WSO

Watsco, Inc. 10-Q Summary: Quarter Ended March 31, 1998

Business Context and Reporting Period

This Form 10-Q covers the quarterly period ended March 31, 1998, for Watsco, Inc., a Florida corporation engaged in the wholesale distribution of air conditioning, heating, and refrigeration products. The company operates seasonally, with revenues typically increasing from May through August. The financial statements include results from five acquisitions completed in February and March 1998 and exclude the results of discontinued operations (Watsco Components, Inc. and Dunhill Staffing Systems, Inc.), which were divested in late 1997.

Key Financial Metrics

Cash Flow: Net cash used in operating activities was $15.6 million, primarily due to increases in inventory and accounts receivable. Net cash used in investing activities was $5.0 million, driven by business acquisitions ($3.2 million) and capital expenditures ($1.8 million). Net cash provided by financing activities was $17.1 million, largely from borrowings under the revolving credit agreement.

Material Changes vs. Prior Period

• Revenue Growth: Revenue increased 79% ($76.4 million) year-over-year. Excluding acquisitions, organic revenue growth was 9% ($8.7 million), driven by market share gains and expanded product lines.
• Profitability: While gross profit increased 83%, net income from continuing operations decreased 14% ($1.8 million to $1.8 million) due to a significant rise in interest expense and selling, general, and administrative (SG&A) costs.
• Expenses: SG&A expenses increased 97% ($17.6 million), primarily due to costs associated with acquired companies and new branch openings. As a percentage of revenue, SG&A rose to 20.8% from 18.9%.
• Interest Expense: Net interest expense surged 349% ($1.3 million increase) due to higher average borrowings utilized to fund acquisitions.
• Discontinued Operations: Net income from discontinued operations was $149,000 in 1998 compared to $221,000 in 1997.

Outlook, Risks, and Management Commentary

Management Commentary: Management attributes the increase in gross margin (23.4% vs. 22.9%) to improved pricing disciplines and new national vendor programs. The company maintains a $260 million revolving credit facility, with $152.3 million outstanding as of March 31, 1998. Interest rate swaps totaling $100 million are in place to manage exposure to variable rates.

Acquisitions: The company completed five acquisitions in Q1 1998 and two additional acquisitions in April and May 1998 (combined prior year revenue approx. $27 million). Management continues to evaluate potential acquisition candidates but has no binding agreements.

Risks and Contingencies:

• Seasonality: Results for the first quarter are not indicative of full-year performance due to seasonal sales patterns.
• Forward-Looking Statements: The filing includes a Safe Harbor statement noting that actual results may differ materially from projections due to risks and uncertainties.
• Debt Covenants: The credit agreement contains financial covenants regarding net worth, interest coverage, and debt coverage ratios, as well as limits on capital expenditures and dividends.

Investor Verification Checklist

• Verify the organic revenue growth rate of 9% excluding the impact of the five Q1 acquisitions.
• Confirm the sustainability of the 23.4% gross margin given the increased SG&A ratio (20.8%) and higher interest costs.
• Review the terms of the $260 million revolving credit facility and the company's compliance with financial covenants.
• Assess the integration progress and financial contribution of the seven total acquisitions completed or announced in the first half of 1998.
• Monitor the impact of the $100 million interest rate swap agreements on future interest expense as LIBOR rates fluctuate.