Watsco, Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Unaudited consolidated results. Watsco distributes HVAC/R equipment, parts and supplies through 603 locations in the U.S., Canada, Mexico and Puerto Rico, with additional export coverage.
Key financial results
Amounts in millions of dollars, except per-share data and percentages.
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $1,536.7 | $1,394.9 | $3,900.2 | $3,698.0 |
| Gross profit | $373.8 | $334.7 | $940.6 | $896.4 |
| Gross margin | 24.3% | 24.0% | 24.1% | 24.2% |
| Operating income | $156.8 | $125.3 | $331.3 | $314.9 |
| Net income attributable to Watsco | $106.5 | $83.5 | $223.6 | $208.7 |
| Diluted EPS | $2.76 | $2.20 | $5.82 | $5.54 |
- Q3 revenue rose 10%; same-store revenue increased 8%. Watsco attributed growth principally to residential HVAC replacement demand and a higher mix of high-efficiency systems. Residential HVAC equipment volume increased 18%, with average selling price up 1%.
- Q3 operating margin increased to 10.2% from 9.0%; SG&A was 14.4% of revenue versus 15.3%. Management cited stronger gross margin on residential HVAC equipment, operating efficiencies and cost controls.
- For the first nine months, revenue increased 5% and same-store revenue increased 1%. Watsco reported a 10-basis-point decline in gross margin, citing a sales mix shift toward lower-margin HVAC equipment. Same-store SG&A declined 1%.
Cash flow, balance sheet and liquidity
- Operating cash flow for the first nine months was $372.8 million, compared with $197.5 million in 2019. Management attributed the increase mainly to lower inventory and the timing of payments for accrued expenses and other liabilities.
- Investing cash outflow was $11.5 million, versus $65.0 million; financing cash outflow was $342.8 million, versus $155.7 million. Financing use included $197.5 million of dividends and $155.0 million of net revolver repayments.
- At September 30, cash was $92.6 million, including $64.7 million held by foreign subsidiaries. Working capital was $1,034.6 million, down from $1,085.0 million at year-end 2019.
- Revolver borrowings were $0.7 million, down from $155.7 million at December 31, 2019. The unsecured facility was increased to $560 million in April 2020 and matures December 5, 2023. Watsco said it was in covenant compliance.
- Shareholders’ equity was $1.81 billion. Operating and finance lease liabilities were separately reported; they are not included in the revolver borrowing figure.
- Cash dividends paid during the first nine months were $5.15 per share. The Board declared a $1.775-per-share quarterly dividend on October 1, 2020; future dividends remain at the Board’s discretion.
Management commentary, outlook and risks
- Watsco provided no specific financial guidance in the filing. Management said the pandemic’s full impact could not be reasonably estimated and depended on uncertain future developments.
- All locations were operating as of the filing date, with contactless sales and servicing at many locations. The company described its liquidity and low debt as strengths, and said operating cash flow, cash on hand and available revolver capacity were expected to meet foreseeable needs.
- COVID-19 disruptions affected some locations in Q2; restrictions resumed in certain markets during Q3. Risks include further closures or operating limits, supplier and delivery interruptions, employee availability, customer demand and payment capacity, and weaker commercial construction or new-construction activity. Management noted potential shifts toward repairs or value-oriented equipment could reduce sales and margins.
- HVAC/R demand is seasonal and weather-sensitive, with residential replacement demand typically strongest in Q2 and Q3 and heating demand usually strongest in Q4.
- Carrier and affiliates accounted for 65% of Q3 inventory purchases and 62% for the first nine months. Amounts payable to Carrier and affiliates, net of receivables, were approximately $106 million at quarter-end. The filing identifies supplier concentration as a risk.
- Watsco disclosed an estimated $183 million contingent purchase amount related to potential additional RSI ownership, under contractual purchase rights and obligations. The company said available liquidity should be sufficient to fund a purchase if required.
- Routine litigation was not expected by management to have a material adverse effect based on information then available. Self-insurance reserves were $5.2 million. The filing also identifies economic conditions, competition, commodity costs, weather, foreign exchange, regulation, cybersecurity and access to liquidity as risks.
Important facts for investors to verify
- Whether residential replacement demand and the Q3 margin improvement persist, particularly as commercial HVAC and construction markets remain weaker.
- How COVID-19 conditions, restrictions and supply-chain disruptions affect future sales, margins, collections and operations.
- Whether the higher operating cash flow is sustained, given management’s emphasis on inventory reduction and payment timing.
- Carrier supplier concentration and the terms and continuity of the commercial relationship with Carrier.
- The timing and amount of any RSI ownership purchase obligation, and its effect on liquidity and debt.
- Future dividend decisions, revolver availability and covenant compliance.