WSO Q4 Deep Dive: A2L Transition and Margin Initiatives Shape Outlook

Equipment distributor Watsco (NYSE:WSO) missed Wall Street’s revenue expectations in Q4 CY2025, with sales falling 10% year on year to $1.58 billion. Its non-GAAP profit of $1.68 per share was 11.1% below analysts’ consensus estimates.

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StockStory’s Take

Watsco's fourth quarter results reflected ongoing industry disruption from the transition to next-generation A2L refrigerant equipment, resulting in lower unit volumes compared to the prior year. Management attributed the sales decline to a “20% growth rate last year” that created a tough comparison, alongside a 17% drop in unit volumes in 2025. Despite these headwinds, CEO Albert Nahmad highlighted progress in gross margin improvement, stating, “We achieved double-digit pricing gains on the new A2L products and raised gross margins by 40 basis points to 27.1%.” The company also emphasized disciplined cost control, with SG&A expenses dropping 2% even as new locations were integrated.

Looking ahead, Watsco’s leadership expects the regulatory-driven market volatility to subside, with the A2L product transition largely behind them. Management remains focused on margin improvement through pricing optimization and a new initiative to expand in the fragmented parts and supplies market. President A.J. Nahmad signaled confidence in the company’s long-term positioning, noting, “We continue to invest in innovation and technology that separate us from competitors.” Watsco aims to enhance inventory turns and generate incremental cash flow, with efforts to further leverage its technology platforms and expand gross margins toward a 30% target.

Key Insights from Management’s Remarks

Management pointed to the successful navigation of regulatory changes, progress in technology adoption, and disciplined cost management as key factors shaping the latest quarter’s performance and strategic direction.

• A2L compliance transition: The shift to A2L refrigerant products drove double-digit price gains but led to lower unit volumes as the market adjusted to new technical and regulatory demands. Management described this as a “much more stable channel this year than…over the last probably four or five years.”
• Margin improvement focus: Watsco lifted gross margins by 40 basis points year on year through pricing discipline and increased use of pricing optimization tools, with a long-term ambition to reach 30% gross margins. Technology-enabled pricing strategies are still being scaled across branches and SKUs.
• Inventory and cash flow discipline: The company met its $500 million inventory reduction goal and generated $400 million in cash flow for the quarter, supporting a 10% dividend increase. Management emphasized maintaining a debt-free balance sheet and the importance of cash flow over GAAP earnings for dividend sustainability.
• Expansion in parts and supplies: Watsco launched a strategic initiative to increase sales in the fragmented parts and supplies segment, which currently accounts for about 30% of its sales. Management sees this as a margin-accretive growth opportunity.
• Digital and AI investment: E-commerce penetration grew to 35% of total sales, with the OnCallAir platform’s gross merchandise value rising 20% year over year. The company is harnessing artificial intelligence to optimize customer experience and operational efficiency.

Drivers of Future Performance

Watsco’s outlook is shaped by expectations for a more normalized operating environment, ongoing technology investments, and efforts to grow non-equipment sales.

• Normalization after regulatory headwinds: Management anticipates a more stable market environment now that the A2L transition and other major regulatory disruptions are behind them. CEO Albert Nahmad commented that “the beginning line is in a much better place” as contractors are now trained and prepared to sell A2L-compliant products.
• Margin expansion strategies: The company is accelerating the deployment of pricing optimization tools and targeting greater penetration in the high-margin parts and supplies business. These initiatives are expected to drive incremental gross margin gains, with the 30% margin target seen as achievable over the next several years.
• Technology and operational efficiency: Continued investment in digital platforms and artificial intelligence is intended to streamline operations, enhance customer engagement, and improve inventory turns. Management also cited ongoing efforts to optimize SG&A expenses, with potential for further reductions as growth investments are balanced with efficiency gains.

Catalysts in Upcoming Quarters

Looking ahead, the StockStory team will be monitoring (1) the pace and effectiveness of technology adoption in sales and pricing optimization, (2) the degree to which the parts and supplies initiative increases non-equipment revenue mix and margins, and (3) signs of market normalization in unit volumes as contractors adapt to the A2L product environment. Execution on inventory turns and cash flow generation will also be key indicators of operational progress.

Watsco currently trades at $422.81, up from $417.92 just before the earnings. Is there an opportunity in the stock?See for yourself in our full research report (it’s free).

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