WSO Q1 Earnings Call: Miss on Revenue as A2L Transition, Tariffs, and Product Mix Shape Outlook

Equipment distributor Watsco (NYSE: WSO) missed Wall Street’s revenue expectations in Q1 CY2025, with sales falling 2.2% year on year to $1.53 billion. Its non-GAAP profit of $1.93 per share was 14.5% below analysts’ consensus estimates.

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StockStory’s Take

Watsco’s first quarter performance reflected the impact of regulatory-driven product transitions, seasonality, and shifting market dynamics. Management emphasized that the ongoing switch to A2L refrigerant systems, which will ultimately affect more than half of total sales, was a central operational focus. CEO Albert Nahmad cited increased training efforts and technology upgrades to help customers adapt to the new systems, while President A.J. Nahmad described the company’s ability to rapidly adjust pricing and inventory as critical this quarter.

Looking forward, leadership expects the benefits of the new A2L products to become more prominent in the coming quarters, especially as the peak selling season approaches. Management acknowledged potential headwinds from proposed tariffs and international market uncertainty, but maintained that domestic demand and margin trends have shown recent improvement. As Albert Nahmad stated, Watsco is “collaborating closely with our OEM partners on current and future pricing actions” in response to tariffs, and remains focused on navigating price fluctuations and supply challenges.

Key Insights from Management’s Remarks

The first quarter was influenced by regulatory changes, product mix shifts, and external cost pressures. Management attributed top-line softness to seasonality, inventory transitions, and weaker non-equipment categories, while highlighting the company’s adaptability and focus on long-term margin optimization.

• A2L System Transition: The transition to A2L refrigerant-based HVAC systems is underway, expected to impact 55% of Watsco's total sales. Management reported significant investments in inventory conversion, customer training, and technology enhancements to support this shift.
• Replacement Business Growth: The core HVAC replacement market grew by over 10%, with higher sales volumes and a richer mix of high-efficiency systems. This segment offset some softness in new construction and commercial segments.
• Gross Margin Dynamics: Gross margin improvements were attributed to favorable segment mix (more replacement, less new construction/commercial) and early price optimization, especially on legacy 410A inventory. Management said mix and pricing contributed to margins, but called out that “aspirational” long-term goals remain to reach a 30% gross profit margin.
• Tariff and Pricing Actions: April saw two major price increases from OEMs, driven by new tariffs. Watsco is collaborating with suppliers to implement these changes quickly using its pricing technology, with management stating most actions are price increases rather than temporary surcharges.
• International and Commercial Weakness: International markets, particularly Canada and Latin America, accounted for 9% of sales and showed greater volatility. Commercial HVAC and non-equipment categories (like parts and supplies) posted year-on-year declines, attributed to seasonality and product transition disruptions.

Drivers of Future Performance

Management’s outlook centers on the continued ramp of A2L systems, evolving pricing actions due to tariffs, and the ability to capitalize on a mix shift toward higher-margin replacement sales during the busier selling season.

• A2L Rollout Acceleration: The full transition to A2L refrigerants is expected to drive sales and margin opportunities as the higher-priced, more efficient systems gain market share in Q2 and Q3.
• Tariff-Driven Pricing Volatility: Proposed tariffs on HVAC components and refrigerants may result in additional price increases from OEMs, with management emphasizing agility in passing through costs and maintaining demand.
• Seasonal Demand and Supply Chain: Management highlighted that the first quarter is the smallest of the year; performance in Q2 and Q3 will depend on how quickly the new product mix is adopted and whether recent price hikes impact end-user demand or spur a shift toward lower-priced alternatives.

Top Analyst Questions

• Stephen Volkmann (Jefferies): Asked about the mix between legacy 410A and new 454B product volumes, and how pricing dynamics affected gross margins. Management shared that 20-25% of Q1 residential volumes were A2L products, with pricing and mix both aiding margins.
• David Manthey (Baird): Inquired about softness in new construction and international business, and whether Watsco was holding share. Management attributed the softness to one fewer sales day and contractor choices to delay new construction purchases until the A2L transition, but stated no share loss was evident.
• Jeffrey Sprague (Vertical Research): Asked about the mechanism of OEM pricing (surcharge vs. price increase) and potential for price relief if tariffs are reversed. Management confirmed nearly all recent OEM actions are permanent price increases, not surcharges, and that pricing would adjust if tariff pressures eased.
• Tommy Moll (Stephens): Probed Watsco’s technology capabilities for dynamic pricing and whether early trends in Q2 suggested a rebound. Management emphasized the flexibility of their pricing tools and that domestic business was showing mid-single-digit growth with stable margins early in Q2.
• Chris Snyder (Morgan Stanley): Queried the expected pace of 454B adoption and whether a share shift back to Watsco is likely as competitors run out of legacy inventory. Management estimated that over 60% of recent sales are now 454B, with the transition accelerating and leveling the competitive landscape.

Catalysts in Upcoming Quarters

Looking ahead, our analysts will closely track (1) how quickly the A2L refrigerant transition translates to higher sales volumes and improved margins, (2) the effect of additional OEM price increases or tariff-driven cost hikes on demand and profit, and (3) the extent to which domestic replacement business can offset continued weakness in international and commercial segments. The pace of inventory conversion and the market’s response to higher system prices will also be important indicators.

Watsco currently trades at a forward P/E ratio of 31.8×. In the wake of earnings, is it a buy or sell? The answer lies in our free research report.

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