Watsco(WSO_B) - 2020 Q2 - Quarterly Report

PART I. FINANCIAL INFORMATION This section presents the company's unaudited condensed consolidated financial statements and management's discussion and analysis of financial condition and results of operations Item 1. Condensed Consolidated Unaudited Financial Statements This section presents Watsco's unaudited financial statements for Q2 and H1 2020, including income, balance sheets, and cash flows, showing mixed performance with increased operating cash flow Condensed Consolidated Unaudited Statements of Income For Q2 2020, revenues slightly decreased by 1.2% to $1.36 billion, and net income fell by 3.9% to $86.6 million, while H1 2020 revenues increased by 2.6% to $2.36 billion, but net income decreased by 6.5% to $117.1 million Condensed Consolidated Statements of Income (Unaudited) | (In thousands, except per share data) | Quarter Ended June 30, 2020 | Quarter Ended June 30, 2019 | Six Months Ended June 30, 2020 | Six Months Ended June 30, 2019 | | :--- | :--- | :--- | :--- | :--- | | Revenues | $1,355,385 | $1,371,854 | $2,363,541 | $2,303,132 | | Gross profit | $319,199 | $327,984 | $566,814 | $561,744 | | Operating income | $129,249 | $134,400 | $174,492 | $189,532 | | Net income attributable to Watsco, Inc. | $86,578 | $90,155 | $117,080 | $125,192 | | Diluted EPS | $2.26 | $2.40 | $3.02 | $3.34 | Condensed Consolidated Balance Sheets As of June 30, 2020, total assets increased slightly to $2.64 billion, cash and cash equivalents rose to $79.6 million, and borrowings under the revolving credit agreement significantly decreased to $33.4 million Balance Sheet Highlights (Unaudited) | (In thousands) | June 30, 2020 | December 31, 2019 | | :--- | :--- | :--- | | Total current assets | $1,631,469 | $1,546,730 | | Total assets | $2,636,727 | $2,556,161 | | Borrowings under revolving credit agreement | $33,357 | $155,700 | | Total current liabilities | $638,858 | $461,717 | | Total Watsco, Inc. shareholders' equity | $1,437,039 | $1,435,427 | Condensed Consolidated Unaudited Statements of Cash Flows Net cash provided by operating activities significantly increased to $261.3 million for H1 2020, primarily due to inventory reduction, while net cash used in financing activities rose due to credit facility repayments and higher dividend payments Cash Flow Summary (Unaudited, in thousands) | | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Net cash provided by operating activities | $261,255 | $68,447 | $192,808 | | Net cash used in investing activities | ($7,982) | ($30,806) | $22,824 | | Net cash used in financing activities | ($247,299) | ($65,327) | ($181,972) | | Net increase (decrease) in cash | $5,119 | ($26,979) | $32,098 | | Cash and cash equivalents at end of period | $79,573 | $55,915 | $23,658 | Notes to Condensed Consolidated Unaudited Financial Statements The notes detail accounting policies, revenue disaggregation, acquisitions, debt, and related-party transactions, highlighting that U.S. revenues dominate and Carrier is a key supplier - Revenues are disaggregated by geography and product line. For the six months ended June 30, 2020, the U.S. accounted for $2.13 billion (89.9%) of total revenues, while HVAC equipment represented 69% of total sales[33] - On April 10, 2020, the company increased its aggregate borrowing capacity under its revolving credit agreement from $500 million to $560 million. As of June 30, 2020, $33.4 million was outstanding[47][48] - The company has significant related-party transactions with Carrier Global Corporation. Purchases from Carrier and its affiliates comprised 60% of all inventory purchases during the first six months of 2020[65] Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Management discusses the COVID-19 pandemic's impact, noting disruptions and cost-saving measures, with Q2 2020 same-store sales decreasing 6% due to market disruption, yet the company maintained strong liquidity and generated record operating cash flow Impact of the COVID-19 Pandemic The COVID-19 pandemic significantly impacted Q2 2020 business, leading to temporary closures and cost-reduction measures, though the company's strong balance sheet and liquidity position it well to navigate uncertainty - The company's work was deemed essential, allowing operations to continue with modifications, such as restricted public access to branches and contactless sales[73] - Actions were taken to reduce costs, including reductions in fixed-cost compensation, rent abatement, and curtailing discretionary spending. Variable costs are expected to moderate with business activity[75] - As of June 30, 2020, the company had a strong liquidity position with $79.6 million in cash, only $33.4 million drawn