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Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
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[X] Quarterly Report Pursuant To Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Quarterly Period Ended September 30, 2001
or
[ ] Transition Report Pursuant To Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Transition Period From
___ to ___
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Commission file number 1-5581
I.R.S. Employer Identification Number 59-0778222
WATSCO, INC.
(a Florida Corporation)
2665 South Bayshore Drive, Suite 901
Coconut Grove, Florida 33133
Telephone: (305) 714-4100
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 X NO _
--
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: 23,424,375 shares of the
Company's Common Stock ($.50 par value), excluding treasury shares of 3,199,250
and 3,234,943 shares of the Company's Class B Common Stock ($.50 par value),
excluding treasury shares of 48,263 were outstanding as of October 31, 2001.
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PART I. FINANCIAL INFORMATION
WATSCO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, 2001 and December 31, 2000
(In thousands, except per share data)
September 30, December 31,
2001 2000
------------- ------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 8,399 $ 4,781
Accounts receivable, net 173,719 163,770
Inventories 210,234 205,805
Other current assets 12,415 18,179
----------- ----------
Total current assets 404,767 392,535
Property and equipment, net 32,063 30,258
Intangible assets, net 125,621 128,656
Other assets 7,674 12,021
----------- ----------
$ 570,125 $ 563,470
=========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 548 $ 1,887
Accounts payable 88,234 86,108
Accrued liabilities 28,268 26,099
----------- ----------
Total current liabilities 117,050 114,094
----------- ----------
Long-term obligations:
Borrowings under revolving credit agreement 90,000 138,000
Long-term notes 30,000 -
Bank and other debt 2,521 2,878
----------- ----------
Total long-term obligations 122,521 140,878
----------- ----------
Deferred income taxes and other liabilities 8,101 4,334
----------- ----------
Shareholders' equity:
Common Stock, $.50 par value 13,309 13,217
Class B Common Stock, $.50 par value 1,642 1,579
Paid-in capital 208,214 204,871
Unearned compensation related to outstanding restricted stock (8,219) (6,031)
Accumulated other comprehensive income (loss), net of tax (2,652) 105
Retained earnings 143,799 122,348
Treasury stock, at cost (33,640) (31,925)
----------- ----------
Total shareholders' equity 322,453 304,164
----------- ----------
$ 570,125 $ 563,470
=========== ==========
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Quarter and Nine Months Ended September 30, 2001 and 2000
(In thousands, except per share data)
(Unaudited)
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
2001 2000 2001 2000
--------- --------- --------- -----------
Revenue $ 336,008 $ 361,723 $ 965,270 $1,020,520
Cost of sales 254,959 275,288 731,448 777,217
Cost of sales - restructuring 328 - 328 -
--------- --------- --------- ----------
Gross profit 80,721 86,435 233,494 243,303
Selling, general and administrative expenses 62,471 64,042 185,352 189,559
Restructuring costs 3,017 - 3,017 -
--------- --------- --------- ----------
Operating income 15,233 22,393 45,125 53,744
Interest expense, net 2,408 3,424 7,936 9,818
--------- --------- --------- ----------
Income before income taxes 12,825 18,969 37,189 43,926
Income taxes 4,745 7,056 13,759 16,340
--------- --------- --------- ----------
Net income $ 8,080 $ 11,913 $ 23,430 $ 27,586
========= ========= ========= ==========
Basic earnings per share $ 0.31 $ 0.45 $ 0.90 $ 1.03
--------- --------- --------- ----------
Diluted earnings per share $ 0.29 $ 0.43 $ 0.86 $ 0.99
--------- --------- --------- ----------
Weighted average shares and equivalent shares
used to calculate earnings per share:
Basic 25,971 26,426 25,958 26,707
========= ========= ========= ==========
Diluted 27,424 27,748 27,299 27,962
========= ======== ======== ==========
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, 2001 and 2000
(In thousands)
(Unaudited)
2001 2000
-------- --------
Cash flows from operating activities:
Net income $ 23,430 $ 27,586
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 9,147 9,129
Provision for doubtful accounts 3,631 2,649
Restructuring costs and other non-cash charges 5,915 -
Other, net 175 413
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable (14,407) (30,262)
Inventories (4,757) (22,228)
Accounts payable and accrued liabilities 3,106 20,069
Other, net 2,819 (1,594)
-------- --------
Net cash provided by operating activities 29,059 5,762
-------- --------
Cash flows from investing activities:
Business acquisitions, net of cash acquired - (3,065)
Capital expenditures (3,990) (5,858)
Proceeds from sale of property and equipment 1,281 -
-------- --------
Net cash used in investing activities (2,709) (8,923)
-------- --------
Cash flows from financing activities:
Net borrowings (repayments) under revolving credit agreement (48,000) 22,500
Proceeds from issuance of long-term notes 30,000 -
Net repayments of bank and other debt (1,696) (5,235)
Net proceeds from issuances of common stock 637 1,003
Common stock dividends (1,958) (2,055)
Repurchase of common stock (1,715) (12,642)
-------- --------
Net cash provided by (used in) financing activities (22,732) 3,571
-------- --------
Net increase in cash and cash equivalents 3,618 410
Cash and cash equivalents at beginning of period 4,781 7,484
-------- --------
Cash and cash equivalents at end of period $ 8,399 $ 7,894
======== ========
See accompanying notes to condensed consolidated financial statements.
