Exhibit 13
WATSCO, INC. AND SUBSIDIARIES
SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended December 31,
(In thousands, except per share data) 2002(1) 2001(2) 2000(3) 1999 1998(4)
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OPERATIONS
Revenue $ 1,181,136 $ 1,238,646 $ 1,310,166 $ 1,249,550 $ 1,062,265
Gross profit 287,276 299,040 306,780 295,116 241,924
Operating income 50,924 48,324 45,815 59,439 54,066
Income from continuing operations 28,536 24,441 19,114 29,481 26,972
Income from continuing operations
adjusted for SFAS No. 142 28,536 26,726 21,382 31,533 28,617
============================================================================================================
SHARE DATA
Diluted earnings per share
from continuing operations $1.07 $0.90 $0.69 $0.99 $0.94
Diluted earnings per share
from continuing operations
adjusted for SFAS No. 142 1.07 0.98 0.77 1.06 1.00
Cash dividends declared per share:
Common Stock $0.115 $0.10 $0.10 $0.10 $0.10
Class B Common Stock 0.115 0.10 0.10 0.10 0.10
Weighted average shares outstanding
for diluted earnings per share 26,674 27,251 27,793 29,741 28,690
Common stock outstanding 26,032 26,745 26,497 27,907 28,032
============================================================================================================
BALANCE SHEET INFORMATION
Total assets $ 503,719 $ 520,820 $ 563,470 $ 588,180 $ 535,323
Long-term obligations 80,233 101,900 140,878 159,415 172,301
Shareholders' equity 329,201 322,420 304,164 301,716 274,568
============================================================================================================
(1) Effective January 1, 2002, goodwill is no longer being amortized in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets" as
more fully described in Notes 1 and 9 to the consolidated financial
statements.
(2) During 2001, the Company recorded restructuring and other non-cash
charges of $5,795 ($3,691 or $0.14 per share on an after-tax basis), as
more fully described in Note 8 to the consolidated financial statements.
(3) During 2000, the Company recorded restructuring and other non-cash
charges of $13,169 ($8,270 or $0.30 per share on an after-tax basis), as
more fully described in Note 8 to the consolidated financial statements.
(4) Excludes the results of the Company's manufacturing operation, which was
accounted for as a discontinued operation in 1998.
1
WATSCO, INC. AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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, which accounted for 97% of 2002 revenue and presently
operates from 276 locations in 31 states and a national temporary staffing and
permanent placement services ("Staffing") segment, which accounted for 3% of
2002 revenue.
The following table sets forth, as a percentage of revenue, the Company's
consolidated statement of income data for the years ended December 31, 2002,
2001 and 2000.
2002 2001 2000
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Revenue 100.0% 100.0% 100.0%
Cost of sales 75.7 75.9 76.3
Cost of sales - restructuring - - .3
- -----------------------------------------------------------------------------------
Gross profit 24.3 24.1 23.4
Selling, general and
administrative expenses 20.0 19.7 19.3
Goodwill amortization - .3 .3
Restructuring costs - .2 .3
- -----------------------------------------------------------------------------------
Operating income 4.3 3.9 3.5
Interest expense (.6) (.8) (1.0)
Investment write-down - - (.1)
Income taxes (1.3) (1.1) (.9)
- -----------------------------------------------------------------------------------
Net income 2.4% 2.0% 1.5%
===================================================================================
The following table sets forth revenue (in thousands) by business segment for
the years ended December 31, 2002, 2001 and 2000.
2002 2001 2000
- ----------------------------------------------------------------------------------------------
Distribution $ 1,147,561 97% $ 1,194,587 96% $ 1,243,208 95%
Staffing 33,575 3% 44,059 4% 66,958 5%
- ----------------------------------------------------------------------------------------------
Total revenue $ 1,181,136 100% $ 1,238,646 100% $ 1,310,166 100%
==============================================================================================
The following narratives include the results of operations acquired during 2002
and 2000. Acquisitions have been accounted for under the purchase method of
accounting and, accordingly, their results of operations have been included in
the consolidated results of the Company beginning on their respective dates 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.
MATTERS AFFECTING COMPARABILITY
The following matters affect the comparability of results between 2002, 2001 and
2000.
During 2001 and 2000, the Company implemented several initiatives to improve
operating efficiency and enhance profitability. As a result of these
initiatives, the Company closed certain under performing locations and reduced
market overlap, disposed of inventory related to discontinued product lines,
eliminated other unproductive SKUs, integrated operations of certain
subsidiaries and exited certain business relationships. The Company's
initiatives related to the 2001 and 2000 Restructuring Plans are complete as of
December 31, 2002. Refer to Note 8 to the consolidated financial statements and
in this section under "Restructuring and Non-cash Charges" for further
information.
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142
requires that goodwill and certain other intangible assets deemed to have
indefinite useful lives are no longer amortized but are reviewed annually for
impairment. SFAS No. 142 does not require retroactive restatement for
2
all periods presented; however, it does require the disclosure of prior year
effects adjusted for the elimination of amortization of goodwill and
indefinite-lived intangible assets. Had the provision of SFAS No. 142 been
applicable to the years ended December 31, 2001 and 2000, diluted earnings per
share would have been 98 cents and 77 cents, respectively. The initial
impairment review as of the transition date of January 1, 2002 was completed in
the second quarter of 2002 and resulted in no goodwill impairment charge. Also,
on January 1, 2003, the Company performed the required annual impairment test
and determined there was no impairment. Refer to Note 9 to the consolidated
financial statements for further information.
CONSOLIDATED COMPARISON OF YEAR ENDED DECEMBER 31, 2002 WITH YEAR ENDED DECEMBER
31, 2001
Revenue in 2002 decreased $57.5 million, or 5%, as compared to 2001.
Distribution segment revenue in 2002 decreased $47.0 million, or 4%, over 2001.
On a same-store basis, revenue in the Distribution segment decreased $44.5
million, or 4%, over 2001, including a $27.6 million or 2.5% same-store sales
decline in residential and light commercial HVAC products, as sales increases in
the Company's southeastern markets were offset by declines in other markets.
Sales results also include lower sales of commercial products and an 18% decline
in sales to the manufactured housing market. Sales to the manufactured housing
market, which represented 6% of the Distribution segment's revenue, continue to
be affected by a tightened financing market for home dealers and consumers.
Staffing segment revenue in 2002 decreased $10.5 million, or 24%, over 2001.
This decrease is primarily attributable to lower sales demand due to economic
softness in 2002 and the effect of seven location closures during 2001. On a
same-store basis, Staffing segment revenue in 2001 decreased $7.4 million, or
18%, over 2001.
Gross profit in 2002 decreased $11.8 million, or 4%, over 2001, primarily as a
result of the aforementioned revenue decrease offset by gross profit margin
improvement in the Distribution segment. Gross profit margin increased to 24.3%
in 2002 from 24.1% in 2001, primarily as a result of improved pricing
disciplines in the Distribution segment. On a same-store basis and excluding
restructuring charges incurred in 2002 and 2001, the Company's Distribution
segment gross profit decreased $10.2 million, or 4%.
Selling, general and administrative expenses in 2002 decreased $11.0 million, or
4%, over 2001, primarily due to the aforementioned revenue decrease and other
cost savings initiatives. Selling, general and administrative expenses,
excluding restructuring charges of $2.9 million and goodwill amortization of
$3.6 million in 2001, as a percent of revenue, increased from 19.7% to 20.0%.
Such increase was primarily due to operating inefficiencies resulting from lower
than expected sales volume to the Distribution segment's manufactured housing
market and in the Staffing segment. On a same-store basis and excluding
restructuring charges and goodwill amortization incurred in 2001, the Company's
Distribution segment selling, general and administrative expenses decreased $7.6
million or 3% and as a percent of revenue selling, general and administrative
expenses increased to 18.6% in 2002 from 18.5% in 2001.
Interest expense, net in 2002 decreased $2.8 million, or 28%, from 2001
primarily due to 35% lower average daily borrowings during the year and lower
interest rates.
The effective tax rate declined to 34.8% in 2002 from 36.3% in 2001. This
reflects the benefit of reversing $1.3 million in valuation reserves related to
state operating loss carryforwards and an internal reorganization of the
Company's subsidiary ownership structure that was more tax efficient than the
previous structure.
CONSOLIDATED COMPARISON OF YEAR ENDED DECEMBER 31, 2001 WITH YEAR ENDED DECEMBER
31, 2000
Revenue in 2001 decreased $71.5 million, or 5%, as compared to 2000. Revenue
results were primarily impacted by the closure of locations, the discontinuance
of certain under performing product lines in the Distribution segment and lower
sales demand in the Staffing segment.
Distribution segment revenue in 2001 decreased $48.6 million, or 4%, over 2000.
On a same-store basis, revenue in the Distribution segment decreased $29.2
million, or 2%, over 2000, including a $13.2 million or 1.2% same-store sales
decline in residential and light commercial HVAC products. The decrease in
revenue also includes the closure of 42 distribution locations, the
discontinuance of certain under performing product lines during 2001 and 2000
and an 18% decline in sales to the manufactured housing market, which
represented 9% of the Distribution segment's revenue in 2001.
3
Staffing segment revenue in 2001 decreased $22.9 million, or 34%, over 2000.
This decrease was primarily attributable to lower sales demand due to economic
softness experienced in the United States in 2001 and the effect of seven
location closures during 2001. On a same-store basis, revenue in 2001 decreased
$16.3 million, or 27%, over 2000.
Gross profit in 2001 decreased $7.7 million, or 3%, over 2000, primarily as a
result of the aforementioned revenue decrease offset by gross profit margin
improvement in the Distribution segment. Gross profit margin increased to 24.1%
in 2001 from 23.4% in 2000, primarily as a result of improved pricing
disciplines and improved vendor programs in the Distribution segment. Excluding
restructuring charges, gross profit margin increased to 24.1% in 2001 from 23.7%
in 2000. On a same-store basis and excluding restructuring charges incurred in
2001 and 2000, the Company's Distribution segment gross profit decreased $.5
million, or .2%.
Selling, general and administrative expenses in 2001 decreased $8.9 million, or
4%, over 2000, primarily due to the cost savings attributable to the closure of
42 locations in the Distribution segment and seven locations in the Staffing
segment. Selling, general and administrative expenses, excluding restructuring
charges of $2.9 million and $4.2 million, in 2001 and 2000, respectively, as a
percent of revenue increased to 20.0% in 2001 from 19.6% in 2000. Such increase
was primarily due to operating inefficiencies resulting from lower than expected
sales volume to the Distribution segment's manufactured housing market and in
the Staffing segment. On a same-store basis and excluding restructuring charges
incurred in 2001 and 2000, the Company's Distribution segment selling, general
and administrative expenses decreased $3.6 million or 2% and as a percent of
revenue selling, general and administrative expenses increased to 18.9% in 2001
from 18.7% in 2000.
A write-down of $2.2 million was recorded in 2000 for an impairment of an
investment in marketable securities of one of the Company's primary competitors.
Interest expense, net in 2001 decreased $3.3 million, or 25%, from 2000
primarily due to 20% lower average daily borrowings during the year and lower
interest rates.
The effective tax rate declined to 36.3% in 2001 from 37.2% in 2000 due to
various tax initiatives.
