Watsco, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010. Watsco distributes HVAC/R equipment, parts and supplies. Results include its 60%-owned Carrier Enterprise joint venture, consolidated from July 1, 2009; Carrier holds the remaining 40%. Unless otherwise noted, figures below are in U.S. dollars.
Financial performance
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Revenue | $864.8m | $405.0m | $1,374.6m | $696.3m |
| Gross profit / margin | $201.1m / 23.3% | $101.0m / 24.9% | $323.7m / 23.5% | $175.2m / 25.2% |
| Operating income / margin | $70.9m / 8.2% | $26.3m / 6.5% | $79.8m / 5.8% | $24.7m / 3.6% |
| Net income attributable to Watsco | $35.0m | $16.3m | $38.9m | $15.1m |
| Diluted EPS | $1.08 | $0.56 | $1.20 | $0.52 |
Q2 net income before allocation to the noncontrolling interest was $48.2m; $13.2m was attributable to that interest. Six-month amounts were $53.7m and $14.8m, respectively. Net interest expense was $0.9m in Q2 and $1.8m for the six months. Effective tax rates attributable to Watsco were 38.0% for both 2010 periods, versus 37.3% and 37.2% in the comparable periods.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was $56.8m, versus $27.6m in 2009. Investing cash outflow was $4.2m, including $3.8m capital expenditures and a $2.4m acquisition; financing cash outflow was $23.0m.
- Cash increased to $87.8m at June 30, 2010 from $58.1m at year-end. Working capital was $567.2m, up from $531.4m.
- Revolving-credit borrowings were $20.0m, compared with $12.8m at December 31, 2009; current maturities and other long-term obligations brought total reported obligations to approximately $20.7m. Watsco had a $300m unsecured facility, of which Carrier Enterprise’s separate $75m secured facility had no borrowings outstanding at June 30.
- Accounts receivable was $385.5m and inventory $522.5m, up from $266.3m and $410.1m at year-end; accounts payable rose to $344.8m from $145.8m. Management attributed working-capital movements in part to seasonal inventory buildup and increased sales.
Changes versus comparable periods
- Reported revenue rose 114% in Q2 and 97% for the first half, principally reflecting Carrier Enterprise, which contributed $399.6m and $625.4m, respectively. Same-store revenue increased 14% in Q2 and 7% year to date.
- Same-store Q2 sales benefited from 25% growth in HVAC equipment, including stronger unit sales and a mix shift toward higher-efficiency products; refrigeration sales rose 5%. For the first half, HVAC equipment sales rose 17%, other HVAC products declined 3%, and refrigeration sales increased 3%.
- Reported gross margin declined 160 basis points in Q2 and 170 basis points year to date, largely due to lower Carrier Enterprise selling margins. Same-store gross margin fell 30 basis points in Q2 but improved 10 basis points for the first half.
- SG&A as a share of revenue declined to 15.1% from 18.4% in Q2 and to 17.7% from 21.6% for the first half. Same-store SG&A increased 1% in Q2 and decreased 4% year to date, with management citing profit-enhancement efforts and lower bad-debt expense.
- Reported comparisons are affected by the joint venture’s different consolidation periods. The filing’s unaudited 2009 pro forma figures, assuming the venture existed from the start of each period, were revenue of $740.2m and Watsco-attributable net income of $21.3m for Q2, and revenue of $1,256.8m and attributable net income of $18.3m for the first half.
Outlook, risks and notable items
- No specific earnings or revenue guidance is provided. Management said operating cash flows and available credit were currently sufficient for liquidity needs, anticipated dividends and capital expenditures, and that it continued to evaluate acquisition opportunities.
- Demand is seasonal: residential air-conditioning replacement demand is strongest in Q2 and Q3, while heating demand usually peaks in Q4. Weather can materially affect results. Cited risks include economic and housing conditions, competition, supplier concentration, commodity costs, consumer spending and debt, commercial construction, liquidity and interest rates, regulation, insurance, and execution of business strategy.
- Carrier and affiliates represented 54% of purchases in both reported periods; approximately $157m was payable to them at June 30. The filing says related-party transactions were believed to be at arm’s length. Carrier Enterprise’s remaining transition-services arrangements were expected to expire at various dates during 2010.
- A $10m interest-rate swap fixed a portion of variable-rate exposure at 5.07% through October 2011. Its negative fair value was $0.6m; approximately $0.45m of accumulated unrealized losses was expected to be reclassified to earnings over the next 12 months.
- The board declared a $0.52-per-share quarterly dividend on July 1, paid July 30. The company reported ordinary-course litigation and said known matters were not expected to materially affect financial condition or results, while noting outcomes and insurance adequacy are uncertain. Self-insurance reserves were $9.2m.
- Management reported disclosure controls effective and no material change in internal control during the quarter. Internal-control assessment of the 95 Carrier Enterprise locations had not yet been completed; those locations represented approximately 45% of consolidated assets and first-half revenue.
Important facts for investors to verify
- Assess underlying performance using same-store results and the pro forma comparisons, given the major Carrier Enterprise consolidation effect.
- Monitor gross-margin pressure from Carrier Enterprise and product mix, alongside the reported improvement in SG&A leverage.
- Review seasonal working-capital needs, receivable and inventory growth, and available borrowing capacity under both credit facilities.
- Evaluate supplier and related-party concentration with Carrier, including the payable balance and the ongoing joint-venture relationship.
- Check subsequent disclosures on Carrier Enterprise internal controls, the interest-rate hedge, and the sustainability of dividends and acquisition plans.