General
Watsco, Inc. and its subsidiaries (collectively, Watsco, or we, us or our
) was incorporated in Florida
in 1956 and is the largest distributor of air conditioning, heating and refrigeration equipment and related parts and supplies (HVAC/R) in the HVAC/R distribution industry in North America. At December 31, 2016, we operated from 565
locations in 37 U.S. States, Canada, Mexico and Puerto Rico with additional market coverage on an export basis to portions of Latin America and the Caribbean, through which we serve approximately 88,000 active contractors and dealers that service
the replacement and new construction markets. Our revenues in HVAC/R distribution have increased from $64.1 million in 1989 to $4.2 billion in 2016, resulting from our strategic acquisition of companies with established market positions
and subsequent building of revenues and profit through a combination of additional locations, introduction of new products and other initiatives.
3
Our principal executive office is located at 2665 South Bayshore Drive, Suite 901, Miami, Florida 33133, and our
telephone number is
(305) 714-4100.
Our website address on the Internet is www.watsco.com and
e-mails
may be sent to info@watsco.com. Our website address is
included in this report only as an inactive textual reference. Information contained on, or available through, our website is not incorporated by reference in, or made a part of, this report.
Air Conditioning, Heating and Refrigeration Industry
The
HVAC/R distribution industry is highly fragmented with approximately 2,100 distribution companies. The industry in the United States and Canada is well-established, having had its primary period of growth during the post-World War II era with the
advent of affordable central air conditioning and heating systems for both residential and commercial applications. The advent of HVAC/R products in Latin America and the Caribbean is also well-established, but has emerged in more recent years as
those economies have grown and products have become more affordable and have matured from luxury to necessity.
Based on data published in the 2016 IBIS
World Industry Report for Heating and Air Conditioning Contractors in the U.S. and other available data, we estimate that the annual market on an installed basis for residential central air conditioning, heating and refrigeration equipment and
related parts and supplies is approximately $88.0 billion. Air conditioning and heating equipment is manufactured primarily by seven major companies that together account for approximately 90% of all units shipped in the United States each
year. These companies are: Carrier Corporation (Carrier), a subsidiary of United Technologies Corporation; Goodman Manufacturing Company, L.P. (Goodman), a subsidiary of Daikin Industries, Ltd.; Rheem Manufacturing Company
(Rheem); Trane Inc. (Trane), a subsidiary of Ingersoll-Rand Company Limited; York International Corporation, a subsidiary of Johnson Controls, Inc.; Lennox International, Inc.; and Nordyne Corporation (Nordyne), a
subsidiary of Nortek Corporation. These manufacturers distribute their products through a combination of factory-owned and independent distributors who, in turn, supply the equipment and related parts and supplies to contractors and dealers
nationwide that sell to and install the products for consumers, businesses and other
end-users.
Air conditioning
and heating equipment is sold to the replacement and new construction markets for both residential and commercial applications. The residential replacement market has increased in size and importance over the past several years as a result of the
aging of the installed base of residential central air conditioners and furnaces, the introduction of new higher energy efficient models, the remodeling and expansion of existing homes, the addition of central air conditioning to homes that
previously had only heating products and consumers overall unwillingness to live without air conditioning or heating products. The mechanical life of central air conditioning and furnaces varies by geographical region due to usage and ranges
from approximately 8 to 20 years. According to data published by the Energy Information Administration in 2013 there are approximately 89 million central air conditioning and heating systems installed in the United States that have been in
service for more than 10 years. Many installed units are currently reaching the end of their useful lives, which we believe will provide a growing and stable replacement market.
Additionally, we sell a variety of
non-equipment
products, representing more than 300,000 SKUs, including parts,
ductwork, air movement products, insulation, tools, installation supplies, thermostats and air quality products. We distribute products manufactured by Honeywell International, Inc. (Honeywell), Johns Manville (Johns
Manville) and Owens Corning Insulating Systems, LLC (Owens Corning), among others.
We also sell products to the refrigeration market.
These products include condensing units, compressors, evaporators, valves, refrigerant,
walk-in
coolers and ice machines for industrial and commercial applications. We distribute products manufactured by
Copeland Compressor Corporation, a subsidiary of Emerson Electric Co. (Emerson), The Chemours Company (Chemours), Mueller Industries, Inc. (Mueller) and Welbilt, Inc. (Welbilt), among others.
