Watsco, Inc. 2026 Q3 Earnings Call

Welcome to our third quarter earnings call. This is Al Nahmad, Chairman and CEO. With me is A.J. Nahmad, President, Paul Johnston, Barry Logan, and Rick Gomez. Before we start, a 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 on the report. I am happy to report that Watsco's third quarter results reflect improving demand and simpler operating conditions in our industry and in our business. The last six years brought a pandemic, supply chain disruption, regulatory transitions, and tariff volatility. Through it all, we stayed the course and invested in our business. Demand trends are now normalizing, organic growth is improving, and our digital ecosystem is producing measurable results in driving growth.

Our largest and most impactful product group, which is residential HVAC equipment, grew 7% during the quarter, with gains on both unit volume and pricing. We expect the impact from the A2L transition will be largely over by the end of this year. Third quarter reflects Jackson Supply, which was acquired on June 1 of this year. Jackson has $230 million in annual sales and operates from 25 Sunbelt locations. Jackson is performing well and grew 16% during the quarter. We are also pleased to have completed the acquisition of The Granite Group. Granite has annual sales of approximately $500 million and serves over 11,000 customers from 82 locations in the Northeast. Granite marks the fourth business acquired by Watsco that serves both HVAC and plumbing contractors. Today, Watsco has 112 locations that offer both HVAC and plumbing products.

Our M&A pipeline has always included companies that have historically distributed both HVAC and plumbing products. We hope to have other similar businesses to join us. As is our culture, Granite will continue to independently operate and grow their business with our full support. They have big ambitions, and we will support their leadership in any way we can. Watsco is a more efficient company this year. We have made investments in technology, SupplySync, VCR, Hydros, and other initiatives that will benefit growth in the years ahead. Excluding these investments, fixed costs have increased 1% so far in 2026. In terms of our balance sheet, we ended the quarter with $649 million cash and no debt.

Even after using a portion of our cash to fund the Granite transaction in October, we remain a positive net cash flow position and are committed to maintaining a pristine balance sheet, enabling investments in growth opportunities as they arise. Turning to the third quarter results, sales increased 7% to a record $2.22 billion and 4% on a same-store basis. Gross profit was a record $586 million. Gross margins were 26.4%. SG&A increased 5%, excluding Jackson, primarily due to variable expenses. Operating income was $225 million with an operating margin of 10.1%, and earnings per share came in at $3.77. Gross margins over the last 12 months has been in a narrow range and more in line with historical seasonality and current business conditions.

Having said that, we remain focused on reaching our long-term goal of 30% and believe we have the right tools in place to get us there. Year-to-date, operating cash flow has improved 79% to $304 million, reflecting our continued vigilance towards managing our assets. Finally, I am going to hand this call over to AJ Nahmad, who is our President, to provide an update on Watsco's technology initiatives, and he will be joined by other leaders of Watsco. AJ? Thank you, and good morning to 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 are ambitious and straightforward. First, leverage our industry-leading repository of data, products, market, customer, competitor, pricing, you name it. This underpins and empowers the industry's most advanced technology platforms. Second, 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 distribution operations to better serve customers and gain operating efficiencies along the way. Finally, develop and launch technologies that help our customers grow their businesses. Importantly, we see contractor behavior evolving in ways that benefit the technology-enabled distributor long term. Our core technology platforms continue to scale and add value.

E-commerce sales have grown 12% year-to-date, while outpacing overall growth and broader industry metrics. E-commerce reached 37% of sales over the last 12 months, with certain markets at 60%-70% penetration. Digital engagement with our mobile app is strong at more than 73,000 active monthly users. OnCallAir continues its growth trajectory. Over the last year, approximately 351,000 proposals were presented to homeowners, generating $2 billion of gross merchandise value, a 14% increase over the comparable period. Simply put, the contractors we serve digitally are growing faster, have greater loyalty, and we believe we can lower our cost to serve at scale over time. Just as exciting, the new initiatives announced late last year are making progress. SupplySync.com, our newest platform to serve the growing segment of large institutional customers, launched earlier this year to great fanfare.

We have launched a pilot program and are transacting with customers, with a plan to scale it to more and more customers in the coming months. This is a growing channel with unique customer needs that provides incremental growth opportunity for Watsco while leveraging our existing scale and infrastructure. VCR, which stands for Vendor Consolidation and Rationalization, continues to expand across many of our non-equipment product categories. Relationships with our strategic vendor partners have strengthened, and in many cases, are at all-time highs. Hydros, which is our investment in shared logistics and distribution, has further matured and will continue to scale in 2027 to more locations and more vendors. 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.

We view these technology investments as critical to growing our leadership position in the HVAC industry and attractive to the entrepreneurs of companies like Jackson Supply and Granite Group and many others before them to aid our M&A strategy of acquiring great businesses in our space. We invite you to visit us and learn more about what we consider to be our long-term competitive advantage. 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. Our unique ownership culture, shared by more than 8,200 employees, rewards and incentivizes long-term performance.

With that, let's turn to Q&A.

Morning, Tommy. Morning, Al. Thank you for taking my questions.

Of course. I want to start on gross margin, which I suspect will dominate this call.