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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 March 31, 2002
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: 23,474,218 shares of the
Company's Common Stock ($.50 par value), excluding treasury shares of 3,537,950
and 3,408,810 shares of the Company's Class B Common Stock ($.50 par value)
excluding treasury shares of 221,002 were outstanding as of April 18, 2002.
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PART I. FINANCIAL INFORMATION
WATSCO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, 2002 and December 31, 2001
(In thousands, except per share data)
March 31, December 31,
2002 2001
------------- ------------
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 6,311 $ 9,132
Accounts receivable, net 135,959 143,301
Inventories 193,712 185,943
Other current assets 26,411 18,823
-------- --------
Total current assets 362,393 357,199
Property and equipment, net 29,511 30,703
Intangible assets, net 125,403 124,737
Other assets 7,824 8,181
-------- --------
$525,131 $520,820
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 384 $ 429
Accounts payable 67,972 58,127
Accrued liabilities 21,459 28,985
-------- --------
Total current liabilities 89,815 87,541
-------- --------
Long-term obligations:
Borrowings under revolving credit agreement 70,000 70,000
Long-term notes 30,000 30,000
Bank and other debt 1,831 1,900
-------- --------
Total long-term obligations 101,831 101,900
-------- --------
Deferred income taxes and other liabilities 8,489 8,959
-------- --------
Shareholders' equity:
Common Stock, $.50 par value 13,495 13,391
Class B Common Stock, $.50 par value 1,816 1,661
Paid-in capital 215,915 210,859
Unearned compensation related to outstanding restricted stock (9,444) (9,772)
Accumulated other comprehensive loss, net of tax (1,575) (2,062)
Retained earnings 145,720 143,487
Treasury stock, at cost (40,931) (35,144)
-------- --------
Total shareholders' equity 324,996 322,420
-------- --------
$525,131 $520,820
======== ========
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended March 31, 2002 and 2001
(In thousands, except per share data)
(Unaudited)
2002 2001
--------- --------
Revenue $256,815 $278,113
Cost of sales 193,840 209,351
-------- --------
Gross profit 62,975 68,762
Selling, general and administrative expenses 56,344 62,103
-------- --------
Operating income 6,631 6,659
Interest expense, net 1,867 2,892
-------- --------
Income before income taxes 4,764 3,767
Income taxes 1,722 1,401
-------- --------
Net income $ 3,042 $ 2,366
======== ========
Earnings per share:
Basic $0.12 $0.09
----- -----
Diluted $0.11 $0.09
----- -----
Weighted average shares and equivalent shares
used to calculate earnings per share:
Basic 25,837 25,965
====== ======
Diluted 27,549 27,203
====== ======
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months Ended March 31, 2002 and 2001
(In thousands)
(Unaudited)
2002 2001
---------- ----------
Cash flows from operating activities:
Net income $3,042 $2,366
Adjustments to reconcile net income to net
cash provided by (used in) operating activities:
Depreciation and amortization 2,025 3,070
Tax benefit from exercise of stock options 2,165 69
Provision for doubtful accounts 1,613 1,169
Restructuring change in estimate (228) -
Other, net 85 (241)
Changes in operating assets and liabilities, net of
effects of acquisitions:
Accounts receivable 5,871 2,072
Inventories (7,711) (19,541)
Accounts payable and accrued liabilities 447 7,816
Other, net (7,223) (13,282)
------ ------
Net cash provided by (used in) operating activities 86 (16,502)
------ ------
Cash flows from investing activities:
Business acquisitions, net of cash acquired (687) -
Capital expenditures (679) (1,456)
Proceeds from sale of property and equipment 116 692
------ ------
Net cash used in investing activities (1,250) (764)
------ ------
Cash flows from financing activities:
Purchase of treasury stock (2,591) (1,013)
Common stock dividends (666) (654)
Net repayments of bank and other debt (114) (570)
Net proceeds from issuances of common stock 1,714 91
Proceeds from issuance of long-term notes - 30,000
Net repayments under revolving credit agreement - (11,500)
------ ------
Net cash provided by (used in) financing activities (1,657) 16,354
------ ------
Net decrease in cash and cash equivalents (2,821) (912)
Cash and cash equivalents at beginning of period 9,132 4,781
------ ------
Cash and cash equivalents at end of period $6,311 $3,869
====== ======
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
March 31, 2002
(Amounts in thousands, except share data)
(Unaudited)
1. The condensed consolidated balance sheet as of December 31, 2001, 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.
