Watsco, Inc. — Q3 2022 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2022; unaudited results compared with the same 2021 periods. Watsco distributes HVAC/R equipment, parts and supplies, operating 675 locations across the U.S., Canada, Mexico and Puerto Rico.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Nine months 2022 | Nine months 2021 |
|---|---|---|---|---|
| Revenue | $2,035.8 million | $1,782.6 million | $5,693.1 million | $4,768.3 million |
| Gross profit | $550.8 million | $482.7 million | $1,596.7 million | $1,255.4 million |
| Gross margin | 27.1% | 27.1% | 28.0% | 26.3% |
| Operating income | $236.3 million | $206.8 million | $694.4 million | $505.5 million |
| Net income attributable to Watsco | $157.6 million | $140.9 million | $463.5 million | $340.1 million |
| Diluted EPS | $4.03 | $3.62 | $11.86 | $8.75 |
- Q3 revenue rose 14% and Watsco-attributable net income rose 12%. Nine-month revenue rose 19% and attributable net income rose 36%.
- Q3 operating margin was 11.6%, unchanged year over year; nine-month operating margin increased to 12.2% from 10.6%. Nine-month SG&A was 16.2% of revenue versus 16.1%.
- Q3 HVAC equipment revenue increased 13%; other HVAC products rose 15% and commercial refrigeration rose 18%. For HVAC equipment, higher average selling prices (+14%) more than offset a 1% volume decline.
- For the first nine months, same-store revenue increased 17%. HVAC equipment average selling price rose 15% and volume rose 2%; management attributed margin improvement primarily to pricing and residential HVAC product mix.
- Interest expense was $0.5 million in Q3 and $2.2 million for nine months, up from $0.2 million and $0.8 million, respectively, primarily due to higher average revolver borrowings and interest rates. The company-specific effective tax rate was 23.8% for both 2022 periods, versus 22.8% for Q3 2021 and 22.9% for the nine-month 2021 period.
Cash flow, debt and liquidity
- Nine-month operating cash flow was $358.9 million, compared with $319.7 million in 2021. Investing cash outflow was $26.4 million versus $140.1 million, chiefly reflecting lower acquisition spending; financing cash outflow was $315.5 million versus $187.9 million.
- Operating cash flow included substantial working-capital uses: $276.7 million for inventory and $170.7 million for receivables, partly offset by $212.8 million from accounts payable and other liabilities. Capital expenditures were $26.5 million.
- Cash was $130.2 million at September 30, 2022, including $103.3 million held by foreign subsidiaries. Working capital was $1,470.4 million, up from $1,234.7 million at December 31, 2021; inventory and receivables increased amid inflation, strong business conditions and supply-chain precautions.
- Revolver borrowings were $8.8 million, down from $89.0 million at year-end 2021. The unsecured revolving facility provides up to $560 million (seasonally reducible to $460 million) and matures December 5, 2023. Watsco reported compliance with its covenants and said available cash, operating flows and borrowing capacity should meet foreseeable liquidity needs, while noting funding and market risks.
- Nine-month dividends paid were $6.35 per share. After quarter-end, the board raised the quarterly dividend from $2.20 to $2.45 per share, beginning with the January 2023 payment.
Changes, outlook and material risks
- Management estimated supplier supply-chain constraints, component shortages, labor shortages and transportation delays reduced first-nine-month revenue by approximately 3%–4%. It said the future effect is uncertain. Inflation, labor availability and supply disruptions remain relevant business conditions; COVID-19 effects had become less central than broader economic and marketplace dynamics.
- No specific earnings or revenue guidance is provided. Management emphasized seasonality: residential air-conditioning replacement demand is typically strongest in Q2 and Q3, while heating demand usually peaks in Q1 and Q4; weather can materially affect results.
- New minimum SEER efficiency requirements generally rise in 2023. Higher-efficiency residential HVAC sales grew 23% organically in the first nine months, compared with 17% growth in U.S. residential HVAC equipment sales overall.
- Carrier represented 60% of inventory purchases for the first nine months (64% in 2021); approximately $167 million was payable to Carrier and affiliates at quarter-end, net of receivables. Supplier concentration is a risk to monitor.
- A post-quarter vesting of 975,622 CEO-affiliate Class B restricted shares had a disclosed value of $265.1 million. Watsco funded $104.3 million of statutory withholding, partly offset by a $19.7 million CEO cash payment and surrender of 311,408 shares. The company said the vesting value would be deductible on its 2022 tax return and lower its effective tax rate. This is an unusual compensation and tax item.
- Watsco disclosed a contingent obligation to purchase additional RSI shares, estimated at approximately $324 million at quarter-end under the shareholder agreement. The company said available operating cash and revolver capacity would be sufficient if a purchase were required.
- Hurricane Ian disrupted Florida operations late in September, but management said the impact on Q3 results was not significant and affected locations were operating by the filing date. The company said known litigation was not expected to materially affect financial condition or results.
Important facts for investors to verify
- Whether pricing, product mix and higher-efficiency-system demand can offset HVAC equipment volume weakness and potential market normalization.
- Whether inventory levels and supplier constraints improve, and how the estimated 3%–4% lost revenue and working-capital investment evolve.
- Carrier concentration, related-party purchasing terms and the approximately $167 million net payable balance.
- The potential timing and funding consequences of the approximately $324 million RSI purchase obligation, as well as the revolver’s December 2023 maturity and refinancing terms.
- The actual 2022 tax benefit and effective-tax-rate impact from the CEO-affiliate share vesting, and the effect of the higher dividend on cash available for operations and investment.