Forward-Looking Statements
This Quarterly Report on Form
10-Q
contains or incorporates by reference statements that are not historical in
nature and that are intended to be, and are hereby identified as,
"forward-looking statements" as defined in the Private Securities Litigation
Reform Act of 1995. Statements which are not historical in nature, including the
words "anticipate," "estimate," "could," "should," "may," "plan," "seek,"
"expect," "believe," "intend," "target," "will," "project," "focused,"
"outlook," "goal," "designed," and variations of these words and negatives
thereof and similar expressions are intended to identify forward-looking
statements, including statements regarding, among others, (i) economic
conditions, (ii) business and acquisition strategies, (iii) potential
acquisitions and/or joint ventures and investments in unconsolidated entities,
(iv) financing plans, and (v) industry, demographic and other trends affecting
our financial condition or results of operations. These forward-looking
statements are based on management's current expectations, are not guarantees of
future performance and are subject to a number of risks, uncertainties, and
changes in circumstances, certain of which are beyond our control. Actual
results could differ materially from these forward-looking statements as a
result of several factors, including, but not limited to:

     •    general economic conditions, both in the United States and in the
          international markets we serve;



  •   competitive factors within the HVAC/R industry;



  •   effects of supplier concentration;



  •   fluctuations in certain commodity costs;



  •   consumer spending;



  •   consumer debt levels;



  •   the 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
COVID-19
Pandemic and Item 1A "Risk Factors" of our Annual Report on Form
10-K
for the year ended December 31, 2020, 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.

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The following information should be read in conjunction with the condensed
consolidated unaudited financial statements, including the notes thereto,
included under Part I, Item 1 of this Quarterly Report on Form
10-Q.
In addition, reference should be made to our audited consolidated financial
statements and notes thereto, and related Management's Discussion and Analysis
of Financial Condition and Results of Operations included in our Annual Report
on Form
10-K
for the year ended December 31, 2020.
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, 2021, we operated from 601 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.
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 first and fourth
quarters. Demand related to the new construction sectors throughout most of the
markets we serve tends to be fairly evenly distributed throughout the year and
depends largely on housing completions and related weather and economic
conditions.
Impact of the
COVID-19
Pandemic
For certain periods of the
COVID-19
pandemic thus far, some U.S. states had been under executive orders requiring
that all workers remain at home unless their work was 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. Some of our locations
experienced short-term closures for
COVID-19
employee health concerns or operated at a diminished capacity, which negatively
impacted our business during March and April 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
second half of 2020, viral infections began to increase, resulting in the
resumption of restrictions in certain markets in which we operate. Although we
have learned to navigate
COVID-19
while maintaining our operations in all material respects, the pandemic
continued to impact our business and operating results in the first quarter of
2021.
Consistent with broader social trends, we have taken steps to safeguard the
health of our employees and customers. This has included creating space between
work areas, providing ample personal protective equipment and cleaning supplies,
having formal policies for mitigation in the event of cases of illness,
utilizing technologies where work duties enable working from home, and
instituting contactless sales and servicing capabilities at many of our
locations to create social distancing. As of the date of this filing, all of our
locations are operating, and, due to these precautions, have been functioning
effectively, including our internal controls over financial reporting. 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 implemented plans intended to preserve adequate
liquidity and ensure that our business continued 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.
As restrictions ease and normal economic conditions and operations resume, the
various austerity measures to curtail discretionary spending have eased.
With respect to liquidity, we believe that our balance sheet remains strong
with $93.9 million in cash, $48.9 million in borrowings drawn under our
$560.0 million credit facility and $1.8 billion of shareholders' equity, in each
case as of March 31, 2021. During these uncertain times, we believe that our
scale, our currently 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.
The full impact of the
COVID-19
pandemic on our financial condition and results of operations will continue to
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 the risks disclosed in Item 1A "Risk Factors" of our Annual Report
on Form
10-K
for the year ended December 31, 2020. We intend to 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 ("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. The export division, Carrier InterAmerica Corporation, redomesticated
from the U.S. Virgin Islands to Delaware effective December 31, 2019, following
which Carrier InterAmerica Corporation became a separate operating entity in
which we have an 80% controlling interest 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.,
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 own 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 with Carrier, which we refer to as
Carrier Enterprise III. 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.
On April 9, 2021, we acquired certain assets and assumed certain liabilities
comprising the HVAC distribution business of Temperature Equipment Corporation,
an HVAC distributor operating from 32 locations in Illinois, Indiana, Kansas,
Michigan, Minnesota, Missouri and Wisconsin. We formed a new, stand-alone joint
venture with Carrier, TEC Distribution LLC ("TEC"), that will operate this
business. We have an 80% controlling interest in TEC, and Carrier has a 20%
non-controlling
interest.
Critical Accounting Policies
Management's discussion and analysis of financial condition and results of
operations is based upon the condensed consolidated unaudited financial
statements included in this Quarterly Report on Form
10-Q,
which have been prepared in accordance with U.S. generally accepted accounting
principles. The preparation of these condensed consolidated unaudited financial
statements requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the condensed consolidated unaudited financial
statements, and the reported amount of revenues and expenses during the
reporting period. Actual results may differ from these estimates under different
assumptions or conditions. At least quarterly, management reevaluates its
judgments and estimates, which are based on historical experience, current
trends, and various other assumptions that are believed to be reasonable under
the circumstances.
Our critical accounting policies are included in our 2020 Annual Report on Form
10-K,
as filed with the SEC on February 26, 2021. We believe that there have been no
significant changes during the quarter ended March 31, 2021 to the critical
accounting policies disclosed in our Annual Report on Form
10-K
for the year ended December 31, 2020.

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Results of Operations
The following table summarizes information derived from our condensed
consolidated unaudited statements of income, expressed as a percentage of
revenues, for the quarters ended March 31, 2021 and 2020:

                                                2021         2020
Revenues                                         100.0 %      100.0 %
Cost of sales                                     74.1         75.4

Gross profit                                      25.9         24.6
Selling, general and administrative expenses      19.2         20.2
Other income                                       0.4          0.1

Operating income                                   7.2          4.5
Interest expense, net                              0.0          0.1

Income before income taxes                         7.2          4.4
Income taxes                                       1.4          0.8

Net income                                         5.8          3.6
Less: net income attributable to
non-controlling
interest                                           1.0          0.6

Net income attributable to Watsco, Inc.            4.8 %        3.0 %



Note: Due to rounding, percentages may not add up to 100. 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, 2021 and 2020, one and seven locations, respectively, that we opened were near existing locations and were therefore included in "same-store basis" information. The table below summarizes the changes in our locations for the 12 months ended March 31, 2021:



                     Number of
                     Locations
March 31, 2020              603
Opened                        2
Closed                       (5 )

December 31, 2020           600
Opened                        2
Closed                       (1 )

March 31, 2021              601



Revenues
Revenues for the first quarter of 2021 increased $128.0 million, or 13%, as
compared to the first quarter of 2020, including $1.3 million attributable to
locations opened during the preceding 12 months, offset by $1.6 million from
locations closed. Sales of HVAC equipment (67% of sales) increased 14%, which
included an 18% increase in residential HVAC equipment, sales of other HVAC
products (29% of sales) increased 11%, and sales of commercial refrigeration
products (4% of sales) increased 10%. On a same-store basis, revenues increased
$128.3 million, or 13%, as compared to the same period in 2020. For HVAC
equipment, the increase in revenues was primarily due to demand for residential
HVAC equipment and a higher mix of high-efficiency air conditioning and heating
systems, which sell at higher unit prices, resulting in a 16% increase in volume
and a 2% increase in the average selling price.
Gross Profit
Gross profit for the first quarter of 2021 increased $47.2 million, or 19%, as
compared to the first quarter of 2020, primarily as a result of increased
revenues. Gross profit margin for the quarter ended March 31, 2021 increased 130
basis-points to 25.9% versus 24.6%, primarily due to the impact of pricing and
mix for HVAC equipment.
Selling, General and Administrative Expenses
Selling, general and administrative expenses for the first quarter of 2021
increased $14.2 million, or 7%, as compared to the first quarter of 2020,
primarily due to increased revenues. Selling, general and administrative
expenses as a percent of revenues for the quarter ended March 31, 2021 decreased
to 19.2% versus 20.2% for the same period in 2020 primarily due to increased
leverage on fixed costs driven by increased revenues and actions taken to
improve operating efficiencies and to reduce costs and curtail discretionary
spending in response to the pandemic.

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Other Income
Other income of $4.7 million and $1.0 million for the first quarters of 2021 and
2020, respectively, represents our share of the net income of Russell Sigler,
Inc. ("RSI").
Interest Expense, Net
Interest expense, net, for the first quarter of 2021 decreased 89%, primarily as
a result of a decrease in average outstanding borrowings and a lower effective
interest rate, in each case under our revolving credit facility, as compared to
the same period in 2020.
Income Taxes
Income taxes increased to $15.7 million for the first quarter of 2021, as
compared to $8.2 million for the first quarter of 2020, 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 22.0% and 21.0% for the quarters ended March 31, 2021 and 2020,
respectively. The increase was primarily due to higher state income taxes in
2021 as compared to the same period in 2020.
Net Income Attributable to Watsco, Inc.
Net income attributable to Watsco, Inc. for the quarter ended March 31, 2021
increased $24.6 million, or 81%, compared to the same period in 2020. The
increase was primarily driven by higher revenues, gross profit, and other income
and lower interest 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, 2021, we had $93.9 million of cash and cash equivalents, of
which $78.7 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.
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 after December 31, 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, which may exceed what would
have been the comparable LIBOR rate. Additionally, disruptions in the credit and
capital markets could also result in increased borrowing costs and/or reduced
borrowing capacity under our revolving credit agreement.

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Working Capital
Working capital increased to $1,064.5 million at March 31, 2021 from
$997.3 million at December 31, 2020, reflecting higher levels of inventories,
primarily due to the seasonality of our business.
Cash Flows
The following table summarizes our cash flow activity for the quarters ended
March 31, 2021 and 2020 (in millions):

                                                            2021         2020        Change

Cash flows (used in) provided by operating activities $ (37.7 ) $ 41.9 $ (79.6 ) Cash flows provided by (used in) investing activities $ 1.2 $ (3.8 ) $ 5.0 Cash flows used in financing activities

$ (16.3 )    $ (59.4 )    $  43.1


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.
Operating Activities
The increase in net cash used in operating activities was primarily due to
increases in the level of inventory in 2021 as compared to 2020.
Investing Activities
Net cash provided by investing activities was primarily due to proceeds from the
sale of equity securities, partially offset by higher capital expenditures in
2021.
Financing Activities
The decrease in net cash used in financing activities was primarily attributable
to higher borrowings partially offset by an increase in dividends paid in 2021.
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 effectively reduces fees payable in respect of the
unused portion of the commitment), and we effected this reduction in 2020.
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, 2021 $48.9 million was outstanding under the revolving credit
agreement. At December 31, 2020 there was no outstanding balance 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,
2021.
Investment in Unconsolidated Entity
Carrier Enterprise I has a 38.1% ownership interest in RSI, an HVAC distributor
operating from 30 locations in the Western U.S. Our proportionate share of the
net income of RSI is included in other income in our condensed consolidated
unaudited statements of income.
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, 2021, the estimated purchase amount we would be contingently
liable for was approximately $222.0 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.

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Acquisitions
On April 9, 2021, we acquired certain assets and assumed certain liabilities
comprising the HVAC distribution business of Temperature Equipment Corporation,
an HVAC distributor operating from 32 locations in Illinois, Indiana, Kansas,
Michigan, Minnesota, Missouri and Wisconsin. We formed a new, stand-alone joint
venture with Carrier, TEC, that will operate this business. We have an 80%
controlling interest in TEC, and Carrier has a 20%
non-controlling
interest. Consideration for the purchase was paid in cash, consisting of
$105.2 million paid to Temperature Equipment Corporation (Carrier contributed
$21.0 million and we contributed $84.2 million) and $1.5 million for repayment
of indebtedness.
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 $1.775 and $1.60 per share of Common stock and Class B
common stock during the quarters ended March 31, 2021 and 2020, respectively. On
April 1, 2021, our Board of Directors declared a regular quarterly cash dividend
of $1.95 per share of both Common and Class B common stock that was paid on
April 30, 2021 to shareholders of record as of April 15, 2021. 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, 2021,
there were 1,129,087 shares remaining authorized for repurchase under the
program.

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