WATSCO INC
10-Ks and 10-Qs
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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
(a Florida Corporation)
Telephone: (305 ) 714-4100
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class |
Trading |
Name of each exchange | ||
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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 Yes
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). ☒
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.| |
☒ |
Accelerated filer |
☐ | |||
| Non-accelerated filer |
☐ |
Smaller reporting company |
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| Emerging growth company |
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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.
WATSCO, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM
10-Q
TABLE OF CONTENTS
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| Item 3. |
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| Item 1. |
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| Item 1A. |
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| Item 2. |
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| Item 6. |
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| 24 |
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| EXHIBITS |
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2 of 24
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, |
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2020 |
2019 |
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Revenues |
$ |
$ | ||||||
Cost of sales |
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Gross profit |
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Selling, general and administrative expenses |
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Other income |
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Operating income |
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Interest expense, net |
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Income before income taxes |
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Income taxes |
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Net income |
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Less: net income attributable to non-controlling interest |
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Net income attributable to Watsco, Inc. |
$ |
$ | ||||||
Earnings per share for Common and Class B common stock: |
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Basic and Diluted |
$ |
$ | ||||||
See accompanying notes to condensed consolidated unaudited financial statements.
3
of 2
4 WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
| Quarters Ended March 31, |
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| 2020 |
2019 |
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| Net income |
$ |
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$ | |
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| Other comprehensive (loss) income, net of tax |
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| Foreign currency translation adjustment |
( |
) |
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| Unrealized gain (loss) on cash flow hedging instruments arising during the period |
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( |
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| Reclassification of loss (gain) on cash flow hedging instruments into earnings |
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( |
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| Other comprehensive (loss) income |
( |
) |
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| Comprehensive income |
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| Less: comprehensive (loss) income attributable to non-controlling interest |
( |
) |
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| Comprehensive income attributable to Watsco, Inc. |
$ |
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$ | |
||||
See accompanying notes to condensed consolidated unaudited financial statements.
4
of 2
4 WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
March 31, 2020 |
December 31, 2019 |
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(Unaudited) |
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ASSETS |
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Current assets: |
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Cash and cash equivalents |
$ |
$ | ||||||
Accounts receivable, net |
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Inventories |
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Other current assets |
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Total current assets |
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Property and equipment, net |
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Operating lease right-of-use assets |
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Goodwill |
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Intangible assets, net |
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Investment in unconsolidated entity |
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Other assets |
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$ |
$ | |||||||
LIABILITIES AND SHAREHOLDERS’ EQUITY |
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Current liabilities: |
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Current portion of lease liabilities |
$ |
$ | ||||||
Accounts payable |
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Accrued expenses and other current liabilities |
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Total current liabilities |
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Long-term obligations: |
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Borrowings under revolving credit agreement |
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Operating lease liabilities, net of current portion |
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Finance lease liabilities, net of current portion |
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Total long-term obligations |
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Deferred income taxes and other liabilities |
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Commitments and contingencies |
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Watsco, Inc. shareholders’ equity: |
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Common stock, $ |
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Class B common stock, $ |
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Preferred stock, $ |
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Paid-in capital |
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Accumulated other comprehensive loss, net of tax |
( |
) |
( |
) | ||||
Retained earnings |
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Treasury stock, at cost |
( |
) |
( |
) | ||||
Total Watsco, Inc. shareholders’ equity |
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Non-controlling interest |
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Total shareholders’ equity |
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$ |
$ | |||||||
See accompanying notes to condensed consolidated unaudited financial statements.
5
of 24
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF SHAREHOLDERS’ EQUITY
| (In thousands, except |
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 |
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| Balance at December 31, 2019 |
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$ |
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$ |
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$ |
( |
) |
$ |
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$ |
( |
) |
$ |
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$ |
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| Net income |
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| Other comprehensive ( loss ) |
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( |
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| Issuances of non-vested restricted shares of common stock |
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( |
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— |
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| Common stock contribution to 401(k) plan |
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| Stock issuances from exercise of stock options and employee stock purchase plan |
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| Retirement of common stock |
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| Share-based compensation |
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| Cash dividends declared and paid on Common and Class B common stock, $ |
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( |
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| Balance at March 31, 2020 |
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$ |
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$ |
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$ |
( |
) |
$ |
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$ |
( |
) |
$ |
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$ |
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Continued on next page.
