10-Q
2020Q1--12-31falseWATSCO INC0000105016FL 0000105016 2020-01-01 2020-03-31 0000105016 2020-03-31 0000105016 2019-12-31 0000105016 2019-01-01 2019-03-31 0000105016 2019-03-31 0000105016 2018-12-31 0000105016 wso:CarrierAndItsAffiliatesMember us-gaap:SupplierConcentrationRiskMember us-gaap:CostOfGoodsTotalMember 2020-01-01 2020-03-31 0000105016 us-gaap:ForeignExchangeForwardMember us-gaap:CashFlowHedgingMember 2020-01-01 2020-03-31 0000105016 us-gaap:CommonStockMember 2020-01-01 2020-03-31 0000105016 us-gaap:CommonClassBMember 2020-01-01 2020-03-31 0000105016 wso:CarrierAndItsAffiliatesMember us-gaap:SupplierConcentrationRiskMember 2020-01-01 2020-03-31 0000105016 wso:ForeignExchangeForwardAndOptionContractsMember us-gaap:NotDesignatedAsHedgingInstrumentEconomicHedgeMember 2020-01-01 2020-03-31 0000105016 us-gaap:AccumulatedTranslationAdjustmentMember 2020-01-01 2020-03-31 0000105016 us-gaap:AccumulatedGainLossNetCashFlowHedgeParentMember 2020-01-01 2020-03-31 0000105016 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Table of Contents
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM
10-Q
 
 
Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Quarterly Period Ended March 31, 2020
or
Transition Report Pursuant To Section 13 or 15(d) of the Securities Exchange Act of 1934
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the Transition Period From
                    
to
                    
Commission file number
1-5581
I.R.S. Employer Identification Number
59-0778222
 
WATSCO, INC.
(a Florida Corporation)
 
 
 
 
 
2665 South Bayshore Drive, Suite 901
Miami, Florida 33133
Telephone: (305)
 714-4100
 
Securities registered pursuant to Section 12(b) of the Act:
         
Title of each class
 
Trading
 
Symbol(s)
 
Name of each exchange
 
on which registered
Common stock, $0.50 par value
 
WSO
 
New York Stock Exchange
Class B common stock, $0.50 par value
 
WSOB
 
New York Stock Exchange
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. 
 
   Yes  
    No  
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation
S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  
    No  
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company, or
 an
emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule
12b-2
of the Exchange Act.
             
Large accelerated filer
 
 
Accelerated filer
 
             
Non-accelerated
 filer
 
 
Smaller reporting company
 
             
 
 
Emerging growth company
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Exchange Act).    Yes 
    No 
The registrant’s common stock outstanding as of May 4, 2020 comprised (i) 32,758,823 shares of Common stock, $0.50 par value per share, excluding 4,823,988 treasury shares and (ii) 5,599,436 shares of Class B common stock, $0.50 par value per share, excluding 48,263 treasury shares. 
 
 

Table of Contents
WATSCO, INC. AND SUBSIDIARIES
 
QUARTERLY REPORT ON FORM
10-Q
TABLE OF CONTENTS
             
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
3
 
 
 
 
 
 
 
 
 
 
 
4
 
 
 
 
 
 
 
 
 
 
 
5
 
 
 
 
 
 
 
 
 
 
 
6
 
 
 
 
 
 
 
 
 
 
 
8
 
 
 
 
 
 
 
 
 
 
 
9
 
 
 
 
 
 
 
 
Item 2.
 
 
 
15
 
 
 
 
 
 
 
 
Item 3.
 
 
 
21
 
 
 
 
 
 
 
 
Item 4.
 
 
 
21
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 1.
 
 
 
22
 
 
 
 
 
 
 
 
Item 1A.
 
 
 
22
 
 
 
 
 
 
 
 
Item 2.
 
 
 
22
 
 
 
 
 
 
 
 
Item 6.
 
 
 
23
 
 
 
 
 
 
 
 
24
 
 
 
 
 
 
EXHIBITS
 
 
 
 
2 of 24

Table of Contents
PART I.
FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF INCOME
(In thousands, except per share data)
 
Quarters Ended March 31,
 
 
2020
   
2019
 
Revenues
 
$
1,008,156
 
  $
931,278
 
Cost of sales
 
 
760,541
 
   
697,518
 
                 
Gross profit
 
 
247,615
 
   
233,760
 
Selling, general and administrative expenses
 
 
203,386
 
   
180,072
 
Other income
 
 
1,014
 
   
1,444
 
                 
Operating income
 
 
45,243
 
   
55,132
 
Interest expense, net
 
 
790
 
   
776
 
                 
Income before income taxes
 
 
44,453
 
   
54,356
 
Income taxes
 
 
8,206
 
   
10,552
 
                 
Net income
 
 
36,247
 
   
43,804
 
Less: net income attributable to
non-controlling
interest
 
 
5,745
 
   
8,767
 
                 
Net income attributable to Watsco, Inc.
 