RESTRUCTURING AND NON-CASH CHARGES
During 2001 and 2000, the Company implemented several initiatives to improve
operating efficiency and enhance profitability. As a result of these
initiatives, the Company closed certain under performing locations and reduced
market overlap, disposed of inventory related to discontinued product lines,
eliminated other unproductive SKUs, integrated operations of certain
subsidiaries and exited certain business relationships. The Company's activities
related to the 2001 and 2000 Restructuring Plans discussed below are complete as
of December 31, 2002.
2001 Restructuring Plan
In September 2001, the Company's Board of Directors approved plans to integrate
the Distribution segment's manufactured housing subsidiaries, close six
distribution locations, close seven staffing locations and exit certain licensee
relationships in the Staffing segment (the "2001 Restructuring Plan"). During
the second quarter of 2002, based on a continued reassessment of the 2001
Restructuring Plan and activities, the Company determined that three of the six
distribution locations should remain open. In the Staffing segment, all seven
locations were closed and the licensee relationships were terminated in 2001.
In connection with the 2001 Restructuring Plan, the Company recorded
restructuring pre-tax charges of $3.4 million ($2.2 million after-tax or 8 cents
per share on a diluted basis) 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 Securities and Exchange Commission Staff Accounting
Bulletin ("SAB") 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 for an inventory valuation reserve for discontinued product lines.
The portion of the restructuring charge that relates to the valuation of
inventory to be disposed of has been classified in cost of sales in the
consolidated statement of income for the year ended December 31, 2001. During
the year ended December 31, 2001, the Company reversed restructuring charges of
$.2 million, primarily due to lease buy-outs settled at more favorable terms
than expected.
4
Also during 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 Distribution segment, $.8 million for additional accounts receivable
valuation reserves in the Staffing segment and $.7 million related to a
terminated licensee's workers compensation program in the Staffing segment.
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 in the consolidated statement of income for the year
ended December 31, 2001.
On an after-tax basis, restructuring and other non-cash charges were $3.7
million for the year ended December 31, 2001 (14 cents per share on a diluted
basis).
During the year ended December 31, 2002, the Company reversed restructuring
charges of $.5 million, primarily due to lease buy-outs settled at more
favorable terms than expected and incurred an additional $.2 million for
inventory valuation reserves for discontinued product lines.
2000 Restructuring Plan
In December 2000, the Company's Board of Directors approved plans adopted by
certain operating subsidiaries to close under performing locations, reduce
market overlap, dispose of inventory related to discontinued product lines and
eliminate other unproductive SKUs (the "2000 Restructuring Plan"). In connection
with the 2000 Restructuring Plan, 25 distribution locations closed during 2000
and 7 distribution locations closed during 2001.
The Company recorded restructuring charges of $8.5 million ($5.3 million
after-tax or 19 cents per share on a diluted basis) during the fourth quarter of
2000. A portion of the restructuring charge ($4.3 million on a pre-tax basis)
related to the valuation of inventory to be disposed of and is classified in
cost of sales in the Company's consolidated statement of income for the year
ended December 31, 2000.
Also during the fourth quarter of 2000, the Company recorded non-cash charges of
$.8 million related to additional inventory reserves in cost of sales, $1.7
million related to accounts receivable valuation reserves in selling, general
and administrative expenses and $2.2 million related to the write-down of an
impaired investment in one of the Company's primary competitors in other
expense. See Note 1 to the consolidated financial statements for additional
information regarding the Company's policy on accounting for investment
securities.
On an after-tax basis, restructuring and other non-cash charges were $8.3
million for the year ended December 31, 2000 (30 cents per share on a diluted
basis).
LIQUIDITY AND CAPITAL RESOURCES
Management assesses the Company's liquidity in terms of its ability to generate
cash to execute its business strategy, 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.
In April 2002, the Company executed a bank-syndicated, unsecured revolving
credit agreement that provides for borrowings of up to $225.0 million, expiring
in April 2005. The April 2002 agreement replaced the Company's previous
revolving credit agreement that would have expired on August 8, 2002. At
December 31, 2002 and 2001, $50.0 and $70.0 million, respectively were
outstanding under a then existing revolving credit agreement. Borrowings under
the revolving credit agreement are used to fund seasonal working capital needs
and for other general corporate purposes, including acquisitions. Borrowings
under the revolving credit agreement bear interest at primarily LIBOR-based
rates plus a spread that is dependent upon the Company's financial performance
(LIBOR plus 1.0% and .5% at December 31, 2002 and 2001, respectively). The
Company pays 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. The Company is in
compliance with such covenants at December 31, 2002.
The Company has a $125.0 million private placement shelf facility. In October
2002, the Company extended the maturity of the fscility to January 2006. 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
5
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 then existing
revolving credit facility.
At December 31, 2002, the Company had two interest rate swap agreements 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. The Company continuously monitors
developments in the capital markets and only enters into swap transactions with
established counterparties having investment grade ratings. See Note 11 to the
consolidated financial statements for further information and MD&A section
"Qualitative and Quantitative Disclosures about Market Risk."
At December 31, 2002, the Company is contingently liable under standby letters
of credit aggregating approximately $5.8 million that were primarily used as
collateral to cover any contingency related to additional risk assessments
pertaining to the self-insurance programs maintained by the Company. The Company
does not expect any material losses to result from the issuance of the standby
letters of credit because claims are not expected to exceed premiums paid.
Accordingly, the estimated fair value of these instruments is zero at December
31, 2002.
Working capital decreased to $259.1 million at December 31, 2002 from $269.7
million at December 31, 2001. This decrease was primarily due to reductions in
accounts receivable and inventory, partially offset by a reduction in accrued
liabilities. The accounts receivable decrease in 2002 correlates to the revenue
decrease in 2002 and the impact of improved collection efforts in the
Distribution segment. Accordingly, days sales in accounts receivable improved to
42 in 2002 from 44 in 2001. Inventory at December 31, 2002 decreased compared to
December 31, 2001 primarily due to lower inventory levels required from lower
sales levels in 2002 and the effect of the disposal of certain discontinued and
under performing product lines in connection with the Company's 2001 and 2000
Restructuring Plans. Inventory turns improved to 4.9 in 2002 from 4.8 in 2001.
Net cash provided by operating activities was $66.9 million in 2002 compared to
$52.6 million in 2001, an increase of $14.3 million, primarily due to the
aforementioned reductions in working capital. Net cash provided by operating
activities was $52.6 million in 2001 compared to $49.1 million in 2000, an
increase of $3.5 million, also due to reductions in working capital.
Net cash used in investing activities increased to $4.1 million in 2002 from
$3.3 million in 2001, primarily as a result of acquisitions during 2002, offset
by the proceeds received from the sale of property and equipment. Net cash used
in investing activities decreased to $3.3 million in 2001 from $10.1 million in
2000 primarily as a result of decreases in capital expenditures in 2001.
Net cash used in financing activities of $46.0 million in 2002 resulted
primarily from purchases of the Company's common stock, net repayments under the
revolving credit agreement and payments of common stock dividends, offset by
proceeds from the issuance of common stock. Net cash used in financing
activities of $44.9 million in 2001 resulted primarily from net repayments under
the revolving credit agreement and purchases of the Company's common stock,
offset by proceeds from the issuance of Notes under the private placement
facility.
The Company's Board of Directors authorized the repurchase, at management's
discretion, of up to 7.5 million shares of the Company's common stock in the
open market or via private transactions. Shares repurchased under the program
are accounted for using the cost method and result in a reduction of
shareholders' equity. The Company purchased 1.6 million shares at a cost of
$24.5 million in 2002, .3 million shares at a cost of $3.2 million in 2001 and
1.8 million shares at a cost of $17.6 million in 2000. In aggregate, the Company
has repurchased 5.0 million shares of Common Stock and Class B Common Stock at a
cost of $59.6 million.
Cash dividends of 11.5 cents and 10 cents per share were paid in 2002 and 2001,
respectively. In January 2003, the Company's Board of Directors approved an
increase in the quarterly cash dividend to 4 cents per share from 3 cents per
share. Future dividends will be at the sole discretion of the Board of Directors
and will depend upon such factors as the Company's profitability, financial
condition, cash requirements, future prospects and other factors deemed relevant
by the Company's Board of Directors.
The Company has adequate availability of capital from operations, its existing
revolving credit agreement 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. 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.
6
The following summarizes the Company's contractual obligations at December 31,
2002:
Payments due by Period (in millions)
----------------------------------------------------------------
Within 1 Year 2-3 Years 4-5 Years After 5 Years
------------- --------------- ------------- -------------
Non-cancelable operating lease obligations $ 24,769 $ 32,607 $ 14,442 $ 6,075
Long-term debt - 10,000 20,000 -
Minimum royalty payments - 2,000 2,000 4,000
Bank and other debt 272 233 - -
------------- --------------- ------------- -------------
Total $ 25,041 $ 44,840 $ 36,442 $ 10,075
============= =============== ============== =============
The Company also had standby letters of credit outstanding amounting to $5.8
million at December 31, 2002.
GENERAL CONSIDERATIONS
Sales of residential central air conditioners, heating equipment and parts and
supplies distributed by the Company have historically been seasonal.
Furthermore, the Company's results of operations can be impacted favorably or
unfavorably based on the severity or mildness of weather patterns during summer
or winter selling seasons. 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. Demand
related to the new construction sectors throughout most of the Sunbelt markets
is fairly even during the year except for dependence on housing completions and
related weather and economic conditions.
QUALITATIVE AND QUANTITATIVE 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 financial institutions with
investment grade credit ratings, thereby minimizing the risk of credit loss. All
items described are non-trading. See Notes 1 and 11 to the consolidated
financial statements for further information.
The Company has entered into interest rate swap agreements to reduce its
exposure to market risks from changing interest rates under its revolving credit
agreement. 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.
At December 31, 2002, the Company's two interest rate swaps aggregate a notional
value of $50.0 with a maturity of $20.0 million in 2003 and $30.0 million in
2007. An interest rate swap with a notional value of $10.0 million matured in
2002. The swap agreements exchange the variable rate of LIBOR plus the spread on
its revolving credit agreement to fixed interest rate payments ranging from
6.25% to 6.49%.
Effective January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," 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. All interest rate swaps are effective as cash
flow hedges and therefore there is no effect on current earnings from hedge
ineffectiveness.
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 has also
recorded a loss in OCI relating to the change in value of the cash flow hedges
of $1.3 million, net of income tax benefit of $.7 for the year ended December
31, 2002 and $1.5 million, net of income tax benefit of $.9 million for the year
ended December 31, 2001. The fair market values of the derivative financial
instruments are liabilities of $5.4 million and $3.4 million at December 31,
2002 and 2001, respectively, and are recorded in other liabilities in the
Company's consolidated balance sheets.
7
During the years ended December 31, 2002 and 2001, the Company reclassified $1.6
million, net of income tax benefit of $.9 million and $.8 million, net of income
tax benefit of $.4 million, respectively, from accumulated other comprehensive
income to current period earnings (recorded as interest expense, net in the
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 December 31, 2002, approximately $2.0 million
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 (1.36% at December
31, 2002).
The earnings and cash flows to be paid under the Company's revolving credit
agreement are sensitive to changes in LIBOR. The Company performed a sensitivity
analysis to determine the potential variability on earnings and cash flows based
on the Company's swap portfolio and variable rate debt through the respective
maturity dates of the swap portfolio. The average interest rates on the variable
rate debt and the average receive rate on the interest rate swaps were derived
from implied forward three-month LIBOR curves. The variability on earnings and
cash flows aggregated approximately $5.0 million over the remaining life of the
swap. This information constitutes a "forward-looking statement" and actual
results may differ significantly based on actual borrowings and interest rates.
