Watsco, Inc. — Q1 2011 Form 10-Q
Reporting period: Quarter ended March 31, 2011; comparisons are with Q1 2010 unless otherwise noted. Watsco distributes air-conditioning, heating and refrigeration equipment, parts and supplies. At quarter-end, it operated 502 locations in 36 states and Puerto Rico. Financial figures below are in millions of dollars, except per-share amounts.
Financial performance
| Metric | Q1 2011 | Q1 2010 | Change |
|---|---|---|---|
| Revenue | $534.3 | $509.8 | +5% |
| Gross profit / margin | $135.0 / 25.3% | $122.6 / 24.1% | +10%; margin +1.2 percentage points |
| SG&A / revenue | $118.3 / 22.1% | $113.7 / 22.3% | Expense +4% |
| Operating income | $16.7 | $8.9 | +88% |
| Net income attributable to Watsco | $7.5 | $3.8 | +96% |
| Diluted EPS | $0.21 | $0.10 | +$0.11 |
| Net interest expense | $0.8 | $0.9 | Down 8% |
Management attributed improved earnings mainly to higher sales, stronger gross margins, and lower SG&A as a share of revenue. Same-store revenue increased 5%. HVAC equipment sales rose 3%, other HVAC products 4%, and refrigeration products 20%. Higher-efficiency equipment mix, increased selling prices, and improved vendor discounts and rebates supported gross margin.
Cash flow, balance sheet and liquidity
- Operating cash flow was negative $44.9 million, versus negative $5.8 million in Q1 2010. Seasonal inventory buildup was the primary driver: inventory increased $110.9 million during the quarter.
- Investing cash flow was negative $1.6 million, mainly reflecting $1.7 million of capital expenditures. Financing cash flow was negative $44.4 million, including a $32.0 million return of capital to the joint-venture partner, $16.9 million of dividends, and $12.9 million of distributions to noncontrolling interests.
- Cash fell to $35.5 million from $126.5 million at year-end 2010. Working capital was $553.5 million, down from $572.0 million.
- Revolving-credit borrowings totaled $24.1 million at March 31, 2011: $10.0 million under Watsco’s $300 million unsecured facility and $14.1 million under Carrier Enterprise’s $75 million secured facility. Both facilities mature in 2012. Management reported compliance with covenants and said cash and available credit were sufficient for current needs.
- Total shareholders’ equity was $894.5 million, including $132.8 million of noncontrolling interest. Total assets were $1.236 billion.
Material developments, outlook and risks
- On April 29, 2011, Watsco completed a second joint venture with Carrier covering the northeastern United States. Watsco acquired a 60% controlling interest for $35.7 million cash and contributed 14 locations valued at $36.0 million; Carrier contributed 28 locations. The venture operates 42 locations in nine states. Carrier’s contributed network had 2010 revenue of approximately $210 million. The purchase price remains subject to working-capital adjustments.
- The board declared a quarterly dividend of $0.57 per share in April, paid April 29; Q1 dividends paid were $0.52 per share. Future dividends are discretionary and subject to credit-agreement restrictions and other factors.
- The filing provides no specific earnings or revenue guidance. Management cautioned that Q1 results are not necessarily indicative of full-year results. HVAC/R demand is seasonal, typically strongest for residential air-conditioning replacement in Q2 and Q3 and heating equipment in Q4; weather can materially affect results.
- Risks cited include economic and competitive conditions, supplier concentration, commodity costs, consumer spending and debt, housing activity, commercial construction, liquidity and credit-market access, weather, insurance, regulation, and interest rates. Purchases from Carrier and affiliates were 41% of total purchases in Q1 2011; approximately $92 million was payable to them, net of receivables, at quarter-end.
- Watsco reported ordinary-course litigation and did not expect known matters to materially affect results or financial condition. Self-insurance reserves were $6.2 million. One $10 million interest-rate swap fixing 30-day LIBOR at 5.07% matures in October 2011; the filing estimated approximately $0.3 million of accumulated unrealized losses would be reclassified to earnings over the next seven months.
- Management said disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter.
Investor verification priorities
- Assess whether the seasonal inventory build and negative operating cash flow convert to cash during the peak selling season.
- Verify the final working-capital adjustment, funding and integration of the Carrier Northeast joint venture, and its realized contribution versus the illustrative pro forma results.
- Monitor gross-margin sustainability, vendor rebates and purchasing terms, especially given the substantial Carrier supplier relationship.
- Review revolver availability, covenant headroom, and refinancing or liquidity needs as the credit facilities mature in 2012.
- Track weather, housing and construction trends, and confirm the board’s future dividend decisions and cash requirements.