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 inthe 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 endedDecember 31, 2020 , as well as the other documents and reports that we file with theSEC . 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. 14 of 23
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Table of Contents 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 endedDecember 31, 2020 . Company OverviewWatsco, Inc. was incorporated inFlorida 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 inNorth America . AtMarch 31, 2021 , we operated from 601 locations in 38 U.S. States,Canada ,Mexico , andPuerto Rico with additional market coverage on an export basis to portions ofLatin America and theCaribbean . 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, someU.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 ofMarch 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 endedDecember 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. 15 of 23
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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 in13 Sun Belt states andPuerto Rico , and its export division inMiami, 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 theU.S. Virgin Islands toDelaware effectiveDecember 31, 2019 , following whichCarrier InterAmerica Corporation became a separate operating entity in which we have an 80% controlling interest and Carrier has a 20% non-controlling interest. OnAugust 1, 2019 , Carrier Enterprise I acquired substantially all of the HVAC assets and assumed certain of the liabilities ofPeirce-Phelps, Inc. , an HVAC distributor operating from 19 locations inPennsylvania ,New Jersey , andDelaware . In 2011, we formed a second joint venture with Carrier, in which Carrier contributed 28 of its company-owned locations in theNortheast U.S. , and we contributed 14 locations in theNortheast U.S. , and we then purchased Carrier's distribution operations inMexico , which included seven locations. Collectively, the Northeast locations and theMexico 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. EffectiveMay 31, 2019 , we purchased an additional 20% ownership interest inHomans 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 inCanada to Carrier Enterprise III. We have a 60% controlling interest in Carrier Enterprise III, and Carrier has a 40% non-controlling interest. OnApril 9, 2021 , we acquired certain assets and assumed certain liabilities comprising the HVAC distribution business ofTemperature Equipment Corporation , an HVAC distributor operating from 32 locations inIllinois ,Indiana ,Kansas ,Michigan ,Minnesota ,Missouri andWisconsin . 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 withU.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 theSEC onFebruary 26, 2021 . We believe that there have been no significant changes during the quarter endedMarch 31, 2021 to the critical accounting policies disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2020 . 16 of 23
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Table of Contents 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 endedMarch 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
Number of LocationsMarch 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 endedMarch 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 endedMarch 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. 17 of 23
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Table of Contents 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 ofRussell 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 endedMarch 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 toWatsco, Inc. Net income attributable toWatsco, Inc. for the quarter endedMarch 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 ofMarch 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 afterDecember 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. 18 of 23
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Table of Contents Working Capital Working capital increased to$1,064.5 million atMarch 31, 2021 from$997.3 million atDecember 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 endedMarch 31, 2021 and 2020 (in millions): 2021 2020 Change
Cash flows (used in) provided by operating 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. OnApril 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 fromOctober 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 onDecember 5, 2023 . AtMarch 31, 2021 $48.9 million was outstanding under the revolving credit agreement. AtDecember 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 atMarch 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 theWestern 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. AtMarch 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. 19 of 23
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Table of Contents Acquisitions OnApril 9, 2021 , we acquired certain assets and assumed certain liabilities comprising the HVAC distribution business ofTemperature Equipment Corporation , an HVAC distributor operating from 32 locations inIllinois ,Indiana ,Kansas ,Michigan ,Minnesota ,Missouri andWisconsin . 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 toTemperature 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 endedMarch 31, 2021 and 2020, respectively. OnApril 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 onApril 30, 2021 to shareholders of record as ofApril 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 InSeptember 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. AtMarch 31, 2021 , there were 1,129,087 shares remaining authorized for repurchase under the program.
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