Culture and Business Strategy
We have built our network
of locations using a buy and build philosophy, which has produced substantial historical long-term growth in revenues and profits. The buy component of the strategy has focused on acquiring market leaders to either expand
into new geographic areas or gain additional market share in existing markets. We have employed a disciplined and conservative approach which seeks opportunities that fit well-defined financial and strategic criteria. The build component
of the strategy has focused on implementing a growth culture at acquired companies, by adding products and locations to better serve customers, investing in scalable technologies and exchanging ideas and business concepts amongst the executive
management teams. Newly acquired businesses have access to our capital resources and established vendor relationships to provide their customers with an expanded array of product lines on favorable terms and conditions with an intensified commitment
to service. We have also developed a culture whereby leaders, managers and employees are provided the opportunity to own shares of Watsco through a variety of stock-based equity plans. We believe that this culture instills a performance-driven,
long-term focus on the part of our employees and aligns their interests with the interests of other Watsco shareholders.
4
Strategy in Existing Markets
Our strategy for growth in existing markets focuses on customer service and product expansion to satisfy the needs of the higher growth, higher margin
replacement market, in which customers generally demand immediate, convenient and reliable service. We respond to this need by (i) offering a broad range of product lines, including the necessary equipment, parts and supplies to enable a
contractor to install or repair a central air conditioner, furnace or refrigeration system, (ii) maintaining a strong density of warehouse locations for increased customer convenience, (iii) maintaining well-stocked inventories to ensure
that customer orders are filled in a timely manner, (iv) providing a high degree of technical expertise at the point of sale and (v) developing and implementing technology to further enhance customer service capabilities. We believe these
concepts provide a competitive advantage over smaller, less-capitalized competitors that are unable to commit resources to open and maintain additional locations, implement technological business solutions, provide the same range of products,
maintain the same inventory levels or attract the wide range of expertise that is required to support a diverse product offering. In some geographic areas, we believe we have a competitive advantage over factory-operated distribution networks, which
typically do not maintain inventories of parts and supplies that are as diversified as ours and which have fewer warehouse locations than we do, making it more difficult for these competitors to meet the time-sensitive demands of the replacement
market.
In addition to the replacement market, we sell to the new construction market, including new homes and commercial construction. We believe our
reputation for reliable, high-quality service and relationships with contractors, who may serve both the replacement and new construction markets, allow us to compete effectively in these markets.
Technology Strategy
We are actively transforming our
business by investing in scalable technology platforms to further strengthen our leadership position, accelerate sales and profit growth, increase the speed and convenience of serving customers and extend our reach into new geographies and sales
channels. Our initiatives include: (i) the development and implementation of mobile applications for iOS and Android devices focused on helping our customers operate more efficiently and interact with our locations more easily;
(ii) enabling
e-commerce
between our customers and our subsidiaries; (iii) supply chain optimization; (iv) building the largest source of digitized HVAC/R product information; (v) the
development and implementation of business analytics systems and related data sets, which provide enhanced management tools; and (vi) maintaining our website, ACDoctor.com, which educates consumers about energy efficient HVAC solutions and
financial incentives related to the installation of energy efficient systems and connects them with high quality contractors.
Performance-Based
Compensation & Stock-Based Equity Plans
We maintain a culture that rewards performance through a variety of performance-based pay, commission
programs, cash incentives and stock-based equity programs. Stock-based plans include 401(k) matching contributions to eligible employees, a voluntary employee stock purchase plan and the granting of stock options and
non-vested
restricted stock based on individual merit and measures of performance. Our equity compensation plans are designed to promote long-term performance, as well as to create long-term employee
retention, continuity of leadership and an ownership culture whereby management and employees think and act as owners of the Company. We believe that our restricted stock program is unique because an employees restricted share
grants generally vest entirely at the end of his or her career (age 62 or later) and, prior to retirement, these grants remain subject to significant risks of forfeiture.
Product Line Expansion
We actively seek new or expanded
territories of distribution from our key equipment suppliers. We continually evaluate new parts and supply products to support equipment sales and further enhance service to our customers. This initiative includes increasing the product offering
with existing vendors and identifying new product opportunities through traditional and
non-traditional
supply channels. We have also introduced private-label products as a means to obtain market share and
grow revenues. We believe that our private-label branded products complement our existing product offerings at selected locations, based on customer needs and the particular market position and price of these products.
Acquisition Strategy
We focus on acquiring businesses
that either complement our current presence in existing markets or establish a presence in new geographic markets. Since 1989, we have acquired 59 HVAC/R distribution businesses, six of which currently operate as primary operating subsidiaries. The
other smaller acquired distributors have been integrated into or are under the management of our primary operating subsidiaries. Through a combination of sales and market share growth, opening of new locations,
tuck-in
acquisitions, expansion of product lines, improved pricing and programs that have resulted in higher gross profit, performance incentives and a culture of equity value for key leadership, we have
produced substantial sales and earnings growth post-acquisition. We continue to pursue additional strategic acquisitions and/or joint ventures to allow further penetration in existing markets and expansion into new geographic markets.
5
Operating Philosophy
We encourage our local leadership to operate in a manner that builds upon the long-term relationships they have established with their suppliers and customers.
Typically, we maintain the identity and culture of businesses by retaining their historical trade names, management teams and sales organizations and continuity of their product brand-name offerings. We believe this strategy allows us to build on
the value of the acquired operations by creating additional sales opportunities while providing an attractive exit strategy for the former owners of these companies.
We maintain a specialized staff at our corporate headquarters that provides functional support for our subsidiaries growth strategies in their
respective markets. Such functional support staff includes specialists in finance, accounting, product procurement, information technology, treasury and working capital management, tax planning, risk management and safety. Certain general and
administrative expenses are targeted for cost savings by leveraging the overall business volume and improving operating efficiencies.
DESCRIPTION OF
BUSINESS
Products
We sell an expansive line of
products and maintain a diverse mix of inventory to meet our customers immediate needs, and we seek to provide products a contractor would generally require when installing or repairing a central air conditioner, furnace or refrigeration
system on short notice. The cooling capacity of air conditioning units is measured in tons. One ton of cooling capacity is equivalent to 12,000 British Thermal Units (BTUs) and is generally adequate to air condition approximately 500
square feet of residential space. The products we distribute consist of: (i) equipment, including residential ducted and ductless air conditioners ranging from 1 to 5 tons, gas, electric and oil furnaces ranging from 50,000 to 150,000 BTUs,
commercial air conditioning and heating equipment and systems ranging from
1-1/2
to 25 tons and other specialized equipment, (ii) parts, including replacement compressors, evaporator coils, motors and
other component parts and (iii) supplies, including thermostats, insulation material, refrigerants, ductwork, grills, registers, sheet metal, tools, copper tubing, concrete pads, tape, adhesives and other ancillary supplies.
Sales of HVAC equipment, which we currently source from approximately 20 vendors, accounted for 66% of our revenues for both the years ended December 31,
2016 and 2015. Sales of other HVAC products, which we currently source from approximately 1,200 vendors, comprised 29% of our revenues for both the years ended December 31, 2016 and 2015. Sales of commercial refrigeration products, which we
currently source from approximately 150 vendors, accounted for 5% of our revenues for both the years ended December 31, 2016 and 2015.
Distribution and Sales
At December 31, 2016, we
operated from 565 locations, a vast majority of which are located in regions that we believe have demographic trends favorable to our business. We maintain large inventories at each of our warehouse locations, and either deliver products to
customers using one of our trucks or a third party logistics provider, or we make products available for
pick-up
at the location nearest to the customer. We have approximately 1,000 commissioned salespeople,
averaging more than 10 years of experience in the HVAC/R distribution industry.
The markets we serve are as follows:
|
|
|
|
|
|
|
|
|
|
|
% of Revenues for
the Year Ended
December 31, 2016
|
|
|
Number of
Locations as of
December 31, 2016
|
|
United States
|
|
|
87
|
%
|
|
|
507
|
|
Latin America and the Caribbean
|
|
|
7
|
%
|
|
|
21
|
|
Canada
|
|
|
6
|
%
|
|
|
37
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
|
100
|
%
|
|
|
565
|
|
|
|
|
|
|
|
|
|
|
The largest market we serve is the United States, in which the most significant markets for HVAC/R products are in the Sun
Belt States. Accordingly, the majority of our distribution locations are in the Sun Belt, with the highest concentration in Florida and Texas. These markets have been a strategic focus of ours given their size, the reliance by homeowners and
businesses on HVAC/R products to maintain a comfortable indoor environment and the population growth in these areas over the last 40 years, which has led to a substantial installed base requiring replacement, a shorter useful life for equipment
given the hours of operation and the focus by electrical utilities on consumer incentives designed to promote replacement of HVAC/R equipment in an effort to improve energy efficiency.