4 of 15
WATSCO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2001
(In thousands, except share data)
(Unaudited)
1. The condensed consolidated balance sheet as of December 31, 2000, which has
been derived from the Company's audited financial statements, and the
unaudited interim condensed consolidated 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 accounting principles
generally accepted in the United States have been condensed or omitted
pursuant to those rules and regulations, although the Company believes the
disclosures made are adequate to make the information presented not
misleading. In the opinion of management, all adjustments necessary for a
fair presentation have been included in the condensed consolidated financial
statements herein.
2. The results of operations for the quarter and nine months ended September 30,
2001, are not necessarily indicative of the results for the year ending
December 31, 2001. The sale of the Company's products and services is
seasonal with revenue generally increasing during the months of May through
August.
3. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States 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 financial statements and the reported amounts of revenue and expenses
during the reporting period. Actual results could differ from those
estimates.
4. Basic earnings per share is computed by dividing net income by the total
weighted average shares outstanding. Diluted earnings per share additionally
assumes, if dilutive, any added dilution from common stock equivalents.
Shares used to calculate earnings per share are as follows:
Quarter Ended Nine Months Ended
September 30, September 30,
---------------------- ----------------------
2001 2000 2001 2000
---------- ---------- ---------- ----------
Weighted average shares outstanding 25,970,994 26,425,616 25,957,645 26,707,331
Dilutive stock options and restricted shares of
common stock 1,452,608 1,322,073 1,341,108 1,254,773
---------- ---------- ---------- ----------
Shares for diluted earnings per share 27,423,602 27,747,689 27,298,753 27,962,104
========== ========== ========== ==========
Stock options and restricted shares of common
stock outstanding which are not included in
the calculation of diluted earnings per
share because their impact is antidilutive 2,552,086 2,848,998 2,715,137 2,867,301
========== ========== ========== ==========
5. The Company enters into interest rate swap agreements to reduce its exposure
to market risks from changing interest rates. Under the swap agreements, the
Company agrees to exchange, at specified intervals, the difference between
fixed and variable interest amounts calculated by reference to a notional
principal amount. Any differences paid or received on interest rate swap
agreements are recognized as adjustments to interest expense over the life of
each swap, thereby adjusting the effective interest rate on the underlying
obligation. The Company does not hold or issue such financial instruments for
trading purposes. Derivatives used for hedging purposes must be designated
as, and effective as, a hedge of the identified risk exposure at the
inception of the contract. Accordingly, changes in the fair value of the
derivative contract must be highly correlated with changes in the fair value
of the underlying hedged item at inception of the hedge and over the life of
the hedge contract.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which established accounting and
5 of 15
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required
to be recorded on the balance sheet at fair value. If the derivative is
designated as a fair value hedge, the changes in the fair value of the
derivative and of the hedged item attributable to the hedged risk are
recognized in earnings. If the derivative is designated as a cash flow hedge,
the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income ("OCI") and are recognized in the
income statement when the hedged items affect earnings. Ineffective portions
of changes in the fair value of cash flow hedges are recognized in earnings.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative pre-
tax reduction to OCI of $1,001 ($629 after-tax). The Company also recorded a
loss of $1,582, net of income tax benefit of $929, and a loss of $2,082, net
of income tax benefit of $1,223, in OCI relating to the change in value of
the cash flow hedges for the quarter and nine months ended September 30,
2001, respectively.
