Watsco Inc.

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Watsco Inc.

2665 South Bayshore Drive, Suite 901
Coconut Grove, Florida 33133
U.S.A.
Telephone: (305) 714-4100
Fax: (305) 858-4492
Web site: http://www.watsco.com

Public Company
Incorporated: 1956
Employees: 2,700
Sales: $1.24 billion (2001)
Stock Exchanges: New York
Ticker Symbol: WSO
NAIC: 421730 Warm Air Heating and Air-Conditioning Equipment and Supplies Wholesalers; 561320 Temporary Help Services

Watsco Inc. is the nation’s leading distributor of air conditioning, heating, and refrigeration equipment, the largest player in a fragmented industry. The company wholesales various brands of heating and cooling equipment to more than 35,000 contractors across the country and in Puerto Rico. Watsco also sells parts and equipment to the refrigeration market, including compressors, evaporators, valves, coolers, and ice machines. Watsco’s subsidiary Dunhill Staffing operates in an entirely different business segment, providing temporary personnel placement. Watsco expanded enormously through acquisitions, especially in the 1980s, when it grew from a Florida supplier into a dominant force in the Sunbelt region. Its three largest markets are Florida, California, and Texas, where air conditioning is standard for most housing. Much of the company’s growth came not from new housing but from replacement service as air conditioning units installed during housing booms in the 1970s and early 1980s reached obsolescence ten or 20 years later. Albert Nahmad has run Watsco since 1973. He and Director David Fleeman own approximately 50 percent of the company.

A Small Player Through the 1970s

Watsco Inc. was incorporated in Florida in 1956 and began selling shares to the public in 1962. In 1968 it was first listed on the American Stock Exchange, and the company began making acquisitions. Watsco’s prime business was manufacturing heating and cooling equipment and door and window parts, with headquarters in Hialeah. After 1969, Watsco bought up a slew of smaller companies in different industries and scattered locations. Watsco merged with Sun Engineering in 1969, and in 1971 spent $217,000 to pick up Chicago-based Wabash Corp. and Kesco Products of New York. The company acquired another manufacturing plant in 1973, Allin Manufacturing, and the next year snapped up Mumma Tool & Die Company. In 1977 Watsco paid Clairol, Inc. $275,000 for its Sybil Ives line of hair care products. Watsco ran a Professional Hair Care division, consisting of Sybil Ives and another manufacturing unit, until 1982. Annual revenues through the early 1970s were from $3 million to $4 million. In a profile on Watsco in Florida Trend magazine (October 1992), the company’s sales and earnings throughout the 1970s were characterized as “unspectacular.” The company in many ways fit the model of the corporate conglomerate that dominated that era, with operations spread across several market segments—hair care and air conditioning could hardly be more different—with disparate plants from Florida to Los Angeles.

The company came under the control of a new leader in 1973, Albert H. Nahmad. He became chairman, president, and chief executive officer in December of that year, and eventually he took the company in a new direction. Nahmad had a background both in business and in engineering. He earned a bachelor of science degree in mechanical engineering from the University of New Mexico, followed by a master’s degree in industrial management from Purdue University. He then worked for several years for the chemical and packaging conglomerate W.R. Grace, and for the accounting firm Arthur Young & Co. (later Ernst & Young). For several years after Nahmad’s ascendancy at Watsco, things did not look too different. The company continued to pick up smaller firms, including Del Mar Engineering Co. in 1977 and Cam-Stat Inc. of Los Angeles in 1981. The company divested its Professional Hair Care division in 1982. It made $540,000 on the sale, nearly twice what it had paid for the Clairol division five years earlier. In addition, Nahmad made several moves to somewhat consolidate Watsco. In 1982 Watsco’s Los Angeles-based subsidiary Del Mar moved its base to Hialeah, where it became part of Watsco’s Production Enterprises division. The next year another California subsidiary, Cam-Stat, also moved to Hialeah, so that Watsco’s operations were not so far-flung. The company also made a significant investment in 1982, buying up an 8.5 percent interest in Florida Commercial Banks, Inc. for slightly more than $3 million. Two years later Watsco sold its interest in the bank for more than $8.5 million.

Beginning to Move in the 1980s

By the mid-1980s, Watsco’s revenue had grown to about $15 million. Watsco’s air conditioning business was apparently doing well. Florida had seen a boom in housing in the 1970s as many people migrated to the state, and Watsco continued to thrive even as the boom flattened because it sold replacement parts. Air conditioners, used almost year-round in Florida, usually wore out after about ten years, so the replacement cycle was in full swing in the 1980s even as new home construction slowed. By 1986, Chairman Nahmad was anxious to expand Watsco, which was flush with cash. Nahmad made it known that he was looking for acquisitions, and even took out an advertisement in the Wall Street Journal asking people with companies to sell to contact him. The company soon settled on its Sun Belt strategy, growing by acquisition of heating and cooling distribution companies in southern California, Arizona, Nevada, and other warm-weather areas. But first Watsco took an unexpected step. Its first major acquisition of the mid-1980s was not related to its core business any more than hair care had been. In 1988 Watsco put down approximately $2.5 million for a temporary staffing firm called Dunhill Staffing Systems, Inc. Dunhill had revenue of roughly $21 million annually, and temporary employment was expected to be a high-growth business. Nahmad first announced that he would spin off the division for a profit within a few years, but Dunhill continued to be a part of Watsco through late 2002.

The real key to Watsco’s growth came the next year, when Watsco greatly increased its market share in the air conditioning distribution business with two other acquisitions. By 1988, Watsco’s revenue had risen to about $22 million, and it was still focused mainly on manufacturing parts for the heating and cooling industry in Florida. Watsco bought 80 percent of one of Florida’s largest residential air conditioning distributors, Gemaire Distributors, Inc., for $17 million. The other 20 percent of the company was held by Rheem, an air conditioner manufacturer that occupied the number two spot in the industry. Three months after picking up the majority of Gemaire, Watsco bought 80 percent of another distributor, the Harry Alter Co. Watsco had held slightly more than 10 percent of the air conditioning distribution market in Florida in 1988. With the addition of its new subsidiaries, Watsco soon had about 16 percent of the Florida market. In 1990, Watsco followed this up by buying a 50 percent interest in the largest residential air conditioner distribution company in California and Arizona. This was Heating and Cooling Supply, Inc., a privately held firm. Watsco had planned to buy 80 percent of Heating and Cooling, raising money through a special stock offering. Iraq’s invasion of Kuwait and the possibility of war in the Persian Gulf flattened the stock market, making Watsco’s stock offering a bad bet, and the company withdrew it. Instead Watsco settled for a smaller piece of Heating and Cooling, paying $31.4 million. Rheem again bought the other half. But the acquisition allowed Watsco to double its share of the distribution market in southern California and Arizona, and company revenues shot up. By 1991 Watsco was bringing in $169 million, up from $22 million just three years earlier.

Steady Growth in the 1990s

An interesting fact in Watsco’s surge of growth was that the country was in recession and housing was in a downswing in Florida and California. New building starts were down, and yet Watsco thrived by selling parts and distributing equipment to contractors for replacement jobs. In Florida, air conditioners lasted about ten years, and in California, where the machines were generally on only half the year, they typically lasted 20. The early 1990s coincided with peak need for air conditioner replacement in both states, following earlier growth in housing. Watsco also grew by moving into new markets. It opened a branch of Heating and Cooling Supply in Las Vegas in 1991, expecting vigorous housing growth there. Watsco also began exploring the distribution business in Latin America. The company got a surge of business in the wake of Hurricane Andrew as well. The hurricane devastated southern Florida in August 1992, and some 90,000 homes were damaged or destroyed. The rebuilding effort required tens of thousands of new air conditioners.

As Watsco’s distribution business took off, its manufacturing business also prospered. By 1993 about three quarters of the company’s revenue came from distribution. The manufacturing side of the business had not kept up, and yet it remained strong and profitable. Besides making replacement parts, Watsco began manufacturing electronic temperature controls, which it sold to other heating and cooling manufacturers. These had a profit margin of nearly 40 percent, about twice the margin of the distribution business. Watsco also began making a new product in 1992, which it called the Flash. The Flash was a machine that captured and filtered chlorofluorocarbons (CFCs), the coolant commonly used in air conditioners and refrigerators. The Flash was manufactured by a Watsco subsidiary in Hialeah, and it was important because the Clean Air Act enacted in July 1992 prohibited the release of CFCs into the air. The Flash made it possible for air conditioning repairers to recycle CFCs, in compliance with the law. With this new product, Watsco hoped that its manufacturing business would equal the distribution side by the end of the decade.

Company Perspectives:

The most critical factor contributing to Watsco’s successful track record of profitable growth has been its commitment to service and this commitment will become increasingly important in the future. Effective service at the distribution level contributes to the contractor customer’s productivity, profitability and long-term success.

