Watsco, Inc. — Q1 2019 Form 10-Q
Reporting period: Quarter ended March 31, 2019; unaudited, compared with Q1 2018. Watsco distributes HVAC/R equipment, parts and supplies and operated 575 locations across the U.S., Canada, Mexico and Puerto Rico. Results are seasonal and can be affected by weather; residential replacement demand is generally strongest in the second and third quarters.
Financial performance
| Metric | Q1 2019 | Q1 2018 | Change |
|---|---|---|---|
| Revenue | $931.3 million | $926.6 million | Up 0.5% |
| Gross profit / margin | $233.8 million / 25.1% | $230.8 million / 24.9% | Margin up 20 bps |
| Operating income / margin | $55.1 million / 5.9% | $53.9 million / 5.8% | Up 2.2% |
| Net income attributable to Watsco | $35.0 million | $34.2 million | Up 2.4% |
| Diluted EPS | $0.88 | $0.89 | Down $0.01 |
| Operating cash flow | $52.9 million | $(41.6) million | Improved $94.5 million |
| Capital expenditures | $4.1 million | $3.5 million | Up $0.6 million |
Revenue increased $4.7 million. Same-store revenue rose $3.3 million: HVAC equipment sales increased 2%, while other HVAC products declined 2% and commercial refrigeration declined 4%. HVAC equipment growth reflected price increases and a higher mix of high-efficiency systems, partly offset by a 1% volume decline. Management attributed improved gross margin primarily to stronger HVAC equipment selling margins. SG&A increased 1% in dollars but remained 19.3% of revenue. The effective tax rate attributable to Watsco declined to 22.7% from 23.8%, primarily due to higher share-based payment deductions.
Balance sheet, debt and liquidity
- Cash was $77.3 million at March 31, 2019, including $67.2 million held by foreign subsidiaries. Cash decreased $5.6 million during the quarter.
- Working capital was $1,020.6 million, down from $1,084.2 million at year-end; management said the decrease primarily reflected current lease liabilities recognized upon adoption of the new lease standard.
- Borrowings were $137.5 million under the $500 million unsecured revolving credit facility and $2.3 million under a Mexican short-term line. The revolver matures December 2023; management reported compliance with its covenants.
- The balance sheet recorded $183.3 million of operating lease right-of-use assets and $181.9 million of operating lease liabilities. Adoption of the lease standard materially affected the balance sheet but had no significant impact on income or cash flows.
- Operating cash flow improvement mainly reflected the timing of payments for accrued expenses and other current liabilities. Dividends paid were $60.0 million, compared with $46.6 million a year earlier; the quarterly dividend was $1.60 per share versus $1.25.
Changes, outlook and risks
- Q1 2019 net income attributable to Watsco increased despite diluted EPS declining one cent. Comprehensive income attributable to Watsco was $37.8 million versus $30.6 million, including a favorable foreign currency translation effect compared with Q1 2018.
- Management provided no specific revenue or earnings guidance. It said operating cash flows, cash on hand and revolver availability should meet foreseeable liquidity needs, while cautioning that funding sufficiency cannot be assured.
- On April 2, 2019, a subsidiary acquired the assets and assumed certain liabilities of Dunphey & Associates, a seven-location distributor, for $16.8 million cash and 50,952 Watsco shares valued at $7.5 million. On April 22, a Carrier joint venture acquired a further 1.8% of Russell Sigler, increasing its stake to 38.1%.
- Watsco estimated a contingent purchase obligation of approximately $142 million related to potential purchases of additional Russell Sigler shares under the shareholders agreement.
- Carrier and affiliates supplied 61% of inventory purchases in the quarter, compared with 62% in Q1 2018; net amounts payable to them were approximately $101 million at quarter-end. Supplier concentration is a stated risk.
- Other cited risks include seasonality and weather, economic and construction conditions, competition, commodity costs, liquidity and credit-market access, interest rates and the LIBOR transition, foreign exchange, regulation, insurance and cybersecurity. Management said known litigation was not expected to materially affect financial condition or results, based on information available.
Important facts for investors to verify
- Whether seasonal demand and weather support stronger results in the typically busier second and third quarters.
- Whether margin gains persist and how equipment pricing, product mix and lower volume affect sales and profitability.
- Working-capital and cash-flow trends, especially inventory growth and the timing of supplier and other liability payments.
- Exposure to Carrier as a major supplier, and the potential size and timing of the contingent Russell Sigler share-purchase obligation.
- Post-quarter acquisition performance, integration costs and financing needs; the filing gives no quantified earnings outlook.
- Lease commitments, including approximately $14 million of future minimum commitments for leases not yet commenced, and the effect of debt, dividends and acquisitions on liquidity.