6
Markets
The
table below identifies the number of our stores by location as of December 31, 2016:
|
|
|
|
|
Florida
|
|
|
107
|
|
Texas
|
|
|
82
|
|
North Carolina
|
|
|
37
|
|
California
|
|
|
36
|
|
Georgia
|
|
|
36
|
|
South Carolina
|
|
|
29
|
|
Tennessee
|
|
|
22
|
|
Virginia
|
|
|
22
|
|
Louisiana
|
|
|
19
|
|
New York
|
|
|
13
|
|
Alabama
|
|
|
9
|
|
Mississippi
|
|
|
9
|
|
Massachusetts
|
|
|
8
|
|
Missouri
|
|
|
8
|
|
Maryland
|
|
|
7
|
|
Arizona
|
|
|
6
|
|
Arkansas
|
|
|
6
|
|
Connecticut
|
|
|
6
|
|
Kansas
|
|
|
5
|
|
New Jersey
|
|
|
5
|
|
Oklahoma
|
|
|
5
|
|
Utah
|
|
|
5
|
|
Maine
|
|
|
3
|
|
Iowa
|
|
|
2
|
|
Kentucky
|
|
|
2
|
|
Nebraska
|
|
|
2
|
|
Nevada
|
|
|
2
|
|
Pennsylvania
|
|
|
2
|
|
Rhode Island
|
|
|
2
|
|
South Dakota
|
|
|
2
|
|
West Virginia
|
|
|
2
|
|
Colorado
|
|
|
1
|
|
Indiana
|
|
|
1
|
|
New Hampshire
|
|
|
1
|
|
New Mexico
|
|
|
1
|
|
North Dakota
|
|
|
1
|
|
Vermont
|
|
|
1
|
|
|
|
|
|
|
United States
|
|
|
507
|
|
Canada
|
|
|
37
|
|
Mexico
|
|
|
12
|
|
Puerto Rico
|
|
|
9
|
|
|
|
|
|
|
Total
|
|
|
565
|
|
|
|
|
|
|
Joint Ventures with Carrier Corporation
In 2009, we formed a joint venture with Carrier, which we refer to as Carrier Enterprise I, in which Carrier contributed 95 of its company-owned locations in
13 Sun Belt states and Puerto Rico and its export division in Miami, Florida, and we contributed 15 locations that distributed Carrier products. In July 2012, we exercised our option to acquire an additional 10% ownership interest in Carrier
Enterprise I, which increased our ownership interest to 70%; and, on July 1, 2014, we exercised our last remaining option to acquire an additional 10% ownership interest in Carrier Enterprise I, which increased our controlling interest to 80%.
Neither we nor Carrier has any remaining options to purchase additional ownership interests in Carrier Enterprise I, or any of our other joint ventures with Carrier, which are described below.
7
In 2011, we formed a second joint venture with Carrier and completed two additional transactions. In April 2011,
Carrier contributed 28 of its company-owned locations in eight Northeast U.S. states, and we contributed 14 locations in the Northeast United States. In July 2011, we purchased Carriers distribution operations in Mexico, which included seven
locations. Collectively, the Northeast locations and the Mexico operations are referred to as Carrier Enterprise II. Following formation of this joint venture, we owned a 60% controlling interest. On November 29, 2016, we purchased an
additional 10% ownership interest in Carrier Enterprise II, and, on February 13, 2017, we again purchased an additional 10% ownership interest in Carrier Enterprise II, which together increased our controlling interest to 80%.
In 2012, we formed a third joint venture, which we refer to as Carrier Enterprise III, with UTC Canada Corporation, referred to as UTC Canada, an affiliate of
Carrier. Carrier contributed 35 of its company-owned locations in Canada to Carrier Enterprise III. We have a 60% controlling interest in Carrier Enterprise III, and UTC Canada has a 40%
non-controlling
interest.
Combined, the joint ventures with Carrier represented 61% of our revenues for the year ended December 31, 2016. See
Supplier
Concentration
in Business Risk Factors in Item 1A.
The business and affairs of the joint ventures are controlled, directed and managed
exclusively by Carrier Enterprise Is, Carrier Enterprise IIs and Carrier Enterprise IIIs respective boards of directors (the Boards) pursuant to related operating agreements. The Boards have full, complete and exclusive
authority, power and discretion to manage and control the business, property and affairs of their respective joint ventures and to make all decisions regarding those matters and to perform activities customary or incident to the management of such
joint ventures, including approval of distributions to us, Carrier and UTC Canada. Each Board is composed of five directors, of whom three directors represent our controlling interest and two directors represent Carriers
non-controlling
interest. Matters presented to the Boards for vote are considered approved or consented to upon the receipt of the affirmative vote of at least a majority of all directors entitled to vote with the
exception of certain governance matters, which require joint approval.