During the nine months ended September 30, 2001, the Company reclassified
$666 from accumulated other comprehensive income to current period earnings
(recorded as interest expense, net in the condensed consolidated statement of
income). The net deferred loss recorded in accumulated other comprehensive
income will be reclassified to earnings on a quarterly basis as interest
payments occur. As of September 30, 2001, approximately $2,100 in deferred
losses on derivative instruments accumulated in other comprehensive income is
expected to be reclassified to earnings during the next twelve months using a
current three month LIBOR-based average receive rate (2.69% at September 30,
2001).
6. Comprehensive income consists of net income, changes in the value of
available-for-sale securities and derivative instruments and the cumulative
change in accounting principles as further discussed in Note 5 to the
condensed consolidated financial statements at September 30, 2001. The
components of the Company's comprehensive income are as follows for the
quarter and nine months ended September 30, 2001 and 2000:
Quarter Ended Nine Months Ended
September 30, September 30,
--------------------- ------------------
2001 2000 2001 2000
-------- -------- ------- ---------
Net income $ 8,080 $11,913 $23,430 $27,586
Unrealized holding losses on investments
arising during the period, net of income
tax benefit of $25, $150, $27 and
$258, respectively (43) (253) (46) (436)
Cumulative effect of accounting change, net of
income tax benefit of $372 - - (629) -
Loss on derivative instruments, net of
income tax benefit of $929 and
$1,223, respectively (1,582) - (2,082) -
------- ------- ------- -------
Comprehensive income $ 6,455 $11,660 $20,673 $27,150
======= ======= ======= =======
7. In December 2000, the Company's Board of Directors approved plans adopted by
certain operating units of the Company to improve operating efficiency and
profitability (the "2000 Plan"). Those initiatives eliminate certain
underperforming locations, reduce market overlap, dispose of inventory
related to discontinued product lines and eliminate other nonproductive SKUs.
In connection with these restructuring activities, 25 locations closed during
2000 and 7 locations closed during 2001.
In September 2001, the Company's Board of Directors approved plans to
integrate the operations of the Company's manufactured housing subsidiaries,
close locations in the manufactured housing and personnel staffing operations
and exit certain relationships in the personnel staffing operation (the "2001
Plan"). In connection with these restructuring activities, 6 manufactured
housing locations will close in the first quarter of 2002 along with 7
personnel staffing locations already closed in 2001. The Company expects that
the restructuring activities will result in a simplified operating structure
that should enhance future profitability.
6 of 15
In connection with the 2001 Plan, the Company recorded restructuring charges
of $3,424 ($2,157 after-tax) during the third quarter of 2001 in accordance
with Emerging Issues Task Force ("EITF") Issue 94-3, "Liability Recognition
for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (Including Certain Costs Incurred in a Restructuring)," SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and SEC Staff Accounting Bulletin No. 100,
"Restructuring & Impairment Charges." The pre-tax charges are comprised of
$1,424 related to non-cancelable lease obligations, $1,314 related to the
write-down of assets impaired as a result of the restructuring activities,
$358 for facility exit costs and $328 related to the inventory valuation
reserve of discontinued product lines. The restructuring charges are
included as a separate line item within operating income in the condensed
consolidated statements of income, except for the inventory valuation
reserve of discontinued product lines, which is included in cost of sales.
Also in the third quarter of 2001, the Company recorded non-cash charges of
$1,085 for the write-off of an asset related to a supply arrangement in the
manufactured housing operation, $827 for additional accounts receivable
valuation reserves in the personnel staffing operation and $686 related to a
terminated licensee's workers compensation program in the personnel staffing
operation. Non-cash charges are included in selling, general and
administrative expenses, except for the charge related to the worker's
compensation program which is included in cost of sales.
The restructuring charges were determined based on formal plans approved by
the Company's Board of Directors using the best information available to it
at the time. The amounts the Company may ultimately incur may change, as the
balance of the Company's initiative to streamline operations is executed.
The Company reversed $79 related to a contractual lease commitment
associated with the 2000 Plan for a facility that the Company decided not to
close.
The following table summarizes the activity in restructuring liabilities or
valuation reserves during the nine months ended September 30, 2001 and
charges recorded in the third quarter of 2001.
