Watsco, Inc. — Q1 2015 Form 10-Q
Reporting period: Quarter ended March 31, 2015. Watsco distributes HVAC/R equipment, parts and supplies through 569 locations. Results are seasonal: residential air-conditioning replacement demand is generally strongest in the second and third quarters, and weather can materially affect sales.
Financial performance
Unless noted otherwise, dollar amounts are in millions; statements report amounts in thousands.
| Metric | Q1 2015 | Q1 2014 | Change |
|---|---|---|---|
| Revenue | $809.0 | $762.6 | +6% |
| Gross profit / margin | $204.2 / 25.2% | $188.1 / 24.7% | +9%; margin +0.5 pts |
| Operating income / margin | $47.0 / 5.8% | $35.6 / 4.7% | +32% |
| Net income attributable to Watsco | $23.0 | $16.8 | +38% |
| Diluted EPS | $0.65 | $0.48 | +$0.17 |
| Net cash from operating activities | $(16.8) | $24.9 | $(41.7) |
Same-store revenue grew 7%, led by an 8% increase in HVAC equipment sales, including 8% growth in residential and 11% in commercial equipment. Other HVAC products rose 2% and commercial refrigeration rose 5%. Management attributed growth primarily to strong residential replacement demand and a higher-efficiency product mix.
SG&A rose 3% to $157.2 million, slower than revenue growth, and declined to 19.4% of revenue from 20.0%, reflecting fixed-cost leverage. Net interest expense increased 36% to $1.4 million, primarily because average borrowings were higher. The effective tax rate attributable to Watsco was 37.5%, versus 37.0%.
Cash, liquidity and debt
- Cash and equivalents were $16.3 million at March 31, 2015, down from $24.4 million at year-end; $10.9 million was held by foreign subsidiaries.
- Operating cash use was $16.8 million, principally reflecting seasonal inventory investment and working-capital timing. Inventory was $800.9 million, up from $678.0 million at December 31, 2014.
- Working capital was $917.2 million, compared with $870.3 million at year-end. Capital expenditures were $3.1 million.
- Revolver borrowings were $340.7 million, up from $303.2 million. The unsecured facility provides up to $600 million and matures July 1, 2019; Watsco reported covenant compliance.
- Dividends paid were $0.70 per share, compared with $0.40 a year earlier. The board declared another $0.70 quarterly dividend on April 1, payable April 30.
Material changes, outlook and risks
- Revenue increased 6% overall; same-store growth was 7%. The company also benefited from its July 2014 purchase of an additional 10% interest in Carrier Enterprise I, which reduced the share of earnings attributable to noncontrolling interests.
- Other comprehensive loss was $18.4 million, mainly from a $19.9 million foreign-currency translation loss. This reduced Watsco shareholders’ equity through accumulated other comprehensive loss.
- Management said cash on hand, operating cash flows and available revolver capacity should meet foreseeable liquidity needs, while cautioning that funding sufficiency and access to credit are not assured. No quantitative earnings or revenue guidance was provided; Q1 results are not necessarily indicative of full-year results.
- Key risks include seasonality and weather, economic and construction conditions, competition, supplier concentration, commodity costs, access to liquidity, interest and foreign-exchange rates, insurance, regulation and cybersecurity. Carrier and affiliates represented 58% of inventory purchases in Q1 2015, versus 61% in Q1 2014; net amounts payable to them were approximately $85 million at quarter-end.
- Watsco reported ordinary-course litigation and stated that known claims are not expected to materially affect its financial condition or results. Self-insurance reserves were $4.9 million; adverse claims development could require additional reserves.
Important facts for investors to verify
- Whether seasonal inventory investment converts to operating cash as the peak selling season progresses.
- Revenue, gross-margin and same-store trends, including the contribution from higher-efficiency products and Carrier joint ventures.
- Revolver utilization, covenant headroom, borrowing costs and liquidity available under the $600 million facility.
- Carrier supplier dependence and the financial effect of currency movements, including the reported translation loss and outstanding currency hedges.
- Future dividend sustainability and any changes in demand, weather, claims or other risks that could affect full-year results.