CRITICAL ACCOUNTING POLICIES
Management's discussion and analysis of the Company's financial condition and
results of operations is 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 management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amount of revenue and expenses during the reporting period. Actual
results may differ from these estimates under different assumptions or
conditions. Management frequently reevaluates its judgments and estimates which
are based on historical experience, current trends and various other assumptions
that are believed to be reasonable under the circumstances.
The Company's significant accounting policies are discussed in Note 1 to the
Company's consolidated financial statements. Management believes that the
following accounting policies include a higher degree of judgment and/or
complexity and, thus, are considered to be critical accounting policies.
Management has discussed the development and selection of the Company's critical
accounting policies with the Audit Committee of the Board of Directors and the
Audit Committee has reviewed the Company's disclosures relating to them.
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's accounting for doubtful accounts contains uncertainty because
management must use judgment to assess the collectibility of these payments.
When preparing these estimates, management considers a numbers of factors,
including past transactions with customers, creditworthiness of specific
customers, historical trends and other information. The allowance for doubtful
accounts was $3.8 million and $6.3 million at December 31, 2002 and 2001,
respectively. 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.
Inventory Valuation
Inventories consist of air conditioning, heating and refrigeration equipment and
related parts and supplies and are valued at the lower of cost or market on a
first-in, first-out basis. As part of this valuation process, excess and
slow-moving inventories are reduced to estimated net realizable value. The
Company's accounting for excess and slow-moving inventory contains uncertainty
because management must use judgment to estimate when the inventory will be sold
and the quantities and prices at which the inventory will be sold in the normal
course of business. When preparing these estimates, management considers
historical results, inventory levels, current operating trends and sales
forecasts. These estimates can be affected by a number of factors, including
general economic conditions and other factors affecting demand for the Company's
inventory. In the event the Company's estimates differ from actual results, the
allowance for excess and slow-moving inventories may be adjusted.
8
Goodwill
Effective January 1, 2002 goodwill is no longer amortized and is subject to
impairment testing at least annually using a fair-value based approach. The
Company evaluates the recoverability of goodwill for impairment when events or
changes in circumstances indicate that the carrying amount of goodwill may not
be recoverable. The Company's accounting for impairment contains uncertainty
because management must use judgment in determining appropriate market value
multiples. The initial impairment review as of the transition date of January 1,
2002 was completed in the second quarter and resulted in no goodwill impairment
charge. Also, on January 1, 2003, the Company performed the required annual
impairment test and determined there was no impairment. See Note 1 and 9 to the
consolidated financial statements for further information. As previously
discussed, operating results of the Staffing segment have been negatively
impacted by economic softness experienced in the past two years. The carrying
amount of goodwill at December 31, 2002 for the Staffing segment was $4.0
million. In the event that the operating results of the Staffing segment do not
improve, a goodwill impairment charge may be necessary to the extent that the
implied fair value of goodwill is less than the carrying value.
Self-Insurance Reserves
The Company maintains self-insured retentions for its health benefits and
casualty insurance programs and limits its exposure by maintaining stop-loss and
aggregate liability coverages. The estimate of the Company's self-insurance
liability contains uncertainty since management must use judgment to estimate
the ultimate cost that will be incurred to settle reported claims and unreported
claims for incidents incurred but not reported as of the balance sheet date.
When estimating the Company's self-insurance liability, management considers a
number of factors, which include historical claim experience, demographic
factors, severity factors and valuations provided by independent third-party
actuaries. Management reviews its assumptions with its independent third party
actuaries to evaluate whether the self-insurance liability is adequate. If
actual claims exceed these estimates, additional reserves may be required.
Income Taxes
Income taxes are accounted for under the asset and liability method. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial reporting basis
and the tax basis of assets and liabilities at enacted tax rates expected to be
in effect when such amounts are recovered or settled. The use of estimates by
management is required to determine income tax expense, deferred tax assets and
any related valuation allowance and deferred tax liabilities. The Company has
recorded a valuation allowance of $.5 million as of December 31, 2002 due to
uncertainties related to the ability to utilize some of the deferred tax assets,
primarily consisting of federal net operating loss carryforwards of $.3 million,
which will expire in 2004, and state net operating loss carryforwards of $4.1
million, which will expire in varying amounts through 2017. The valuation
allowance is based on the Company's estimates of future taxable income by
jurisdiction in which the deferred tax assets will be recoverable. These
estimates can be affected by a number of factors, including possible tax audits
or general economic conditions or competitive pressures that could affect the
Company's future taxable income. If management's estimates of future taxable
income differ from actual taxable income, the deferred tax asset and any related
valuation allowance will need to be adjusted. Any adjustment to the deferred tax
asset and any related valuation allowance could materially impact the Company's
consolidated financial position and results of operations.
Although management believes that the estimates discussed above are reasonable
and the related calculations conform to generally accepted accounting
principles, actual results could differ from these estimates and such
differences could be material.
NEW ACCOUNTING PRONOUNCEMENTS
Effective January 1, 2002, the Company adopted 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 impairment testing and
recognition for goodwill and intangible assets. Pursuant to SFAS No. 142,
intangible assets must be periodically tested for impairment (see Note 9 to the
consolidated financial statements).
In June 2001, the Financial Accounting Standards Board ("FASB") 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
9
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.
Effective 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 ("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 of 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. The adoption of
SFAS No. 144 did not have a material impact on the Company's consolidated
financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146, requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 requires that the initial measurement of a
liability be at fair value. The Company plans to adopt SFAS No. 146 effective
January 1, 2003 and does not expect that the adoption will have a material
impact on its consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition to SFAS No. 123's fair value method of accounting for stock-based
employee compensation. SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to require
disclosures in the summary of significant accounting policies of the effects of
an entity's accounting policy with respect to stock-based employee compensation
on reported net income and earnings per share in annual and interim financial
statements. SFAS No. 148 does not amend SFAS No. 123 to require companies to
account for employee stock options using the fair value method. The Company
adopted the disclosure provisions required in SFAS No. 148 effective December
31, 2002 and has provided the necessary disclosure in Notes 1 and 6 to the
consolidated financial statements.
In January 2003, the FASB issued EITF Issue No. 02-16 ("02-16"), "Accounting by
a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor." EITF No. 02-16 addresses accounting and reporting issues related to how
a reseller should account for cash consideration received from vendors.
Generally, cash consideration received from vendors is presumed to be a
reduction of the prices of the vendor's products or services and should,
therefore, be characterized as a reduction of cost of sales when recognized in
the customer's income statement. However, under certain circumstances this
presumption may be overcome and recognition as revenue or as a reduction of
other costs in the income statement may be appropriate. EITF No. 02-16 also
addresses the accounting for a rebate or refund of a specified amount of cash
consideration that is payable if the customer completes a specified cumulative
level of purchases or remains a customer for a specified period. EITF No. 02-16
permits customers to recognize a rebate or refund of a specified amount of cash
consideration that is payable if the customer completes a specified cumulative
level of purchases or remains a customer for a specified period as a reduction
of cost of sales, if the customer can reasonably estimate the amount of the
rebate or refund on a systematic and rationale allocation. EITF No. 02-16 is
effective for fiscal periods beginning after December 15, 2002. The Company does
not expect that the adoption of EITF No. 02-16 will have a material effect on
the Company's consolidated financial position or results of operations.
SAFE HARBOR STATEMENT
This annual report contains statements which, to the extent they are not
historical fact, constitute "forward-looking statements" under the securities
laws. 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. 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 Commission filings, including but not limited to, the discussion
included in the Business section of the Company's Form 10-K under the headings
"General Risk Factors" and "Business Risk Factors".
10
WATSCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31,
(IN THOUSANDS, EXCEPT PER SHARE DATA) 2002 2001 2000
- -----------------------------------------------------------------------------------------------------
Revenue $ 1,181,136 $ 1,238,646 $ 1,310,166
Cost of sales 893,614 939,278 999,117
Cost of sales - restructuring 246 328 4,269
- -----------------------------------------------------------------------------------------------------
Gross profit 287,276 299,040 306,780
Selling, general and administrative expenses 236,891 247,847 256,753
Restructuring activities (539) 2,869 4,212
- -----------------------------------------------------------------------------------------------------
Operating income 50,924 48,324 45,815
- -----------------------------------------------------------------------------------------------------
Other expense:
Interest expense, net 7,190 9,955 13,211
Investment write-down - - 2,169
- -----------------------------------------------------------------------------------------------------
Total other expense 7,190 9,955 15,380
- -----------------------------------------------------------------------------------------------------
Income before income taxes 43,734 38,369 30,435
Income taxes 15,198 13,928 11,321
- -----------------------------------------------------------------------------------------------------
Net income $ 28,536 $ 24,441 $ 19,114
=====================================================================================================
Earnings per share:
Basic $ 1.12 $ 0.94 $ 0.72
Diluted $ 1.07 $ 0.90 $ 0.69
=====================================================================================================
Weighted average shares and equivalent shares used to calculate earnings per
share:
Basic 25,558 25,946 26,549
Diluted 26,674 27,251 27,793
=====================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
11
WATSCO, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
(IN THOUSANDS, EXCEPT SHARE DATA) 2002 2001
- ---------------------------------------------------------------------------------------------------------------
ASSETS
Current assets:
Cash and cash equivalents $ 25,880 $ 9,132
Accounts receivable, net 129,396 143,301
Inventories 176,407 185,943
Other current assets 13,878 18,823
- ---------------------------------------------------------------------------------------------------------------
Total current assets 345,561 357,199
- ---------------------------------------------------------------------------------------------------------------
Property and equipment, net 25,850 30,703
Goodwill, net 125,536 124,737
Other assets 6,772 8,181
- ---------------------------------------------------------------------------------------------------------------
$ 503,719 $ 520,820
===============================================================================================================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 272 $ 429
Accounts payable 59,965 58,127
Accrued liabilities 26,215 28,985
- ---------------------------------------------------------------------------------------------------------------
Total current liabilities 86,452 87,541
- ---------------------------------------------------------------------------------------------------------------
Long-term obligations:
Borrowings under revolving credit agreement 50,000 70,000
Long-term notes 30,000 30,000
Bank and other debt 233 1,900
- ---------------------------------------------------------------------------------------------------------------
