Watsco, Inc. — Q2 2014 Form 10-Q
Business and period: HVAC/R equipment and parts distributor operating 570 locations across the U.S., Canada, Mexico and Puerto Rico. This unaudited filing covers the quarter and six months ended June 30, 2014; comparisons are with 2013. Sales are seasonal, with residential air-conditioning replacement demand typically strongest in the second and third quarters.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | $1,170.2 million | $1,120.5 million | $1,932.8 million | $1,834.1 million |
| Gross profit / margin | $279.3 million / 23.9% | $266.7 million / 23.8% | $467.3 million / 24.2% | $442.1 million / 24.1% |
| Operating income / margin | $113.0 million / 9.7% | $105.1 million / 9.4% | $148.5 million / 7.7% | $135.6 million / 7.4% |
| Net income attributable to Watsco | $56.1 million | $51.3 million | $72.9 million | $64.7 million |
| Diluted EPS | $1.60 | $1.48 | $2.08 | $1.87 |
- Revenue increased 4% in Q2 and 5% for the six-month period; same-store revenue grew 5% in both periods. Management cited higher residential replacement demand and a shift toward higher-efficiency, higher-priced systems.
- Watsco-attributable net income rose 9% in Q2 and 13% year to date. Gross margin improved 10 basis points in both comparisons; SG&A as a share of revenue fell to 14.2% from 14.4% in Q2 and to 16.5% from 16.7% year to date, reflecting operating leverage.
- Net interest expense decreased 26% in Q2 and 21% year to date, attributed to lower average borrowings and lower effective interest rates. The effective tax rate attributable to Watsco was 36.7% for Q2 and 36.8% year to date.
Cash flow, liquidity and debt
- For the six months, operating cash flow was negative $65.2 million, versus negative $76.9 million in 2013. Seasonal increases in receivables and inventory were major cash uses; inventory buildup was described as preparation for the summer selling season.
- Investing cash flow was negative $5.6 million, including $5.8 million of capital expenditures. Financing cash flow was positive $68.2 million, including $118.8 million of net revolver borrowings, partly offset by dividends and distributions to noncontrolling interests. Cash declined $2.6 million to $16.9 million.
- At June 30, working capital was $960.6 million. Cash was $16.9 million; accounts receivable was $549.9 million and inventory was $760.0 million. Revolver borrowings were $348.8 million, up from $230.0 million at year-end 2013.
- A June 25 credit amendment raised revolving capacity from $500 million to $600 million, extended maturity to July 1, 2019, and increased the swingline subfacility to $90 million. Watsco said it was in compliance with covenants and expected cash, operating flows and available borrowing to meet foreseeable liquidity needs, while cautioning that funding access is not assured.
Material developments, outlook and risks
- On July 1, 2014, Watsco exercised an option to purchase an additional 10% of Carrier Enterprise I for an estimated $90.5 million cash, increasing its ownership to 80%. The price remained subject to adjustment; neither party had further options to acquire interests in the Carrier joint ventures.
- The board declared a $0.60-per-share quarterly dividend on July 1, paid July 31. The company paid $0.80 per share during the first six months of 2014, versus $0.50 in 2013.
- No specific earnings or revenue guidance was provided. Management highlighted demand, weather and seasonality as important variables. Risks include economic conditions, competition, supplier concentration, commodity costs, housing and commercial construction activity, liquidity and credit-market access, regulation, insurance, interest rates and foreign exchange.
- Carrier and its affiliates accounted for 60% of inventory purchases in the first six months, versus 56% in 2013; approximately $108 million was payable to them at June 30. Foreign-currency forward contracts had $59.5 million notional value and maturities through October 2014; related fair-value changes were recorded in SG&A.
- Routine litigation was reported; management did not expect known matters to materially affect financial condition or results. Self-insurance reserves were $5.2 million. The company adopted new tax-benefit presentation guidance without impact and planned to adopt the new revenue-recognition standard in 2017, with impact still under evaluation.
Facts for investors to verify
- Whether the seasonal working-capital build converts to operating cash in the second half, and how receivables and inventory develop.
- The final purchase-price adjustment for the additional Carrier Enterprise I interest and its effect on borrowing levels and future earnings attributable to Watsco.
- Revolver availability, covenant headroom and interest-rate exposure after borrowings increased.
- The sustainability of same-store growth, improved product mix and margin gains amid weather, demand and supplier-concentration risks.
- Future dividend decisions and any material developments in litigation, insurance reserves or revenue-standard implementation.