Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM
10-Q
 
☒
Quarterly Report Pursuant to Section
 13 or 15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended March 31,September 30, 2020
or
☐
Transition Report Pursuant To Section
 13 or 15(d) of the Securities Exchange Act of 1934
For the Transition Period From
    
    
    
    
to
    
    
    
    
For the Transition Period From
to
Commission file number
1-5581
I.R.S. Employer Identification Number
59-0778222
 
WATSCO, INC.
(a Florida Corporation)
2665 South Bayshore Drive, Suite 901
Miami, Florida 33133
Telephone:
(305)
 714-4100
 
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading

Symbol(s)
Symbol(s)
Name of each exchange

on which registered
Common stock, $0.50 par value
WSO
New York Stock Exchange
Class B common stock, $0.50 par value
WSOB
New York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    
Yes  
☒
    No  
☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation
S-T
(§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  
☒
    No  
☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a
non-accelerated
filer, a smaller reporting company, or
 an
emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule
12b-2
of the Exchange Act.
Large accelerated filer
☒
Accelerated filer
☐
    
Non-accelerated
filer
☐
Smaller reporting company
☐
    
 
 
Emerging growth company
☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  
☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule
12b-2
of the Exchange Act).    Yes  
☐
    No  
☒
The registrant’s common stock outstanding as of May 4,November 2, 2020 comprised (i) 32,758,82332,846,271 shares of Common stock, $0.50 par value per share, excluding 4,823,988 treasury shares and (ii) 5,599,4365,635,926 shares of Class B common stock, $0.50 par value per share, excluding 48,263 treasury shares.
 
 
Table of Contents
WATSCO, INC. AND SUBSIDIARIES
 
QUARTERLY REPORT ON FORM
10-Q
TABLE OF CONTENTS
Page No.
PART I. FINANCIAL INFORMATION
   
   
Item 1.
Condensed Consolidated Unaudited Financial Statements
   
   
 
Condensed Consolidated Unaudited Statements of Income – Quarters and Nine Months Ended March 31,September 30, 2020 and 2019
3
   
 
Condensed Consolidated Unaudited Statements of Comprehensive Income ���– Quarters and Nine Months Ended March 31,September 30, 2020 and 2019
4
   
 
Condensed Consolidated Balance Sheets – March 31,September 30, 2020 (Unaudited) and December 31, 2019
5
   
 
Condensed Consolidated Unaudited Statements of Shareholders’ Equity – Quarters and Nine Months Ended March 31,September 30, 2020 and 2019
6
   
 
Condensed Consolidated Unaudited Statements of Cash Flows – QuartersNine Months Ended March 31,September 30, 2020 and 2019
8
   
 
Notes to Condensed Consolidated Unaudited Financial Statements
9
   
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
15
16
   
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
21
Item 4.
Controls and Procedures
21
PART II. OTHER INFORMATION
  
24
 
   
      Item 4.
Controls and Procedures
24
  
Item 1.
PART II. OTHER INFORMATION
Legal Proceedings
  
22
 
   
      Item 1.
Legal Proceedings
25
   
Item 1A.
Risk Factors
22
25
   
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
22
Item 6.
Exhibits
23
26
  
SIGNATURE
24
27
  
EXHIBITS
  
 
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Table of Contents
PART I.
FINANCIAL INFORMATION
ITEM 1.
ITEM 1.
CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF INCOME
(In thousands, except per share data)
 
Quarters Ended March 31,
 
 
2020
  
2019
 
Revenues
 $
1,008,156
  $
931,278
 
Cost of sales
  
760,541
   
697,518
 
         
Gross profit
  
247,615
   
233,760
 
Selling, general and administrative expenses
  
203,386
   
180,072
 
Other income
  
1,014
   
1,444
 
         
Operating income
  
45,243
   
55,132
 
Interest expense, net
  
790
   
776
 
         
Income before income taxes
  
44,453
   
54,356
 
Income taxes
  
8,206
   
10,552
 
         
Net income
  
36,247
   
43,804
 
Less: net income attributable to
non-controlling
interest
  
5,745
   
8,767
 
         
Net income attributable to Watsco, Inc.
 $
30,502
  $
35,037
 
         
Earnings per share for Common and Class B common stock:
      
Basic and Diluted
 $
0.72
  $
0.88
 
         
   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2020   2019   2020   2019 
Revenues
  
$
1,536,671
 
  $1,394,915   
$
3,900,212
 
  $3,698,047 
Cost of sales
  
 
1,162,908
 
   1,060,224   
 
2,959,635
 
   2,801,612 
  
 
 
   
 
 
   
 
 
   
 
 
 
Gross profit
  
 
373,763
 
   334,691   
 
940,577
 
   896,435 
Selling, general and administrative expenses
  
 
221,037
 
   212,902   
 
618,476
 
   589,523 
Other income
  
 
4,055
 
   3,530   
 
9,172
 
   7,939 
  
 
 
   
 
 
   
 
 
   
 
 
 
Operating income
  
 
156,781
 
   125,319   
 
331,273
 
   314,851 
Interest expense, net
  
 
108
 
   1,434   
 
1,181
 
   3,422 
  
 
 
   
 
 
   
 
 
   
 
 
 
Income before income taxes
  
 
156,673
 
   123,885   
 
330,092
 
   311,429 
Income taxes
  
 
30,467
 
   24,230   
 
63,397
 
   60,060 
  
 
 
   
 
 
   
 
 
   
 
 
 
Net income
  
 
126,206
 
   99,655   
 
266,695
 
   251,369 
Less: net income attributable to
non-controlling
interest
  
 
19,717
 
   16,175   
 
43,126
 
   42,697 
  
 
 
   
 
 
   
 
 
   
 
 
 
Net income attributable to Watsco, Inc.
  
$
106,489
 
  $83,480   
$
223,569
 
  $208,672 
  
 
 
   
 
 
   
 
 
   
 
 
 
Earnings per share for Common and Class B common stock:
        
Basic
  
$
2.77
 
  $2.20   
$
5.83
 
  $5.54 
  
 
 
   
 
 
   
 
 
   
 
 
 
Diluted
  
$
2.76
 
  $2.20   
$
5.82
 
  $5.54 
  
 
 
   
 
 
   
 
 
   
 
 
 
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
   Quarter Ended
September 30,		  Nine Months Ended
September 30,		 
   2020  2019  2020  2019 
Net income
  
$
126,206
 
 $99,655  
$
266,695
 
 $251,369 
Other comprehensive income (loss), net of tax
     
Foreign currency translation adjustment
  
 
5,514
 
  (3,038)  
 
(6,592
)
 
  7,264 
Unrealized (loss) gain on cash flow hedging instruments
  
 
(416
)
 
  255  
 
948
 
  (798) 
Reclassification of gain on cash flow hedging
instruments into earnings
  
 
(509
) 
  (140)  
 
(691
) 
  (542) 
  
 
 
  
 
 
  
 
 
  
 
 
 
Other comprehensive income (loss)
  
 
4,589
 
  (2,923)  
 
(6,335
)
 
  5,924 
  
 
 
  
 
 
  
 
 
  
 
 
 
Comprehensive income
  
 
130,795
 
  96,732  
 
260,360
 
  257,293 
Less: comprehensive income attributable to
non-controlling
interest
  
 
21,283
 
  15,146  
 
40,986
 
  44,693 
  
 
 
  
 
 
  
 
 
  
 
 
 
Comprehensive income attributable to Watsco, Inc.
  
$
109,512
 
 $81,586  
$
219,374
 
 $212,600 
  
 
 
  
 
 
  
 
 
  
 
 
 
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF COMPREHENSIVE INCOME
(In thousands)
         
 
Quarters Ended March 31,
 
 
2020
  
2019
 
Net income
 $
36,247
  $
43,804
 
Other comprehensive (loss) income, net of tax
      
Foreign currency translation adjustment
  
(21,929
)
 
  
5,005
 
Unrealized gain (loss) on cash flow hedging instruments arising during the period
  
2,534
   
(536
)
Reclassification of loss (gain) on cash flow hedging instruments into earnings
  
115
   
(274
)
         
Other comprehensive (loss) income
  
(19,280
)
 
  
4,195
 
Comprehensive income
  
16,967
   
47,999
 
Less: comprehensive (loss) income attributable to non-controlling interest
  
(796
)
 
  
10,179
 
         
Comprehensive income attributable to Watsco, Inc.
 $
17,763
  $
37,820
 
         
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except per share data)
 
March 31,
2020
  
December 31,
2019
 
 
(Unaudited)
   
ASSETS
      
Current assets:
      
Cash and cash equivalents
 $
51,236
  $
74,454
 
Accounts receivable, net
  
574,827
   
533,810
 
Inventories
  
942,815
   
920,786
 
Other current assets
  
21,501
   
17,680
 
         
Total current assets
  
1,590,379
   
1,546,730
 
Property and equipment, net
  
97,443
   
98,523
 
Operating lease
right-of-use
assets
  
221,285
   
223,369
 
Goodwill
  
406,998
   
411,217
 
Intangible assets, net
  
160,736
   
172,004
 
Investment in unconsolidated entity
  
95,847
   
94,833
 
Other assets
  
9,141
   
9,485
 
         
 $
2,581,829
  $
2,556,161
 
         
LIABILITIES AND SHAREHOLDERS’ EQUITY
      
Current liabilities:
      
Current portion of lease liabilities
 $
69,344
  $
69,421
 
Accounts payable
  
311,586
   
239,666
 
Accrued expenses and other current liabilities
  
139,544
   
152,630
 
         
Total current liabilities
  
520,474
   
461,717
 
         
Long-term obligations:
      
