Watsco, Inc. 10-Q Summary: Quarter Ended September 30, 2009
Business Context and Reporting Period
This Form 10-Q covers the quarterly period ended September 30, 2009, and the nine months ended September 30, 2009. Watsco, Inc. is the largest distributor of air conditioning, heating, and refrigeration (HVAC/R) equipment and supplies in the United States. A material event during this period was the formation of a joint venture, Carrier Enterprise, LLC, on July 1, 2009, with Carrier Corporation. Watsco holds a 60% controlling interest in the venture, which added 95 locations to Watsco's footprint, bringing the total to 510 locations across 36 states.
Key Financial Metrics
| Metric (in thousands) | Q3 2009 | Q3 2008 | 9 Months 2009 | 9 Months 2008 |
|---|---|---|---|---|
| Revenues | $741,895 | $475,225 | $1,438,209 | $1,365,446 |
| Gross Profit | $172,009 | $126,673 | $347,228 | $355,737 |
| Gross Margin % | 23.2% | 26.7% | 24.1% | 26.1% |
| Operating Income | $41,452 | $37,704 | $66,184 | $92,856 |
| Net Income (Total) | $27,141 | $23,332 | $42,251 | $57,026 |
| Net Income Attributable to Watsco | $21,131 | $23,332 | $36,241 | $57,026 |
| Diluted EPS (Watsco) | $0.66 | $0.81 | $1.21 | $1.98 |
| Cash and Equivalents | $65,317 | $41,444 (Dec 31, 2008) | N/A | |
| Working Capital | $578,545 | $348,879 (Dec 31, 2008) | N/A | |
| Debt (Revolving Credit) | $43,000 | $20,000 (Dec 31, 2008) | N/A |
Material Changes vs. Prior Period
- Revenue Growth: Q3 2009 revenues increased 56% ($266.7 million) compared to Q3 2008. This growth was driven primarily by the $339.4 million contribution from the Carrier Enterprise joint venture and other acquisitions. On a same-store basis, revenues declined 15% due to economic conditions and lower commodity pricing.
- Margin Compression: Gross profit margin decreased to 23.2% in Q3 2009 from 26.7% in Q3 2008. The decline is attributed to lower margins at the new joint venture, a shift in sales mix toward lower-margin HVAC equipment, and competitive pricing on commodity products (copper, sheet metal, refrigerant).
- Net Income: Net income attributable to Watsco decreased 9% in Q3 2009 ($21.1 million vs. $23.3 million) and 36% for the nine-month period ($36.2 million vs. $57.0 million). The decline is primarily due to lower gross margins and higher selling, general, and administrative (SG&A) expenses as a percentage of revenue, despite cost-saving initiatives.
- Liquidity: Cash and cash equivalents increased to $65.3 million from $41.4 million at year-end 2008. Borrowings under the revolving credit agreement increased to $43.0 million to fund a $48.0 million capital contribution to the joint venture.
Guidance, Outlook, and Risks
Management Commentary: Management notes that results are seasonal, with peak demand for residential air conditioning in the second and third quarters. The company faces headwinds from the broader economic downturn, which has reduced demand and pressured pricing on commodity-sensitive products. However, the Carrier Enterprise joint venture has expanded market reach to over 50,000 customers.
Risks and Contingencies:
- Supplier Concentration: Purchases from six key suppliers comprised 77% of total purchases in Q3 2009. Carrier and an affiliated supplier accounted for 57% of purchases.
- Joint Venture Integration: Risks include the successful integration of the joint venture, diversion of management attention, and potential loss of key employees.
- Market Conditions: Future results depend on general economic conditions, consumer spending, new housing starts, and weather patterns.
- Commodity Prices: Fluctuations in the cost of copper, galvanized sheet metal, and refrigerant significantly impact revenue and margins.
Investor Verification Checklist
- Joint Venture Performance: Verify the integration progress and margin trajectory of the Carrier Enterprise joint venture, which now represents a significant portion of consolidated assets and revenue.
- Commodity Exposure: Assess the impact of ongoing volatility in copper and refrigerant prices on future gross margins, given that these products represented 12-13% of same-store revenue.
- Debt Covenants: Confirm continued compliance with financial covenants (leverage and interest coverage ratios) under the amended $300 million revolving credit facility.
- Working Capital Needs: Monitor the $6.0 million working capital adjustment expected in Q4 2009 related to the joint venture purchase price.
- Noncontrolling Interest: Review the impact of the 40% noncontrolling interest in Carrier Enterprise on net income attributable to Watsco shareholders.