6
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| (In thousands, except |
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 |
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| Balance at December 31, 2018 |
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$ |
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$ |
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$ |
( |
) |
$ |
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$ |
( |
) |
$ |
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$ |
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| Net income |
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| Other comprehensive income |
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| Issuances of non-vested restricted shares of common stock |
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( |
) | — |
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| Forfeitures of non-vested restricted shares of common stock |
( |
) | ( |
) | |
— |
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| Common stock contribution to 401(k) plan |
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| Stock issuances from exercise of stock options and employee stock purchase plan |
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| Retirement of common stock |
( |
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) | ( |
) | ( |
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| Share-based compensation |
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| Cash dividends declared and paid on Common and Class B common stock, $ |
( |
) | ( |
) | ||||||||||||||||||||||||||||
| Balance at March 31, 2019 |
|
$ |
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$ |
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$ |
( |
) |
$ |
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$ |
( |
) |
$ |
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$ |
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See accompanying notes to consolidated financial statements.
7
of 24
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
Quarters Ended March 31, |
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2020 |
2019 |
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Cash flows from operating activities: |
||||||||
Net income |
$ |
$ | ||||||
Adjustments to reconcile net income to net cash provided by operating activities: |
||||||||
Depreciation and amortization |
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Share-based compensation |
||||||||
Non-cash contribution to 401(k) plan |
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Provision for doubtful accounts |
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Other income from investment in unconsolidated entity |
( |
) |
( |
) | ||||
Other, net |
( |
) | ||||||
Changes in operating assets and liabilities: |
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Accounts receivable |
( |
) |
( |
) | ||||
Inventories |
( |
) |
( |
) | ||||
Accounts payable and other liabilities |
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Other, net |
( |
) |
( |
) | ||||
Net cash provided by operating activities |
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Cash flows from investing activities: |
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Capital expenditures |
( |
) |
( |
) | ||||
Proceeds from sale of property and equipment |
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Net cash used in investing activities |
( |
) |
( |
) | ||||
Cash flows from financing activities: |
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Dividends on Common and Class B common stock |
( |
) |
( |
) | ||||
Repurchases of common stock to satisfy employee withholding tax obligations |
( |
) |
( |
) | ||||
Net repayments of long-term obligations |
( |
) |
( |
) | ||||
Proceeds from short-term borrowings |
— |
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Net proceeds under revolving credit agreement |
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Net proceeds from issuances of common stock |
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Net cash used in financing activities |
( |
) |
( |
) | ||||
Effect of foreign exchange rate changes on cash and cash equivalents |
( |
) |
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Net decrease in cash and cash equivalents |
( |
) |
( |
) | ||||
Cash and cash equivalents at beginning of period |
||||||||
Cash and cash equivalents at end of period |
$ |
$ | ||||||
See accompanying notes to condensed consolidated unaudited financial statements.
