Watsco, Inc. — Q3 2012 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2012. Watsco distributes HVAC/R equipment, parts and supplies and operated 579 locations across the U.S., Canada, Mexico and Puerto Rico. Figures below are in millions of dollars except per-share amounts.
Financial performance
| Metric | Q3 2012 | Q3 2011 | 9M 2012 | 9M 2011 |
|---|---|---|---|---|
| Revenue | $1,020.9 | $914.0 | $2,666.2 | $2,331.9 |
| Gross profit / margin | $242.5 / 23.8% | $219.4 / 24.0% | $631.6 / 23.7% | $567.6 / 24.3% |
| Operating income / margin | $85.7 / 8.4% | $74.3 / 8.1% | $191.5 / 7.2% | $166.6 / 7.1% |
| Net income attributable to Watsco | $41.0 | $33.5 | $88.6 | $77.1 |
| Diluted EPS | $1.19 | $1.02 | $2.61 | $2.34 |
Q3 revenue rose 12% and Watsco-attributable net income rose 22%; nine-month revenue rose 14% and attributable net income rose 15%. Same-store revenue increased 1% in Q3 and 3% for nine months. Acquired Carrier Enterprise II and III locations contributed substantially to reported growth. Gross margin contracted 20 basis points in Q3 and 60 basis points year to date, primarily from a sales mix shift toward lower-margin HVAC equipment. SG&A as a share of revenue improved to 15.4% from 15.9% in Q3 and to 16.5% from 17.2% year to date, reflecting fixed-cost leverage and lower doubtful-account provisions.
Cash flow, liquidity and capital
- Nine-month operating cash flow was $64.4, versus cash used of $58.7 in 2011. The improvement reflected, among other factors, higher accounts payable and other liabilities; receivables and inventory remained significant uses of cash.
- Investing cash outflow was $141.2, including $132.4 of net acquisition spending and $9.2 of capital expenditures. Financing cash inflow was $106.7, principally reflecting revolver borrowings. Cash ended the period at $46.0, up from $15.7 at year-end 2011.
- Working capital was $812.8 at September 30, compared with $605.1 at December 31, 2011; management attributed part of the increase to the Canadian joint venture and seasonal receivables and inventory.
- Revolving-credit borrowings were $202.2, versus $20.0 current borrowings at year-end 2011. The new unsecured $500 million facility matures in April 2017; management said the company complied with its covenants. No interest-rate hedge was outstanding.
- Cash dividends paid during the first nine months were $1.86 per share. On October 1, the board declared a $5.00-per-share special dividend and a $0.62 regular dividend, paid October 31.
Material transactions, outlook and risks
- Watsco acquired a 60% controlling interest in Carrier Enterprise III, the Canadian distribution joint venture, for cash and 1.25 million Watsco shares. The preliminary purchase allocation included $216.5 of goodwill and intangible assets and remains subject to valuation estimates. Watsco also bought an additional 10% of Carrier Enterprise I for $51.9, increasing its interest to 70%.
- No specific earnings or revenue guidance is provided. Management said operating cash flow, cash on hand and available credit should meet foreseeable liquidity needs, while noting credit-market disruption could limit borrowing access or raise costs.
- Demand is seasonal, typically strongest for residential air-conditioning replacements in Q2 and Q3 and heating equipment in Q4; results can vary with weather, housing activity and economic conditions. Other cited risks include competition, commodity costs, consumer spending and debt, commercial construction, foreign exchange, insurance, regulation, and supplier concentration.
- Carrier and affiliates represented 57% of purchases in both Q3 and the first nine months of 2012; approximately $90 million was payable to Carrier and affiliates at quarter-end. Management considers related-party transactions to be at arm’s length.
- Management said known litigation was not expected to have a material adverse effect. Self-insurance reserves were $5.1. Internal controls were judged effective, but acquired Carrier Enterprise II and III locations—about 27% of consolidated assets and 15% of nine-month revenue—had not yet been included in the company’s internal-control assessment.
Key facts for investors to verify
- How much of revenue and earnings growth reflects acquisitions versus sustainable same-store demand, and whether gross-margin pressure persists.
- Final purchase accounting and realized performance for Carrier Enterprise III, including goodwill and intangible-asset valuations.
- Seasonal working-capital needs, cash conversion and revolver usage after the special dividend.
- Exposure to Carrier as a major supplier and the status of internal-control assessments for acquired operations.