Charges Charges
Balance at Utilized in Utilized in Balance at
December 31, 2001 for 2001 Plan 2001 for Change in September 30,
2000 2000 Plan Charges 2001 Plan Estimate 2001
- ----------------------------------------------------------------------------------------------------------------------
Discontinued product lines $3,484 $(2,404) $ 328 $ - $ - $1,408
Non-cancelable lease obligations 1,194 (981) 1,424 (24) (79) 1,534
Asset write-downs - - 1,314 (1,314) - -
Other 477 (411) 358 (29) - 395
- --------------------------------------------------------------------------------------------- ------------------------
Total $5,155 $(3,796) $3,424 $(1,367) $ (79) $3,337
======================================================================================================================
8. The Company's condensed consolidated financial statements include the
operations of Dunhill Staffing Systems Inc. ("Dunhill"), a personnel
staffing subsidiary. Summarized results for Dunhill are as follows:
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2001 2000 2001 2000
------- ------- ------- -------
Revenue $10,493 $16,445 $34,279 $50,414
======= ======= ======= =======
Operating income(loss) $(2,686) $ 737 $(2,415) $ 1,850
======= ======= ======= =======
Dunhill's total assets were $11,933 and $16,181 at September 30, 2001 and
December 31, 2000, respectively.
As previously discussed in Note 7 to the condensed consolidated financial
statements at September 30, 2001, the Company closed 7 locations and exited
certain relationships in Dunhill. In connection with these restructuring
activities the Company recorded restructuring charges of $1,131 ($713 after-
tax) for Dunhill. The pre-tax charges for Dunhill are comprised of $707
related to the write-down of assets impaired as a result of the
restructuring activities, $384 related to non-cancelable lease obligations
and $40 related to facility exit costs. The Company also recorded non-cash
charges in Dunhill of $827 for additional accounts receivable valuation
reserves and $686 for a terminated licensee's workers compensation program.
9. The Company's bank-syndicated credit agreement is scheduled to mature on
August 8, 2002. The Company has the ability and intent to refinance the
revolving credit agreement on a long-term basis. Accordingly, the short-term
borrowings under the agreement, which aggregated $90,000 at September 30,
2001, have been classified as long-term debt in the Company's condensed
consolidated balance sheet at September 30, 2001.
10. In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 141, "Business Combinations." SFAS No. 141 eliminates the pooling-of-
interest method of accounting for business combinations and modifies the
application of the purchase accounting method. The elimination of the
pooling-of-interest method is effective for transactions initiated after
June 30, 2001. The remaining provisions of SFAS No. 141 will be effective
for transactions accounted for using the purchase method that are completed
after June 30, 2001. The Company does not believe that the adoption of SFAS
No. 141 will have a significant impact on its consolidated financial
statements.
In July 2001, the FASB also issued SFAS No. 142 "Goodwill and Intangible
Assets." SFAS No. 142 eliminates the current requirement to amortize
goodwill and indefinite-lived intangible assets, addresses the amortization
of intangible assets with a defined life and addresses the impairment
testing and recognition for goodwill and
7 of 15
intangible assets. SFAS No. 142 will apply to goodwill and intangible assets
arising from transactions completed before and after the Statement's
effective date. SFAS No. 142 is effective for fiscal 2002. The Company will
stop recording approximately $4,000 of amortization expense related to
intangible assets in 2002. The Company is currently assessing the Statement
and has not yet made a determination of the impact that the adoption of SFAS
No. 142 will have on the consolidated financial statements.
In August 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." It applies to legal obligations associated with the
retirement of long-lived assets that result from the acquisition,
construction, development and (or) the normal operation of a long-lived
asset, except for certain obligations of lessees. SFAS No. 143 requires that
the fair value of a liability for an asset retirement obligation be
recognized in the period in which it is incurred if a reasonable estimate of
fair value can be made and subsequently allocated to expense using a
systematic and rational method. The associated asset retirement costs are
capitalized as part of the carrying amount of the long-lived asset and
subsequently allocated to expense over the asset's useful life. SFAS No. 143
is effective for financial statements issued for fiscal years beginning
after June 15, 2002. The Company does not belief that the adoption of SFAS
No. 143 will have a significant impact on its consolidated financial
statements.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment
or Disposal of Long-Lived Assets." SFAS No. 144 replaces SFAS No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of" and the accounting and reporting provisions of
Accounting Principles Board Opinion ("APB") No. 30, "Reporting the Results
of Operations - Unusual and Infrequently Occurring Events and Transactions."
