Watsco(WSO) - 2021 Q1 - Quarterly Report

PART I. FINANCIAL INFORMATION Details Watsco's unaudited financial statements, management's analysis, market risks, and internal controls for Q1 2021 Item 1. Condensed Consolidated Unaudited Financial Statements Presents Watsco's unaudited Q1 2021 financial statements, including income, comprehensive income, balance sheets, equity, and cash flows, with notes highlighting significant growth Condensed Consolidated Unaudited Statements of Income Details Watsco's Q1 2021 income statement, showing significant year-over-year growth in revenues, gross profit, operating income, and net income | Metric | Q1 2021 (thousands) | Q1 2020 (thousands) | YoY Change | | :--- | :--- | :--- | :--- | | Revenues | $1,136,118 | $1,008,156 | +12.7% | | Cost of sales | 841,297 | 760,541 | +10.6% | | Gross profit | 294,821 | 247,615 | +19.1% | | Operating income | 81,880 | 45,243 | +81.0% | | Net income attributable to Watsco, Inc. | $55,092 | $30,502 | +80.6% | | Basic and Diluted EPS | $1.39 | $0.72 | +93.1% | Condensed Consolidated Unaudited Statements of Comprehensive Income Presents Watsco's Q1 2021 comprehensive income, highlighting the positive impact of foreign currency translation adjustments on overall results | Metric | Q1 2021 (thousands) | Q1 2020 (thousands) | | :--- | :--- | :--- | | Net income | $66,127 | $36,247 | | Other comprehensive income (loss) | 3,776 | (19,280) | | Comprehensive income | 69,903 | 16,967 | | Comprehensive income attributable to Watsco, Inc. | $57,566 | $17,763 | - Foreign currency translation adjustment significantly improved from a loss of $(21,929) thousand in Q1 2020 to a gain of $3,457 thousand in Q1 2021, contributing to the increase in comprehensive income[17] Condensed Consolidated Balance Sheets Outlines Watsco's financial position as of March 31, 2021, showing changes in assets, liabilities, and equity compared to year-end 2020 | Metric | March 31, 2021 (thousands) | December 31, 2020 (thousands) | Change (thousands) | | :--- | :--- | :--- | :--- | | Total current assets | $1,695,355 | $1,484,445 | +$210,910 | | Total assets | $2,692,264 | $2,484,347 | +$207,917 | | Total current liabilities | $630,820 | $487,145 | +$143,675 | | Total shareholders' equity | $1,796,827 | $1,779,761 | +$17,066 | | Cash and cash equivalents | $93,875 | $146,067 | -$52,192 | | Inventories, net | $986,648 | $781,299 | +$205,349 | Condensed Consolidated Unaudited Statements of Shareholders' Equity Details changes in Watsco's shareholders' equity during Q1 2021, driven by net income, other comprehensive income, and cash dividends - Total shareholders' equity increased from $1,779,761 thousand at December 31, 2020, to $1,796,827 thousand at March 31, 2021, primarily due to net income and other comprehensive income, partially offset by cash dividends[22] - Cash dividends declared and paid on Common and Class B common stock were $1.775 per share in Q1 2021, up from $1.60 per share in Q1 2020[22][24] Condensed Consolidated Unaudited Statements of Cash Flows Presents Watsco's Q1 2021 cash flow activities, highlighting a significant increase in cash used in operations due to inventory build-up | Cash Flow Activity | Q1 2021 (thousands) | Q1 2020 (thousands) | Change (thousands) | | :--- | :--- | :--- | :--- | | Operating activities | $(37,745) | $41,859 | $(79,604) | | Investing activities | $1,221 | $(3,849) | +$5,070 | | Financing activities | $(16,250) | $(59,388) | +$43,138 | | Net decrease in cash and cash equivalents | $(52,192) | $(23,218) | $(28,974) | | Cash and cash equivalents at end of period | $93,875 | $51,236 | +$42,639 | - Net cash used in operating activities increased significantly in Q1 2021 to $(37.7) million from $41.9 million provided in Q1 2020, primarily due to a substantial increase in inventory levels[27][90] Notes to Condensed Consolidated Unaudited Financial Statements Provides detailed explanations and disclosures supporting Watsco's condensed consolidated unaudited financial statements for Q1 2021 Note 1. Basis of Presentation Describes Watsco's business, financial statement preparation, seasonality, and the ongoing impact of the COVID-19 pandemic - Watsco, Inc. is the largest distributor of HVAC/R equipment and supplies in North America, incorporated in Florida in 1956[30] - The financial statements are condensed, unaudited, and prepared in accordance with U.S. GAAP, consolidating wholly-owned subsidiaries and three joint ventures with Carrier Global Corporation, and accounting for a 38.1% investment in Russell Sigler, Inc. under the equity method[30][31] - Sales are seasonal, with residential AC demand highest in Q2/Q3 and heating equipment demand highest in Q1/Q4, making results for the quarter not necessarily indicative of the full year[32] - The COVID-19 pandemic has impacted operations and its future impact remains uncertain, depending on the pandemic's duration, severity, and economic conditions[35] Note 2. Revenues Breaks down Watsco's Q1 2021 revenues by geographical region and major product lines, showing growth in the United States and Canada | Revenue Source | Q1 2021 (thousands) | Q1 2020 (thousands) | | :--- | :--- | :--- | | Primary Geographical Regions: | | | | United States | $1,011,266 | $899,545 | | Canada | 74,492 | 55,341 | | Latin America and the Caribbean | 50,360 | 53,270 | | Major Product Lines: | | | | HVAC equipment | 67% | 66% | | Other HVAC products | 29% | 30% | | Commercial refrigeration products | 4% | 4% | Note 3. Earnings Per Share Details Watsco's basic and diluted earnings per share for Q1 2021 and Q1 2020, along with weighted-average common shares outstanding | Metric | Q1 2021 | Q1 2020 | | :--- | :--- | | Basic earnings per share | $1.39 | $0.72 | | Diluted earnings per share | $1.39 | $0.72 | | Weighted-average common shares outstanding – Basic | 35,179,521 | 34,995,048 | | Weighted-average common shares outstanding – Diluted | 35,329,833 | 35,023,989 | Note 4. Other Comprehensive Income (Loss) Analyzes components of Watsco's other comprehensive income (loss) for Q1 2021, highlighting the impact of foreign currency translation adjustments | Component | Q1 2021 (thousands) | Q1 2020 (thousands) | | :--- | :--- | :--- | | Foreign currency translation adjustment | $3,457 | $(21,929) | | Unrealized gain on cash flow hedging instruments, net of tax | 76 | 2,534 | | Reclassification of loss on cash flow hedging instruments into earnings, net of tax | 243 | 115 | | Total Other comprehensive income (loss) | $3,776 | $(19,280) | - Accumulated other comprehensive loss, net of tax, improved from $(51,789) thousand at March 31, 2020, to $(32,393) thousand at March 31, 2021, primarily due to a positive foreign currency translation adjustment[39] Note 5. Derivatives Explains Watsco's use of foreign currency derivatives for hedging and their impact on comprehensive income and earnings - The company uses foreign currency forward and option contracts to offset foreign exchange rate fluctuations, with some designated as cash flow hedges and others not[40][41][43] | Derivative Impact | Q1 2021 (thousands) | Q1 2020 (thousands) | | :--- | :--- | :--- | | Gain recorded in accumulated other comprehensive loss (cash flow hedges) | $103 | $3,473 | | Loss reclassified from accumulated other comprehensive loss into earnings (cash flow hedges) | $333 | $157 | | Gains from derivatives not designated as hedging instruments | $27 | $829 | Note 6. Fair Value Measurements Presents fair value measurements for Watsco's equity securities and derivative financial instruments, categorized by valuation levels | Asset/Liability | Balance Sheet Location | March 31, 2021 (Total) | December 31, 2020 (Total) | Valuation Level | | :--- | :--- | :--- | :--- | :--- | | Equity securities | Other assets | $1,412 | $6,065 | Level 1 | | Derivative financial instruments | Accrued expenses and other current liabilities | $5 | $101 | Level 2 | - Equity securities are valued using Level 1 inputs (closing stock prices from active markets), while derivative financial instruments (foreign currency contracts) are valued using Level 2 inputs (observable market inputs like forward rates)[46][47] Note 7. Shareholders' Equity Details activities impacting Watsco's shareholders' equity, including cash dividends and proceeds from stock option exercises and employee stock plans - Cash dividends of $1.775 per share were paid in Q1 2021, an increase from $1.60 per share in Q1 2020[48] | Activity | Q1 2021 (thousands) | Q1 2020 (thousands) | | :--- | :--- | :--- | | Cash received from stock option exercise | $3,469 | $2,188 | | Net proceeds from employee stock purchase plan | $405 | $353 | Note 8. Commitments and Contingencies Addresses Watsco's involvement in litigation and self-insurance reserves, noting no expected material adverse effects on financial condition - The company is involved in incidental litigation but does not believe the ultimate liability will materially adversely affect financial condition or results, maintaining significant insurance coverage[52] - Self-insurance reserves for casualty and health benefit programs were $6,453 thousand at March 31, 2021, up from $5,404 thousand at December 31, 2020[53] Note 9. Related Party Transactions Outlines Watsco's transactions with related parties, including significant purchases from and payables to Carrier and its affiliates - Purchases from Carrier and its affiliates comprised 61% of all inventory purchases in Q1 2021 (up from 57% in Q1 2020), with approximately $140 million payable to them at March 31, 2021[54] - Sales to Carrier and its affiliates were approximately $23 million in Q1 2021, consistent with $22 million in Q1 2020[54] - Fees paid to Greenberg Traurig, P.A., where a board member is Senior Chairman, were $66 thousand in Q1 2021 for legal services[55] Note 10. Subsequent Event Describes Watsco's acquisition of Temperature Equipment Corporation's HVAC distribution business and the formation of a new joint venture with Carrier - On April 9, 2021, Watsco acquired the HVAC distribution business of Temperature Equipment Corporation (TEC), forming a new joint venture with Carrier, TEC Distribution LLC, with Watsco holding an 80% controlling interest[56] - The acquisition consideration was $105.2 million in cash, with Watsco contributing $84.16 million and Carrier contributing $21.04 million, plus $1.5 million for debt repayment[56] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management's analysis of Watsco's Q1 2021 financial performance, condition, and operations, covering revenue growth, COVID-19 impact, joint ventures, and liquidity Forward-Looking Statements Highlights that the report contains forward-looking statements subject to various risks and uncertainties, including economic and market factors - The report contains forward-looking statements regarding economic conditions, business strategies, potential acquisitions, financing plans, and industry trends, which are subject to risks and uncertainties[57] - Key risk factors include general economic conditions, competitive factors, supplier concentration, commodity costs, consumer spending, COVID-19 impact, housing market, interest rates, and foreign currency fluctuations[58] Company Overview Provides an overview of Watsco's position as North America's largest HVAC/R distributor, its revenue sources, expense structure, and business seasonality - Watsco, Inc. is North America's largest distributor of HVAC/R equipment and supplies, operating from 601 locations across 38 U.S. States, Canada, Mexico, and Puerto Rico as of March 31, 2021[60] - Revenues are primarily from HVAC/R sales, with selling, general, and administrative expenses largely consisting of salaries, commissions, marketing, and warehouse operating costs[61] - Sales are seasonal, with residential AC demand peaking in Q2/Q3 and heating equipment in Q1/Q4, influenced by weather and economic conditions[62] Impact of the COVID-19 Pandemic Discusses the ongoing impact of the COVID-19 pandemic on Watsco's operations, implemented safeguards, cost reduction measures, and strong financial position - Watsco's operations were deemed essential, allowing continued operation with modifications despite short-term closures and diminished capacity in early 2020, and ongoing impacts in Q1 2021[63] - The company implemented safeguards for employees and customers, including social distancing, PPE, and contactless services, with all locations operating effectively as of the filing date[64] - Cost reduction measures were implemented, including compensation reductions and curtailing discretionary spending, which have eased as restrictions lift[65] - Watsco maintains a strong balance