. Go ahead, please.

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

I'm going to let Paul Johnston respond to that.

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

Some data behind that. When we say non-equipment, there are really two things that are not equipment: parts and supplies. That may be a more direct way of calling that category something, parts and supplies. Parts basically is 8% of Watsco's revenues. Parts and supplies, everything else, is over 20% of Watsco's revenues. Just in the scope of the bandwidth of that discussion, parts will never substitute what's happening in the replacement market in that discussion. The data just isn't there to support that. At the end of the day, it's the consumer that's spending $8,000, $10,000, $12,000 on a pair of new machines for their home, as Paul's suggesting. Where we see in the Sun Belt, that's a more frequent purchase and a more ordinary purchase and a more necessity purchase. We do see some differences as we go North of the Sun Belt.

We do like it that Watsco's 75% in the Sun Belt in that respect. It's really, I think, more of the crux of the answer is built on what are consumers spending on their homes right now. That's probably the bigger orientation to this than whether we're selling more compressors or not versus the replacement market.

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

That's a very good question. I don't think we're out of the woods yet. There's some merit to that. Who wants to add more to that? Is it you, Paul, or A.J.?

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

In aggregate, we are not seeing increase in demand. It's the fourth quarter. In aggregate, it's still below this time last year. This time last year it was an extraordinary quarter, but nevertheless, we're seeing that and we're dealing with it. We're getting more productive in our operations and more efficient, given the lower volumes, temporarily or lower. And we are adjusting to the circumstances.

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

I mean just now a little bit of therapy about it, just to be, again, very direct about it. So we're clear. A year ago, fourth quarter unit volumes, unit volumes for Watsco were up almost 20%, between 15% and 20%. A year later the variance is going to be exposed to that comparable rate. After the fourth quarter is when things started to become, I would say, less extreme in that regard. I think the fourth quarter a year ago is still in the context of the transition started, the 410A availability was at its peak, be it contractors, builders, national accounts, whomever it was, was drawing on Distribution for 410A because they could get it. It's really the last of the cyclical things in this discussion, I think, about the transition is the fourth quarter now.

It's the smallest quarter of the year, it's off season and it'll be. There obviously is noise in the fourth quarter this year, but it really doesn't bear a resemblance as we go forward into next year as a consequential trend. I would say it's more about the comp a year ago than whether the market has changed any at all in the last 20 days.

I think that last sentence summarizes the barrier. The pacing, our pacing, and the industry pacing is roughly the same. The computer changes in Q4.

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

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

Yeah, I think, I mean it's obviously been a fluid market and one of the noisiest years in our industry in recent memory. By the way, with all that noise, our earnings are largely intact. I think that says a lot about the resiliency of our business model and of distribution in general. If we step back, let's examine the big macro factors. We don't have influence over interest rates. We can't influence consumer sentiment or new housing completions or existing home sales. These are all things that impact the unit movement numbers that everyone is focused on. We have control and we have influence over many other things. We have control over how many customers we serve and that's been growing steadily over time. We have influence over our margins and that too has steadily improved with more upside to go.

We think we have control over our expenses and we're taking steps to improve efficiencies. With the product transition now largely behind us, we control our inventory and as you can see, we made great progress to improve working capital and cash flow in the quarter. We have influence on how we partner with OEMs and we're right now developing aggressive growth strategies with our key partners for next year. We control our balance sheet and of course it's never been stronger. We control our technology, which is I think the most important competitive advantage we have, with more innovation being introduced right now in real time to help future growth. Even as we navigate this admittedly fluid industry dynamic, I think we've done a great job of acting on the things within our control and we will continue to do so.

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

Yeah, hey, morning all. I want to follow-up on the fourth quarter. Could you just comment on what you've seen quarter to date in terms of total sales?

Gotcha. It sounds like your biggest supplier is talking about units down 30%. It sounds like you disagree with that.

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

That's helpful. Mid-single digit decline and then [crosstalk]

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

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

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

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

Because contractors installed fewer systems?

Yeah, I mean, again, if we consider the number of units that did decline, put it in a unit number and then ask the question, what are the components of the unit decline? New construction is the largest component of that discussion. We can see it in, we can see our customers, we can see the special pricing we give. We can count the number of units we sell into new construction. It was down as a percentage, down the most in that overall discussion. I don't know, offhand, if that got worse in August and September, that's a little granular for my brain this morning. That's the largest component of the discussion.

If interest rates or home building activity or existing home sales get generated in the forward period over the next 12 months, that's an opportunity because that is the largest component of both the quarter and the year to date decline in units. In terms of the replacement market and everything else, there's always a measure of consumer discretion. Always. When a contractor walks in and says, this thing will cost you $10,000, $12,000.

To the extent the consumer is either tighter or worried or credit crunched or more paralyzed in some way about spending $10,000, $12,000 or more on something, it's going to affect. Did that get worse in August and September? It looks like it. Is it permanent or temporary? Is it long-term or short-term? We'll see. At least in our industry's history, it's never long-term. It's always a short-term dynamic. Anyways, that's just some big picture thoughts on that.

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

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

Morning, Al. Thank you. I feel like I'm in a parallel universe here. In 25 years covering Watsco, this is the closest I've come to hearing guidance.It's pretty amazing. As long as we're talking about it, the -5% to 10% revenue declines in the fourth quarter, we're talking about equipment only there, correct?