The Company has two reportable business segments - the distribution of air
conditioning, heating and refrigeration equipment and related parts and
supplies ("Distribution") segment and a national temporary staffing and
permanent placement services ("Staffing") segment.
2. The results of operations for the three months ended March 31, 2002, are
not necessarily indicative of the results for the year ending December 31,
2002. Sales of residential central air conditioners, heating equipment and
parts and supplies distributed by the Company have historically been
seasonal with revenue generally increasing during the months of May through
August. Demand related to the residential central air conditioning
replacement market is highest in the second and third quarters with demand
for heating equipment usually highest in the fourth quarter.
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. Significant estimates include
valuation reserves for accounts receivable and inventory, income taxes and
restructuring. Actual results could differ from those estimates.
4. Basic earnings per share is computed by dividing net income by the total of
the weighted average number of 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 for the three months ended March 31, 2002 and 2001:
2002 2001
----------- ----------
Weighted average shares outstanding 25,836,749 25,965,195
Dilutive stock options and restricted shares of
common stock 1,711,824 1,237,854
----------- ----------
Shares for diluted earnings per share 27,548,573 27,203,049
=========== ==========
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 1,917,175 3,020,001
=========== ==========
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
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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 requires that all derivatives,
whether designated in hedging relationships or not, 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 in January 2001 resulted in a cumulative
pre-tax reduction to OCI of $1,001 ($629 after tax). The Company recorded
a gain of $738 ($471 after-tax) and a loss of $1,427 ($896 after-tax) in
OCI relating to the change in value of the cash flow hedges for the three
months ended March 31, 2002 and 2001, respectively. At March 31, 2002 and
December 31, 2001, the fair value of derivatives held by the Company was a
liability of $2,647 and $3,424, respectively.
During the three months ended March 31, 2002 and 2001, the Company
reclassified $668 and $63, respectively from OCI to current period
earnings (recorded as interest expense, net in the condensed consolidated
statements of income). The net deferred loss recorded in accumulated OCI
will be reclassified to earnings as interest payments occur. As of March
31, 2002, approximately $1,700 in deferred losses on derivative
instruments accumulated in OCI are expected to be reclassified to earnings
during the next twelve months using a current three month LIBOR-based
average receive rate (3.09% at March 31, 2002). All open derivative
contracts mature by October 2007.
6. Comprehensive income consists of net income and 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 March 31, 2002 and 2001. The
components of the Company's comprehensive income are as follows for the
three months ended March 31, 2002 and 2001:
2002 2001
------ ------
Net income $3,042 $2,366
Gain (loss) on derivative instruments, net of
income tax (expense) benefit of $(267)
and $531, respectively 471 (896)
Unrealized holding gain (loss) on investments
arising during the period net of income
tax (expense) benefit of $(9)
and $9, respectively 16 (15)
Cumulative effect of accounting change,
net of income tax benefit of $372 - (629)
------ ------
Comprehensive income $3,529 $ 826
====== ======
7. In September 2001, the Company's Board of Directors approved plans to
integrate the operations of the Company's manufactured housing
subsidiaries, close certain under performing locations in the Distribution
and Staffing segments and exit certain licensee relationships in the
Staffing segment. In connection with the restructuring plan (the "Plan"),
the Company plans to close 6 Distribution locations during 2002 and closed
7 Staffing locations in 2001. The restructuring activities are expected to
be completed in 2002.
