[Management View]
Watsco's management addressed the challenges of the 2025 transition to A2L refrigerants, affecting 55% of historical product sales. Despite a 4% sales decline due to lower volumes, the company achieved record gross profit margins. Strategic technology investments are driving digital channel growth and pricing optimization.
[Outlook]
Watsco plans to continue reducing inventory levels and focus on technology adoption to enhance efficiency and growth. The company aims for a 30% gross profit margin and is developing the Watsco One sales platform for multi-location institutional customers, set for a 2026 launch.
[Financial Performance]
Sales declined 4% YoY, with residential and international segments subdued. Gross margin reached 29%, driven by OEM pricing actions and digital pricing optimization. SG&A expenses rose 6% due to transition-related costs and acquisitions. Inventory peaked at $2 billion, reduced to $1.8 billion in Q3 2025.
[Q&A Highlights]
Question 1: Ryan Merkel asked about the weaker-than-expected volumes in Q2 and the impact of weather and A2L transition.
Answer: Paul Johnston and Barry Logan explained that April was strong, May was weak due to northern weather, and June improved. Residential new construction was down 15-20%, but replacement remained strong. International sales, particularly in Mexico, were volatile but improved in June and July.
Question 2: Ryan Merkel inquired about the sustainability of the 29% gross margin achieved in Q2.
Answer: Barry Logan explained that OEM price increases and internal price optimization efforts contributed to the strong margin. However, he cautioned against expecting the 29% margin to continue in the second half, suggesting a more sustainable benchmark of 27% plus.
Question 3: Brett Linzey asked about the year-over-year gross margin contribution from pricing optimization tools, parts mix, and raw pricing.
Answer: Rick Gomez explained that 50 to 60 basis points of gross margin enhancement were due to day-to-day distributor activities, with an additional 200 basis points from price optimization and technology. The complexity of pricing in the industry benefits distributors, and there is still room for improvement.
Question 4: Brett Linzey inquired about the impact of the cylinder shortage and its expected duration.
Answer: Paul Johnston explained that the shortage was due to refrigerant allocation, but it is becoming less of a concern as allocations increase. The company expects to be off allocation by August, and the shortage is not seen as the main reason for the slower market.
Question 5: Tommy Moll asked about inventory levels and future trends.
Answer: Albert Nahmad acknowledged that inventory levels were higher than expected, peaking at $2 billion, but have been reduced to $1.8 billion in Q3. The transition to A2L products requires maintaining both old and new inventory, but the company expects to reduce inventory investment by the end of the year.
Question 6: Tommy Moll inquired about the M&A environment and pipeline.
Answer: Albert Nahmad expressed eagerness to explore M&A opportunities, especially in the current soft market. The company has a strong balance sheet to support potential acquisitions and is in discussions with a significant target.
Question 7: David Manthey asked about consumer preferences during the product transition.
Answer: Paul Johnston stated that the industry has not seen a significant shift towards high-efficiency products, with 85% of the market still at minimum efficiency levels. The brands being sold have remained consistent, with no significant migration to lower-branded products.
Question 8: Brett Linzey asked about the year-over-year gross margin contribution from pricing optimization tools, parts mix, and raw pricing.
Answer: Rick Gomez explained that 50 to 60 basis points of gross margin enhancement were due to distributor activities, with an additional 200 basis points from price optimization and technology. The complexity of pricing in the industry benefits distributors, and there is still room for growth.
Question 9: Brett Linzey inquired about the impact of the cylinder shortage and its potential continuation into H2.
Answer: Paul Johnston explained that the shortage was due to refrigerant allocation, but it is becoming less of a concern as allocations increase. The company expects to be off allocation by August, and the shortage is not the sole cause of the slower market.
Question 10: Brett Linzey asked about the impact of the cylinder shortage on the quarter and its potential continuation into H2.
Answer: Paul Johnston explained that the shortage was due to refrigerant allocation, but it is becoming less of a concern as allocations increase. The company expects to be off allocation by August, and the shortage is not the sole cause of the slower market.
Question 11: David Manthey inquired about consumer preference during the product transition.
Answer: Paul Johnston stated that the industry has not shifted towards high-efficiency products, with 85% of the market still at minimum efficiency levels. The brands being sold have remained consistent, with no significant migration to lower-branded products.
[Sentiment Analysis]
1. Analysts expressed concerns about weaker-than-expected volumes and the impact of the A2L transition and weather on sales. However, they acknowledged the strong gross margin performance and the company's efforts in price optimization and technology adoption.
2. Management maintained a positive tone, emphasizing their focus on margin improvement, technology adoption, and M&A opportunities. They acknowledged the challenges of the current market but expressed confidence in their ability to navigate them and achieve long-term growth goals.
1. Sales declined by 4% due to double-digit pricing gains for new equipment being offset by lower volumes.
2. SG&A expenses increased by 6% due to the A2L transition and new locations, with core SG&A growth higher than preferred in a down quarter.
3. Inventory levels peaked at $2 billion, exceeding expectations, but were reduced to $1.8 billion in Q3 2025.
4. The residential new construction market is down 15%-20%, impacting sales.
5. Tariffs and metals inflation are affecting input costs for non-equipment segments, with a 10% increase in copper-heavy products.
6. The cylinder shortage is expected to abate by the second half of 2025, but it was a concern during the quarter.
Watsco is navigating a challenging market environment in 2025, marked by a significant transition to A2L refrigerants, which has impacted inventory, supply chain, and staffing. Despite a 4% decline in total sales, the company achieved record gross profit margins in Q2 2025, driven by OEM pricing actions and digital pricing optimization. Management remains focused on technology adoption and expanding higher-margin parts and supplies to drive future growth. The company is also actively exploring M&A opportunities in the fragmented HVAC distribution market, with one significant target under consideration. Watsco's leadership is confident in their ability to leverage their strong balance sheet and technology investments to navigate current challenges and achieve long-term growth goals, including a $10 billion revenue target, 30% gross margin, and five times inventory turns. The company is also developing the Watsco One sales platform to target multi-location institutional customers, with a planned launch in 2026. Despite current market challenges, Watsco is optimistic about improved efficiency in SG&A and a more stable market environment in 2026. The company's focus on technology adoption and higher-margin parts expansion positions it well for future growth and consolidation opportunities in the HVAC distribution market.