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HVACR wholesale distributor Watsco Inc. reported record third-quarter and nine-month operating results for the periods ended Sept. 30, 2021.
Watsco’s entrepreneurial culture, which empowers leaders to think and act locally, continues to drive record performance with nearly all operating metrics reaching record levels. The company achieved new performance records for sales, gross profit, gross margin, operating income, operating margin, net income and earnings per share (EPS) for both periods.
This performance includes stepped-up investments to grow customer adoption of Watsco’s various technology platforms, which collectively enhance operational efficiency and help contractors grow and better serve homeowners and businesses. The distributor believes the pace of innovation and change is accelerating, and its customer-focused solutions, scale and leadership position provide significant long-term value.
As examples, sales growth rates of contractors that are active users far outpace growth rates among non-users, and annual attrition rates are meaningfully lower among active technology users as compared to traditional customers.
Watsco has also made substantial incremental investments in its network during 2021. The company completed three acquisitions over the first three quarters, investing $114 million of capital in strong businesses and has opened 20 new stores to drive future growth and support local customers.
Looking ahead, Watsco believes it can meaningfully contribute to sustainability and greenhouse gas emissions reduction through the sale of new HVAC equipment that replaces older systems operating at lower efficiencies. Based on estimates validated by independent sources, since Jan. 1, 2020 through Sept. 30, 2021, Watsco facilitated the reduction of an estimated 19.4 billion pounds of carbon dioxide emissions from the sale of replacement residential air conditioners, heat pumps and furnaces.
“We believe that Watsco can play a role at scale in addressing climate change given that many of the estimated 110 million HVAC systems, installed in the U.S., operate under older energy-efficiency standards and historically use high-global warming potential refrigerants and natural gas,” said Albert H. Nahmad, Watsco’s chairman and CEO. “We are investing resources and leveraging our technology to increase awareness among contractors, business owners and consumers, and we will collaborate with our OEM partners to impact climate change.”
Key performance metrics:
• 31 percent increase in EPS to a record $3.62;
• 16 percent sales growth to a record $1.78 billion (8 percent growth on a same-store basis);
• 32 percent increase in operating income to a record $207 million (25 percent increase on a same-store basis);
• 140 basis-point operating margin expansion to a record 11.6 percent (same-store operating margin of 11.8 percent);
• 29 percent gross profit increase to a record $483 million (20 percent increase on a same-store basis);
• 280 basis-point gross margin increase to a record 27.1 percent;
• 28 percent increase in SG&A expenses (17 percent increase on a same-store basis);
• 113 percent increase in operating cash flow to a record $238 million.
Sales trends (excluding acquisitions):
• 7 percent growth in HVAC equipment (69 percent of sales);
• 12 percent increase in other HVAC products (27 percent of sales);
• 27 percent increase in commercial refrigeration products (4 percent of sales).
Nine-Month Period Results
Key performance metrics:
• 50 percent increase in EPS to a record $8.75;
• 22 percent sales growth to a record $4.77 billion (17 percent growth on a same-store basis);
• 53 percent increase in operating income to a record $505 million (46 percent increase on a same-store basis);
• 210 basis-point operating margin expansion to a record 10.6 percent (same-store operating margin was 10.6 percent);
• 33 percent gross profit increase to a record $1.26 billion (27 percent growth on a same-store basis);
• 220 basis-point gross margin increase to a record 26.3 percent;
• 24 percent increase in SG&A expenses (17 percent increase on a same-store basis).
Sales trends (excluding acquisitions):
• 16 percent growth in HVAC equipment (69 percent of sales);
• 16 percent increase in other HVAC products (27 percent of sales);
• 28 percent increase in commercial refrigeration products (4 percent of sales).
Factors Impacting 2021 Performance
A number of unique factors are influencing the HVACR industry during 2021. Collectively, these factors present opportunities for Watsco to better serve customers and develop additional market share in a complex operating environment. The following summarizes the factors that have impacted 2021’s performance:
1. Pricing. Throughout 2021, HVACR manufacturers have experienced significant inflationary pressures and have raised prices accordingly. In turn, Watsco has raised its selling prices, resulting in higher year-to-date sales and enhanced profitability. The company actively monitors market conditions through a variety of processes and technologies and communicates with suppliers to sustain competitiveness and profitability.
During the first nine months of 2021, sales of residential HVAC equipment in U.S. markets (excluding acquisitions) increased 16 percent, including a 6 percent increase in average selling price.
2. Product availability. All OEMs and manufacturers have experienced some level of supply chain disruptions caused by component availability, labor shortages, transportation delays and other supply chain challenges, all of which have impacted typical lead times and overall availability of HVAC products.
While supply chain disruptions impacted third-quarter residential sales, Watsco nonetheless experienced growth in residential units during the quarter. This is all the more positive considering the strong third-quarter comparative performance experienced last year. More recently, product availability has improved and Watsco is encouraged by current volume trends and the OEMs ability to meet strong end-market demand.
3. Operating expenses. As a result of the supply chain disruptions, Watsco’s field leadership and front-line associates have done extraordinary things to service customers, which has resulted in higher personnel costs and other SG&A expense increases. For example, Watsco’s logistics costs increased 20 percent or $19 million (33 cents per share) during the nine-month period, reflecting higher-than-normal inventory movement across its network to meet customer demand.
The company expects this incremental cost to be temporary headwind and moderate in 2022 as the supply chain normalizes.
4. Technology investments. Watsco continues to invest in its transformative technologies, especially as it relates to increasing customer adoption and gaining market share. Headcount dedicated to technology increased by 20 percent compared to a year ago and overall spending has increased $5 million in 2021 (10 cents per share). Technology spending was $41 million over the 12 months ending Sept. 30, 2021.
5. People investments. In response to strong demand and consistent with its long-term focus, Watsco added more than 450 employees since a year ago in support of defined growth initiatives, including staffing 20 new locations.
In addition, Watsco’s culture to reward performance through a number of pay-for-performance programs has resulted in a $36 million increase in performance-based compensation (65 cent EPS impact for the nine-month period ended Sept. 30, 2021).
“We believe we have delivered extraordinary performance under extraordinary circumstances thus far in 2021,” Nahmad added. “Despite the unprecedented operating environment, our teams continue to focus on their first priority, serving customers, and we will continue to make investments to enable growth, competitiveness and to build the industry’s most innovative technologies.”
Cash Flow and Dividends
Watsco’s operating cash flow for the quarter increased 113 percent to a record $238 million. For the nine-month period ended Sept. 30, 2021, operating cash flow was $320 million versus $373 million in 2020, reflecting investments in working capital consistent with sales growth. The company has targeted operating cash flow to exceed net income in 2021. Since 2016, operating cash flow was approximately $1.9 billion versus net income of $1.8 billion, surpassing the company’s goal.
Watsco has paid cash dividends to shareholders for 47 consecutive years. The company’s philosophy is to share increasing amounts of cash flow through higher dividends while maintaining a conservative financial position with continued capacity to build its distribution network. Effective April 2021, Watsco increased its annual dividend rate by 10 percent to $7.80 per share.
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