8
of 24
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. 9
of 24
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 |
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| Primary Geographical Regions: |
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| United States |
$ |
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$ | |
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| Canada |
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| Latin America and the Caribbean |
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$ |
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$ | |
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| Major Product Lines: |
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| HVAC equipment |
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% |
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% | ||||
| Other HVAC products |
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% |
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% | ||||
| Commercial refrigeration products |
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% |
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% | ||||
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% |
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% | |||||
10 of 24
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 |
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| Basic Earnings per Share: |
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| Net income attributable to Watsco, Inc. shareholders |
$ |
|
$ | |
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| Less: distributed and undistributed earnings allocated to non-vested restricted common stock |
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| Earnings allocated to Watsco, Inc. shareholders |
$ |
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$ | |
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| Weighted-average common shares outstanding – Basic |
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| Basic earnings per share for Common and Class B common stock |
$ |
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$ | |
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| Allocation of earnings for Basic: |
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| Common stock |
$ |
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$ | |
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| Class B common stock |
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$ |
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$ | |
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| Diluted Earnings per Share: |
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| Net income attributable to Watsco, Inc. shareholders |
$ |
|
$ | |
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| Less: distributed and undistributed earnings allocated to non-vested restricted common stock |
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| Earnings allocated to Watsco, Inc. shareholders |
$ |
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$ | |
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| Weighted-average common shares outstanding – Basic |
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| Effect of dilutive stock options |
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| Weighted-average common shares outstanding – Diluted |
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| Diluted earnings per share for Common and Class B common stock |
$ |
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$ | |
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| Anti-dilutive stock options not included above |
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Diluted earnings per share for our Common stock assumes the conversion of all 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.
of
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 |
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| Foreign currency translation adjustment |
$ |
( |
) |
$ | |
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| Unrealized gain (loss) on cash flow hedging instruments |
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( |
) | |||||
| Income tax (expense) benefit |
( |
) |
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| Unrealized gain (loss) on cash flow hedging instruments, net of tax |
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( |
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| Reclassification of loss (gain) on cash flow hedging instruments into earnings |
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( |
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| Income tax (benefit) expense |
( |
) |
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| Reclassification of loss (gain) on cash flow hedging instruments into earnings, net of tax |
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( |
) | |||||
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| Other comprehensive (loss) income |
$ |
( |
) |
$ | |
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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 |
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| Foreign currency translation adjustment: |
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| Beginning balance |
$ |
( |
) |
$ | ( |
) | ||
| Current period other comprehensive (loss) income |
( |
) |
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| Ending balance |
( |
) |
( |
) | ||||
| Cash flow hedging instruments: |
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| Beginning balance |
( |
) |
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| Current period other comprehensive income (loss) |
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( |
) | |||||
| Reclassification adjustment |
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( |
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| Ending balance |
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| Accumulated other comprehensive loss, net of tax |
$ |
( |
) |
$ | ( |
) | ||
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 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 .
of
our open foreign currency forward contracts had maturities of The impact from foreign exchange derivative instruments designated as cash flow hedges was as follows:
| Quarters Ended March 31, |
2020 |
2019 |
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| Gain (loss) recorded in accumulated other comprehensive loss |
$ |
|
$ | ( |
) | |||
| Loss (gain) reclassified from accumulated other comprehensive loss into earnings |
$ |
|
$ | ( |
) | |||
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, 4,900 ,
2020
was $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
.12 of 24
| Asset Derivatives |
Liability Derivatives |
|||||||||||||||
| March 31, 2020 |
December 31, 2019 |
March 31, 2020 |
December 31, 2019 |
|||||||||||||
| Derivatives designated as hedging instruments |
$ |
|
$ | — |
$ |
|
$ | |
||||||||
| Derivatives not designated as hedging instruments |
|
— |
|
|
||||||||||||
| Total derivative instruments |
$ |
|
$ | — |
$ |
|
$ | |
||||||||
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 |
$ |
|
$ |
— |
$ |
|
$ |
— |
|||||||||||
| Equity securities |
Other assets |
$ |
|
$ |
|
$ |
— |
$ |
— |
|||||||||||
| Liabilities: |
||||||||||||||||||||
| Derivative financial instruments |
Accrued expenses and other current liabilities |
$ |
|
$ |
— |
$ |
|
$ |
— |
|||||||||||
| Balance Sheet Location |
Total |
Fair Value Measurements at December 31, 2019 Using |
||||||||||||||||||
| Level 1 |
Level 2 |
Level 3 |
||||||||||||||||||
| Assets: |
||||||||||||||||||||
| Equity securities |
Other assets |
$ | |
$ | |
$ | — |
$ | — |
|||||||||||
| Liabilities: |
||||||||||||||||||||
| Derivative financial instruments |
Accrued expenses and other current liabilities |
$ | |
$ | — |
$ | |
$ | — |
|||||||||||
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
Derivative financial instruments
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 .
14 of 24
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.
15 of 24
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.16 of 24
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 unaudited financial statements, and the reported amount of revenues and expenses during the reporting period. Actual results may differ from these estimates under different assumptions or conditions. At least quarterly, management reevaluates its judgments and estimates, which are based on historical experience, current trends, and various other assumptions that are believed to be reasonable under the circumstances.Our critical accounting policies are included in our 2019 Annual Report on Form
10-K,
as filed with the SEC on February 28, 2020. We believe that there have been no significant changes during the quarter ended March 31, 2020 to the critical accounting policies disclosed in our Annual Report on Form 10-K
for the year ended December 31, 2019.New Accounting Standards
Refer to Note 1 to our condensed consolidated unaudited financial statements included in this Quarterly Report on Form
10-Q
for a discussion of recently adopted accounting standards.Results of Operations
The following table summarizes information derived from our condensed consolidated unaudited statements of income, expressed as a percentage of revenues, for the quarters ended March 31, 2020 and 2019:
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| 2020 |
2019 |
|||||||
| Revenues |
100.0 |
% |
100.0 |
% | ||||
| Cost of sales |
75.4 |
74.9 |
||||||
| Gross profit |
24.6 |
25.1 |
||||||
| Selling, general and administrative expenses |
20.2 |
19.3 |
||||||
| Other income |
0.1 |
0.2 |
||||||
| Operating income |
4.5 |
5.9 |
||||||
| Interest expense, net |
0.1 |
0.1 |
||||||
| Income before income taxes |
4.4 |
5.8 |
||||||
| Income taxes |
0.8 |
1.1 |
||||||
| Net income |
3.6 |
4.7 |
||||||
| Less: net income attributable to non-controlling interest |
0.6 |
0.9 |
||||||
| Net income attributable to Watsco, Inc. |
3.0 |
% |
3.8 |
% | ||||
Note: Due to rounding, percentages may not add up to 100.
The following narratives reflect our acquisition of the HVAC distribution businesses of N&S Supply of Fishkill, Inc. (“N&S”) in November 2019, PPI in August 2019, Dunphey & Associates Supply Co., Inc. (“DASCO”) in April 2019, as well as the purchase of an additional 1.8% ownership interest in Russell Sigler, Inc. (“RSI”) in April 2019, and the purchase of an additional 20% ownership interest in Homans effective May 31, 2019. We did not acquire any businesses during the quarters ended March 31, 2020 or 2019.
In the following narratives, computations and other information referring to “same-store basis” exclude the effects of locations closed, acquired, or locations opened, in each case during the immediately preceding 12 months, unless such locations are within close geographical proximity to existing locations. At March 31, 2020 and 2019, seven and nine locations, respectively, that we opened were near existing locations and were therefore included in “same-store basis” information.
The table below summarizes the changes in our locations for the 12 months ended March 31, 2020:
| Number of Locations |
||||
| March 31, 2019 |
575 |
|||
| Opened |
8 |
|||
| Acquired |
33 |
|||
| Closed |
(10 |
) | ||
| December 31, 2019 |
606 |
|||
| Opened |
1 |
|||
| Closed |
(4 |
) | ||
| March 31, 2020 |
603 |
|||
Revenues
Revenues for the first quarter of 2020 increased $76.9 million, or 8%, as compared to the first quarter of 2019, including $61.0 million attributable to the new locations acquired and $1.5 million from other locations opened during the preceding 12 months, offset by $2.9 million from locations closed. Sales of HVAC equipment (66% of sales) increased 7%, sales of other HVAC products (30% of sales) increased 9% and sales of commercial refrigeration products (4% of sales) were flat. On a same-store basis, revenues increased $17.3 million, or 2%, as compared to the same period in 2019, reflecting a 2% increase in sales of HVAC equipment (67% of sales), which included a 4% increase in residential HVAC equipment (5% increase in U.S. markets and an 11% decrease in international markets), a 2% increase in sales of other HVAC products (29% of sales) and flat sales of commercial refrigeration products (4% of sales). For HVAC equipment, the increase in revenues was primarily due to demand for the replacement of residential HVAC equipment and a higher mix of high-efficiency air conditioning and heating systems, which sell at higher unit prices, resulting in a 4% increase in volume and a 1% increase in the average selling price.
