Watsco, Inc. — Q3 2011 Form 10-Q
Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2011. Watsco distributes HVAC/R equipment, parts and supplies. It reported results that include two 2011 Carrier-related ventures, in which it holds 60% controlling interests. At quarter-end, Watsco operated 539 locations.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $914.0m | $812.8m | $2,331.9m | $2,187.3m |
| Gross profit | $219.4m | $195.5m | $567.6m | $519.2m |
| Operating income | $74.3m | $64.0m | $166.6m | $143.8m |
| Net income attributable to Watsco | $33.5m | $31.4m | $77.1m | $70.3m |
| Diluted EPS | $1.02 | $0.97 | $2.34 | $2.16 |
- Revenue increased 12% in Q3 and 7% in the nine-month period. Same-store sales rose 4% and 2%, respectively; new Carrier ventures contributed $75.0m in Q3 and $119.9m for nine months.
- Gross margin was 24.0% in Q3 (24.1% prior year) and 24.3% for nine months (23.7% prior year). Management attributed the nine-month improvement to pricing and vendor discounts/rebates; Q3 margin was pressured by a shift toward lower-margin HVAC equipment.
- Operating margin was 8.1% in Q3 versus 7.9%; for nine months it was 7.1% versus 6.6%. Watsco-attributable net income increased 7% in Q3 and 10% for nine months.
- Nine-month operating cash flow was negative $58.7m, versus positive $96.7m in 2010. Working-capital changes included inventory outflows of $96.6m and receivables outflows of $62.5m; management cited seasonal inventory buildup, purchase of previously consigned inventory and $70m of incremental vendor payments following changed payment terms.
- Investing cash outflow was $53.5m, including $44.7m of acquisition spending and $9.2m of capital expenditures. Financing provided $6.7m, including increased revolving-credit borrowings, offset by dividends, distributions and a $32.0m return of capital to the noncontrolling interest.
Liquidity, debt and material changes
- Cash was $21.0m at September 30, 2011, down from $126.5m at year-end 2010. Working capital was $610.6m, up from $572.0m; management said working capital excluding the new locations was $551.9m.
- Revolving-credit borrowings totaled $115m: $75m under Watsco’s $300m facility and $40m under Carrier Enterprise’s amended $125m facility. Both facilities mature in 2012 and the balances were classified as current. Watsco reported covenant compliance.
- Watsco said it intended to refinance both facilities before maturity, but cautioned that refinancing on equivalent terms was not assured. Management believed operating cash flow, cash and available credit would meet foreseeable liquidity needs.
- Watsco formed Carrier Enterprise Northeast in April, contributing 14 locations and paying cash for its 60% interest; it acquired a 60% interest in Carrier’s Mexico distribution operations in July for $9m. Acquisition-related costs were $0.3m in Q3 and $1.1m for nine months.
- The Board increased the quarterly dividend from $0.57 to $0.62 per share, with the increase expected in the January 2012 payment. The filing notes that future dividends remain subject to Board discretion and credit-agreement restrictions.
Outlook, risks and other notable matters
- No quantified earnings or revenue guidance was provided. Results are seasonal and sensitive to summer and winter weather; the filing cautions that interim results are not necessarily indicative of full-year results.
- Key disclosed risks include economic and construction conditions, housing activity, weather, consumer spending, commodity costs, competition, interest rates, liquidity and refinancing, foreign exchange, insurance and supplier concentration. Purchases from Carrier and affiliates were 47% of total purchases for the first nine months of 2011.
- Watsco stated that known litigation was not expected to materially affect financial condition or results, while noting uncertainty in outcomes and insurance coverage. Self-insurance reserves were $5.9m.
- Management concluded disclosure controls were effective. Internal control over financial reporting for the acquired Carrier Northeast and Mexico locations had not yet been assessed; together, they represented approximately 10% of consolidated assets and 5% of nine-month revenue.
Important facts for investors to verify
- Progress and final terms of refinancing the two revolving-credit facilities before their 2012 maturities.
- Whether the sharp operating cash outflow and working-capital investment reverse as seasonal demand and vendor-payment patterns normalize.
- Organic sales and margins, separately from acquisition contributions, and performance of the Carrier Northeast and Mexico operations.
- Continued covenant compliance, credit availability and the capacity to fund dividends and operations amid low cash balances.
- Completion of internal-control assessments for the recently acquired locations and the effect of continued dependence on Carrier as a supplier.