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Quarterly Report Under Section 13 or 15(d)
of the Securities Exchange Act of 1934
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
- --------------------------------------------------------------------------------
[X] Quarterly Report Pursuant To Section 13 or
15(d) of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2002
or
[ ] Transition Report Pursuant To Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the Transition Period From
___ to ___
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Commission file number 1-5581
I.R.S. Employer Identification Number 59-0778222
WATSCO, INC.
(a Florida Corporation)
2665 South Bayshore Drive, Suite 901
Coconut Grove, Florida 33133
Telephone: (305) 714-4100
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES X NO
--- ---
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the last practicable date: 22,928,461 shares of the
Company's Common Stock ($.50 par value), excluding treasury shares of 4,259,919
and 3,395,606 shares of the Company's Class B Common Stock ($.50 par value),
excluding treasury shares of 48,263 were outstanding as of August 7, 2002.
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PART I. FINANCIAL INFORMATION
WATSCO, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
June 30, 2002 and December 31, 2001
(In thousands, except per share data)
June 30, December 31,
2002 2001
---------------- ------------
(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents $ 7,794 $ 9,132
Accounts receivable, net 163,304 143,301
Inventories 200,638 185,943
Other current assets 15,716 18,823
-------- --------
Total current assets 387,452 357,199
Property and equipment, net 28,764 30,703
Intangible assets, net 125,533 124,737
Other assets 7,413 8,181
-------- --------
$549,162 $520,820
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current portion of long-term obligations $ 354 $ 429
Accounts payable 85,091 58,127
Accrued liabilities 23,261 28,985
-------- --------
Total current liabilities 108,706 87,541
-------- --------
Long-term obligations:
Borrowings under revolving credit agreement 67,700 70,000
Long-term notes 30,000 30,000
Bank and other debt 1,765 1,900
-------- --------
Total long-term obligations 99,465 101,900
-------- --------
Deferred income taxes and other liabilities 9,224 8,959
-------- --------
Shareholders' equity:
Common Stock, $.50 par value 13,584 13,391
Class B Common Stock, $.50 par value 1,728 1,661
Paid-in capital 217,982 210,859
Unearned compensation related to outstanding restricted stock (9,239) (9,772)
Accumulated other comprehensive loss, net of tax (2,333) (2,062)
Retained earnings 155,040 143,487
Treasury stock, at cost (44,995) (35,144)
-------- --------
Total shareholders' equity 331,767 322,420
-------- --------
$549,162 $520,820
======== ========
See accompanying notes to condensed consolidated financial statements.
2 of 19
WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Quarter and Six Months Ended June 30, 2002 and 2001
(In thousands, except per share data)
(Unaudited)
Quarter Ended Six Months Ended
June 30, June 30,
---------------------- ---------------------
2002 2001 2002 2001
---------- ---------- ---------------------
Revenue $331,170 $351,149 $587,985 $629,262
Cost of sales 249,900 267,138 443,740 476,489
-------- -------- -------- --------
Gross profit 81,270 84,011 144,245 152,773
Selling, general and administrative expenses 59,832 60,778 116,176 122,881
-------- -------- -------- --------
Operating income 21,438 23,233 28,069 29,892
Interest expense, net 1,914 2,636 3,781 5,528
-------- -------- -------- --------
Income before income taxes 19,524 20,597 24,288 24,364
Income taxes 7,058 7,613 8,780 9,014
-------- -------- -------- --------
Net income $ 12,466 $ 12,984 $ 15,508 $ 15,350
======== ======== ======== ========
Basic earnings per share $0.48 $0.50 $0.60 $0.59
----- ----- ----- -----
Diluted earnings per share $0.46 $0.48 $0.57 $0.56
----- ----- ----- -----
Weighted average shares and equivalent shares
used to calculate earnings per share:
Basic 26,018 25,937 25,928 25,951
====== ====== ====== ======
Diluted 27,328 27,325 27,181 27,251
====== ====== ====== ======
See accompanying notes to condensed consolidated financial statements.
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WATSCO, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, 2002 and 2001
(In thousands)
(Unaudited)
2002 2001
-------- --------
Cash flows from operating activities:
Net income $ 15,508 $ 15,350
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 4,028 6,084
Provision for doubtful accounts 2,939 2,311
Tax benefit from exercise of stock options 2,562 84
Other, net 67 (220)
Changes in operating assets and liabilities:
Accounts receivable (22,243) (28,554)
Inventories (13,705) (22,642)
Accounts payable and accrued liabilities 19,335 18,981
Other, net 4,676 4,124
-------- --------
Net cash provided by (used in) operating activities 13,167 (4,482)
-------- --------
Cash flows from investing activities:
Capital expenditures (2,053) (3,115)
Business acquisitions, net of cash acquired (1,933) -
Proceeds from sale of property and equipment 615 1,233
-------- --------
Net cash used in investing activities (3,371) (1,882)
-------- --------
Cash flows from financing activities:
Purchase of treasury stock (9,851) (1,184)
Net proceeds from issuances of common stock 3,459 253
Net repayments under revolving credit agreement (2,300) (20,097)
Common stock dividends (1,457) (1,297)
Payment of debt acquisition costs (775) -
Net repayments of bank and other debt (210) (643)
Proceeds from issuance of long-term notes - 30,000
-------- --------
Net cash provided by (used in) financing activities (11,134) 7,032
-------- --------
Net increase (decrease) in cash and cash equivalents (1,338) 668
Cash and cash equivalents at beginning of period 9,132 4,781
-------- --------
Cash and cash equivalents at end of period $ 7,794 $ 5,449
======== ========
See accompanying notes to condensed consolidated financial statements.
