Watsco, Inc. (WSO) Earnings Call Transcript & Summary

Good day, and welcome to the Watsco, Inc. Second Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Al Nahmad, Chairman. Please go ahead.

Good morning, everyone. Welcome to our second quarter earnings call. This is Al Nahmad, Chairman and CEO; and with me is A.J. Nahmad, President; also Paul Johnston and Barry Logan and Rick Gomez. Before we start, our 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'm happy to report that our second quarter results reflect stabilizing markets under far more conventional operating conditions. The last 5 years brought a pandemic, supply chain disruptions, regulatory transitions and tariff volatility. Through it all, we stayed the course and invested in our business. Now the operating environment is normalizing, revenue is growing and our digital ecosystem is producing measurable results. Our largest and most impacted product segment, residential HVAC equipment grew 5% during the quarter with gains in both unit volume and pricing. We closed on Jackson Supply on June 1, and we are thrilled to welcome their team to the Watsco family. Jackson is a legend in our industry with $230 million in annual sales, operating from 25 Sunbelt locations. As in our culture, the Jackson team will continue to operate and grow their business with our full support. They have big ambitions, and we will gladly support their leadership team in any way we can. Turning to second quarter results. Sales increased 2% to $2.1 billion. Gross profit was $579 million with gross margin of 27.5% versus 29.3% last year. SG&A increased 2%, excluding acquisitions. Operating income was $238 million and had an operating margin of 11.3%. Earnings per share came in at $4 per share. My earlier comment regarding volatility and disruption had the greatest short-term impact on the gross margins. Let me say that again. My earlier comment regarding volatility and disruption had the greatest short-term impact on our gross margins in '26 versus '25. During 2025, OEMs instituted aggressive pricing action in response to inflation and tariffs, benefiting gross margin in 2025. By comparison, 2026 OEM pricing actions were more moderate and consistent with historical levels. Looking beyond the onetime impact from a year ago, gross margins over the last month has been in a narrow range and more consistent with historical gross margins. Now this is important. Having said that, we remain focused on reaching our long-term goal of 30% in gross profit margin. As for SG&A, we have become a more efficient company as business conditions have simplified. The modest increase in SG&A reflects continued technology investments along with the addition of Jackson Supply. Moving on to our balance sheet. We ended the quarter with $464 million in cash and no debt. No surprise. We remain committed to maintaining a pristine balance sheet, enabling investment in growth opportunities as they come up. Operating cash flow for the 6-month period improved by $168 million, reflecting a lower ramp-up of seasonal inventory. We expect to achieve further inventory efficiency as lead times normalize and the A2L product transition moves behind us. In April, we increased our annual dividend by 10% to $13.20 per share. Interesting, 2026 marks our 52nd consecutive year of paying dividends. Finally, I'm going to hand the call over to A.J., the President -- our President, to provide an update on Watsco's technology initiatives. A.J?

Thank you, and good morning, everyone. With the complexity of the last few years largely behind us, we believe our technology investments have made us a stronger company with higher growth prospects and a widening competitive moat. Our goals have been ambitious and straightforward. First, build the industry's largest repository of data, product, market, customer, competitor pricing, you name it. This underpins and empowers the industry's most advanced technology platforms. Second, through widespread adoption and use of our technologies, revolutionize our customer experience so that contractors, installers and technicians love doing business and only want to do business with the Watsco companies. Next, transform our supply chain and store level operations through digital platforms to better serve those customers and gain operating efficiencies along the way. And finally, develop and launch technologies that help our customers grow their own businesses so they can drag us along with their growth. Big picture, we see contractor behavior evolving in ways that benefit the technology-enabled distributor in the long term. In terms of 2026 first half highlights, our core technology platforms continue to scale and add value. E-commerce sales have grown 13%, well outpacing overall growth. In terms of penetration, e-commerce reached 37% of total sales over the last 12 months with certain markets at 50% to 70% penetration. Digital engagement with our mobile apps is strong as well at more than 70,000 active monthly users. And our OnCallAir platform continues its growth trajectory. Over the last year, more than 340,000 proposals were presented to homeowners using the tool, generating $1.9 billion of gross merchandise value, a 15% increase over the comparable period. Simply put, the contractors we serve digitally are growing faster, attrit less, and we believe we can lower our cost to serve at scale over time. At our Investor Day last year, we communicated several new initiatives that leverage our technology advantage and represent new growth opportunities that will materialize in the years ahead. SupplySync.com, our newest platform to serve the growing segment of large institutional customers launched in the second quarter to great fanfare. Our plan is to scale it to more and more customers in the coming months and years. This is a new and growing channel with different customer needs. We see an incremental growth opportunity beyond our day-to-day business while leveraging our existing scale and infrastructure. VCR, which stands for vendor consolidation and rationalization has expanded across many of our nonequipment product categories. Relationships with our strategic vendor partners continues to strengthen. Hydros, which is our investment in shared logistics and distribution among our business units has further matured and will become more important over time. And the transformational use of AI continues to evolve throughout Watsco. I could spend the next few hours just on that subject. These investments, along with our scale, entrepreneurial culture and capacity to invest are unmatched in our industry. In closing, a reminder of our fundamentals. Watsco is the market leader and the technology leader in what remains a highly fragmented HVAC distribution market. The products we sell are a necessity and the installed base continues to expand. We have deep and collaborative relationships with industry-leading manufacturers and industry partners. We offer the broadest variety of products and operate a large and growing network to serve more and more customers. And our unique ownership culture shared by more than 7,000 employees rewards and incentivizes long-term performance. With that, let's turn to Q&A.

