Watsco, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. Unaudited results. Watsco distributes air-conditioning, heating and refrigeration equipment, parts and supplies; it operated 526 locations at quarter-end. Amounts below are in millions except per-share data.
Financial performance
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Revenue | $883.5 | $864.8 | $1,417.9 | $1,374.6 |
| Gross profit / margin | $213.2 / 24.1% | $201.1 / 23.3% | $348.2 / 24.6% | $323.7 / 23.5% |
| Operating income / margin | $75.5 / 8.5% | $70.9 / 8.2% | $92.2 / 6.5% | $79.8 / 5.8% |
| Net income attributable to Watsco | $36.0 | $35.0 | $43.5 | $38.9 |
| Diluted EPS | $1.09 | $1.08 | $1.32 | $1.20 |
- Q2 revenue rose 2% year over year; six-month revenue rose 3%. Same-store revenue declined 2% in Q2 but increased 1% for the first half.
- Q2 gross profit increased 6%; first-half gross profit increased 8%. Management attributed margin improvement to selling prices, a shift toward higher-margin non-equipment products, and, for the first half, improved vendor discounts and rebates.
- Q2 SG&A rose 6% to $137.7 million and was 15.6% of revenue, versus 15.1%. First-half SG&A rose 5% to $255.9 million and was 18.1% of revenue, versus 17.7%. Acquisition-related costs were $0.5 million in Q2 and $0.8 million for the first half.
- Net income attributable to Watsco increased 3% in Q2 and 12% in the first half. First-half EPS growth was 10% diluted.
Cash flow, balance sheet and liquidity
- First-half operating cash flow was negative $42.2 million, compared with positive $56.8 million in 2010. Seasonal working-capital investment—especially inventory buildup—and lower accounts payable and other liabilities were the main drivers. The buildup included about $15 million of inventory purchased from a key supplier that had previously been consigned.
- Investing cash outflow was $41.1 million, including $35.7 million cash consideration for the Northeast joint venture and $5.7 million in capital expenditures. Financing cash outflow was $24.6 million, including $35.7 million in dividends, a $32.0 million return of capital to the noncontrolling interest, and $15.8 million in noncontrolling-interest distributions; these were partly offset by $55.0 million of net revolving-credit borrowings.
- Cash declined from $126.5 million at December 31, 2010 to $18.6 million at June 30, 2011. Working capital was $637.3 million, up from $572.0 million; excluding the Northeast locations, it was $593.8 million.
- Revolving-credit borrowings were $65.0 million, up from $10.0 million at year-end. Watsco’s unsecured revolving facility permits up to $300 million and matures in August 2012. The separate Carrier Enterprise facility had no borrowings at quarter-end; it was increased from $75 million to $125 million in July 2011. Management said the company and Carrier Enterprise were in covenant compliance and believed available cash flows and credit facilities were sufficient for current needs.
- Current assets were $1,082.7 million and current liabilities $445.3 million. Total shareholders’ equity was $971.4 million. The filing reports total long-term obligations of $65.0 million, including revolving-credit borrowings.
Material changes, outlook and risks
- On April 29, Watsco formed Carrier Enterprise Northeast with Carrier, contributing 14 locations and acquiring a 60% controlling interest. Carrier contributed 28 locations. Watsco’s stated consideration was $49.2 million in fair value, comprising $35.7 million cash and $14.8 million in contributed locations; preliminary allocation included $32.96 million of goodwill and intangibles. The new locations contributed $44.9 million of Q2 and first-half revenue. Carrier Enterprise and the new venture are 60%-owned by Watsco, with Carrier holding the remaining 40%.
- Q2 same-store revenue softness reflected lower replacement-market HVAC equipment demand and a shift in mix away from equipment. HVAC equipment sales fell 5% in Q2 and 2% for the first half; refrigeration sales rose 8% and 13%, respectively.
- After quarter-end, Watsco acquired a 60% interest in Carrier’s Mexico HVAC/R distribution operations for $9 million cash. The network had 2010 revenue of approximately $75 million and six locations. Also after quarter-end, the Carrier Enterprise credit line was increased to $125 million following a change in inventory payment terms.
- No specific full-year earnings or revenue guidance was provided. Management noted HVAC/R seasonality, with residential replacement demand typically strongest in the second and third quarters and heating demand generally strongest in the fourth; weather can materially affect results. Management stated that acquisitions and joint ventures continue to be evaluated.
- Principal risks identified include economic and competitive conditions, supplier concentration, commodity costs, consumer spending and debt, housing activity, commercial construction, liquidity and credit-market access, seasonality and weather, insurance, regulation, interest rates, and execution of the business strategy. Carrier accounted for 48% of purchases in Q2 2011 and 45% for the first half; amounts payable to Carrier and affiliates, net of receivables, were approximately $191 million at June 30.
- Watsco said known litigation was not expected to materially affect its financial condition or results. Self-insurance reserves were $6.2 million. Disclosure controls were assessed as effective; controls over the newly added Northeast locations had not yet been assessed as of the filing.
Important facts for investors to verify
- Whether seasonal inventory and receivables convert to cash in the second half, given the first-half operating cash outflow and lower cash balance.
- Whether same-store demand improves and margin gains persist after the Q2 mix shift and vendor pricing, discounts and rebates.
- The final purchase-price allocation and performance of Carrier Enterprise Northeast, and the financing and results of the subsequent Mexico acquisition.
- Carrier-related supplier concentration, related-party balances, and the effects of the amended Carrier Enterprise payment terms and credit facility.
- Debt-facility covenant headroom, maturity and refinancing needs, dividend sustainability, and the seasonal impact of weather and HVAC/R demand.