Customers and Customer Service
Air conditioning and heating contractors and dealers that install HVAC/R products in homes and businesses must be licensed given the highly-regulated nature of
the products, refrigerant, natural gas and building and zoning requirements. We currently serve approximately 88,000 active contractors and dealers who service the replacement and new construction markets for residential and light commercial central
air conditioning, heating and refrigeration systems. No single customer in 2016, 2015 or 2014 represented more than 2% of our consolidated revenues. We focus on providing products where and when the customer needs them, technical support by phone or
on site as required, and quick and efficient service at our locations. Increased customer convenience is also provided through mobile applications and
e-commerce,
which allows customers to access information
online 24 hours a day, seven days a week to search for desired products, verify inventory availability, obtain pricing, place orders, check order status, schedule pickup or delivery times and make payments. We believe we compete successfully with
other distributors primarily on the basis of an experienced sales organization, strong service support, maintenance of well-stocked inventories, density of warehouse locations, high quality reputation, broad product lines and the ability to foresee
customer demand for new products.
Key Supplier Relationships
Given our leadership position, Watsco represents a strategic business relationship to many of the leading manufacturers in our industry. Significant
relationships with HVAC/R equipment manufacturers include Carrier, Rheem, Goodman, Welbilt, Mitsubishi Electric Corporation, Gree Electric Appliances, Inc., Trane, Midea Group and Nordyne. In addition, we have substantial relationships with
manufacturers of
non-equipment
HVAC/R products, including Chemours, Emerson, Flexible Technologies, Inc., Honeywell, Johns Manville, Mueller and Owens Corning.
We believe the diversity of products that we sell, along with the manufacturers current product offerings, quality, marketability and brand-name
recognition, allow us to operate favorably relative to our competitors. To maintain brand-name recognition, the HVAC/R equipment manufacturers provide national advertising and participate with us in cooperative advertising programs and promotional
incentives that are targeted to both dealers and
end-users.
We estimate that the replacement market for residential air conditioning equipment is approximately 85% of industry unit sales in the United States,
and we expect this percentage to increase as units installed in the past 20 years wear out or otherwise become practical to replace sooner with newer, more energy-efficient models.
8
The Companys top ten suppliers accounted for 85% of our purchases, including 62% from Carrier and 10% from
Rheem. Given the significant concentration of our suppliers, particularly with Carrier and Rheem, any significant interruption with these suppliers could temporarily disrupt the operations of certain of our subsidiaries, impact current inventory
levels and could adversely affect our financial results. If any restrictions or significant increase in tariffs under existing trade agreements or the elimination of the North American Free Trade Agreement (NAFTA) are imposed on products
that our top ten suppliers import or assemble products outside of the United States, particularly from Mexico and China, we could be required to raise our prices, which may result in the loss of customers and harm to our business. Future financial
results are also materially dependent upon the continued market acceptance of these manufacturers respective products and their ability to continue to manufacture products that comply with laws relating to environmental and efficiency
standards. However, the Company believes that alternative or substitute products would be readily available in the event of disruption of current supplier relationships given the Companys prominence in the marketplace, including the number of
locations, sales personnel, support structure, marketing and sales expertise, financial position and established market share. See Business Risk Factors in Item 1A of this Annual Report on Form
10-K
for further discussion.
Distribution Agreements
We maintain trade name and distribution agreements with Carrier and Rheem that provide us distribution rights on an exclusive basis in specified territories
that are not subject to a stated term or expiration date. We also maintain distribution agreements with various other suppliers, either on an exclusive or
non-exclusive
basis, for various terms ranging from
one to ten years. Certain distribution agreements contain provisions that restrict or limit the sale of competitive products in the locations that sell such branded products. Other than where such location-level restrictions apply, we may distribute
the lines of other manufacturers air conditioning or heating equipment in other locations in the same territories.
See
Supplier
Concentration
in Business Risk Factors in Item 1A of this Annual Report on Form
10-K.
Seasonality
Sales of residential central air
conditioners, heating equipment and parts and supplies are seasonal. Furthermore, profitability 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 typically highest in the second and third quarters, and demand for heating equipment is usually highest in the fourth quarter. Demand related to the new construction sectors throughout
most of the markets is fairly even during the year except for dependence on housing completions and related weather and economic conditions.
Competition
We operate in highly competitive
environments. We compete with a number of distributors and also with several air conditioning and heating equipment manufacturers that distribute a significant portion of their products through their own distribution organizations in certain
markets. Competition within any given geographic market is based upon product availability, customer service, price and quality. Competitive pressures or other factors could cause our products or services to lose market acceptance or result in
significant price erosion, all of which would have a material adverse effect on our results of operations, cash flows and liquidity.