$
30,502
 
  $
35,037
 
                 
Earnings per share for Common and Class B common stock:
   
     
 
Basic and Diluted
 
$
0.72
 
  $
0.88
 
                 
See accompanying notes to condensed consolidated unaudited financial statements.
3
of
2
4

Table of Contents
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
                 
 
Quarters Ended March 31,
 
 
2020
   
2019
 
Net income
 
$
36,247
 
  $
43,804
 
Other comprehensive (loss) income, net of tax
   
     
 
Foreign currency translation adjustment
 
 
(21,929
)
 
   
5,005
 
Unrealized gain (loss) on cash flow hedging instruments arising during the period
 
 
2,534
     
(536
)
Reclassification of loss (gain) on cash flow hedging instruments into earnings
 
 
115
     
(274
)
                 
Other comprehensive (loss) income
 
 
(19,280
)
 
   
4,195
 
Comprehensive income
 
 
16,967
 
   
47,999
 
Less: comprehensive (loss) income attributable to non-controlling interest
 
 
(796
)
 
   
10,179
 
                 
Comprehensive income attributable to Watsco, Inc.
 
$
17,763
 
  $
37,820
 
                 
 
 
See accompanying notes to condensed consolidated unaudited financial statements.
4
of
2
4

Table of Contents
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
March 31,
2020
   
December 31,
2019
 
 
(Unaudited)
   
 
ASSETS
 
 
 
 
 
 
Current assets:
   
     
 
Cash and cash equivalents
 
$
51,236
 
  $
74,454
 
Accounts receivable, net
 
 
574,827
 
   
533,810
 
Inventories
 
 
942,815
 
   
920,786
 
Other current assets
 
 
21,501
 
   
17,680
 
                 
Total current assets
 
 
1,590,379
 
   
1,546,730
 
Property and equipment, net
 
 
97,443
 
   
98,523
 
Operating lease
right-of-use
assets
 
 
221,285
 
   
223,369
 
Goodwill
 
 
406,998
 
   
411,217
 
Intangible assets, net
 
 
160,736
 
   
172,004
 
Investment in unconsolidated entity
 
 
95,847
 
   
94,833
 
Other assets
 
 
9,141
 
   
9,485
 
                 
 
$
2,581,829
 
  $
2,556,161
 
                 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
Current liabilities:
   
     
 
Current portion of lease liabilities
 
$
69,344
 
  $
69,421
 
Accounts payable
 
 
311,586
 
   
239,666
 
Accrued expenses and other current liabilities
 
 
139,544
 
   
152,630
 
                 
Total current liabilities
 
 
520,474
 
   
461,717
 
                 
Long-term obligations:
   
     
 
Borrowings under revolving credit agreement
 
 
156,143
 
   
155,700
 
Operating lease liabilities, net of current portion
 
 
152,065
 
   
154,271
 
Finance lease liabilities, net of current portion
 
 
2,106
 
   
2,009
 
                 
Total long-term obligations
 
 
310,314
 
   
311,980
 
                 
Deferred income taxes and other liabilities
 
 
68,155
 
   
67,697
 
                 
Commitments and contingencies
   
     
 
Watsco, Inc. shareholders’ equity:
   
     
 
Common stock, $0.50 par value
 
 
18,789
 
   
18,768
 
Class B common stock, $0.50 par value
 
 
2,821
 
   
2,765
 
Preferred stock, $0.50 par value
 
 
 
   
 
Paid-in
capital
 
 
920,190
 
   
907,877
 
Accumulated other comprehensive loss, net of tax
 
 
(51,789
)
   
(39,050
)
Retained earnings
 
 
601,771
 
   
632,507
 
Treasury stock, at cost
 
 
(87,440
)
   
(87,440
)
                 
Total Watsco, Inc. shareholders’ equity
 
 
1,404,342
 
   
1,435,427
 
Non-controlling
interest
 
 
278,544
 
   
279,340
 
                 
Total shareholders’ equity
 
 
1,682,886
 
   
1,714,767
 
                 
 
$
2,581,829
 
  $
2,556,161
 
                 
See accompanying notes to condensed consolidated unaudited financial statements.
5
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24

Table of Contents
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF SHAREHOLDERS’ EQUITY
                                                                 
(In thousands, except
 
share and per share data)
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Shares
 
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Amount
 
 
Paid-In

Capital
 
 
Accumulated
Other
Comprehensive
Loss
 
 
Retained
Earnings
 
 
Treasury
Stock
 
 
Non-controlling

Interest
 
 
Total
 
Balance at December 31, 2019
 
 
38,194,056
 
 
$
21,533
 
 
$
907,877
 
 
$
(39,050
)
 
$
632,507
 
 
$
(87,440
)
 
$
279,340
 
 
$
1,714,767
 
Net income
   
 
     
 
     
 
     
 
     
30,502
     
 
     
5,745
     
36,247
 
Other comprehensive
(
loss
)
   
 
     
 
     
 
     
(12,739
   
 
     
 
     
(6,541
   
(19,280
Issuances of
non-vested
restricted shares of common stock
   
113,765
     
57
     
(57
)    
 
     
 
     
 
     
 
     
 
Common stock contribution to 401(k) plan
   
25,216
     
13
     
4,530
     
 
     
 
     
 
     
 
     
4,543
 
Stock issuances from exercise of stock options and employee stock purchase plan
   
18,674
     
9
     
2,532
     
 
     
 
     
 
     
 
     
2,541
 
Retirement of common stock
   
(4,828
)    
(2
)    
(789
)    
 
     
 
     
 
     
 
     
(791
)
Share-based compensation
   
 
     