sheet with $93.9 million in cash, $48.9 million in borrowings under its credit facility, and $1.8 billion in shareholders' equity as of March 31, 2021, positioning it well to navigate pandemic impacts[66] Joint Ventures with Carrier Global Corporation ("Carrier") Details Watsco's existing and newly formed joint ventures with Carrier Global Corporation, outlining their controlling interests - Watsco has three main joint ventures with Carrier: Carrier Enterprise I (80% controlling interest, formed 2009), Carrier Enterprise II (80% controlling interest, formed 2011), and Carrier Enterprise III (60% controlling interest, formed 2012)[68][69][70] - A new joint venture, TEC Distribution LLC, was formed on April 9, 2021, to operate the acquired HVAC distribution business of Temperature Equipment Corporation, with Watsco holding an 80% controlling interest[71] Critical Accounting Policies States that management's discussion relies on U.S. GAAP financial statements and confirms no significant changes to critical accounting policies in Q1 2021 - Management's discussion relies on condensed consolidated unaudited financial statements prepared under U.S. GAAP, requiring estimates and assumptions that are reevaluated quarterly[72] - No significant changes to critical accounting policies were reported for Q1 2021 compared to the 2020 Annual Report on Form 10-K[73] Results of Operations Analyzes Watsco's Q1 2021 operational performance, including revenues, gross profit, expenses, and net income, highlighting key drivers of change Revenues Examines Watsco's Q1 2021 revenue growth, driven by increased HVAC equipment sales volume and average selling prices | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Total Revenues | $1,136.1 million | $1,008.2 million | +13% | | HVAC equipment sales | +14% | | | | Residential HVAC equipment sales | +18% | | | | Other HVAC products sales | +11% | | | | Commercial refrigeration products sales | +10% | | | - Same-store revenues increased by 13% compared to Q1 2020, driven by a 16% increase in HVAC equipment volume and a 2% increase in average selling price, reflecting demand for residential HVAC and high-efficiency systems[77] Gross Profit Analyzes Watsco's Q1 2021 gross profit and margin improvement, primarily due to increased revenues and favorable pricing and product mix | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Gross profit | $294.8 million | $247.6 million | +19% | | Gross profit margin | 25.9% | 24.6% | +130 basis-points | - The increase in gross profit and margin was primarily due to increased revenues and the positive impact of pricing and product mix for HVAC equipment[78] Selling, General and Administrative Expenses Reviews Watsco's Q1 2021 SG&A expenses, noting a decrease as a percentage of revenues due to leverage on fixed costs and cost reduction efforts | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | SG&A expenses | $217.6 million | $203.4 million | +7% | | SG&A as % of revenues | 19.2% | 20.2% | -100 basis-points | - The decrease in SG&A as a percentage of revenues was primarily due to increased leverage on fixed costs from higher revenues and cost reduction efforts in response to the pandemic[79] Other Income Highlights the significant increase in Watsco's Q1 2021 other income, primarily from its share of net income from Russell Sigler, Inc | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Other income | $4.7 million | $1.0 million | +370% | - Other income represents Watsco's share of net income from Russell Sigler, Inc. (RSI), showing a significant increase[80] Interest Expense, Net Examines the substantial decrease in Watsco's Q1 2021 net interest expense, attributed to lower borrowings and reduced effective interest rates | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Interest expense, net | $0.088 million | $0.790 million | -89% | - The substantial decrease in net interest expense was due to lower average outstanding borrowings and a reduced effective interest rate under the revolving credit facility[81] Income Taxes Analyzes Watsco's Q1 2021 income taxes and effective tax rate, noting an increase primarily due to higher state income taxes | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Income