But it was the distribution business that continued to lead the way through the 1990s. The industry was still fairly fragmented, made up of many small players, and Watsco had many opportunities to expand by acquisition. ‘There’s no one out there consolidating in the industry except us,” CEO Nahmad told the Wall Street Journal (June 20, 1994). In that interview Nahmad also announced that Watsco’s profit for 1994 was expected to go up by about 20 percent. The company moved to the more prestigious New York Stock Exchange that year. In 1996 Watsco bought out Rheem’s minority interest in the subsidiaries they had controlled together, Gemaire, Heating & Cooling Supply, and Comfort Supply, a 1993 acquisition that they had split 80/20. These all became wholly owned subsidiaries of Watsco. The company also bought Three States Supply Company that year, as well as a North Carolina distributor called Central Air Conditioning Distributors, Inc. Then in early 1997 Watsco paid approximately $22 million for Coastline Distribution, Inc. and four manufacturing plants, all owned by Inter-City Products Corporation. Inter-City was one of the nation’s largest manufacturers of heating and cooling equipment, with several major brands, including Comfortmaker and Arcoaire. It had 25 branches of its Coastline Distribution business, spread through Florida, Georgia, Alabama, the Carolinas, the Washington, D.C. area, and parts of southern California. The addition of Coastline brought the number of Watsco distribution outlets up to 116. Within a few months, Watsco announced that it was buying two distribution operations from the air conditioner maker Carrier Corporation. This was the company’s 15th acquisition in the heating and cooling equipment distribution business since 1989, and it brought the number of Watsco’s distribution branches up to 133.

With the distribution business growing so quickly, Watsco decided to sell off most of its manufacturing business in 1998. Its nondistribution business by that time contributed less than 8 percent of Watsco’s total revenue. It sold its manufacturing subsidiary Watsco Components Inc. that year to International Comfort Products Corporation. Watsco continued to snap up smaller distributors, in 1998 buying a Georgia firm that distributed heaters and air conditioners to the mobile home industry. Kaufman Supply had annual revenue of more than $100 million, and looked to have a lucrative niche in the thriving mobile home market in the Southeast.

By the late 1990s, Watsco had become a billion-dollar company. It had made significant inroads into the heating and cooling distribution markets in key Sunbelt states. In 1999, the company announced that it was ready to move into New England, which was new territory for Watsco. New England was served by some 40 different distributors, and the total market for heating and cooling, including parts and supplies, was estimated to be worth more than $400 million. Watsco bought up two major Northeast distributors, Homans Associates, Inc. and Heat, Inc. in 1999, and declared that it was actively looking for more acquisitions in the area. Watsco had more than 300 distribution outlets after it added Homan and Heat. The company finished 1999 with record growth. Revenue grew 17 percent, to $1.25 billion. Watsco was by now the largest independent distributor of residential heating and cooling equipment in the country. It continued its push into the Northeast in 2000 with the purchase of Anderson Sales Corporation, based in Farmingdale, New York. Anderson had annual revenues of around $40 million, with five distribution branches in New York and New Jersey.

By 2000, Watsco seemed to be entering another mode, concentrating on increasing efficiency and profitability in its existing operations instead of focusing on growth through acquisition. The company reported sales of $1.3 billion, up slightly from the previous year. Watsco began closing several dozen branches in 2000, and it closed more in 2001. It also announced that it would eliminate some product lines that were not selling well or had poor profit margins. The company looked for other ways to cut costs, too. It restructured the unit it had bought from Kaufman Supply, which sold heating and cooling to mobile homes and other manufactured housing. This market had declined more than 20 percent in 2000, and Watsco laid off workers and revamped the business in anticipation of a recovery some time later. Watsco also invested in new technology in the early 2000s, introducing an online service providing heating and cooling contractors 24-hour access to Watsco’s distribution network. Revenue for 2001 shrank slightly. Yet Watsco still seemed to see opportunities for future growth in the distribution market. Company analysts perceived the distribution industry as undercapitalized and fragmented, suggesting there was still a place for a well-heeled consolidator.

Principal Subsidiaries

A&C Distributors, Inc.; ACDoctor.com Inc.; Air Supply, Inc.; Air Systems Distributors, Inc.; Atlantic Service & Supply, Inc.; CAD Watsco, Inc.; Baker Distributing Co.; Central Air Conditioning Distributors, Inc.; Coastline Distribution, Inc.; Cooling Holding, Inc.; Comfort Supply, Inc.; CP Distributors, Inc.; Gemaire Distributors, Inc.; GMC Distributors, Inc.; H.B. Adams Distributors, Inc.; Heat Incorporated; Heating & Cooling Supply, Inc.; Homans Associates, Inc.; NSI Supply, Inc.; Three States Supply Co. Inc.; Weathertrol Supply Co.; William Wurzbach Co., Inc.; Dunhill Staffing Systems, Inc.; Dunhill Temporary Systems, Inc.