Total long-term obligations 80,233 101,900
- ---------------------------------------------------------------------------------------------------------------
Deferred income taxes and other liabilities 7,833 8,959
- ---------------------------------------------------------------------------------------------------------------
Commitments and contingencies (Notes 11 and 12)
Shareholders' equity:
Common Stock, $0.50 par value,
60,000,000 shares authorized in 2002 and 2001
and 27,468,289 and 26,780,912 shares issued
in 2002 and 2001, respectively 13,734 13,391
Class B Common Stock, $0.50 par value, 10,000,000 shares authorized in 2002
and 2001 and 3,533,676 and 3,322,980 shares issued
in 2002 and 2001, respectively 1,767 1,661
Paid-in capital 216,124 210,859
Unearned compensation related to outstanding restricted stock (9,067) (9,772)
Accumulated other comprehensive loss, net of tax (3,399) (2,062)
Retained earnings 169,649 143,487
Treasury stock, at cost, 4,970,213 and 3,359,313 shares of common
stock in 2002 and 2001, respectively (59,607) (35,144)
- ---------------------------------------------------------------------------------------------------------------
Total shareholders' equity 329,201 322,420
- ---------------------------------------------------------------------------------------------------------------
$ 503,719 $ 520,820
===============================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
12
WATSCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Stock Accumulated
and Other
Class B Common Stock Paid-In Unearned Comprehensive Retained Treasury
(IN THOUSANDS, EXCEPT SHARE DATA) Shares Amount Capital Compensation Income (Loss) Earnings Stock Total
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1999 27,907,077 $ 14,627 $ 202,106 $ (5,998) $ (669) $ 105,971 $ (14,321) $ 301,716
Net income 19,114 19,114
Changes in value of investments,
net of income taxes 774 774
---------
Comprehensive income 19,888
---------
Contribution to 401(k) plan 85,906 43 947 990
Issuances from exercise of stock
options and employee stock purchase
plan 171,419 85 1,161 1,246
Tax benefit from exercise of stock
options 276 276
Issuances of restricted shares of
common stock 127,000 63 1,144 (1,207) -
Forfeitures of restricted shares of
common stock (45,000) (22) (763) 785 -
Amortization of unearned compensation 389 389
Common stock dividends, $0.10 per share (2,737) (2,737)
Purchase of treasury stock (1,749,313) (17,604) (17,604)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 26,497,089 14,796 204,871 (6,031) 105 122,348 (31,925) 304,164
Net income 24,441 24,441
Cumulative effect of accounting change
in derivatives, net of income taxes (629) (629)
Changes in value of investments and
derivatives, net of income taxes (1,538) (1,538)
----------
Comprehensive income 22,274
----------
Contribution to 401(k) plan 63,368 32 868 900
Issuances from exercise of stock
options and employee stock purchase
plan 102,749 51 789 840
Tax benefit from exercise of stock
options 167 167
Issuances of restricted shares of
common stock 375,173 188 4,642 (4,830) -
Forfeitures of restricted shares of
common stock (30,000) (15) (478) 493 -
Amortization of unearned compensation 596 596
Common stock dividends, $0.10 per share (3,302) (3,302)
Purchase of treasury stock (263,800) (3,219) (3,219)
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 26,744,579 15,052 210,859 (9,772) (2,062) 143,487 (35,144) 322,420
Net income 28,536 28,536
Changes in value of investments and
derivatives, net of income taxes (1,337) (1,337)
----------
Comprehensive income 27,199
----------
Retirement of common stock (482,680) (241) (7,897) (8,138)
Contribution to 401(k) plan 51,140 25 814 839
Issuances from exercise of stock
options and employee stock purchase
plan 1,297,806 649 6,770 7,419
Tax benefit from exercise of stock
options 5,153 5,153
Issuances of restricted shares of
common stock 14,560 7 235 (242) -
Forfeitures of restricted shares of
common stock (10,441) (5) (126) 131 -
Amortization of unearned compensation 816 816
Issuance for acquisition 27,688 14 316 330
Common stock dividends, $0.115 per
share (2,374) (2,374)
Purchase of treasury stock (1,610,900) (24,463) (24,463)
- -----------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 26,031,752 $ 15,501 $ 216,124 $ (9,067) $ (3,399) $ 169,649 $ (59,607) $ 329,201
====================================================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
13
WATSCO, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
(In thousands) 2002 2001 2000
- -------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 28,536 $ 24,441 $ 19,114
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 7,295 7,900 8,259
Amortization of goodwill - 3,587 3,612
Amortization of unearned compensation 816 596 389
Provision for doubtful accounts 5,317 6,319 5,386
Non-cash restructuring activities (293) 2,938 6,981
Investment write-down - - 2,169
Deferred income taxes 1,351 (1,838) 1,241
Non-cash stock contribution to 40l(k) plan 839 900 990
Tax benefit from exercise of stock options 5,153 167 276
Changes in operating assets and liabilities,
net of effects of acquisitions:
Accounts receivable 9,999 14,150 (2,362)
Inventories 10,211 19,534 12,970
Accounts payable and accrued liabilities (5,634) (25,830) (5,751)
Other, net 3,271 (291) (4,214)
- -------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 66,861 52,573 49,060
- -------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Capital expenditures (4,539) (4,624) (7,032)
Proceeds from sale of property and equipment 2,338 1,285 -
Business acquisitions, net of cash acquired (1,864) - (896)
Other, net - 35 (2,175)
- -------------------------------------------------------------------------------------------------------------
Net cash used in investing activities (4,065) (3,304) (10,103)
- -------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net repayments under revolving credit agreement (20,000) (68,000) (17,000)
Proceeds from issuance of long-term notes - 30,000 -
Net repayments of bank and other debt (1,824) (1,901) (5,565)
Net proceeds from issuances of common stock 4,031 840 1,246
Common stock dividends (3,017) (2,638) (2,737)
Payment of debt acquisition costs (775) - -
Purchase of treasury stock (24,463) (3,219) (17,604)
- -------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (46,048) (44,918) (41,660)
- -------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 16,748 4,351 (2,703)
Cash and cash equivalents at beginning of year 9,132 4,781 7,484
- -------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 25,880 $ 9,132 $ 4,781
=============================================================================================================
The accompanying notes to consolidated financial statements are an integral part
of these statements.
14
WATSCO, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(In thousands, except share data)
1. SIGNIFICANT ACCOUNTING POLICIES
Nature 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, which accounted for 97% of 2002 consolidated revenue
and presently operates from 276 locations in 31 states and a national temporary
staffing and permanent employment services ("Staffing") segment, which accounted
for 3% of 2002 consolidated revenue. Included in the Distribution segment are
operations that sell products for residential and commercial applications and
products specifically designed for the manufactured housing market.
Basis of Consolidation
The consolidated financial statements include the accounts of Watsco, its
wholly-owned subsidiaries and a majority-owned subsidiary. All significant
intercompany accounts and transactions have been eliminated.
Use of Estimates
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,
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Significant estimates include valuation reserves for accounts
receivable and inventory, income taxes, self-insurance and restructuring. Actual
results could differ from those estimates.
Revenue Recognition
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. The Company assesses collection
based on a number of factors, including past transactions and credit-worthiness
of customers, historical trends and other information. Substantially all
customer returns relate to products that are returned under warranty obligations
underwritten by the Company's manufacturers. Accordingly, the Company believes
that its risk of loss for customer returns is mitigated.
Cash and Cash Equivalents
The Company considers all highly liquid instruments purchased with an original
maturity of three months or less to be cash equivalents.
New Accounting Pronouncements
Effective January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("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 impairment testing and recognition for goodwill and
intangible assets. Pursuant to SFAS No. 142, intangible assets must be
periodically tested for impairment (see Note 9).
In June 2001, the Financial Accounting Standards Board ("FASB") 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.
Effective 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
15
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 of 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. The adoption of SFAS No. 144 did not have a
material impact on the Company's consolidated financial statements.
In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated
with Exit or Disposal Activities." SFAS No. 146 requires that a liability for a
cost associated with an exit or disposal activity be recognized when the
liability is incurred. SFAS No. 146 requires that the initial measurement of a
liability be at fair value. The Company plans to adopt SFAS No. 146 effective
January 1, 2003 and does not expect that the adoption will have a material
impact on its consolidated financial statements.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure." SFAS No. 148 amends SFAS No. 123,
"Accounting for Stock-Based Compensation," to provide alternative methods of
transition to SFAS No. 123's fair value method of accounting for stock-based
employee compensation. SFAS No. 148 also amends the disclosure provisions of
SFAS No. 123 and APB No. 28, "Interim Financial Reporting," to require
disclosures in the summary of significant accounting policies of the effects of
an entity's accounting policy with respect to stock-based employee compensation
on reported net income and earnings per share in annual and interim financial
statements. SFAS No. 148 does not amend SFAS No. 123 to require companies to
account for employee stock options using the fair value method. The Company
adopted the disclosure provisions required in SFAS No. 148 effective December
31, 2002. See Note 6 for a description of the Company's stock-based compensation
plans.
The Company applies the intrinsic value-based method of accounting prescribed by
APB No. 25, "Accounting for Stock Issued to Employees," and related
interpretations, in accounting for its fixed plan stock options. As such,
compensation expense would be recorded on the date of grant only if the current
market price of the underlying stock exceeded the exercise price. SFAS No. 123,
"Accounting for Stock-Based Compensation," established preferred accounting and
mandatory disclosure requirements using a fair value-based method of accounting
for stock-based employee compensation plans. As allowed by SFAS No. 123, the
Company has elected to continue to apply the intrinsic value-based method of
accounting described above and has adopted the disclosure requirements of SFAS
No. 123. Had compensation cost for the Company's stock-based compensation plans
been determined based on the fair value method at the grant dates for awards
under the stock option plans and purchases under the employee stock purchase
plan consistent with the method of SFAS No. 123, the Company's pro forma net
earnings and earnings per share would be as follows:
Years Ended December 31, 2002 2001 2000
- -------------------------------------------------------------------------------------
Net income, as reported $ 28,536 $ 24,441 $ 19,114
Deduct:
Stock-based compensation expense determined
under fair value based method, net of tax 2,766 4,187 4,261
Net income, pro forma $ 25,770 $ 20,254 $ 14,853
Basic earnings per share As reported $ 1.12 $0.94 $ 0.72
Pro forma $ 1.01 $0.78 $ 0.56
Diluted earnings per share As reported $ 1.07 $ 0.90 $ 0.69
Pro forma $ 0.97 $ 0.74 $ 0.53
The Company's pro forma information above is not representative of the pro forma
effect of the fair value provisions of SFAS No. 123 on the Company's net income
in future years because pro forma compensation expense related to grants made
prior to 1995 may not be taken into consideration.
The weighted-average fair value at date of grant for stock options granted
during 2002, 2001 and 2000 was $9.37, $8.16 and $6.56, respectively, and was
estimated using the Black-Scholes option valuation model with the following
weighted-average assumptions:
Years Ended December 31, 2002 2001 2000
- -------------------------------------------------------------------------------------
Expected life in years 6.5 7.2 7.7
Risk-free interest rate 3.8% 5.1% 5.1%
Expected volatility 59.4% 67.5% 71.5%
Dividend yield 0.7% 0.7% 0.8%
The Black-Scholes option valuation model was developed for use in estimating the
fair value of traded options, which have no vesting restrictions and are fully
transferable. In addition, option valuation models require the input of highly
subjective assumptions, including expected stock price volatility. The Company's
stock-based compensation arrangements have characteristics significantly
different from those of traded options, and changes in the subjective input
assumptions used in valuation models can materially affect the fair value
estimate. As a result, the existing models may not necessarily provide a
reliable single measure of the fair value of its stock-based compensation.
16
In January 2003, the FASB issued EITF Issue No. 02-16 ("02-16"), "Accounting by
a Customer (Including a Reseller) for Certain Consideration Received from a
Vendor." EITF No. 02-16 addresses accounting and reporting issues related to how
a reseller should account for cash consideration received from vendors.