Borrowings under revolving credit agreement
  
156,143
   
155,700
 
Operating lease liabilities, net of current portion
  
152,065
   
154,271
 
Finance lease liabilities, net of current portion
  
2,106
   
2,009
 
         
Total long-term obligations
  
310,314
   
311,980
 
         
Deferred income taxes and other liabilities
  
68,155
   
67,697
 
         
Commitments and contingencies
      
Watsco, Inc. shareholders’ equity:
      
Common stock, $0.50 par value
  
18,789
   
18,768
 
Class B common stock, $0.50 par value
  
2,821
   
2,765
 
Preferred stock, $0.50 par value
  
—
   
—
 
Paid-in
capital
  
920,190
   
907,877
 
Accumulated other comprehensive loss, net of tax
  
(51,789
)  
(39,050
)
Retained earnings
  
601,771
   
632,507
 
Treasury stock, at cost
  
(87,440
)  
(87,440
)
         
Total Watsco, Inc. shareholders’ equity
  
1,404,342
   
1,435,427
 
Non-controlling
interest
  
278,544
   
279,340
 
         
Total shareholders’ equity
  
1,682,886
   
1,714,767
 
         
 $
2,581,829
  $
2,556,161
 
         
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF SHAREHOLDERS’ EQUITY
                                 
(In thousands, except
 
share and per share data)
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Shares
  
Common Stock,
Class B
Common Stock
and Preferred
Stock Amount
  
Paid-In

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

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

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

Interest
  
Total
 
Balance at December 31, 2018
  
37,461,643
  $
21,167
  $
832,121
  $
(45,968
) $
627,969
  $
(87,440
) $
253,864
  $
1,601,713
 
Net income
              
35,037
      
8,767
   
43,804
 
Other comprehensive income
           
2,783
         
1,412
   
4,195
 
Issuances of
non-vested
restricted shares of common stock
  
77,049
   
39
   
(39
)              
—
 
 
 
Forfeitures of
non-vested
restricted shares of common stock
  
(5,000
)  
(3
)  
3
               
—
 
 
 
Common stock contribution to 401(k) plan
  
30,715
   
15
   
4,259
               
4,274
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
8,925
   
4
   
1,121
               
1,125
 
Retirement of common stock
  
(2,985
)  
(1
)  
(427
)              
(428
)
Share-based compensation
        
4,537
               
4,537
 
Cash dividends declared and paid on Common and Class B common stock, $1.60 per share
              
(59,965
)        
(59,965
)
                                 
Balance at March 31, 2019
  
37,570,347
  $
21,221
  $
841,575
  $
(43,185
) $
603,041
  $
(87,440
) $
264,043
  $
1,599,255
 
                                 
See accompanying notes to consolidated financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
 
Quarters Ended March 31,
 
 
2020
  
2019
 
Cash flows from operating activities:
      
Net income
 $
36,247
  $
43,804
 
Adjustments to reconcile net income to net cash provided by operating activities:
      
Depreciation and amortization
  
6,479
   
5,768
 
Share-based compensation
  
4,912
   
3,849
 
Non-cash contribution to 401(k) plan
  
4,543
   
4,274
 
Provision for doubtful accounts
  
2,005
   
1,406
 
Other income from investment in unconsolidated entity
  
(1,014
)  
(1,444
)
Other, net
  
668
   
(221
)
Changes in operating assets and liabilities:
      
Accounts receivable
  
(46,534
)  
(2,329
)
Inventories
  
(27,280
)  
(55,560
)
Accounts payable and other liabilities
  
66,049
   
55,350
 
Other, net
  
(4,216
)  
(1,961
)
         
Net cash provided by operating activities
  
41,859
   
52,936
 
         
Cash flows from investing activities:
      
Capital expenditures
  
(3,859
)  
(4,132
)
Proceeds from sale of property and equipment
  
10
   
29
 
         
Net cash used in investing activities
  
(3,849
)  
(4,103
)
         
Cash flows from financing activities:
      
Dividends on Common and Class B common stock
  
(61,238
)  
(59,965
)
Repurchases of common stock to satisfy employee withholding tax obligations
  
(791
)  
(428
)
Net repayments of long-term obligations
  
(343
)  
(230
)
Proceeds from short-term borrowings
  
—
   
2,340
 
Net proceeds under revolving credit agreement
  
443
   
2,300
 
Net proceeds from issuances of common stock
  
2,541
   
1,127
 
         
Net cash used in financing activities
  
(59,388
)  
(54,856
)
         
Effect of foreign exchange rate changes on cash and cash equivalents
  
(1,840
)
 
  
402
 
         
Net decrease in cash and cash equivalents
  
(23,218
)  
(5,621
)
Cash and cash equivalents at beginning of period
  
74,454
   
82,894
 
         
Cash and cash equivalents at end of period
 $
51,236
  $
77,273
 
         
   September 30,
2020		  December 31,
2019		 
   (Unaudited)    
ASSETS
   
Current assets:
   
Cash and cash equivalents
  
$
92,600
 
 $74,454 
Accounts receivable, net
  
 
644,124
 
  533,810 
Inventories
  
 
884,653
 
  920,786 
Other current assets
  
 
22,742
 
  17,680 
  
 
 
  
 
 
 
Total current assets
  
 
1,644,119
 
  1,546,730 
Property and equipment, net
  
 
97,660
 
  98,523 
Operating lease
right-of-use
assets
  
 
218,884
 
  223,369 
Goodwill
  
 
409,783
 
  411,217 
Intangible assets, net
  
 
164,551
 
  172,004 
Investment in unconsolidated entity
  
 
103,355
 
  94,833 
Other assets
  
 
9,333
 
  9,485 
  
 
 
  
 
 
 
  
$
2,647,685
 
 $2,556,161 
  
 
 
  
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
   
Current liabilities:
   
Current portion of lease liabilities
  
$
71,174
 
 $69,421 
Accounts payable
  
 
352,694
 
  239,666 
Accrued expenses and other current liabilities
  
 
185,630
 
  152,630 
  
 
 
  
 
 
 
Total current liabilities
  
 
609,498
 
  461,717 
  
 
 
  
 
 
 
Long-term obligations:
   
Borrowings under revolving credit agreement
  
 
668
 
  155,700 
Operating lease liabilities, net of current portion
  
 
149,075
 
  154,271 
Finance lease liabilities, net of current portion
  
 
3,569
 
  2,009 
  
 
 
  
 
 
 
Total long-term obligations
  
 
153,312
 
  311,980 
  
 
 
  
 
 
 
Deferred income taxes and other liabilities
  
 
74,937
 
  67,697 
  
 
 
  
 
 
 
Commitments and contingencies
  
   
Watsco, Inc. shareholders’ equity:
   
Common stock, $0.50 par value
  
 
18,830
 
  18,768 
Class B common stock, $0.50 par value
  
 
2,830
 
  2,765 
Preferred stock, $0.50 par value
  
 
—  
 
  —   
Paid-in
capital
  
 
940,015
 
  907,877 
Accumulated other comprehensive loss, net of tax
  
 
(43,245
) 
  (39,050) 
Retained earnings
  
 
658,622
 
  632,507 
Treasury stock, at cost
  
 
(87,440
) 
  (87,440) 
  
 
 
  
 
 
 
Total Watsco, Inc. shareholders’ equity
  
 
1,489,612
 
  1,435,427 
Non-controlling
interest
  
 
320,326
 
  279,340 
  
 
 
  
 
 
 
Total shareholders’ equity
  
 
1,809,938
 
  1,714,767 
  
 
 
  
 
 
 
  
$
2,647,685
 
 $2,556,161 
  
 
 
  
 
 
 
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF SHAREHOLDERS’ EQUITY
(In thousands, except share and
per share data)
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Shares
  
Common Stock,
Class B
Common Stock
and Preferred
Stock Amount
  
Paid-In

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

Interest
  
Total
 
Balance at December 31
,
2019
  
 
38,194,056
 
 
$
21,533
 
 
$
907,877
 
 
$
(39,050
) 
 
$
632,507
 
 
$
(87,440
) 
 
$
279,340
 
 
$
1,714,767
 
Net income
  
   
 
   
 
   
 
   
 
 
30,502
 
 
   
 
 
5,745
 
 
 
36,247
 
Other comprehensive (loss)
  
   
 
   
 
   
 
 
(12,739
) 
 
   
 
   
 
 
(6,541
) 
 
 
(19,280
) 
Issuances of
non-vested
restricted shares of common stock
  
 
113,765
 
 
 
57
 
 
 
(57
) 
 
   
 
   
 
   
 
 
—
 
Common stock contribution to 401
(k) plan
  
 
25,216
 
 
 
13
 
 
 
4,530
 
 
   
 
   
 
   
 
 
4,543
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
18,674
 
 
 
9
 
 
 
2,532
 
 
   
 
   
 
   
 
 
2,541
 
Retirement of common stock
  
 
(4,828
) 
 
 
(2
) 
 
 
(789
) 
 
   
 
   
 
   
 
 
(791
) 
Share-based compensation
  
   
 
   
 
 
6,097
 
 
   
 
   
 
   
 
 
6,097
 
Cash dividends declared and paid on Common and Class B common stock, $1.60
per share
  
   
 
   
 
   
 
   
 
 
(61,238
) 
 
   
 
 
(61,238
) 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at March 31
,
2020
  
 
38,346,883
 
 
 
21,610
 
 
 
920,190
 
 
 
(51,789
) 
 
 
601,771
 
 
 
(87,440
) 
 
 
278,544
 
 
 
1,682,886
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
  
   
 
   
 
   
 
   
 
 
86,578
 
 
   
 
 
17,664
 
 
 
104,242
 
Other comprehensive income
  
   
 