4 of 19
WATSCO, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2002
(In thousands, except share data)
(Unaudited)
1. The condensed consolidated balance sheet as of December 31, 2001, which has
been derived from the Company's audited financial statements, and the
unaudited interim condensed consolidated financial statements, have been
prepared pursuant to the rules and regulations of the Securities and
Exchange Commission. Certain information and note disclosures normally
included in the annual financial statements prepared in accordance with
accounting principles generally accepted in the United States have been
condensed or omitted pursuant to those rules and regulations, although the
Company believes the disclosures made are adequate to make the information
presented not misleading. In the opinion of management, all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation have been included in the condensed consolidated financial
statements herein.
These statements should be read in conjunction with the consolidated
financial statements and notes thereto included in the Annual Report on
Form 10-K for the year ended December 31, 2001.
The Company has two reportable business segments - the distribution of air
conditioning, heating and refrigeration equipment and related parts and
supplies ("Distribution") segment and a national temporary staffing and
permanent placement services ("Staffing") segment.
2. The results of operations for the quarter and six months ended June 30,
2002, are not necessarily indicative of the expected results for the year
ending December 31, 2002. Sales of residential central air conditioners,
heating equipment and parts and supplies distributed by the Company have
historically been seasonal with revenue generally increasing during the
months of May through August. Demand related to the residential central air
conditioning replacement market is highest in the second and third quarters
with demand for heating equipment usually highest in the fourth quarter.
3. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenue and
expenses during the reporting period. Significant estimates include
valuation reserves for accounts receivable and inventory, income taxes, and
restructuring. Actual results could differ from those estimates.
4. Basic earnings per share is computed by dividing net income by the total of
the weighted average number of shares outstanding. Diluted earnings per
share additionally assumes, if dilutive, any added dilution from common
stock equivalents. Shares used to calculate earnings per share are as
follows:
Quarter Ended Six Months Ended
June 30, June 30,
-------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Weighted average shares outstanding 26,017,834 25,936,682 25,927,791 25,950,860
Dilutive stock options and restricted shares of
common stock 1,310,306 1,388,655 1,252,728 1,300,410
---------- ---------- ---------- ----------
Shares for diluted earnings per share 27,328,140 27,325,337 27,180,519 27,251,270
========== ========== ========== ==========
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 729,874 2,938,699 962,921 3,022,951
=========== ========== =========== ==========
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5. The Company has entered into interest rate swap agreements with an
aggregate notional amount of $50,000 to reduce its exposure to market risks
from changing interest rates. Under the swap agreements, the Company has
agreed to exchange, at specified intervals, the difference between fixed
and variable interest amounts calculated by reference to the notional
principal amount. Any differences paid or received on interest rate swap
agreements are recognized as adjustments to interest expense over the life
of each swap, thereby adjusting the effective interest rate on the
underlying obligation. The Company does not hold or issue such financial
instruments for trading purposes. Derivatives used for hedging purposes
must be designated as, and effective as, a hedge of the identified risk
exposure at the inception of the contract. Accordingly, changes in the fair
value of the derivative contract must be highly correlated with changes in
the fair value of the underlying hedged item at inception of the hedge and
over the life of the hedge contract.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative
Instruments and Hedging Activities," which requires that all derivatives,
whether designated in hedging relationships or not, be recorded on the
balance sheet at fair value. If the derivative is designated as a fair
value hedge, the changes in the fair value of the derivative and of the
hedged item attributable to the hedged risk are recognized in earnings. If
the derivative is designated as a cash flow hedge, the effective portions
of changes in the fair value of the derivative are recorded in other
comprehensive income ("OCI") and are recognized in the income statement
when the hedged items affect earnings. Ineffective portions of changes in
the fair value of cash flow hedges are recognized in earnings.
The adoption of SFAS No. 133 on January 1, 2001 resulted in a cumulative
pre-tax reduction to OCI of $1,001 ($629 after-tax). The Company recorded a
loss of $1,167 ($745 after-tax), a gain of $629 ($396 after-tax), a loss of
$429 ($274 after-tax) and a loss of $794 ($500 after-tax) in OCI relating
to the change in value of the cash flow hedges for the quarter and six
months ended June 30, 2002 and 2001, respectively. At June 30, 2002 and
December 31, 2001, the fair value of derivatives held by the Company was a
liability of $3,811 and $3,424, respectively, which is included in other
long-term liabilities in the accompanying condensed consolidated balance
sheets.
During the six months ended June 30, 2002 and 2001, the Company
reclassified $1,316 and $287, respectively from OCI to current period
earnings (recorded as interest expense, net in the condensed consolidated
statements of income). The net deferred loss recorded in OCI will be
reclassified to earnings as interest payments occur. As of June 30, 2002,
approximately $2,300 in deferred losses on derivative instruments
accumulated in OCI are expected to be reclassified to earnings during the
next twelve months using a current three month LIBOR-based average receive
rate (1.82% at June 30, 2002). All open derivative contracts mature by
October 2007.
6. Comprehensive income consists of net income, changes in the value of
available-for-sale securities and derivative instruments and the cumulative
effect of a change in accounting principle as further discussed in Note 5
to the condensed consolidated financial statements. Components of the
Company's comprehensive income are as follows:
Quarter Ended Six Months Ended
June 30, June 30,
------------------------ ------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Net income $12,466 $12,984 $15,508 $15,350
Unrealized holding gains (losses) on investments
arising during the period, net of income tax
benefit (expense) of $7, $(7), $(2) and $2,
respectively (13) 12 3 (3)
Cumulative effect of a change in accounting
principle, net of income tax benefit of $372 - - - (629)
Gain (loss) on derivative instruments, net of
income tax benefit (expense) of $422, $(233),
$155 and $294, respectively (745) 396 (274) (500)
------- ------- -------- -------
Comprehensive income $11,708 $13,392 $15,237 $14,218
======= ======= ======= =======
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7. In September 2001, the Company's Board of Directors approved plans to
integrate the operations of two subsidiaries and close six locations in the
Distribution segment and close seven locations and exit certain licensee
relationships in the Staffing segment. During the second quarter of 2002,
based on a continued reassessment of such restructuring plans and
activities, the Company determined that three of the six locations in the
Distribution segment should remain open. In the Staffing segment, all seven
locations were closed and the licensee relationships were terminated in
2001. The remaining restructuring activities are expected to be completed
in 2002.
The following table summarizes the Company's restructuring liabilities and
valuation reserves for the six months ended June 30, 2002:
Balance Write-down of Balance
December 31, Cash Assets to Net Change in June 30,
2001 Payments Realizable Value Estimate 2002
- ------------------------------------------------------------------------------------------------------------------
Noncancelable lease obligations $1,091 $(401) $ - $(424) $266
Discontinued product lines 328 (151) (278) 320 219
Other 294 (68) - (40) 186
- ------------------------------------------------------------------------------------------------------------------
$1,713 $(620) $(278) $(144) $671
- ------------------------------------------------------------------------------------------------------------------
At June 30, 2002, a restructuring liability of $452 is included in accrued
liabilities and an inventory valuation reserve of $219 is netted against
inventories in the unaudited condensed consolidated balance sheet.
The restructuring charges were determined based on formal plans approved by
the Company's Board of Directors using the best information available to it
at the time. The amounts the Company may ultimately incur may change, as
the balance of the Company's initiatives to streamline operations are
executed. The Company expects that the restructuring activities will result
in a simplified operating structure that should enhance future
profitability.
8. On January 1, 2002, the Company adopted the provisions of SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS No. 142 eliminates the
requirement to amortize goodwill and indefinite-lived intangible assets,
addresses the amortization of intangible assets with a defined life and
addresses the impairment testing and recognition for goodwill and
intangible assets. In lieu of amortizing goodwill, the Company was required
to perform an initial impairment review of goodwill as of the transition
date of January 1, 2002 and will perform annual impairment reviews
thereafter. The initial impairment review resulted in no goodwill
impairment charge.
Net income and basic and diluted earnings per share, adjusted to exclude
amounts no longer being amortized are as follows:
Quarter Ended Six Months Ended
June 30, June 30,
------------------------ ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
Reported net income $12,466 $12,984 $15,508 $15,350
Adjustments:
Goodwill amortization expense - 896 - 1,796
Income tax effect - (332) - (665)
Adjusted net income $12,466 $13,548 $15,508 $16,481
Basic earnings per share:
Reported $0.48 $0.50 $0.60 $0.59
Adjusted $0.48 $0.52 $0.60 $0.64
Diluted earnings per share:
Reported $0.46 $0.48 $0.57 $0.56
Adjusted $0.46 $0.50 $0.57 $0.60
On January 1, 2002 the Company also adopted SFAS No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 replaces
SFAS No. 121, "Accounting for the
7 of 19
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed
of" and the accounting and reporting provisions of Accounting Principles
Board Opinion No. 30, "Reporting the Results of Operations - Unusual and
Infrequently Occurring Events and Transactions." SFAS No. 144 also amends
Accounting Research Bulletin No. 51, "Consolidated Financial Statements,"
to eliminate the exception to consolidation for a subsidiary for which
control is likely to be temporary. SFAS No. 144 establishes a single
accounting model for assets to be disposed of by sale whether previously
held and used or newly acquired. There was no impact to the Company's
operating results or financial position related to the adoption of this
standard.
In June 2001, the Financial Accounting Standards Board issued SFAS No. 143,
"Accounting for Asset Retirement Obligations." SFAS No. 143 applies to
legal obligations associated with the retirement of long-lived assets that
result from the acquisition, construction, development and (or) the normal
operation of a long-lived asset, except for certain obligations of lessees.
SFAS No. 143 requires that the fair value of a liability for an asset
retirement obligation be recognized in the period in which it is incurred
if a reasonable estimate of fair value can be made and subsequently
allocated to expense using a systematic and rational method. The associated
asset retirement costs are capitalized as part of the carrying amount of
the long-lived asset and subsequently allocated to expense over the asset's
useful life. SFAS No. 143 is effective for financial statements issued for
fiscal years beginning after June 15, 2002. The Company does not believe
that the adoption of SFAS No. 143 will have a significant impact on its
consolidated financial statements.
9. The Company has two reportable business segments - Distribution and
Staffing. The Distribution segment has similar products, vendors,
customers, marketing strategies and operations. The operating segments are
managed separately because each offers distinct products and services.
Segment data is as follows:
Quarter Ended Six Months Ended
June 30, June 30,
----------------------------- ---------------------------
2002 2001\(1)\ 2002 2001\(1)\
---------- ------------- ---------- ------------
Revenue:
Distribution $322,837 $339,312 $571,629 $605,476
Staffing 8,333 11,837 16,356 23,786
-------- -------- -------- --------
$331,170 $351,149 $587,985 $629,262
======== ======== ======== ========
Operating income (loss):
Distribution $ 24,147 $ 24,768 $ 33,417 $ 33,544
Staffing (333) 208 (621) 272
Corporate expenses (2,376) (1,743) (4,727) (3,924)
-------- -------- -------- --------
$ 21,438 $ 23,233 $ 28,069 $ 29,892
======== ======== ======== ========
(1) As discussed in Note 8, effective January 1, 2002, the Company adopted
SFAS No. 142, which requires that indefinite-lived intangible assets
and goodwill no longer be subject to amortization. Goodwill
amortization expense recorded in segment operating income for the
quarter and six months ended June 30, 2001 is as follows: Distribution
- $847 and $1,698, respectively, and Staffing - $49 and $98,
respectively. Excluding goodwill amortization expense, segment
operating income for the quarter and six months ended June 30, 2001 is
as follows: Distribution - $25,615 and $35,242, respectively, and
Staffing - $257 and $370, respectively.
10. 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 new agreement replaced the Company's previous revolving
credit agreement, which was to expire on August 8, 2002. Borrowings under
the new revolving credit agreement bear interest at primarily LIBOR-based
rates plus a spread that is dependent upon the Company's financial
performance. The Company 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
8 of 19
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 June 30, 2002.
11. In January 2002, a wholly-owned subsidiary of the Company completed the
purchase of the net assets and business of a wholesale distributor of air
conditioning and heating products that operates from a single location in
Tucson, Arizona. Consideration for the acquisition consisted of cash
payments of $687 and the issuance of 27,688 shares of the Common Stock
having a fair value of $330. The acquisition was accounted for under the
purchase method of accounting and, accordingly, its results of operations
have been included in the unaudited condensed consolidated statements of
income beginning on the date of acquisition. This acquisition was not
deemed to be a material business combination by the Company.
In May 2002, a wholly-owned subsidiary of the Company completed the
purchase of the net assets and business of a wholesale distributor of air
conditioning and heating products that operates from four locations in
Mississippi. Consideration for the acquisition consisted of cash payments
aggregating $1,246 and is subject to adjustment upon the completion of
audits of the assets purchased and liabilities assumed. The acquisition was
accounted for under the purchase method of accounting and, accordingly, its
results of operations have been included in the unaudited condensed
consolidated statement of income beginning on the date of acquisition. This
acquisition was not deemed to be a material business combination by the
Company.
12. 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.
13. The Company declared quarterly cash dividends of $.03 and $.025 per share,
in 2002 and 2001, respectively.
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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 and a national temporary staffing and permanent
placement services ("Staffing") segment.
The following table sets forth, as a percentage of revenue, the Company's
condensed consolidated statement of income data for the quarter and six months
ended June 30, 2002 and 2001:
Quarter Six Months
Ended June 30, Ended June 30,
----------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
Revenue 100.0% 100.0% 100.0% 100.0%
Cost of sales 75.5 76.1 75.5 75.7
----- ----- ----- -----
Gross profit 24.5 23.9 24.5 24.3
Selling, general and administrative expenses 18.0 17.3 19.8 19.5
----- ----- ----- -----
Operating income 6.5 6.6 4.7 4.8
Interest expense, net (0.6) (0.7) (0.6) (0.9)
Income taxes (2.1) (2.2) (1.5) (1.5)
----- ----- ----- -----
Net income 3.8% 3.7% 2.6% 2.4%
===== ===== ===== =====
The following table sets forth revenue by business segment for the quarter
and six months ended June 30, 2002 and 2001.
Quarter Six Months
Ended June 30, Ended June 30,
--------------------------------- --------------------------------
2002 2001 2002 2001
-------- -------- -------- --------
Distribution $322,837 97% $339,312 97% $571,629 97% $605,476 96%
Staffing 8,333 3 11,837 3 16,356 3 23,786 4
-------- --- -------- --- -------- --- -------- ---
Total revenue $331,170 100% $351,149 100% $587,985 100% $629,262 100%
======== === ======== ==== ======== === ======== ====
The following narratives include the results of operations acquired during
2002. See Note 11 to the condensed consolidated financial statements. The
acquisitions were 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" excludes
the effects of locations opened and closed during the prior twelve months.