 
     
6,097
     
 
     
 
     
 
     
 
     
6,097
 
Cash dividends declared and paid on Common and Class B common stock, $1.60 per share
   
 
     
 
     
 
     
 
     
(61,238
)    
 
     
 
     
(61,238
)
                                                                 
Balance at March 31, 2020
 
 
38,346,883
 
 
$
21,610
 
 
$
920,190
 
 
$
(51,789
)
 
$
601,771
 
 
$
(87,440
)
 
$
278,544
 
 
$
1,682,886
 
                                                                 
 
 
 
 
 
Continued on next page.
6
of
24

Table of Contents
                                                                 
(In thousands, except
 
share and per share data)
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Shares
 
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Amount
 
 
Paid-In

Capital
 
 
Accumulated
Other
Comprehensive
Loss
 
 
Retained
Earnings
 
 
Treasury
Stock
 
 
Non-controlling

Interest
 
 
Total
 
Balance at December 31, 2018
 
 
37,461,643
 
 
$
21,167
 
 
$
832,121
 
 
$
(45,968
)
 
$
627,969
 
 
$
(87,440
)
 
$
253,864
 
 
$
1,601,713
 
Net income
   
     
     
     
     
35,037
     
     
8,767
     
43,804
 
Other comprehensive income
   
     
     
     
2,783
     
     
     
1,412
     
4,195
 
Issuances of
non-vested
restricted shares of common stock
   
77,049
     
39
     
(39
)    
     
     
     
     
 
 
 
Forfeitures of
non-vested
restricted shares of common stock
   
(5,000
)    
(3
)    
3
     
     
     
     
     
 
 
 
Common stock contribution to 401(k) plan
   
30,715
     
15
     
4,259
     
     
     
     
     
4,274
 
Stock issuances from exercise of stock options and employee stock purchase plan
   
8,925
     
4
     
1,121
     
     
     
     
     
1,125
 
Retirement of common stock
   
(2,985
)    
(1
)    
(427
)    
     
     
     
     
(428
)
Share-based compensation
   
     
     
4,537
     
     
     
     
     
4,537
 
Cash dividends declared and paid on Common and Class B common stock, $1.60 per share
   
     
     
     
     
(59,965
)    
     
     
(59,965
)
                                                                 
Balance at March 31, 2019
 
 
37,570,347
 
 
$
21,221
 
 
$
841,575
 
 
$
(43,185
)
 
$
603,041
 
 
$
(87,440
)
 
$
264,043
 
 
$
1,599,255
 
                                                                 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
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Table of Contents
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
 
Quarters Ended March 31,
 
 
2020
   
2019
 
Cash flows from operating activities:
   
     
 
Net income
 
$
36,247
 
  $
43,804
 
Adjustments to reconcile net income to net cash provided by operating activities:
   
     
 
Depreciation and amortization
 
 
6,479
 
   
5,768
 
Share-based compensation
 
 
4,912
 
   
3,849
 
Non-cash contribution to 401(k) plan
 
 
4,543
 
   
4,274
 
Provision for doubtful accounts
 
 
2,005
 
   
1,406
 
Other income from investment in unconsolidated entity
 
 
(1,014
)
   
(1,444
)
Other, net
 
 
668
     
(221
)
Changes in operating assets and liabilities:
   
     
 
Accounts receivable
 
 
(46,534
)
   
(2,329
)
Inventories
 
 
(27,280
)
   
(55,560
)
Accounts payable and other liabilities
 
 
66,049
 
   
55,350
 
Other, net
 
 
(4,216
)
   
(1,961
)
                 
Net cash provided by operating activities
 
 
41,859
 
   
52,936
 
                 
Cash flows from investing activities:
   
     
 
Capital expenditures
 
 
(3,859
)
   
(4,132
)
Proceeds from sale of property and equipment
 
 
10
 
   
29
 
                 
Net cash used in investing activities
 
 
(3,849
)
   
(4,103
)
                 
Cash flows from financing activities:
   
     
 
Dividends on Common and Class B common stock
 
 
(61,238
)
   
(59,965
)
Repurchases of common stock to satisfy employee withholding tax obligations
 
 
(791
)
   
(428
)
Net repayments of long-term obligations
 
 
(343
)
   
(230
)
Proceeds from short-term borrowings
 
 
 
   
2,340
 
Net proceeds under revolving credit agreement
 
 
443
 
   
2,300
 
Net proceeds from issuances of common stock
 
 
2,541
 
   
1,127
 
                 
Net cash used in financing activities
 
 
(59,388
)
   
(54,856
)
                 
Effect of foreign exchange rate changes on cash and cash equivalents
 
 
(1,840
)
 
   
402
 
                 
Net decrease in cash and cash equivalents
 
 
(23,218
)
   