   
 
   
 
 
5,521
 
 
   
 
   
 
 
2,835
 
 
 
8,356
 
Issuances of
non-vested
restricted shares of common stock
  
 
15,500
 
 
 
8
 
 
 
(8
) 
 
   
 
   
 
   
 
 
—
  
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
32,073
 
 
 
16
 
 
 
4,529
 
 
   
 
   
 
   
 
 
4,545
 
Retirement of common stock
  
 
(6,377
) 
 
 
(4
) 
 
 
(1,092
) 
 
   
 
   
 
   
 
 
(1,096
) 
Share-based compensation
  
   
 
   
 
 
5,226
 
 
   
 
   
 
   
 
 
5,226
 
Cash dividends declared and paid on Common and Class B common stock, $1.775
per share
  
   
 
   
 
   
 
   
 
 
(68,077
) 
 
   
 
 
(68,077
) 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at June 30
,
2020
  
 
38,388,079
 
 
 
21,630
 
 
 
928,845
 
 
 
(46,268
) 
 
 
620,272
 
 
 
(87,440
) 
 
 
299,043
 
 
 
1,736,082
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
  
   
 
   
 
   
 
   
 
 
106,489
 
 
   
 
 
19,717
 
 
 
126,206
 
Other comprehensive income
  
   
 
   
 
   
 
 
3,023
 
 
   
 
   
 
 
1,566
 
 
 
4,589
 
Issuances of
non-vested
restricted shares of common stock
  
 
20,000
 
 
 
10
 
 
 
(10
) 
 
   
 
   
 
   
 
 
—
  
 
Forfeitures of
non-vested
restricted shares of common stock
  
 
(3,589
) 
 
 
(2
) 
 
 
2
 
 
   
 
   
 
   
 
 
—
  
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
55,473
 
 
 
28
 
 
 
8,438
 
 
   
 
   
 
   
 
 
8,466
 
Retirement of common stock
  
 
(11,943
) 
 
 
(6
) 
 
 
(2,749
) 
 
   
 
   
 
   
 
 
(2,755
) 
Share-based compensation
  
   
 
   
 
 
5,489
 
 
   
 
   
 
   
 
 
5,489
 
Cash dividends declared and paid on Common and Class B common stock, $1.775
per share
  
   
 
   
 
   
 
   
 
 
(68,139
) 
 
   
 
 
(68,139
) 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30
,
2020
  
 
38,448,020
 
 
$
21,660
 
 
$
940,015
 
 
$
(43,245
) 
 
$
658,622
 
 
$
(87,440
) 
 
$
320,326
 
 
$
1,809,938
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Continued on next page.
6 of 27
(In thousands, except share and
per share data)
 
Common Stock,
Class B
Common Stock
and Preferred
Stock Shares
  
Common Stock,
Class B
Common Stock
and Preferred
Stock Amount
  
Paid-In

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

Interest
  
Total
 
Balance at December 31
,
2018
  
 
37,461,643
 
 
$
21,167
 
 
$
832,121
 
 
$
(45,968
) 
 
$
627,969
 
 
$
(87,440
) 
 
$
253,864
 
 
$
1,601,713
 
Net income
  
   
 
   
 
   
 
   
 
 
35,037
 
 
   
 
 
8,767
 
 
 
43,804
 
Other comprehensive income
  
   
 
   
 
   
 
 
2,783
 
 
   
 
   
 
 
1,412
 
 
 
4,195
 
Issuances of
non-vested
restricted shares of common stock
  
 
77,049
 
 
 
39
 
 
 
(39
) 
 
   
 
   
 
   
 
 
—
  
 
Forfeitures of
non-vested
restricted shares of common stock
  
 
(5,000
) 
 
 
(3
) 
 
 
3
 
 
   
 
   
 
   
 
 
—
  
 
Common stock contribution to 401
(k) plan
  
 
30,715
 
 
 
15
 
 
 
4,259
 
 
   
 
   
 
   
 
 
4,274
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
8,925
 
 
 
4
 
 
 
1,121
 
 
   
 
   
 
   
 
 
1,125
 
Retirement of common stock
  
 
(2,985
) 
 
 
(1
) 
 
 
(427
) 
 
   
 
   
 
   
 
 
(428
) 
Share-based compensation
  
   
 
   
 
 
4,537
 
 
   
 
   
 
   
 
 
4,537
 
Cash dividends declared and paid on Common and Class B common stock, $1.60
per share
  
   
 
   
 
   
 
   
 
 
(59,965
) 
 
   
 
 
(59,965
) 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at March 31
,
2019
  
 
37,570,347
 
 
 
21,221
 
 
 
841,575
 
 
 
(43,185
) 
 
 
603,041
 
 
 
(87,440
) 
 
 
264,043
 
 
 
1,599,255
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
  
   
 
   
 
   
 
   
 
 
90,155
 
 
   
 
 
17,755
 
 
 
107,910
 
Other comprehensive income
  
   
 
   
 
   
 
 
3,039
 
 
   
 
   
 
 
1,613
 
 
 
4,652
 
Issuances of
non-vested
restricted shares of common stock
  
 
26,354
 
 
 
13
 
 
 
(13
) 
 
   
 
   
 
   
 
 
—
  
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
15,807
 
 
 
9
 
 
 
1,942
 
 
   
 
   
 
   
 
 
1,951
 
Retirement of common stock
  
 
(3,608
) 
 
 
(2
) 
 
 
(553
) 
 
   
 
   
 
   
 
 
(555
) 
Share-based compensation
  
   
 
   
 
 
4,324
 
 
   
 
   
 
   
 
 
4,324
 
Cash dividends declared and paid on Common and Class B common stock, $1.60
per share
  
   
 
   
 
   
 
   
 
 
(60,213
) 
 
   
 
 
(60,213
) 
Common stock issued for Dunphey & Associates Supply Co., Inc.
  
 
50,952
 
 
 
25
 
 
 
7,425
 
 
   
 
   
 
   
 
 
7,450
 
Investment in unconsolidated entity
  
   
 
   
 
   
 
   
 
   
 
   
 
 
988
 
 
 
988
 
Decrease in
non-controlling
interest in Carrier Enterprise II
  
   
 
   
 
 
(25,768
) 
 
   
 
   
 
   
 
 
(6,632
) 
 
 
(32,400
) 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at June 30
,
2019
  
 
37,659,852
 
 
 
21,266
 
 
 
828,932
 
 
 
(40,146
) 
 
 
632,983
 
 
 
(87,440
) 
 
 
277,767
 
 
 
1,633,362
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
  
   
 
   
 
   
 
   
 
 
83,480
 
 
   
 
 
16,175
 
 
 
99,655
 
Other comprehensive (loss)
  
   
 
   
 
   
 
 
(1,894
) 
 
   
 
   
 
 
(1,029
) 
 
 
(2,923
) 
Issuances of
non-vested
restricted shares of common stock
  
 
37,834
 
 
 
19
 
 
 
(19
) 
 
   
 
   
 
   
 
 
—
 
Forfeitures of
non-vested
restricted shares of common stock
  
 
(5,337
) 
 
 
(3
) 
 
 
3
 
 
   
 
   
 
   
 
 
—
 
Stock issuances from exercise of stock options and employee stock purchase plan
  
 
36,374
 
 
 
19
 
 
 
4,510
 
 
   
 
   
 
   
 
 
4,529
 
Retirement of common stock
  
 
(4,030
) 
 
 
(2
) 
 
 
(667
) 
 
   
 
   
 
   
 
 
(669
) 
Share-based compensation
  
   
 
   
 
 
3,706
 
 
   
 
   
 
   
 
 
3,706
 
Cash dividends declared and paid on Common and Class B common stock, $1.60
per share
  
   
 
   
 
   
 
   
 
 
(60,276
) 
 
   
 
 
(60,276
) 
Common stock issued for Peirce-Phelps, Inc.
  
 
372,543
 
 
 
186
 
 
 
58,452
 
 
   
 
   
 
   
 
 
58,638
 
Investment in Peirce-Phelps, Inc.
  
   
 
   
 
   
 
   
 
   
 
   
 
 
17,000
 
 
 
17,000
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30
,
2019
  
 
38,097,236
 
 
$
21,485
 
 
$
894,917
 
 
$
(42,040
) 
 
$
656,187
 
 
$
(87,440
) 
 
$
309,913
 
 
$
1,753,022
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
See accompanying notes to condensed consolidated unaudited financial statements.
7 of 27
WATSCO, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
 
  
Nine Months Ended
September 30,
 
 
  
2020
 
 
2019
 
Cash flows from operating activities:
  
   
 
   
Net income
  
$
266,695
 
 
$
251,369
 
Adjustments to reconcile net income to net cash provided by operating activities:
  
   
 
   
Depreciation and amortization
  
 
19,350
 
 
 
17,983
 
Share-based compensation
  
 
15,802
 
 
 
11,992
 
Non-cash
contribution to 401(k) plan
  
 
4,543
 
 
 
4,274
 
Deferred income tax provision
  
 
3,177
 
 
 
2,765
 
Other income from investment in unconsolidated entity
  
 
(9,172
) 
 
 
(7,939
) 
Other, net
  
 
1,776
 
 
 
1,260
 
Changes in operating assets and liabilities, net of effects of acquisitions:
  
   
 
   
Accounts receivable
  
 
(113,017
) 
 
 
(102,813
) 
Inventories
  
 
34,448
 
 
 
(74,448
) 
Accounts payable and other liabilities
  
 
158,094
 
 
 
99,627
 
Other, net
  
 
(8,918
) 
 
 
(6,539
) 
 
  
 
 
 
 
 
 
 
Net cash provided by operating activities
  
 
372,778
 
 
 