Generally, cash consideration received from vendors is presumed to be a
reduction of the prices of the vendor's products or services and should,
therefore, be characterized as a reduction of cost of sales when recognized in
the customer's income statement. However, under certain circumstances this
presumption may be overcome and recognition as revenue or as a reduction of
other costs in the income statement may be appropriate. EITF No. 02-16 also
addresses the accounting for a rebate or refund of a specified amount of cash
consideration that is payable if the customer completes a specified cumulative
level of purchases or remains a customer for a specified period. EITF No. 02-16
permits customers to recognize a rebate or refund of a specified amount of cash
consideration that is payable if the customer completes a specified cumulative
level of purchases or remains a customer for a specified period as a reduction
of cost of sales, if the customer can reasonably estimate the amount of the
rebate or refund on a systematic and rationale allocation. EITF No. 02-16 is
effective for fiscal periods beginning after December 15, 2002. The Company does
not expect that the adoption of EITF No. 02-16 will have a material effect on
the Company's consolidated financial position or results of operations.
Inventories
Inventories consist of air conditioning, heating and refrigeration equipment and
related parts and supplies and are valued at the lower of cost or market on a
first-in, first-out basis. As part of this valuation process, excess and
slow-moving inventories are reduced to their estimated net realizable value.
Property and Equipment
Property and equipment are stated at cost. Depreciation and amortization of
property and equipment is computed using the straight-line method. Buildings and
improvements are being depreciated or amortized over estimated useful lives
ranging from 1-40 years. Leasehold improvements are amortized over the shorter
of the respective lease terms or useful lives. Estimated useful lives for other
depreciable assets range from 3-12 years. Included in property and equipment is
a corporate aircraft with an estimated useful life of 10 years. Depreciation and
amortization expense related to property and equipment amounted to $7,295,
$7,900 and $8,259 for the years ended December 31, 2002, 2001 and 2000,
respectively.
Recoverability of Long-Lived Assets
The Company evaluates the recoverability of long-lived asset when events or
circumstances indicate that the carrying amount of long-lived assets is not
recoverable. When events or circumstances indicate that the carrying amount of
long-lived assets is not recoverable, the Company determines whether the
amortization of the balance over its remaining life can be recovered through
undiscounted future operating cash flows. The amount of impairment, if any, is
measured based on projected discounted cash flows using a discount rate
reflecting the Company's average cost of funds. The assessment for the
recoverability of long-lived assets will be impacted if estimated future
operating cash flows are not achieved.
Goodwill
In accordance with SFAS No. 142, goodwill is no longer amortized but instead the
Company is required to perform an annual impairment test for goodwill for each
reporting unit or on an interim basis if the Company encounters events or
changes in circumstance that would indicate whether or not the book value of
goodwill has been impaired. If the fair value of the reporting unit is less than
its carrying value, an impairment loss is recorded to the extent that the
implied fair value of goodwill (as defined under SFAS No. 142) within the
reporting unit is less than its carrying value (see Note 9).
Investment Securities
Investments in marketable equity securities of $170 and $204 at December 31,
2002 and 2001, respectively, are included in other assets and are classified as
available-for-sale. The Company records the securities at fair value with
unrealized holding gains and losses, net of applicable income taxes, included as
a separate component of shareholders' equity. Dividend and interest income are
recognized when earned. The difference between cost and market was an unrealized
holding gain of $76 and $95 in 2002 and 2001, respectively, net of income tax
expense of $41 and $56 in 2002 and 2001, respectively. During the year ended
December 31, 2000, the Company recorded a $2,169 write-down related to the
permanent impairment of an investment in marketable securities. The marketable
securities were 75,166 shares in stock of a then publicly traded company. The
Company's original basis was $29.26 per share and had declined to 41 cents per
share at December 31, 2000. In accordance with SFAS No. 115, "Accounting for
Certain Investments in Equity Securities," the Company determined that the
investment had been permanently impaired based on the probability of recovering
the original investment, the financial condition and prospects of the entity and
other factors. In May 2001, all of the outstanding shares of the issuer's common
stock were sold following a merger at a tender offer price of 45 cents per
share.
Advertising Costs
Advertising costs are expensed as incurred. Advertising expense amounted to
$4,674, $4,305 and $4,833 for the years ended December 31, 2002, 2001 and 2000,
respectively.
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
17
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.
Earnings Per Share
Basic earnings per share is computed by dividing net income by 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:
Years Ended December 31, 2002 2001 2000
- ---------------------------------------------------------------------------------------------
Weighted average shares outstanding 25,557,653 25,946,110 26,549,211
Dilutive stock options and restricted
shares of common stock 1,116,112 1,304,941 1,243,821
- ---------------------------------------------------------------------------------------------
Shares for diluted earnings per share 26,673,765 27,251,051 27,793,032
=============================================================================================
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 1,504,607 1,994,350 2,886,251
=============================================================================================
Derivative Instruments
The Company adopted SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," which establishes 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. See Note 11 for further information regarding the Company's hedging
activities.
Comprehensive Income
Comprehensive income consists of net income and changes in the value of
available-for-sale securities and derivative instruments at December 31, 2002,
2001 and 2000. The changes in components of other comprehensive income for
available-for-sale and derivative instruments for the years ended December 31,
2002, 2001 and 2000, respectively, are as follows:
Years Ended December 31, 2002 2001 2000
- ----------------------------------------------------------------------------------------------------------------
Unrealized loss on derivative instruments, net of income tax
benefit of $700 and $894, in 2002 and 2001, respectively $ (1,315) $ (1,528) $ -
Cumulative effect of accounting change of derivative instruments,
net of income tax benefit of $372 - (629) -
Unrealized holding losses of available-for-sales securities
arising during the period, net of income tax benefit
of $12, $4 and $27, respectively (22) (11) (45)
Reclassification adjustment for losses realized from the
write-down of available-for-sale securities, net of income
tax of $1 and $480, respectively - 1 819
- ----------------------------------------------------------------------------------------------------------------
Changes in value of available-for-sale securities
and derivative instruments, net of income taxes $ (1,337) $ (2,167) $ 774
================================================================================================================
18
Shipping & Handling
In July 2000, the Emerging Issues Task Force ("EITF") issued 00-10, "Accounting
for Shipping and Handling Fees and Costs." EITF 00-10 became effective in the
fourth quarter of 2000. EITF 00-10 prohibits the netting of shipping and
handling costs against shipping and handling revenue. EITF 00-10 permits
companies to adopt a policy of including shipping and handling costs in cost of
sales or other income statement line items. Shipping and handling costs included
in selling, general and administrative expenses amounted to $5,214, $5,697 and
$6,438 for the years ended December 31, 2002, 2001 and 2000, respectively.
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 liabilities include 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 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. See Note 8 for further information regarding the
Company's restructuring programs.
Reclassifications
Certain reclassifications have been made to the 2001 and 2000 consolidated
financial statements to conform to the 2002 presentation.
2. SUPPLIER CONCENTRATION
The Company has distribution agreements with five key equipment suppliers.
Purchases from these five suppliers comprised 46%, 45% and 46% of all purchases
made in 2002, 2001 and 2000, respectively. The Company's largest supplier
accounted for 17%, 16% and 16% of all purchases made in 2002, 2001 and 2000,
respectively. Any significant interruption by the manufacturers or a termination
of a distribution agreement could disrupt the operations of certain
subsidiaries.
3. PROPERTY AND EQUIPMENT, NET
Property and equipment, net, consists of:
December 31, 2002 2001
- -----------------------------------------------------------------
Land, buildings and improvements $ 15,567 $ 17,616
Machinery, vehicles and equipment 31,396 31,624
Furniture and fixtures 19,805 19,482
Corporate aircraft 7,542 6,271
- -----------------------------------------------------------------
74,310 74,993
Less: accumulated depreciation
and amortization (48,460) (44,290)
- -----------------------------------------------------------------
$ 25,850 $ 30,703
=================================================================
4. LONG-TERM OBLIGATIONS
Revolving Credit Agreement
In April 2002, the Company executed a bank-syndicated, unsecured revolving
credit agreement which provides for borrowings of up to $225,000, expiring in
April 2005. The April 2002 agreement replaced the Company's previous revolving
credit agreement that would have expired on August 8, 2002. At December 31, 2002
and 2001, $50,000 and $70,000, respectively, were outstanding under a then
existing revolving credit agreement. Borrowings under the revolving credit
agreement are used to fund seasonal working capital needs and for other general
corporate purposes, including acquisitions. Borrowings under the revolving
credit agreement bear interest at primarily LIBOR-based rates plus a spread that
is dependent upon the Company's financial performance (LIBOR plus 1.0% and .5%
at December 31, 2002 and 2001, respectively). The Company pays 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. The Company is in compliance with
such covenants at December 31, 2002. See Note 11 for details related to interest
rate swap agreements designated as hedges.
19
Long-term Notes
The Company has a $125,000 private placement shelf facility. In October 2002,
the Company extended the maturity of the facility to January 2006. 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 agreement. On February 7, 2001, the Company issued
$30,000 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 $10,000 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 then existing revolving
credit facility.
Bank and Other Debt
Bank and other debt (net of current portion) of $233 and $1,900 at December 31,
2002 and 2001, respectively, primarily consists of promissory notes issued for
business acquisitions and capital leases on equipment. Interest rates on bank
and other debt range from 4% to 13% and mature at varying dates through 2005.
Annual maturities of bank and other debt for the years subsequent to December
31, 2002 are $272 in 2003, $226 in 2004 and $7 in 2005.
Total cash payments for interest were $7,165, $9,888 and $12,499 for the years
ended December 31, 2002, 2001 and 2000, respectively.
5. INCOME TAXES
The components of income tax expense (benefit) are as follows:
Years Ended December 31, 2002 2001 2000
- ---------------------------------------------------------------------------
Federal $ 15,420 $ 14,587 $ 11,087
State (222) (659) 234
- ---------------------------------------------------------------------------
$ 15,198 $ 13,928 $ 11,321
===========================================================================
Current $ 13,847 $ 15,766 $ 10,080
Deferred 1,351 (1,838) 1,241
- ---------------------------------------------------------------------------
$ 15,198 $ 13,928 $ 11,321
===========================================================================
Following is a reconciliation of the effective income tax rate:
Years Ended December 31, 2002 2001 2000
- ------------------------------------------------------------------------
Federal statutory rate 35.0% 35.0% 35.0%
Change in valuation allowance (2.8) - -
State income taxes, net of federal benefit 2.6 1.3 2.2
- ------------------------------------------------------------------------
34.8% 36.3% 37.2%
========================================================================
The following is a summary of the significant components of the Company's
deferred tax assets and liabilities:
December 31, 2002 2001
- -------------------------------------------------------------------------
Deferred tax assets:
Depreciation and amortization $ 327 $ (101)
Accounts receivable reserves 1,546 2,295
Capitalized inventory costs and inventory reserves 1,520 4,740
Unrealized loss on derivative instruments 2,006 1,243
Net operating loss carryforwards of subsidiaries 4,330 3,053
Other 1,268 363
- -------------------------------------------------------------------------
10,997 11,593
Less valuation allowance (505) (1,758)
- -------------------------------------------------------------------------
Total deferred tax assets 10,492 9,835
- -------------------------------------------------------------------------
Deferred tax liabilities:
Deductible goodwill (6,937) (4,886)
Other (905) (948)
- -------------------------------------------------------------------------
Total deferred tax liabilities (7,842) (5,834)
- -------------------------------------------------------------------------
Net deferred tax assets (1) $ 2,650 $ 4,001
=========================================================================
(1) Net deferred tax assets of $3,185 and $7,615 have been included in the
consolidated balance sheets in "Other current assets" at December 31, 2002
and 2001, respectively.
20
SFAS No. 109 requires a valuation allowance to reduce the deferred tax assets
reported if, based on the weight of the evidence, it is more likely than not
that some portion or all of the deferred tax assets will not be realized.