SFAS No. 144 also amends Accounting Research Bulletin No. 51, "Consolidated
Financial Statements," to eliminate the exception to consolidation for a
subsidiary for which control is likely to be temporary. SFAS No. 144
establishes a single accounting model for assets to be disposed of by sale
whether previously held and used or newly acquired. SFAS No. 144 retains the
provisions of APB No. 30 for presentation of discontinued operations in the
income statement, but broadens the presentation to include a component of an
entity. SFAS No. 144 is effective for fiscal years beginning after December
15, 2001 and the interim period within. The Company does not believe that
the adoption of SFAS No. 144 will have a material impact on its consolidated
financial statements.
11. Certain reclassifications have been made to the 2000 balances to conform to
the 2001 presentation.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Results of Operations
The following table presents the Company's consolidated financial results for
the quarter and nine months ended September 30, 2001 and 2000, expressed as a
percent of revenue:
Quarter Nine Months
Ended September 30, Ended September 30,
--------------------- --------------------
2001 2000 2001 2000
----- ----- ----- -----
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales 75.9 76.1 75.8 76.2
Cost of sales - restructuring .1 - - -
----- ----- ----- -----
Gross profit 24.0 23.9 24.2 23.8
Selling, general and administrative expenses 18.6 17.7 19.2 18.5
Restructuring costs .9 - .3 -
----- ----- ----- -----
Operating income 4.5 6.2 4.7 5.3
Interest expense, net 0.7 0.9 0.8 1.0
Income taxes 1.4 2.0 1.5 1.6
----- ----- ----- -----
Net income 2.4% 3.3% 2.4% 2.7%
===== ===== ===== =====
Data presented in the following narratives referring to "same-store basis"
excludes the effects of operations acquired or locations opened and closed
during the prior twelve months.
QUARTER ENDED SEPTEMBER 30, 2001 VS. QUARTER ENDED SEPTEMBER 30, 2000
Revenue for the three months ended September 30, 2001 decreased $25.7 million,
or 7%, when compared to the same period in 2000. On a same-store basis, revenue
decreased $10.8 million, or 3% when compared to prior year in the Company's core
residential and light-commercial air conditioning, heating and refrigeration
("HVAC") business (such business operations comprised 90% of third quarter
revenue). Revenue results in the quarter were primarily impacted by the closure
of 35 locations, a 14% same-store sales decline in the manufactured housing
operations and lower sales demand in the personnel staffing operations as a
result of weaker industry conditions. For the quarter ended September 30, 2001,
manufactured housing and personnel staffing operations represented 7% and 3% of
revenue, respectively.
Gross profit for the three months ended September 30, 2001 decreased $5.7
million, or 7%, as compared to the same period in 2000, primarily as a result of
the aforementioned revenue decrease. Gross profit margin in the third quarter
increased to 24.0% in 2001 from 23.9% in 2000. The increase in gross profit
margin is primarily attributable to improved pricing disciplines and improved
vendor programs. Excluding restructuring charges, gross profit margin increased
20 basis-points to 24.1% from 23.9%. On a same-store basis in the Company's core
HVAC business, gross profit decreased $1.4 million or 2%, and gross profit
margin increased to 24.1% in 2001 from 23.7% in 2000.
Selling, general and administrative expenses for the three months ended
September 30, 2001 increased $1.4 million, or 2%, compared to the same period in
2000, primarily due to restructuring charges incurred in 2001, offset by the
cost savings attributable to the closure of 35 locations. Selling, general and
administrative expenses, excluding restructuring charges, as a percent of
revenue increased to 18.6% in 2001 from 17.7% in 2000. Such increase was
primarily due to operating inefficiencies resulting from lower than expected
sales volume during the quarter and additional non-cash charges incurred in the
manufactured housing and personnel staffing operations, as further discussed in
the MD&A section under the heading "Restructuring and Other Non-cash Charges."
On a same-store
9 of 15
basis in the Company's core HVAC business, selling, general and administrative
expenses decreased $.3 million, or 1%, and as a percent of revenue increased to
17.7% in 2001 from 17.2% in 2000.
Interest expense, net for the third quarter in 2001 decreased $1.0 million, or
30%, compared to the same period in 2000, primarily due to lower average
borrowings and lower interest rates during the quarter.
The effective tax rate for the three months ended September 30, 2001 declined
to 37.0% from 37.2% in 2000 following the implementation of certain tax planning
strategies.