197,531
 
 
  
 
 
 
 
 
 
 
Cash flows from investing activities:
  
   
 
   
Capital expenditures
  
 
(11,608
) 
 
 
(14,007
) 
Business acquisitions, net of cash acquired
  
 
—  
 
 
 
(47,343
) 
Investment in unconsolidated entity
  
 
—  
 
 
 
(4,940
) 
Proceeds from sale of property and equipment
  
 
61
 
 
 
1,295
 
 
  
 
 
 
 
 
 
 
Net cash used in investing activities
  
 
(11,547
) 
 
 
(64,995
) 
 
  
 
 
 
 
 
 
 
Cash flows from financing activities:
  
   
 
   
Dividends on Common and Class B common stock
  
 
(197,454
) 
 
 
(180,454
) 
Net (repayments) proceeds under revolving credit agreement
  
 
(155,032
) 
 
 
34,100
 
Repurchases of common stock to satisfy employee withholding tax obligations
  
 
(2,299
) 
 
 
(1,528
) 
Net repayments of long-term obligations
  
 
(1,003
) 
 
 
(920
) 
Payment of fees related to revolving credit agreement
  
 
(189
) 
 
 
—  
 
Proceeds from
non-controlling
interest for investment in unconsolidated entity
  
 
—  
 
 
 
988
 
Purchase of additional ownership from
non-controlling
interest
  
 
—  
 
 
 
(32,400
) 
Proceeds from
non-controlling
interest for investment in Peirce-Phelps, Inc.
  
 
—  
 
 
 
17,000
 
Net proceeds from issuances of common stock
  
 
13,207
 
 
 
7,480
 
 
  
 
 
 
 
 
 
 
Net cash used in financing activities
  
 
(342,770
) 
 
 
(155,734
) 
 
  
 
 
 
 
 
 
 
Effect of foreign exchange rate changes on cash and cash equivalents
  
 
(315
) 
 
 
454
 
 
  
 
 
 
 
 
 
 
Net increase (decrease) in cash and cash equivalents
  
 
18,146
 
 
 
(22,744
) 
Cash and cash equivalents at beginning of period
  
 
74,454
 
 
 
82,894
 
 
  
 
 
 
 
 
 
 
Cash and cash equivalents at end of period
  
$
92,600
 
 
$
60,150
 
 
  
 
 
 
 
 
 
 
Supplemental cash flow information:
  
   
 
   
Common stock issued for Peirce-Phelps, Inc.
  
 
—  
 
 
$
58,638
 
Common stock issued for Dunphey & Associates Supply Co., Inc.
  
 
—  
 
 
$
7,450
 
See accompanying notes to condensed consolidated unaudited financial statements.
8 of 27
WATSCO, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
March 31,
September 30, 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,September 30, 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.
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), which we refer to as Carrier. 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 three3 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 and nine months ended March 31,September 30, 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
reserves 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 StatesStates. In March 2020, the World Health Organization declared
COVID-19
a pandemic. The
COVID-19
pandemic has resulted,impacted and is likelycould further impact our operations and the operations of our suppliers and customers as a result of quarantines, facility closures, illnesses, and travel and logistics restrictions. The extent to continuewhich the
COVID-19
pandemic continues to result, in significant economic disruption and has and will likely adversely affectimpact our business, and results of operations. Although these disruptionsoperations, and financial condition will depend on future developments, which are expectedhighly uncertain and cannot be predicted, including, but not limited to be temporary, significant uncertainty exists concerning the magnitude, of theduration, spread, severity, and 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 impacteffects of the
COVID-19
pandemic on our employees, customers, suppliers, and vendors, and to what extent normal economic and operating conditions can resume. Even after the
COVID-19
pandemic has subsided, we may continue to experience adverse impacts to our resultsbusiness as a result of operationsany economic recession or depression that has occurred as a result of the
COVID-19
pandemic. Therefore, we cannot be reasonably estimated but could be material and last for an extended period ofestimate the impact at this 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
9 of 27
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​​​​​​​
Table of Contents
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.
 
22.
.
REVENUES
Disaggregation of Revenues
The following table presents our revenues disaggregated by primary geographical regions and major product lines within our single reporting segment:
         
Quarters Ended March 31,
 
2020
  
2019
 
Primary Geographical Regions:
      
United States
 $
899,545
  $
806,511
 
Canada
  
55,341
   
59,256
 
Latin America and the Caribbean
  
53,270
   
65,511
 
         
 $
1,008,156
  $
931,278
 
         
Major Product Lines:
      
HVAC equipment
  
66
%  
67
%
Other HVAC products
  
30
%  
29
%
Commercial refrigeration products
  
4
%  
4
%
         
  
100
%  
100
%
         
 
   Quarter Ended
September 30,		  Nine Months Ended
September 30,		 
   2020  2019  2020  2019 
Primary Geographical Regions:
     
United States
  
$
1,391,340
 
 $1,232,564  
$
3,517,533
 
 $3,258,283 
Canada
  
 
91,429
 
  85,422  
 
218,687
 
  222,429 
Latin America and the Caribbean
  
 
53,902
 
  76,929  
 
163,992
 
  217,335 
  
 
 
  
 
 
  
 
 
  
 
 
 
  
$
1,536,671
 
 $1,394,915  
$
3,900,212
 
 $3,698,047 
  
 
 
  
 
 
  
 
 
  
 
 
 
Major Product Lines:
     
HVAC equipment
  
 
70
% 
  68%  
 
70
% 
  68% 
Other HVAC products
  
 
27
% 
  29%  
 
27
% 
  28% 
Commercial refrigeration products
  
 
3
% 
  3%  
 
3
% 
  4% 
  
 
 
  
 
 
  
 
 
  
 
 
 
  
 
100
% 
  100%  
 
100
% 
  100% 
  
 
 
  
 
 
  
 
 
  
 
 
 
10 of 24
27
Table of Contents
33.
.
EARNINGS PER SHARE
The following table presents the calculation of basic and diluted earnings per share for our Common and Class B common stock:
         
Quarters Ended March 31,
 
2020
  
2019
 
Basic Earnings per Share:
      
Net income attributable to Watsco, Inc. shareholders
 $
30,502
  $
35,037
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
5,233
   
4,924
 
         
Earnings allocated to Watsco, Inc. shareholders
 $
25,269
  $
30,113
 
         
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
  
34,995,048
   
34,388,117
 
 
 
 
 
 
 
 
 
 
Basic earnings per share for Common and Class B common stock
 $
0.72
  $
0.88
 
Allocation of earnings for Basic:
      
Common stock
 $
23,409
  $
27,856
 
Class B common stock
  
1,860
   
2,257
 
         
 $
25,269
  $
30,113
 
         
Diluted Earnings per Share:
      
Net income attributable to Watsco, Inc. shareholders
 $
30,502
  $
35,037
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
5,233
   
4,924
 
         
Earnings allocated to Watsco, Inc. shareholders
 $
25,269
  $
30,113
 
         
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding – Basic
  
34,995,048
   
34,388,117
 
Effect of dilutive stock options
  
28,941
   
14,485
 
         
Weighted-average common shares outstanding – Diluted
  
35,023,989
   
34,402,602
 
         
 
 
 
 
 
 
 
 
 
Diluted earnings per share for Common and Class B common stock
 $
0.72
  $
0.88
 
 
 
 
 
 
 
 
 
 
Anti-dilutive stock options not included above
  
164,130
   
322,584
 
 
   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2020   2019   2020   2019 
Basic Earnings per Share:
        
Net income attributable to Watsco, Inc. shareholders
  
$
106,489
 
  $83,480   
$
223,569
 
  $208,672 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
 
9,146
 
   6,973   
 
19,178
 
   17,326 
  
 
 
   
 
 
   
 
 
   
 
 
 
Earnings allocated to Watsco, Inc. shareholders
  
$
97,343
 
  $76,507   
$
204,391
 
  $191,346 
  
 
 
   
 
 
   
 
 
   
 
 
 
  
 
 
 
     
 
 
 
    
Weighted-average common shares outstanding - Basic
  
 
35,099,871
 
   34,755,627   
 
35,046,156
 
   34,544,425 
Basic earnings per share for Common and Class B common stock
  
$
2.77
 
  $2.20   
$
5.83
 
  $5.54 
Allocation of earnings for Basic:
        
Common stock
  
$
90,197
 
  $70,836   
$
189,364
 
  $177,075 
Class B common stock
  
 
7,146
 
   5,671   
 
15,027
 
   14,271 
  
 
 
   
 
 
   
 
 
   
 
 
 
  
$
97,343
 
  $76,507   
$
204,391
 
  $191,346 
  
 
 
   
 
 
   
 
 
   
 
 
 
Diluted Earnings per Share:
        
Net income attributable to Watsco, Inc. shareholders
  
$
106,489
 
  $83,480   
$
223,569
 
  $208,672 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
 
9,135
 
   6,971   
 
19,175
 
   17,325 
  
 
 
   
 
 
   
 
 
   
 
 
 
Earnings allocated to Watsco, Inc. shareholders
  
$
97,354
 
  $76,509   
$
204,394
 
  $191,347 
  
 
 
   
 
 
   
 
 
   
 
 
 
     
Weighted-average common shares outstanding - Basic
  
 
35,099,871
 
   34,755,627   
 
35,046,156
 
   34,544,425 
Effect of dilutive stock options
  
 
137,151
 
   33,328   
 
62,887
 
   25,294 
  
 
 
   
 
 
   
 
 
   
 
 
 
Weighted-average common shares outstanding - Diluted
  
 
35,237,022
 
   34,788,955   
 
35,109,043
 
   34,569,719 
  
 
 
   
 
 
   
 
 
   
 
 
 
Diluted earnings per share for Common and Class B common stock
  
$
2.76
 
  $2.20   
$
5.82
 
  $5.54 
  
 
 
 
     
 
 
 
    
Anti-dilutive stock options not included above
  
 
3,750
 
   183,083  ��
 
27,755
 
   220,013 
Diluted earnings per share for our Common stock assumes the conversion of all
of
our Class B common stock into Common stock as of the beginning of the fiscal year; therefore, no allocation of earnings to Class B common stock is required. At March 31,September 30, 2020 and 2019, our outstanding Class B common stock was convertible into 2,575,7402,576,570 and 2,577,8752,576,336 shares of our Common stock, respectively.
 