Gross Profit
Gross profit for the first quarter of 2020 increased $13.9 million, or 6%, as compared to the first quarter of 2019, primarily as a result of increased revenues. Gross profit margin for the quarter ended March 31, 2020 declined 50 basis-points to 24.6% versus 25.1%, primarily due to lower benefit of pricing actions taken by our HVAC equipment suppliers and overall competitive conditions.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first quarter of 2020 increased $23.3 million, or 13%, as compared to the first quarter of 2019, primarily due to newly acquired locations. Selling, general and administrative expenses as a percent of revenues for the quarter ended March 31, 2020 increased to 20.2% versus 19.3% for the same period in 2019. On a same-store basis, selling, general and administrative expenses increased 4% as compared to the same period in 2019, primarily due to additional employee headcount and related employee benefit costs and increased costs related to ongoing technology initiatives.
Other Income
Other income of $1.0 million and $1.4 million for the first quarters of 2020 and 2019, respectively, represents our share of the net income of RSI.
Interest Expense, Net
Interest expense, net, for the first quarter of 2020 increased 2%, primarily as a result of an increase in average outstanding borrowings, partially offset by a lower effective interest rate for the 2020 period, in each case under our revolving credit facility, as compared to the same period in 2019.
Income Taxes
Income taxes decreased to $8.2 million for the first quarter of 2020, as compared to $10.6 million for the first quarter of 2019, and represent a composite of the income taxes attributable to our wholly owned operations and income taxes attributable to the Carrier joint ventures, which are primarily taxed as partnerships for income tax purposes; therefore, Carrier is responsible for its proportionate share of income taxes attributable to its share of earnings from these joint ventures. The effective income tax rates attributable to us were 21.0% and 22.7% for the quarters ended March 31, 2020 and 2019, respectively. The decrease was primarily due to higher share-based payment tax benefits in 2020 as compared to the same period in 2019.
Net Income Attributable to Watsco, Inc.
Net income attributable to Watsco for the quarter ended March 31, 2020 decreased $4.5 million, or 13%, compared to the same period in 2019. The decrease was primarily driven by higher selling, general and administrative expenses, partially offset by higher revenues, a reduction in income taxes and a decrease in net income attributable to the
non-controlling
interest, as discussed above.Liquidity and Capital Resources
We assess our liquidity in terms of our ability to generate cash to execute our business strategy and fund operating and investing activities, taking into consideration the seasonal demand for HVAC/R products, which peaks in the months of May through August. Significant factors that could affect our liquidity include the following:
| • | cash needed to fund our business (primarily working capital requirements); |
| • | borrowing capacity under our revolving credit facility; |
| • | the ability to attract long-term capital with satisfactory terms; |
| • | acquisitions, including joint ventures and investments in unconsolidated entities; |
| • | dividend payments; |
| • | capital expenditures; and |
| • | the timing and extent of common stock repurchases. |
Sources and Uses of Cash
We rely on cash flows from operations and borrowing capacity under our revolving credit agreement to fund seasonal working capital needs and for other general corporate purposes, including dividend payments (if and as declared by our Board of Directors), capital expenditures, business acquisitions, and development of our long-term operating and technology strategies. Additionally, we may also generate cash through the issuance and sale of our Common stock.
As of March 31, 2020, we had $51.2 million of cash and cash equivalents, of which $39.0 million was held by foreign subsidiaries. The repatriation of cash balances from our foreign subsidiaries could have adverse tax impacts or be subject to capital controls; however, these balances are generally available to fund the ordinary business operations of our foreign subsidiaries without legal restrictions.