NINE MONTHS ENDED SEPTEMBER 30, 2001 VS. NINE MONTHS ENDED SEPTEMBER 30, 2000
Revenue for the nine months ended September 30, 2001 decreased $55.3 million,
or 5%, when compared to the same period in 2000. On a same-store basis, revenue
decreased $7.7 million, or 1% when compared to prior year in the Company's core
HVAC business (such business operations comprised 89% of nine month revenue).
Revenue results for the nine month period were primarily impacted by the closure
of 35 locations, a 19% same-store sales decline in the manufactured housing
operations and lower sales demand in the personnel staffing operations as a
result of weaker industry conditions. For the nine months ended September 30,
2001, manufactured housing and personnel staffing operations represented 7% and
4% of revenue, respectively.
The Company's sales performance during 2001 compares favorably to industry
data compiled by the Air Conditioning and Refrigeration Institute ("ARI").
According to ARI, distributor shipments through September 2001 declined 5% in
the United States. In contrast, same-store sales in the Company's core HVAC
business decreased 1% during the same period, a strong indicator that market
share increases have been achieved.
Gross profit for the nine months ended September 30, 2001 decreased $9.8
million, or 4%, as compared to the same period in 2000, primarily as a result of
the aforementioned revenue decrease. Gross profit margin for the nine months
ended increased to 24.2% in 2001 from 23.8% in 2000. The increase in gross
profit margin is primarily attributable to improved pricing disciplines and
improved vendor programs. On a same-store basis in the Company's core HVAC
business, gross profit remained flat and gross profit margin increased to 24.0%
in 2001 from 23.8% in 2000.
Selling, general and administrative expenses for the nine months ended
September 30, 2001 decreased $1.2 million, or 1%, compared to the same period in
2000, primarily due to the cost savings attributable to the closure of 35
locations, offset in part by restructuring charges incurred in 2001. Selling,
general and administrative expenses, excluding restructuring charges, as a
percent of revenue increased to 19.2% in 2001 from 18.5% in 2000. Such increase
was primarily due to operating inefficiencies resulting from lower than expected
sales volume during the nine months and due to additional non-cash charges
incurred in the manufactured housing and personnel staffing operations, as
further discussed in the MD&A section under "Restructuring and Other Non-cash
Charges". On a same-store basis in the Company's core HVAC business, selling,
general and administrative expenses increased $1.7 million, or 1%, and as a
percent of revenue increased to 18.5% in 2001 from 18.2% in 2000.
Interest expense, net for the nine months ended September 30, 2001 decreased
$1.9 million, or 19%, compared to the same period in 2000, primarily due to
lower average borrowings and lower interest rates during the period.
The effective tax rate for the nine months ended September 30, 2001 declined
to 37.0% from 37.2% in 2000 following the implementation of certain tax planning
strategies.
Restructuring and Other Non-cash Charges
In December 2000, the Company's Board of Directors approved plans adopted by
certain operating units of the Company to improve operating efficiency and
profitability (the "2000 Plan"). Those initiatives eliminate certain
underperforming locations, reduce market overlap, dispose of inventory related
to discontinued product lines and eliminate other nonproductive SKUs. In
connection with these restructuring activities, 25 locations closed during 2000
and 7 locations closed during 2001. The Company believes that the remaining
restructuring liability and valuation reserves are adequate to complete all
other restructuring activities by December 31, 2001.
10 of 15
In September 2001, the Company's Board of Directors approved plans to
integrate the operations of the Company's manufactured housing subsidiaries,
close locations in the manufactured housing and personnel staffing operations
and exit certain relationships in its personnel staffing operation (the "2001
Plan"). In connection with these restructuring activities, 6 manufactured
housing locations will close in the first quarter of 2002 along with 7 personnel
staffing locations already closed in 2001. The Company expects that the
restructuring activities will result in a simplified operating structure that
should enhance future profitability.