taxes | $15.7 million | $8.2 million | +91.5% | | Effective income tax rate | 22.0% | 21.0% | +100 basis-points | - The increase in income taxes and effective tax rate was primarily due to higher state income taxes in 2021[82] Net Income Attributable to Watsco, Inc. Summarizes the significant increase in Watsco's Q1 2021 net income, driven by higher revenues, improved gross profit, and reduced expenses | Metric | Q1 2021 | Q1 2020 | Change | | :--- | :--- | :--- | :--- | | Net income attributable to Watsco, Inc. | $55.1 million | $30.5 million | +81% | - The significant increase was primarily driven by higher revenues, improved gross profit, increased other income, and reduced net interest expense[83] Liquidity and Capital Resources Discusses Watsco's liquidity and capital resources, including funding sources, cash position, working capital, and credit facilities Sources and Uses of Cash Outlines Watsco's primary sources and uses of cash, including operating cash flows, credit facilities, and funding for dividends and acquisitions - Watsco relies on operating cash flows and its revolving credit agreement to fund seasonal working capital needs and for other general corporate purposes, including dividend payments, capital expenditures, business acquisitions, and strategic investments[84] - As of March 31, 2021, the company had $93.9 million in cash and cash equivalents, with $78.7 million held by foreign subsidiaries, generally available to fund the ordinary business operations of its foreign subsidiaries[85] - The company believes its operating cash flows, cash on hand, and available funds under its revolving credit agreement are sufficient to meet liquidity needs in the foreseeable future, but acknowledges potential impacts from credit market disruptions or LIBOR reform[86][87] Working Capital Analyzes Watsco's Q1 2021 working capital increase, primarily driven by higher inventory levels reflecting business seasonality | Metric | March 31, 2021 (millions) | December 31, 2020 (millions) | Change (millions) | | :--- | :--- | :--- | :--- | | Working capital | $1,064.5 | $997.3 | +$67.2 | - The increase in working capital was primarily due to higher levels of inventories, reflecting the seasonality of the business[88] Cash Flows Details Watsco's Q1 2021 cash flow activities from operations, investing, and financing, highlighting changes and their primary drivers | Cash Flow Activity | Q1 2021 (millions) | Q1 2020 (millions) | Change (millions) | | :--- | :--- | :--- | :--- | | Operating activities | $(37.7) | $41.9 | $(79.6) | | Investing activities | $1.2 | $(3.8) | $5.0 | | Financing activities | $(16.3) | $(59.4) | $43.1 | - Net cash used in operating activities increased primarily due to increases in the level of inventory in 2021 as compared to 2020[90] - Net cash provided by investing activities was primarily due to proceeds from the sale of equity securities, partially offset by higher capital expenditures in 2021[91] - The decrease in net cash used in financing activities was primarily attributable to higher borrowings partially offset by an increase in dividends paid in 2021[92] Revolving Credit Agreement Describes Watsco's unsecured revolving credit agreement, outstanding borrowings, and compliance with financial covenants - Watsco maintains an unsecured, syndicated multicurrency revolving credit agreement with an aggregate borrowing capacity of $560.0 million (increased from $500.0 million on April 10, 2020), maturing December 5, 2023[93] - As of March 31, 2021, $48.9 million was outstanding under the agreement, compared to no outstanding balance at December 31, 2020[94] - The company was in compliance with all financial covenants (consolidated leverage and interest coverage ratios) at March 31, 2021[94] Investment in Unconsolidated Entity Details Watsco's indirect investment in Russell Sigler, Inc. and the associated contingent liability for potential future share purchases - Carrier Enterprise I holds a 38.1% ownership interest in Russell Sigler, Inc. (RSI), an HVAC distributor[95] - Watsco has a contingent liability of approximately $222.0 million at March 31, 2021, to purchase remaining RSI shares if Carrier Enterprise I owns 85% or more, or if RSI