Watsco, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015, compared with the same 2014 periods. Watsco distributes HVAC/R equipment and related products through 567 locations in the U.S., Canada, Mexico and Puerto Rico. Results are seasonal, with residential air-conditioning demand generally strongest in the second and third quarters.
Financial results
| Metric | Q3 2015 | Q3 2014 | 9M 2015 | 9M 2014 |
|---|---|---|---|---|
| Revenue | $1,177.0m | $1,135.0m | $3,209.4m | $3,067.8m |
| Gross profit / margin | $285.8m / 24.3% | $274.8m / 24.2% | $785.3m / 24.5% | $742.1m / 24.2% |
| Operating income / margin | $110.7m / 9.4% | $105.2m / 9.3% | $282.5m / 8.8% | $253.8m / 8.3% |
| Net income attributable to Watsco | $58.0m | $54.5m | $146.4m | $127.3m |
| Diluted EPS | $1.64 | $1.56 | $4.16 | $3.64 |
- Q3 revenue rose 4% and Watsco-attributable net income rose 6%. Nine-month revenue rose 5% and attributable net income rose 15%.
- Same-store revenue increased 5% in both periods. Management attributed growth mainly to strong replacement demand and a richer mix of higher-efficiency systems. Nine-month gross margin improved 30 basis points, primarily on higher realized margins for residential HVAC equipment.
- SG&A rose 3% in Q3 and 3% for the nine months; as a share of revenue it was flat at 14.9% in Q3 and improved to 15.7% from 15.9% year to date. Technology initiatives added $2.2m of incremental Q3 costs and $5.4m year to date.
- Interest expense was $1.5m in Q3, down 1%; nine-month expense was $4.5m, up 19%, reflecting higher average borrowings partly offset by a lower effective rate. Effective tax rates attributable to Watsco were 36.7% for Q3 and 36.9% year to date.
Cash flow, liquidity and debt
- For the nine months, operating cash flow was $99.8m, versus $41.7m in 2014. Investing used $19.9m, including $20.6m of capital expenditures; financing used $75.0m, including $73.8m of dividends. Cash increased $4.1m to $28.5m, of which $18.6m was held by foreign subsidiaries.
- At September 30, 2015, working capital was $983.5m; current assets were $1,314.5m and current liabilities $331.0m. Accounts receivable and inventories increased from year-end, primarily reflecting seasonal working-capital needs.
- Revolver borrowings were $304.9m under a $600m facility maturing July 2019; an additional $2.4m was drawn on a Mexican subsidiary credit line. Total borrowings were approximately $307.3m, compared with $303.2m on the revolver at December 2014. Management said the company was in compliance with covenants and expected operating cash flow, cash and available credit to meet foreseeable liquidity needs, while cautioning that funding availability is not assured.
Material changes, outlook and risks
- Watsco acquired an additional 10% of Carrier Enterprise I in July 2014, bringing its ownership to 80%; management said this contributed to the year-over-year increase in Watsco-attributable nine-month earnings through a lower non-controlling-interest share. No businesses were acquired in the first nine months of 2015.
- The board approved a quarterly dividend increase from $0.70 to $0.85 per share beginning with the dividend payable in January 2016. No formal earnings or revenue guidance is provided in the supplied filing text.
- Supplier concentration is significant: Carrier and affiliates accounted for 62% of inventory purchases in both the Q3 and nine-month 2015 periods; approximately $82m was payable to them, net of receivables, at quarter-end.
- Foreign currency translation reduced other comprehensive income by $31.6m in the first nine months. Watsco used foreign-exchange forward contracts, including cash-flow hedges with $24.9m notional value at quarter-end.
- Management identified general 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, regulation, insurance, cybersecurity and execution of its strategy as risks. Litigation was described as incidental; management did not expect known matters to materially adversely affect financial condition or results.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. Results are unaudited and interim; management notes that seasonal patterns mean period results may not indicate full-year results.
Important facts for investors to verify
- Whether same-store demand, product mix and gross-margin gains persist beyond the peak cooling season.
- How working-capital requirements, particularly receivables and inventory, affect cash conversion and borrowing needs.
- Carrier’s continued importance as both a supplier and joint-venture partner, and the financial implications of that concentration.
- The sustainability of the higher dividend alongside capital expenditures, seasonal borrowing and any future acquisitions.
- Exposure to foreign exchange, weather, housing/construction trends and potential changes in credit availability or borrowing costs.