WSO

Watsco, Inc. 10-Q Summary: Period Ended June 30, 1998

Business Context and Reporting Period

This Form 10-Q covers the quarterly and six-month periods ended June 30, 1998, for Watsco, Inc., a Florida corporation engaged in the wholesale distribution of air conditioning, heating, and refrigeration equipment and related parts. The company operates seasonally, with revenue typically increasing from May through August. As of August 3, 1998, the company had 16,399,001 shares of Common Stock and 2,177,275 shares of Class B Common Stock outstanding. A three-for-two stock split was declared for payment on August 14, 1998.

Key Financial Metrics

Liquidity: The company maintains a $260 million revolving credit agreement, with $170.4 million outstanding as of June 30, 1998. Interest rate swaps covering $100 million of notional amount are in place to manage exposure.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 64% ($106.2M) in Q2 and 70% ($182.6M) for the six months compared to 1997. Organic growth (excluding acquisitions) was 15% in Q2 and 12% for the six months, driven by market share gains and expanded product lines.
• Acquisitions: Significant growth is attributed to acquisitions completed in April 1998 (two wholesale distributors) and July 1998 (Kaufman Supply, Inc.).
• Discontinued Operations: The company sold its manufacturing operation, Watsco Components, Inc., in May 1998. This resulted in a loss on sale of $398,000 (net of tax) and a net loss from discontinued operations of $440,000 for the quarter.
• Expenses: Selling, general, and administrative (SG&A) expenses rose 70% in Q2 and 81% for the six months, primarily due to acquired company costs and new location startups. SG&A as a percentage of revenue increased to 15.9% (Q2) and 17.8% (6 months) from 15.4% and 16.8% respectively in 1997.
• Interest Expense: Net interest expense surged 455% in Q2 and 352% for the six months due to higher borrowings utilized to fund acquisitions.

Outlook, Risks, and Management Commentary

• Seasonality: Management notes that results for the first half of the year are not necessarily indicative of full-year results due to seasonal sales patterns peaking in summer months.
• Capital Resources: The company believes it has adequate capital from operations and its credit facility to fund current operations and anticipated growth. It is actively evaluating potential acquisitions but has no binding agreements as of the filing date.
• Accounting Changes: The company adopted SFAS No. 130 (Comprehensive Income) effective Jan 1, 1998. SFAS No. 133 (Derivatives) is expected to be adopted in 1999 but is not anticipated to be material.
• Risks: Forward-looking statements are subject to risks including market conditions, interest rate fluctuations, and the integration of acquired businesses.

Investor Verification Checklist

• Acquisition Integration: Verify the financial performance of the April and July 1998 acquisitions to ensure they meet projected synergies and revenue targets.
• Debt Servicing: Monitor the impact of the increased debt load ($173.3M long-term) on future interest expenses and cash flow, particularly as LIBOR rates fluctuate.
• Discontinued Operations: Confirm the final settlement of the Watsco Components sale and ensure no lingering liabilities from the discontinued staffing business.
• Stock Split Impact: Verify the execution of the three-for-two stock split declared for August 14, 1998, and its effect on share price and liquidity.
• Working Capital Trends: Track the continued increase in accounts receivable and inventory to ensure they align with revenue growth and do not indicate collection or obsolescence issues.