11 of 27
4.
OTHER COMPREHENSIVE INCOME (LOSS) INCOME
Other comprehensive income (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 (losses) gains (losses) on cash
flow hedging instruments. The tax effects allocated to each component of other
comprehensive income (loss) income were as follows:
         
Quarters Ended March 31,
 
2020
  
2019
 
Foreign currency translation adjustment
 $
(21,929
)
 
 $
5,005
 
 
 
��
 
 
 
 
 
 
Unrealized gain (loss) on cash flow hedging instruments
  
3,473
   
(735
)
Income tax (expense) benefit
  
(939
)
 
  
199
 
         
Unrealized gain (loss) on cash flow hedging instruments, net of tax
  
2,534
   
(536
)
         
 
 
 
 
 
 
 
 
 
Reclassification of loss (gain) on cash flow hedging instruments into earnings
  
157
   
(375
)
Income tax (benefit) expense
  
(42
)
 
  
101
 
         
Reclassification of loss (gain) on cash flow hedging instruments into earnings, net of tax
  
115
   
(274
)
         
 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income
 $
(19,280
)
 
 $
4,195
 
         
 
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Table of Contents
 
  
Quarter Ended
September 30,
 
  
Nine Months Ended
September 30,
 
 
  
2020
 
  
2019
 
  
2020
 
  
2019
 
Foreign currency translation adjustment
  
$
5,514
 
  
$
(3,038
) 
  
$
(6,592
) 
  
$
7,264
 
Unrealized (loss) gain on cash flow hedging instruments
  
 
(570
) 
  
 
351
 
  
 
1,297
 
  
 
(1,093
) 
Income tax benefit (expense)
  
 
154
 
  
 
(96
) 
  
 
(349
) 
  
 
295
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Unrealized (loss) gain on cash flow hedging instruments, net of tax
  
 
(416
) 
  
 
255
 
  
 
948
 
  
 
(798
) 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
     
 
 
 
    
Reclassification of gain on cash flow hedging instruments into earnings
  
 
(697
) 
  
 
(191
) 
  
 
(946
) 
  
 
(742
) 
Income tax expense
  
 
188
 
  
 
51
 
  
 
255
 
  
 
200
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Reclassification of gain on cash flow hedging instruments into earnings, net of tax
  
 
(509
) 
  
 
(140
) 
  
 
(691
) 
  
 
(542
) 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
     
 
 
 
    
Other comprehensive income (loss)
  
$
4,589
 
  
$
(2,923
) 
  
$
(6,335
) 
  
$
5,924
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
The changes in each component of accumulated other comprehensive loss, net of tax, were as follows:
         
Quarters Ended March 31,
 
2020
  
2019
 
Foreign currency translation adjustment:
      
Beginning balance
 
$
 
(38,599
) $
(46,604
)
Current period other comprehensive (loss) income
  
(14,328
)
 
  
3,269
 
         
Ending balance
  
(52,927
)  
(43,335
)
         
Cash flow hedging instruments:
      
Beginning balance
  
(451
)
 
  
636
 
Current period other comprehensive
income
(loss)
  
1,520
   
(322
)
Reclassification adjustment
  
69
   
(164
)
         
Ending balance
  
1,138
   
150
 
         
Accumulated other comprehensive loss, net of tax
 $
(51,789
) $
(43,185
)
         
 
Nine Months Ended September
 30,
  2020   2019 
Foreign currency translation adjustment:
    
Beginning balance
  
$
(38,599
)
  $(46,604)
Current period other comprehensive (loss) income
  
 
(4,349
)    4,732
  
 
 
   
 
 
 
Ending balance
  
 
(42,948
) 
   (41,872) 
  
 
 
   
 
 
 
Cash flow hedging instruments:
    
Beginning balance
  
 
(451
)    636
Current period other comprehensive income (loss)
  
 
568
 
   (479) 
Reclassification adjustment
  
 
(414
) 
   (325) 
  
 
 
   
 
 
 
Ending balance
  
 
(297
) 
   (168) 
  
 
 
   
 
 
 
Accumulated other comprehensive loss, net of tax
  
$
(43,245
)
  $(42,040)
  
 
 
   
 
 
 
 
55.
.
DERIVATIVES
PURCHASE OF OWNERSHIP INTEREST FROM JOINT VENTURE
Effective May 31, 2019, we purchased an additional 20% ownership interest in Homans Associates II LLC (“Homans”) from our second joint venture with Carrier, Carrier Enterprise Northeast, LLC, which we refer to as Carrier Enterprise II, for cash consideration of $32,400, which increased our ownership in Homans to 100%. Homans previously operated as a division of Carrier Enterprise II and subsequent to the purchase operates as a
wholly owned
subsidiary of the Company with 17 locations in the Northeastern U.S.
 
6.
INVESTMENT IN UNCONSOLIDATED ENTITY
On June 21, 2017, our first joint venture with Carrier, Carrier Enterprise, LLC, which we refer to as Carrier Enterprise I, acquired a 34.9% ownership interest in Russell Sigler, Inc. (“RSI”), an HVAC distributor operating from 30 locations in the Western U.S. We have an 80% controlling interest in Carrier Enterprise I, and Carrier has a 20%
non-controlling
interest. Carrier Enterprise I acquired its ownership interest in RSI for cash consideration of $63,600, of which we contributed $50,880 and Carrier contributed $12,720. 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% for cash consideration of $3,760, of which we contributed $3,008 and Carrier contributed $752. Effective April 22, 2019, Carrier Enterprise I acquired an additional 1.8% ownership interest in RSI for cash consideration of $4,940, of which we contributed $3,952 and Carrier contributed $988. This acquisition increased Carrier Enterprise I’s ownership interest in RSI to 38.1%.
 
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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. Additionally, Carrier Enterprise I has the right to appoint two of RSI’s six board members. Given Carrier Enterprise I’s 38.1% equity interest in RSI and its right to appoint 2 out of RSI’s 6 board members, this investment in RSI is accounted for under the equity
method
.
 
7.
ACQUISITIONS
N&S Supply of Fishkill, Inc.
On November 26, 2019, one of our wholly owned subsidiaries acquired certain assets and assumed certain liabilities of N&S Supply of Fishkill, Inc., a distributor of air conditioning, heating and plumbing products operating from 7 locations in New York and Connecticut. The purchase price was composed of cash consideration of $12,000, the issuance of 22,435 shares of Common stock having a fair value of $4,032 and the
re
payment of certain indebtedness. The purchase price resulted in the recognition of $2,644 in goodwill. The tax basis of
such
goodwill is deductible for income tax purposes over 15 years.
Peirce-Phelps, Inc.
On August 1, 2019, Carrier Enterprise I acquired substantially all 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, for $85,000 less certain average revolving indebtedness. Consideration for the net purchase price consisted of $10,000 in cash, 372,543 shares of Common stock having a fair value of $58,344, net of a discount for lack of marketability, and the payment of certain average revolving indebtedness. Carrier contributed cash of $17,000 to Carrier Enterprise I in connection with the acquisition of PPI.
The purchase price resulted in the recognition of $28,884 in goodwill and intangibles. The fair value of the identified intangible assets was $19,000 and consisted of $13,500 in trade names and distribution rights, and $5,500 in customer relationships to be amortized over an
18-year
period. The tax basis of
such
goodwill is deductible for income tax purposes over 15 years.
The table below presents the allocation of the total consideration to tangible and intangible assets acquired and liabilities assumed from the acquisition of PPI based on the respective fair values as of August 1, 2019:
 
Cash and cash equivalents
  $4,299 
Accounts receivable
   30,719 
Inventories
   45,491 
Other current assets
   135 
Property and equipment
   2,544 
Operating lease
right-of-use
assets
   19,072 
Goodwill
   9,884 
Intangibles
   19,000 
Other assets
   299 
Accounts payable
   (11,079) 
Accrued expenses and other current liabilities
   (13,038) 
Operating lease liabilities, net of current portion
   (14,100) 
  
 
 
 
Total
  $93,226 
  
 
 
 
Dunphey & Associates Supply Co., Inc.
On April 2, 2019, one of our wholly owned subsidiaries acquired certain assets and assumed certain liabilities of Dunphey & Associates Supply Co., Inc., a distributor of air conditioning and heating products operating from 7 locations in New Jersey, New York and Connecticut, for cash consideration of $16,758 and the issuance of 50,952 shares of Common stock having a fair value of $6,891, net of a discount for lack of marketability. The purchase price resulted in the recognition of $8,974 in goodwill and intangibles. The fair value of the identified intangible assets was $5,300 and consisted of $2,500 trade names and trademarks, and $2,800 in customer relationships to be amortized over a
15-year
period. The tax basis of
such
goodwill is deductible for income tax purposes over 15 years.
The results of operations of these acquisitions have been included in the consolidated financial statements from their respective dates of acquisition. The pro forma effect of the acquisitions was not deemed significant to the consolidated financial statements.
 