shareholders exercise their right to sell[96] Acquisitions Reports on Watsco's recent acquisition of Temperature Equipment Corporation's HVAC business and its ongoing strategy for potential future acquisitions - On April 9, 2021, Watsco acquired the HVAC distribution business of Temperature Equipment Corporation (TEC) for $105.2 million in cash, forming a new 80%-controlled joint venture with Carrier[98] - The company continuously evaluates potential acquisitions and believes its financial position supports additional debt or equity financing for suitable opportunities[99] Common Stock Dividends Details Watsco's cash dividends paid in Q1 2021 and the subsequent dividend declared, reflecting an increase year-over-year - Cash dividends of $1.775 per share were paid in Q1 2021, up from $1.60 per share in Q1 2020[100] - A quarterly cash dividend of $1.95 per share was declared on April 1, 2021, paid on April 30, 2021[100] Company Share Repurchase Program Outlines Watsco's share repurchase program, including shares repurchased to date and remaining authorized shares - The Board authorized a repurchase program for up to 7,500,000 shares in September 1999; 6,370,913 shares have been repurchased at a cost of $114.4 million since inception[101] - As of March 31, 2021, 1,129,087 shares remained authorized for repurchase under the program, with no repurchases since 2008[101] Item 3. Quantitative and Qualitative Disclosures about Market Risk No material changes to market risk disclosures were reported for Q1 2021 compared to the 2020 Annual Report on Form 10-K - No material changes to market risk information were reported for the quarter ended March 31, 2021, compared to the 2020 Annual Report on Form 10-K[102] Item 4. Controls and Procedures Management evaluated and deemed disclosure controls and procedures effective as of March 31, 2021, with no material changes in internal control over financial reporting - Disclosure controls and procedures were evaluated and deemed effective at a reasonable assurance level as of March 31, 2021, by management, including the CEO, EVP, and CFO[103][104] - No material changes in internal control over financial reporting occurred during the quarter ended March 31, 2021[105] PART II. OTHER INFORMATION Presents other information for Watsco, Inc., including legal proceedings, risk factors, equity security sales, and required exhibits Item 1. Legal Proceedings Information on legal proceedings is incorporated from Note 8, indicating incidental litigation with no expected material adverse effect on financial condition or results - Information on legal proceedings is incorporated from Note 8, indicating involvement in incidental litigation with no expected material adverse effect on financial condition or results of operations[107][52] Item 1A. Risk Factors Risk factors for Q1 2021 are consistent with those outlined in the 2020 Annual Report on Form 10-K, with no material changes - Risk factors for Q1 2021 are consistent with those outlined in the 2020 Annual Report on Form 10-K, with no material changes[108] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds On March 10, 2021, 22,752 shares of Common stock were issued to the Profit Sharing Retirement Plan & Trust as an employer match for the 2020 plan year, exempt from registration - On March 10, 2021, 22,752 shares of Common stock were issued to the Profit Sharing Retirement Plan & Trust as an employer match for the 2020 plan year, exempt from registration under Section 3(a)(2) of the Securities Act of 1933[109] Item 6. Exhibits Exhibits include employment agreements, certifications from the CEO, EVP, and CFO, and various Inline XBRL documents, ensuring compliance - Exhibits include the Twenty-second Amendment dated January 1, 2021, to the Employment Agreement with Albert H. Nahmad, certifications from the CEO, EVP, and CFO (pursuant to Sarbanes-Oxley Act sections 302 and 906), and various Inline XBRL documents[112] SIGNATURE Confirms the official signing of the report by the Chief Financial Officer on May 6, 2021, as required by the Securities Exchange Act of 1934 - The report was signed by Ana M. Menendez, Chief Financial Officer, on May 6, 2021, as required by the Securities Exchange Act of 1934[114]