Watsco, Inc. — Q2 2015 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2015; comparisons are to the same 2014 periods. Watsco distributes HVAC/R equipment, parts and supplies and operated 566 locations in the U.S., Canada, Mexico and Puerto Rico. Financial amounts below are in USD millions unless noted.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Revenue | $1,223.4 | $1,170.2 | $2,032.4 | $1,932.8 |
| Gross profit / margin | $295.2 / 24.1% | $279.3 / 23.9% | $499.5 / 24.6% | $467.3 / 24.2% |
| Operating income / margin | $124.9 / 10.2% | $113.0 / 9.7% | $171.9 / 8.5% | $148.5 / 7.7% |
| Net income attributable to Watsco | $65.4 | $56.1 | $88.5 | $72.9 |
| Diluted EPS | $1.85 | $1.60 | $2.51 | $2.08 |
- Revenue grew 5% in both the quarter and first half. Same-store revenue increased 5% in Q2 and 6% for the half, led by HVAC equipment demand; higher-efficiency product mix also supported sales.
- Watsco-attributable net income increased 17% in Q2 and 21% for the first half. Management cited revenue growth, improved margins, lower SG&A as a share of revenue, and a reduced non-controlling share of Carrier Enterprise I earnings following Watsco’s additional 10% purchase in July 2014.
- SG&A was $170.4 million in Q2 and $327.6 million for the half; it rose 2% and 3%, respectively, but declined as a share of revenue to 13.9% and 16.1%. Net interest expense increased 31% in Q2 and 33% for the half, primarily due to higher average borrowings.
Cash flow, debt and liquidity
- For the first half, operating cash flow was a use of $74.1 million, versus a use of $65.2 million in 2014. Seasonal increases in receivables and inventory contributed to the outflow. Investing cash use was $14.0 million, including $14.6 million of capital expenditures; financing provided $85.8 million.
- Cash was $21.9 million at June 30, 2015, including $11.2 million held by foreign subsidiaries. Working capital was $1,069.5 million, up from $870.3 million at year-end, primarily due to seasonal receivables and inventory.
- Revolver borrowings were $433.4 million, up from $303.2 million at year-end, under a $600 million unsecured facility maturing July 2019. An additional $2.6 million was outstanding under a Mexican short-term credit line. The company reported compliance with debt covenants. Management believed operating cash flow, cash on hand and available credit would meet foreseeable liquidity needs, while noting funding and market-access risks.
- Cash dividends paid in the first half were $1.40 per common and Class B share, versus $0.80 in 2014. A $0.70-per-share quarterly dividend was declared July 1, 2015. No shares were repurchased in either Q2 period.
Outlook, risks and notable items
- No specific earnings or revenue guidance was provided. Management cautioned that results are seasonal and affected by weather; residential air-conditioning replacement demand typically peaks in Q2 and Q3, while heating demand is usually strongest in Q4.
- Key stated risks include economic and competitive conditions, supplier concentration, commodity costs, housing and construction activity, weather and seasonality, liquidity and credit-market access, interest and foreign-exchange rates, insurance, regulation, cybersecurity and execution of business strategy.
- Purchases from Carrier and affiliates represented 62% of inventory purchases in the first half (60% in 2014); approximately $108 million was payable to Carrier and affiliates at June 30, 2015, net of receivables. This is a material supplier and related-party concentration.
- Foreign-currency translation contributed a $16.9 million loss to first-half other comprehensive income. The company also reported foreign-currency forward contracts, including $29.0 million of notional value designated as cash-flow hedges.
- Management said known litigation was not expected to have a material adverse effect, while noting outcomes cannot be predicted with certainty. Self-insurance reserves were $4.8 million. Disclosure controls were assessed as effective; no material change in internal control was reported.
Investor verification priorities
- Confirm whether same-store sales momentum and gross-margin gains persisted beyond the seasonally strong second and third quarters.
- Track seasonal working-capital cash use, receivables and inventory, and the resulting dependence on revolver borrowings.
- Review debt capacity, interest costs, covenant headroom and availability of the syndicated credit facility.
- Assess the implications of Carrier’s share of inventory purchases and the related-party payable balance.
- Verify dividend sustainability against operating cash flow, capital expenditures and seasonal liquidity needs.