(5,621
)
Cash and cash equivalents at beginning of period
 
 
74,454
 
   
82,894
 
                 
Cash and cash equivalents at end of period
 
$
51,236
 
  $
77,273
 
                 
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
March 31, 2020
(In thousands, except share and per share data)
1.
BASIS OF PRESENTATION
Basis of Consolidation
Watsco, Inc. (collectively with its subsidiaries, “Watsco,” “we,” “us,” or “our”) was incorporated in Florida in 1956 and is the largest distributor of air conditioning, heating and refrigeration equipment and related parts and supplies (“HVAC/R”) in the HVAC/R distribution industry in North America. The accompanying March 31, 2020 interim condensed consolidated unaudited financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, but we believe the disclosures made are adequate to make the information presented not misleading. In the opinion of management, all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation have been included in the condensed consolidated unaudited financial statements included herein. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2019 Annual Report on Form
10-K.
The condensed consolidated unaudited financial statements contained in this report include the accounts of Watsco, all of its wholly owned subsidiaries and the accounts of three joint ventures with Carrier Global Corporation (“Carrier”), in each of which Watsco maintains a controlling interest. All significant intercompany balances and transactions have been eliminated in consolidation.
The results of operations for the quarter ended March 31, 2020 are not necessarily indicative of the results to be expected for the year ending December 31, 2020. Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal. Furthermore, profitability can be impacted favorably or unfavorably based on weather patterns, particularly during
the
Summer and Winter selling seasons. Demand related to the residential central air conditioning replacement market is typically highest in the second and third quarters, and demand for heating equipment is usually highest in the fourth quarter. Demand related to the new construction sectors throughout most of the markets we serve tends to be fairly evenly distributed throughout the year and depends largely on housing completions and related weather and economic conditions.
Use of Estimates
The preparation of condensed consolidated unaudited financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated unaudited financial statements and the reported amounts of revenues and expenses for the reporting period. Significant estimates include valuation reserves for accounts receivable, net realizable value adjustments to inventories, valuation reserve
s
for income taxes, reserves related to loss contingencies and the valuation of goodwill, indefinite-lived intangible assets and long-lived assets. While we believe that these estimates are reasonable, actual results could differ from such estimates.
Impact of
COVID-19
Pandemic
A novel strain of coronavirus,
COVID-19,
surfaced in December 2019 and has spread around the world, including to the United States In March 2020, the World Health Organization declared
COVID-19
a pandemic. The
COVID-19
pandemic has resulted, and is likely to continue to result, in significant economic disruption and has and will likely adversely affect our business and results of operations. Although these disruptions are expected to be temporary, significant uncertainty exists concerning the magnitude of the impact and duration of the
COVID-19
pandemic. As we cannot predict the duration or scope of the
COVID-19
pandemic, the anticipated negative financial impact to our results of operations cannot be reasonably estimated but could be material and last for an extended period of time.
Recently Adopted Accounting Standards
Financial Instruments—Credit Losses
In June 2016, the
Financial Accounting Standards Board (“FASB”) issued guidance that modifies the impairment model to utilize an expected loss methodology in place of the incurred loss methodology for financial instruments, including trade receivables, contract assets, long-term receivables and
off-balance
sheet credit exposures. Under the new standard, an entity will be required to consider a broader range of information to estimate expected credit losses, including historical information, current conditions and a reasonable forecast period, which may result in earlier recognition of certain losses. This guidance is effective for interim and annual periods beginning after December 15, 2019 using a modified retrospective approach. The adoption of this guidance did not have a material impact on our consolidated financial statements.
 
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Intangibles—Goodwill and Other
In January 2017, the FASB issued guidance to simplify the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this updated standard, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity also should consider income tax effects from any
tax-deductible
goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if any. This guidance is effective prospectively and is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted. The adoption of this guidance did not have a material impact on our consolidated financial statements.
 
2
.
REVENUES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Disaggregation of Revenues
The following table presents our revenues disaggregated by primary geographical regions and major product lines within our single reporting segment:
                 
Quarters Ended March 31,
 
2020
 
 
2019
 
Primary Geographical Regions:
 
 
 
 
 
 
United States
 
$
899,545
 
  $
806,511
 
Canada
 
 
55,341
 
   
59,256
 
Latin America and the Caribbean
 
 
53,270
 
   
65,511
 
                 
 
$
1,008,156
 
  $
931,278
 
                 
Major Product Lines:
 
 
 
 
 
 
HVAC equipment
 
 
66
%
   
67
%
Other HVAC products
 
 
30
%
   
29
%
Commercial refrigeration products
 
 
4
%
   
4
%
                 
 
 
100
%
 
 
100
%
                 
 
 
 
 
 
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3
.
EARNINGS PER SHARE
The following table presents the calculation of basic and diluted earnings per share for our Common and Class B common stock:
                 
Quarters Ended March 31,
 
2020
 
 
2019
 
Basic Earnings per Share:
 
 
 
 
 
 
Net income attributable to Watsco, Inc. shareholders
 
$
30,502
 
  $
35,037
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
 
 
5,233
 
   
4,924
 
                 
Earnings allocated to Watsco, Inc. shareholders
 
$
25,269
 
  $
30,113
 
                 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
 
 
34,995,048
 
   
34,388,117
 
 
 
 
 
 
 
 
 
 
Basic earnings per share for Common and Class B common stock
 
$
0.72
 
  $
0.88
 
Allocation of earnings for Basic:
   
     
 
Common stock
 
$
23,409
 
  $
27,856
 
Class B common stock
 
 
1,860
 
   
2,257
 
                 
 
$
25,269
 
  $
30,113
 
                 
Diluted Earnings per Share:
 
 
 
 
 