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The following table summarizes the activity in restructuring liabilities or
valuation reserve during the three months ended March 31, 2002.
Beginning Cash Change in Ending
Balance Payments Estimate Balance
- -----------------------------------------------------------------------------------------
Noncancelable lease obligations $1,091 $(338) $(228) $ 525
Discontinued product lines 328 - - 328
Other 294 (44) - 250
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$1,713 $(382) $(228) $1,103
- ------------------------------------------------------------------------------------------
Selling, general and administrative expenses in 2002 include a credit of
$228 related to a change in estimated lease buy-outs in the Distribution
segment. At March 31, 2002, a restructuring liability of $775 is included
in accrued liabilities and an inventory valuation reserve of $328 is netted
against inventories in the consolidated balance sheet.
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 initiatives to streamline operations are
executed. The Company expects that the restructuring activities will result
in a simplified operating structure that should enhance future
profitability.
8. On January 1, 2002, the Company adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 eliminates the
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
intangible assets. In lieu of amortizing goodwill, the Company is required
to perform an initial impairment review of goodwill in 2002 and an annual
impairment review thereafter. In accordance with SFAS No. 142, the Company
expects to complete this initial review by June 30, 2002. There can be no
assurance that at the time the review is completed a material impairment
charge will not be recorded. Any impairment charge resulting from the
initial impairment testing will be reflected as a cumulative effect of a
change in accounting principle.
Net income, basic and diluted earnings per share for the three months
ended March 31, 2001, adjusted to exclude amounts no longer being
amortized are as follows:
Three Months Ended
March 31,
---------------------
2002 2001
---- ----
Reported net income $3,042 $2,366
Adjustments:
Goodwill amortization expense - 883
Income taxes - (328)
Adjusted net income: $3,042 $2,921
Basic earnings per share:
Reported $0.12 $0.09
Adjusted $0.12 $0.11
Diluted earnings per share:
Reported $0.11 $0.09
Adjusted $0.11 $0.11
On January 1, 2002 the Company also adopted 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 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
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for assets to be disposed of by sale whether previously held and used or
newly acquired. There was no impact to the Company's operating results or
financial position related to the adoption of this standard.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 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 believe
that the adoption of SFAS No. 143 will have a significant impact on its
consolidated financial statements.
9. The Company has two reportable business segments - Distribution and
Staffing. The Distribution segment has similar products, customers,
marketing strategies and operations. The operating segments are managed
separately because each offers distinct products and services.
Segment data for the three months ended March 31, 2002 and 2001 is as
follows:
2002/(1)/ 2001
- ---------------------------------------------------------------------------------------------
Revenue:
Distribution $248,792 $266,164
Staffing 8,023 11,949
- ---------------------------------------------------------------------------------------------
$256,815 $278,113
=============================================================================================
Operating income (loss):
Distribution $9,270 $8,776
Staffing (288) 64
Corporate expenses (2,351) (2,181)
- ---------------------------------------------------------------------------------------------
$6,631 $6,659
=============================================================================================
/(1)/ As discussed in Note 8, effective January 1, 2002, the Company
adopted SFAS No. 142 which requires that intangible assets deemed to have
indefinite lives and goodwill no longer be subject to amortization.
Goodwill amortization expense recorded in segment operating income for the
three months ended March 31, 2001 is as follows: Distribution - $819 and
Staffing - $31. Excluding goodwill amortization expense, segment operating
income for the three months ended March 31, 2001, is as follows:
Distribution - $9,595 and Staffing - $95.
10. In January 2002, the Company completed the purchase of the net assets and
business of a wholesale distributor of air conditioning and heating
products. Consideration for the acquisition consisted of cash payments of
$687 and the issuance of 27,688 shares of Common Stock having a fair value
of $330. The acquisition was accounted for under the purchase method of
accounting and, accordingly, its results of operations have been included
in the unaudited condensed consolidated statements of income beginning on
the date of acquisition. This acquisition was not material to the Company's
operations.