QUARTER ENDED JUNE 30, 2002 VS. QUARTER ENDED JUNE 30, 2001
Consolidated revenue for the three months ended June 30, 2002 decreased
$20.0 million, or 6%, compared to the same period in 2001.
Distribution segment revenue for the three months ended June 30, 2002,
decreased $16.5 million, or 5%. On a same-store basis, revenue in the
Distribution segment decreased $16.9 million or 5%, including a $10.8
10 of 19
million or 4% same-store sales decline in residential and light-commercial
HVAC products and a 24% same-store sales decline to the manufactured housing
market. Sales to the manufactured housing market, which represented 6% of the
Distribution segment's second quarter revenue in 2002, continues to be affected
by a tightened financing market for dealers and consumers. Revenue for the
quarter reflects same-store sales gains in the southern markets offset by a
sales decline in replacement systems in the western markets and lower overall
sales of commercial products.
Staffing segment revenue for the three months ended June 30, 2002 decreased
$3.5 million or 30%, primarily due to weakened demand for temporary staffing
services and the effect of seven location closures during 2001. On a same-store
basis, revenue for the three months ended June 30, 2002 decreased $2.4 million,
or 22%, over 2001.
Consolidated gross profit for the three months ended June 30, 2002
decreased $2.7 million, or 3%, as compared to the same period in 2001, primarily
as a result of the aforementioned revenue decrease. Gross profit margin for the
three months ended June 30, 2002 increased to 24.5% in 2002 from 23.9% in 2001
primarily due to higher markups on certain product offerings.
Consolidated selling, general and administrative expenses for the three
months ended June 30, 2002 decreased $.9 million, or 2%, compared to the same
period in 2001, primarily due to the aforementioned revenue decrease. Excluding
goodwill amortization expense in 2001, selling, general and administrative
expenses for the quarter ended June 30, 2002 remained flat. Selling, general and
administrative expenses as a percent of revenue increased to 18.0% in 2002 from
17.3% in 2001, primarily due to the impact of fixed costs being spread over
lower sales volume.
Interest expense, net for the three months ended June 30, 2002 decreased
approximately $.7 million, or 27%, compared to the same period in 2001,
primarily due to improved cash flow and lower average borrowings during the
quarter.
The effective tax rate was 36.2% for the three months ended June 30, 2002
and 37.0% for the three months ended June 30, 2001 following the implementation
of tax planning strategies.
SIX MONTHS ENDED JUNE 30, 2002 VS. SIX MONTHS ENDED JUNE 30, 2001
Consolidated revenue for the six months ended June 30, 2002 decreased $41.3
million, or 7%, compared to the same period in 2001.
Distribution segment revenue for the six months ended June 30, 2002,
decreased $33.8 million, or 6%. On a same-store basis, revenue in the
Distribution segment decreased $31.9 million or 5%, including a $23.8 million or
4% same-store sales decline in residential and light-commercial HVAC products
and an 18% same-store sales decline to the manufactured housing market. Sales to
the manufactured housing market, which represented 7% of the Distribution
segment's revenue in 2002, continues to be affected by a tightened financing
market for dealers and consumers. Revenue for the six months ended June 30, 2002
reflects same-store sales gains in the southern markets offset by a sales
decline in replacement systems in the western markets and lower overall sales of
commercial products.
Staffing segment revenue for the six months ended June 30, 2002 decreased
$7.4 million or 31%, primarily due to weakened demand for temporary staffing
services and the effect of seven location closures during 2001. On a same-store
basis, revenue for the three months ended June 30, 2002 decreased $4.9 million,
or 23%, over 2001.
Consolidated gross profit for the six months ended June 30, 2002 decreased
$8.5 million, or 6%, as compared to the same period in 2001, primarily as a
result of the aforementioned revenue decrease. Gross profit margin for the six
months ended June 30, 2002 increased to 24.5% in 2002 from 24.3% in 2001
primarily due to higher markups on certain product offerings.
Consolidated selling, general and administrative expenses for the six
months ended June 30, 2002 decreased $6.7 million, or 5%, compared to the same
period in 2001, primarily due to the aforementioned
11 of 19
revenue decrease. Excluding goodwill amortization expense in 2001, selling,
general and administrative expenses for the six months ended June 30, 2002
decreased $4.9 million, or 4%. Selling, general and administrative expenses as a
percent of revenue increased to 19.8% in 2002 from 19.5% in 2001.
Interest expense, net for the six months ended June 30, 2002 decreased
approximately $1.7 million, or 32%, compared to the same period in 2001,
primarily due to improved cash flow and lower average borrowings during the
period.
The effective tax rate was 36.1% for the six months ended June 30, 2002 and
37.0% for the six months ended June 30, 2001 following the implementation of tax
planning strategies.