 
Net income attributable to Watsco, Inc. shareholders
 
$
30,502
 
  $
35,037
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
 
 
5,233
 
   
4,924
 
                 
Earnings allocated to Watsco, Inc. shareholders
 
$
25,269
 
  $
30,113
 
                 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
 
 
34,995,048
 
   
34,388,117
 
Effect of dilutive stock options
 
 
28,941
 
   
14,485
 
                 
Weighted-average common shares outstanding – Diluted
 
 
35,023,989
 
   
34,402,602
 
                 
 
 
 
 
 
 
 
 
 
Diluted earnings per share for Common and Class B common stock
 
$
0.72
 
  $
0.88
 
 
 
 
 
 
 
 
 
 
Anti-dilutive stock options not included above
 
 
164,130
 
   
322,584
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted earnings per share for our Common stock assumes the conversion of all
of
our Class B common stock into Common stock as of the beginning of the fiscal year; therefore, no allocation of earnings to Class B common stock is required. At March 31, 2020 and 2019, our outstanding Class B common stock was convertible into 2,575,740 and 2,577,875 shares of our Common stock, respectively.
 
4.
OTHER COMPREHENSIVE (LOSS) INCOME
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income consists of the foreign currency translation adjustment associated with our Canadian operations’ use of the Canadian dollar as their functional currency and changes in the unrealized gains (losses) on cash flow hedging instruments. The tax effects allocated to each component of other comprehensive (loss) income were as follows:
                 
Quarters Ended March 31,
 
2020
 
 
2019
 
Foreign currency translation adjustment
 
$
(21,929
)
 
  $
5,005
 
 
 
 
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging instruments
 
 
3,473
     
(735
)
Income tax (expense) benefit
 
 
(939
)
 
   
199
 
                 
Unrealized gain (loss) on cash flow hedging instruments, net of tax
 
 
2,534
     
(536
)
                 
 
 
 
 
 
 
 
 
 
Reclassification of loss (gain) on cash flow hedging instruments into earnings
 
 
157
     
(375
)
Income tax (benefit) expense
 
 
(42
)
 
   
101
 
                 
Reclassification of loss (gain) on cash flow hedging instruments into earnings, net of tax
 
 
115
     
(274
)
                 
 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income
 
$
(19,280
)
 
  $
4,195
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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The changes in each component of accumulated other comprehensive loss, net of tax, were as follows:
                 
Quarters Ended March 31,
 
2020
 
 
2019
 
Foreign currency translation adjustment:
   
     
 
Beginning balance
 
$
 
(38,599
)
  $
(46,604
)
Current period other comprehensive (loss) income
 
 
(14,328
)
 
   
3,269
 
                 
Ending balance
 
 
(52,927
)
   
(43,335
)
                 
Cash flow hedging instruments:
   
     
 
Beginning balance
 
 
(451
)
 
   
636
 
Current period other comprehensive
income
(loss)
 
 
1,520
     
(322
)
Reclassification adjustment
 
 
69
     
(164
)
                 
Ending balance
 
 
1,138
 
   
150
 
                 
Accumulated other comprehensive loss, net of tax
 
$
(51,789
)
  $
(43,185
)
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
5
.
DERIVATIVES
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
We enter into foreign currency forward and option contracts to offset the earnings impact that foreign exchange rate fluctuations would otherwise have on certain monetary liabilities that are denominated in nonfunctional currencies.
Cash Flow Hedging Instruments
We enter into foreign currency forward contracts that are designated as cash flow hedges. The settlement of these derivatives results in reclassifications from accumulated other comprehensive loss to earnings for the period in which the settlement of these instruments occurs. The maximum period for which we hedge our cash flow using these instruments is 12 months. Accordingly, at March 31, 2020, all
of
our open foreign currency forward contracts had maturities of one year or less. The total notional value of our foreign currency exchange contracts designated as cash flow hedges at March 31, 2020 was $48,200, and such contracts have varying terms expiring through December 2020.
The impact from foreign exchange derivative instruments designated as cash flow hedges was as follows:
                 
Quarters Ended March 31,
 
2020
 
 
2019
 
Gain (loss) recorded in accumulated other comprehensive loss
 
$
3,473
    $
(735
)
Loss (gain) reclassified from accumulated other comprehensive loss into earnings
 
$
157
    $
(375
)
 
 
 
 
 
At March 31, 2020, we expected an estimated $2,597
pre-tax
gain to be reclassified into earnings to reflect the fixed prices obtained from foreign exchange hedging within the next 12 months.
Derivatives Not Designated as Hedging Instruments
We have also entered into foreign currency forward and option contracts that are either not designated as hedges or did not qualify for hedge accounting. These derivative instruments were effective economic hedges for all the periods presented. The fair value gains and losses on these contracts are recognized in earnings as a component of selling, general and administrative expenses. The total notional value of our foreign currency exchange contracts not designated as hedging instruments at March 31,
2020
was $4,900,
and such contracts subsequently expired during April 2020.
We recognized a gain (loss)
of $829 and $
(
113
)
from foreign currency forward and option contracts not designated as hedging instruments in our condensed consolidated unaudited statements of income for the quarters ended March 31,
2020
and
2019
, respectively.
The following table summarizes the fair value of derivative instruments, which consist solely of foreign exchange contracts, included in other current assets and accrued expenses and other current liabilities in our condensed consolidated unaudited balance sheets.
See Note
6
.
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Asset Derivatives
   
