Watsco, Inc. — Q3 2010 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2010; unaudited. Watsco distributes HVAC/R equipment, parts and supplies. At quarter-end it operated 507 locations. Figures below are in millions of dollars except per-share data and percentages.
Financial performance
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Revenue | $812.8 | $741.9 | $2,187.3 | $1,438.2 |
| Gross profit | $195.5 | $172.0 | $519.2 | $347.2 |
| Gross margin | 24.1% | 23.2% | 23.7% | 24.1% |
| SG&A | $131.5 | $130.6 | $375.4 | $281.0 |
| Operating income | $64.0 | $41.5 | $143.8 | $66.2 |
| Net income attributable to Watsco | $31.4 | $21.1 | $70.3 | $36.2 |
| Diluted EPS | $0.97 | $0.66 | $2.16 | $1.21 |
- Q3 revenue increased 10% and Watsco-attributable net income increased 49% year over year. Q3 gross margin rose 90 basis points; operating margin increased to 7.9% from 5.6%.
- Nine-month revenue increased 52%, while Watsco-attributable net income increased 94%. Nine-month gross margin declined 40 basis points, while operating margin rose to 6.6% from 4.6%.
- Nine-month operating cash flow was $96.7 million, versus $38.5 million in 2009. Investing cash flow was $(7.3) million and financing cash flow was $(47.6) million. Cash increased to $99.9 million from $58.1 million at year-end 2009.
- At September 30, working capital was $587.8 million. Total current assets were $916.7 million and current liabilities $328.9 million.
- Borrowings under Watsco’s revolving credit agreement were $22.1 million; other long-term obligations were $0.6 million. The separate Carrier Enterprise facility had no borrowings. Net interest expense was $0.9 million for Q3 and $2.7 million year to date.
Material changes and business drivers
- Q3 same-store revenue increased 10%, primarily from price increases, stronger replacement demand and sales mix favoring higher-efficiency systems and non-equipment products. Product sales increased 8% for HVAC equipment, 11% for other HVAC products and 19% for refrigeration products.
- Nine-month same-store revenue increased 8%. Reported nine-month growth primarily reflected the Carrier Enterprise joint venture, contributing $625.4 million of revenue, as well as other acquired and opened locations. The comparison is therefore substantially affected by the 2009 joint venture formation.
- Q3 gross-margin expansion reflected sales mix and higher margins on higher-efficiency systems. Year-to-date consolidated margin was pressured by lower selling margins at Carrier Enterprise; same-store margin improved 50 basis points.
- SG&A was nearly flat in Q3 and increased 34% year to date, primarily because of Carrier Enterprise. As a share of revenue it declined to 16.2% from 17.6% for Q3 and 17.1% from 19.5% year to date.
- Watsco owns 60% of Carrier Enterprise and reports a 40% noncontrolling interest. Q3 and nine-month net income attributable to that interest was $12.1 million and $26.9 million, respectively.
Liquidity, outlook and risks
- Management stated that operating cash flow and available credit lines were sufficient for current needs, including anticipated dividends and capital expenditures. Watsco’s unsecured revolver provides up to $300 million and matures in August 2012; Carrier Enterprise’s separate secured facility provides up to $75 million and matures in July 2012. The filing reports covenant compliance at quarter-end.
- Cash flows and sales are seasonal: residential air-conditioning replacement demand is generally strongest in Q2 and Q3, while heating demand is generally strongest in Q4. Weather can affect results. Management gave no specific earnings or revenue guidance.
- The board declared a quarterly dividend of $0.52 per share, paid October 29, 2010. Future dividends remain at the board’s discretion and subject to financial condition, cash needs and credit-agreement restrictions.
- Risks highlighted include economic and construction conditions, competition, supplier concentration, commodity costs, consumer spending and debt, weather and seasonality, access to liquidity, interest rates, insurance, regulation and execution of business strategy. Purchases from Carrier and affiliates represented 52% of purchases year to date; approximately $110 million was payable to them at quarter-end.
- Management said known litigation was not expected to materially affect financial condition or results, while noting outcomes cannot be predicted with certainty. Self-insurance reserves were $7.1 million.
- Disclosure controls were deemed effective at a reasonable-assurance level. However, internal controls over financial reporting had not yet been assessed for the 95 Carrier Enterprise locations, representing approximately 45% of consolidated assets and 46% of nine-month revenue.
Important facts for investors to verify
- How much of reported growth and earnings improvement reflects underlying same-store performance versus the Carrier Enterprise consolidation and other acquisitions.
- Carrier Enterprise’s margins, working-capital needs, future distributions and Watsco’s options to acquire additional ownership interests.
- Supplier concentration and the scale and terms of related-party purchases and payables with Carrier and its affiliates.
- Seasonal working-capital requirements, revolver availability, covenant headroom and the effect of interest rates; the filing also describes an interest-rate swap with $10 million notional value and a 5.07% fixed rate through October 2011.
- Completion and results of the internal-control assessment for Carrier Enterprise, and any subsequent changes in reported performance or risk exposures.