Watsco, Inc. — Q1 2014 Form 10-Q
Reporting period: Quarter ended March 31, 2014. Unaudited results; amounts below are in U.S. dollars. Watsco distributes air conditioning, heating and refrigeration equipment and related products, operating 568 locations across the U.S., Canada, Mexico and Puerto Rico. Sales are seasonal, with residential air-conditioning demand typically peaking in the second and third quarters.
Financial performance
| Metric | Q1 2014 | Q1 2013 | Change |
|---|---|---|---|
| Revenue | $762.6 million | $713.6 million | Up 7% |
| Gross profit / margin | $188.1 million / 24.7% | $175.4 million / 24.6% | Profit up 7%; margin up 0.1 percentage point |
| Operating income / margin | $35.6 million / 4.7% | $30.6 million / 4.3% | Income up 16% |
| Net income | $24.4 million | $21.1 million | Up 16% |
| Net income attributable to Watsco | $16.8 million | $13.4 million | Up 25% |
| Basic and diluted EPS | $0.48 | $0.39 | Up 23% |
| Net cash from operating activities | $24.9 million | $(17.5) million | Improved $42.4 million |
Same-store revenue increased 7%, led by an 8% rise in HVAC equipment sales; other HVAC products rose 5% and commercial refrigeration rose 2%. SG&A increased 5% in dollars but declined to 20.0% of revenue from 20.3%, reflecting improved fixed-cost leverage. Net interest expense fell 15% to $1.0 million. The effective tax rate attributable to Watsco was 37.0%, compared with 36.75% a year earlier.
Liquidity, debt and cash flow
- Cash and cash equivalents were $19.5 million at March 31, 2014, including $16.3 million held by foreign subsidiaries. Working capital was $786.0 million, versus $777.6 million at year-end 2013.
- Borrowings under the $500 million unsecured revolving credit facility were $226.7 million, down from $230.0 million at December 31, 2013. The facility matures July 1, 2018; Watsco reported compliance with its covenants.
- Operating cash flow benefited from higher net income and payment timing for accrued expenses, partly offset by the seasonal inventory build. Inventory increased to $707.8 million from $583.2 million at year-end.
- Investing cash use was $1.7 million, mainly capital expenditures. Financing cash use was $23.1 million, including $13.9 million in dividends and $7.6 million in distributions to noncontrolling interests. Cash ended the quarter at $19.5 million.
Material changes, outlook and risks
- Management attributed sales growth primarily to strong residential HVAC demand. It cautioned that quarterly results are not necessarily indicative of full-year performance because of seasonal demand and weather sensitivity.
- Watsco intended to exercise its July 2014 option to acquire an additional 10% of Carrier Enterprise I, increasing its ownership to 80%. The purchase price is formula-based and was not stated; management expected to fund it with available credit capacity.
- The quarterly dividend increased from $0.40 to $0.60 per share, with the higher rate expected to apply to the July 2014 payment. Future dividends remain subject to board discretion.
- Carrier and affiliates supplied 61% of inventory purchases, up from 55% in Q1 2013; approximately $126 million was payable to them, net of receivables, at quarter-end. This concentration is a material supplier dependency.
- Foreign currency translation loss was $9.2 million, compared with $2.9 million in Q1 2013, reducing comprehensive income. Watsco uses foreign-exchange forwards as economic hedges; outstanding contracts had a $52.5 million notional value and expired through July 2014.
- Risks highlighted include supplier concentration, competition, commodity costs, economic and housing activity, weather and seasonality, liquidity and credit-market access, foreign exchange, regulation, and insurance exposure. Watsco said known litigation was not expected to materially affect financial condition or results, while noting outcomes cannot be predicted with certainty.
- Management believed operating cash flow, cash on hand and available revolving-credit funds would meet foreseeable liquidity needs, but gave no quantified earnings or revenue guidance. Disclosure controls were deemed effective; no material change in internal control was reported.
Important facts for investors to verify
- Whether the planned additional Carrier Enterprise I stake purchase was completed, and its final price and financing.
- Whether seasonal inventory converts to sales and cash during the peak selling period, and whether operating cash flow remains positive.
- How Carrier-related supply concentration and amounts payable evolve, and whether the higher dividend is supported by cash generation.
- The effects of weather, residential HVAC demand and foreign-exchange movements on subsequent results and margins.
- Any developments in litigation, self-insurance reserves or revolving-credit covenant headroom.