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8.
DEBT
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 $500,000 to $560,000. The credit agreement matures on December 5, 2023.
At September 30, 2020 and December 31, 2019, $668 and $155,700, 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 September 30, 2020.
 
9.
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,September 30, 2020, all
of
our open foreign currency forward contracts had maturities of one year or less. The total notional value of our foreign currency exchange contracts designated as cash flow hedges at March 31,September 30, 2020 was $48,200,$11,000, and such contracts have varying terms expiring through December 2020.January 2021.
The impact from foreign exchange derivative instruments designated as cash flow hedges was as follows:
         
Quarters Ended March 31,
 
2020
  
2019
 
Gain (loss) recorded in accumulated other comprehensive loss
 $
3,473
  $
(735
)
Loss (gain) reclassified from accumulated other comprehensive loss into earnings
 $
157
  $
(375
)
 
 
  
Quarter Ended
September 30,
 
  
Nine Months Ended
September 30,
 
 
  
2020
 
  
2019
 
  
2020
 
  
2019
 
(Loss) gain recorded in accumulated other comprehensive loss
  
$
(570
) 
  
$
 351
 
  
$
1,297
 
  
$
(1,093
) 
Gain reclassified from accumulated other comprehensive loss into earnings
  
$
(697
) 
  
$
(191
) 
  
$
(946
) 
  
$
(742
) 
At March 31,September 30, 2020, we expected an estimated $2,597$682
pre-tax
gainloss 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 of 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,
September 30, 2020
was $4,900,
$4,600, and such contracts
subsequently expired during AprilOctober 2020.
We recognized a gain (loss)
(losses) gains
of $829$(454) and $
(
113
)
$128 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,September 30, 2020 and 2019, respectively.
We recognized gains (losses) of 
$57 and $(175) from foreign currency forward and option contracts not designated as hedging instruments in our condensed consolidated unaudited statements of income for the nine months ended September 30, 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
. 10.
12
 
  
Asset Derivatives
 
  
Liability Derivatives
 
 
  
September 30, 2020
 
  
December 31, 2019
 
  
September 30, 2020
 
  
December 31, 2019
 
Derivatives designated as hedging instruments
  
$
—  
 
  
$
—  
 
  
$
394
 
  
$
944
 
Derivatives not designated as hedging instruments
  
 
6
 
  
 
—  
 
  
 
—  
 
  
 
63
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Total derivative instruments
  
$
6
 
  
$
—  
 
  
$
394
 
  
$
 1,007
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
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27
Table of Contents
                 
 
Asset Derivatives
  
Liability Derivatives
 
 
March 31, 2020
  
December 31, 2019
  
March 31, 2020
  
December 31, 2019
 
Derivatives designated as hedging instruments
 $
2,604
  $
—  
  $
56
  $
944
 
Derivatives not designated as hedging instruments
  
122
   
—  
   
4
   
63
 
                 
Total derivative instruments
 $
2,726
  $
—  
  $
60
  $
1,007
 
                 
610.
.
FAIR VALUE MEASUREMENTS
The following tables present our assets and liabilities carried at fair value that are measured on a recurring basis:
                     
 
Balance Sheet Location
  
Total
  
Fair Value Measurements
at March 31, 2020 Using
 
Level 1
  
Level 2
  
Level 3
 
Assets:
               
Derivative financial instruments
  
Other current assets
  $
2,726
  $
—
  $
2,726
  $
—
 
Equity securities
  
Other assets
  $
269
  $
269
  $
—
  $
—
 
Liabilities:
               
Derivative financial instruments
  
Accrued expenses and other current liabilities
  $
60
  $
—
  $
60
  $
—
 
 
                     
 
Balance Sheet Location
  
Total
  
Fair Value Measurements
at December 31, 2019 Using
 
Level 1
  
Level 2
  
Level 3
 
Assets:
               
Equity securities
  
Other assets
  $
402
  $
402
  $
—  
  $
 —  
 
Liabilities:
               
Derivative financial instruments
  
Accrued expenses and other current liabilities
  $
1,007
  $
 —  
  $
1,007
  $
 —  
 
 
  
 
 
 
  
Total
 
  
Fair Value Measurements
at September 30, 2020 Using
 
  
 
Balance Sheet Location
  
Level 1
 
  
Level 2
 
  
Level 3
 
Assets:
  
   
  
   
  
   
  
   
  
   
Derivative financial instruments
  
 
Other current assets
 
  
$
6
 
  
$
—  
 
  
$
6
 
  
$
—  
 
Equity securities
  
 
Other assets
 
  
$
442
 
  
$
442
 
  
$
—  
 
  
$
—  
 
Liabilities:
  
   
  
   
  
   
  
   
  
   
Derivative financial instruments
  
 
Accrued expenses and other
current liabilities
 
  
$
394
 
  
$
—  
 
  
$
394
 
  
$
—  
 
     
 
  
 
 
 
  
Total
 
  
Fair Value Measurements
at December 31, 2019 Using
 
  
 
Balance Sheet Location
  
Level 1
 
  
Level 2
 
  
Level 3
 
Assets:
  
   
  
   
  
   
  
   
  
   
Equity securities
  
 
Other assets
 
  
$
402
 
  
$
402
 
  
$
—  
 
  
$
—  
 
Liabilities:
  
   
  
   
  
   
  
   
  
   
Derivative financial instruments
  
 
Accrued expenses and other current liabilities
 
  
$
1,007
 
  
$
—  
 
  
$
1,007
 
  
$
—  
The following is a description of the valuation techniques used for these assets and liabilities, as well as the level of input used to measure fair value:
Equity securities
– these investments are exchange-traded equity securities. Fair values for these investments are based on closing stock prices from active markets and are therefore classified within Level 1 of the fair value hierarchy.
Derivative financial instruments
– these derivatives are foreign currency forward and option contracts. See Note
5
. 9. 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.
711.
.
SHAREHOLDERS’ EQUITY
Common Stock Dividends
We paid cash dividends of $1.775, $1.60,
$5.15, and $4.80 per share of both Common stock and Class B common stock during both the quarters
and nine months ended March 31,September 30, 2020 and 2019.2019, respectively.
Non-Vested
Restricted Stock
During the quarter and nine months ended March 31,September 30, 2020, 4,8285,361 shares of Common and Class B common stock with an aggregate fair market value of $791$1,265, and 11,693 shares of Common and Class B common stock with an aggregate fair market value of $2,299, respectively, were withheld as payment in lieu of cash to satisfy tax withholding obligations in connection with the vesting of
non-vested
restricted stock. These shares were retired upon delivery. During the quarter and nine months ended March 31,September 30, 2019, 2,9853,231 shares of Common stock with an aggregate fair market value of $535, and 9,824 shares of Common and Class B common stock with an aggregate fair market value of $428$1,518, respectively, were withheld as payment in lieu of cash to satisfy tax withholding obligations in connection with the vesting of
non-vested
restricted stock. These shares were retired upon delivery.
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Exercise of Stock Options
Cash received from the exerciseCommon stock issued as a result of stock options exercised during the quarters and nine months ended
March 31, September 30, 2020 and 2019, was $2,188$6,573, $3,986, $11,978, and $717,$6,229, respectively.
During the quarter and nine months ended September 30, 2020, 6,582 shares of Common stock with an aggregate fair market value of $1,490, and 11,455 shares of Common stock with an aggregate fair market value of $2,343, respectively, were withheld as payment in lieu of cash for stock option exercises. These shares were retired upon delivery. During both the quarter and nine months ended September 30, 2019, 799 shares of Common stock with an aggregate fair market value of $134 were withheld as payment in lieu of cash for stock option exercises. These shares were retired upon delivery.
15 of 27
Employee Stock Purchase Plan
During the quarters ended March 31,September 30, 2020 and 2019, we received net proceeds of $353$401 and $410,
$418, respectively, for shares of our Common stock purchased under our employee stock purchase plan. During the nine months ended September 30, 2020 and 2019, we received net proceeds of $1,229 and $1,251, respectively, for shares of our Common stock purchased under our employee stock purchase plan.
 
812.
.
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$5,249 and $3,062 at March 31,September 30, 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.
913.
.
RELATED PARTY TRANSACTIONS
Purchases from Carrier and its affiliates comprised 57%65% and 60% of all inventory purchases made during the quarters ended September 30, 2020 and 2019, respectively. Purchases from Carrier and its affiliates comprised 62% and 61% of all inventory purchases made during the quartersnine months ended March 31,September 30, 2020 and 2019, respectively. At March 31,September 30, 2020 and December 31, 2019, approximately $125,000$106,000 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 and nine months ended March 31,September 30, 2020 and 2019 included approximately $22,000$27,000, $24,000, $82,000, and $21,000,$68,000, respectively, of sales to Carrier and its affiliates. We believe these transactions are conducted on terms equivalent to an
arm’s-length
basis
terms
in the ordinary course of business.
10.
A member of our Board of Directors is the Senior Chairman of Greenberg Traurig, P.A., which serves as our principal outside counsel for compliance and acquisition-related legal services. During the quarters and nine months ended September 30, 2020 and 2019, fees to this firm for services performed were $28, $175, $28, and $175, respectively, and $28 was payable at September 30, 2020.
SUBSEQUENT EVENTS
On April 3, 2020, United Technologies Corporation completed the
spin-off
of Carrier Corporation into an independent, publicly traded company, now named Carrier Global Corporation (NYSE: CARR).
On April 10, 2020, we increased the aggregate borrowing capacity of our unsecured syndicated multicurrency revolving credit agreement from $500,000 to $560,000.
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Table of Contents
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;
 
