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 September
June 30, 2018

2019

or

☐

Transition Report Pursuant To Section
 13 or 15(d) of the Securities Exchange Act of 1934

For the Transition Period From
to

Commission file number
1-5581

I.R.S. Employer Identification Number
59-0778222

WATSCO, INC.

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)
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  Yes  
☒    NO  
    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  Yes  
☒    NO  
    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 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 ☐ 
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  Yes  
☐    NO  
    No  
☒

The number of shares of each class of ourregistrant’s common stock outstanding as of NovemberAugust 5, 2018 was2019 comprised (i) 32,118,302
32,613,520
shares of Common stock, $0.50 par value per share, excluding 4,823,988 treasury shares and (ii) 5,309,088
5,446,199
shares of Class B common stock, $0.50 par value per share, excluding 48,263 treasury shares.

WATSCO, INC. AND SUBSIDIARIES

QUARTERLY REPORT ON FORM10-Q

TABLE OF CONTENTS

  Page No. 

PART I. FINANCIAL INFORMATION

Table of Contents
WATSCO, INC. AND SUBSIDIARIES
QUARTERLY REPORT ON FORM 10-Q
TABLE OF CONTENTS

Item 1.

Condensed Consolidated Unaudited Financial Statements
 

Page No.

PART I. FINANCIAL INFORMATION
Item 1.
Condensed Consolidated Unaudited Financial Statements
Condensed Consolidated Unaudited Statements of Income – QuarterQuarters and NineSix Months Ended SeptemberJune 30, 20182019 and 20172018

3
  3 

Condensed Consolidated Unaudited Statements of Comprehensive Income – QuarterQuarters and NineSix Months Ended SeptemberJune 30, 20182019 and 20172018

4
  4 

Condensed Consolidated Balance Sheets – SeptemberJune 30, 20182019 (Unaudited) and December 31, 20172018

5
  5 
Condensed Consolidated Unaudited Statements of Shareholders’ Equity – Quarters and Six Months Ended June 30, 2019 and 2018
6
 

Condensed Consolidated Unaudited Statements of Cash Flows – NineSix Months Ended SeptemberJune 30, 20182019 and 20172018

8
  6 

Notes to Condensed Consolidated Unaudited Financial Statements

9
  7 

Item 2.

 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
  16 

Item 3.

 
Quantitative and Qualitative Disclosures about Market Risk
23
  23 

Item 4.

 

Controls and Procedures

23
PART II. OTHER INFORMATION
  23 

PART II. OTHER INFORMATION

Item 1.		 

Item 1.

Legal Proceedings
 

Legal Proceedings

24
  23 

Item 1A.

 

Risk Factors

24
  23 

Item 6.

2.		 

ExhibitsUnregistered Sales of Equity Securities and Use of Proceeds

24
  24 
Item 6.
Exhibits
25

SIGNATURE

  
25
SIGNATURE
26
 

EXHIBITS

 

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PARTI. FINANCIAL INFORMATION

ITEM 1.

CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

WATSCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF INCOME

(In thousands, except per share data)

   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2018   2017   2018   2017 

Revenues

  $1,296,007   $1,229,591   $3,555,327   $3,377,610 

Cost of sales

   976,998    933,696    2,684,719    2,552,881 
  

 

 

   

 

 

   

 

 

   

 

 

 

Gross profit

   319,009    295,895    870,608    824,729 

Selling, general and administrative expenses

   200,408    183,728    565,519    534,515 

Other income

   3,696    2,294    8,491    2,294 
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

   122,297    114,461    313,580    292,508 

Interest expense, net

   1,047    2,117    2,375    5,019 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

   121,250    112,344    311,205    287,489 

Income taxes

   24,364    32,325    63,678    82,855 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   96,886    80,019    247,527    204,634 

Less: net income attributable tonon-controlling interest

   17,723    14,990    44,188    39,668 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to Watsco, Inc.

  $79,163   $65,029   $203,339   $164,966 
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share for Common and Class B common stock:

        

Basic

  $2.12   $1.82   $5.44   $4.62 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted

  $2.11   $1.82   $5.43   $4.62 
  

 

 

   

 

 

   

 

 

   

 

 

 

                 
 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Revenues
 $
1,371,854
  $
1,332,743
  $
2,303,132
  $
2,259,320
 
Cost of sales
  
1,043,870
   
1,011,977
   
1,741,388
   
1,707,721
 
                 
Gross profit
  
327,984
   
320,766
   
561,744
   
551,599
 
Selling, general and administrative expenses
  
196,549
   
186,577
   
376,621
   
365,111
 
Other income
  
2,965
   
3,157
   
4,409
   
4,795
 
                 
Operating income
  
134,400
   
137,346
   
189,532
   
191,283
 
Interest expense, net
  
1,212
   
763
   
1,988
   
1,328
 
                 
Income before income taxes
  
133,188
   
136,583
   
187,544
   
189,955
 
Income taxes
  
25,278
   
28,319
   
35,830
   
39,314
 
                 
Net income
  
107,910
   
108,264
   
151,714
   
150,641
 
Less: net income attributable to
non-controlling
interest
  
17,755
   
18,307
   
26,522
   
26,465
 
                 
Net income attributable to Watsco, Inc.
 $
90,155
  $
89,957
  $
125,192
  $
124,176
 
                 
Earnings per share for Common and Class B common stock:
            
Basic
 $
2.40
  $
2.41
  $
3.34
  $
3.33
 
                 
Diluted
 $
2.40
  $
2.40
  $
3.34
  $
3.32
 
                 
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,		 
   2018  2017  2018  2017 

Net income

  $96,886  $80,019  $247,527  $204,634 

Other comprehensive income (loss), net of tax

     

Foreign currency translation adjustment

   4,269   9,385   (7,422)   17,310 

Unrealized gain (loss) on cash flow hedging instruments

   231   (934)   762   (1,021) 

Reclassification of (gain) loss on cash flow hedging instruments into earnings

   (915)   64   (57)   (797) 

Unrealized gain on equity securities

   —     13   —     16 
  

 

 

  

 

 

  

 

 

  

 

 

 

Other comprehensive income (loss)

   3,585   8,528   (6,717)   15,508 
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income

   100,471   88,547   240,810   220,142 

Less: comprehensive income attributable tonon-controlling interest

   19,006   18,201   41,708   45,518 
  

 

 

  

 

 

  

 

 

  

 

 

 

Comprehensive income attributable to Watsco, Inc.

  $81,465  $70,346  $199,102  $174,624 
  

 

 

  

 

 

  

 

 

  

 

 

 

                 
 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Net income
 $
107,910
  $
108,264
  $
151,714
  $
150,641
 
Other comprehensive income (loss), net of tax            
Foreign currency translation adjustment
  
5,297
   
(5,046
)  
10,302
   
(11,691
)
Unrealized (loss) gain on cash flow hedging instruments  
(517
)  
380
   
(1,053
)  
531
 
Reclassification of (gain) loss on cash flow hedging instruments into earnings  
(128
)  
105
   
(402
)  
858
 
                 
Other comprehensive income (loss)  
4,652
   
(4,561
)  
8,847
   
(10,302
)
                 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Comprehensive income
  
112,562
   
103,703
   
160,561
   
140,339
 
Less: comprehensive income attributable to
non-controlling
interest
  
19,368
   
16,636
   
29,547
   
22,702
 
                 
Comprehensive income attributable to Watsco, Inc.
 $
93,194
  $
87,067
  $
131,014
  $
117,637
 
                 
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)

   September 30,
2018		  December 31,
2017		 
   (Unaudited)    

ASSETS

   

Current assets:

   

Cash and cash equivalents

  $67,612  $80,496 

Accounts receivable, net

   602,753   478,133 

Inventories

   810,869   761,314 

Other current assets

   20,611   17,454 
  

 

 

  

 

 

 

Total current assets

   1,501,845   1,337,397 

Property and equipment, net

   91,275   91,198 

Goodwill

   397,451   382,729 

Intangible assets, net

   153,446   161,065 

Other assets

   86,731   74,488 
  

 

 

  

 

 

 
  $2,230,748  $2,046,877 
  

 

 

  

 

 

 

LIABILITIES AND SHAREHOLDERS’ EQUITY

   

Current liabilities:

   

Current portion of other long-term obligations

  $178  $244 

Borrowings under revolving credit agreement (Note 5)

   116,400   —   

Accounts payable

   234,482   230,476 

Accrued expenses and other current liabilities

   157,761   185,757 
  

 

 

  

 

 

 

Total current liabilities

   508,821   416,477 
  

 

 

  

 

 

 

Long-term obligations:

   

Borrowings under revolving credit agreement (Note 5)

   —     21,800 

Other long-term obligations, net of current portion

   169   285 
  

 

 

  

 

 

 

Total long-term obligations

   169   22,085 
  

 

 

  

 

 

 

Deferred income taxes and other liabilities

   61,208   57,338 
  

 

 

  

 

 

 

Commitments and contingencies

   

Watsco, Inc. shareholders’ equity:

   

Common stock, $0.50 par value

   18,464   18,412 

Class B common stock, $0.50 par value

   2,684   2,638 

Preferred stock, $0.50 par value

   —     —   

Paid-in capital

   829,050   804,008 

Accumulated other comprehensive loss, net of tax

   (38,157)   (34,221) 

Retained earnings

   642,643   594,556 

Treasury stock, at cost

   (87,440)   (87,440) 
  

 

 

  

 

 

 

Total Watsco, Inc. shareholders’ equity

   1,367,244   1,297,953 

Non-controlling interest

   293,306   253,024 
  

 

 

  

 

 

 

Total shareholders’ equity

   1,660,550   1,550,977 
  

 

 

  

 

 

 
  $2,230,748  $2,046,877 
  

 

 

  

 

 

 

 
June 30,
2019
  
December 31,
2018
 
 
(Unaudited)
   
ASSETS
      
Current assets:
      
Cash and cash equivalents
 $
55,915
  $
82,894
 
Accounts receivable, net
  
655,418
   
501,908
 
Inventories
  
967,394
   
837,129
 
Other current assets
  
16,367
   
19,875
 
         
Total current assets
  
1,695,094
   
1,441,806
 
Property and equipment, net
  
95,586
   
91,046
 
Operating lease
right-of-use
assets
  
190,530
   
—  
 
Goodwill
  
398,575
   
391,998
 
Intangible assets, net
  
155,120
   
147,851
 
Other assets
  
97,529
   
88,332
 
         
 $
2,632,434
  $
2,161,033
 
         
LIABILITIES AND SHAREHOLDERS’ EQUITY
      
Current liabilities:
      
Current portion of long-term obligations
 $
60,784
  $
246
 
Accounts payable
  
356,062
   
200,229
 
Accrued expenses and other current liabilities
  
163,672
   
157,091
 
         
Total current liabilities
  
580,518
   
357,566
 
         
Long-term obligations:
      
Borrowings under revolving credit agreement
  
219,600
   
135,200
 
Operating lease liabilities, net of current portion
  
129,636
   
—  
 
Other long-term obligations, net of current portion
  
1,712
   
552
 
         
Total long-term obligations
  
350,948
   
135,752
 
         
Deferred income taxes and other liabilities
  
67,606
   
66,002
 
         
Commitments and contingencies
      
       
Watsco, Inc. shareholders’ equity:
      
Common stock, $0.50 par value
  
18,531
   
18,476
 
Class B common stock, $0.50 par value
  
2,735
   
2,691
 
Preferred stock, $0.50 par value
  
—  
   
—  
 
Paid-in
capital
  
828,932
   
832,121
 
Accumulated other comprehensive loss, net of tax
  
(40,146
)  
(45,968
)
Retained earnings
  
632,983
   
627,969
 
Treasury stock, at cost
  
(87,440
)  
(87,440
)
         
Total Watsco, Inc. shareholders’ equity
  
1,355,595
   
1,347,849
 
Non-controlling
interest
  
277,767
   
253,864
 
         
Total shareholders’ equity
  
1,633,362
   
1,601,713
 
         
 $
2,632,434
  $
2,161,033
 
         
See accompanying notes to condensed consolidated unaudited financial statements.

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WATSCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS

(In thousands)

   Nine Months Ended
September 30,		 
   2018  2017 

Cash flows from operating activities:

   

Net income

  $247,527  $204,634 

Adjustments to reconcile net income to net cash provided by operating activities:

   

Depreciation and amortization

   16,500   16,509 

Share-based compensation

   11,769   9,599 

Deferred income tax provision

   3,925   4,101 

Non-cash contribution to 401(k) plan

   2,945   2,428 

Other income from investment in unconsolidated entity

   (8,491)   (2,294) 

Other, net

   927   103 

Changes in operating assets and liabilities, net of effects of acquisition:

   

Accounts receivable

   (126,181)   (89,394) 

Inventories

   (50,566)   (97,685) 

Accounts payable and other liabilities

   (23,286)   141,885 

Other, net

   (5,004)   (507) 
  

 

 

  

 

 

 

Net cash provided by operating activities

   70,065   189,379 
  

 

 

  

 

 

 

Cash flows from investing activities:

   

Capital expenditures

   (12,897)   (13,829) 

Business acquisition, net of cash acquired

   (5,828)   —   

Investment in unconsolidated entity

   (3,760)   (63,600) 

Proceeds from sale of property and equipment

   143   139 
  

 

 

  

 

 

 

Net cash used in investing activities

   (22,342)   (77,290) 
  

 

 

  

 

 

 

Cash flows from financing activities:

   

Dividends on Common and Class B common stock

   (154,951)   (119,468) 

Repurchases of common stock to satisfy employee withholding tax obligations

   (3,782)   (4,674) 

Distributions tonon-controlling interest

   (2,178)   (6,799) 

Net (repayments) proceeds of other long-term obligations

   (182)   41 

Purchase of additional ownership fromnon-controlling interest

   —     (42,688) 

Net proceeds from the sale of Common stock

   —     5,391 

Proceeds fromnon-controlling interest for investment in unconsolidated entity

   752   12,720 

Net proceeds from issuances of common stock

   5,979   3,115 

Net proceeds under revolving credit agreement

   94,600   49,406 
  

 

 

  

 

 

 

Net cash used in financing activities

   (59,762)   (102,956) 
  

 

 

  

 

 

 

Effect of foreign exchange rate changes on cash and cash equivalents

   (845)   1,524 
  

 

 

  

 

 

 

Net (decrease) increase in cash and cash equivalents

   (12,884)   10,657 

Cash and cash equivalents at beginning of period

   80,496   56,010 
  

 

 

  

 

 

 

Cash and cash equivalents at end of period

  $67,612  $66,667 
  

 

 

  

 

 

 

Supplemental cash flow information:

   

Common stock issued for Alert Labs Inc.

  $8,180   —   

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, 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
 
                                 
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, 2017
  
37,228,715
  
$
21,050
  
$
804,008
  
$
(34,221
)
 
$
594,556
  
$
(87,440
)
 
$
253,024
  
$
1,550,977
 
Cumulative-effect adjustment
           
301
   
(301
)        
—  
 
Net income
              
34,219
      
8,158
   
42,377
 
Other comprehensive loss
           
(3,649
)        
(2,092
)  
(5,741
)
Issuances of
non-vested
restricted
shares of common stock
  
91,609
   
46
   
(46
)              
—  
 
Forfeitures of
non-vested
restricted
shares of common stock
  
(3,000
)  
(2
)  
2
               
—  
 
Common stock contribution to
401(k) plan
  
17,318
   
9
   
2,936
               
2,945
 
Stock issuances from exercise of stock options and employee stock
purchase plan
  
37,130
   
19
   
4,322
               
4,341
 
Retirement of common stock
  
(5,041
)  
(3
)  
(911
)              
(914
)
Share-based compensation
        
4,400
               
4,400
 
Cash dividends declared and paid on Common and Class B common
stock, $1.25 per share
              (46,581)          
(46,581
)
Distributions to
non-controlling

interest
                     
(2,178
)  
(2,178
)
Balance at March 31, 2018
  
37,366,731
  $
21,119
  $
814,711
  
$
(37,569
)
 
$
581,893
  
$
(87,440
)
 
 
$
256,912
  $
1,549,626
 
Net income              89,957       18,307    108,264 
Other comprehensive loss           (2,890)         (1,671)   (4,561)
Issuances of non-vested restricted
shares of common stock		  8,500   4   (4)               —   
Forfeitures of non-vested restricted
shares of common stock		  (5,000)  (2)  2                —   
Stock issuances from exercise of stock options and employee stock
purchase plan		  11,935   6   1,595                1,601 
Retirement of common stock  (14,534)  (7)  (2,492)               (2,499)
Share-based compensation        3,747                 3,747 
Cash dividends declared and paid on Common and Class B common
stock, $1.45 per share		              (54,184)          (54,184)
Balance at June 
30, 2018
  
37,367,632
  
$
21,120
  
$
817,559
  
$
(40,459
)
 
$
617,666
  
$
(87,440
)
 
$
273,548
  
$
1,601,994
 
                                 
See accompanying notes to condensed consolidated unaudited financial statements.

6

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WATSCO, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED UNAUDITED STATEMENTS OF CASH FLOWS
(In thousands)
         
 
Six Months Ended
June 30,
 
 
2019
  
2018
 
Cash flows from operating activities:
      
Net income
 $
151,714
  $
150,641
 
Adjustments to reconcile net income to net cash provided by (used in) operating activities:      
Depreciation and amortization
  
11,656
   
11,027
 
Share-based compensation
  
8,174
   
7,336
 
Deferred income tax provision
  
1,156
   
1,569
 
Other income from investment in unconsolidated entity
  
(4,409
)  
(4,795
)
Other, net
  
5,644
   
3,260
 
Changes in operating assets and liabilities, net of effects of acquisition:
      
Accounts receivable
  
(146,441
)  
(183,105
)
Inventories
  
(117,591
)  
(113,831
)
Accounts payable and other liabilities
  
161,685
   
107,908
 
Other, net
  
(3,141
)  
734
 
         
Net cash provided by (used in) operating activities  
68,447
   
(19,256
)
         
Cash flows from investing activities:
      
Business acquisition, net of cash acquired
  
(16,761
)  
—  
 
Capital expenditures
  
(9,197
)  
(8,824
)
Investment in unconsolidated entity
  
(4,940
)  
—  
 
Proceeds from sale of property and equipment
  
92
   
86
 
         
Net cash used in investing activities
  
(30,806
)  
(8,738
)
         
Cash flows from financing activities:
      
Dividends on Common and Class B common stock  (120,178)  (100,765)
Purchase of additional ownership from non-controlling interest  (32,400)  —   
Repurchases of common stock to satisfy employee withholding tax obligations  
(983
)  (2,213)
Net repayments of long-term obligations  
(230
)  
(121
)
Distributions to non-controlling interest  
—  
   
(2,178
)
Proceeds from short-term borrowings
  
—  
   
1,510
 
Proceeds from
non-controlling
interest for investment in unconsolidated entity
  
988
   
—  
 
Net proceeds from issuances of common stock  
3,076
   
4,741
 
Net proceeds under revolving credit agreement  
84,400
   
119,800
 
         
Net cash (used in) provided by financing activities  
(65,327
)  
20,774
 
         
Effect of foreign exchange rate changes on cash and cash equivalents
  
707
   
(1,276
)
         
Net decrease in cash and cash equivalents
  
(26,979
)  
(8,496
)
Cash and cash equivalents at beginning of period
  
82,894
   
80,496
 
         
Cash and cash equivalents at end of period
 $
55,915
  $
72,000
 
         
 
 
 
 
 
 
 
Supplemental cash flow information:
      
Common stock issued for Dunphey & Associates Supply Co., Inc.
 $
7,450
   
—  
 
See accompanying notes to condensed consolidated unaudited financial statements.
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WATSCO, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS

September

June 30, 2018

2019

(In thousands, except share and per share data)

1.

BASIS OF PRESENTATION

Basis of Consolidation

Watsco, Inc. (collectively with its subsidiaries, “Watsco,” “we,” “us”“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 SeptemberJune 30, 20182019 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 20172018 Annual Report on Form
10-K.

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 three joint ventures with Carrier 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 ninesix months ended SeptemberJune 30, 20182019 are not necessarily indicative of the results to be expected for the year ending December 31, 2018.2019. Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal. Furthermore, results of operations can be impacted favorably or unfavorably based on weather patterns, primarily 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 market is generally evenly distributed throughout the year, subject to weather and economic conditions, including their effect on the number of housing completions.

Equity Method Investments

Investments in which we have the ability to exercise significant influence, but do not control, are accounted for under the equity method of accounting and are included in other assets in our consolidated balance sheets. Under this method of accounting, our proportionate share of the net income or loss of the investee is included in other income in our consolidated statements of income. The excess, if any, of the carrying amount of our investment over our ownership percentage in the underlying net assets of the investee is attributed to certain fair value adjustments with the remaining portion recognized as goodwill.

Reclassifications

Certain reclassifications of prior year amounts have been made to conform to the 2018 presentation. These reclassifications had no effect on net income or earnings per share as previously reported.

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, inventories and income taxes, reserves related to self-insurance programsloss contingencies and the valuation of goodwill, and indefinite lived intangible assets and long-lived intangible assets. While we believe that these estimates are reasonable, actual results could differ from such estimates.

Recently Adopted Accounting Standards

Revenue Recognition

Leases
In May 2014,February 2016, the Financial Accounting Standards Board (the “FASB”(“FASB”) issued a standard on revenue recognition that provides a single, comprehensive revenue recognition model for all contracts with customers. The standard is principle-based and provides a five-step model to determine the measurement of revenue and timing of when it is recognized. In 2015 and 2016, the FASB issued several updates to this standard. The adoption of this standard and its related amendments (collectively, the “New Revenue Standard”) on January 1, 2018 did not result in the recognition of a cumulative adjustment to opening retained earnings under the modified retrospective approach, nor did it have a significant impact on our consolidated net income, balance sheet or cash flow. See Note 2.

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Financial Instruments

In January 2016, the FASB issued guidance related to certain aspects of recognition, measurement, presentation and disclosure of financial instruments. Most prominent among the changes to the standard is the requirement that changes in the fair value of equity investments, with certain exceptions, be recognized through net income rather than other comprehensive income. This guidance must be applied using a modified retrospective approach through a cumulative-effect adjustment to retained earnings and became effective for interim and annual periods beginning after December 15, 2017. The adoption of this guidance did not have a material impact on our consolidated financial statements. A cumulative-effect adjustment captured the previously held unrealized losses of $301 related to our equity securities carried at fair value. See Note 4.

Stock Compensation

In May 2017, the FASB issued guidance to clarify when to account for a change to the terms or conditions of a share-based payment award as a modification. Under the new guidance, modification accounting is required only if the fair value, the vesting conditions or the classification of the award (as equity or liability) changes as a result of the change in terms or conditions. This guidance must be applied prospectively and became effective for interim and annual periods beginning after December 15, 2017. The adoption of this guidance did not have a material impact on our consolidated financial statements.

Derivatives and Hedging

In August 2017, the FASB issued guidance to simplify the accounting for hedging derivatives. This guidance is effective prospectively and is effective for interim and annual periods beginning after December 15, 2018 with early adoption permitted. We elected to adopt this guidance during the quarter ended June 30, 2018, which did not have a material impact on our consolidated financial statements.

Recently Issued Accounting Standards Not Yet Adopted

Leases

In February 2016, the FASB issued guidance on accounting for leases, which requires lessees to recognize most leases on their balance sheets for the rights and obligations created by those leases. The guidance requires the use of a modified retrospective approach to apply the standard at the beginning of the earliest period presented in the financial statements. In July 2018, the FASB issued updated guidance was issued whichthat provides an additional transition method of adoption that allows entities to initially apply the standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings. We will adoptThe adoption of this standard and its related amendments (collectively, the guidance“New Lease Standard”) on January 1, 2019 using thisdid not result in the recognition of a cumulative adjustment to opening retained earnings under the additional transition method, and recognize a cumulative-effect adjustment to the opening balance of retained earnings.

Based on our preliminary assessment of our lease portfolio, we expect the adoption of this guidance tonor did it have a material impact on our consolidated balance sheets due to the recognition ofright-of-use assets and lease liabilities. However, we do not expect a materialsignificant impact on our consolidated statements of income. We are in the process of collecting data and designing processes and controls to account for our leases in accordance with the new guidance. Our current minimum lease commitments are disclosed inincome or cash flows. See Note 16 to our audited consolidated financial statements contained in our Annual Report on Form10-K for the year ended December 31, 2017.

2.

Recently Issued Accounting Standards Not Yet Adopted
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. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

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Table of Contents
2.

REVENUES

LEASES

Adoption of New RevenueLease Standard

We adopted the New RevenueLease Standard on January 1, 20182019 using the modified retrospective approach. The New Revenue Standard did not have an impact on the amount or timing of our revenue recognition; however, certain paymentsadditional transition method described in Note 1 to customers were reclassified from expenses to a reduction from revenues, resulting in an immaterial impact to the individual financial statement line items of ourthese condensed consolidated unaudited statements of income.financial statements. Results for reporting periods beginning on and after January 1, 20182019 are presented under the New Revenue Standard, while prior period resultsLease Standard. Prior periods have not been adjustedrestated. The New Lease Standard had a material impact on our consolidated balance sheet due to the recognition of
right-of-use
(“ROU”) assets and continuelease liabilities for operating leases, while accounting for finance leases remained substantially unchanged. 
Practical Expedients
We elected the package of practical expedients which did not require us to be reportedreassess (1) whether existing contracts contain embedded leases, (2) the lease classification of existing leases, and (3) whether initial direct costs for existing leases would qualify for capitalization under the accounting standards in effectNew Lease Standard. We also elected the practical expedients related to short-term leases and separating lease components from non-lease components for those periods.

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all underlying asset classes.

Revenue Recognition

Revenue primarily consists of sales of air conditioning, heating

Operating and refrigerationFinance Leases
We have operating leases for real property, vehicles and equipment, and related partsfinance leases primarily for vehicles. Operating leases are included in operating lease
right-of-use
assets, current portion of long-term obligations, and supplies. We generate our revenue primarily from the sale of finished products to customers; therefore, the significant majority of our contracts are short-termoperating lease liabilities in nature and have only a single performance obligation to deliver products; therefore, we satisfy our performance obligation under such contracts when we transfer control of the product to the customer. Some contracts contain a combination of product sales and services, the latter of which is distinct and accounted for as a separate performance obligation. We satisfy our performance obligations for services when we render the services within the agreed-upon service period. Total service revenue is not material and accounted for less than 1% of our consolidated revenues for both the quarter and nine months ended September 30, 2018.

Revenue is recognized when control transfersbalance sheet. Finance leases are not considered significant to our customers when picked upconsolidated balance sheet or via shipmentconsolidated statement of products or deliveryincome. Finance lease ROU assets at June 30, 2019 of services. We measure revenue as the amount of consideration we expect to be entitled to receive in exchange for those goods or services, net of any variable considerations (e.g., rights to return product, sales incentives, others) and any taxes collected from customers and subsequently remitted to governmental authorities. Revenue for shipping and handling charges is recognized when products$2,759 are delivered to the customer.

Product Returns

We estimate product returns based on historical experience and record them on a gross basis. Substantially all customer returns relate to products that are returned under manufacturers’ warranty obligations. Accrued sales returns of $14,702 at September 30, 2018 were included in accrued expensesproperty and other current liabilitiesequipment, net in our condensed consolidated unaudited balance sheet.

Sales Incentives

We estimate sales incentives expected Finance lease liabilities at June 30, 2019 of $2,852 are included in current portion of long-term obligations and other long-term obligations, net of current portion in our condensed consolidated unaudited balance sheet.

ROU assets represent our right to be paid overuse an underlying asset for the lease term, ofand lease liabilities represent our obligation to make lease payments arising from the programlease. Operating lease ROU assets and liabilities are recognized at commencement date based on the present value of lease payments over the lease term. As most likely amounts. Sales incentivesof our leases do not provide an implicit rate, we use our incremental borrowing rate based on the information available at commencement dates of the respective leases in determining the present value of the applicable lease payments.
Operating lease ROU assets also include any lease
pre-payments
made and exclude lease incentives. Certain of our leases include variable payments, which are excluded from lease ROU assets and lease liabilities, and are expensed as incurred. Our leases have remaining lease terms of
1-9
years, some of which include options to extend the leases for up to five years. The exercise of lease renewal options is at our sole discretion, and our lease ROU assets and liabilities reflect only the options we are reasonably certain that we will exercise. Certain real property lease agreements have lease and
non-lease
components, which are generally accounted for as a reductionsingle lease component. Lease expense for lease payments is recognized on a straight-line basis over the lease term. Lease payments for short-term leases, which are 12 months or less without a purchase option that is likely to be exercised, are recognized as lease cost on a straight-line basis over the lease term.
The components of operating lease expense were as follows:
         
 
Quarter ended
June 30, 2019
  
Six months��ended
June 30, 2019
 
Lease cost
 $
17,984
  $
35,760
 
Short-term lease cost
  
2,433
   
4,609
 
Variable lease cost
  
109
   
315
 
Sublease income
  
(32
)  
(81
)
         
Total operating lease cost
 $
20,494
  $
40,603
 
         
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Supplemental balance sheet information related to operating leases were as follows:
     
June 30,
 
2019
 
ROU assets
 $
190,530
 
 
 
 
 
 
Current portion of long-term obligations
 $
59,644
 
Operating lease liabilities
  
129,636
 
     
Total operating lease liabilities
 $
189,280
 
     
 
 
 
 
 
Weighted Average Remaining Lease Term (in years)
  
3.7
 years
 
Weighted Average Discount Rate
  
4.53
%
Supplemental cash flow information related to operating leases were as follows:
     
Six Months Ended June 30,
 
2019
 
Operating cash flows for the measurement of operating lease liabilities
 $
35,544
 
Operating lease
right-of-use
assets obtained in exchange for operating lease obligations
 $
222,332
 
At June 30, 2019, maturities of operating lease liabilities over each of the next five years and thereafter were as follows:
     
Remainder of 2019 $
35,321
 
2020
  
60,667
 
2021
  
47,995
 
2022
  
33,232
 
2023
  
19,039
 
Thereafter
  
9,921
 
     
Total lease payments
  
206,175
 
Less imputed interest
  
16,895
 
     
Total lease liability
 $
189,280
 
     
At June 30, 2019, we had additional operating leases, primarily for real property, that had not yet commenced. Such leases had estimated future minimum rental commitments of approximately $17,000. These operating leases are expected to commence in 2019 with lease terms of
5-11
years. These undiscounted amounts are not included in the transaction price and are generally paidtable above.
Prior to the adoption of the New Lease Standard, rental commitments on an annual basis.

undiscounted basis were approximately $219,300 at December 31, 2018 under

non-cancelable
operating leases and were payable as follows: $70,400 in 2019, $55,100 in 2020, $41,300 in 2021, $28,500 in 2022, $15,700 in 2023, and $8,300 thereafter.
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3.REVENUES
Disaggregation of Revenues

The following table presents our revenues disaggregated by primary geographical regions and major product lines within our single reporting segment:

   Quarter Ended
September 30,		  Nine Months Ended
September 30,		 
   2018  2017(1)  2018  2017(1) 

Primary Geographical Regions:

     

United States

  $1,176,087  $1,114,162  $3,233,731  $3,064,181 

Canada

   87,251   76,408   218,730   199,788 

Mexico

   32,669   39,021   102,866   113,641 
  

 

 

  

 

 

  

 

 

  

 

 

 
  $1,296,007  $1,229,591  $3,555,327  $3,377,610 
  

 

 

  

 

 

  

 

 

  

 

 

 

Major Product Lines:

     

HVAC equipment

   68%   68%   68%   67% 

Other HVAC products

   28%   27%   28%   28% 

Commercial refrigeration products

   4%   5%   4%   5% 
  

 

 

  

 

 

  

 

 

  

 

 

 
   100%   100%   100%   100% 
  

 

 

  

 

 

  

 

 

  

 

 

 

                 
 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Primary Geographical Regions:
            
United States
 $
1,219,208
  $
1,181,461
  $
2,025,719
  $
1,990,962
 
Canada
  
77,751
   
79,119
   
137,007
   
131,479
 
Latin America and the Caribbean
  
74,895
   
72,163
   
140,406
   
136,879
 
                 
 $
1,371,854
  $
1,332,743
  $
2,303,132
  $
2,259,320
 
                 
Major Product Lines:
            
HVAC equipment
  
69
%  
68
%  
68
%  
67
%
Other HVAC products
  
28
%  
28
%  
28
%  
29
%
Commercial refrigeration products
  
3
%  
4
%  
4
%  
4
%
                 
  
100
%  
100
%  
100
%  
100
%
                 
(1)4.

As noted above, prior period amounts have not been adjusted under the modified retrospective method and remain as originally reported for such periods.

Practical Expedients

We generally expense sales commissions when incurred because the amortization period is one year or less. These costs are recorded within selling, general and administrative expenses. We do not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.

9 of 25

3.

EARNINGS PER SHARE

The following table presents the calculation of basic and diluted earnings per share for our Common and Class B common stock:

   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2018   2017   2018   2017 

Basic Earnings per Share:

        

Net income attributable to Watsco, Inc. shareholders

  $79,163   $65,029   $203,339   $164,966 

Less: distributed and undistributed earnings allocated tonon-vested restricted common stock

   6,451    5,470    16,600    13,844 
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings allocated to Watsco, Inc. shareholders

  $72,712   $59,559   $186,739   $151,122 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding - Basic

   34,339,859    32,712,151    34,301,672    32,679,334 

Basic earnings per share for Common and Class B common stock

  $2.12   $1.82   $5.44   $4.62 

Allocation of earnings for Basic:

        

Common stock

  $67,201   $54,627   $172,571   $138,594 

Class B common stock

   5,511    4,932    14,168    12,528 
  

 

 

   

 

 

   

 

 

   

 

 

 
  $72,712   $59,559   $186,739   $151,122 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted Earnings per Share:

        

Net income attributable to Watsco, Inc. shareholders

  $79,163   $65,029   $203,339   $164,966 

Less: distributed and undistributed earnings allocated tonon-vested restricted common stock

   6,448    5,468    16,593    13,840 
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings allocated to Watsco, Inc. shareholders

  $72,715   $59,561   $186,746   $151,126 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding - Basic

   34,339,859    32,712,151    34,301,672    32,679,334 

Effect of dilutive stock options

   59,530    34,215    64,850    32,516 
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted-average common shares outstanding - Diluted

   34,399,389    32,746,366    34,366,522    32,711,850 
  

 

 

   

 

 

   

 

 

   

 

 

 

Diluted earnings per share for Common and Class B common stock

  $2.11   $1.82   $5.43   $4.62 

Anti-dilutive stock options not included above

   79,316    12,571    39,751    33,156 

                 
 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Basic Earnings per Share:
            
Net income attributable to Watsco, Inc. shareholders
 $
90,155
  $
89,957
  $
125,192
  $
124,176
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
7,512
   
7,379
   
10,355
   
10,147
 
                 
Earnings allocated to Watsco, Inc. shareholders
 $
82,643
  $
82,578
  $
114,837
  $
114,029
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding - Basic
  
34,435,099
   
34,309,885
   
34,411,738
   
34,282,261
 
Basic earnings per share for Common and Class B common stock
 $
2.40
  $
2.41
  $
3.34
  $
3.33
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
 
 
      
 
 
     
Allocation of earnings for Basic:
            
Common stock
 $
76,456
  $
76,321
  $
106,234
  $
105,383
 
Class B common stock
  
6,187
   
6,257
   
8,603
   
8,646
 
                 
 $
82,643
  $
82,578
  $
114,837
  $
114,029
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted Earnings per Share:
            
Net income attributable to Watsco, Inc. shareholders
 $
90,155
  $
89,957
  $
125,192
  $
124,176
 
Less: distributed and undistributed earnings allocated to
non-vested
restricted common stock
  
7,511
   
7,374
   
10,354
   
10,144
 
                 
Earnings allocated to Watsco, Inc. shareholders
 $
82,644
  $
82,583
  $
114,838
  $
114,032
 
                 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average common shares outstanding - Basic
  
34,435,099
   
34,309,885
   
34,411,738
   
34,282,261
 
Effect of dilutive stock options
  
27,861
   
69,310
   
21,210
   
67,554
 
                 
Weighted-average common shares outstanding - Diluted
  
34,462,960
   
34,379,195
   
34,432,948
   
34,349,815
 
                 
Diluted earnings per share for Common and Class B common stock
 $
2.40
  $
2.40
  $
3.34
  $
3.32
 
Anti-dilutive stock options not included above
  
174,457
   
40,797
   
213,270
   
24,044
 
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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 SeptemberJune 30, 20182019 and 2017,2018, our outstanding Class B common stock was convertible into 2,602,528 2,577,858 
and 2,709,194 2,599,496
shares of our Common stock, respectively.

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4.5.

OTHER COMPREHENSIVE
INCOME 
(LOSS)

Other comprehensive
income
(loss) consists of the foreign currency translation adjustment associated with our Canadian operations’ use of the Canadian dollar as itstheir functional currency and changes in the unrealized (losses)
gains (losses)
on cash flow hedging instruments and equity securities. instruments.
The tax effects allocated to each component of other comprehensive income (loss) were as follows:

   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2018   2017   2018   2017 

Foreign currency translation adjustment

  $4,269   $9,385   $(7,422)   $17,310 

Unrealized gain (loss) on cash flow hedging instruments

   316    (1,280)    1,043    (1,399) 

Income tax (expense) benefit

   (85)    346    (281)    378 
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gain (loss) on cash flow hedging instruments, net of tax

   231    (934)    762    (1,021) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Reclassification of (gain) loss on cash flow hedging instruments into earnings

   (1,253)    88    (78)    (1,092) 

Income tax expense (benefit)

   338    (24)    21    295 
  

 

 

   

 

 

   

 

 

   

 

 

 

Reclassification of (gain) loss on cash flow hedging instruments into earnings, net of tax

   (915)    64    (57)    (797) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gain on equity securities

   —      20    —      25 

Income tax expense

   —      (7)    —      (9) 
  

 

 

   

 

 

   

 

 

   

 

 

 

Unrealized gain on equity securities, net of tax

   —      13    —      16 
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive income (loss)

  $3,585   $8,528   $(6,717)   $15,508 
  

 

 

   

 

 

   

 

 

   

 

 

 

                 
 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Foreign currency translation adjustment
 $ 
5,297
  $
(5,046
) $ 
10,302
  $
(11,691
)
Unrealized (loss)
gain
on cash flow hedging instruments
  
(709
)  
520
   
(1,444
)  
727
 
Income tax
benefit 
(expense)
  
192
   
(140
)  
391
   
(196
)
                 
Unrealized (loss) gain on cash flow hedging instruments, net of tax   
(517
)  
380
   
(1,053
)  
531
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reclassification of (gain)
loss
on cash flow hedging instruments into earnings
  
(176
)  
144
   
(551
)  
1,175
 
Income tax expense (benefit)   
48
   
(39
)  
149
   
(317
)
                 
Reclassification of (gain) 
loss
on cash flow hedging instruments into earnings, net of
tax
  
(128
)  
105
   
(402
)  
858
 
Other comprehensive
income 
(loss)
 $
4,652
  $
(4,561
) $
8,847
  $
(10,302
)
                 
The changes in each component of accumulated other comprehensive loss, net of tax, were as follows:

Nine Months Ended September 30,

  2018   2017 

Foreign currency translation adjustment:

    

Beginning balance

  $(33,499)  $(43,459)

Current period other comprehensive (loss) income

   (4,660)    10,733
  

 

 

   

 

 

 

Ending balance

   (38,159)    (32,726) 
  

 

 

   

 

 

 

Cash flow hedging instruments:

    

Beginning balance

   (421)    215

Current period other comprehensive income (loss)

   457   (613) 

Less reclassification adjustment

   (34)    (478) 
  

 

 

   

 

 

 

Ending balance

   2   (876) 
  

 

 

   

 

 

 

Equity securities:

    

Beginning balance

   (301)    (286) 

Cumulative-effect adjustment to retained earnings

   301   —   

Current period other comprehensive income

   —      16
  

 

 

   

 

 

 

Ending balance

   —      (270) 
  

 

 

   

 

 

 

Accumulated other comprehensive loss, net of tax

  $(38,157)  $(33,872)
  

 

 

   

 

 

 

5.

DEBT

We maintain an unsecured, syndicated 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. Effective February 5, 2018, we decreased the borrowing capacity under this revolving credit agreement from $600,000 to $300,000. At September 30, 2018 and December 31, 2017, $116,400 and $21,800, respectively, were outstanding under the revolving credit agreement. The credit agreement matures on July 1, 2019 and, accordingly,

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Six Months Ended June 30,
 
2019
  
2018
 
Foreign currency translation adjustment:
      
Beginning balance
 $
(46,604
) $
(33,499
)
Current period other comprehensive
income 
(loss)
  
6,695
   
(7,373
)
         
Ending balance
  
(39,909
)  
(40,872
)
         
Cash flow hedging instruments:
      
Beginning balance
  
636
   
(421
)
Current period other comprehensive (loss) income
  
(631
)  
319
 
Reclassification adjustment
  
(242
)  
515
 
         
Ending balance
  
(237
)  
413
 
         
Equity securities:
      
Beginning balance
  
—  
   
(301
)
Cumulative-effect adjustment to retained earnings
  
—  
   
301
 
         
Ending balance
  
—  
   
—  
 
         
Accumulated other comprehensive loss, net of tax
 $
(40,146
) $
(40,459
)
         

borrowings outstanding under the credit agreement are classified as current liabilities in our condensed consolidated unaudited balance sheet at September 30, 2018. We believe that we will refinance the credit agreement at or prior to its maturity on similar terms and subject to similar conditions.

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, 2018.

6.

PURCHASE OF ADDITIONAL OWNERSHIP INTEREST INFROM JOINT VENTURE

On February 13, 2017,

Effective May 31, 2019, we purchased an additional 10%20% ownership interest in Homans Associates II LLC (“Homans”) from Carrier Enterprise Northeast, LLC which we refer to as (“Carrier Enterprise II,II”) for cash consideration of $42,688,$32,400, which increased our controlling interest from 70%ownership in Homans to 80%100%. Homans previously operated as a division of Carrier Enterprise II was formed in 2011and subsequent to the purchase operates as a joint venturestand-alone subsidiary of the Company with Carrier. Carrier Enterprise II had sales of approximately $545,000 for the year ended December 31, 2017 from 4016 locations in the northeastern United States and 14 locations in Mexico.

Northeastern U.S.
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7.

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 an approximately 35%a 34.9% ownership interest in Russell Sigler, Inc. (“RSI”), an HVAC distributor with 2017 sales of approximately $680,000, 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%. Total for cash consideration of $3,760 that was paid on July 5, 2018, 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%.
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%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 36.3% ownership38.1​​​​​​​% voting equity interest in RSI and its right to appoint two out of RSI’s six board members, this investment in RSI is accounted for under the equity method.

8.

ACQUISITION

On August 23, 2018,April 2, 2019, one of our wholly owned subsidiaries acquired Alert Labscertain assets and assumed certain liabilities of Dunphey & Associates Supply Co., Inc., a technology company baseddistributor of air conditioning and heating products operating from seven locations in Ontario, Canada forNew Jersey, New York and Connecticut. The purchase price was composed of cash consideration of $5,889$16,781 and the issuance of 47,10350,952 shares of Common stock having a fair value of $8,180.

$7,450.

The results of operations of thethis acquisition havehas been included in the consolidated financial statements from the date of acquisition. The pro forma effect of the acquisition was not deemed significant to the consolidated financial statements.

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 SeptemberJune 30, 2018,2019, 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 SeptemberJune 30, 20182019 was $36,800,$43,900, and such contracts have varying terms expiring through June 2019.

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March 2020

.

The impact from foreign exchange derivative instruments designated as cash flow hedges was as follows:

   Quarter Ended
September 30,		   Nine Months Ended
September 30,		 
   2018   2017   2018   2017 

Gain (loss) recorded in accumulated other comprehensive loss

  $ 316   $(1,280)   $1,043   $(1,399) 

(Gain) loss reclassified from accumulated other comprehensive loss into earnings

  $(1,253)   $88   $(78)   $(1,092) 

 
Quarter Ended
June 30,
  
Six Months Ended
June 30,
 
 
2019
  
2018
  
2019
  
2018
 
(Loss) gain
recorded in accumulated other comprehensive loss
 $
(709
) $
520
  $
(1,444
) $
727
 
(Gain) loss reclassified from accumulated other comprehensive loss into earnings $
(176
) $
144
  $
(551
) $
1,175
 
At SeptemberJune 30, 2018,2019, we expected an estimated $3$545
pre-tax gain
loss 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
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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 SeptemberJune 30, 20182019 was $12,000,$15,160, and such contracts have varying terms expiring through November 2018.

August 2019
.
We recognized losses(losses) gains of $(108), $(502), $(299)$(190) and $(912)$180 from foreign currency forward and option contracts not designated as hedging instruments in our condensed consolidated unaudited statements of income for the quarters ended June 30, 2019 and nine2018, respectively. We recognized losses of $303 and $191 from foreign currency forward and option contracts not designated as hedging instruments in our condensed consolidated unaudited statements of income for the six months ended SeptemberJune 30, 2019 and 2018, and 2017, 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 10.

   Asset Derivatives   Liability Derivatives 
   September 30, 2018   December 31, 2017   September 30, 2018   December 31, 2017 

Derivatives designated as hedging instruments

  $123   $70   $334   $773 

Derivatives not designated as hedging instruments

   —      180    74   184 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total derivative instruments

  $123   $250   $ 408   $ 957 
  

 

 

   

 

 

   

 

 

   

 

 

 

 
Asset Derivatives
  
Liability Derivatives
 
 
June 30, 2019
  
December 31, 2018
  
June 30, 2019
  
December 31, 2018
 
Derivatives designated as hedging instruments
 $
11
  $
1,262
  $
851
  $
3
 
Derivatives not designated as hedging
instruments
  
—
   
58
   
164
   
11
 
                 
Total derivative instruments
 $
11
  $
1,320
  $
1,015
  $
14
 
                 
10.

FAIR VALUE MEASUREMENTS

The following tables present our assets and liabilities carried at fair value that are measured on a recurring basis:

      Total   Fair Value Measurements
at September 30, 2018 Using		 
  

Balance Sheet Location

  Level 1   Level 2   Level 3 

Assets:

          

Derivative financial instruments

  Other current assets  $123   $—    $123   $—  

Equity securities

  Other assets  $372   $372   $—    $—  

Liabilities:

          

Derivative financial instruments

  Accrued expenses and other current liabilities  $408   $—    $408   $—  
      Total   Fair Value Measurements
at December 31, 2017 Using		 
  

Balance Sheet Location

  Level 1   Level 2   Level 3 

Assets:

          

Derivative financial instruments

  Other current assets  $250   $—    $250   $—  

Equity securities

  Other assets  $332   $332   $—    $—  

Liabilities:

          

Derivative financial instruments

  Accrued expenses and other current liabilities  $957   $—    $957   $—  

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Total
  
Fair Value Measurements
at June 30, 2019 Using
 
Balance Sheet Location
 
Level 1
  
Level 2
  
Level 3
  
Assets:
             
Derivative financial instruments
 
Other current assets
 $
11
  $
—  
  $
11
  $
—  
 
Equity securities
 
Other assets
 $
310
  $
310
  $
—  
  $
—  
 
Liabilities:
             
Derivative financial instruments
 
Accrued expenses and other current liabilities
 $
1,015
  $
—  
  $
1,015
  $
—  
 
  
Total
  
Fair Value Measurements
at December 31, 2018 Using
 
Balance Sheet Location
 
Level 1
  
Level 2
  
Level 3
  
Assets:
             
Derivative financial instruments
 
Other current assets
 $
1,320
  $
—  
  $
1,320
  $
—  
 
Equity securities
 
Other assets
 $
279
  $
279
  $
—  
  $
—  
 
Liabilities:
             
Derivative financial instruments
 
Accrued expenses and other current liabilities
 $
14
  $
—  
  $
14
  $
—  
 
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
– thethese 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 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.

There were no transfers in or out of Level 1 and Level 2 during the ninesix months ended SeptemberJune 30, 2018.

2019.
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11.

SHAREHOLDERS’ EQUITY

At-the-Market Offering Program

On August 23, 2017, we entered into a sales agreement with Robert W. Baird & Co. Inc., which enabled the Company to issue and sell shares of Common stock in one or more negotiated transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), for a maximum aggregate offering amount of up to $250,000 (the “ATM Program”). The offer and sale of our Common stock pursuant to the ATM Program was registered under the Securities Act pursuant to our automatically effective shelf registration statement on FormS-3 (FileNo. 333-207831).

During the quarter and nine months ended September 30, 2017, we sold 35,000 shares of Common stock under the ATM Program for net proceeds of $5,391. Direct costs of $285 incurred in connection with the offering were charged against the proceeds from the sale of Common stock and reflected as a reduction ofpaid-in capital. At September 30, 2017, $244,560 remained available for sale under the Sales Agreement. As of December 31, 2017, we had completed the offering of shares under the ATM Program. The net proceeds were primarily used to repay outstanding debt and for general corporate purposes.

Common Stock Dividends

We paid cash dividends of $1.60, $1.45, $1.25, $4.15$3.20, and $3.35$2.70 per share of both Common stock and Class B common stock during the quarters and ninesix months ended SeptemberJune 30, 2019 and 2018, and 2017, respectively.

Non-Vested
Restricted Stock

During the quartersquarter and ninesix months ended SeptemberJune 30, 2018 and 2017, we granted 10,000, 9,000, 110,109 and 164,899 shares ofnon-vested restricted stock, respectively.

During the quarters and nine months ended September 30, 2018 and 2017, 8,830, 12,354, 21,754 and 32,4542019, 3,608 shares of Common and Class B common stock respectively, with an aggregate fair market valuesvalue of $1,562, $1,893, $3,775$555, and $4,664,6,593 shares of Common and Class B common stock with an aggregate fair market value of $983, 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 six months ended June 30, 2018,

12,924
shares of Common stock with an aggregate fair market value of $
2,213
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.
Exercise of Stock Options

During the quarters and nine months ended September 30, 2018 and 2017, 8,600, 9,084, 53,184 and 25,084 stock options, respectively, were exercised for Common stock.

Cash received from commonCommon stock issued as a result of stock options exercised during the quarters and ninesix months ended SeptemberJune 30, 2019 and 2018, was $1,526, $1,369, $2,243, and 2017, was $856, $801, $4,837 and $2,111,$3,981, respectively.

During the quarter and nine months ended SeptemberJune 30, 2018, 3761,610 shares of Common stock with an aggregate fair market value of $69 and 7,027$286 were withheld as payment in lieu of cash for stock option exercises. These shares were retired upon delivery. During the six months ended June 30, 2018, 6,651 shares of Common stock with an aggregate fair market value of $1,269, respectively,$1,200 were withheld as payment in lieu of cash for stock option exercises and related tax withholdings. During the quarter and nine months ended September 30, 2017, 350 shares of Common stock with an aggregate fair market value of $53 were withheld as payment in lieu of cash for stock option exercises and related tax withholdings.exercises. These shares were retired upon delivery.

Employee Stock Purchase Plan

During the quarters ended June 30, 2019 and nine months ended September 30, 2018, we received net proceeds of $423 and 2017, 2,235, 2,718, 6,716 and 6,977$414, respectively, for shares of Common stock respectively, were issued under our employee stock purchase plan for whichplan. During the six months ended June 30, 2019 and 2018, we received net proceeds of $382, $402, $1,142$833 and $1,004, respectively.

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401(k) Plan

During the nine months ended September 30, 2018 and 2017, we issued 17,318 and 16,389$760, respectively, for shares of Common stock respectively, toissued under our profit sharing retirement plan, representing the Commonemployee stock discretionary matching contributions of $2,945 and $2,428, respectively.

Non-controlling Interest

As described under the heading “Joint Ventures with Carrier Corporation” in Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operation” contained in this Quarterly Report on Form10-Q, we maintain three joint ventures with Carrier that we describe as Carrier Enterprise I, Carrier Enterprise II and Carrier Enterprise III. We have an 80% controlling interest in Carrier Enterprise I and Carrier Enterprise II and a 60% controlling interest in Carrier Enterprise III. Carrier owns the remainingnon-controlling interests in such joint ventures. The following table reconciles shareholders’ equity attributable to Carrier’snon-controlling interests:

Non-controlling interest at December 31, 2017

  $253,024 

Net income attributable tonon-controlling interest

   44,188 

Foreign currency translation adjustment

   (2,762) 

Distributions tonon-controlling interest

   (2,178) 

Investment in unconsolidated entity

   752 

Gain recorded in accumulated other comprehensive loss

   305 

Gain reclassified from accumulated other comprehensive loss into earnings

   (23) 
  

 

 

 

Non-controlling interest at September 30, 2018

  $293,306 
  

 

 

 

purchase plan.
12.

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 $2,562$3,383 and $2,344$2,311 at SeptemberJune 30, 20182019 and December 31, 2017,2018, respectively, were established related to such programs and are included in accrued expenses and other current liabilities in our condensed consolidated unaudited balance sheets.

13.

RELATED PARTY TRANSACTIONS

Purchases from Carrier and its affiliates comprised 64%, 62%, 63% and 62%64% of all inventory purchases made during the quarters ended June 30, 2019 and nine2018, respectively. Purchases from Carrier and its affiliates comprised 62% and 63% of all inventory purchases made during the six months ended SeptemberJune 30, 20182019 and 2017,2018, respectively. At SeptemberJune 30, 20182019 and December 31, 2017,2018, approximately $93,000$122,000 and $75,000,$71,000, 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 ninesix months ended SeptemberJune 30, 20182019 and 20172018 included approximately $28,000, $19,000, $65,000$23,000, $21,000, $44,000, and $51,000,$37,000, respectively, of sales to Carrier and its affiliates. We believe these transactions are conducted on terms equivalent to an
arm’s-length
basis in the ordinary course of business.

A member

16 of our Board26
Table of Directors is the Chairman and Chief Executive Officer of Moss & Associates LLC, who served as general contractor for the remodeling of our Miami headquarters, which was completed in 2018. We paid Moss & Associates LLC $0, $58, $124 and $702 for construction services performed during the quarters and nine months ended September 30, 2018 and 2017, respectively, and no amount was payable at September 30, 2018.

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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 ninesix months ended SeptemberJune 30, 20182019 and 2017,June 30, 2018, we paid this firm $0, $71,$14, $0 and $18 and $291 for services performed, respectively, and $113no amount was payable at SeptemberJune 30, 2018.

14.

SUBSEQUENT EVENT

On October 23, 2018,2019.

A member of our Board of Directors approvedis the Chairman and Chief Executive Officer of Moss & Associates LLC, which served as general contractor for the remodeling of our Miami headquarters that was completed in 2018. We paid Moss & Associates LLC $71 and $124 for construction services performed during the quarters and six months ended June 30, 2018, respectively.
14.SUBSEQUENT EVENT
On August 1, 2019, Carrier Enterprise I acquired substantially all of the assets and assumed certain of the liabilities of Peirce-Phelps, Inc. (“PPI”), an increase toHVAC distributor operating from 19 locations in Pennsylvania, New Jersey, and Delaware, for $85,000 less certain average revolving indebtedness. Consideration for the quarterlynet purchase price consisted of $10,000 in cash dividend per shareand 372,543 shares of Common and Class B common stock having a fair value of $58,638. Carrier contributed cash of $
17,000
to $1.60 per share from $1.45 per share, beginningCarrier Enterprise I in connection with the dividend that will be paid in January 2019.

acquisition of PPI.
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;

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;

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 political 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 other 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 included in Item 1A “Risk Factors” of our Annual Report on Form
10-K
for the year ended December 31, 2017,2018, 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
17 of 26  
Table of Contents
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.

16 of 25

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, 2017.

2018.

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 SeptemberJune 30, 2018,2019, we operated from 568585 locations in 37 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 are payable mostlywe operate under
non-cancelable
operating leases.

Sales of residential central air conditioners, heating equipment, and parts and supplies are seasonal. Furthermore, results of operations can be impacted favorably or unfavorably based on weather patterns, primarily 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 market is generallyfairly evenly distributed throughout the year subject toand depends largely on housing completions and related weather and economic conditions, including their effect on the number of housing completions.

conditions.

Joint Ventures with Carrier Corporation

In 2009, we formed a joint venture with Carrier Corporation (“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. In July 2012, we exercised our option to acquireWe have an additional 10% ownership80% controlling interest in Carrier Enterprise I, which increased our ownership interest to 70%; and on July 1, 2014, we exercised our last remaining option to acquire an additional 10% ownership interest in Carrier Enterprise I, which increased our controlling interest to 80%. Neither Watsco nor Carrier has any remaining options to purchase additional ownership interests in Carrier Enterprise I or any of our other joint ventures with Carrier, which are described below.

a 20%

non-controlling
interest.
In 2011, we formed a second joint venture with Carrier and completed two additional transactions. In April 2011, Carrier contributed 28 of its company-owned locations in the Northeast U.S., and we contributed 14 locations in the Northeast U.S. In July 2011, we 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. On November 29, 2016, we purchasedWe have an additional 10% ownership80% controlling interest in Carrier Enterprise II, and on February 13, 2017,Carrier has a 20%
non-controlling
interest. Effective May 31, 2019, we again purchased an additional 10%20% ownership interest in Homans Associates II LLC (“Homans”) from Carrier Enterprise II, following which together increasedwe owned 100% of Homans. Homans previously operated as a division of Carrier Enterprise II and now operates as one of our controlling interest to 80%.

stand-alone-subsidiaries.

In 2012, we formed a third joint venture, which we refer to as Carrier Enterprise III, with UTC Canada Corporation, referred to as UTC Canada, an affiliate of 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 UTC Canada has a 40%
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 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 20172018 Annual Report on Form
10-K,
as filed with the SEC on March 1, 2018.February 28, 2019. We believe that there have been no significant changes during the quarter ended SeptemberJune 30, 20182019 to the critical accounting policies disclosed in our Annual Report on Form
10-K
for the year ended December 31, 2017.

172018.

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26

Recent

Table of Contents
New Accounting Pronouncements

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 and not yetto be 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 ninesix months ended SeptemberJune 30, 20182019 and 2017:

   Quarter Ended
September 30,		  Nine Months Ended
September 30,		 
   2018  2017  2018  2017 

Revenues

   100.0%   100.0%   100.0%   100.0% 

Cost of sales

   75.4   75.9   75.5   75.6 
  

 

 

  

 

 

  

 

 

  

 

 

 

Gross profit

   24.6   24.1   24.5   24.4 

Selling, general and administrative expenses

   15.5   14.9   15.9   15.8 

Other income

   0.3   0.2   0.2   0.1 
  

 

 

  

 

 

  

 

 

  

 

 

 

Operating income

   9.4   9.3   8.8   8.7 

Interest expense, net

   0.1   0.2   0.1   0.1 
  

 

 

  

 

 

  

 

 

  

 

 

 

Income before income taxes

   9.4   9.1   8.8   8.5 

Income taxes

   1.9   2.6   1.8   2.5 
  

 

 

  

 

 

  

 

 

  

 

 

 

Net income

   7.5   6.5   7.0   6.1 

Less: net income attributable tonon-controlling interest

   1.4   1.2   1.2   1.2 
  

 

 

  

 

 

  

 

 

  

 

 

 

Net income attributable to Watsco, Inc.

   6.1%   5.3%   5.7%   4.9% 
  

 

 

  

 

 

  

 

 

  

 

 

 

2018:

                 
 
Quarter
Ended June 30,
  
Six Months
Ended June 30,
 
 
2019
  
2018
  
2019
  
2018
 
Revenues
  
100.0
%  
100.0
%  
100.0
%  
100.0
%
Cost of sales
  
76.1
   
75.9
   
75.6
   
75.6
 
                 
Gross profit
  
23.9
   
24.1
   
24.4
   
24.4
 
Selling, general and administrative expenses
  
14.3
   
14.0
   
16.4
   
16.2
 
Other income
  
0.2
   
0.2
   
0.2
   
0.2
 
                 
Operating income
  
9.8
   
10.3
   
8.2
   
8.5
 
Interest expense, net
  
0.1
   
0.1
   
0.1
   
0.1
 
                 
Income before income taxes
  
9.7
   
10.2
   
8.1
   
8.4
 
Income taxes
  
1.8
   
2.1
   
1.6
   
1.7
 
                 
Net income
  
7.9
   
8.1
   
6.6
   
6.7
 
Less: net income attributable to
non-controlling
interest
  
1.3
   
1.4
   
1.2
   
1.2
 
                 
Net income attributable to Watsco, Inc.
  
6.6
%  
6.7
%  
5.4
%  
5.5
%
                 
Note: Due to rounding, percentages may not add up to 100.

The following narratives reflect our acquisition of Dunphey & Associates Supply Co., Inc. in April 2019, Alert Labs Inc. in August 2018, and our acquisition of an HVAC distributor in November 2018 as well as the purchase of an additional 1.8% and 1.4% ownership interest in Russell Sigler, Inc. (“RSI”), in which we purchasedApril 2019 and June 2018, respectively, and the purchase of an approximately 35%additional 20% ownership interest in June 2017 and an additional 1.4% ownership interest in June 2018, and our additional 10% ownership interest in Carrier Enterprise II, which we acquired in February 2017. We did not acquire any material businesses during 2018 or 2017.

Homans effective May 31, 2019.

In the following narratives, computations and other information referring to “same-store basis” exclude the effects of locations closed, acquired, or locations opened, or closed during the immediately preceding 12 months, unless they are within close geographical proximity to existing locations.locations, during the immediately preceding 12 months. At Septemberboth June 30, 2019 and 2018, 8 locations opened were near existing locations and 2017, 22 and 34 locations, respectively, were excluded fromtherefore included in “same-store basis” information.
The table below summarizes the changes in our locations for the 12 months ended SeptemberJune 30, 2018:

2019:
  Number of
Locations		 

September 30, 2017

562

Opened

3

Closed

(5) 

December 31, 2017

560

Opened

11

Closed

(3) 

September 30, 2018

568 
 

Number of
Locations

June 30, 2018
568
Opened
4
Acquired
3
Closed
(4
)
December 31, 2018
571
Opened
11
Acquired
7
Closed
(4
)
June 30, 2019
585
 

Third

Second Quarter of 20182019 Compared to ThirdSecond Quarter of 2017

2018

Revenues

Revenues for the thirdsecond quarter of 20182019 increased $66.4$39.1 million, or 5%3%, including $3.4$22.8 million from locations opened and acquired during the preceding 12 months, offset by $3.8$3.6 million from locations closed. On a same-store basis, revenues increased $66.8$19.9 million, or 5%1%, as compared to the same period in 2017,2018, reflecting a 7%3% increase in sales of HVAC equipment (68%(69% of sales), which included a 6%4% increase in residential HVAC equipment, and a 9% increase in commercial HVAC equipment, a 4% increase2% decrease in sales of other HVAC products (28% of sales) and flata 1% decrease in sales of commercial refrigeration products (4%(3% of sales). TheFor residential HVAC equipment, the increase in same-store revenues was primarily due
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to realization of price increases demand for the replacement of residential and commercial HVAC equipment and a higher mix of high-efficiency air conditioning and heating systems, which sell at higher unit prices.

18prices, and demand for the replacement of 25

residential HVAC equipment, resulting in a 3% increase in the average selling price and a 1% increase in volume.

Gross Profit

Gross profit for the thirdsecond quarter of 20182019 increased $23.1$7.2 million, or 8%2%, primarily as a result of increased revenues. Gross profit margin for the quarter ended SeptemberJune 30, 2018 improved 502019 declined 20 basis-points to 24.6%23.9% versus 24.1% for the same period in 2017,2018, primarily due to an improvementa shift in selling margins forsales mix toward HVAC equipment.

equipment, which generates a lower gross profit margin than

non-equipment
products.
Selling, General and Administrative Expenses

Selling, general and administrative expenses for the thirdsecond quarter of 20182019 increased $16.7$10.0 million, or 9%5%, primarily due to increased revenues, additional sales and service-related headcount and an increase in performance-based compensation specific to certain markets.revenues. Selling, general and administrative expenses as a percent of revenues for the quarter ended SeptemberJune 30, 20182019 increased to 15.5%14.3% versus 14.9%14.0% for the same period in 2017.2018. On a same-store basis, selling, general and administrative expenses increased 9%3% as compared to the same period in 2017. The increase in2018. Excluding new locations opened or acquired during the last 12 months, selling, general and administrative expenses as a percentageincreased $4.6 million, or 2%. Selling, general and administrative expenses included $1.5 million of revenues was primarily due to our inability to leverage fixed operatingadditional costs to the same extent asfor 2019 in 2017.

excess of 2018 for ongoing technology initiatives.

Other Income

Other income of $3.7$3.0 million and $2.3$3.2 million for the second quarters ended September 30,of 2019 and 2018, and 2017, respectively, representsrepresented our share of the net income of RSI.

Interest Expense, Net

Net interest

Interest expense, net for the thirdsecond quarter of 2018 decreased $1.12019 increased $0.4 million, or 51%59%, primarily as a result of a decreasean increase in average outstanding borrowings partially offset byand a higher effective interest rate for the 20182019 period, in each case under our revolving credit facility, as compared to the same period in 2017.

2018.

Income Taxes

Income taxes decreased to $24.4$25.3 million for the thirdsecond quarter of 2019, as compared to $28.3 million for the second quarter of 2018 as compared to $32.3 million for the third quarter of 2017 and arerepresent 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.purposes; therefore, Carrier is responsible for its proportionate share of income taxes attributable to its share of earnings. The effective income tax rates attributable to us were 23.3%21.7% and 32.8%23.8% for the quarters ended SeptemberJune 30, 20182019 and 2017,2018, respectively. The decrease was primarily due to lower estimated foreign withholding taxes in the reductionsecond quarter of 2019 as compared to the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018 as a result of the Tax Cuts and Jobs Act of 2017.

same period in 2018.

Net Income Attributable to Watsco, Inc.

Net income attributable to Watsco for the quarter ended SeptemberJune 30, 20182019 increased $14.1$0.2 million or 22%, compared to the same period in 2017.2018. The increase was primarily driven by higher revenues expandedand gross profit, margins, lower interest expense, net, and lowera reduction in income taxes and a decrease in net income attributable to the
non-controlling
interest related to the purchase of the additional 20% interest in Homans, partially offset by higher selling, general and administrative expenses as a percent of revenues,and interest expense as discussed above.

Nine Months Ended September 30, 2018

First Half of 2019 Compared to Nine Months Ended September 30, 2017

First Half of 2018

Revenues

Revenues for the nine months ended September 30, 2018first half of 2019 increased $177.7$43.8 million, or 5%2%, including $14.0$26.9 million from locations opened and acquired during the preceding 12 months, offset by $10.3$6.2 million from locations closed. On a same-store basis, revenues increased $174.0$23.1 million, or 5%1%, as compared to the same period in 2017,2018, reflecting a 7%3% increase in sales of HVAC equipment (68% of sales), which included a 7% increase in residential HVAC equipment and a 6% increase in commercial HVAC equipment, a 5% increase2% decrease in sales of other HVAC products (28% of sales) and flat sales ofa 2% decrease in commercial refrigeration products (4% of sales). TheFor residential HVAC equipment, the increase in same-store revenues was primarily due to realization of price increases and demand for the replacement of residential and commercial HVAC equipment. Revenues from sales of residential HVAC equipment also benefited from an improved salesa higher mix of higher-efficiencyhigh-efficiency air conditioning and heating systems, which sell at higher unit prices.

prices, resulting in a 3% increase in the average selling price.

Gross Profit

Gross profit for the nine months ended September 30, 2018first half of 2019 increased $45.9$10.1 million, or 6%2%, primarily as a result of increased revenues. Gross profit margin remained consistent at 24.4% for the nine months ended September 30, 2018 improved 10 basis-pointsfirst half of 2019 as compared to 24.5% versus 24.4%, primarily due to increased demand for higher-efficiency residential HVAC equipment and an improvementthe same period in selling margins for HVAC equipment.

2018.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the nine months ended September 30, 2018first half of 2019 increased $31.0$11.5 million, or 6%3%, primarily due to increased revenues. Selling, general and administrative expenses as a percentage of revenues for the ninesix months ended SeptemberJune 30, 20182019 increased
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to 15.9%16.4% versus 15.8%16.2% for the same period in 2017.2018. On a same-store basis, selling, general and administrative expenses increased 6%1% as compared to the same period in 2017. The increase in2018. Excluding new locations opened or acquired during the last 12 months, selling, general and administrative expenses was primarily due to our inability to leverage fixed operatingincreased $4.3 million, or 1%. Selling, general and administrative expenses included $2.9 million of additional costs to the same extent asfor 2019 in 2017.

19excess of 25

2018 for ongoing technology initiatives.

Other Income

Other income of $8.5$4.4 million and $2.3$4.8 million for the nine months ended September 30,first half of 2019 and 2018, and 2017, respectively, representsrepresented our share of the net income of RSI.

Interest Expense, Net

Net interest

Interest expense, net for the nine months ended September 30, 2018 decreased $2.6first half of 2019 increased $0.7 million, or 53%50%, primarily as a result of a decreasean increase in average outstanding borrowings partially offset byand a higher effective interest rate for the 20182019 period, in each case under our revolving credit facility, as compared to the same period in 2017.

2018.

Income Taxes

Income taxes decreased to $63.7$35.8 million for the nine months ended September 30, 2018first half of 2019, as compared to $82.9$39.3 million for the nine months ended September 30, 2017first half of 2018 and arerepresent 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.purposes; therefore, Carrier is responsible for its proportionate share of income taxes attributable to its share of earnings. The effective income tax rates attributable to us were 23.6%22.0% and 33.0%23.8% for the nine months ended September 30,first half of 2019 and 2018, and September 30, 2017, respectively. The decrease was primarily due to lower estimated foreign withholding taxes in the reductionfirst half of 2019 as compared to the U.S. federal corporate tax rate from 35% to 21% effective January 1, 2018 as a result of the Tax Cuts and Jobs Act of 2017.

same period in 2018.

Net Income Attributable to Watsco, Inc.

Net income attributable to Watsco for the nine months ended September 30, 2018first half of 2019 increased $38.4$1.0 million, or 23%1%, compared to the same period in 2017.2018. The increase was primarily driven by higher revenues and othergross profit, and a reduction in income expanded profit margins, lowertaxes, partially offset by higher selling, general and administrative expenses and interest expense net, and lower income taxes as discussed above.

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 (to the extent 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 proceeds from the issuance and sale of our Common stock.

As of SeptemberJune 30, 2018,2019, we had $67.6$55.9 million of cash and cash equivalents, of which $57.4$37.7 million was held by foreign subsidiaries. The repatriation of cash balances from our foreign subsidiaries could have adverse tax consequencesimpacts or be subject to capital controls; however, these balances are generally available without legal restrictions to fund the ordinary business operations of our foreign subsidiaries.

subsidiaries without legal or other 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. While we have the intent and current ability to refinance our revolving credit agreement on similar terms and subject to similar conditions on a long-term basis prior to its maturity in 2019, there is no assurance that we will be able to refinance with the same terms and conditions.

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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
21 of 26
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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 LIBOR will be replaced by lenders with an alternative rate, which may exceed what would have been the comparable LIBOR rate. Disruptions in the credit and capital markets, including a transition away from LIBOR, could also result in increased borrowing costs and/or reduced borrowing capacity under our revolving credit agreement.

Working Capital

Working capital increased to $993.0$1,114.6 million at SeptemberJune 30, 20182019 from $920.9$1,084.2 million at December 31, 2017,2018, reflecting higher levels of accounts receivable and inventories, primarily due to the seasonality of our business.

Inventory is also higher as a result of new locations opened and acquired, as well as additional inventory received in anticipation of the transition to new energy conservation standards for residential furnace fans that became effective on July 3, 2019. These increases were partially offset by the timing of accounts payable and accrued liabilities as well as the current portion of lease liabilities recognized as current liabilities as a result of the adoption of the New Lease Standard on January 1, 2019.

Cash Flows

The following table summarizes our cash flow activity for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 (in millions):

   2018   2017   Change 

Cash flows provided by operating activities

  $70.1   $189.4   $(119.3) 

Cash flows used in investing activities

  $(22.3)   $(77.3)   $55.0 

Cash flows used in financing activities

  $(59.8)   $(103.0)   $43.2 

             
 
2019
  
2018
  
Change
 
Cash flows provided by (used in) operating activities
 $
68.4
  $
(19.3
) $
87.7
 
Cash flows used in investing activities
 $
(30.8
) $
(8.7
) $
(22.1
)
Cash flows (used in) provided by financing activities
 $
 (65.3
) $
20.8
  $
(86.1
)
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 decreaseincrease in net cash provided by operating activities was primarily due to the comparative timing of payments for accrued expenses and other current liabilities and higher accounts receivable driven by increased sales volume, partially offset by a lower increase in inventory and higher net income in the 2018 period.

2019 versus 2018.

Investing Activities

Net cash used in investing activities was lowerhigher due to the purchase of an ownership interest in RSI for $63.6 million in 2017, partially offset by an acquisition for cash consideration of $5.9 millionpaid for acquisitions and the purchase of an additional ownership interest in RSI for $3.8 million in 2018.

2019.

Financing Activities

The decreaseincrease in net cash used in financing activities was primarily attributable to lower net proceeds borrowed under our revolving credit agreement, in the 2018 period and the purchase of an additional 10%20% ownership interest in Carrier Enterprise IIHomans for $42.7$32.4 million in 2017, partially offset byand an increase in dividends paid in 2018.

2019.

Revolving Credit Agreement

We maintain an unsecured, $500.0 million 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. Effective February 5, 2018, we decreasedThe credit facility has a seasonal component from October 1 to March 31, during which the borrowing capacity under this revolvingmay be reduced to $400.0 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 from $600.0 million to $300.0 million. matures on December 5, 2023.
At SeptemberJune 30, 20182019 and December 31, 2017, $116.42018, $219.6 million and $21.8$135.2 million, respectively, were outstanding under the revolving credit agreement, respectively. The credit agreement matures on July 1, 2019 and accordingly, borrowings outstanding are classified as current liabilities in our condensed consolidated unaudited balance sheet at September 30, 2018. We believe that we will refinance the credit agreement at or prior to its maturity on similar terms and subject to similar conditions.

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 SeptemberJune 30, 2018.

2019.

Purchase of Additional Ownership Interest infrom Joint Venture

On February 13, 2017,

Effective May 31, 2019, we purchased an additional 10%20% ownership interest in Homans from Carrier Enterprise II for cash consideration of $42.7$32.4 million, which increased our controlling interestownership in Homans to 100%. Homans previously operated as a division of Carrier Enterprise II and subsequent to 80%. We used borrowings under our revolving credit agreement to finance this acquisition.

21the purchase operates as a stand-alone subsidiary of 25

the Company with 16 locations in the Northeastern U.S.

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Investment in Unconsolidated Entity

On June 21, 2017, Carrier Enterprise I acquired an approximately 35%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 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 June 30, 2019, the estimated purchase amount we would be contingently liable for was approximately $138.0 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 August 23, 2018,April 2, 2019, one of our wholly owned subsidiaries acquired Alert Labscertain assets and assumed certain liabilities of Dunphey & Associates Supply Co., Inc., a technology company baseddistributor of air conditioning and heating products operating from seven locations in Ontario, Canada forNew Jersey, New York and Connecticut. The purchase price was composed of cash consideration of $5.9$16.8 million and the issuance of 47,10350,952 shares of Common stock having a fair value of $8.2$7.5 million.

On August 1, 2019, Carrier Enterprise I acquired substantially all of the 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 $85.0 million less certain average revolving indebtedness. Consideration for the net purchase price consisted of $10.0 million in cash and 372,543 shares of Common stock having a fair value of $58.6 million. Carrier contributed cash of $17.0 million to Carrier Enterprise I in connection with the acquisition of PPI.
We continually evaluate potential acquisitions and/or joint ventures and investments in unconsolidated entities. We routinely hold discussions with a number of 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 $4.15$3.20 and $3.35$2.70 per share of both Common stock and Class B common stock during the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively. On OctoberJuly 1, 2018,2019, our Board of Directors declared a regular quarterly cash dividend of $1.45$1.60 per share of both Common and Class B common stock that was paid on OctoberJuly 31, 20182019 to shareholders of record as of October 15, 2018. On October 23, 2018, our Board of Directors approved an increase to the quarterly cash dividend per share of Common and Class B common stock to $1.60 per share from $1.45 per share, beginning with the dividend that will be paid in JanuaryJuly 16, 2019. Future dividends and/or changes in dividend rates will beare at the sole discretion of the Board of Directors and will depend upon such factors asincluding, but not limited to, cash flow generated by operations, profitability, financial condition, cash requirements, and future prospects and other factors deemed relevant by our Board of Directors.

At-the-Market Offering Program

In August 2017, we entered into a sales agreement with Robert W. Baird & Co. Inc., which enabled the Company to issue and sell shares of Common stock in one or more negotiated transactions that are deemed to be “at the market” offerings as defined in Rule 415 under the Securities Act of 1933, as amended (the “Securities Act”), for a maximum aggregate offering amount of up to $250.0 million (the “ATM Program”). The offer and sale of our Common stock pursuant to the ATM Program was registered under the Securities Act pursuant to our automatically effective shelf registration statement on FormS-3 (FileNo. 333-207831).

During the quarter and nine months ended September 30, 2017, we sold 35,000 shares of Common stock under the ATM Program for net proceeds of $5.4 million. Direct costs of $0.3 million incurred in connection with the offering were charged against the proceeds from the sale of Common stock and reflected as a reduction ofpaid-in capital. At September 30, 2017, $244.6 million remained available for sale under the Sales Agreement. As of December 31, 2017, we had completed the offering of shares under the ATM Program. The net proceeds were primarily used to repay outstanding debt and for general corporate purposes.

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. NoWe last repurchased shares were repurchased during the quarters ended September 30, 2018 or 2017.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 SeptemberJune 30, 2018,2019, there were 1,129,087 shares remaining authorized for repurchase under the program.

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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, 2017.

2018.
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”), Senior Vice President (“SVP”) and Chief Financial Officer (“CFO”), to allow for timely decisions regarding required disclosure and appropriate SEC filings.

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Our management, with the participation of our CEO, SVP 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, SVP and CFO concluded that our disclosure controls and procedures were effective, at a reasonable assurance level, at and as of such date.

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 SeptemberJune 30, 2018,2019, 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 Dunphey & Associates Supply Co., Inc. (“DASCO”), which represented approximately 1% of our total consolidated assets at June 30, 2019 and approximately 1% of our consolidated revenues for the six months ended June 30, 2019. From the acquisition date of April 2, 2019, the processes and systems of DASCO did not impact the internal controls over financial reporting for our other consolidated subsidiaries.

PART II. OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS

Information with respect to this item may be found in Note 12 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 SeptemberJune 30, 20182019 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, 2017.

232018.

ITEM 2.UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Recent Sales of 25

Unregistered Securities

On April 2, 2019, we issued 50,952 shares of unregistered Common stock in connection with an asset purchase agreement representing 30% of the purchase price to acquire certain assets and assume certain liabilities of Dunphey & Associates Supply Co. This issuance was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 3(a)(2) thereof.
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ITEM 6.

EXHIBITS

 31.1 # 
  31.1 #
Certification of Chief Executive Officer pursuant to Securities Exchange Act Rules13a- 15(e) and15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 31.2 # 
  31.2 #
Certification of Senior Vice President pursuant to Securities Exchange Act Rules13a-15(e) and15d-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 Rules13a- 15(e) and15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 32.1 + 
  32.1 +
Certification of Chief Executive Officer, Senior Vice President and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes- Oxley Act of 2002.
101.INS # XBRL Instance Document.
101.SCH # 
101.INS #
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 #
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.

#

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: NovemberAugust 8, 20182019
  
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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