Watsco, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016; unaudited. Watsco distributes HVAC/R equipment, parts and supplies and operated 568 locations across the U.S., Canada, Mexico and Puerto Rico. Results are seasonal, with residential air-conditioning demand typically strongest in the second and third quarters.
Financial results
| Metric | Q3 2016 | Q3 2015 | 9M 2016 | 9M 2015 |
|---|---|---|---|---|
| Revenue | $1,241.2m | $1,177.0m | $3,307.1m | $3,209.4m |
| Gross profit / margin | $302.2m / 24.3% | $285.8m / 24.3% | $806.5m / 24.4% | $785.3m / 24.5% |
| Operating income / margin | $119.3m / 9.6% | $110.7m / 9.4% | $287.6m / 8.7% | $282.5m / 8.8% |
| Net income attributable to Watsco | $63.1m | $58.0m | $153.3m | $146.4m |
| Diluted EPS | $1.78 | $1.64 | $4.32 | $4.16 |
| Operating cash flow | Not presented for the quarter | $146.3m | $99.8m |
Balance sheet and liquidity
- At September 30, cash was $35.9m, accounts receivable $548.0m, inventory $739.7m and working capital $990.9m.
- Revolving-credit borrowings were $219.4m, down from $245.3m at December 31, 2015. The unsecured facility provides up to $600m and matures July 1, 2019; the company reported covenant compliance.
- Nine-month capital expenditures were $9.0m. Cash dividends paid were $90.3m; distributions to non-controlling interests were $26.0m.
Changes and management commentary
- Q3 revenue rose 5%; same-store revenue increased 6%, supported by replacement demand and improved mix of higher-efficiency systems. Same-store HVAC equipment sales rose 7%, other HVAC products 2%, and commercial refrigeration 7%.
- For nine months, revenue increased 3% and same-store revenue increased 3%. Gross margin declined 10 basis points, primarily due to lower realized margins on residential HVAC equipment.
- Q3 SG&A rose 4% but declined to 14.7% of revenue from 14.9%. Nine-month SG&A rose 3% and remained 15.7% of revenue. Technology initiatives added $0.7m of Q3 and $3.2m of nine-month costs versus prior-year periods.
- Watsco attributed higher operating cash flow mainly to the timing of accrued-expense payments and lower inventory compared with the prior-year period. Financing cash outflow increased, reflecting higher dividends, non-controlling-interest distributions and debt repayments.
- No numerical earnings or revenue guidance was provided. Management said operating cash flow, cash and borrowing capacity should meet foreseeable liquidity needs, while noting that funding access and sufficiency are not assured.
Risks, contingencies and unusual items
- Seasonality and weather, economic conditions, competition, supplier concentration, commodity costs, housing and commercial construction, liquidity, interest and foreign-exchange rates, regulation, cybersecurity and international political risks may affect results.
- Carrier and affiliates accounted for 62% of inventory purchases in both comparison periods. Watsco owed them approximately $100m net at quarter-end, versus $85m at year-end 2015.
- A shareholder derivative lawsuit concerning CEO incentive compensation was pending. Watsco said it would defend the case and did not expect a material financial effect. A non-cancelable purchase order with a key supplier totaled approximately $44m.
- On October 20, 2016, after quarter-end, Watsco purchased a corporate aircraft for $30.7m. The October quarterly dividend was $1.05 per share.
- Early adoption of share-based payment guidance added tax benefits of $0.6m in Q3 and $2.9m for nine months to income-tax benefit; the change also affected cash-flow classification.
Important facts for investors to verify
- Whether revenue growth and stronger replacement demand persist beyond the peak seasonal selling period, and whether residential HVAC gross margins recover.
- Working-capital needs, cash conversion and borrowing availability through seasonal demand swings; note that $29.0m of cash was held by foreign subsidiaries.
- Exposure to Carrier as supplier and joint-venture partner, including purchase terms and the significance of the 62% inventory-purchase concentration.
- Cash-flow and balance-sheet effects of the $30.7m aircraft purchase, dividends, supplier commitment and any developments in the shareholder litigation.
- The impact of ongoing technology spending and the share-based compensation accounting change on future expenses, taxes and reported cash flows.