In connection with the 2001 Plan, the Company recorded restructuring charges
of $3.4 million ($2.1 million after-tax) during the third quarter of 2001 ($0.08
per share on a diluted basis for the quarter and nine months ended September 30,
2001) in accordance with Emerging Issues Task Force ("EITF") Issue 94-3,
"Liability Recognition for Certain Employee Termination Benefits and Other Costs
to Exit an Activity (Including Certain Costs Incurred in a Restructuring)," SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of," and SEC Staff Accounting Bulletin No. 100,
"Restructuring & Impairment Charges." The pre-tax charges are comprised of $1.4
million related to non-cancelable lease obligations, $1.3 million related to the
write-down of assets impaired as a result of the restructuring activities, $.4
million for facility exit costs and $.3 million related to the inventory
valuation reserve of discontinued product lines. The restructuring charges are
included as a separate line item within operating income in the condensed
consolidated statements of income, except for the inventory valuation reserve of
discontinued product lines, which is included in cost of sales.
Also in the third quarter of 2001, the Company recorded non-cash charges of
$1.1 million for the write-off of an asset related to a supply arrangement in
the manufactured housing operation, $.8 million for additional accounts
receivable valuation reserves in the personnel staffing operation and
$.7 million related to a terminated licensee's workers compensation program in
the personnel staffing operation. Non-cash charges are included in selling,
general and administrative expenses, except for the charge related to the
worker's compensation program, which is included in cost of sales.
On an after-tax basis, restructuring and other non-cash charges were $3.8
million or $0.14 per share on a dilutive basis for the quarter and nine month
period ended September 30, 2001.
The restructuring charges were determined based on formal plans approved by
the Company using the best information available to it at the time. The amounts
the Company may ultimately incur may change, as the balance of the Company's
initiative to streamline operations is executed. The Company reversed $.1
million related to a contractual lease commitment associated with the 2000 Plan
for a facility that the Company decided not to close.
Liquidity and Capital Resources
The Company maintains a bank-syndicated revolving credit agreement that
provides for borrowings of up to $315.0 million, expiring on August 8, 2002.
Borrowings under the unsecured agreement are used to fund seasonal working
capital needs and for other general corporate purposes, including acquisitions.
Borrowings under the agreement, which aggregated $90.0 million at September 30,
2001, bear interest at primarily LIBOR-based rates plus a spread that is
dependent upon the Company's financial performance (LIBOR plus .6% at September
30, 2001). The Company has the ability and intent to refinance the revolving
credit agreement on a long-term basis. Accordingly, the short-term outstanding
borrowings under the agreement have been classified as long-term debt in the
consolidated balance sheet at September 30, 2001. The revolving credit
agreement contains customary affirmative and negative covenants including
certain financial covenants with respect to the Company's consolidated net
worth, interest and debt coverage ratios and limits capital expenditures and
dividends in addition to other restrictions. The Company was in compliance with
all covenants at September 30, 2001.
On January 31, 2000, the Company entered into a $125.0 million private
placement shelf facility. The uncommitted loan facility provides the Company a
source of long-term, fixed-rate financing as a complement to the variable rate
borrowings available under its existing revolving credit facility. On February
7, 2001, the Company issued $30.0 million Senior Series A Notes ("Notes")
bearing 7.07% interest under its private placement shelf facility. The Notes
have an average life of 5 years with repayment in equal installments of $10.0
million beginning on April 9, 2005 until the final maturity on April 9, 2007.
Interest is to be paid on a quarterly basis beginning on April 9, 2001. The
Company used the net proceeds from the issuance of the Notes for the repayment
of a portion of its outstanding indebtedness under its revolving credit
facility.
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The Company's Board of Directors has authorized the repurchase, at
management's discretion, of up to 6 million shares of the Company's 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. During the nine months ended September 30, 2001, the
Company purchased 152,000 shares at a cost of $1.7 million. Cumulatively under
the program, the Company has purchased approximately 3.2 million shares at a
cost of $33.6 million.
Working capital increased to $287.7 million at September 30, 2001 from $278.4
million at December 31, 2000 primarily due to the Company's seasonal build-up of
inventory and revenue yielding higher accounts receivable during the months of
May through August.
Cash and cash equivalents increased $3.6 million during the nine month period
ended September 30, 2001. Principal sources of cash were provided by cash flows
from operations. Year to date cash flows from operations were $29.1 million
versus $5.8 million in 2000. The principal uses of cash were for repayments
under the revolver credit agreement, capital expenditures, common stock dividend
payments and the Company's repurchase of its Common Stock.
The Company has adequate availability of capital from operations and its
borrowings to fund present operations and anticipated growth, including
expansion in its current and targeted market areas. The Company continually
evaluates potential acquisitions and has held discussions with a number of
acquisition candidates; however, the Company currently has no binding agreement
with respect to any acquisition candidates. Should suitable acquisition
opportunities or working capital needs arise that would require additional
financing, the Company believes that its financial position and earnings history
provide a solid base for obtaining additional financing resources at competitive
rates and terms.
