Watsco, Inc. — Q1 2021 Form 10-Q
Reporting period: Quarter ended March 31, 2021; unaudited. Watsco distributes HVAC/R equipment, parts and supplies through 601 locations. Unless noted otherwise, financial figures below are in millions of dollars.
Financial performance
| Metric | Q1 2021 | Q1 2020 | Change |
|---|---|---|---|
| Revenue | $1,136.1 | $1,008.2 | +13% |
| Gross profit | $294.8 | $247.6 | +19% |
| Operating income | $81.9 | $45.2 | +81% |
| Net income attributable to Watsco | $55.1 | $30.5 | +81% |
| Diluted EPS | $1.39 | $0.72 | +93% |
| Cash from operating activities | $(37.7) | $41.9 | $(79.6) |
- Gross margin improved to 25.9% from 24.6%; SG&A declined to 19.2% of revenue from 20.2%, and operating margin rose to 7.2% from 4.5%.
- Revenue growth was primarily driven by residential HVAC equipment. HVAC equipment sales rose 14% (residential equipment +18%); other HVAC products rose 11%, and commercial refrigeration rose 10%. Higher residential equipment volume and mix contributed to growth.
- Other income, representing Watsco’s share of RSI earnings, was $4.7 million versus $1.0 million. Net interest expense fell to $0.1 million from $0.8 million.
Liquidity, debt and cash flow
- Cash was $93.9 million at March 31, versus $146.1 million at year-end; $78.7 million was held by foreign subsidiaries. Working capital was $1,064.5 million, up from $997.3 million at year-end.
- Operating cash outflow was chiefly associated with a $204.6 million inventory increase, partly offset by higher accounts payable and other liabilities. Cash decreased by $52.2 million during the quarter.
- Watsco had $48.9 million drawn on its $560 million revolving credit facility, compared with no revolver borrowings at December 31, 2020. The company reported covenant compliance and said available cash, operating cash flow and borrowing capacity should meet foreseeable liquidity needs.
- Cash dividends paid were $1.775 per share, compared with $1.60 a year earlier. A $1.95-per-share dividend was declared April 1 and paid April 30, 2021.
Material changes, outlook and risks
- On April 9, 2021, after quarter-end, Watsco and Carrier acquired the HVAC distribution business of Temperature Equipment Corporation and formed an 80%-owned joint venture. Purchase consideration included $105.2 million paid to the seller, with Watsco contributing $84.2 million, plus $1.5 million to repay indebtedness.
- Management provided no quantified earnings or revenue guidance. It noted that HVAC/R demand is seasonal, with residential air-conditioning replacement demand generally strongest in the second and third quarters; weather can materially affect results.
- COVID-19 continued to affect operations, and its future effects remained uncertain. Management said all locations were operating at the filing date and described cost-control and employee/customer safety measures.
- Risks highlighted include supplier concentration, commodity costs, economic and construction conditions, weather, seasonality, COVID-19, liquidity and financing access, foreign exchange, regulation and cybersecurity. Carrier and affiliates accounted for 61% of inventory purchases, up from 57%.
- Watsco disclosed an estimated contingent purchase amount of approximately $222 million related to potential additional ownership interests in RSI. It said known litigation was not expected to materially adversely affect financial condition or results; self-insurance reserves were $6.5 million.
Important facts for investors to verify
- Whether revenue growth and gross-margin improvement persist through seasonal peak periods, and how pricing, product mix and supply conditions evolve.
- Whether inventory growth converts into cash; Q1 operating cash flow was negative despite substantially higher earnings.
- Liquidity and leverage after the TEC acquisition, including the use of revolver capacity and the availability of foreign-held cash.
- Exposure to Carrier as a major supplier and joint-venture partner, and the terms and performance of the TEC and RSI arrangements.
- The continuing effects of COVID-19, weather, and other stated business risks; management cautioned that Q1 results are not necessarily indicative of full-year results.