Watsco, Inc. — Q1 2012 Form 10-Q
Reporting period: Quarter ended March 31, 2012. Watsco distributes HVAC/R equipment, parts and supplies and operated 541 locations at quarter-end. Amounts below are in U.S. dollars; financial statement amounts are in millions unless otherwise noted.
Financial performance
| Metric | Q1 2012 | Q1 2011 | Change |
|---|---|---|---|
| Revenue | $633.5 | $534.3 | +19% |
| Gross profit / margin | $150.6 / 23.8% | $135.0 / 25.3% | +12% gross profit; margin down 1.5 percentage points |
| SG&A / revenue | $130.7 / 20.6% | $118.3 / 22.1% | +11% expense; ratio improved 1.5 points |
| Operating income / margin | $19.9 / 3.2% | $16.7 / 3.2% | +19% operating income |
| Net income | $13.5 | $11.1 | +21% |
| Net income attributable to Watsco | $8.5 | $7.5 | +13% |
| Diluted EPS | $0.23 | $0.21 | +$0.02 |
| Net interest expense | $0.9 | $0.8 | +8% |
Revenue growth included $63.2 million from 35 Carrier Enterprise II locations acquired in 2011. Same-store revenue rose 7%, with HVAC equipment sales up 12% and commercial refrigeration sales up 11%; other HVAC product sales declined 1%. Management attributed same-store growth primarily to strong replacement demand. Gross margin fell due mainly to a sales mix shift toward lower-margin HVAC equipment and the timing of inventory purchases affecting vendor discounts and rebates. SG&A as a share of revenue improved through fixed-cost leverage.
Cash flow, balance sheet and liquidity
- Operating cash flow was positive $9.5 million, versus an outflow of $44.9 million a year earlier. The comparison reflected, among other factors, the prior-year seasonal inventory build and the timing of accounts payable and other liabilities.
- Investing cash outflow was $3.8 million, including $3.9 million of capital expenditures. Financing cash outflow was $3.3 million, including $20.5 million of dividends, partly offset by $22.5 million of net revolver borrowings.
- Cash was $18.1 million at March 31, 2012. Current assets were $911.0 million and current liabilities $307.3 million; reported working capital was $603.6 million, slightly below $605.1 million at year-end 2011.
- Revolver borrowings were $42.5 million at quarter-end, compared with $20.0 million at December 31, 2011. Current maturities of long-term obligations were negligible at $0.016 million. Total debt is not stated as a single figure in the filing text.
- Inventory increased to $532.4 million from $465.3 million at year-end. The company reported total shareholders’ equity of $1,000.0 million, including $203.9 million of noncontrolling interest.
Material developments, outlook and risks
- On April 27, 2012, after quarter-end, Watsco completed a Canadian joint venture, Carrier Enterprise III, with a 60% controlling interest and operations at 35 locations. Consideration included $82.0 million in cash and 1.25 million Watsco common shares valued at $93.3 million; the final purchase price remains subject to working-capital adjustments.
- Also on April 27, Watsco entered a new unsecured, five-year $500 million revolving credit facility, replacing two prior facilities. The proceeds were used to repay approximately $154 million owed under those facilities and to fund the Canadian transaction. The facility includes leverage and interest-coverage covenants and matures in April 2017.
- Management said operating cash flow, cash on hand and borrowing availability were expected to meet foreseeable liquidity needs, including the planned July 2012 purchase of an additional 10% interest in Carrier Enterprise I for approximately $51 million. This was management’s expectation, not a guarantee.
- HVAC/R sales are seasonal: residential cooling demand generally peaks in the second and third quarters, heating demand in the fourth quarter, and weather can materially affect results. Management expected seasonal inventory buildup in Q2.
- Key disclosed risks include economic and housing conditions, weather, competition, supplier concentration, commodity costs, liquidity and credit-market access, interest and foreign-exchange rates, regulation, insurance exposure and execution of the business strategy. Carrier and its affiliates accounted for 52% of purchases in Q1 2012, up from 41% a year earlier; approximately $76 million was payable to them, net of receivables, at quarter-end.
- Management stated known litigation was not expected to have a material adverse effect based on information available, while noting outcomes cannot be predicted with certainty. Self-insurance reserves were $4.3 million. Management reported disclosure controls were effective and no material change in internal control during the quarter; internal controls at the 35 Carrier Enterprise II locations had not yet been assessed.
Most important facts for investors to verify
- Whether seasonal demand and weather support Q2/Q3 sales, and whether the gross-margin decline from product mix and vendor rebate timing persists.
- Post-quarter financing and acquisition effects: final Canadian joint-venture purchase price, share issuance dilution, revolver utilization, borrowing costs and covenant headroom.
- Whether Watsco exercises the planned $51 million option to increase its Carrier Enterprise I ownership and how the transaction is funded.
- Whether supplier concentration and related-party purchasing terms change, and whether the expanded Carrier relationships create operational or financial dependencies.
- Inventory, receivables and payables trends, cash conversion, and the adequacy of self-insurance reserves and internal controls at acquired locations.