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We believe that our operating cash flows, cash on hand, and funds available for borrowing under our revolving credit agreement are sufficient to meet our liquidity needs in the foreseeable future. However, there can be no assurance that our current sources of available funds will be sufficient to meet our cash requirements.
Our access to funds under our revolving credit agreement depends on the ability of the syndicate banks to meet their respective funding commitments. Disruptions in the credit and capital markets could adversely affect our ability to draw on our revolving credit agreement and may also adversely affect the determination of interest rates, particularly rates based on LIBOR, which is one of the base rates under our revolving credit agreement. LIBOR is the subject of recent proposals for reform that currently provide for the
phase-out
of LIBOR by 2021. The consequences of these developments with respect to LIBOR cannot be entirely predicted but could result in an increase in the cost of our debt, as it is currently anticipated that lenders will replace LIBOR with the Secured Overnight Financing Rate (“SOFR”), which may exceed what would have been the comparable LIBOR rate. Additionally, disruptions in the credit and capital markets could also result in increased borrowing costs and/or reduced borrowing capacity under our revolving credit agreement.Working Capital
Working capital decreased to $1,069.9 million at March 31, 2020 from $1,085.0 million at December 31, 2019.
Cash Flows
The following table summarizes our cash flow activity for the quarters ended March 31, 2020 and 2019 (in millions):
| 2020 |
2019 |
Change |
||||||||||
| Cash flows provided by operating activities |
$ |
41.9 |
$ | 52.9 |
$ | (11.0 |
) | |||||
| Cash flows used in investing activities |
$ |
(3.8 |
) |
$ | (4.1 |
) | $ | 0.3 |
||||
| Cash flows used in financing activities |
$ |
(59.4 |
) |
$ | (54.9 |
) | $ | (4.5 |
) | |||
The individual items contributing to cash flow changes for the periods presented are detailed in the condensed consolidated unaudited statements of cash flows contained in this Quarterly Report on Form
10-Q.
Operating Activities
The decrease in net cash provided by operating activities was primarily due to higher accounts receivable driven by increased sales volume, timing of collections and lower net income, partially offset by a reduction in the level seasonal increases in inventory in 2020 as compared to 2019.
Investing Activities
Net cash used in investing activities was lower due to a decrease in capital expenditures in 2020.
Financing Activities
The increase in net cash used in financing activities was primarily attributable to lower borrowing requirements and an increase in dividends paid in 2020.
Revolving Credit Agreement
We maintain an unsecured, syndicated multicurrency revolving credit agreement, which we use to fund seasonal working capital needs and for other general corporate purposes, including acquisitions, dividends (if and as declared by our Board of Directors), capital expenditures, stock repurchases and issuances of letters of credit. On April 10, 2020, we increased the aggregate borrowing capacity of our revolving credit agreement from $500.0 million to $560.0 million. The credit facility has a seasonal component from October 1 to March 31, during which the borrowing capacity may be reduced to $460.0 million at our discretion (which would effectively reduce fees payable in respect of the unused portion of the commitment). Included in the credit facility are a $100.0 million swingline subfacility, a $10.0 million letter of credit subfacility, a $75.0 million alternative currency borrowing sublimit and an $8.0 million Mexican borrowing sublimit. The credit agreement matures on December 5, 2023.
At March 31, 2020 and December 31, 2019, $156.1 million and $155.7 million, respectively, were outstanding under the revolving credit agreement. The revolving credit agreement contains customary affirmative and negative covenants, including financial covenants with respect to consolidated leverage and interest coverage ratios, and other customary restrictions. We believe we were in compliance with all covenants at March 31, 2020.
