Watsco, Inc. — Q1 2020 Form 10-Q
Business context and reporting period
Quarter ended March 31, 2020; unaudited results. Watsco is a North American HVAC/R distributor operating 603 locations. The business is seasonal, with residential air-conditioning demand typically strongest in the second and third quarters. Comparisons are affected by acquisitions completed in 2019.
Financial performance and liquidity
Amounts below are in millions of dollars, except per-share data; figures are rounded.
| Metric | Q1 2020 | Q1 2019 | Change |
|---|---|---|---|
| Revenue | $1,008.2 | $931.3 | +8% |
| Gross profit / margin | $247.6 / 24.6% | $233.8 / 25.1% | +6% / -50 bps |
| Operating income / margin | $45.2 / 4.5% | $55.1 / 5.9% | -18% |
| Net income attributable to Watsco | $30.5 | $35.0 | -13% |
| Diluted EPS | $0.72 | $0.88 | -18% |
| Cash provided by operations | $41.9 | $52.9 | -$11.0 |
At March 31, cash was $51.2 million and revolving-credit borrowings were $156.1 million. Working capital was $1,069.9 million. The company reported total current assets of $1,590.4 million and current liabilities of $520.5 million. The revolving facility capacity was increased from $500 million to $560 million on April 10; it matures in December 2023. Watsco reported compliance with its covenants. Operating cash flow declined mainly due to higher receivables, timing of collections, and lower net income, partly offset by a smaller seasonal inventory build. Capital expenditures were $3.9 million; dividends paid were $61.2 million.
Material changes versus the prior comparable period
- Revenue rose $76.9 million. Acquired locations contributed $61.0 million; same-store revenue increased 2%.
- Gross margin contracted primarily because supplier pricing benefits were lower and competition remained strong.
- SG&A increased 13% to $203.4 million, largely due to acquired locations; SG&A rose to 20.2% of revenue from 19.3%.
- Net income attributable to Watsco fell mainly because of higher SG&A, partly offset by higher revenue, lower taxes, and lower income attributable to non-controlling interests.
- Foreign-currency translation contributed to a $19.3 million other comprehensive loss, versus $4.2 million of other comprehensive income in Q1 2019.
Outlook, risks, contingencies, and unusual items
Management provided no quantified earnings or revenue guidance. It said COVID-19’s eventual financial impact could be material and could not be reasonably estimated. At filing, all locations were operating, but public branch access was restricted; some locations had experienced short closures or reduced capacity. Potential disruptions include supplier production and delivery, staffing, customer operations and payments, and shifts toward repairs, lower-priced equipment, and weaker new-construction or commercial demand. Watsco cited cost-control measures, including compensation reductions, rent abatements, vendor-term changes, and reduced discretionary spending, and said its cash, borrowing capacity, and operating cash flows were expected to meet foreseeable liquidity needs.
The board declared a $1.775-per-share quarterly dividend on April 1, 2020, paid April 30; future dividends remain at the board’s discretion. Carrier accounted for 57% of inventory purchases in Q1 2020, down from 61% a year earlier. Watsco estimated a contingent purchase obligation of approximately $142 million related to potential purchases of additional RSI ownership interests. Management said known litigation was not expected to materially affect financial condition or results. Carrier became an independent public company on April 3, 2020.
Important facts for investors to verify
- How COVID-19 affected subsequent-quarter sales, gross margin, collections, supplier availability, and branch operations.
- Whether the 2% same-store revenue growth and margin decline persisted after Q1, separating organic trends from acquisitions.
- Cash conversion and seasonal working-capital needs, particularly receivables and inventory, and available capacity under the expanded credit facility.
- The sustainability of the dividend and the potential funding and timing of the contingent RSI ownership purchase.
- Ongoing exposure to Carrier as a major inventory supplier and the effect of currency movements on earnings and equity.