Employees
We had approximately 5,050 employees as of December 31, 2016, substantially all of which are
non-union
employees. Most of these employees are employed on a full-time basis and our relations with our employees are good.
Order Backlog
Order backlog is not a material aspect of our business, and no material portion of our business is subject to government contracts.
Government Regulations, Environmental and Health and Safety Matters
Our business is subject to federal, state and local laws and regulations relating to the storage, handling, transportation and release of hazardous materials
into the environment. These laws and regulations include the Clean Air Act, relating to minimum energy efficiency standards of HVAC systems and the production, servicing and disposal of certain
ozone-depleting
refrigerants used in such systems, including those established at the Montreal Protocol in 1992 concerning the
phase-out
of the production of
CFC-based
refrigerants on
January 1, 2010 for use in new equipment. We are also subject to regulations concerning the transport of hazardous materials, including regulations adopted pursuant to the Motor Carrier Safety Act of 1990. Our operations are also subject to
health and safety requirements including the Occupational, Safety and Health Act. We believe that we operate our business in compliance with all applicable federal, state and local laws, rules and regulations.
9
Our industry and business are also subject to a United States Department of Energy (DOE) mandate,
effective January 1, 2015, that effects changes to the minimum required efficiency of HVAC systems. The DOE has divided the United States into three regions, the North, the Southeast and the Southwest, according to the number of hours that an
air conditioner spends cooling a home during the hotter months. Prior to 2015, there was a national minimum standard for energy efficiency of 13 SEER (seasonal energy efficiency rating, the metric used to measure energy efficiency) for all equipment
produced in the United States. Beginning in 2015, the new standard increased the minimum allowed efficiency to 14 SEER for the Southeast and Southwest regions. During 2015, the Company began transitioning out of its 13 SEER inventory in these
regions while an increasing mix of higher-efficiency 14 SEER inventory was purchased and sold. This transition was completed during 2016 in accordance with the timeline required by the mandate.
Financial Information About Geographic Areas
Our
operations are primarily within the United States, including Puerto Rico, Canada and Mexico. Products are also sold from the United States on an export-only basis to portions of Latin America and the Caribbean Basin. The following tables set forth
revenues and long-lived assets by geographic area (in millions):
|
|
|
|
|
|
|
|
|
|
|
|
|
Years Ended December 31,
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
3,813
|
|
|
$
|
3,711
|
|
|
$
|
3,525
|
|
Canada
|
|
|
267
|
|
|
|
264
|
|
|
|
301
|
|
Mexico
|
|
|
141
|
|
|
|
138
|
|
|
|
119
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Revenues
|
|
$
|
4,221
|
|
|
$
|
4,113
|
|
|
$
|
3,945
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31,
|
|
2016
|
|
|
2015
|
|
|
2014
|
|
Long-Lived Assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
United States
|
|
$
|
468
|
|
|
$
|
442
|
|
|
$
|
435
|
|
Canada
|
|
|
156
|
|
|
|
155
|
|
|
|
187
|
|
Mexico
|
|
|
5
|
|
|
|
5
|
|
|
|
5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Long-Lived Assets
|
|
$
|
629
|
|
|
$
|
602
|
|
|
$
|
627
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenues are attributed to countries based on the location of the store from which the sale occurred. Long-lived assets
consist of property and equipment, goodwill and intangible assets.
Available Information
Our website is at
www.watsco.com
. Our investor relations website is located at
www.investors.watsco.com
. We make available, free of charge, on
our investor relations website under the heading SEC Filings our annual reports on Form
10-K,
quarterly reports on Form
10-Q,
current reports on Form
8-K
and any amendments to those reports filed with or furnished to the Securities and Exchange Commission (the SEC) pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended,
as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Our website address is included in this report only as an inactive textual reference. Information contained on, or available through, our
website is not incorporated by reference in, or made a part of, this report.
Business Risk Factors
Supplier Concentration
The Companys top ten
suppliers accounted for 85% of our purchases during 2016, including 62% from Carrier and 10% from Rheem. Given the significant concentration of our supply chain, particularly with Carrier and Rheem, any significant interruption by any of the key
manufacturers or a termination of a relationship could temporarily disrupt the operations of certain of our subsidiaries. Additionally, our operations are materially dependent upon the continued market acceptance and quality of these
manufacturers products and their ability to continue to manufacture products that are competitive and that comply with laws relating to environmental and efficiency standards. Our inability to obtain products from one or more of these
manufacturers or a decline in market acceptance of these manufacturers products could have a material adverse effect on our results of operations, cash flows and liquidity.