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Investment in Unconsolidated Entity
On June 21, 2017, Carrier Enterprise I acquired a 34.9% ownership interest in RSI, an HVAC distributor operating from 30 locations in the Western U.S. for cash consideration of $63.6 million, of which we contributed $50.9 million, and Carrier contributed $12.7 million. Effective June 29, 2018, Carrier Enterprise I acquired an additional 1.4% ownership interest in RSI, which increased Carrier Enterprise I’s ownership interest in RSI to 36.3%. Total cash consideration of $3.8 million was paid on July 5, 2018, of which we contributed $3.0 million and Carrier contributed $0.8 million. Effective April 22, 2019, Carrier Enterprise I acquired an additional 1.8% ownership interest in RSI, which increased Carrier Enterprise I’s ownership interest in RSI to 38.1% for cash consideration of $4.9 million, of which we contributed $3.9 million and Carrier contributed $1.0 million.
Carrier Enterprise I is a party to a shareholders’ agreement (the “Shareholders’ Agreement”) with RSI and its shareholders. Pursuant to the Shareholders’ Agreement, RSI’s shareholders have the right to sell, and Carrier Enterprise I has the obligation to purchase, their respective shares of RSI for a purchase price determined based on either book value or a multiple of EBIT, the latter of which Carrier Enterprise I used to calculate the price paid for its investment in RSI. RSI’s shareholders may transfer their respective shares of RSI common stock only to members of the Sigler family or to Carrier Enterprise I, and, at any time from and after the date on which Carrier Enterprise I owns 85% or more of RSI’s outstanding common stock, it has the right, but not the obligation, to purchase from RSI’s shareholders the remaining outstanding shares of RSI common stock. At March 31, 2020, the estimated purchase amount we would be contingently liable for was approximately $142.0 million. We believe that our operating cash flows, cash on hand, and funds available for borrowing under our revolving credit agreement will be sufficient to purchase any additional ownership interests in RSI.
Acquisitions
We continually evaluate potential acquisitions and/or joint ventures and investments in unconsolidated entities. We routinely hold discussions with several acquisition candidates. Should suitable acquisition opportunities arise that would require additional financing, we believe our financial position and earnings history provide a sufficient basis for us to either obtain additional debt financing at competitive rates and on reasonable terms or raise capital through the issuance of equity securities.
Common Stock Dividends
We paid cash dividends of $1.60 per share of Common stock and Class B common stock during both the quarters ended March 31, 2020 and 2019. On April 1, 2020, our Board of Directors declared a regular quarterly cash dividend of $1.775 per share of both Common and Class B common stock that was paid on April 30, 2020 to shareholders of record as of April 15, 2020. 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.
Company Share Repurchase Program
In September 1999, our Board of Directors authorized the repurchase, at management’s discretion, of up to 7,500,000 shares of common stock in the open market or via private transactions. Shares repurchased under the program are accounted for using the cost method and result in a reduction of shareholders’ equity. We last repurchased shares under this plan in 2008. In aggregate, 6,370,913 shares of Common and Class B common stock have been repurchased at a cost of $114.4 million since the inception of the program. At March 31, 2020, there were 1,129,087 shares remaining authorized for repurchase under the program.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes to the information regarding market risk provided in Item 7A, Quantitative and Qualitative Disclosures about Market Risk, of our Annual Report on Form
10-K
for the year ended December 31, 2019.ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rule
13a-15(e)
under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are, among other things, designed to ensure that information required to be disclosed by us under the Exchange Act is accumulated and communicated to management, including our Chief Executive Officer (“CEO”), Executive Vice President (“EVP”) and Chief Financial Officer (“CFO”), to allow for timely decisions regarding required disclosure and appropriate SEC filings.Our management, with the participation of our CEO, EVP and CFO, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report, and, based on that evaluation, our CEO, EVP and CFO concluded that our disclosure controls and procedures were effective, at a reasonable assurance level, at and as of such date.