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effects of supplier concentration;
fluctuations in certain commodity costs;
consumer spending;
consumer debt levels;
the continued impact of the
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 the
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 the 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,September 30, 2020, we operated from 603 locations in 38 U.S. States, Canada, Mexico, and Puerto Rico with additional market coverage on an export basis to portions of Latin America and the Caribbean.
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Revenues primarily consist of sales of air conditioning, heating, and refrigeration equipment, and related parts and supplies. Selling, general and administrative expenses primarily consist of selling expenses, the largest components of which are salaries, commissions, and marketing expenses that are variable and correlate to changes in sales. Other significant selling, general and administrative expenses relate to the operation of warehouse facilities, including a fleet of trucks and forklifts, and facility rent, a majority of which we operate under
non-cancelable
operating leases.
Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal. Furthermore, profitability can be impacted favorably or unfavorably based on weather patterns, particularly during the Summer and Winter selling seasons. Demand related to the residential central air conditioning replacement market is typically highest in the second and third quarters, and demand for heating equipment is usually highest in the fourth quarter. Demand related to the new construction sectors throughout most of the markets we serve tends to be fairly evenly distributed throughout the year and depends largely on housing completions and related weather and economic conditions.
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Impact of the
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. AsFor certain periods 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. Certainthus far, some U.S. states have issuedhad been under executive orders requiring that all workers remain at home unless their work iswas critical, essential, or life-sustaining. We believe that, based on the various standards published to date, the work our employees perform is essential, and as such we continued to operate with certain modifications during these periods. A few of our locations experienced short-term closures for
COVID-19
employee health concerns or operated at a diminished capacity, which negatively impacted business during the second quarter of 2020. At the end of the second quarter of 2020, many of the markets in which we operate had begun to ease
COVID-19
restrictions that had been in place earlier in the period. However, during the third quarter of 2020, viral infections began to increase, resulting in the resumption of restrictions in certain markets in which we operate. As of the date of this filing, all of our locations are performing is essential.operating, and we have instituted contactless sales and servicing capabilities at many of our locations designed to safeguard our employees and customers. In light of the continued high rate of viral infections that exists as of the date of this filing, there remains significant uncertainty concerning the magnitude of the impact and duration of the
COVID-19
pandemic.
In response to the pandemic, we have implemented plans intended to preserve adequate liquidity and ensure that our business can continue to operate during this uncertain time. In addition, we have taken actions to reduce costs, including reductions in compensation, rent abatement, changes to vendor terms and other austerity measures to curtail discretionary spending in light of the circumstances. Other costs, including hourly wages, overtime, sales commissions, temporary labor, performance-based compensation, advertising, and delivery expenses are expected to vary in correlation with our overall business activity. If and to the extent restrictions ease and normal economic conditions and operations resume, the various austerity measures to curtail discretionary spending may ease.
With respect to liquidity, we believe that our balance sheet remains strong with $92.6 million in cash, of $51.2$0.7 million debtin borrowings drawn from our $560.0 million credit facility and $1.8 billion of $156.1 million and shareholders’ equity as of $1.7 billion at March 31,September 30, 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 philosophy toward quarterly dividend plans remaindividends remains currently unchanged, most recently at $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 employees, customers, and suppliers, how quickly normal economic conditions and operations resume and whether the pandemic exacerbates other risks disclosed in Item 1A “Risk Factors” of our Annual Report on Form
10-K
for the year ended December 31, 2019. We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and shareholders.
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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.
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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,September 30, 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 and nine months ended March 31,September 30, 2020 and 2019:
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Quarter Ended
September 30,
 
  
Nine Months Ended
September 30,
 
 
  
2020
 
  
2019
 
  
2020
 
  
2019
 
Revenues
  
 
100.0
% 
  
 
100.0
% 
  
 
100.0
% 
  
 
100.0
% 
Cost of sales
  
 
75.7
 
  
 
76.0
 
  
 
75.9
 
  
 
75.8
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Gross profit
  
 
24.3
 
  
 
24.0
 
  
 
24.1
 
  
 
24.2
 
Selling, general and administrative expenses
  
 
14.4
 
  
 
15.3
 
  
 
15.9
 
  
 
15.9
 
Other income
  
 
0.3
 
  
 
0.3
 
  
 
0.2
 
  
 
0.2
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Operating income
  
 
10.2
 
  
 
9.0
 
  
 
8.5
 
  
 
8.5
 
Interest expense, net
  
 
0.0
 
  
 
0.1
 
  
 
0.0
 
  
 
0.1
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Income before income taxes
  
 
10.2
 
  
 
8.9
 
  
 
8.5
 
  
 
8.4
 
Income taxes
  
 
2.0
 
  
 
1.7
 
  
 
1.6
 
  
 
1.6
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Net income
  
 
8.2
 
  
 
7.1
 
  
 
6.8
 
  
 
6.8
 
Less: net income attributable to
non-controlling
interest
  
 
1.3
 
  
 
1.2
 
  
 
1.1
 
  
 
1.2
 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
Net income attributable to Watsco, Inc.
  
 
6.9
% 
  
 
6.0
% 
  
 
5.7
% 
  
 
5.6
% 
 
  
 
 
 
  
 
 
 
  
 
 
 
  
 
 
 
         
 
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 quartersquarter or nine months ended March 31, 2020 or 2019.September 30, 2020.
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,September 30, 2020 and 2019, seventwo and nine10 locations, respectively, that we opened were near existing locations and were therefore included in “same-store basis” information.
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The table below summarizes the changes in our locations for the 12 months ended March 31,September 30, 2020:
Number of
Locations
March 31, 2019
575Number of
Locations
Opened
September 30, 2019
8
603
Acquired
33
7
Closed
(10
)
December 31, 2019
606
Opened
1
Closed
(4
)
 
March
December 31, 20202019
606
Opened
3
Closed
(6
) 
 
September 30, 2020
603
 
Third Quarter of 2020 Compared to Third Quarter of 2019
Revenues
Revenues for the firstthird quarter of 2020 increased $76.9$141.8 million, or 8%10%, as compared to the first quarter of 2019, including $61.0$38.1 million attributable to the new locations acquired and $1.5$1.3 million from other locations opened during the preceding 12 months, offset by $2.9$2.4 million from locations closed. Sales of HVAC equipment (66%(70% of sales) increased 7%12%, sales of other HVAC products (30%(27% of sales) increased 9%4% and sales of commercial refrigeration products (4%(3% of sales) wereremained flat. On a same-store basis, revenues increased $17.3$104.8 million, or 2%8%, as compared to the same period in 2019, reflecting a 2%10% increase in sales of HVAC equipment (67%(70% of sales), which included a 4%17% increase inof residential HVAC equipment (5%(19% increase in U.S. markets and an 11%a 3% increase in international markets) and a 17% decrease in international markets),sales of commercial HVAC equipment, a 2% increase in sales of other HVAC products (29%(27% of sales) and flat sales of commercial refrigeration products (4%(3% of sales). ForThe increase in same-store revenues of HVAC equipment the increase in revenues was primarily due to strong demand for the replacement of residential HVAC equipment and a higheran increased mix of high-efficiency air conditioning and heating systems, which sell at higher unit prices, resultingpartially offset by lower sales of commercial HVAC equipment due to the pandemic-related market disruption. The increase in a 4%residential HVAC equipment was composed of an 18% increase in volume and a 1% increase in the average selling price.
Gross Profit
Gross profit for the firstthird quarter of 2020 increased $13.9$39.1 million, or 6%12%, as compared to the first quarter of 2019, primarily as a result of increased revenues. Gross profit margin for the quarter ended March 31,September 30, 2020 declined 50improved 30 basis-points to 24.6%24.3% versus 25.1%,24.0% for the same period in 2019, primarily due to lower benefit of pricing actions taken by ourhigher realized gross margins for residential HVAC equipment suppliers and overall competitive conditions.   equipment.
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Selling, General and Administrative Expenses
Selling, general and administrative expenses for the firstthird quarter of 2020 increased $23.3$8.1 million, or 13%4%, as compared to the first quarter of 2019, primarily due to newly acquired locations.increased revenues. Selling, general and administrative expenses as a percent of revenues for the third quarter ended March 31,of 2020 increaseddecreased to 20.2%14.4% versus 19.3%15.3% for the same period in 2019. On a same-store basis, selling, general and administrative expenses increased 4%were flat as compared to the same period in 2019 primarily due to additional employee headcountactions taken to improve operating efficiency and related employee benefitto reduce costs and increasedcurtail discretionary spending in response to the pandemic. Selling, general and administrative expenses included $0.2 million of additional costs related tofor 2020 in excess of 2019 for ongoing technology initiatives.initiatives, including initiatives designed to ameliorate the impact of, or otherwise address, the pandemic.
Other Income
Other income of $4.1 million and $3.5 million for the third quarters of 2020 and 2019, respectively, represented our share of the net income of RSI.
Interest Expense, Net
Interest expense, net for the third quarter of 2020 decreased $1.3 million, or 92%, primarily as a result of a decrease in average outstanding borrowings and 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 increased to $30.5 million for the third quarter of 2020, as compared to $24.2 million for the third quarter of 2019 and represent a composite of the income taxes attributable to our wholly owned operations and income taxes attributable to the Carrier
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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 rate attributable to us was consistent at 22.2% for both quarters ended September 30, 2020 and 2019.
Income Attributable to Watsco, Inc.
Net income attributable to Watsco for the quarter ended September 30, 2020 increased $23.0 million, or 28%, compared to the same period in 2019. The increase was primarily driven by higher revenues and gross profit, and reduced selling, general and administrative expenses as a percentage of revenues.
Nine Months Ended September 30, 2020 Compared to Nine Months Ended September 30, 2019
Revenues
Revenues for the nine months ended September 30, 2020 increased $202.2 million, or 5%, including $165.7 million attributable to new locations acquired and $3.6 million from other locations opened during the preceding 12 months, offset by $10.2 million from locations closed. Sales of HVAC equipment (70% of sales) increased 7%, sales of other HVAC products (27% of sales) increased 2% and sales of commercial refrigeration products (3% of sales) decreased 5%. On a same-store basis, revenues increased $43.1 million, or 1%, as compared to the same period in 2019, reflecting a 3% increase in sales of HVAC equipment (69% of sales), which included a 7% increase in residential HVAC equipment (8% increase in U.S. markets and a 4% decrease in international markets) and a 15% decrease in sales of commercial HVAC equipment, a 2% decrease in sales of other HVAC products (27% of sales) and a 5% decrease in commercial refrigeration products (4% of sales). The increase in same-store revenues of HVAC equipment was primarily due to demand for the replacement of residential HVAC equipment, partially offset by lower sales of commercial HVAC equipment due to the pandemic-related market disruption. The increase in residential HVAC equipment was composed of an 8% increase in volume while the average selling price remained flat.
Gross Profit
Gross profit for the nine months ended September 30, 2020 increased $44.1 million, or 5%, primarily as a result of increased revenues. Gross profit margin for the nine months ended September 30, 2020 declined 10 basis-points to 24.1% versus 24.2% for the same period in 2019, primarily due to a shift in sales mix toward HVAC equipment, which generates a lower gross profit margin than
non-equipment
products.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the nine months ended September 30, 2020 increased $29.0 million, or 5%, primarily due to increased revenues. Selling, general and administrative expenses as a percentage of revenues remained consistent at 15.9% for the nine months ended September 30, 2020 as compared to the same period in 2019. On a same-store basis, selling, general and administrative expenses decreased 1% as compared to the same period in 2019 primarily due to actions taken to improve operating efficiencies and to reduce costs and curtail discretionary spending in response to the pandemic. Selling, general and administrative expenses included $1.8 million of additional costs for 2020 in excess of 2019 for ongoing technology initiatives, including initiatives designed to ameliorate the impact of, or otherwise address, the pandemic.
Other Income
Other income of $1.0$9.2 million and $1.4$7.9 million for the first quarters ofnine months ended September 30, 2020 and 2019, respectively, representsrepresented our share of the net income of RSI.
Interest Expense, Net
Interest expense, net for the first quarter ofnine months ended September 30, 2020 increased 2%decreased $2.2 million, or 65%, primarily as a result of an increasea decrease in average outstanding borrowings partially offset byand 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 decreasedincreased to $8.2$63.4 million for the first quarter ofnine months ended September 30, 2020, as compared to $10.6$60.1 million for the first quarter ofnine months ended September 30, 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%22.0% and 22.7%22.1% for the quartersnine months ended March 31,September 30, 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.
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Net Income Attributable to Watsco, Inc.
Net income attributable to Watsco for the quarternine months ended March 31,September 30, 2020 decreased $4.5increased $14.9 million, or 13%7%, compared to the same period in 2019. The decreaseincrease was primarily driven by higher selling, generalrevenues and administrative expenses, partially offset by higher revenues, a reduction in income taxesgross profit, and a decrease in net income attributable to the
non-controlling
lower interest as discussed above.expense, net.
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,September 30, 2020, we had $51.2$92.6 million of cash and cash equivalents, of which $39.0$64.7 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. We believe that the transition from LIBOR will not materially impact our financial position or results of operations. 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$1,034.6 million at March 31,September 30, 2020 from $1,085.0 million at December 31, 2019.2019, reflecting lower levels of inventory from inventory optimization activities and due to pandemic-related supply chain disruptions, resulting in reduced purchases in 2020 versus 2019, higher levels of accounts payable and accrued expenses, which were offset by higher levels of accounts receivable due to the seasonality of our business.
Cash Flows
The following table summarizes our cash flow activity for the quartersnine months ended March 31,September 30, 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
)
 
