What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-08-05 compared with 2021-05-06 · 87 added, 55 removed, 159 unchanged (47% of the section changed)

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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.

At June 30, 2021, we operated from 655 locations in 42 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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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.

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 throughout 2020.

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

At the end of the second quarter of 2020, many of the markets in which we operate had begun to ease the 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.

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, which negatively impacted our operations.

During this period, we took steps to safeguard the health of our employees and customers.

This included creating additional space between work areas, providing personal protective equipment and cleaning supplies, establishing 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.

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

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

In addition, we took 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 in 2020.

However, as economic activity has been recovering, the impact of the pandemic on our business has been more reflective of greater economic and marketplace dynamics, which include supply chain disruptions and labor shortages, rather than pandemic-related issues such as location closures, mandated restrictions and employee illness.

As restrictions have eased and normal economic conditions have largely resumed, our various austerity measures to curtail discretionary spending have eased.

Notwithstanding the recent resurgence of economic activity, in light of variant strains of the virus and 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

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

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, the extent to which normal economic and operating conditions are impacted, 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.

Joint Ventures with Carrier Global Corporation (“Carrier”)

Joint Ventures with Carrier Global Corporation

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.

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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 formed a new, stand-alone joint venture with Carrier, TEC Distribution LLC (“TEC”), that operates this business.

We have an 80% controlling interest in TEC, and Carrier has a 20% non-controlling

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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

We believe that there have been no significant changes during the quarter ended June 30, 2021 to the critical accounting policies disclosed in our Annual Report on Form 10-K

for the year ended December 31, 2020.

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:

The following table summarizes information derived from our condensed consolidated unaudited statements of income, expressed as a percentage of revenues, for the quarters and six months ended June 30, 2021 and 2020:

Ended June 30,

Six Months Ended

Cost of sales

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Due to rounding, percentages may not add up to 100.

The following narratives reflect our acquisitions of Acme Refrigeration of Baton Rouge LLC (“ACME”) in May 2021, and TEC in April 2021.

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:

March 31, 2020

At June 30, 2021 and 2020, one and three 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 June 30, 2021:

June 30, 2020

December 31, 2020

March 31, 2021

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 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.

June 30, 2021

Second Quarter of 2021 Compared to Second Quarter of 2020

Revenues for the second quarter of 2021 increased $494.3 million, or 36%, including $104.8 million attributable to the new locations acquired and $1.9 million from other locations opened during the preceding 12 months, offset by $1.3 million from locations closed.

Sales of HVAC equipment (71% of sales) increased 35%, sales of other HVAC products (26% of sales) increased 33% and sales of commercial refrigeration products (3% of sales) increased 45%.

On a same-store basis, revenues increased $388.9 million, or 29%, as compared to the same period in 2020, reflecting a 29% increase in sales of HVAC equipment (71% of sales), which included a 28% increase in sales of residential HVAC equipment (27% increase in U.S.

markets) and a 32% increase in sales of commercial HVAC equipment, a 25% increase in sales of other HVAC products (26% of sales) and a 45% increase in sales of commercial refrigeration products (3% of sales).

For HVAC equipment, the increase in revenues was primarily due to strong demand for residential HVAC equipment, the realization of price increases, and a higher mix of high-efficiency air conditioning and heating systems, which sell at higher unit prices, resulting in a 15% increase in volume and a 12% increase in the average selling price, as well as higher sales of commercial HVAC equipment.

Gross profit for the second quarter of 2021 increased $158.7 million, or 50%, primarily as a result of increased revenues.

Gross profit margin for the quarter ended June 30, 2021 improved 220 basis-points to 25.8% versus 23.6% for the same period in 2020, 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.

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.

Selling, general and administrative expenses for the second quarter of 2021 increased $72.6 million, or 37%, primarily due to increased revenues and newly acquired locations.

Selling, general and administrative expenses as a percent of revenues for the second quarter of 2021 increased to 14.4% versus 14.3% for the same period in 2020.

On a same-store basis, selling, general and administrative expenses increased 28% as compared to the same period in 2020, primarily due to increased performance-based compensation costs commensurate with the increase in revenue and profitability in 2021 and easing of short-term austerity measures taken during the second quarter of 2020 to reduce costs and curtail discretionary spending in response to the pandemic.

Other income of $5.5 million and $4.1 million for the second quarters of 2021 and 2020, respectively, represents our share of the net income of Russell Sigler, Inc.

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 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;

Interest expense, net for the second quarter of 2021 increased $0.2 million, or 58%, primarily as a result of an increase in average outstanding borrowings and a higher effective interest rate, in each case under our revolving credit facility, as compared to the same period in 2020.

Income taxes increased to $44.2 million for the second quarter of 2021, as compared to $24.7 million for the second 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.

The effective income tax rates attributable to us were 23.4% and 22.1% for the quarters ended June 30, 2021 and 2020, respectively.

The increase was primarily due to higher state income taxes and proportionately higher income in the second quarter of 2021 as compared to tax credits and share-based compensation deductions in the second quarter of 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.

for the quarter ended June 30, 2021 increased $57.5 million, or 66%, compared to the same period in 2020.

The increase was primarily driven by higher revenues and expanded profit margins, partially offset by higher income taxes and an increase in the net income attributable to the non-controlling

First Half of 2021 Compared to First Half of 2020

Revenues for the first half of 2021 increased $622.2 million, or 26%, including $104.8 million attributable to the new locations acquired and $3.2 million from other locations opened during the preceding 12 months, offset by $3.0 million from locations closed.

Sales of HVAC equipment (69% of sales) increased 27%, sales of other HVAC products (28% of sales) increased 23%, and sales of commercial refrigeration products (3% of sales) increased 28%.

On a same-store basis, revenues increased $517.2 million, or 22%, as compared to the same period in 2020, reflecting a 23% increase in sales of HVAC equipment (69% of sales), which included a 24% increase in sales of residential HVAC equipment (23% increase in U.S.

markets) and a 16% increase in sales of commercial HVAC equipment, a 19% increase in sales of other HVAC products (27% of sales) and a 28% increase in commercial refrigeration products (4% of sales).

For HVAC equipment, the increase in revenues was primarily due to strong demand for residential HVAC equipment, the realization of price increases, and a higher mix of high-efficiency air conditioning and heating systems, which sell at higher unit prices, resulting in a 15% increase in volume and an 8% increase in the average selling price, as well as higher sales of commercial HVAC equipment.

Gross profit for the first half of 2021 increased $205.9 million, or 36%, primarily as a result of increased revenues.

Gross profit margin for the six months ended June 30, 2021 improved 190 basis-points to 25.9% versus 24.0% for the same period in 2020, due to the impact of pricing and mix for HVAC equipment.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the first half of 2021 increased $86.9 million, or 22%, primarily due to increased revenues.

Selling, general and administrative expenses as a percentage of revenues for the six months ended June 30, 2021 decreased to 16.2% versus 16.8% 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.

On a same-store basis, selling, general and administrative expenses increased 17% as compared to the same period in 2020 primarily due to increased performance-based compensation costs commensurate with increased revenues and profitability.

Other income of $10.2 million and $5.1 million for the first half of 2021 and 2020, respectively, represents our share of the net income of RSI.

Interest Expense, Net

Interest expense, net for the first half of 2021 decreased $0.5 million, or 50%, 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 increased to $59.9 million for the first half of 2021, as compared to $32.9 million for the first half 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 23.0% and 21.8% for the first half of 2021 and 2020, respectively.

The increase was primarily due to higher state income taxes and proportionately higher income in 2021 as compared to tax credits and share-based compensation deductions in 2020.

Net Income Attributable to Watsco, Inc.

Net income attributable to Watsco, Inc.

for the first half of 2021 increased $82.1 million, or 70%, compared to the same period in 2020.

The increase was primarily driven by higher revenues and expanded profit margins, partially offset by higher income taxes and an increase in the net income attributable to the non-controlling

Liquidity and Capital Resources

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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.

As of June 30, 2021, we had $96.8 million of cash and cash equivalents, of which $80.6 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.

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 for the foreseeable future.

However, there can be no assurance that our current sources of available funds will be sufficient to meet our cash requirements.

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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.

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 an alternative 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.

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.

The following table summarizes our cash flow activity for the quarters ended March 31, 2021 and 2020 (in millions):

Cash flows (used in) provided by operating activities

Cash flows provided by (used in) investing activities

Working capital increased to $1,206.8 million at June 30, 2021, reflecting 50 new locations added by acquisitions in 2021, which in aggregate added $105.2 million of working capital.

Excluding these new locations, working capital increased 10% to $1,101.6 million at June 30, 2021 from $997.3 million at December 31, 2020, primarily due to higher accounts receivable consistent with overall increased sales, the seasonality of our business, and higher levels of inventory in support of stronger business conditions.

The following table summarizes our cash flow activity for the six months ended June 30, 2021 and 2020 (in millions):

Cash flows provided by operating activities

Cash flows used in investing activities

Cash flows used in financing activities

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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.

The decrease in net cash provided by operating activities was primarily due to higher accounts receivable driven by increased sales and higher levels of inventory in support of strong business conditions 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.

Net cash used in investing activities was higher primarily due to cash consideration paid for the acquisitions of TEC and ACME.

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.

The decrease in net cash used in financing activities was primarily attributable to increased uses of cash and borrowings to fund working capital and acquisitions in 2021 versus 2020 (funded by our revolving credit agreement) and offset by $21.0 million in proceeds from the non-controlling

interest for its contribution to the acquisition of TEC in 2021 and an increase in dividends paid in 2021.

Revolving Credit Agreement

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The credit agreement matures on December 5, 2023.

At March 31, 2021 $48.9 million was outstanding under the revolving credit agreement.

At June 30, 2021 $114.2 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.

We believe we were in compliance with all covenants at June 30, 2021.

Investment in Unconsolidated Entity

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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.

At June 30, 2021, the estimated purchase amount we would be contingently liable for was approximately $299.0 million.

We believe that our operating cash flows, cash on hand, and funds available for borrowing under our revolving credit agreement would be sufficient to purchase any additional ownership interests in RSI.

On May 7, 2021, we acquired certain assets and assumed certain liabilities of ACME, a distributor of air conditioning, heating, and refrigeration products, operating from 18 locations in Louisiana and Mississippi, for $22.9 million less certain average revolving indebtedness.

Consideration for the net purchase price consisted of $18.1 million in cash, 8,492 shares of Common stock having a fair value of $2.6 million, and $3.1 million repayment of indebtedness, net of cash acquired of $1.3 million.

We formed a new, stand-alone joint venture with Carrier, TEC, that will operate this business.

We formed a new, stand-alone joint venture with Carrier, TEC, that operates this business.

We have an 80% controlling interest in TEC, and Carrier has a 20% non-controlling

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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.

We paid cash dividends of $3.725 and $3.375 per share of Common stock and Class B common stock during the six months ended June 30, 2021 and 2020, respectively.

On July 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 July 30, 2021 to shareholders of record as of July 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.

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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.

At June 30, 2021, there were 1,129,087 shares remaining authorized for repurchase under the program.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis