Business context and reporting period
Watsco, Inc. is a North American distributor of HVAC/R equipment, parts and supplies. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2022. Watsco operated 673 locations in 42 U.S. states, Canada, Mexico and Puerto Rico.
Financial performance
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2022 | Q2 2021 | First half 2022 | First half 2021 |
|---|---|---|---|---|
| Revenue | $2,133.8 | $1,849.6 | $3,657.3 | $2,985.8 |
| Gross profit | $595.5 | $477.9 | $1,045.9 | $772.8 |
| Operating income | $287.1 | $216.8 | $458.1 | $298.7 |
| Net income attributable to Watsco | $192.6 | $144.1 | $305.9 | $199.2 |
| Diluted EPS | $4.93 | $3.71 | $7.83 | $5.13 |
- Gross margin improved to 27.9% in Q2 from 25.8%, and to 28.6% for the first half from 25.9%. Operating margin was 13.5% and 12.5%, respectively, compared with 11.7% and 10.0% in the prior periods.
- Q2 revenue rose 15% year over year; Watsco-attributable net income rose 34%. First-half revenue rose 22%, and attributable net income rose 54%.
- Same-store revenue increased 14% in Q2 and 19% in the first half. Management attributed HVAC equipment growth mainly to higher realized prices and a richer mix of higher-efficiency systems; average selling prices increased 16% in Q2 and 17% for the first half. Q2 HVAC equipment volume declined 1%, while first-half volume rose 3%.
- Operating cash flow was $73.1 million for the first half, versus $81.9 million a year earlier. Working-capital investment, particularly inventory, weighed on cash generation. Capital expenditures were $19.0 million.
- Cash and cash equivalents were $129.0 million at June 30, 2022; working capital was $1,562.6 million. Revolver borrowings were $203.6 million, up from $89.0 million at year-end 2021. The unsecured revolving facility totals $560 million and matures December 5, 2023; Watsco reported covenant compliance. Current portion of long-term obligations was $88.6 million. Lease liabilities are reported separately.
Changes, outlook and risks
- Margin expansion reflected pricing and mix benefits, including supplier price increases passed to customers. SG&A rose 18% in Q2 and 23% for the first half, with higher variable selling costs, headcount investment and new locations; SG&A as a share of revenue also increased modestly.
- No specific financial guidance or quantified full-year outlook is provided in the filing. Management said results are seasonal, with residential cooling demand generally strongest in the second and third quarters, and warned that interim results are not necessarily indicative of the full year.
- Supply-chain disruptions, component availability, labor shortages and transportation delays continued to constrain product availability and fulfillment. Other identified risks include economic conditions, supplier concentration, commodity costs, housing and construction activity, weather, interest rates, foreign exchange, regulation and cybersecurity.
- Management said the effects of COVID-19 had increasingly manifested through broader marketplace and supply-chain dynamics; future pandemic effects could not be reasonably estimated. New minimum SEER standards are expected to take effect in 2023. Higher-efficiency residential HVAC sales grew 22% organically in the first half.
- Watsco held $99.3 million of its cash at foreign subsidiaries. A 975,622-share CEO restricted-stock vesting was scheduled for October 15, 2022; estimated withholding taxes using June 30 prices and rates were about $94 million, which the company expected to fund with cash or revolver availability.
- Watsco estimated a contingent purchase obligation of approximately $306 million under its agreement relating to its investment in Russell Sigler, Inc. The company said known litigation was not expected to materially adversely affect its financial condition or results, while noting outcomes cannot be predicted with certainty.
Important facts for investors to verify
- Whether inventory growth and supply constraints unwind without materially reducing demand, margins or operating cash flow.
- How much revenue and earnings growth reflects pricing and mix versus underlying unit volumes; Q2 HVAC equipment volume declined 1%.
- Revolver utilization, borrowing costs, covenant headroom and the facility’s December 2023 maturity.
- The cash impact and funding source for the estimated $94 million CEO vesting-related tax withholding.
- The potential timing and final amount of the estimated $306 million Russell Sigler contingent purchase obligation.
- Exposure to Carrier: its affiliates accounted for 58% of inventory purchases in the first half, and approximately $178 million was payable to them, net of receivables, at June 30, 2022.