The purchase price allocation for the acquisition is as follows:
Accounts receivable $ 142
Inventory 24
Other current assets 58
Property and equipment 121
Intangible assets 672
Fair value of common stock issued (330)
-------
Cash used in acquisition, net of cash acquired $ 687
======
11. In April 2002, the Company executed a bank-syndicated revolving credit
agreement which provides for borrowings of up to $225,000, expiring on
April 2005. The unsecured agreement replaced the Company's
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previous revolving credit agreement which was to expire on August 8, 2002.
The Company chose to reduce the total funding provided under the new
credit agreement because improved cash flows and a reduction in total debt
outstanding have made alternative sources of financing more readily
available to the Company. Borrowings under the new revolving credit
agreement bear interest at primarily LIBOR based rates plus a spread that
is dependent upon the Company's financial performance. The Company will
pay a variable commitment fee on the unused portion of the commitment. 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. No debt was outstanding under this agreement at March 31,
2002.
12. In May 2002, Baker Distributing Inc., a wholly-owned subsidiary of the
Company completed the purchase of the net assets and business of a
wholesale distributor of air conditioning and heating products that
operates from four locations in Mississippi. Consideration for the
acquisition consisted of cash payments of approximately $1,400.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 2002 VS. THREE MONTHS ENDED MARCH 31, 2001
RESULTS OF OPERATIONS
Watsco, Inc. and its subsidiaries (collectively, the "Company" or "Watsco")
is the largest independent distributor of air conditioning, heating and
refrigeration equipment and related parts and supplies ("HVAC") in the United
States. The Company has two business segments - the HVAC distribution
("Distribution") segment and a national temporary staffing and permanent
placement services ("Staffing") segment. Included in the Distribution segment
are operations that sell products specifically designed for the manufactured
housing market.
The following table sets forth, as a percentage of revenue, the Company's
condensed consolidated statement of income data for the three months ended March
31, 2002 and 2001.
2002 2001
---- ----
Revenue 100.0 % 100.0 %
Cost of sales 75.5 75.3
----- -----
Gross profit 24.5 24.7
Selling, general and administrative expenses 21.9 22.3
----- -----
Operating income 2.6 2.4
Interest expense, net 0.7 1.0
Income taxes 0.7 0.5
----- -----
Net income 1.2 % 0.9 %
===== =====
The following table sets forth revenue by business segment for the three
months ended March 31, 2002 and 2001.
2002 2001
- ----------------------------------------------------------------------
Distribution $248,792 97% $266,164 96%
Staffing 8,023 3% 11,949 4%
- ----------------------------------------------------------------------
Total revenue $256,815 100% $278,113 100%
======================================================================
The following narratives include the results of an operation acquired during
2002. See Note 10 to the condensed consolidated financial statements. The
acquisition was accounted for under the purchase method of accounting and,
accordingly, its results of operations have been included in the consolidated
results of the Company beginning on its date of acquisition. Data presented in
the following narratives referring to "same-store basis" exclude the effects of
operations acquired or locations opened and closed during the prior twelve
months.
Consolidated revenue for the three months ended March 31, 2002 decreased
$21.3 million, or 8%, compared to the same period in 2001. Revenue results were
primarily impacted by soft market conditions in the Distribution and Staffing
segments, the discontinuance of certain under performing product lines in the
Distribution segment and location closures. As described in Note 2 of the
Condensed Consolidated Financial Statements, the first quarter is the seasonal
low point of the year for the Distribution segment as it falls between the key
air conditioning and furnace selling seasons.
Distribution segment revenue for the three months ended March 31, 2002,
decreased $17.4 million, or 7%. On a same-store basis, revenue in the
Distribution segment decreased $15.0 million or 6%, including a $13.0 million or
5% same-store sales decline in residential and light-commercial HVAC products
and a 10% same-store sales decline in the manufactured housing operation. The
manufactured housing operation, which represented 8% of the Distribution
segment's revenue in 2002, continues to be affected by a tightened financing
market for home dealers and consumers.