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Changes in Internal Control over Financial Reporting
We are continuously seeking to improve the efficiency and effectiveness of our operations and of our internal controls. This results in refinements to processes throughout the Company. However, there were no changes in internal controls over financial reporting (as such term is defined in Rules
13a-15(f)
and 15d-15(f)
under the Exchange Act) during the quarter ended March 31, 2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.In accordance with the rules and regulations of the SEC, we have not yet assessed the internal control over financial reporting of N&S, PPI or DASCO, which collectively represented approximately 7% of our total consolidated assets at March 31, 2020 and approximately 6% of our consolidated revenues for the quarter ended March 31, 2020. From the respective acquisition dates of November 26, 2019, August 1, 2019 and April 2, 2019 to March 31, 2020, the processes and systems of N&S, PPI and DASCO did not impact the internal controls over financial reporting for our other consolidated subsidiaries.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item may be found in Note 8 to our condensed consolidated unaudited financial statements contained in this Quarterly Report on Form
10-Q
under the caption “Litigation, Claims and Assessments,” which information is incorporated by reference in this Item 1 of Part II of this Quarterly Report on Form 10-Q.
ITEM 1A. RISK FACTORS
Information about risk factors for the quarter ended March 31, 2019 does not differ materially from that set forth in Part I, Item 1A of our Annual Report on Form
10-K
for the year ended December 31, 2019, except for the addition of the following risk factor.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 began to impact our operations late in the first quarter of 2020 and is likely to continue to adversely affect our business and results of operations, including as a result of government authorities imposing mandatory closures, work-from-home orders and social distancing protocols, or imposing other restrictions. These actions could materially adversely affect our ability to adequately staff and maintain our operations, impair our ability to sustain sufficient financial liquidity and adversely impact our financial results. While our locations continue to operate, we have restricted public access to our branches and a few of our locations experienced short-term closures for COVID-19
employee health concerns or are operating at a diminished capacity, negatively impacting sales at the end of the first quarter of 2020 and through the date of this filing. 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.ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of Unregistered Securities
On March 9, 2020, we issued 25,216 shares of our Common stock to our Profit Sharing Retirement Plan & Trusts (the “Plans”) representing the employer match under the Plans for the plan year ended December 31, 2019, without registration. This issuance was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 3(a)(2) thereof. The Plans are profit sharing retirement plans that are qualified under Section 401 of the Internal Revenue Code of 1986, as amended. The assets of the Plans are held in a single trust fund for the benefit of our employees, and no Plan holds assets for the benefit of the employees of any other employer. All of the contributions to the Plans from our employees have been invested in assets other than our Common stock. We have contributed all of the Common stock held by the Plans as a discretionary matching contribution, which, at the time of contribution, was lower in value than the employee contributions that the contribution matched.
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ITEM 6. EXHIBITS
INDEX TO EXHIBITS
| 10.1 # |
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| 10.2 |
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| 31.1 # |
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| 31.2 # |
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| 31.3 # |
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| 32.1 + |
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| 101.INS # |
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. | |||
| 101.SCH # |
Inline XBRL Taxonomy Extension Schema Document. | |||
| 101.CAL # |
Inline XBRL Taxonomy Extension Calculation Linkbase Document. | |||
| 101.DEF # |
Inline XBRL Taxonomy Extension Definition Linkbase Document. | |||
| 101.LAB # |
Inline XBRL Taxonomy Extension Label Linkbase Document. | |||
| 101.PRE # |
Inline XBRL Taxonomy Extension Presentation Linkbase Document. | |||
| 104 |
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, formatted in Inline XBRL. |
| # | filed herewith. |
| + | furnished herewith. |
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| WATSCO, INC. | ||||||
| (Registrant) | ||||||
| Date: May 7, 2020 |
By: |
/s/ Ana M. Menendez | ||||
| Ana M. Menendez | ||||||
| Chief Financial Officer (on behalf of the Registrant and as Principal Financial Officer) | ||||||
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TABLE OF CONTENTS
Part I. Financial InformationItem 1. Condensed Consolidated Unaudited Financial StatementsItem 2. Management S Discussion and Analysis Of Financial Condition and Results Of OperationsItem 3. Quantitative and Qualitative Disclosures About Market RiskItem 4. Controls and ProceduresPart II. Other InformationItem 1. Legal ProceedingsItem 1A. Risk FactorsItem 2. Unregistered Sales Of Equity Securities and Use Of ProceedsItem 6. Exhibits