Management has determined that $505 of valuation allowance at December 31, 2002
is necessary to reduce the deferred tax assets to the amount that will more
likely than not be realized. The change in valuation allowance for the current
year of $1,253 is reflected as a reduction in the provision for income taxes
during 2002. At December 31, 2002, the Company had federal net operating loss
carryforwards of $696, which expire in the year 2004, and state net operating
loss carryforwards of $106,000, which expire in varying amounts from 2003
through 2017. These amounts are available to offset future taxable income.
Total cash payments for income taxes were $6,973, $13,280 and $11,247 for the
years ended December 31, 2002, 2001 and 2000, respectively.
6. STOCK BASED COMPENSATION AND BENEFIT PLANS
Stock Option Plans
In June 2001, the Company's shareholders approved the 2001 Incentive
Compensation Plan ("2001 Plan"). The 2001 Plan is administered by the
Compensation Committee (the "Committee") of the Board of Directors. The 2001
Plan provides for the award of a broad variety of stock-based compensation
alternatives such as non-qualified stock options, incentive stock options,
restricted stock, performance awards, dividend equivalents, deferred stock and
stock appreciation rights at no less than 100% of the market price on the date
the option is granted. Options under the 2001 Plan are for a term of ten years
and are exercisable as determined by the Committee. Under the 2001 Plan, awards
for an aggregate of 3,000,000 shares of Common Stock and Class B Common Stock
may be granted. Options as to 445,475 shares of Common Stock, net of
cancellations and 200,000 shares of Class B Common Stock have been granted
through December 31, 2002. There were 2,227,733 shares of common stock reserved
for future grants as of December 31, 2002 under the 2001 Plan.
The Company's 2001 Plan provides for acceleration of exercisability of the
options upon the occurrence of certain events relating to a change of control,
merger, sale of assets or liquidation of the Company. Additionally, the
Committee or Board of Directors may impose on any award or the exercise thereof,
at the date of grant or thereafter, such additional terms and conditions not
inconsistent with the provisions of the 2001 Plan, as the Committee or the Board
of Directors shall determine, including terms requiring forfeiture of awards in
the event of termination of employment by the participant and terms permitting a
participant to make elections relating to his or her award. The Committee or the
Board of Directors shall retain full power and discretion to accelerate, waive
or modify, at any time, any term or condition of an award that is not mandatory
under the 2001 Plan.
The Company also maintains the 1991 Stock Option Plan (the "1991 Plan"), which
expired during 2001; therefore, no additional options may be granted. Options as
to 3,075,638 of common stock are outstanding under the 1991 Plan at December 31,
2002. Options under the 1991 Plan are for a term of ten years and are
exercisable as determined by the Committee. During 2002, 4,446 shares of Common
Stock and 195,912 shares of Class B Common Stock with an aggregate market value
of $3,367 were delivered to the Company as payment for stock option exercises.
Under the 1991 Plan, the Committee may waive the vesting period and permit
options to be exercised immediately.
A summary of option activity is shown below:
2002 2001 2000
----------------------- ---------------------- ------------------------
Weighted- Weighted- Weighted-
Average Average Average
Exercise Exercise Exercise
Options Price Options Price Options Price
- ---------------------------------------------------------------------------------------------------------------
Outstanding on January 1, 5,003,809 $ 10.48 4,923,096 $ 10.78 4,157,833 $ 11.23
Granted 206,625 14.30 655,325 11.46 1,121,289 9.39
Exercised (1,243,533) 5.43 (69,301) 6.95 (91,275) 5.84
Forfeited (252,788) 14.12 (505,311) 15.11 (264,751) 13.75
- ---------------------------------------------------------------------------------------------------------------
Outstanding on December 31, 3,714,113 $ 12.13 5,003,809 $ 10.48 4,923,096 $ 10.78
===============================================================================================================
Options exercisable at end of year 2,682,088 $ 12.42 3,428,980 $ 10.07 3,158,851 $ 10.01
===============================================================================================================
21
The following sets forth certain information with respect to those stock options
outstanding on December 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------------- -----------------------------
Weighted- Weighted- Weighted-
Number Average Average Number Average
Outstanding at Exercise Remaining Exercisable at Exercise
December 31, 2002 Price Contractual Life December 31, 2002 Price
- ----------------------------------------------------------------------------------------------------------
$2.32 - $5.00 236,251 $ 3.93 1.0 236,251 $ 3.93
$5.01 - $10.00 899,800 8.34 6.2 575,600 8.23
$10.01-$15.00 1,366,575 12.46 7.3 761,575 12.84
$15.01-$20.00 1,206,237 16.72 4.8 1,103,712 16.09
$20.01-$23.17 5,250 21.08 4.5 4,950 20.96
- ----------------------------------------------------------------------------------------------------------
3,714,113 $ 12.13 5.8 2,682,088 $ 12.42
==========================================================================================================
Employee Stock Purchase Plan
Effective July 1, 1996, the Company adopted the Watsco, Inc. Qualified Employee
Stock Purchase Plan under which full-time employees with at least 90 days of
service may purchase up to an aggregate of 800,000 shares of the Company's
Common Stock. The plan allows participating employees to purchase, through
payroll deductions or lump-sum contribution, shares of the Company's Common
Stock at 85% of the fair market value at specified times subject to certain
restrictions. During 2002, 2001 and 2000 employees purchased 52,795, 31,681 and
77,822 shares of Common Stock at an average price of $12.39, $10.38 and $8.54
per share, respectively. Cash dividends received by the Employee Stock Purchase
Plan were reinvested in the Company's Common Stock and resulted in additional
shares issued in the amount of 1,478, 1,767 and 2,322 for the years ended
December 31, 2002, 2001 and 2000, respectively. At December 31, 2002, 189,733
shares remained available for purchase under the plan.
Restricted Stock
During 2002 and 2001, the Company granted 14,560 and 122,673 shares of
restricted common stock, respectively, under the 2001 Plan, which are subject to
certain restrictions. Prior to the adoption of the 2001 Plan, certain employees
were also granted an aggregate of 252,500 and 127,000 shares of restricted
common stock in 2001 and 2000, respectively. The restrictions lapse upon
attainment of retirement age or under other circumstances. During 2002, 2001 and
2000, 10,441, 30,000 and 45,000 shares, respectively, were forfeited. The
unearned compensation resulting from the grant of restricted shares is reported
as a reduction of shareholders' equity in the consolidated balance sheets and is
being amortized to earnings over the period from date of issuance to the
respective estimated retirement age of each employee. Total amortization expense
related to the restricted shares amounted to $816, $596 and $389 for the years
ended December 31, 2002, 2001 and 2000, respectively.
401(k) Plan
The Company has a profit sharing retirement plan for its employees that is
qualified under Section 401(k) of the Internal Revenue Code. The Company makes
an annual matching contribution based on a percentage of eligible employee
compensation deferrals. The contribution is made in cash or by the issuance of
the Company's Common Stock to the plan on behalf of its employees. For the years
ended December 31, 2002, 2001 and 2000, the Company's aggregate contribution to
the plan was $848, $909 and $998, respectively.
7. ACQUISITIONS
During 2002, the Company acquired two wholesale distributors of air conditioning
and heating products in Arizona and Mississippi for aggregate cash consideration
of $1,864 (net of cash acquired) and 27,688 shares of Common Stock having a fair
value of $330. These acquisitions were accounted for under the purchase method
of accounting and, accordingly, their results of operations have been included
in the consolidated statement of income beginning on the dates of acquisition.
During 2000, the Company completed the acquisition of a refrigeration equipment
distributor in Florida for cash consideration of $896.
The Company's reported revenue, net income and diluted earnings per share would
not be materially different if the above acquisitions had occurred on January 1,
2000.
8. RESTRUCTURING AND NON-CASH CHARGES
During 2001 and 2000, the Company implemented several initiatives to improve
operating efficiency and enhance profitability. As a result of these
initiatives, the Company closed certain under performing locations and reduced
market overlap, disposed of inventory related to discontinued product lines,
eliminated other unproductive SKUs, integrated operations of certain
subsidiaries and exited
22
certain business relationships. The Company's activities related to the 2001 and
2000 Restructuring Plans discussed below are complete as of December 31, 2002.
2001 Restructuring Plan
In September 2001, the Company's Board of Directors approved plans to integrate
the Distribution segment's manufactured housing subsidiaries, close six
distribution locations, close seven staffing locations and exit certain licensee
relationships in the Staffing segment (the "2001 Restructuring Plan"). During
the second quarter of 2002, based on a continued reassessment of the 2001
Restructuring Plan and activities, the Company determined that three of the six
distribution locations should remain open. In the Staffing segment, all seven
locations were closed and the licensee relationships were terminated in 2001.
In connection with the 2001 Restructuring Plan, the Company recorded
restructuring charges of $3,424 ($2,181 after-tax) during the third quarter of
2001 in accordance with 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 SAB No. 100, "Restructuring & Impairment Charges." The portion of the
restructuring charge that relates to the valuation of inventory to be disposed
of ($328 on a pre-tax basis) has been classified in cost of sales in the
Company's consolidated statement of income for the year ended December 31, 2001.
Also during 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
Distribution segment, $827 for additional accounts receivable valuation reserves
in the Staffing segment and $686 related to a terminated licensee's workers
compensation program in the Staffing segment. 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 in the
Company's consolidated statement of income for the year ended December 31, 2001.
On an after-tax basis, the restructuring and other non-cash charges were $3,691
for the year ended December 31, 2001.
2000 Restructuring Plan
In December 2000, the Company's Board of Directors approved plans adopted by
certain operating subsidiaries to close under performing locations, reduce
market overlap, dispose of inventory related to discontinued product lines and
eliminate other unproductive SKUs (the "2000 Restructuring Plan"). In connection
with the 2000 Restructuring Plan, 25 distribution locations closed during 2000
and 7 distribution locations closed during 2001.
The Company recorded restructuring charges of $8,481 ($5,326 after-tax) during
the fourth quarter of 2000. A portion of the restructuring charge ($4,269 on a
pre-tax basis) related to the valuation of inventory to be disposed of and is
classified in cost of sales in the Company's consolidated statement of income
for the year ended December 31, 2000.
Also during the fourth quarter of 2000, the Company recorded non-cash charges of
$788 related to additional inventory reserves in cost of sales, $1,731 related
to accounts receivable valuation reserves in selling, general and administrative
expenses and $2,169 related to the write-down of an impaired investment in one
of the Company's primary competitors in other expense. See Note 1 for additional
information regarding the Company's policy on accounting for investment
securities.
On an after-tax basis, restructuring and other non-cash charges were $8,270 for
the year ended December 31, 2000.
23
The following table summarizes the activity in restructuring liabilities or
valuation reserves during the years ended December 31, 2002, 2001 and 2000 for
the 2001 and 2000 Restructuring Plans:
Utilized
Balance Restructuring -------------------------- Change in Balance
January 1 Charges Cash Non-cash Estimate December 31
- ----------------------------------------------------------------------------------------------------------------------
2002 Activity:
Noncancelable lease obligations $ 1,091 $ - $ (605) $ - $ (486) $ -
Discontinued product lines 328 - - (574) 246 -
Other 294 - (241) - (53) -
- ----------------------------------------------------------------------------------------------------------------------
$ 1,713 $ - $ (846) $ (574) $ (293) $ -
- ----------------------------------------------------------------------------------------------------------------------
2001 Activity:
Discontinued product lines $ 3,484 $ 328 $ - $ (3,484) $ - $ 328
Noncancelable lease obligations 1,194 1,424 (1,224) - (303) 1,091
Other 409 358 (524) (25) 76 294
Asset write-down 68 1,314 - (1,382) - -
- ----------------------------------------------------------------------------------------------------------------------
$ 5,155 $ 3,424 $ (1,748) $ (4,891) $ (227) $ 1,713
- ----------------------------------------------------------------------------------------------------------------------
2000 Activity:
Discontinued product lines $ - $ 4,269 $ - $ (785) $ - $ 3,484
Noncancelable lease obligations - 1,541 (347) - - 1,194
Write-down of accounts receivable - 924 - (894) - 30
Employee severance and benefits - 326 (272) - - 54
Write-down of property and equipment - 185 - (147) - 38
Other - 1,236 (881) - - 355
- ----------------------------------------------------------------------------------------------------------------------
$ - $ 8,481 $ (1,500) $ (1,826) $ - $ 5,155
- ----------------------------------------------------------------------------------------------------------------------
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 Company's restructuring activities have resulted in a simplified
operating structure that should enhance future profitability.
9. GOODWILL & OTHER INTANGIBLE ASSETS
On January 1, 2002, the Company adopted the provisions of SFAS No. 142. 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. To apply the provisions of SFAS No. 142, the Company is
required to identify its reporting units. Based on an analysis of economic
characteristics and how the Company operates its business, the Company has
designated its business segments as its reporting units: Distribution and
Staffing. In accordance with the transition provisions of SFAS No. 142, the
Company was required to perform an initial impairment review of goodwill as of
the transition date of January 1, 2002. This test involved the use of estimates
to determine the fair value of the Company's reporting units with which goodwill
was associated and compared to the carrying value of the reporting unit. The
initial impairment review as of the transition date of January 1, 2002 was
completed in the second quarter of 2002 and resulted in no goodwill impairment
charge.
On January 1, 2003, the Company performed the required annual goodwill
impairment test and determined there was no impairment.
The Company evaluates the recoverability of goodwill for impairment when events
or changes in circumstances indicate that the carrying amount of goodwill may
not be recoverable. The Company's accounting for impairment contains uncertainty
because management must use judgment in determining appropriate market value
multiples. The operating results of the Staffing segment have been negatively
impacted by economic softness experienced in the past two years. In the event
that the operating results of the Staffing segment do not improve, a goodwill
impairment charge may be necessary to the extent that the implied fair value of
goodwill is less than the carrying value. There can be no assurance that
goodwill impairment will not occur in the future.
24
Net income and basic and diluted earnings per share, adjusted to exclude amounts
no longer being amortized are as follow:
Year Ended December 31, 2002 2001 2000
- -------------------------------------------------------------------------------
Reported net income $ 28,536 $ 24,441 $ 19,114
Adjustments:
Goodwill amortization expense - 3,587 3,612
Income tax effect - (1,302) (1,344)
Adjusted net income $ 28,536 $ 26,726 $ 21,382
Basic earnings per share:
Reported $ 1.12 $ 0.94 $ 0.72
Adjusted $ 1.12 $ 1.03 $ 0.81
Diluted earnings per share:
Reported $ 1.07 $ 0.90 $ 0.69
Adjusted $ 1.07 $ 0.98 $ 0.77
The changes in the carrying amount of goodwill for the year ended December 31,
2002 are as follow:
Distribution Staffing Total
- -------------------------------------------------------------------------------
Balance at December 31, 2001 $ 120,754 $ 3,983 $ 124,737
Goodwill acquired during the period 790 9 799
- -------------------------------------------------------------------------------
Balance at December 31, 2002 $ 121,544 $ 3,992 $ 125,536
===============================================================================
See Note 7 for additional information regarding acquisitions made in 2002.
10. SHAREHOLDERS' EQUITY
Common Stock and Class B Common Stock share equally in the earnings of the
Company and are identical in most other respects except (i) Common Stock has
limited voting rights, each share of Common Stock being entitled to one vote on
most matters and each share of Class B Common Stock being entitled to ten votes;
(ii) shareholders of Common Stock are entitled to elect 25% of the Board of
Directors (rounded up to the nearest whole number) and Class B shareholders are
entitled to elect the balance of the Board of Directors; (iii) cash dividends
may be paid on Common Stock without paying a cash dividend on Class B Common
Stock and no cash dividend may be paid on Class B Common Stock unless at least
an equal cash dividend is paid on Common Stock and (iv) Class B Common Stock is
convertible at any time into Common Stock on a one-for-one basis at the option
of the shareholder.
The Company's Board of Directors authorized the repurchase, at management's
discretion, of up to 7,500,000 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. The
Company purchased 1,610,900 shares at a cost of $24,463 in 2002, 263,800 shares
at a cost of $3,219 in 2001 and 1,749,313 shares at a cost of $17,604 in 2000.
In aggregate since the inception of the repurchase plan in 1999, the Company has
repurchased 4,970,213 shares of Common Stock and Class B Common Stock at a cost
of $59,607.
11. FINANCIAL INSTRUMENTS
Recorded Financial Instruments
The Company's recorded financial instruments consist of cash and cash
equivalents, accounts receivable, accounts payable, the current portion of
long-term obligations, borrowings under revolving credit agreement and debt
instruments included in other long-term obligations. At December 31, 2002 and
2001, the fair values of cash and cash equivalents, accounts receivable,
accounts payable and the current portion of long-term obligations approximated
their carrying values due to the short-term nature of these instruments.
The fair values of borrowings under the revolving credit agreement and debt
instruments included in long-term obligations also approximate their carrying
value based upon interest rates available to the Company for similar instruments
with consistent terms and remaining maturities.
Off-Balance Sheet Financial Instruments
The Company has entered into interest rate swap agreements to reduce its
exposure to market risks from changing interest rates under its revolving credit
agreement. 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
25
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.
At December 31, 2002 and 2001, the Company's interest rate swap portfolio
consisted of swaps aggregating a notional value of $50,000 and $60,000,
respectively and maturity dates ranging from 2003 to 2007. The swap agreements
exchange the variable rate of LIBOR plus the spread on its revolving credit
agreement to fixed interest rate payments ranging from 6.25% to 6.49% in 2002
and 2001. All interest rate swaps are effective as cash flow hedges and
therefore there is no effect on current earnings from hedge ineffectiveness.
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 in
OCI relating to the change in value of the cash flow hedges of $1,315, net of
income tax benefit of $700 for the year ended December 31, 2002 and $1,528, net
of income tax benefit of $894 for the year ended December 31, 2001. The fair
market values of the derivative financial instruments are liabilities of $5,438
and $3,424 at December 31, 2002 and 2001, respectively, and are recorded in
other liabilities in the Company's consolidated balance sheets.
During the years ended December 31, 2002 and 2001, the Company reclassified
$1,613, net of income tax benefit of $859 and $786, net of income tax benefit of
$448, respectively from accumulated other comprehensive income to current period
earnings (recorded in interest expense, net in the consolidated statements 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 December 31, 2002, approximately $2,007 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 (1.36% at December 31, 2002).
At December 31, 2002 and 2001, respectively, the Company is contingently liable
under standby letters of credit aggregating approximately $5,819 and $3,400,
respectively, that were primarily used as collateral to cover any contingency
related to additional risk assessments pertaining to the self-insurance programs
maintained by the Company. The Company does not expect any material losses to
result from the issuance of the standby letters of credit because claims are not
expected to exceed premiums paid. Accordingly, the estimated fair value of these
instruments is zero.
Concentrations of Credit Risk
Financial instruments, which potentially subject the Company to concentrations
of credit risk, consist principally of cash investments and accounts receivable.
The Company places its temporary cash investments with high credit quality
financial institutions and limits the amount of credit exposure to any one
financial institution or investment. 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. The Company establishes and monitors an
allowance for doubtful accounts based on past transactions with customers, the
credit worthiness of specific customers, historical trends and other
information. At December 31, 2002 and 2001, the allowance for doubtful accounts
was $3,758 and $6,321, respectively. 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.
12. COMMITMENTS AND CONTINGENCIES
Operating Leases
At December 31, 2002, the Company is obligated under non-cancelable operating
leases of real property and equipment used in its operations for minimum annual
rentals of $24,769 in 2003, $18,983 in 2004, $13,624 in 2005, $8,619 in 2006,
$5,823 in 2007 and $6,075 thereafter. Rental expense for the years ended
December 31, 2002, 2001 and 2000 was $27,490, $27,962 and $26,462, respectively.
Minimum Royalty Payments
At December 31, 2002, the Company is obligated under its licensing agreement
with Whirlpool Corporation to make minimum royalty payments of $1,000 each year
starting in 2004 and ending in 2011.
Litigation, Claims and Assessments
The Company and its subsidiaries are involved in litigation incidental to the
operation of the Company's business. The Company vigorously defends all matters
in which the Company or its subsidiaries are named defendants and, for insurable
losses, maintains significant levels of insurance to protect against adverse
judgments, claims or assessments that may affect the Company. In the opinion of
the Company, although the adequacy of existing insurance coverage or the outcome
of any legal proceedings cannot be predicted with certainty, the ultimate
liability associated with any claims or litigation in which the Company or its
subsidiaries are involved will not materially affect the Company's financial
condition or results of operations.
26
Self-insurance
The Company maintains self-insured retentions for its health benefits and
casualty insurance programs and limits its exposure by maintaining stop-loss and
aggregate liability coverages. The estimate of the Company's self-insurance
liability contains uncertainty since management must use judgment to estimate
the ultimate cost that will be incurred to settle reported claims and unreported
claims for incidents incurred but not reported as of the balance sheet date.
When estimating the Company's self-insurance liability, management considers a
number of factors, which include historical claim experience, demographic
factors, severity factors and valuations provided by independent third-party
actuaries. Management reviews its assumptions with its independent third party
actuaries to evaluate whether the self-insurance liability is adequate. If
actual claims exceed these estimates, additional reserves may be required.
13. SEGMENT INFORMATION
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," requires companies to provide certain information about their
operating segments. The Company has two reportable segments: HVAC equipment and
related parts and supplies - which comprises 97%, 96% and 95% of revenue in
2002, 2001 and 2000, respectively, and a personnel staffing services business.
The Distribution segment has similar products, customers, marketing strategies
and operations. The operating segments are managed separately because each
offers distinct products and services.
The reporting segments follow the same accounting policies used for the
Company's consolidated financial statements as described in Note 1. The chief
operating decision maker evaluates performance of the segments based on
operating income. Costs excluded from this profit measure are interest expense
and income taxes. Corporate expenses are primarily comprised of corporate
overhead expenses. Thus, operating income includes only the costs that are
directly attributable to the operations of the individual segment. Assets not
identifiable to an individual segment are corporate assets, which are primarily
comprised of cash and cash equivalents, deferred taxes and certain property
and equipment.
No single customer accounted for more than 10% of the Company's revenue in 2002,
2001 and 2000.