Restructuring Activities
In September 2001, the Company's Board of Directors approved plans to
integrate the operations of two subsidiaries and close six locations in the
Distribution segment and close seven locations and exit certain licensee
relationships in the Staffing segment. During the second quarter of 2002, based
on a continued reassessment of such restructuring plans and activities, the
Company determined that three of the six locations in the Distribution segment
should remain open. In the Staffing segment, all seven locations were closed and
the licensee relationships were terminated in 2001. The remaining restructuring
activities are expected to be completed in 2002.
During the six months ended June 30, 2002, the Company incurred pre-tax
cash outflows of $.6 million. At June 30, 2002, a restructuring liability of $.5
million is included in accrued liabilities and an inventory valuation reserve of
$.2 million is netted against inventories in the unaudited condensed
consolidated balance sheet.
Critical Accounting Policies
The accounting policies below are critical to the Company's business
operations and the understanding of results of operations. The Company's
discussion and analysis of its financial condition and results of operations are
based upon the Company's consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these financial statements requires the
Company to make estimates and assumptions that affect the reported amounts of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of the consolidated financial statements and the reported amount of revenue
and expenses during the reporting period. The Company bases its estimates on
historical experience and on various other factors that are believed to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Revenue Recognition
The Company's revenue recognition policy is significant because revenue is
the key component of results of operations. The Company recognizes revenue in
accordance with Securities and Exchange Commission Staff Accounting Bulletin
("SAB") No. 101, "Revenue Recognition in Financial Statements," as amended by
SAB 101A and 101B. Revenue for the Company primarily consists of sales of air
conditioning, heating and refrigeration equipment and related parts and supplies
and service fee revenue from the Company's Staffing segment. SAB 101 requires
that four basic criteria must be met before revenue can be recognized: (1)
persuasive evidence of an arrangement exists, (2) delivery has occurred or
services have been rendered, (3) the amounts recognized are fixed and
determinable, and (4) collectibility is reasonably assured. The Company records
revenue after it receives a purchase commitment with a fixed determinable price
from the customer and shipment of products or delivery of services has occurred.
Allowance for Doubtful Accounts
The Company maintains an allowance for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
The Company establishes and monitors the allowance for doubtful accounts based
on the credit risk of specific customers, customer concentrations, historical
trends
12 of 19
and other information. Although the Company believes its allowance is
sufficient, if the financial condition of the Company's customers were to
deteriorate, resulting in an impairment of their ability to make payments,
additional allowances may be required. Concentrations of credit risk with
respect to accounts receivable are limited due to the large number of customers
comprising the Company's customer base and their dispersion across many
different geographical regions. Substantially all customer returns are under
warranty by the Company's manufacturers. Accordingly, the Company's risk of loss
for customer returns is mitigated.
Inventory Valuation
Inventories consist of air conditioning, heating and refrigeration
equipment and related parts and supplies and are stated at the lower of cost
(first-in, first-out method) or market. Provision is made as necessary to reduce
excess or obsolete inventories to their estimated net realizable value. The
process for evaluating the value of excess and obsolete inventory often requires
the Company to make subjective judgments and estimates concerning future sales
levels, quantities and prices at which such inventory will be able to be sold in
the normal course of business. Accelerating the disposal process or incorrect
estimates of future sales potential may cause the actual results to differ from
the estimates at the time such inventory is disposed or sold.
Income Taxes
The Company provides for federal and state income taxes currently payable, as
well as for those deferred because of temporary differences between reporting
income and expenses for financial statement purposes versus tax purposes.
Deferred tax assets and liabilities reflect the temporary differences between
the financial statement and income tax bases of assets and liabilities. Deferred
tax assets and liabilities are measured using enacted tax rates expected to
apply to taxable income in the years in which those temporary differences are
expected to be recovered or settled. The effect of a change in tax rates is
recognized as income or expense in the period that includes the enactment date.
The Company and its eligible subsidiaries file a consolidated United States
federal income tax return. As the Company generally does not file its income tax
returns until well after the closing process for the December 31 financial
statements is complete, the amounts recorded at December 31 reflect estimates of
what the final amounts will be when the actual income tax returns are filed for
that calendar year. At the end of each interim period, the Company makes its
best estimate of the effective tax rate expected to be applicable for the full
fiscal year. In addition, estimates are often required with respect to, among
other things, the appropriate state income tax rates to use in the various
states that the Company and its subsidiaries are required to file, the potential
utilization of operating loss carry-forwards for both federal and state income
tax purposes and valuation allowances required, if any, for tax assets that may
not be realizable in the future.
Restructuring
The Company records restructuring liabilities at the time the Board of
Directors approves and commits to a restructuring plan that identifies all
significant actions to be taken and the expected completion date of the plan is
within a reasonable period of time. The restructuring liability includes those
restructuring costs that can be reasonably estimated, are not associated with or
do not benefit activities that will be continued and are not associated with or
are not incurred to generate revenue after the plan's commitment date.
Restructuring costs are incurred as a direct result of the plan and are
incremental to other costs incurred by the Company in the conduct of its
activities prior to the commitment date or existed prior to the commitment date
under a contractual obligation that will either continue after the exit plan is
completed with no economic benefit to the Company or reflect a penalty to cancel
a contractual obligation.
