Watsco, Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Watsco distributes HVAC/R equipment, parts and supplies across North America, operating 603 locations at quarter-end. Figures below are in U.S. dollars; financial statement amounts are converted from thousands to millions.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $1,394.9m | $1,296.0m | $3,698.0m | $3,555.3m |
| Gross profit | $334.7m | $319.0m | $896.4m | $870.6m |
| Operating income | $125.3m | $122.3m | $314.9m | $313.6m |
| Net income attributable to Watsco | $83.5m | $79.2m | $208.7m | $203.3m |
| Diluted EPS | $2.20 | $2.11 | $5.54 | $5.43 |
- Q3 revenue rose 8% (same-store growth 3%); nine-month revenue rose 4% (same-store growth 2%). Q3 same-store residential HVAC equipment revenue increased 6%, with volume up 4% and average selling price up 2%.
- Gross margin was 24.0% in Q3 versus 24.6% a year earlier, and 24.2% for the first nine months versus 24.5%. Management attributed the declines primarily to nonrecurrence of supplier pricing benefits received in mid-2018.
- SG&A was 15.3% of Q3 revenue versus 15.5%; it remained 15.9% for the nine-month periods. Technology initiatives added $1.5m of year-over-year Q3 costs and $4.3m for the nine months.
- Q3 net income attributable to Watsco increased 5%; nine-month income increased 3%. Lower tax expense helped nine-month results, while higher interest expense partly offset growth.
Cash flow, liquidity and obligations
- Nine-month operating cash flow was $197.5m, compared with $70.1m in 2018; management said the increase primarily reflected timing of payments for accrued expenses and other current liabilities. Investing cash outflow was $65.0m, including $47.3m for acquisitions; financing cash outflow was $155.7m, including $180.5m of dividends.
- Cash was $60.2m at September 30, 2019, including $43.9m held by foreign subsidiaries. Working capital was $1,148.5m, up from $1,084.2m at year-end 2018; receivables and inventory increased, partly reflecting acquisitions and inventory built ahead of new furnace-fan energy standards.
- Revolver borrowings were $169.3m, up from $135.2m at December 31, 2018. The unsecured revolving facility provides up to $500m, with seasonal capacity reducible to $400m; it matures December 2023. Watsco reported compliance with its covenants.
- Operating lease liabilities totaled $223.9m following adoption of the new lease standard; corresponding right-of-use assets were $225.4m. Adoption materially increased balance-sheet assets and liabilities but did not significantly affect income or cash flows.
- Management said cash on hand, operating cash flow and available revolver capacity should meet foreseeable liquidity needs, while cautioning that funding availability is not assured. The filing gives no numerical earnings or revenue guidance.
Acquisitions, outlook and risks
- Watsco acquired DASCO in April and, through its Carrier joint venture, acquired Peirce-Phelps in August. PPI consideration included $10.0m cash and 372,543 Watsco shares valued at $58.6m, plus payment of certain average revolving indebtedness. The acquired businesses represented approximately 6% of consolidated assets and 2% of nine-month revenue; purchase accounting remained preliminary.
- Watsco paid $32.4m in May to acquire the remaining 20% of Homans, bringing ownership to 100%. Its ownership interest in RSI increased to 38.1%; estimated contingent purchase exposure for potential additional RSI shares was approximately $131m.
- HVAC/R demand is seasonal and weather-sensitive, typically strongest for residential air-conditioning replacement in the second and third quarters. Risks identified include economic and construction conditions, weather, competition, supplier concentration, commodity costs, liquidity and interest rates, currency, regulation, insurance and cybersecurity.
- Carrier and affiliates supplied 60% of Q3 inventory purchases and 61% for the nine months; approximately $120m was payable to them, net of receivables, at quarter-end. Management said related-party transactions were on arm’s-length terms.
- Management did not expect known litigation to materially adversely affect financial condition or results. Disclosure controls were assessed as effective; internal controls at PPI and DASCO had not yet been assessed.
Key facts for investors to verify
- Whether gross-margin pressure persists as supplier pricing benefits from 2018 roll off.
- Whether operating cash flow converts earnings reliably, given its sensitivity to payment timing and seasonal working-capital needs.
- Acquisition integration, final PPI purchase accounting, and the impact of newly added locations on growth and margins.
- Liquidity and potential funding needs, including the $131m estimated RSI purchase exposure, revolver availability and foreign-held cash.
- Carrier supplier concentration and the company’s exposure to weather, housing demand, seasonality and interest-rate or benchmark-rate changes.