Watsco(WSO) - 2021 Q2 - Quarterly Report

PART I. FINANCIAL INFORMATION Item 1. Condensed Consolidated Unaudited Financial Statements This section presents Watsco, Inc.'s unaudited condensed consolidated financial statements and related notes for the quarters and six months ended June 30, 2021 and 2020 Condensed Consolidated Unaudited Statements of Income Watsco reported significant revenue and net income growth for both the second quarter and the first half of 2021 compared to the prior year Condensed Consolidated Unaudited Statements of Income (in thousands) | Metric (in thousands) | Q2 2021 | Q2 2020 | Change (%) | H1 2021 | H1 2020 | Change (%) | | :-------------------- | :------ | :------ | :--------- | :------ | :------ | :--------- | | Revenues | $1,849,640 | $1,355,385 | 36.5% | $2,985,758 | $2,363,541 | 26.3% | | Gross profit | $477,941 | $319,199 | 49.7% | $772,762 | $566,814 | 36.3% | | Operating income | $216,783 | $129,249 | 67.7% | $298,663 | $174,492 | 71.2% | | Net income attributable to Watsco, Inc. | $144,102 | $86,578 | 66.4% | $199,194 | $117,080 | 70.1% | | Basic EPS | $3.73 | $2.26 | 65.0% | $5.16 | $3.03 | 70.3% | | Diluted EPS | $3.71 | $2.26 | 64.2% | $5.13 | $3.02 | 69.9% | Condensed Consolidated Unaudited Statements of Comprehensive Income Comprehensive income attributable to Watsco, Inc. increased significantly for both the second quarter and the first half of 2021, primarily driven by higher net income Condensed Consolidated Unaudited Statements of Comprehensive Income (in thousands) | Metric (in thousands) | Q2 2021 | Q2 2020 | Change (%) | H1 2021 | H1 2020 | Change (%) | | :-------------------- | :------ | :------ | :--------- | :------ | :------ | :--------- | | Net income | $172,133 | $104,242 | 65.1% | $238,260 | $140,489 | 69.6% | | Other comprehensive income (loss) | $3,988 | $8,356 | -52.3% | $7,764 | $(10,924) | N/A | | Comprehensive income attributable to Watsco, Inc. | $146,751 | $92,099 | 59.3% | $204,317 | $109,862 | 86.0% | Condensed Consolidated Balance Sheets As of June 30, 2021, Watsco's total assets and liabilities increased, primarily due to higher accounts receivable, inventories, and borrowings, while shareholders' equity also grew Condensed Consolidated Balance Sheets (in thousands) | Metric (in thousands) | June 30, 2021 | December 31, 2020 | Change (%) | | :-------------------- | :------------ | :---------------- | :--------- | | Cash and cash equivalents | $96,787 | $146,067 | -33.7% | | Accounts receivable, net | $857,864 | $535,288 | 60.2% | | Inventories, net | $1,044,608 | $781,299 | 33.7% | | Total current assets | $2,022,062 | $1,484,445 | 36.2% | | Total assets | $3,131,684 | $2,484,347 | 26.1% | | Total current liabilities | $815,264 | $487,145 | 67.3% | | Borrowings under revolving credit agreement | $114,167 | $— | N/A | | Total long-term obligations | $305,257 | $144,338 | 111.5% | | Total shareholders' equity | $1,931,533 | $1,779,761 | 8.5% | Condensed Consolidated Unaudited Statements of Shareholders' Equity Shareholders' equity increased from December 31, 2020, to June 30, 2021, driven by net income and non-controlling interests, partially offset by dividends Condensed Consolidated Unaudited Statements of Shareholders' Equity (in thousands) | Metric (in thousands) | December 31, 2020 | June 30, 2021 | | :-------------------- | :---------------- | :------------ | | Total Shareholders' Equity | $1,779,761 | $1,931,533 | | Net income (H1 2021) | N/A | $199,194 | | Cash dividends declared and paid (H1 2021) | N/A | $(143,909) | | Investment in TEC Distribution LLC (non-controlling interest) | N/A | $21,040 | Condensed Consolidated Unaudited Statements of Cash Flows Net cash provided by operating activities decreased significantly for H1 2021, while cash used in investing activities increased due to acquisitions, and financing activities saw a reduced outflow Condensed Consolidated Unaudited Statements of Cash Flows (in thousands) | Metric (in thousands) | H1 2021 | H1 2020 | Change (H1 2021 vs H1 2020) | | :-------------------- | :------ | :------ | :-------------------------- | | Net cash provided by operating activities | $81,882 | $261,255 | $(179,373) | | Net cash used in investing activities | $(131,464) | $(7,982) | $(123,482) | | Net cash used in financing activities | $(981) | $(247,299) | $246,318 | | Net (decrease) increase in cash and cash equivalents | $(49,280) | $5,119 | $(54,399) | | Cash and cash equivalents at end of period | $96,787 | $79,573 | $17,214 | Notes to Condensed Consolidated Unaudited Financial Statements These notes provide essential context to the financial statements, detailing Watsco's business, consolidation practices, seasonal sales, COVID-19 impacts, revenue disaggregation, recent acquisitions, and