Watsco, Inc. — Q2 2013 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2013. Watsco distributes HVAC/R equipment, parts and supplies and operated 571 locations in the U.S., Canada, Mexico and Puerto Rico. Unless noted, financial amounts below are in millions of dollars.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Revenue | $1,120.5 | $1,011.8 | $1,834.1 | $1,645.3 |
| Gross profit / margin | $266.7 / 23.8% | $238.5 / 23.6% | $442.1 / 24.1% | $389.1 / 23.6% |
| Operating income / margin | $105.1 / 9.4% | $85.9 / 8.5% | $135.6 / 7.4% | $105.8 / 6.4% |
| Net income attributable to Watsco | $51.3 | $39.1 | $64.7 | $47.6 |
| Diluted EPS | $1.48 | $1.15 | $1.87 | $1.41 |
- Q2 revenue grew 11%; same-store revenue grew 8%. Six-month revenue also grew 11%, with 6% same-store growth. Management attributed same-store growth primarily to strong residential HVAC replacement demand.
- Q2 gross margin expanded 20 basis points; six-month margin expanded 50 basis points. SG&A as a share of revenue declined to 14.4% from 15.1% in Q2 and to 16.7% from 17.2% for six months, reflecting fixed-cost leverage.
- Watsco cited higher revenue, improved margins, lower SG&A ratios and a smaller share of Carrier Enterprise I earnings allocated to noncontrolling interests as drivers of attributable income growth: 31% in Q2 and 36% for six months.
Cash flow, liquidity and debt
- Six-month operating cash flow was negative $76.9, versus negative $59.6 in 2012, primarily reflecting seasonal increases in receivables and inventory. Inventory and receivables used $148.9 and $150.6, respectively, while accounts payable and other liabilities provided $110.8.
- Investing cash outflow was $6.8, versus $88.9 in 2012, when the company paid $82.1 cash for its Carrier Enterprise III interest. Capital expenditures were $7.0.
- Financing provided $36.3, including $84.3 net revolving-credit borrowings; cash dividends were $17.3 and distributions to noncontrolling interests were $31.5. Cash declined $48.2 to $25.5 from year-end 2012.
- At June 30, working capital was $899.2; current assets were $1,261.0 and current liabilities $361.8. Revolver borrowings were $398.3 under a $500.0 facility. The filing says Watsco complied with covenants. It does not specify remaining availability after any letters of credit or other restrictions.
- On July 1, 2013, Watsco amended the facility, extending maturity to July 1, 2018, reducing pricing and improving seasonal covenant flexibility. The company said cash, operating flows and borrowing capacity should meet foreseeable liquidity needs, while noting access to credit markets and bank funding could be impaired.
Changes, outlook and risks
- Growth included revenue from 35 Carrier Enterprise III locations acquired in 2012: $24.9 in Q2 and $87.4 for the six-month period. Watsco made no acquisitions in the first six months of 2013. It increased its Carrier Enterprise I ownership from 60% to 70% in July 2012.
- Residential HVAC equipment sales rose 14% in Q2 and 11% for six months on a same-store basis. Commercial HVAC equipment sales fell 6% in both comparable periods. The business is seasonal, with residential air-conditioning demand typically strongest in Q2 and Q3; weather can materially affect results.
- No specific earnings or revenue guidance is provided. Management said it continues to evaluate acquisitions and joint ventures and believes it could obtain financing for suitable opportunities.
- Risks identified include general economic and competitive conditions, supplier concentration, commodity costs, housing and commercial construction, seasonal demand and weather, liquidity and interest rates, insurance, regulation, foreign exchange and international political risk.
- Carrier and affiliates represented 57% of Q2 purchases and 56% of six-month purchases. Amounts payable to them, net of receivables, were approximately $169.0 at June 30, versus $62.0 at year-end.
- Litigation is described as incidental; management does not expect known claims to materially affect financial condition or results, but outcomes are uncertain. Self-insurance reserves were $5.8. Foreign-currency translation contributed a $13.4 six-month comprehensive loss.
- Management reported effective disclosure controls and no material change in internal control over financial reporting. The company had not yet assessed internal controls at the 35 Carrier Enterprise III locations, representing about 16% of consolidated assets and 8% of six-month revenue.
Important facts for investors to verify
- Whether seasonal receivables and inventory convert to cash in the second half, and whether operating cash outflow improves versus 2012.
- Revolver availability, covenant headroom and the effect of seasonal borrowing under the amended facility.
- How much future growth comes from same-store demand versus acquired locations, and whether commercial HVAC weakness persists.
- Exposure to Carrier as a major supplier and related-party counterparty, including the effect of any changes in purchasing terms.
- Results of the pending internal-control assessment for Carrier Enterprise III and any subsequent material developments in litigation or self-insurance claims.