Watsco, Inc. — Q2 2023 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2023. Financial statements are unaudited. Watsco distributes HVAC/R equipment, parts and supplies across 673 locations in the U.S., Canada, Mexico and Puerto Rico, with export markets in Latin America and the Caribbean. Amounts below are in millions of dollars except per-share data.
Financial results
| Metric | Q2 2023 | Q2 2022 | First half 2023 | First half 2022 |
|---|---|---|---|---|
| Revenue | $2,003.1 | $2,133.8 | $3,553.7 | $3,657.3 |
| Gross profit / margin | $562.6 / 28.1% | $595.5 / 27.9% | $1,010.8 / 28.4% | $1,045.9 / 28.6% |
| Operating income / margin | $265.7 / 13.3% | $287.1 / 13.5% | $430.4 / 12.1% | $458.1 / 12.5% |
| Net income attributable to Watsco | $172.8 | $192.6 | $282.8 | $305.9 |
| Diluted EPS | $4.42 | $4.93 | $7.25 | $7.83 |
| Net interest expense | $3.4 | $1.1 | $4.0 | $1.7 |
- Q2 revenue declined 6%, same-store sales fell 6%, and Watsco-attributable net income decreased 10%. First-half revenue declined 3% and attributable net income decreased 8%.
- Q2 gross margin improved 20 basis points, which management attributed primarily to the timing of price increases. First-half gross margin declined 20 basis points, reflecting less beneficial supplier pricing actions. SG&A was lower in dollars but higher as a share of sales: 15.2% versus 14.8% in Q2 and 16.6% versus 16.4% for the first half.
- Residential HVAC equipment sales weakened: Q2 residential products decreased 12%, while commercial HVAC equipment sales rose 18%. For the first half, residential products decreased 9% and commercial HVAC equipment increased 21%.
Cash flow, balance sheet and debt
- First-half operating cash flow was a use of $89.2 million, versus a source of $73.1 million in 2022. Management cited payment timing to vendors and lower net income; receivables and inventory increases also used cash.
- Investing cash use was $17.6 million, including $15.8 million of capital expenditures. Financing provided $120.5 million, including $342.9 million of net revolver proceeds, partly offset by $190.4 million of dividends and repayments under the prior facility.
- At June 30, cash was $162.5 million, current assets $2,882.6 million and current liabilities $956.0 million; reported working capital was $1,926.6 million. Inventory was $1,689.3 million. Cash included $116.2 million held by foreign subsidiaries.
- Revolver borrowings were $342.9 million, compared with $56.4 million under the prior facility at year-end 2022. Current long-term obligations were $93.1 million; long-term obligations totaled $601.8 million, including the revolver and lease liabilities.
- In March, Watsco replaced its prior facility with a five-year, unsecured $600 million multicurrency revolver maturing in March 2028. The company said it was in compliance with covenants. It reported $3.4 million of Q2 and $4.0 million of first-half net interest expense.
- Cash dividends paid were $4.90 per share in the first half, versus $4.15 in 2022. A $2.45-per-share quarterly dividend declared in July was paid July 31.
Management commentary, outlook and risks
- Management estimated that constrained inventory availability, including temporary production and availability delays at a primary OEM partner, reduced revenue by approximately 4% in both Q2 and the first half. Supply constraints, component availability, labor and logistics challenges, and the transition to higher-efficiency products remain relevant.
- The filing provides no numerical full-year revenue or earnings guidance. Management said operating cash flow, cash, revolver availability and potential ATM proceeds should meet liquidity needs for the foreseeable future, while noting there is no assurance available funds will be sufficient.
- Sales are seasonal, with residential air-conditioning replacement demand typically strongest in Q2 and Q3; weather can affect demand and profitability. Other stated risks include economic conditions, supplier concentration, commodity costs, housing and construction activity, inflation, interest rates, foreign exchange, regulation, cybersecurity and liquidity access.
- Carrier and affiliates accounted for 65% of inventory purchases in the first half, and approximately $214 million was payable to them at June 30, net of receivables. This is a significant supplier concentration.
- In July, Watsco and Carrier Enterprise I agreed to allow, at their discretion, up to 80% of certain purchases of RSI shares from majority holders to be funded with Watsco common stock; sales to Carrier Enterprise I are capped at $125 million in any rolling 12-month period. No such shares had been issued as of the filing. The filing valued the RSI shareholders’ shares at approximately $374 million under the agreement’s criteria.
- Also in July, Watsco agreed to acquire the assets of an HVAC distributor for $95 million, subject to adjustment, payable in Watsco shares. Closing conditions remain outstanding; the filing estimated approximately 264,256 shares using the August 2 closing price.
- The March acquisition of Capitol District Supply was small relative to Watsco, with annual sales of approximately $13 million; consideration included $1.3 million cash, net of cash acquired, and $1.8 million of debt repayment. Litigation is described as incidental, and management did not expect known matters to materially adversely affect results or financial condition.
Most important facts for investors to verify
- Whether HVAC/R supply constraints ease, and whether the estimated 4% revenue impact persists or changes.
- How seasonal working-capital needs, inventory levels and vendor payment timing affect operating cash flow and revolver borrowings.
- Residential demand and unit trends, particularly alongside commercial HVAC growth and pricing effects on margins.
- Carrier supplier concentration, associated payables and any changes to supply arrangements.
- Whether the RSI share-purchase provisions or announced stock-funded acquisition proceed, and their eventual cash, dilution and financing effects.
- Interest-rate exposure, covenant compliance and the availability and terms of liquidity as borrowing needs change.