Watsco, Inc. — Q1 2023 Form 10-Q
Reporting period: Quarter ended March 31, 2023. Unaudited consolidated results. Watsco distributes HVAC/R equipment, parts and supplies; it operated 673 locations across the U.S., Canada, Mexico and Puerto Rico at quarter-end.
Financial performance
| Metric | Q1 2023 | Q1 2022 | Change |
|---|---|---|---|
| Revenue | $1,550.6 million | $1,523.6 million | +2% |
| Gross profit / margin | $448.2 million / 28.9% | $450.4 million / 29.6% | Profit down $2.2 million; margin down 70 bps |
| Operating income / margin | $164.7 million / 10.6% | $171.0 million / 11.2% | Income down $6.3 million |
| Net income attributable to Watsco | $110.1 million | $113.3 million | Down 3% |
| Diluted EPS | $2.83 | $2.90 | Down $0.07 |
| Operating cash flow | $(47.4) million | $(101.6) million | Cash use improved $54.2 million |
SG&A was $287.1 million, up 1%, and declined slightly as a share of revenue to 18.5% from 18.6%. Net interest expense was $0.6 million. The effective tax rate was 23.3%, versus 23.8%.
Cash, liquidity and debt
- Cash and cash equivalents were $141.0 million at March 31, 2023, down from $147.5 million at year-end; $123.2 million was held by foreign subsidiaries.
- Working capital was $1,644.7 million, compared with $1,392.2 million at December 31, 2022. Inventory rose to $1,614.3 million from $1,370.2 million, reflecting seasonal buildup, the efficiency-standard transition, supply conditions and inflation.
- Watsco had $197.6 million outstanding on its revolving facility, classified as long-term, and $92.5 million of current long-term obligations. It replaced its prior facility with a new unsecured, five-year, $600 million multicurrency revolver maturing March 16, 2028. Management said it was in compliance with covenants.
- Financing activities provided $51.3 million; investing activities used $10.4 million, including $3.0 million net cash for an acquisition. Cash dividends paid were $95.0 million, or $2.45 per share.
Changes, commentary and risks
- Same-store sales increased 2%. HVAC equipment sales rose 2% overall: residential products declined 3%, while commercial HVAC equipment increased 23%. Commercial refrigeration sales rose 12%; other HVAC products declined 2%.
- Management attributed the 70-basis-point gross-margin decline primarily to a smaller benefit from supplier pricing actions than in the prior-year quarter. Lower gross profit, higher SG&A and lower equity-method income drove the earnings decline, partly offset by lower taxes and non-controlling interest.
- Supply-chain disruption, component availability, labor and transportation constraints, and the transition to higher-efficiency products affected the ability to meet contractor demand. Management estimated approximately 3% of potential Q1 revenue was lost; future effects were not reasonably estimable.
- On March 3, Watsco acquired Capitol District Supply, a New York distributor with approximately $13 million in annual sales and three locations. Consideration included $1.3 million cash, net of cash acquired, and $1.9 million to repay indebtedness; the acquisition’s pro forma effect was not significant.
- Carrier and affiliates accounted for 62% of inventory purchases, versus 56% a year earlier; approximately $205 million was payable to them, net of receivables, at quarter-end. Management stated these transactions were on arm’s-length terms.
- Watsco’s 38.1% investment in Russell Sigler generated $3.6 million of other income. Under a shareholders’ agreement, the estimated contingent purchase obligation for additional RSI shares was approximately $356 million at quarter-end.
- Sales are seasonal, with residential air-conditioning replacement demand typically strongest in Q2 and Q3; weather, housing activity, inflation, interest rates, supplier concentration, regulation, currency and liquidity are among the stated risk factors. No specific full-year financial guidance is provided in this filing.
- Management said known litigation is not expected to materially adversely affect financial condition or results, based on information available; actual outcomes remain uncertain. The filing reported effective disclosure controls and no material change in internal control over financial reporting.
Key facts for investors to verify
- Whether HVAC/R supply constraints and the estimated 3% revenue impact ease or worsen, and whether the inventory buildup converts into sales without margin pressure.
- Revenue mix and demand trends, especially residential unit volumes, commercial HVAC growth, and the effect of the 2023 efficiency-standard transition.
- Gross-margin direction and the extent to which supplier pricing, product mix and competitive conditions affect profitability.
- Working-capital needs and seasonal cash conversion, including inventory levels, receivables and availability under the new revolving facility.
- Carrier purchase concentration and the potential size, timing and financing implications of the contingent RSI share-purchase obligation.