Watsco, Inc. — Q2 2012 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2012. Watsco distributes HVAC/R equipment, parts and supplies and operated 575 locations across the U.S., Canada, Mexico and Puerto Rico. Results are seasonal, with residential air-conditioning demand typically strongest in the second and third quarters. Financial figures below are in millions of dollars unless stated otherwise.
Financial performance
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $1,011.8 | $883.5 | $1,645.3 | $1,417.9 |
| Gross profit | $238.5 | $213.2 | $389.1 | $348.2 |
| Operating income | $85.9 | $75.5 | $105.8 | $92.2 |
| Net income attributable to Watsco | $39.1 | $36.0 | $47.6 | $43.5 |
| Diluted EPS | $1.15 | $1.09 | $1.41 | $1.32 |
| Gross margin | 23.6% | 24.1% | 23.6% | 24.6% |
| SG&A as a percentage of revenue | 15.1% | 15.6% | 17.2% | 18.1% |
- Q2 revenue grew 15%; Watsco-attributable net income rose 9%. For the first half, revenue grew 16% and attributable net income rose 9%.
- Same-store revenue increased 2% in Q2 and 4% for the first half. Management cited stronger HVAC equipment and commercial refrigeration sales, including demand for replacement HVAC equipment.
- Gross margin declined 50 basis points in Q2 and 100 basis points for the first half, mainly because of sales mix shifting toward lower-margin HVAC equipment and commercial products. SG&A leverage partially offset this pressure.
- Interest expense increased 35% in Q2 and 23% for the first half, primarily reflecting higher average borrowings. The effective tax rate attributable to Watsco was 36.9% for Q2 and 37.0% for the first half, versus 38.0% in each 2011 comparable period; management cited lower foreign tax rates and non-recurring tax benefits.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was negative $59.6 million, versus negative $42.2 million a year earlier. Seasonal inventory buildup and timing of payments contributed to cash use; accounts receivable also increased with sales.
- First-half investing cash outflow was $88.9 million, including $82.1 million of cash consideration for the Canadian joint venture and $6.9 million of capital expenditures. Financing provided $168.0 million, principally from revolving-credit borrowings.
- Cash was $35.2 million at June 30, 2012, compared with $15.7 million at year-end 2011. Working capital was $856.3 million, up from $605.1 million, partly reflecting the Canadian business added during the period and seasonal working-capital needs.
- Revolving-credit borrowings totaled $235.6 million at June 30, with no current portion reported. Watsco entered a new unsecured, five-year $500 million revolver in April, maturing in April 2017; it reported covenant compliance. Total shareholders’ equity was $1,230.8 million.
- Management stated that operating cash flows, cash on hand and available credit should meet foreseeable liquidity needs, including the approximately $52 million July 2012 purchase of an additional 10% of Carrier Enterprise I. It cautioned that funding availability is not assured, particularly in a disrupted credit market.
Material changes, outlook and risks
- On April 27, Watsco formed Carrier Enterprise III with UTC Canada, acquiring a 60% controlling interest in a 35-location Canadian distribution business for $82.1 million cash and 1.25 million Watsco shares valued at $93.3 million. Purchase accounting was preliminary; the final price remained subject to working-capital adjustment, and the company anticipated $220.0 million of goodwill and intangible assets.
- Reported revenue included substantial acquired-business contributions: $110.7 million in Q2 and $173.9 million for the first half from 70 Carrier Enterprise II and III locations. Accordingly, reported growth exceeded same-store growth.
- On July 2, Watsco exercised its option to acquire an additional 10% of Carrier Enterprise I for approximately $52 million, increasing its ownership to 70%. The board also declared a $0.62-per-share quarterly dividend, paid July 31.
- No specific full-year earnings or revenue guidance was provided. Management emphasized seasonal demand, weather sensitivity and its continuing evaluation of acquisitions and joint ventures.
- Disclosed risks include economic conditions, competition and supplier concentration, commodity costs, housing and commercial construction activity, consumer spending, weather and seasonality, liquidity and interest rates, foreign exchange, insurance, regulation, and execution of business strategy. Watsco reported no material change in risk factors from its 2011 Form 10-K.
- Known litigation was not expected by management to have a material adverse effect, based on information available; self-insurance reserves were $4.8 million. The 35 locations added through Carrier Enterprise II and III, representing about 26% of consolidated assets and 13% of first-half revenue, had not yet been included in the company’s internal-control assessment.
Important facts for investors to verify
- How much of subsequent growth and earnings reflects acquired operations versus same-store performance, and how the preliminary Canadian purchase-price allocation is finalized.
- Whether gross-margin pressure from product mix persists and whether operating-cost leverage can continue to offset it.
- Seasonal working-capital cash use, inventory and receivables, revolver availability and covenant headroom after the additional Carrier Enterprise I purchase.
- Integration and control-assessment progress for the acquired businesses, and the impact of the Canadian JV’s noncontrolling interest on earnings attributable to Watsco.
- Exposure to weather, supplier concentration, variable interest rates and foreign-exchange movements; the filing provides no quantified full-year outlook.