WSO

Watsco, Inc. 10-Q Summary: Period Ended June 30, 1997

Business Context and Reporting Period

This Form 10-Q covers the quarterly and six-month periods ended June 30, 1997, for Watsco, Inc., a Florida corporation. The company operates as a wholesale distributor of air conditioning, heating, and refrigeration equipment and related parts. The business is seasonal, with revenues typically increasing from May through August. As of August 5, 1997, the company had 15,096,212 shares of Common Stock and 2,172,647 shares of Class B Common Stock outstanding.

Key Financial Metrics

Note: Debt includes $994k current portion of long-term obligations, $57.9m revolving credit borrowings, and $10.4m other bank debt.

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 53.9% for the quarter and 49.6% for the six-month period compared to 1996. Organic growth (excluding acquisitions) was 3.9% for the quarter and 3.4% for the six months, driven by expanded product lines.
• Acquisition Impact: Significant growth was driven by acquisitions, including Weathertrol Supply Company (completed May 31, 1997), Comfort Products Distributing, Inc., and Central Plains Distributing, Inc. (March 1997).
• Profitability: Net income rose 49.5% for the quarter and 55.4% for the six months. Gross profit margins remained stable or improved slightly (22.1% to 22.6%) due to new vendor procurement programs lowering purchase costs.
• Expenses: Selling, general, and administrative (SG&A) expenses increased 58.8% for the quarter, largely due to the integration of acquired companies and startup costs for new branches. SG&A as a percentage of revenue increased from 15.6% to 16.1% for the quarter.
• Interest Expense: Decreased 27.6% for the quarter and 26.6% for the six months due to lower average borrowings.

Guidance, Outlook, and Risks

Outlook and Capital Resources: Management states that results for the interim period are not necessarily indicative of full-year results due to seasonality. The company has adequate capital from operations and a $260 million revolving credit agreement (amended August 8, 1997) to fund operations and acquisitions. The company is actively evaluating potential acquisitions.

Pending Transactions: The company has executed letters of intent for two additional acquisitions with aggregate annual revenues of approximately $170 million. Completion is subject to definitive agreements.

Risks and Contingencies:

• Seasonality: Revenue is heavily weighted toward the summer months (May-August).
• Debt Covenants: The revolving credit agreement contains financial covenants regarding net worth, interest coverage, and limits on capital expenditures and dividends.
• Acquisition Integration: Recent and pending acquisitions involve integration risks and higher initial cost structures.

Investor Verification Checklist

• Acquisition Accounting: Verify the purchase price allocation and goodwill amortization for the Weathertrol Supply Company acquisition ($3.0 million excess amortized over 40 years).
• Working Capital Usage: Confirm that the $85.2 million net proceeds from the February 1997 stock issuance were utilized as stated (paying down debt and funding acquisitions).
• Debt Capacity: Review the specific financial covenants in the new $260 million credit agreement to ensure compliance with net worth and coverage ratios.
• Pending Deals: Monitor the status of the two pending acquisitions totaling $170 million in revenue to assess future growth trajectory.
• Inventory Levels: Note the significant increase in inventory ($150.1 million vs. $87.6 million prior year-end) and verify that this aligns with seasonal demand and new branch stocking requirements.