Liquidity and Capital Resources
Management assesses the Company's liquidity in terms of its ability to
generate cash to fund its operating and investing activities and takes into
consideration the seasonal demand of the Company's products, which peaks 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.
13 of 19
In April 2002, the Company executed a bank-syndicated, unsecured revolving
credit agreement which provides for borrowings of up to $225.0 million, expiring
in April 2005. The new agreement replaced the Company's previous revolving
credit agreement which was to expire on August 8, 2002. At June 30, 2002, $67.7
million was outstanding under this credit agreement. Borrowings under the
agreement were used to fund seasonal working capital needs and for other general
corporate purposes, including acquisitions. Borrowings under the new revolving
credit agreement bear interest at primarily LIBOR-based rates plus a spread that
is dependent upon the Company's financial performance (LIBOR plus 1.125% at June
30, 2002). 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 June 30, 2002.
On January 31, 2000, the Company entered into a $125.0 million private
placement shelf facility. The uncommitted loan facility provides the Company
with a source of long-term, fixed-rate financing as a complement to the variable
rate borrowings available under its existing revolving credit facility. On
February 7, 2001, the Company issued $30.0 million Senior Series A Notes
("Notes") bearing 7.07% interest under its private placement shelf facility. The
Notes have an average life of 5 years with repayment in equal installments of
$10.0 million beginning on April 9, 2005 until the final maturity on April 9,
2007. Interest is paid on a quarterly basis. The Company used the net proceeds
from the issuance of the Notes for the repayment of a portion of its outstanding
indebtedness under its revolving credit facility.
The Company's Board of Directors has authorized the repurchase, at
management's discretion, of up to 6.0 million shares of the Company's stock in
the open market or via private transactions. Shares repurchased under the
program are accounted for using the cost method and result in a reduction of
shareholders' equity. During the six months ended June 30, 2002, the Company
purchased approximately .7 million shares at a cost of approximately $9.8
million. In aggregate, the Company has repurchased 4.1 million shares at a cost
of $45.0 million.
Working capital increased to $278.7 million at June 30, 2002 from $269.7
million at December 31, 2001, primarily due to the Company's seasonal build-up
of inventory in preparation for the spring and summer selling seasons. This
increase was primarily funded by cash flows from operations.
Net cash provided by operating activities was $13.2 million for the six
months ended June 30, 2002 compared to net cash used in operating activities of
$4.5 million for the same period in 2001, an increase of $17.7 million. This
increase is primarily due to the impact of improved collection efforts and
inventory management. During the trailing twelve-month period ended June 30,
2002, accounts receivable days sales improved to 45 in 2002 from 49 in 2001 and
inventory turns improved to 4.4 in 2002 from 4.1 in 2001.
Net cash used in investing activities increased to $3.4 million for the six
months ended June 30, 2002 from $1.9 million for the same period in 2001,
primarily due to business acquisitions in 2002.
During 2002, the Company completed the purchase of the net assets and
business of two wholesale distributors of air conditioning and heating products.
Consideration for the acquisitions consisted of cash payments and the issuance
of Common Stock aggregating $2.2 million. The acquisitions were not deemed to be
material business combinations of the Company.
For the six months ended June 30, 2002, net cash used in financing
activities was $11.1 million primarily due to purchases of treasury stock of
$9.9 million and repayments under the revolving credit agreement of $2.3
million, which were offset by net proceeds from issuances of common stock. Net
cash provided by financing activities for the six months ended June 30, 2001 was
$7.0 million primarily due to proceeds from the issuance of long-term notes in
2001, as discussed above.
The Company believes it has adequate availability of capital from
operations and its 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
14 of 19
binding agreement with respect to any acquisition candidates. Should suitable
acquisition opportunities or working capital needs arise that would require
additional financing, the Company believes that its financial position and
earnings history provide a solid base for obtaining additional financing
resources at competitive rates and terms.
Quantitative and Qualitative Disclosures about Market Risk
The Company's primary market risk exposure consists of interest rate risk.
The Company's objective in managing the exposure to interest rate changes is to
limit the impact of interest rate changes on earnings and cash flows and to
lower its overall borrowing costs. To achieve its objectives, the Company uses
interest rate swaps to manage net exposure to interest rate changes to its
borrowings. These swaps are entered into with a group of financial institutions
with investment grade credit ratings, thereby minimizing the risk of credit
loss. All items described below are non-trading.
At June 30, 2002, the Company had two interest rate swap agreements with an
aggregate notional amount of $50.0 million to manage its net exposure to
interest rate changes related to a portion of the borrowings under the revolving
credit agreement. The interest rate swap agreements effectively convert a
portion of the Company's LIBOR-based variable rate borrowings into fixed rate
borrowings with a weighted average pay rate of 6.4%.
Effective January 1, 2001, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which requires that all derivatives, whether designated
in hedging relationships or not, be recorded on the balance sheet at fair value.
If the derivative is designated as a fair value hedge, the changes in the fair
value of the derivative and of the hedged item attributable to the hedged risk
are recognized in earnings. If the derivative is designated as a cash flow
hedge, the effective portions of changes in the fair value of the derivative are
recorded in other comprehensive income ("OCI") and are recognized in the income
statement when the hedged items affect earnings. Ineffective portions of changes
in the fair value of cash flow hedges are recognized in earnings.
The adoption of SFAS No. 133 in January 2001 resulted in a cumulative
pre-tax reduction to OCI of $1.0 million ($.6 million after-tax). The Company
recorded a loss of $1.2 million ($.7 million after-tax), a gain of $.6 million
($.4 million after-tax), a loss of $.4 million ($.3 million after-tax) and a
loss of $.8 million ($.5 million after-tax) in OCI relating to the change in
value of the cash flow hedges for the quarter and six months ended June 30, 2002
and 2001, respectively. At June 30, 2002 and December 31, 2001, the fair value
of derivatives held by the Company was a liability of $3.8 million and $3.4
million, respectively, which is included in other long-term liabilities in the
accompanying condensed consolidated balance sheets.
During the six months ended June 30, 2002 and 2001, the Company
reclassified $1.3 million and $.3 million, respectively from OCI to current
period earnings (recorded as interest expense, net in the condensed consolidated
statements of income). The net deferred loss recorded in accumulated OCI will be
reclassified to earnings as interest payments occur. As of June 30, 2002,
approximately $2.3 million in deferred losses on derivative instruments
accumulated in OCI are expected to be reclassified to earnings during the next
twelve months using a current three month LIBOR-based average receive rate
(1.82% at June 30, 2002). All open derivative contracts mature by October 2007.
Safe Harbor Statement
This quarterly report contains statements which, to the extent they are not
historical fact, constitute "forward looking statements" under the securities
laws, including statements regarding acquisitions, financing agreements and
industry, demographic and other trends affecting the Company. All forward
looking statements involve risks, uncertainties and other factors that may cause
the actual results, performance or achievements of the Company to differ
materially from those contemplated or projected, forecasted, estimated,
budgeted, expressed or implied by or in such forward looking statements. The
forward looking statements in this document are intended to be subject to the
safe harbor protection provided under the securities laws.
The Company's shareholders should also be aware that while the Company
does, at various times, communicate with securities analysts, it is against SEC
regulation FD and the Company's policies to disclose to such analysts any
material non-public information or other confidential information. Accordingly,
our shareholders should not
15 of 19
assume that the Company agrees with all statements or reports issued by such
analysts. To the extent statements or reports issued by analysts contain
projections, forecasts or opinions by such analysts about our Company, such
reports are not the responsibility of the Company.
For additional information identifying some other important factors which
may affect the Company's operations and markets and could cause actual results
to vary materially from those anticipated in the forward looking statements, see
the Company's Securities and Exchange Commission filings, including but not
limited to, the discussion included in the Business section of the Company's
Form 10-K under the heading "Business Risk Factors".
16 of 19
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There have been no significant changes from the information reported
in the Annual Report on Form 10-K for the period ended December 31,
2001, filed on March 29, 2002.
Item 2. Changes in Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Securities Holders
(a) The Company's 2002 Annual Meeting of Shareholders was held on
June 4, 2002.
(b) The Company's management solicited proxies pursuant to
Regulation 14 under the Securities Exchange Act of 1934. There
was no solicitation in opposition to the management's nominees
as listed in the proxy statement. The following nominees were
elected as indicated in the proxy statement pursuant to the vote
of the shareholders (the Common Stock directors having been
elected by holders of the Company's Common Stock voting as a
single class and the Class B Common Stock directors having been
elected by the Class B Common Stock shareholders voting as a
single class):
Votes For Votes Withheld
--------- --------------
Common Stock Directors
----------------------
Victor Lopez 19,569,895 311,806
Alan Potamkin 19,703,872 177,829
Paul F. Manley 19,565,472 316,229
Class B Common Stock Directors
------------------------------
Albert H. Nahmad 3,347,498 5,216
Cesar L. Alvarez 3,346,316 6,398
George Fugelsang 3,347,498 5,216
Additionally, Messrs. David B. Fleeman, Bob L. Moss and Roberto
Motta will continue to serve as directors of the Company.
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
99.1 Certification from the Chief Executive Officer of Watsco, Inc.
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification from the Chief Financial Officer of Watsco, Inc.
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
17 of 19
(b) Reports on Form 8-K
A report on Form 8-K dated May 22, 2002, disclosed in Item 4, Changes
in Registrant's Certifying Accountant, that the Board of Directors of
the Company and its Audit Committee dismissed Arthur Andersen LLP as
the Company's independent public accountants and engaged Ernst &
Young LLP to serve as the Company's independent public accountants
for the fiscal year 2002.
18 of 19
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
WATSCO, INC.
------------------------------
(Registrant)
By: /s/ Barry S. Logan
--------------------------
Barry S. Logan
Vice President and Secretary
(Chief Financial Officer)
August 14, 2002
19 of 19
Exhibit Index
Exhibit Number Exhibit Description
-------------- -------------------
99.1 Certification from the Chief Executive Officer of Watsco,
Inc. pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification from the Chief Financial Officer of Watsco,
Inc. pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.