Liability Derivatives
 
 
March 31, 2020
 
 
December 31, 2019
 
 
March 31, 2020
 
 
December 31, 2019
 
Derivatives designated as hedging instruments
 
$
2,604
 
  $
—  
   
$
56
 
  $
944
 
Derivatives not designated as hedging instruments
 
 
122
 
   
—  
   
 
4
 
   
63
 
                                 
Total derivative instruments
 
$
2,726
 
  $
—  
   
$
60
 
  $
1,007
 
                                 
 
 
 
 
6
.
FAIR VALUE MEASUREMENTS
The following tables present our assets and liabilities carried at fair value that are measured on a recurring basis:
                                         
 
Balance Sheet Location
 
 
Total
 
 
Fair Value Measurements
at March 31, 2020 Using
 
Level 1
 
 
Level 2
 
 
Level 3
 
Assets:
   
   
 
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments
   
Other current assets
   
$
2,726
 
 
$
 
 
$
2,726
 
 
$
 
Equity securities
   
Other assets
   
$
269
 
 
$
269
 
 
$
 
 
$
 
Liabilities:
   
   
 
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments
   
Accrued expenses and other current liabilities
   
$
60
 
 
$
 
 
$
60
 
 
$
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
                                         
 
Balance Sheet Location
 
 
Total
 
 
Fair Value Measurements
at December 31, 2019 Using
 
Level 1
 
 
Level 2
 
 
Level 3
 
Assets:
   
     
     
     
     
 
Equity securities
   
Other assets
    $
402
    $
402
    $
—  
    $
 —  
 
Liabilities:
   
     
     
     
     
 
Derivative financial instruments
   
Accrued expenses and other current liabilities
    $
1,007
    $
 —  
    $
1,007
    $
 —  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The following is a description of the valuation techniques used for these assets and liabilities, as well as the level of input used to measure fair value:
Equity securities
– these investments are exchange-traded equity securities. Fair values for these investments are based on closing stock prices from active markets and are therefore classified within Level 1 of the fair value hierarchy.
Derivative financial instruments
– these derivatives are foreign currency forward and option contracts. See Note
5
. Fair value is based on observable market inputs, such as forward rates in active markets; therefore, we classify these derivatives within Level 2 of the valuation hierarchy.
7
.
SHAREHOLDERS’ EQUITY
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Stock Dividends
We paid cash dividends of $1.60
per share of both Common stock and Class B common stock during both the quarters
ended March 31, 2020 and 2019.
Non-Vested
Restricted Stock
During the quarter ended March 31, 2020, 4,828 shares of Common and Class B common stock with an aggregate fair market value of $791 were withheld as payment in lieu of cash to satisfy tax withholding obligations in connection with the vesting of restricted stock. These shares were retired upon delivery. During the quarter ended March 31, 2019, 2,985 shares of Common and Class B common stock with an aggregate fair market value of $428 were withheld as payment in lieu of cash to satisfy tax withholding obligations in connection with the vesting of restricted stock. These shares were retired upon delivery.
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Exercise of Stock Options
Cash received from the exercise of stock options during the quarters ended
March 31, 2020 and 2019 was $2,188 and $717, respectively.
Employee Stock Purchase Plan
During the quarters ended March 31, 2020 and 2019, we received net proceeds of $353 and $410,
respectively, for shares of our Common stock purchased under our employee stock purchase plan.
 
8
.
COMMITMENTS AND CONTINGENCIES
Litigation, Claims and Assessments
We are involved in litigation incidental to the operation of our business. We vigorously defend all matters in which we or our subsidiaries are named defendants and, for insurable losses, maintain significant levels of insurance to protect against adverse judgments, claims or assessments that may affect us. Although the adequacy of existing insurance coverage and the outcome of any legal proceedings cannot be predicted with certainty, based on the current information available, we do not believe the ultimate liability associated with any known claims or litigation will have a material adverse effect on our financial condition or results of operations.
Self-Insurance
Self-insurance reserves are maintained relative to company-wide casualty insurance and health benefit programs. The level of exposure from catastrophic events is limited by the purchase of stop-loss and aggregate liability reinsurance coverage. When estimating the self-insurance liabilities and related reserves, management considers a number of factors, which include historical claims experience, demographic factors, severity factors, and valuations provided by independent third-party actuaries. Management reviews its assumptions with its independent third-party actuaries to evaluate whether the self-insurance reserves are adequate. If actual claims or adverse development of loss reserves occur and exceed these estimates, additional reserves may be required. Reserves in the amounts of $3,809 and $3,062 at March 31, 2020 and December 31, 2019, respectively, were established related to such programs and are included in accrued expenses and other current liabilities in our condensed consolidated unaudited balance sheets.
9
.
RELATED PARTY TRANSACTIONS
Purchases from Carrier and its affiliates comprised 57% and 61% of all inventory purchases made during the quarters ended March 31, 2020 and 2019, respectively. At March 31, 2020 and December 31, 2019, approximately $125,000 and $86,000, respectively, was payable to Carrier and its affiliates, net of receivables. Our joint ventures with Carrier also sell HVAC products to Carrier and its affiliates. Revenues in our condensed consolidated unaudited statements of income for the quarters ended March 31, 2020 and 2019 included approximately $22,000 and $21,000, respectively, of sales to Carrier and its affiliates. We believe these transactions are conducted on terms equivalent to an
arm’s-length
basis in the ordinary course of business.
10.
SUBSEQUENT EVENTS
On April 3, 2020, United Technologies Corporation completed the
spin-off
of Carrier Corporation into an independent, publicly traded company, now named Carrier Global Corporation (NYSE: CARR).
On April 10, 2020, we increased the aggregate borrowing capacity of our unsecured syndicated multicurrency revolving credit agreement from $500,000 to $560,000.
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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
This Quarterly Report on Form
10-Q
contains or incorporates by reference statements that are not historical in nature and that are intended to be, and are hereby identified as, “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Statements which are not historical in nature, including the words “anticipate,” “estimate,” “could,” “should,” “may,” “plan,” “seek,” “expect,” “believe,” “intend,” “target,” “will,” “project,” “focused,” “outlook,” “goal,” “designed,” and variations of these words and negatives thereof and similar expressions are intended to identify forward-looking statements, including statements regarding, among others, (i) economic conditions, (ii) business and acquisition strategies, (iii) potential acquisitions and/or joint ventures and investments in unconsolidated entities, (iv) financing plans, and (v) industry, demographic and other trends affecting our financial condition or results of operations. These forward-looking statements are based on management’s current expectations, are not guarantees of future performance and are subject to a number of risks, uncertainties, and changes in circumstances, certain of which are beyond our control. Actual results could differ materially from these forward-looking statements as a result of several factors, including, but not limited to:
  general economic conditions, both in the United States and in the international markets we serve;
 
