Watsco, Inc. — Q2 2021 Form 10-Q
Business context and reporting period. Watsco distributes HVAC/R equipment, parts and supplies through 655 locations across the U.S., Canada, Mexico and Puerto Rico, with additional export markets. This unaudited report covers the quarter and six months ended June 30, 2021; comparisons are against the same periods in 2020. Results are seasonal, with residential air-conditioning demand typically strongest in the second and third quarters.
Financial performance
| Metric | Q2 2021 | Q2 2020 | First half 2021 | First half 2020 |
|---|---|---|---|---|
| Revenue | $1,849.6m | $1,355.4m | $2,985.8m | $2,363.5m |
| Gross profit | $477.9m | $319.2m | $772.8m | $566.8m |
| Operating income | $216.8m | $129.2m | $298.7m | $174.5m |
| Net income attributable to Watsco | $144.1m | $86.6m | $199.2m | $117.1m |
| Diluted EPS | $3.71 | $2.26 | $5.13 | $3.02 |
| Gross margin | 25.8% | 23.6% | 25.9% | 24.0% |
| Operating margin | 11.7% | 9.5% | 10.0% | 7.4% |
- Q2 revenue rose 36%; same-store revenue increased 29%. For the first half, revenue rose 26% and same-store revenue increased 22%.
- Management attributed HVAC equipment growth to strong residential demand, price increases and a greater mix of higher-priced, high-efficiency systems. On a same-store basis, Q2 HVAC equipment sales rose 29%, with volume up 15% and average selling price up 12%.
- Q2 net income attributable to Watsco increased 66%; first-half attributable net income increased 70%. Higher revenue and gross margins drove gains, partly offset by higher taxes and non-controlling interests.
- SG&A was 14.4% of revenue in Q2, compared with 14.3% a year earlier; it was 16.2% for the first half versus 16.8%. Q2 costs reflected higher performance-based compensation and the easing of prior-year cost controls.
Cash flow, liquidity and capital
- First-half operating cash flow was $81.9m, down from $261.3m. Higher receivables and inventory absorbed cash amid increased sales and seasonal working-capital needs.
- Investing cash outflow was $131.5m, including acquisitions; financing cash outflow was $1.0m. Cash declined $49.3m to $96.8m, including $80.6m held by foreign subsidiaries.
- At June 30, current assets were $2,022.1m and current liabilities $815.3m; reported working capital was $1,206.8m. The company said operating cash flow, cash on hand and revolving-credit availability were sufficient for foreseeable needs.
- Revolving-credit borrowings were $114.2m, versus none at December 31, 2020, under a $560m facility maturing December 2023. Watsco reported compliance with its covenants. Current portion of long-term obligations was $81.3m; lease liabilities are also reported separately.
- First-half dividends were $3.725 per share, totaling $143.9m. A $1.95-per-share quarterly dividend was declared July 1 and paid July 30, 2021.
Material changes, acquisitions and other items
- Watsco acquired the Temperature Equipment Corporation HVAC distribution business in April and formed TEC Distribution LLC with Carrier, holding an 80% controlling interest. It acquired Acme Refrigeration of Baton Rouge assets in May. Together the acquisitions added 50 locations; acquisition results were included from their respective closing dates.
- Carrier and affiliates accounted for 72% of Q2 inventory purchases and 67% for the first half, up from 63% and 60%, respectively. Amounts payable to Carrier and affiliates, net of receivables, were approximately $150m at June 30.
- Watsco recognized a $3.8m realized gain from selling certain equity securities during the first half. The filing does not clearly quantify its effect on reported earnings by line item.
- Watsco’s 38.1%-owned investment in Russell Sigler generated $10.2m of first-half equity-method income. Under the shareholder agreement, the estimated contingent purchase amount for additional RSI shares was approximately $299m at June 30.
Outlook, risks and contingencies
- The filing provides no specific financial guidance. Management said it could not reasonably estimate the future effect of COVID-19, citing possible resurgence, variants and uncertain effects on employees, customers and suppliers.
- Management described the current business impact as more tied to broader marketplace dynamics, including supply-chain disruptions and labor shortages. Other cited risks include weather and seasonality, supplier concentration, commodity costs, housing and commercial construction, competition, liquidity, interest rates, currency movements and regulation.
- The company noted that Carrier is a major supplier and that LIBOR was scheduled to be phased out after December 31, 2021, potentially affecting borrowing costs. It stated that known litigation was not expected to materially affect financial condition or results, based on information then available.
- Management concluded disclosure controls were effective at a reasonable assurance level. Internal controls for acquired TEC and Acme had not yet been assessed under the stated SEC transition rules.
Key facts for investors to verify
- Whether strong same-store growth, pricing and product mix persist, and how much revenue growth reflects volume versus price.
- Whether working-capital investment—particularly receivables and inventory—converts to cash as seasonal demand develops.
- Acquisition integration, returns and purchase accounting for TEC and Acme, including the impact of non-controlling interests.
- Exposure to Carrier as a supplier, including the rising share of inventory purchases and payable balance.
- The potential timing and funding implications of the estimated $299m contingent RSI share-purchase obligation.
- Developments in supply availability, labor, COVID-19, weather and financing costs, as well as any subsequent dividend or guidance updates.