   2020   2019   Change 
Cash flows provided by operating activities
  
$
372.8
 
  $197.5   $175.3 
Cash flows used in investing activities
  
$
(11.5
) 
  $(65.0)   $53.5 
Cash flows used in financing activities
  
$
(342.8
) 
  $(155.7)   $(187.1) 
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.
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Operating Activities
The decreaseincrease 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 inventoryof inventories and the comparative timing of payments for accrued expenses and other current liabilities in 2020 as compared toversus 2019.
Investing Activities
Net cash used in investing activities was lower in 2020 due to a decreasecash consideration paid for acquisitions and the purchase of an additional ownership interest in capital expendituresRSI in 2020.2019.
Financing Activities
The increase in net cash used in financing activities was primarily attributable to lower borrowing requirementsnet repayments under our revolving credit agreement 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,September 30, 2020 and December 31, 2019, $156.1$0.7 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,September 30, 2020.
Purchase of Additional Ownership Interest from Joint Venture
20Effective May 31, 2019, we purchased an additional 20% ownership interest in Homans from Carrier Enterprise II for cash consideration of 24$32.4 million, which increased our ownership in Homans to 100%. Homans previously operated as a division of Carrier Enterprise II and subsequent to the purchase operates as a wholly owned subsidiary of the Company with 17 locations in the Northeastern U.S.
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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 for 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,September 30, 2020, the estimated purchase amount we would be contingently liable for was approximately $142.0$183.0 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
On November 26, 2019, one of our wholly owned subsidiaries acquired certain assets and assumed certain liabilities of N&S, a distributor of air conditioning, heating and plumbing products operating from seven locations in New York and Connecticut. The purchase price was composed of cash consideration of $12.0 million, the issuance of 22,435 shares of Common stock having a fair value of $4.0 million and the payment of certain indebtedness.
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On August 1, 2019, Carrier Enterprise I acquired substantially all the HVAC assets and assumed certain of the liabilities of PPI, an HVAC distributor operating from 19 locations in Pennsylvania, New Jersey, and Delaware, for $85.0 million less certain average revolving indebtedness. Consideration for the net purchase price consisted of $10.0 million in cash, 372,543 shares of Common stock having a fair value of $58.3 million, net of a discount for lack of marketability, and the payment of certain average revolving indebtedness. Carrier contributed cash of $17.0 million to Carrier Enterprise I in connection with the acquisition of PPI.
On April 2, 2019, one of our wholly owned subsidiaries acquired certain assets and assumed certain liabilities of DASCO, a distributor of air conditioning and heating products operating from seven locations in New Jersey, New York and Connecticut. The purchase price was composed of cash consideration of $16.8 million and the issuance of 50,952 shares of Common stock having a fair value of $6.9 million, net of a discount for lack of marketability.
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$5.15 and $4.80 per share of Common stock and Class B common stock during both the quartersnine months ended March 31,September 30, 2020 and 2019.2019, respectively. On AprilOctober 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 AprilOctober 30, 2020 to shareholders of record as of AprilOctober 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,September 30, 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,September 30, 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,September 30, 2020 and approximately 6% of our consolidated revenues for the quarter ended March 31,September 30, 2020. From the respective acquisition dates of November 26, 2019, August 1, 2019 and April 2, 2019 to March 31,September 30, 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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Information with respect to this item may be found in Note 812 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, 2019September 30, 2020 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.as set forth below.
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 tocould continue to adversely affect our business and results of operations, including as a result of government authorities imposingimpose or reimpose mandatory closures, work-from-home orders and social distancing protocols, or imposingimpose 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
COVID-19
related factors that have restricted public access to our branchesimpacted, or may negatively impact, sales, gross margin and a fewother results of operations in the future include, but are not limited to: limitations on the ability of our locations experienced short-term closures forsuppliers 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
employee health concerns 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 are operating atdisruption to new construction and commercial markets, which would result in a diminished capacity, negatively impactingreduction in our sales at the end of the first quarter of 2020 and through the date of this filing. consequential gross margin.
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 Sales25 of Unregistered Securities27
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
31.1 #  
10.1 #
Twenty-First Amendment dated January 1, 2020 to Employment Agreement and Incentive Plan dated January 31, 1996 by and between Watsco, Inc. and Albert H. Nahmad.
10.2
Revolving Credit Increase and Joinder Agreement, dated as of April 10, 2020, by and among Watsco, Inc., Watsco Canada, Inc. and Carrier Enterprise Mexico, S. de R.L. de C.V., as Borrowers, Bank of America, N.A., as Administrative Agent, Swing Line Lender and L/C Issuer, Regions Bank, and PNC Bank N.A. as a joining Lender, filed as Exhibit 10.1 to our Current Report on Form 8-K filed with the SEC on April 16, 2020 and incorporated by reference herein.
31.1 #
Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules 13a- 15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 #  
31.2 #
Certification of Executive Vice President pursuant to Securities Exchange Act Rules 13a-15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.3 #  
31.3 #
Certification of Chief Financial Officer pursuant to Securities Exchange Act Rules 13a- 15(e) and 15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 +  
32.1 +
Certification of Chief Executive Officer, Executive Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-OxleySarbanes- Oxley Act of 2002.
101.INS #  
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 #  
101.SCH #
Inline XBRL Taxonomy Extension Schema Document.
101.CAL #  
101.CAL #
Inline XBRL Taxonomy Extension Calculation Linkbase Document.
101.DEF #  
101.DEF #
Inline XBRL Taxonomy Extension Definition Linkbase Document.
101.LAB #  
101.LAB #
Inline XBRL Taxonomy Extension Label Linkbase Document.
101.PRE #  
101.PRE #
Inline XBRL Taxonomy Extension Presentation Linkbase Document.
104  
104
The cover page from the Company’s Quarterly Report on Form
10-Q
for the quarter ended March 31,September 30, 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,November 5, 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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