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

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

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

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

The next question comes from Jeffrey Sprague of Vertical Research Partners. Go ahead, please.

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

I would say that maybe a general reply as I think from specific 4th quarter reply. We want to increase our inventory turns and that effort will continue into the fourth quarter and in the future. We are going to get better inventory turns and that's our goal. I think I've answered your question. That is a focus and we certainly have the capability with our technology to do something about it. We're doing it. As you can tell, the inventory is coming down and it's coming down again in the fourth quarter and the turns are slightly increasing. Create more cash for us and we like that.

are really two curiosities, and the one you're asking about is will our distribution channel, Watsco, be in a more conventional position? Right. That's your, and that's really almost an OEM orientation that then asks the question, you know, has the inventory been reset in line with some kind of, you know, so that you understand what I'm saying.

There is a lot of progress in the third quarter, more progress in the fourth. You could look analytically, where are we today versus history, and answer the question. That can help you with that. What Al is saying is how does inventory affect us looking forward? What if we had five inventory turns instead of four? What would that do to our return on invested capital? What would that do to our real estate? What would that do to our cash flow?

What would it do to the overall handling and load that we carry in our stores? If we had less inventory and better terms, what if we had better technology with our OEMs to replenish our stock every day? Those are the bigger, those are the things we are focused on while trying to reduce inventory by the end of the year. You can understand that it's a longer-term perspective from our point of view.

While we're just trying to get the year-end inventory in line to have, frankly, a strong hand, a strong capital base to flow into next year. I think we said last quarter we were targeting $500 million of reductions by year-end, and second quarter or third quarter was $350 million of that. I think we can improve on the $500 million target. It is a slower time of year to say that, but by the end of the year, I think inventories will be near historical levels versus the size of our company.

Let me say again, when we say inventory turns, we are presently at about 3.6, 3.7. We want to be a lot better than that. Barry used some numbers, but he was just throwing numbers out there. I'm giving you more specific numbers. We have an opportunity to significantly improve inventory turns, which also significantly increases our cash flow and becomes a more productive part of our business with higher inventory turns. We have the ability to get our manufacturers participate in that because generally we're the largest customer and we have the largest impact on the market.

That's what we're doing with them and with our own technology to do better with what we have to achieve the higher turns. I like it. I like higher turns and I like higher cash flow. We're at $600 million cash flow right now in the bank. I'd like to see that number get larger because I'd like to have the ability to do almost any transaction that comes our way. I don't like going into debt for it. I'd like to have the capacity to do what we need to do with the cash we have.

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

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

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

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

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

We are trying to get cooperation from the manufacturer to do better in deliveries.

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

Thank you. I appreciate that. Maybe to follow-up on price, the OEMs that have reported so far talked about an expectation of incremental price in 2026. Maybe a bit of a surprise given what seems like affordability challenges and just overall headwinds facing the consumer, I guess. What are your thoughts on that? Do you feel like just given the balance sheet and maybe the absorption headwinds that they're facing, that gives you guys better ability to push back or negotiate than years past? Thank you.

I couldn't know how to begin to answer that question.

We're a good customer of our manufacturers, and I like to think that we can. They will listen, and we will listen to them. We like to get along with our manufacturer. I don't know how to answer that any better than that.

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

Thank you, I appreciate that perspective.

The next question comes from Mitch Moore of KeyBanc Capital Markets. Go ahead, please.

I know most of the industry is already in those entry level baseline SEER products, but just wondering if you could talk about mix in the quarter. Maybe if you could flesh out if you're seeing consumers trade down to lower tier products.

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

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

Well said. A.J., can you explain OnCall Air.

There may be some new people on this call.

Sure. OnCall Air is a technology initiative. It's actually a business we created in our Watsco Ventures subsidiary and has created a piece of software that's really a sales engine for our contractors or our customers. A customer like AJ's Heating & Cooling would be an OnCall Air customer and use our software to sell in the kitchen house. It's loaded up with all of our data about all the products we sell, our customers, pricing, our inventory, everything you could ever want in terms of creating a world-class, professional, sophisticated proposal or proposals for homeowners as contractors or building owners.

As contractors attempt to sell their wares, our customers that use it are winning more jobs. They're higher ticket jobs, they're higher margin jobs, and like I just said, they're more often than not selling higher efficiency systems than the base tier as well. It's growing, it's growing fast, and it's just a win, win, win for everybody in the channel.

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

This is Rick. I can help you with that answer a little bit. There are two or three contributors there that help and that feel good and sustainable. The first is we had growth in non-equipment and as a category, as a basket, that non-equipment business has higher gross margins. That is a mixed benefit in our gross margin. There was some carryover benefit from springtime OEM pricing actions.

The third, most structural, most interesting aspect of it is that we've talked about the pricing optimization tools that are maturing and getting better every day in the field. AI is making that even better today. Transactional margins were very resilient in a down market and actually slightly up. We take some comfort in that and it feeling and being somewhat or to us, feel somewhat permanent and structural, whatever word you want to use. Those are the large contributors to the margin expansion.

By the way, let me just say this. We don't want to provide information to our competitors they can use. Be careful with how much detail we have. Answer these things. Go ahead, A.J.

Watsco (WSO) Q3 2025 Earnings Call Transcript

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