from its $560 million credit facility, and $1.7 billion in shareholders' equity[76] Results of Operations In Q2 2020, total revenues decreased 1% to $1.36 billion, with same-store sales down 6% due to a 20% decline in commercial HVAC, leading to a 30 basis point drop in gross profit margin to 23.6% - Q2 2020 same-store revenues decreased 6% YoY, reflecting a 4% decrease in HVAC equipment sales (flat residential, -20% commercial), a 9% decrease in other HVAC products, and a 15% decrease in commercial refrigeration products[89] - Q2 2020 gross profit margin declined 30 basis-points to 23.6% from 23.9% in Q2 2019, primarily due to a shift in sales mix toward HVAC equipment, which has a lower gross profit margin[90] - H1 2020 same-store revenues decreased 3% YoY, with a 2% decrease in HVAC equipment sales (residential +1%, commercial -14%) and a 4% decrease in other HVAC products[97] Liquidity and Capital Resources The company's liquidity remains strong, supported by a $560 million revolving credit facility and a surge in operating cash flow to $261.3 million for H1 2020, primarily due to inventory reduction Cash Flow Activity Summary (in millions) | | 2020 | 2019 | Change | | :--- | :--- | :--- | :--- | | Cash flows provided by operating activities | $ 261.3 | $ 68.4 | $ 192.9 | | Cash flows used in investing activities | $ (8.0) | $(30.8) | $ 22.8 | | Cash flows used in financing activities | $(247.3) | $(65.3) | $(182.0) | - The increase in operating cash flow was primarily due to a reduction in the level of inventories[110] - The company paid cash dividends of $3.375 per share during the six months ended June 30, 2020, and the Board declared a regular quarterly cash dividend of $1.775 per share on July 1, 2020[122] Item 3. Quantitative and Qualitative Disclosures about Market Risk The company states that there have been no material changes to the information regarding market risk as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2019 - There have been no material changes to the information regarding market risk from what was provided in the 2019 Annual Report on Form 10-K[124] Item 4. Controls and Procedures Management concluded that the company's disclosure controls and procedures were effective as of June 30, 2020, with no material changes in internal control over financial reporting during the quarter - Management concluded that the company's disclosure controls and procedures were effective at a reasonable assurance level as of the end of the period covered by the report[126] - There were no changes in internal controls over financial reporting during the quarter ended June 30, 2020, that have materially affected, or are reasonably likely to materially affect, the company's internal control over financial reporting[127] PART II. OTHER INFORMATION This section details legal proceedings, updated risk factors, particularly concerning the COVID-19 pandemic, and a comprehensive list of filed exhibits Item 1. Legal Proceedings The company is involved in litigation incidental to its business operations, which management vigorously defends, and does not believe will have a material adverse effect on its financial condition or results of operations - The company is involved in litigation incidental to its business but does not believe the ultimate liability will have a material adverse effect on its financial condition or results of operations[63][129] Item 1A. Risk Factors This section updates risk factors, focusing on the COVID-19 pandemic, including potential disruptions to operations, supply chain limitations, reduced customer demand, and a possible shift to lower-margin products - The COVID-19 pandemic is a significant risk factor that could adversely affect business and results of operations through mandatory closures, work-from-home orders, and social distancing protocols[131] - Specific pandemic-related risks include limitations on suppliers, employee availability, carrier deliveries, and customers' ability to conduct business and make timely payments[132] - The pandemic could alter the sales mix towards lower-margin repair over replacement, value-oriented equipment, and see lower demand from new construction and commercial markets, reducing sales and gross margin[132] Item 6. Exhibits This section lists the exhibits filed with the Form 10-Q, including the Revolving Credit Increase and Joinder Agreement and Sarbanes-Oxley Act certifications from key executives - Exhibit 10.1 is the Revolving Credit Increase and Joinder Agreement, dated April 10, 2020[134] - Exhibits 31.1, 31.2, and 31.3 are the Sarbanes-Oxley Act Section 302 certifications from the Chief Executive Officer, Executive Vice President, and Chief Financial Officer, respectively[136]