Watsco, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are with December 31, 2015. Watsco distributes HVAC/R equipment, parts and supplies, operating 565 locations across the U.S., Canada, Mexico and Puerto Rico. Results are unaudited and the quarter is seasonally affected; residential air-conditioning demand typically peaks in Q2 and Q3.
Financial performance
| Metric | Q1 2016 | Q1 2015 | Change |
|---|---|---|---|
| Revenue | $851.4 million | $809.0 million | +5% |
| Gross profit / margin | $212.4 million / 25.0% | $204.2 million / 25.2% | Profit +4%; margin -20 bps |
| Operating income / margin | $50.7 million / 6.0% | $47.0 million / 5.8% | +8% |
| Net income attributable to Watsco | $25.5 million | $23.0 million | +11% |
| Diluted EPS | $0.71 | $0.65 | +9% |
| Operating cash flow | $41.9 million | $(16.8) million | +$58.7 million |
Revenue growth reflected a 6% same-store increase, led by residential HVAC equipment sales, which rose 9% on a same-store basis. Improved sales mix toward higher-efficiency systems also supported sales. Gross margin declined as mix shifted toward HVAC equipment, which carries lower margins than non-equipment products. SG&A rose 3%, slower than revenue, and declined to 19.0% of revenue from 19.4%; 2016 SG&A included $1.5 million of additional technology-initiative costs. Net interest expense fell 28% to $1.0 million, primarily from lower average borrowings.
Financial position and liquidity
- At March 31, cash was $32.9 million, including $19.7 million held by foreign subsidiaries; working capital was $914.7 million.
- Revolver borrowings were $237.9 million, down from $245.3 million at year-end. The unsecured revolving facility provides up to $600 million and matures July 1, 2019; the company reported covenant compliance. Availability is subject to facility terms and conditions.
- Operating cash flow improved year over year, mainly due to a smaller seasonal inventory build, lower inventory related to the 2015 regional-efficiency-standard transition, and higher net income. Inventory was $746.1 million, up from $674.0 million at year-end.
- Investing cash use was $2.7 million, mainly capital expenditures. Financing cash use was $41.6 million, including $30.0 million of common and Class B dividends, $7.4 million of revolver repayments and $7.1 million of distributions to non-controlling interests. Cash ended the quarter at $32.9 million, down $2.4 million.
Outlook, risks and other notable items
- No quantified earnings or revenue guidance was provided. Management said operating cash flows, cash on hand and borrowing capacity were expected to meet foreseeable liquidity needs, while noting that funding access and market disruptions could affect availability and borrowing costs.
- Demand and results are seasonal and weather-sensitive. Disclosed risks include economic conditions, competition, supplier concentration, commodity costs, housing and commercial construction, liquidity, regulation, interest rates, foreign exchange, cybersecurity and insurance coverage.
- Carrier and affiliates supplied 61% of inventory purchases, up from 58% a year earlier; approximately $90 million was payable to them, net of receivables. A non-cancelable purchase order with a key supplier totaled approximately $176 million.
- A shareholder derivative suit alleges excessive CEO incentive compensation and breach of fiduciary duties. Watsco considers the claims without merit and does not expect a material adverse effect, but litigation outcomes are uncertain.
- Foreign-currency translation and hedging contributed to other comprehensive income of $12.1 million, versus a loss of $18.4 million in Q1 2015. The company disclosed an expected $0.8 million pre-tax hedging loss to be reclassified into earnings within 12 months.
- The board declared a $0.85-per-share quarterly dividend on April 1, 2016. The filing does not provide full-year financial guidance.
Important facts for investors to verify
- Whether same-store sales growth and the improved residential HVAC demand persist through the peak selling season, and how product mix affects gross margin.
- Inventory levels, seasonal working-capital needs, operating cash conversion and reliance on the revolving credit facility.
- Supplier concentration, the $176 million purchase commitment and the terms of the Carrier joint ventures and related-party transactions.
- Potential effects of weather, foreign exchange, commodity costs and other disclosed risks, as well as developments in the shareholder lawsuit.
- Future dividend decisions and the impact of technology spending on expenses and operating performance.