Years ended December 31, 2002 2001 2000
- -------------------------------------------------------------------------------------------------
Revenue:
Distribution $ 1,147,561 $ 1,194,587 $ 1,243,208
Staffing 33,575 44,059 66,958
- -------------------------------------------------------------------------------------------------
$ 1,181,136 $ 1,238,646 $ 1,310,166
=================================================================================================
Operating income:
Distribution $ 64,626 $ 60,659 $ 53,098
Staffing (1,739) (2,265) 2,975
Corporate expenses (11,963) (10,070) (10,258)
- -------------------------------------------------------------------------------------------------
$ 50,924 $ 48,324 $ 45,815
=================================================================================================
Depreciation and amortization:
Distribution $ 6,648 $ 10,713 $ 11,020
Staffing 301 548 607
Corporate 346 226 244
- -------------------------------------------------------------------------------------------------
$ 7,295 $ 11,487 $ 11,871
=================================================================================================
Restructuring and non-cash charges:
Distribution $ (277) $ 3,272 $ 11,000
Staffing (16) 2,523 -
Corporate - - 2,169
- -------------------------------------------------------------------------------------------------
$ (293) $ 5,795 $ 13,169
=================================================================================================
Assets:
Distribution $ 446,411 $ 476,499 $ 522,157
Staffing 10,379 10,836 16,579
Corporate 46,929 33,485 24,734
- -------------------------------------------------------------------------------------------------
$ 503,719 $ 520,820 $ 563,470
=================================================================================================
Capital expenditures:
Distribution $ 3,380 $ 4,366 $ 6,505
Staffing 237 228 455
Corporate 922 30 72
- -------------------------------------------------------------------------------------------------
$ 4,539 $ 4,624 $ 7,032
=================================================================================================
27
14. RELATED PARTY TRANSACTIONS
At December 31, 2002, the Company and a member of the Board of Directors had a
75% and 25% equity interest, respectively, in A2 Jet Leasing LLC ("A2 Jet
Leasing"), a company which performs aircraft leasing services to the Company,
the member of the Board of Directors and his affiliates and unaffiliated third
parties. During 2002, 2001 and 2000, A2 Jet Leasing recovered $770, $702 and
$416, respectively, in costs from the member of the Board of Directors
pertaining to his and his affiliates' usage of the aircraft. In February 2003,
the Company purchased the 25% equity interest owned by the member of the Board
of Directors for total cash consideration of $1,294.
A member of the Company's Board of Directors is the President and Chief
Executive Officer of Greenberg Traurig, P.A., which serves as the Company's
principal outside counsel and receives customary fees for legal services. During
2002, 2001 and 2000, the Company paid this firm $44, $42 and $29, respectively,
for services performed.
On April 15, 2002, the Company granted a loan in the amount of $160 to the
Company's Chief Financial Officer for the purchase of a primary residence. The
loan bears interest at 5%, payable annually, and matures on April 15, 2007. The
loan was approved by the Compensation Committee of the Board of Directors of the
Company and was made on substantially the same terms as those prevailing at the
time for comparable transactions with unrelated persons and does not involve
more than normal risk of collectibility.
15. SUBSEQUENT EVENTS
In January 2003, the Company's Board of Directors approved an increase in the
quarterly cash dividend to $.04 per share from $.03 per share. On an annualized
basis the dividend rate will be $.16 per share. The first dividend at the new
rate was paid on January 31, 2003.
28
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
Board of Directors and Shareholders
Watsco, Inc.
We have audited the accompanying consolidated balance sheet of Watsco, Inc. and
subsidiaries as of December 31, 2002, and the related consolidated statements of
income, shareholders' equity and cash flows for the year then ended. These
financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit. The consolidated financial statements of Watsco,
Inc. as of December 31, 2001 and for each of the two years in the period ended
December 31, 2001, were audited by other auditors who have ceased operations.
Those auditors expressed an unqualified opinion on those financial statements in
their report dated February 11, 2002 (except with respect to the matters
discussed in Note 14, as to which the date is March 22, 2002).
We conducted our audit in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for our
opinion.
In our opinion, the 2002 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Watsco, Inc.
and subsidiaries at December 31, 2002, and the consolidated results of their
operations and their cash flows for the year then ended in conformity with
accounting principles generally accepted in the United States.
As discussed in Note 9 to the consolidated financial statements, effective
January 1, 2002, the Company changed its method of accounting for goodwill to
conform with FASB Statement of Financial Accounting Standards (Statement) No.
142, "Goodwill and Other Intangible Assets."
As discussed above, the financial statements of Watsco, Inc. as of December 31,
2001, and for each of the two years in the period ended December 31, 2001, were
audited by other auditors who have ceased operations. As described in Note 9,
these financial statements have been revised to include the transitional
disclosures required by Statement No. 142, which was adopted by the Company as
of January 1, 2002. Our audit procedures with respect to the disclosures in Note
9 with respect to 2001 and 2000 included (a) agreeing the previously reported
net income to the previously issued financial statements and the adjustments to
reported net income representing amortization expense (including any related tax
effects) recognized in those periods related to goodwill to the Company's
underlying records obtained from management, and (b) testing the mathematical
accuracy of the reconciliation of adjusted net income to reported net income,
and the related earnings-per-share amounts. In our opinion, the disclosures for
2001 and 2000 in Note 9 are appropriate. However, we were not engaged to audit,
review, or apply any procedures to the 2001 and 2000 financial statements of the
Company other than with respect to such disclosures and, accordingly, we do not
express an opinion or any other form of assurance on the 2001 and 2000 financial
statements taken as a whole.
ERNST & YOUNG LLP
Miami, Florida
February 14, 2003
29
REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS
This is a copy of the audit report previously issued by Arthur Andersen LLP
("Arthur Andersen") in connection with Watsco, Inc.'s Form 10-K filing for the
fiscal year ended December 31, 2001. The inclusion of this previously issued
Arthur Andersen report is pursuant the "temporary final rule requirements for
Arthur Andersen LLP auditing client," issued by the U.S. Securities and Exchange
Commission in March 2002. Note that the previously issued Arthur Andersen report
includes references to certain fiscal years that are not required to be
presented in the accompanying consolidated financial statements as of and for
the years ended December 31, 2001 and 2000. This audit report has not been
reissued by Arthur Andersen in connection with this filing on Form 10-K.
As described in Note 9, the Company revised its consolidated financial
statements as of December 31, 2001 and for each of the two years in the period
ended December 31, 2001 to include the transitional disclosures required by SFAS
No. 142, "Goodwill and Intangible Assets."
The Arthur Andersen LLP report does not extend to these revisions to the 2001
and 2000 consolidated financial statements. These revisions to the 2001 and 2000
consolidated financial statements were reported on by Ernst & Young LLP, as
stated in their report appearing on the preceding page.
To Watsco, Inc.:
We have audited the accompanying consolidated balance sheets of Watsco, Inc.
(a Florida corporation) and subsidiaries as of December 31, 2001 and 2000, and
the related consolidated statements of income, shareholders' equity and
comprehensive income and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Watsco, Inc. and subsidiaries
as of December 31, 2001 and 2000, and the results of their operations and their
cash flows for each of the three years in the period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States.
As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2001, Watsco, Inc. and subsidiaries adopted Statement of Financial
Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging
Activities," which changed their method of accounting for derivative
instruments.
ARTHUR ANDERSEN LLP
Miami, Florida,
February 11, 2002 (except with respect to the
matters discussed in Note 14, as to which the
date is March 22, 2002).
30
WATSCO, INC. AND SUBSIDIARIES
SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)
1ST 2ND 3RD 4TH
(In thousands, except per share data) QUARTER QUARTER QUARTER QUARTER TOTAL
- ----------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31, 2002
Revenue (1) $ 256,815 $ 331,170 $ 326,286 $ 266,865 $ 1,181,136
Gross profit 62,975 81,270 80,085 62,946 287,276
- ----------------------------------------------------------------------------------------------------------
Net income (2) $ 3,042 $ 12,466 $ 11,842 $ 1,186 $ 28,536
==========================================================================================================
Diluted earnings per share (2), (4) $ 0.11 $ 0.46 $ 0.45 $ 0.05 $ 1.07
==========================================================================================================
YEAR ENDED DECEMBER 31, 2001
Revenue (1) $ 278,113 $351,149 $ 336,008 $ 273,376 $ 1,238,646
Gross profit 68,762 84,011 80,721 65,546 299,040
- ----------------------------------------------------------------------------------------------------------
Net income $ 2,366 $ 12,984 $ 8,080 $ 1,011 $ 24,441
Net income adjusted for SFAS No. 142 2,921 13,548 8,650 1,607 26,726
==========================================================================================================
Diluted earnings per share (3), (4) $ 0.09 $ 0.48 $ 0.29 $ 0.04 $ 0.90
Diluted earnings per share
adjusted for SFAS No. 142 (3), (4) 0.11 0.50 0.32 0.06 $ 0.98
==========================================================================================================
(1) Sales of residential central air conditioners, heating equipment and
related parts and supplies distributed by the Company have
historically been seasonal. 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. Demand related to the new construction sectors
throughout most of the Sunbelt markets is fairly even during the year
except for dependence on housing completions and related weather and
economic conditions.
(2) Effective January 1, 2002, goodwill is no longer being amortized in
accordance with SFAS No. 142, "Goodwill and Other Intangible Assets"
as more fully described in Notes 1 and 9 to the consolidated financial
statements.
(3) During the 3rd Quarter of 2001, the Company recorded restructuring and
other non-cash charges of $3,691 or $0.14 per share on an after-tax
basis, as more fully described in Note 8 to the consolidated financial
statements.
(4) Quarterly earnings per share are calculated on an individual basis
and, because of rounding and changes in the weighted average shares
outstanding during the year, the summation of each quarter may not
equal the amount calculated for the year as a whole.
31
WATSCO, INC. AND SUBSIDIARIES
INFORMATION ON COMMON STOCK
The Company's Common Stock is traded on the New York Stock Exchange under the
symbol WSO and its Class B Common Stock is traded on the American Stock Exchange
under the symbol WSOB. The following table indicates the high and low prices of
the Company's Common Stock and Class B Common Stock, as reported by the New York
Stock Exchange and American Stock Exchange, respectively, and dividends paid per
share for each quarter during the years ended December 31, 2002, 2001 and 2000.
At March 20, 2003, excluding shareholders with stock in street name, the Company
had 470 Common Stock shareholders of record and 212 Class B Common Stock
shareholders of record.
COMMON CLASS B CASH DIVIDENDS
HIGH LOW HIGH LOW COMMON CLASS B
==================================================================================================
YEAR ENDED DECEMBER 31, 2002:
Fourth quarter $ 16.91 $ 13.70 $ 17.00 $ 14.89 $ .030 $ .030
Third quarter 18.49 12.87 17.95 13.50 .030 .030
Second quarter 19.25 16.30 19.50 17.00 .030 .030
First quarter 18.29 12.90 18.50 14.45 .025 .025
==================================================================================================
YEAR ENDED DECEMBER 31, 2001:
Fourth quarter $ 14.59 $ 11.78 $ 14.35 $ 11.75 $ .025 $ .025
Third quarter 14.48 11.30 14.30 11.00 .025 .025
Second quarter 14.50 11.20 14.30 11.40 .025 .025
First quarter 13.93 10.48 13.75 11.00 .025 .025
==================================================================================================
YEAR ENDED DECEMBER 31, 2000:
Fourth quarter $ 12.04 $ 8.89 $ 11.81 $ 9.00 $ .025 $ .025
Third quarter 13.94 10.05 13.63 10.25 .025 .025
Second quarter 15.75 10.44 15.94 10.50 .025 .025
First quarter 12.50 8.38 12.81 8.88 .025 .025
==================================================================================================
32