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Staffing segment revenue for the three months ended March 31, 2002 decreased
$3.9 million or 33%, primarily attributable to lower sales demand due to the
economic softness experienced in the United States and the effect of 7 location
closures during 2001. On a same-store basis, revenue in 2002 decreased $2.4
million, or 23%, over 2001.
Consolidated gross profit for the three months ended March 31, 2002 decreased
$5.8 million, or 8%, as compared to the same period in 2001, primarily as a
result of the aforementioned revenue decrease. Gross profit margin for the three
months ended March 31, 2002 decreased to 24.5% in 2002 from 24.7% in 2001
primarily due to lower rebates and purchase discounts from vendor incentive
programs, reflecting decreased purchasing activity during the first quarter of
2002 when compared to the same quarter last year.
Consolidated selling, general and administrative expenses for the three
months ended March 31, 2002 decreased $5.8 million, or 9%, compared to the same
period in 2001, primarily due to the aforementioned revenue decrease and cost
savings attributable to the closure of under performing locations throughout
2000 and 2001. Excluding goodwill amortization expense in 2001, selling, general
and administrative expenses decreased $4.9 million or 8%. Selling, general and
administrative expenses as a percent of revenue decreased to 21.9% in 2002 from
22.3% in 2001, primarily due to the Company's continuing effort to reduce
expenses given lower business volume.
Interest expense, net for the three months ended March 31, 2002 decreased
approximately $1.0 million, or 35%, compared to the same period in 2001,
primarily due to improved cash flow and lower average borrowings during the
quarter.
The effective tax rate was 36.1% for the three months ended March 31, 2002
and 37.2% for the three months ended March 31, 2001 following the implementation
of tax planning strategies.
RESTRUCTURING ACTIVITIES
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 Distribution and Staffing segments and exit certain
licensee relationships in the Staffing segment. In connection with the
restructuring plan, the Company plans to close 6 Distribution locations during
2002 and closed 7 Staffing locations in 2001. During the three months ended
March 31, 2002, the Company incurred pre-tax cash outflows of $.4 million, which
were funded by cash generated from operations. During the first quarter of 2002,
the Company reversed restructuring charges of $.2 million (reflected in selling,
general and administrative expenses), due to a reduction in the number of lease
buy-outs. At March 31, 2002, a restructuring liability of $.8 million is
included in accrued liabilities and an inventory valuation reserve of $.3
million is netted against inventories in the unaudited condensed consolidated
balance sheet. The restructuring activities are expected to be completed in
2002.
CRITICAL ACCOUNTING POLICIES
The accounting policies below are critical to the Company's business
operations and the understanding of results of operations. The Company's
discussion and analysis of its financial condition and results of operations are
based upon the Company's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the
Company 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 consolidated financial statements and the reported amount of revenue
and expenses during the reporting period. The Company bases its estimates on
historical experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
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Revenue Recognition
The Company's revenue recognition policy is significant because revenue is
the key component of results of operations. The Company recognizes revenue in
accordance with Securities and Exchange Commission Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition in Financial Statements'", as amended by
SAB 101A and 101B. Revenue for the Company primarily consists of sales of air
conditioning, heating and refrigeration equipment and related parts and supplies
and service fee revenue from the Company's Staffing segment. SAB 101 requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred or
services have been rendered, (3) the amounts recognized are fixed and
determinable, and (4) collectibility is reasonably assured. The Company records
revenue after it receives a purchase commitment with a fixed determinable price
from the customer and shipment of products or delivery of services has occurred.
Allowance For Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. The
Company establishes and monitors the allowance for doubtful accounts based on
the credit risk of specific customers, customer concentrations, historical
trends and other information. Although the Company believes its allowance is
sufficient, if the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Concentrations of credit risk with
respect to accounts receivable are limited due to the large number of customers
comprising the Company's customer base and their dispersion across many
different geographical regions. Substantially all customer returns are under
warranty by the Company's manufacturers. Accordingly, the Company's risk of loss
for customer returns is not material.