10
Many HVAC equipment and component manufacturers, including Carrier and Rheem, source component parts and/or
assemble a significant amount of products for residential and light-commercial applications from Mexico. If any restrictions or significant increases in tariffs are imposed related to such products sourced or assembled from Mexico, whether as a
result of amendments to existing trade agreements or the elimination of NAFTA, and our product costs consequently increase, we would be required to raise our prices, which may result in cost inflation, the loss of customers and harm to our business.
We maintain trade name and distribution agreements with Carrier and Rheem that provide us distribution rights on an exclusive basis in specified
territories. Such agreements are not subject to a stated term or expiration date.
We also maintain other distribution agreements with various other
suppliers, either on an exclusive or
non-exclusive
basis, for various terms ranging from one to ten years. Certain of the distribution agreements contain provisions that restrict or limit the sale of
competitive products in the locations that sell such branded products. Other than where such location-level restrictions apply, we may distribute other manufacturers lines of air conditioning or heating equipment in other locations in the same
territories.
Risks Inherent in Acquisitions
As part
of our strategy, we intend to pursue additional acquisitions of complementary businesses, including through joint ventures. If we complete future acquisitions or enter into new joint ventures, we may be required to incur or assume additional debt
and/or issue additional shares of our common stock as consideration, which will dilute our existing shareholders ownership interest in us and may affect our results of operations. Growth through acquisitions involves a number of risks,
including, but not limited to, the following:
|
|
|
the ability to identify and consummate transactions with complementary acquisition candidates;
|
|
|
|
the successful operation and/or integration of acquired companies;
|
|
|
|
diversion of managements attention from other daily functions;
|
|
|
|
issuance by us of equity securities that would dilute ownership of our existing shareholders;
|
|
|
|
incurrence and/or assumption of significant debt and contingent liabilities; and
|
|
|
|
possible loss of key employees and/or customer relationships of the acquired companies.
|
In addition, acquired
companies may have liabilities that we failed, or were unable, to discover in the course of performing due diligence investigations. We cannot assure you that the indemnification, if any, granted to us by sellers of acquired companies or by joint
venture partners will be sufficient in amount, scope or duration to offset the possible liabilities associated with businesses or properties that we assume upon consummation of an acquisition or joint venture. Any such liabilities, individually or
in the aggregate, could have a material adverse effect on our business.
Failure to successfully manage the operational challenges and risks associated
with, or resulting from, acquisitions could adversely affect our results of operations, cash flows and liquidity.
Competition
We operate in highly competitive environments. We compete with a number of distributors and also with several air conditioning and heating equipment
manufacturers that distribute a significant portion of their products through their own distribution organizations in certain markets. Competition within any given geographic market is based upon product availability, customer service, price and
quality. Competitive pressures or other factors could cause our products or services to lose market acceptance or result in significant price erosion, all of which would have a material adverse effect on our results of operations, cash flows and
liquidity.
Foreign Currency Exchange Rate Fluctuations
The functional currency of our operations in Canada is the Canadian dollar, and the functional currency of our operations in Mexico is the U.S. dollar because
the majority of our Mexican transactions are denominated in U.S. dollars. Foreign currency exchange rates and fluctuations may have an impact on transactions denominated in Canadian dollars and Mexican Pesos, and, therefore, could adversely affect
our financial performance. Although we use foreign currency forward contracts to mitigate the impact of currency exchange rate movements, we do not currently hold any derivative contracts that hedge our foreign currency translational exposure.
11
Seasonality
Sales of residential central air conditioners, heating equipment and parts and supplies are seasonal, resulting in fluctuations in our revenue from quarter to
quarter. Furthermore, profitability 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 typically highest in the second and third quarters, and demand for heating equipment is usually highest in the fourth quarter. Demand related to the new construction sectors throughout most of the markets is fairly even during the year except for
dependence on housing completions and related weather and economic conditions.
Dependence on Key Personnel
Much of our success has depended on the skills, experience and services of senior management personnel. The loss of any of our executive officers or other key
senior management personnel could harm our business. We must continue to recruit, retain and motivate management and other employees sufficiently in order to both maintain our current business and to execute our strategic initiatives. Our success
has also substantially depended on the contributions and abilities of our store employees whom we rely on to give customers a superior
in-store
experience. Accordingly, our performance depends on our ability
to recruit and retain high quality employees to work in and manage our stores. If we are unable to recruit, retain and motivate employees sufficiently in order to maintain our current business and support our projected growth and expansion, our
business and financial performance may be adversely affected.
Decline in Economic Conditions
We rely predominantly on the credit markets and, to a lesser extent, on the capital markets to meet our financial commitments and short-term liquidity needs if
internal funds are not available from our operations. Our access to funds under our line of credit is dependent on the ability of the syndicate banks to meet their respective funding commitments. Disruptions in the credit and capital markets could
adversely affect our ability to draw on our line of credit and may also affect the determination of certain interest rates, particularly rates based on LIBOR, which is one of the base rates under our line of credit. Any disruptions in these markets
could result in increased borrowing costs and/or reduced borrowing capacity under our line of credit. Any long-term disruption could require that we take measures to conserve cash until the markets stabilize or until alternative credit arrangements
or other funding for our business needs can be arranged. Such measures could include reducing or eliminating dividend payments, deferring capital expenditures and reducing or eliminating discretionary uses of cash.
A decline in economic conditions and lack of availability of business and consumer credit could have an adverse effect on our business and results of
operations. Any capital and credit market disruption could cause broader economic downturns, which may lead to reduced demand for our products and increased incidence of customers inability to pay their accounts. Further, bankruptcies or
similar events by customers may cause us to incur bad debt expense at levels higher than historically experienced. Also, our suppliers may be negatively impacted by deteriorating economic conditions, causing disruption or delay of product
availability. These events would adversely impact our results of operations, cash flows and financial position. Additionally, if the conditions of the capital and credit markets adversely affect the financial institutions that have committed to
extended credit to us, they may be unable to fund borrowings under such commitments, which could have an adverse impact on our financial condition, liquidity and our ability to borrow funds, if needed, for working capital, acquisitions, capital
expenditures and other corporate purposes.
International Political Risk
Our international sales and operations, as well as sourcing of products from suppliers with international operations, are subject to various risks associated
with changes in local laws, regulations and policies, including those related to tariffs, trade restrictions and trade agreements, investments, taxation, capital controls, employment regulations, different liability standards and limitations on the
repatriation of funds due to foreign currency controls. Our international sales and operations, as well as sourcing of products from suppliers with international operations are also sensitive to changes in foreign national priorities, including
government budgets, as well as political and economic instability. Unfavorable changes in any of the foregoing could adversely affect our results of operations or could cause a disruption in our supply chain for products sourced internationally.
Additionally, failure to comply with the United States Foreign Corrupt Practices Act could subject us to, among other things, penalties and legal expenses that could harm our reputation and have a material adverse effect on our business, financial
condition and results of operations.
12
General Risk Factors
Goodwill and Intangibles
At December 31, 2016,
goodwill and intangibles represented approximately 29% of our total assets. The recoverability of goodwill and indefinite lived intangibles is evaluated at least annually and when events or changes in circumstances indicate that the carrying amounts
may not be recoverable. The identification and measurement of goodwill impairment involves the estimation of the fair value of our reporting unit and contains uncertainty because management must use judgment in determining appropriate assumptions to
be used in the measurement of fair value. The estimates of fair value of our reporting unit and indefinite lived intangibles are based on the best information available as of the date of the assessment and incorporates managements assumptions
about expected future cash flows and contemplates other valuation techniques. Future cash flows can be affected by changes in the industry, a declining economic environment or market conditions. We cannot assure you that we will not suffer material
impairments to goodwill in the future.
Risks Related to Insurance Coverage
We carry general liability, comprehensive property damage, workers compensation, health benefits and other insurance coverage that management considers
adequate for the protection of its assets and operations. There can be no assurance, however, that the coverage limits of such policies will be adequate to cover losses and expenses for lawsuits brought or which may be brought against us. A loss in
excess of insurance coverage could have a material adverse effect on our financial position and/or profitability. Certain self-insurance risks for casualty insurance programs and health benefits are retained and reserves are established based on
claims filed and estimates of claims incurred but not yet reported. Assurance cannot be provided that actual claims will not exceed present estimates. Exposure to catastrophic losses has been limited by maintaining excess and aggregate liability
coverage and implementing stop-loss control programs.
Insider Ownership
As of December 31, 2016, our directors and executive officers and entities affiliated with them owned (i) Common stock representing 1% of the
outstanding shares of Common stock and (ii) Class B common stock representing 89% of the outstanding shares of Class B common stock. These interests represent 56% of the aggregate combined voting power (including 53% beneficially
owned by Albert H. Nahmad, Chairman and Chief Executive Officer, through shares owned by him and shares held by affiliated limited partnerships and various family trusts). Accordingly, our directors and executive officers collectively have the
voting power to elect six members of our nine-person Board of Directors.