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Watsco Inc. (WSO - Analyst Report) reported fourth quarter 2012 adjusted EPS of 41 cents, up 5% from the year-ago quarter earnings of 39 cents, but missing the Zacks Consensus Estimate of 47 cents. Including one-time items, EPS in the quarter stood at 4 cents compared with 39 cents in the prior-year quarter.

Total revenue increased 19% to a record $765.5 billion, ahead of the Zacks Consensus Estimate of $744 million. Same-store sales increased 7%, including a 5% jump in air conditioning and heating (HVAC) equipment, a 31% surge in commercial refrigeration products and 5% increase in sales of other HVAC products.
Cost and Margins
Cost of sales increased 20% to $582.7 million in the quarter. Gross profit was up 14% to a record $182.8 million. However, gross profit margin dropped 100 basis points (bps) to 23.9%.
Selling, general and administrative expenses rose 16% to $149.4 million in the quarter. Income from operations increased 3% to record $33 million. Operating margin increased 60 basis points to 4.4%.
Fiscal 2012 Performance
Watsco reported adjusted EPS of $3.03, up 11% from $2.74 in 2011 but shy of the Zacks Consensus Estimate of $3.06. Including one-time items, EPS in 2012 was $2.70, down 1% from $2.74 in 2011.
Total revenue increased 15% to a record $3.43 billion, ahead of the Zacks Consensus Estimate of $3.41 billion. Same-store sales increased 4%, including a 5% rise in air conditioning and heating (HVAC) equipment and 211% surge in commercial refrigeration products, while sales of other HVAC products dropped 2%.
Financial Operations
Cash and cash equivalents were $74 million as of Dec 31, 2012, compared with $15.7 million as of Dec 31, 2011. For the year, operating cash flow was record $173 million. Debt-to-capitalization ratio increased to 24% as of Dec 31, 2012 from 2% as of Dec 31, 2011.
Watsco paid $256 million in dividends in 2012. Earlier, in October, Watsco’s board of directors announced a special cash dividend of $5.00 per share. In Jan 2013, Watsco announced it established a regular quarterly dividend rate of 25 cents per share. 
Our Take
Watsco continues to increase its presence in the international markets, which currently contributes 16% of its total sales. This is expected to be an important growth driver for Watsco in the long term.
Domestically, the company witnessed growth in both residential and commercial product segments. Residential unit growth was especially strong in the fourth quarter and that the momentum is expected to continue in 2013 as well.
Watsco has immense potential in the replacement market of air conditioners and heating systems in the U.S, as nearly 89 million of them are more than 10 years old. Backed by its solid balance sheet, Watsco can continue to increase its dividend and make additional investments going forward. Watsco also stands to benefit from a recovery in the housing market.
Watsco’s business is subject to federal, state and local laws and regulations relating to the storage, handling, transportation and release of hazardous materials into the environment. These laws and regulations include the Clean Air Act, relating to minimum energy efficiency standards of HVAC systems and the production, servicing and disposal of certain ozone-depleting refrigerants used in such systems.
Watsco currently retains a short-term Zacks Rank #4 (Sell). Watsco’s peer Lennox International, Inc. (LII - Snapshot Report) reported fourth quarter adjusted EPS of 56 cents compared with 55 cents in the prior year quarter. AAON Inc. and Comfort Systems USA Inc. (FIX - Snapshot Report) are yet to announce their fourth quarter results.

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