Inventory Valuation
Inventories consist of air conditioning, heating and refrigeration equipment
and related parts and supplies and are stated at the lower of cost (first-in,
first-out method) or market. Provision is made as necessary to reduce excess or
obsolete inventories to their estimated net realizable value. The process for
evaluating the value of excess and obsolete inventory often requires the Company
to make subjective judgments and estimates concerning future sales levels,
quantities and prices at which such inventory will be able to be sold in the
normal course of business. Accelerating the disposal process or incorrect
estimates of future sales potential may cause the actual results to differ from
the estimates at the time such inventory is disposed or sold.
Income Taxes
The Company provides for federal and state income taxes currently payable, as
well as for those deferred because of temporary differences between reporting
income and expenses for financial statement purposes versus tax purposes.
Deferred tax assets and liabilities reflect the temporary differences between
the financial statement and income tax bases of assets and liabilities. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect of a change in tax rates is
recognized as income or expense in the period that includes the enactment date.
The Company and its eligible subsidiaries file a consolidated United States
federal income tax return. As the Company generally does not file its income tax
returns until well after the closing process for the December 31 financial
statements is complete, the amounts recorded at December 31 reflect estimates of
what the final amounts will be when the actual income tax returns are filed for
that calendar year. In addition, estimates are often required with respect to,
among other things, the appropriate state income tax rates to use in the various
states that the Company and its subsidiaries are required to file, the potential
utilization of operating loss carry-forwards for both federal and state income
tax purposes and valuation allowances required, if any, for tax assets that may
not be realizable in the future.
Restructuring
The Company records restructuring liabilities at the time the Board of
Directors approves and commits to a restructuring plan that identifies all
significant actions to be taken and the expected completion date of the plan is
within a reasonable period of time. The restructuring liability includes those
restructuring costs that can be reasonably estimated, are not associated with or
do not benefit activities that will be continued and are not associated with
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or are not incurred to generate revenue after the plan's commitment date.
Restructuring costs are incurred as a direct result of the plan and are
incremental to other costs incurred by the Company in the conduct of its
activities prior to the commitment date or existed prior to the commitment date
under a contractual obligation that will either continue after the exit plan is
completed with no economic benefit to the Company or reflect a penalty to cancel
a contractual obligation.
LIQUIDITY AND CAPITAL RESOURCES
Management assesses the Company's liquidity in terms of its ability to
generate cash to fund its operating and investing activities and takes into
consideration the seasonal demand of the Company's products, which peak in the
months of May through August. Significant factors affecting liquidity include
the adequacy of available bank lines of credit and the ability to attract
long-term capital with satisfactory terms, cash flows generated from operating
activities, capital expenditures, the timing and extent of common stock
repurchases and dividend policy.
Until April 2002, the Company maintained a bank-syndicated revolving credit
agreement that provided for borrowings of up to $315.0 million, expiring on
August 8, 2002. At March 31, 2002 and December 31, 2001, $70.0 million was
outstanding under this agreement. Borrowings under the unsecured agreement were
used to fund seasonal working capital needs and for other general corporate
purposes, including acquisitions. Borrowings under the agreement bear interest
at primarily LIBOR-based rates plus a spread that is dependent upon the
Company's financial performance (LIBOR plus .5% at March 31, 2002). 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 is in compliance with
all covenants at March 31, 2002.
In April 2002, the Company executed a bank-syndicated revolving credit
agreement which provides for borrowings of up to $225.0 million, expiring on
April 2005. The unsecured agreement replaced the Company's previous revolving
credit agreement which was to expire on August 8, 2002. The Company chose to
reduce the total funding provided under the new credit agreement because
improved cash flows and a reduction in total debt outstanding have made
alternative sources of financing more readily available to the Company.
Borrowings under the new revolving credit agreement bear interest at primarily
LIBOR based rates plus a spread that is dependent upon the Company's financial
performance. The Company will pay a variable commitment fee on the unused
portion of the commitment. 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. No debt was outstanding under this agreement at March 31, 2002.
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 paid on a quarterly basis. The Company used the net proceeds from
the issuance of the Notes for the repayment of a portion of its outstanding
indebtedness under its revolver credit facility.
The Company's Board of Directors has authorized the repurchase, at
management's discretion, of up to 6.0 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 quarter ended March 31, 2002, the Company
purchased approximately .2 million shares at a cost of approximately $2.6
million. In aggregate, the Company has repurchased 3.6 million shares at a cost
of $37.7 million.
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Working capital increased to $272.6 million at March 31, 2002 from $269.7
million at December 31, 2001, primarily due to the Company's seasonal build-up
of inventory in preparation for the spring and summer selling seasons. This
increase was primarily funded by the collection of accounts receivable and cash
on hand.
Cash and cash equivalents decreased $2.8 million during the first quarter of
2002. Principal sources of cash during the quarter were from profitable
operations. The principal uses of cash were to fund working capital needs,
repurchase common stock and acquire the assets of a business.
In May 2002, Baker Distributing Inc., a wholly-owned subsidiary of the
Company completed the purchase of the net assets and business of a wholesale
distributor of air conditioning and heating products that operates from four
locations in Mississippi. Consideration for the acquisition consisted of cash
payments of approximately $1.4 million.
The Company has adequate availability of capital from operations and its
existing and new revolving credit agreements and private placement shelf
facility 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 except as described above. 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 March 31, 2002, 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, "Accounting for Derivative Instruments
and Hedging Activities," which requires that all derivatives, whether designated
in hedging relationships or not, 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 in January 2001 resulted in a cumulative pre-tax
reduction to OCI of $1.0 million ($.6 million after-tax). The Company recorded a
gain of $.7 million ($.5 million after-tax) and a loss of $1.4 million ($.9
million after-tax) in OCI relating to the change in value of the cash flow
hedges for the three months ended March 31, 2002 and 2001, respectively. At
March 31, 2002 and December 31, 2001, the fair value of derivatives held by the
Company was a liability of $2.6 million and $3.4 million, respectively.
During the three months ended March 31, 2002 and 2001, the Company
reclassified $.7 million and $.1 million, respectively from OCI to current
period earnings (recorded as interest expense, net in the condensed consolidated
statements of income). The net deferred loss recorded in accumulated OCI will be
reclassified to earnings as interest payments occur. As of March 31, 2002,
approximately $1.7 million in deferred losses on derivative instruments
accumulated in OCI are expected to be reclassified to earnings during the next
twelve months using a current three month LIBOR-based average receive rate
(3.09% at March 31, 2002). All open derivative contracts mature by October 2007.
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NEW ACCOUNTING PRONOUNCEMENTS
On January 1, 2002 the Company adopted 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 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. There was no impact to the Company's operating results or financial
position related to the adoption of this standard.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 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 believe that the adoption of SFAS No. 143 will have a significant
impact on its consolidated financial statements.
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.
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
2001 Form 10-K under the heading "Business Risk Factors" and "General Risk
Factors".
15 of 15
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,
2001, filed on March 29, 2002.
Item 2. Changes in Securities and Use of Proceeds
As partial consideration for the acquisition completed during the
quarter ended March 31, 2002, the company issued 27,688 shares of
Common Stock that were not registered under the Securities Exchange
Act of 1933, as Amended (the "Act"). The shares were issued pursuant
to an exemption under Section 4(2) of the Act.
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
10.1 Revolving Credit Agreement dated as of April 19, 2002 among
Watsco, Inc., as borrower, the Lenders from Time to Time Party
Hereto and SunTrust Bank as administrative agent.
(b) Reports on Form 8-K
None
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)
May 14, 2002
Exhibit Index
Ex #10.1 Exhibit Description