related party transactions - Watsco is the largest distributor of air conditioning, heating, and refrigeration equipment and related parts and supplies (HVAC/R) in North America[26] - Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal, with demand for AC highest in Q2/Q3 and heating equipment in Q1/Q4[28] - The impact of COVID-19 has shifted from direct pandemic-related issues (closures, illness) to broader economic and marketplace dynamics, including supply chain disruptions and labor shortages[31] Revenue Disaggregation (in thousands) | Revenue Disaggregation | Q2 2021 | Q2 2020 | H1 2021 | H1 2020 | | :--------------------- | :------ | :------ | :------ | :------ | | Primary Geographical Regions: | | | | | | United States | $1,665,253 | $1,226,649 | $2,676,519 | $2,126,193 | | Canada | $113,880 | $71,917 | $188,372 | $127,258 | | Latin America and the Caribbean | $70,507 | $56,819 | $120,867 | $110,090 | | Major Product Lines (% of total): | | | | | | HVAC equipment | 71% | 71% | 69% | 69% | | Other HVAC products | 26% | 26% | 28% | 28% | | Commercial refrigeration products | 3% | 3% | 3% | 3% | - On May 7, 2021, Watsco acquired Acme Refrigeration of Baton Rouge LLC for $22.855 million (net purchase price of $18.051 million cash, 8,492 shares of Common stock, and $3.141 million repayment of indebtedness)[36] - On April 9, 2021, Watsco acquired the HVAC distribution business of Temperature Equipment Corporation, forming a new joint venture (TEC Distribution LLC) with Carrier, with Watsco holding an 80% controlling interest and the purchase consideration being $105.2 million cash[38] - Purchases from Carrier and its affiliates comprised 72% and 67% of all inventory purchases during Q2 and H1 2021, respectively, indicating a significant related party relationship[58] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses Watsco's strong financial performance in Q2 and H1 2021, driven by demand and acquisitions, while addressing COVID-19 impacts, liquidity, and capital resources Company Overview Watsco, North America's largest HVAC/R distributor, operates 655 locations, with revenues primarily from equipment sales and a seasonal demand pattern - Watsco operates from 655 locations in 42 U.S. states, Canada, Mexico, and Puerto Rico as of June 30, 2021[63] - Revenues primarily consist of sales of air conditioning, heating, and refrigeration equipment, and related parts and supplies[64] - Sales are seasonal, with residential AC demand highest in Q2 and Q3, and heating equipment demand highest in Q1 and Q4[65] Impact of the COVID-19 Pandemic Watsco's essential operations continued during COVID-19, with impacts shifting from direct disruptions to supply chain and labor issues, while austerity measures eased in 2021 - Watsco's employees' work is considered essential, allowing operations to continue with modifications during the pandemic[66] - The pandemic's impact shifted from location closures and employee illness to supply chain disruptions and labor shortages in 2021[70] - The company implemented austerity measures in 2020, which have since eased as economic conditions recovered[69][70] Joint Ventures with Carrier Global Corporation Watsco maintains several joint ventures with Carrier Global Corporation, including the recently formed TEC Distribution LLC in April 2021, primarily holding controlling interests - Watsco has an 80% controlling interest in Carrier Enterprise I, formed in 2009, which includes Carrier InterAmerica Corporation[72] - Watsco holds an 80% controlling interest in Carrier Enterprise II, formed in 2011, which includes operations in the Northeast U.S. and Mexico[74] - A new joint venture, TEC Distribution LLC, was formed with Carrier in April 2021, with Watsco holding an 80% controlling interest, to operate the acquired Temperature Equipment Corporation business[76] Critical Accounting Policies No significant changes to critical accounting policies were reported for the quarter ended June 30, 2021, compared to the 2020 Annual Report on Form 10-K - No significant changes to critical accounting policies were reported for the quarter ended June 30, 2021, compared to the 2020 Annual Report on Form 10-K[78] Results of Operations Watsco achieved robust financial performance in Q2 and H1 2021, with significant revenue and net income growth driven by strong demand, price increases, and improved gross profit margins Results of Operations (% of Revenues) | Metric (% of Revenues) | Q2 2021 | Q2 2020 | H1 2021 | H1 2020 | | :--------------------- | :------ | :------ | :------ | :------ | | Revenues | 100.0% | 100.0% | 100.0% | 100.0% | | Cost of sales | 74.2% | 76.4% | 74.1% | 76.0% | | Gross profit | 25.8% | 23.6% | 25.9% | 24.0% | | Selling, general and administrative expenses | 14.4% | 14.3% | 16.2% | 16.8% | | Operating income | 11.7% | 9.5% | 10.0% | 7.4% | | Net income attributable to Watsco, Inc. | 7.8% | 6.4% | 6.7% | 5.0% | - Revenues for Q2 2021 increased by $494.3 million (36%), with $104.8 million from new acquisitions, resulting in a 29% increase in same-store revenues[83] - Q2 2021 gross profit margin improved by 220 basis-points to 25.8% (vs 23.6% in Q2 2020), primarily due to pricing and mix for HVAC equipment[84] - H1 2021 revenues increased by $622.2 million (26%), with $104.8 million from new acquisitions, resulting in a 22% increase in same-store revenues[91] - H1 2021 gross profit margin improved by 190 basis-points to 25.9% (vs 24.0% in H1 2020), due to pricing and mix for HVAC equipment[92] - Net income attributable to Watsco, Inc. for Q2 2021 increased by $57.5 million (66%) and for H1 2021 increased by $82.1 million (70%) compared to the same periods in 2020[90][97] Liquidity and Capital Resources Watsco's liquidity is supported by operating cash flows and a revolving credit agreement, funding working capital, dividends, and acquisitions, while managing a contingent liability for a potential ownership purchase - Watsco's liquidity is primarily supported by operating cash flows and borrowing capacity under its revolving credit agreement[98] - As of June 30, 2021, cash and cash equivalents totaled $96.8 million, with $80.6 million held by foreign subsidiaries[99] - Working capital increased to $1,206.8 million at June 30, 2021, with $105.2 million attributable to 2021 acquisitions[102] - Net cash provided by operating activities decreased by $179.4 million to $81.9 million for H1 2021, primarily due to higher accounts receivable and inventory[103][104] - Net cash used in investing activities increased by $123.5 million to $131.5 million for H1 2021, mainly due to the ACME and TEC acquisitions[103][105] - As of June 30, 2021, $114.2 million was outstanding under the $560.0 million revolving credit agreement, which matures on December 5, 2023[107] - Watsco has a contingent liability of approximately $299.0 million for the potential purchase of additional ownership interests in Russell Sigler, Inc. (RSI)[110] - Cash dividends of $3.725 per share were paid during H1 2021, an increase from $3.375 per share in H1 2020[115] Item 3. Quantitative and Qualitative Disclosures about Market Risk No material changes to market risk disclosures were reported compared to the company's 2020 Annual Report on Form 10-K - No material changes to market risk information were reported compared to the 2020 Annual Report on Form 10-K[117] Item 4. Controls and Procedures Watsco's disclosure controls and procedures were effective as of June 30, 2021, with no material changes to internal controls, though recent acquisitions' controls remain unassessed - Disclosure controls and procedures were evaluated and deemed effective at a reasonable assurance level as of June 30, 2021[119] - No material changes in internal controls over financial reporting occurred during the quarter ended June 30, 2021[120] - Internal controls over financial reporting for recent acquisitions, ACME and TEC (representing approximately 8% of total consolidated assets and approximately 4% of Q2 2021 consolidated revenues), have not yet been assessed[121] PART II. OTHER INFORMATION Item 1. Legal Proceedings Information regarding legal proceedings is incorporated by reference from Note 9 to the condensed consolidated unaudited financial statements - Information on legal proceedings is referenced from Note 9 of the financial statements[122] Item 1A. Risk Factors No material changes to the risk factors were reported compared to the company's 2020 Annual Report on Form 10-K - No material changes to risk factors were reported compared to the 2020 Annual Report on Form 10-K[123] Item 2. Unregistered Sales of Equity Securities and Use of Proceeds On May 7, 2021, Watsco issued 8,492 shares of unregistered Common stock for the acquisition of Acme Refrigeration, exempt from registration under Section 4(a)(2) of the Securities Act - 8,492 shares of unregistered Common stock were issued on May 7, 2021, for the acquisition of ACME, exempt from registration under Section 4(a)(2) of the Securities Act[124] Item 6. Exhibits This section lists the exhibits filed with the Quarterly Report on Form 10-Q, including certifications from key executives and Inline XBRL documents - Exhibits include certifications from the CEO, EVP, and CFO (Sections 302 and 906 of Sarbanes-Oxley Act) and Inline XBRL documents[126] SIGNATURE SIGNATURE The report was duly signed on August 5, 2021, by Ana M. Menendez, Chief Financial Officer of Watsco, Inc - The report was signed by Ana M. Menendez, Chief Financial Officer, on August 5, 2021[128]