The third quarter for Watsco Inc. (WSO) was a record-breaking quarter on all three fronts – revenues, earnings and cash flows. Net income surged 49% year-over-year to achieve a record of $31 million in the quarter.
EPS was 97 cents, up an impressive 47% from 66 cents in the year-ago quarter and beat the Zacks Consensus Estimate by a penny. The outperformance was driven a combination of higher revenues and operating income.
Revenues increased 10% year-over-year to a third quarter record of $813 million. Revenues however, fell short of the Zacks Consensus Estimate of $821 million. Air conditioning and heating (HVAC) equipment (contributing 60% of sales) grew 8%, sales of other HVAC products (32% of sales) went up 11% and commercial refrigeration products (8% of sales) surged 19%.
Cost of sales increased 8% to $617.2 million in the quarter and as a percentage of revenues, it dropped 87 basis points to 75.9%. Gross profit soared 14% to a record $195.5 million and gross margin upped 87 basis points to 24.1%.
Selling, general, administrative and engineering expenses inched up 1% to $131.5 million in the quarter and as a percentage of sales plummeted 140 basis points to 16.2%. Watsco’s operating income of $64 million in the quarter was a record, increasing 54% year over year with operating margin soaring 230 basis points to 7.9%.
Financial Position
Watsco had cash and cash equivalents of $99.9 million as of September 30, 2010, up from $87.7 million as of June 30, 2010. During the quarter, operating cash flows more than tripled to a record $40 million compared to the year-ago quarter.
Debt-to-capitalization ratio went down to 2% as of September 30, 2010, from 3% as of June 30, 2010.
Outlook
The company expects a shift toward higher-efficiency and environmentally sensitive HVAC systems to continue as conservation efforts, consumer awareness and regulatory norms intensify. Further, there is pent-up demand for replacement HVAC systems, which will likely benefit the company over the next several years as the economy strengthens and replacement activity returns to its historical pattern.
Home construction remains near an all-time low and restoration of building activity will add revenues. The company-added sales of commercial products have turned positive and are expected to recover further as capital spending improves.
Our Take
Watsco uses acquisitions to increase its market share. Despite the economic slowdown, the company continues to actively seek acquisition opportunities to allow further penetration into existing markets and expand into new geographic markets. The company’s joint-venture with Carrier not only added new products to its sales mix, but also marked Watsco’s entry into international markets with the addition of the Latin American and Caribbean sales operations.
Moreover, the company continues to benefit from the transition to higher-efficiency air-conditioning equipment. Watsco sees a huge potential in the replacement market for the next few years.
Watsco is the largest distributor of air conditioning, heating and refrigeration equipment as well as related parts and supplies in the United States. The company operated 508 locations serving over 50,000 customers in 36 states, Puerto Rico, Latin America and the Caribbean.
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