  competitive factors within the HVAC/R industry;
 
  effects of supplier concentration;
 
  fluctuations in certain commodity costs;
 
  consumer spending;
 
  consumer debt levels;
 
  the impact of
COVID-19
pandemic;
 
  new housing starts and completions;
 
  capital spending in the commercial construction market;
 
  access to liquidity needed for operations;
 
  seasonal nature of product sales;
 
  weather patterns and conditions;
 
  insurance coverage risks;
 
  federal, state, and local regulations impacting our industry and products;
 
  prevailing interest rates;
 
  foreign currency exchange rate fluctuations;
 
  international risk;
 
  cybersecurity risk; and
 
  the continued viability of our business strategy.
 
We believe these forward-looking statements are reasonable; however, you should not place undue reliance on any forward-looking statements, which are based on current expectations. For additional information regarding important factors that may affect our operations and could cause actual results to vary materially from those anticipated in the forward-looking statements, please see the discussion below under Impact of
COVID-19
Pandemic, Item 1A “Risk Factors” contained in Part II of this Quarterly Report on this Form
10-Q
and Item 1A “Risk Factors” of our Annual Report on Form
10-K
for the year ended December 31, 2019, as well as the other documents and reports that we file with the SEC. Forward-looking statements speak only as of the date the statements were made. We assume no obligation to update forward-looking information or the discussion of such risks and uncertainties to reflect actual results, changes in assumptions, or changes in other factors affecting forward-looking information, except as required by applicable law. We qualify any and all of our forward-looking statements by these cautionary factors.
The following information should be read in conjunction with the condensed consolidated unaudited financial statements, including the notes thereto, included under Part I, Item 1 of this Quarterly Report on Form
10-Q.
In addition, reference should be made to our audited consolidated financial statements and notes thereto, and related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form
10-K
for the year ended December 31, 2019.
Company Overview
Watsco, Inc. was incorporated in Florida in 1956, and, together with its subsidiaries (collectively, “Watsco,” or “we,” “us,” or “our”) is the largest distributor of air conditioning, heating, and refrigeration equipment, and related parts and supplies (“HVAC/R”) in the HVAC/R distribution industry in North America. At March 31, 2020, we operated from 603 locations in 38 U.S. States, Canada, Mexico, and Puerto Rico with additional market coverage on an export basis to portions of Latin America and the Caribbean.
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Revenues primarily consist of sales of air conditioning, heating, and refrigeration equipment, and related parts and supplies. Selling, general and administrative expenses primarily consist of selling expenses, the largest components of which are salaries, commissions, and marketing expenses that are variable and correlate to changes in sales. Other significant selling, general and administrative expenses relate to the operation of warehouse facilities, including a fleet of trucks and forklifts, and facility rent, a majority of which we operate under
non-cancelable
operating leases.
Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal. Furthermore, profitability can be impacted favorably or unfavorably based on weather patterns, particularly during the Summer and Winter selling seasons. Demand related to the residential central air conditioning replacement market is typically highest in the second and third quarters, and demand for heating equipment is usually highest in the fourth quarter. Demand related to the new construction sectors throughout most of the markets we serve tends to be fairly evenly distributed throughout the year and depends largely on housing completions and related weather and economic conditions.
Impact of
COVID-19
Pandemic
A novel strain of coronavirus,
COVID-19,
surfaced in December 2019 and has spread around the world, including to the United States. In March 2020, the World Health Organization declared
COVID-19
a pandemic. The
COVID-19
pandemic has resulted, and is likely to continue to result, in significant economic disruption and has and will likely continue to adversely affect our business and results of operations. As of the date of this filing, significant uncertainty exists concerning the magnitude of the impact and duration of the
COVID-19
pandemic. A few of our locations experienced short-term closures for
COVID-19
employee health concerns or are operating at a diminished capacity, which impacted sales during the quarter and through the date of this filing and may negatively impact sales until the
COVID-19
pandemic moderates. As of the date of this filing, while all of our locations currently continue to operate, we have restricted public access to our branches and have instituted contactless sales and servicing capabilities to safeguard our employees and customers.
COVID-19