Quantitative and Qualitative Disclosures about Market Risk
The Company's primary market risk exposure consists of interest rate risk. The
Company's objective in managing the exposure to interest rate changes is to
limit the impact of interest rate changes on earnings and cash flows and to
lower its overall borrowing costs. To achieve its objectives, the Company uses
interest rate swaps to manage net exposure to interest rate changes to its
borrowings. These swaps are entered into with a group of financial institutions
with investment grade credit ratings, thereby minimizing the risk of credit
loss. All items described below are non-trading.
At September 30, 2001, the Company had various interest rate swap agreements
with an aggregate notional amount of $60.0 million to manage its net exposure to
interest rate changes related to a portion of the borrowings under the revolving
credit agreement. The interest rate swap agreements effectively convert a
portion of the Company's LIBOR-based variable rate borrowings into fixed rate
borrowings with a weighted average pay rate of 6.4%.
Effective January 1, 2001 the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, which established accounting and
reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts and for hedging activities. All
derivatives, whether designated in hedging relationships or not, are required to
be recorded on the balance sheet at fair value. If the derivative is designated
as a fair value hedge, the changes in the fair value of the derivative and of
the hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions of
changes in the fair value of the derivative are recorded in other comprehensive
income ("OCI") and are recognized in the income statement when the hedged items
affect earnings. Ineffective portions of changes in the fair value of cash flow
hedges are recognized in earnings.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative pre-
tax reduction to OCI of $1.0 million ($.6 million after-tax). The Company also
recorded a loss of $1.6 million, net of income tax benefit of $.9 million, and a
loss of $2.1 million net of income tax benefit of $1.2 million, in OCI relating
to the change in value of the cash flow hedges for the quarter and nine months
ended September 30, 2001, respectively.
During the nine months ended September 30, 2001, the Company reclassified
$0.7 million from accumulated other comprehensive income to current period
earnings (recorded as interest expense, net in the condensed consolidated
statement of income). The net deferred loss recorded in accumulated other
comprehensive income will be reclassified to earnings on a quarterly basis as
interest payments occur. As of September 30, 2001, approximately $2.1 million in
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deferred losses on derivative instruments accumulated in other comprehensive
income is expected to be reclassified to earnings during the next twelve months
using a current three month LIBOR-based average receive rate (2.69% at September
30, 2001).
Safe Harbor Statement
This quarterly report contains statements which, to the extent they are not
historical fact, constitute "forward looking statements" under the securities
laws, including statements regarding acquisitions, financing agreements and
industry, demographic and other trends affecting the Company. All forward
looking statements involve risks, uncertainties and other factors that may cause
the actual results, performance or achievements of the Company to differ
materially from those contemplated or projected, forecasted, estimated,
budgeted, expressed or implied by or in such forward looking statements. The
forward looking statements in this document are intended to be subject to the
safe harbor protection provided under the securities laws.
The Company's shareholders should also be aware that while the Company does,
at various times, communicate with securities analysts, it is against the
Company's policies to disclose to such analysts any material non-public
information or other confidential information. Accordingly, our shareholders
should not assume that the Company agrees with all statements or reports issued
by such analysts. To the extent statements or reports issued by analysts
contain projections, forecasts or opinions by such analysts about our Company,
such reports are not the responsibility of the Company.
For additional information identifying some other important factors which may
affect the Company's operations and markets and could cause actual results to
vary materially from those anticipated in the forward looking statements, see
the Company's Securities and Exchange Commission filings, including but not
limited to, the discussion included in the Business section of the Company's
Form 10-K under the heading "Business Risk Factors".
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no significant changes from the information reported in
the Annual Report on Form 10-K for the period ended December 31, 2000.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
None
(b) Reports on Form 8-K
A report on Form 8-K dated October 30, 2001, disclosed in Item 5, Other
Events and Regulation FD Disclosure, that the Company issued a press
release regarding the Company's plan to integrate the operations of its
manufactured housing subsidiaries and close certain underperforming
locations in its manufacturing and personnel staffing operations.
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SIGNATURES
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)
By: /s/ Barry S. Logan
------------------------------
Barry S. Logan
Vice President and Secretary
(Chief Financial Officer)
November 14, 2001
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