[Operator Instructions] Our first question comes from Steve Volkmann with Jefferies.

Al, I think you said something in your prepared remarks about how the last month, the gross margin has kind of normalized to historical levels. And I'm curious exactly what you think that means because it felt like we were sort of in a normal level in the second quarter, but maybe you have a different definition of that?

I'm going to have Barry Logan, my expert.

Can I just -- if I can jump real quick, I heard that. The prepared remarks was actually last 12 months. I think there was just a skip in the...

I'm misreading.

Yes. Normalization of the last 12 months. So go ahead, Barry.

Yes. I mean, Steve, again, this is the trend line kind of discussion we're talking about versus last year, which was not a trend line in terms of where things have been. So 3, 4 years ago, when margins achieved 27% plus, the question was, will they retreat back to something less than that over time? And we emphatically said no, at 27% is the baseline that we expect looking forward going forward. And I think we said that prior to all the challenges of the last few years going through product change and regulatory change and everything else. So if you look at the trend line over that 2- or 3-, 4-year period now, 27% and change has kind of been where we are. Last year is the anomaly at 29% plus in the second quarter. And so what we were conveying in Al's remarks as well as the press release, it's there in the press release as well, is let's look at things over the last 12 months, which is kind of almost the period of time where you can look back and say, when did some of these volatile items begin to recede or at least lapse and look back the last 12 months, I think the margin is 27.5%. The first quarter, second quarter is in that narrow range as well. And it's just a way to show and identify analytically that last year is something that stands out on its own. And I can't say ignore it, but I could say discount, discount it in the analysis of looking forward over the next several quarters.

Yes. And in the medium and long term, we're super ambitious and we have our sights set on 30% gross margins in the long term. And that's not just a hope and a prayer. We are investing to do exactly that. We believe we can achieve that.

Great. Okay. And then maybe just for the follow-up. We're hearing some commentary, especially in sort of southern states about a real slowdown in new builds. Are you seeing that in your business? Is that part of what's impacting you or not so much?

Paul, do you want to take that?

Yes. We're seeing definitely a slowdown in new construction in the South, predominantly in Florida and in Texas. Those are the 2 big new construction states, and they are slower right now. So it's a very unusual scenario out there where you're seeing strength in the North and weakness in the South right now. But that's the way the market shakes out.

The next question comes from Brett Linzey with Mizuho.

It's Ryan on here for Brett today. I'm curious on pricing. You said OEM pricing in '26 has normalized to historical trends. Does that mean roughly 2% to 3% annual increases from your primary OEM partners? And kind of how does that compare to your own realized ASP growth in the quarter?

Again, there's aspirational prices that are announced and then there's real life as it plays out and the segments of customers and even market pricing is specific even by market. And then within brands, it has different attributes, right? So the composite that we reported in this quarter, in this press release that you read is a 2% price increase on units. And when we say the word units, that's the AHRI equivalent definition of what a unit is, which is a compressor bearing unit. And that 2% is, again, I would say, a very conventional level if I look back over a 10-, 15-year average.

Got it. That's super helpful. And then one more on gross margins here. On the gross margin bridge, you sized the 2025 pricing and A2L comparison of roughly 130 bps of the 175 or so decline. Can you walk through the remaining 50 bps? And then maybe just a little bit more color on how we should be thinking about gross margins for the remainder of the year, Q3 and Q4?

Sure. Well, first, if you noticed also in the data, the equipment business outgrew the non-equipment business. There is a margin differential -- gross margin differential in the 2 populations of products that accounts for a chunk of the remaining difference. We're also owning less inventory all year long, which also means purchases are less, which also means some of the attributes we gain in either purchase discounts or rebates, things like that can moderate down. That's okay. That goes hand-in-hand with how inventory should be managed in this environment over time. Other puts and takes in there that aren't material, but that would be the view of what's in the numbers today. Again, I need to stress to you, if you look back to the last 12 months, look back the last 2 or 3 years, we're in the range that we've been in at this point in the year, at this point year-to-date. Looking forward, again, we're not ones that give guidance and give projections. You've heard my comments, you heard our comments about the last 12 months and kind of where things sit today. Time will tell what the rest of the year will be, but that's how I would look at it is looking at trends over the last 12 months.

The next question comes from Chris Snyder with Morgan Stanley.

I guess you guys built more inventory than you normally would in the first half of the year. I think it was up maybe like since the end of last year at 35%, 36%. I guess how much of that was intentional versus maybe just a demand shortfall that caused you guys to exit with more inventory? And then any reads from that on what it means for your pace of inventory purchase into the back half, but also price cost into the back half just because you guys did buy a little bit earlier this year?

Barry?

Yes, I can give the answer. Yes, I mean, I think we're probably about $100 million ahead of what we might have thought that 7 days' worth of inventory, which is a remarkable statement actually. And so I don't think there's any strategic or tactical thing that went into a June 30 inventory balance. Our field stock is down almost $200 million. You need to account for the Jackson Supply acquisition and your analysis that we bought about $60 million of inventory June 1 as part of Jackson Supply. So you need to consider that. As far as the last half and next half, the idea is to continue to grind on keeping inventory ready for customers while owning less over the rest of the year than we did a year ago. We've done that for 6 months, and we intend to do that over the next 6 months.

Inventory is peak for the year, I believe. And the supply chain amongst our OEM partners is healthier than it was in previous years. And so we expect inventory turns to slowly creep back up.

I appreciate that. And then just maybe a higher level one on just kind of end demand. I mean it seems like from a lot of the sell-through numbers, that end demand is not getting better. It seems like it might be getting worse if we kind of look at sell-through volume declines on negative comps at this point. I guess my question for you guys is, is there -- do you -- is there any plan or strategy or anything that Watsco can do to help improve affordability in the industry, whether that's carrying lower cost brands that are out there? Or is there just anything else because it seems like a challenge, and it doesn't seem like it's getting better.

Well, first, let me say we do carry various brands. I think we have 26 different brands. So we can compete at any level. But also peak in the next quarter shows growth for us anyhow in the mid-single figure in the low about 4%, 5%. So maybe things have turned around.

I would say the market is ahead...

Go ahead, Paul.

No, the market is stabilized. I don't think it's getting worse. I think that's an overstatement on your part. But when I look at the market out there right now, it's stable. It's continuing to grow. I think we've hit bottom and we're coming back out of it again. And so I feel very good that the market is not going to go down further. I think there's still going to be some regional differences that occur as we look out. And as I mentioned earlier, the West Coast and the South have been fairly weak to start the year, but the northern tier states have been very, very strong.

I appreciate your perspective. My point was just more that like the sell-through volumes are seemingly negative if we look at the industry data, and we are comping at this point now negative volumes. So that's why I said that. But I do appreciate that perspective.

Yes. Go ahead, Barry.

I have to say this because it's very critical and really understanding it. Yes, units were down 17% in the calendar year last year. Why were they down 17%? Why? What components -- what's inside of that number? And obviously, I need about half an hour to give you all the analytical pieces I could give you in that analysis. But the question is the -- was the market really down 17% last year just on some kind of holistic basis, or is there something longer term that went on that caused it? And my view, our view and the data, looking at our data is the COVID period clearly borrowed replacement volume from the future. And if units were up 10%, 15% for 2 years, that borrowed some measure of replacement volumes from the period that followed. And our analysis would show that last year's correction in volume, down 17%, fixed much of the overhang from that dynamic. Time will tell. The data is pretty sound in our view, but time will tell. So as we look at this year and replacing systems and consumers rolling out of bed and calling contractors and doing business with us. Clearly, the consumer is the one that has to pay for this stuff. Clearly, the consumer is still a little heavy in terms of that dynamic economically. But when the systems break, they're going to have to be repaired or replaced. And if that -- if we're right about our data and the trend line that we see, this is the baseline. This is the foundation from -- over the next few years. And looking back a year ago and feeling like there's an easy comp, I don't think is a good way of looking at it. Question is, is this a foundation that is -- has momentum or at least stability, and that's why we use the word stability. And is this foundation something that is going to grow in a conventional way over the next several years, I feel better about that. And -- but I don't do it because I look back a year and say, look what happened a year ago. I think at some point, you've got to only look forward in this discussion. Yes. No, I appreciate that. And I remember that cumulative growth analysis that you talked about last quarter, and I thought it was like a really thoughtful way to frame it up.

The next question comes from Ryan Merkel with William Blair.

We've covered a lot of ground, but I just want to focus on what are you seeing in July? You're talking about the market being stable. I'm curious if July is getting better. And given we have such easy comps in the second half, are you guys expecting volume growth year-over-year in the second half?

Barry, Paul, both of you jump into that.