related factors that have impacted, or may negatively impact, sales, gross margin and other results of operations in the future include, but are not limited to: limitations on the ability of our suppliers to manufacture, or procure from manufacturers, the products we sell, or to meet delivery requirements and commitments; limitations on the ability of our employees to perform their work due to illness or other disruptions caused by the pandemic, including local, state, or federal orders requiring employees to remain at home; limitations on the ability of carriers to deliver our products to customers; limitations on the ability of our customers to conduct their businesses and purchase our products; and limitations on the ability of our customers to pay us on a timely basis. Moreover, the
COVID-19
pandemic could alter the mix of our business due to a shift in consumer demand towards repair of equipment rather than replacement, as well as changes in our sales mix toward value-oriented equipment and lower demand and/or disruption to new construction and commercial markets, which would result in a reduction in our sales and consequential gross margin.
In response to the pandemic, we are implementing modifications to preserve adequate liquidity and ensure that our business can continue to operate during this uncertain time. Certain states have issued executive orders requiring that all workers remain at home unless their work is critical, essential, or life-sustaining. We believe that, based on the various standards published to date, the work our employees are performing is essential.
With respect to liquidity, our balance sheet remains strong with cash of $51.2 million, debt of $156.1 million and shareholders’ equity of $1.7 billion at March 31, 2020. In April 2020, we increased our borrowing capacity under our existing revolving credit facility from $500.0 million to $560.0 million with no change to pricing or terms. Our quarterly dividend plans remain currently unchanged, most recently $1.775 per share. Future dividends and/or changes in dividend rates are at the sole discretion of the Board of Directors and depend upon factors including, but not limited to, cash flow generated by operations, profitability, financial condition, cash requirements, and future prospects. During these uncertain times, we believe that our scale, our current low debt-level, conservative leverage ratio, and our historical ability to generate cash flow positions us well as we work through the impacts of the
COVID-19
pandemic.
In addition, we have taken actions to reduce costs, including reductions in fixed-cost compensation, rent abatement, changes to vendor terms and various austerity measures to curtail discretionary spending in light of the circumstances. Other variable costs, including hourly wages, overtime, sales commissions, temporary labor, performance-based compensation, advertising, and delivery expenses are expected to moderate consistent with our overall business activity.
The full impact of the
COVID-19
pandemic on our financial condition and results of operations will depend on future developments, such as the ultimate duration and scope of the pandemic, its impact on our customers and suppliers, how quickly normal economic conditions and operations resume and whether the pandemic exacerbates other risks disclosed in Item 1A “Risk Factors” of our Annual Report on Form
10-K
for the year ended December 31, 2019. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders.
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Table of Contents
Joint Ventures with Carrier Global Corporation
On April 3, 2020, United Technologies Corporation completed the
spin-off
of Carrier Corporation into an independent, publicly traded company, named Carrier Global Corporation (“Carrier”).
In 2009, we formed a joint venture with Carrier, which we refer to as Carrier Enterprise I, in which Carrier contributed 95 of its company-owned locations in 13 Sun Belt states and Puerto Rico, and its export division in Miami, Florida, and we contributed 15 locations that distributed Carrier products. We have an 80% controlling interest in Carrier Enterprise I, and Carrier has a 20%
non-controlling
interest. On August 1, 2019, Carrier Enterprise I acquired substantially all of the HVAC assets and assumed certain of the liabilities of Peirce-Phelps, Inc. (“PPI”), an HVAC distributor operating from 19 locations in Pennsylvania, New Jersey, and Delaware.
In 2011, we formed a second joint venture with Carrier, in which Carrier contributed 28 of its company-owned locations in the Northeast U.S., and we contributed 14 locations in the Northeast U.S., and we then purchased Carrier’s distribution operations in Mexico, which included seven locations. Collectively, the Northeast locations and the Mexico operations are referred to as Carrier Enterprise II. We have an 80% controlling interest in Carrier Enterprise II, and Carrier has a 20%
non-controlling
interest. Effective May 31, 2019, we purchased an additional 20% ownership interest in Homans Associates II LLC (“Homans”) from Carrier Enterprise II, following which we owned 100% of Homans. Homans previously operated as a division of Carrier Enterprise II and now operates as one of our stand-alone, wholly owned subsidiaries.
In 2012, we formed a third joint venture, which we refer to as Carrier Enterprise III, with Carrier. Carrier contributed 35 of its company-owned locations in Canada to Carrier Enterprise III. We have a 60% controlling interest in Carrier Enterprise III, and Carrier has a 40%
non-controlling
interest.
Critical Accounting Policies
Management’s discussion and analysis of financial condition and results of operations is based upon the condensed consolidated unaudited financial statements included in this Quarterly Report on Form
10-Q,
which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these condensed consolidated unaudited financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated