Watsco, Inc. — Form 10-Q Summary
Business context and reporting period
Reports the quarter and nine months ended September 30, 2014; financial statements are unaudited. Watsco distributes HVAC/R equipment and related products across North America, operating 574 locations in 38 U.S. states, Canada, Mexico and Puerto Rico. Results are seasonal and sensitive to weather, with residential air-conditioning replacement demand typically strongest in the second and third quarters.
Financial performance
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Revenue | $1,135.0 million | $1,081.9 million | $3,067.8 million | $2,916.0 million |
| Gross profit / margin | $274.8 million / 24.2% | $258.6 million / 23.9% | $742.1 million / 24.2% | $700.7 million / 24.0% |
| Operating income / margin | $105.2 million / 9.3% | $95.5 million / 8.8% | $253.8 million / 8.3% | $231.1 million / 7.9% |
| Consolidated net income | $71.1 million | $66.1 million | $173.9 million | $159.8 million |
| Net income attributable to Watsco | $54.5 million | $45.7 million | $127.3 million | $110.4 million |
| Diluted EPS | $1.56 | $1.32 | $3.64 | $3.18 |
Revenue increased about 5% in both periods; Watsco-attributable net income rose 19% in Q3 and 15% for the nine months. Management cited higher sales, improved gross margins, operating-cost leverage and a smaller share of earnings allocated to noncontrolling interests. Same-store revenue rose 5% in both periods, primarily on residential HVAC replacement demand and a mix shift toward higher-efficiency equipment. Q3 HVAC equipment sales rose 7%; commercial refrigeration sales rose 14%.
Nine-month operating cash flow was $41.7 million, versus $51.2 million in 2013, mainly reflecting greater receivables and inventory investment. Investing cash use was $8.9 million, including $9.2 million of capital expenditures. Financing cash use was $35.4 million; it included $87.7 million to buy an additional 10% interest in Carrier Enterprise I, while revolving-credit borrowings increased by $122.9 million. Cash declined $2.8 million to $16.7 million. Working capital was $930.6 million, up from $777.6 million at year-end, primarily due to seasonal receivables and inventory.
Balance sheet, debt and liquidity
At September 30, 2014, cash was $16.7 million, accounts receivable $502.5 million and inventory $729.9 million. Revolver borrowings were $352.0 million, compared with $230.0 million at December 31, 2013. In June, Watsco amended its unsecured revolving credit agreement, increasing capacity from $500 million to $600 million and extending maturity to July 1, 2019. The company reported covenant compliance and said operating cash flow, cash and available borrowing capacity should meet foreseeable liquidity needs, while cautioning that funding-market disruptions could impair access or raise costs.
Changes, outlook and risks
- On July 1, Watsco paid $87.7 million for an additional 10% of Carrier Enterprise I, increasing its ownership to 80%; no further purchase options remain for this or the other Carrier joint ventures.
- Cash dividends paid during the first nine months were $1.40 per share, versus $0.75 a year earlier. A $0.60-per-share quarterly dividend was declared October 1 and paid October 31, 2014.
- The filing provides no quantified earnings or revenue guidance. Management described continued acquisition and joint-venture evaluation and stated that current funding sources were expected to cover foreseeable needs.
- Key risks include seasonality and weather, general economic and construction activity, competition, supplier concentration, commodity costs, liquidity and credit-market access, interest rates, foreign exchange, insurance exposure and regulation. Carrier and affiliates accounted for 61% of inventory purchases in the first nine months; approximately $103 million was payable to them, net of receivables, at quarter-end.
- Known litigation was not expected by management to have a material adverse effect based on information available. Self-insurance reserves were $5.0 million; adverse claims development could require additional reserves. Foreign-currency translation reduced nine-month other comprehensive income by $12.6 million.
- A new revenue-recognition standard is scheduled for adoption January 1, 2017; Watsco was evaluating its impact. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether seasonal working-capital needs and inventory levels convert into stronger operating cash flow in subsequent quarters.
- Revolver availability, covenant headroom, borrowing costs and the effect of increased debt following the joint-venture purchase.
- Sales and margin sustainability, including reliance on residential replacement demand, weather, higher-efficiency product mix and Carrier as a major supplier.
- The ongoing effect of the increased Carrier Enterprise I ownership on Watsco-attributable earnings and noncontrolling interests.
- Potential changes in litigation, self-insurance estimates, foreign-exchange exposure and the eventual impact of the 2017 revenue-recognition standard.