<PAGE> 1
- --------------------------------------------------------------------------------
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number: 1-11849
AMERICAN RESIDENTIAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C>
DELAWARE 76-0484996
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
POST OAK TOWER, SUITE 725 77056-5604
5051 WESTHEIMER ROAD (Zip code)
HOUSTON, TEXAS
(Address of principal executive offices)
</TABLE>
(713) 599-0100
(Registrant's telephone number, including area code)
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 [ ]
At November 13, 1998, 15,902,533 shares of Common Stock, par value $.001
per share, of the registrant were outstanding.
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<PAGE> 2
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
PART I -- FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 5,190 $ 2,929
Accounts receivable --
Trade, net of allowance of $2,315 and $2,584........... 47,383 67,366
Other.................................................. 8,821 7,038
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................. 5,337 8,602
Inventories............................................... 17,847 16,001
Prepaid expenses and other current assets................. 3,282 7,504
Net assets held for resale................................ 425 --
-------- --------
Total current assets.............................. 88,285 109,440
PROPERTY AND EQUIPMENT, net................................. 35,528 33,237
GOODWILL, net............................................... 205,528 224,480
OTHER NONCURRENT ASSETS..................................... 5,972 8,214
-------- --------
Total assets...................................... $335,313 $375,371
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt...................... $ 1,284 $ 953
Accounts payable and accrued liabilities.................. 53,409 59,621
Unearned revenue on service and warranty contracts........ 6,001 6,816
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 4,497 5,059
-------- --------
Total current liabilities......................... 65,191 72,449
LONG-TERM DEBT, net of current maturities................... 135,087 158,525
UNEARNED REVENUE ON SERVICE AND WARRANTY CONTRACTS.......... 472 376
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Preferred stock, $.001 par value, 10,000,000 shares
authorized; none issued and outstanding................ -- --
Common stock, $.001 par value, 50,000,000 shares
authorized; 15,321,322 and 15,902,533 shares issued and
outstanding............................................ 15 16
Additional paid-in capital................................ 152,983 158,362
Retained deficit.......................................... (18,435) (14,357)
-------- --------
Total stockholders' equity........................... 134,563 144,021
-------- --------
Total liabilities and stockholders' equity........ $335,313 $375,371
======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE> 3
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED SEPTEMBER 30, ENDED SEPTEMBER 30,
------------------- ---------------------
1997 1998 1997 1998
-------- -------- --------- ---------
<S> <C> <C> <C> <C>
REVENUES............................................ $109,500 $138,750 $272,781 $370,380
COST OF SERVICES.................................... 79,200 106,144 194,512 278,345
-------- -------- -------- --------
Gross profit...................................... 30,300 32,606 78,269 92,035
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES........ 21,925 26,430 56,051 73,091
SPECIAL CHARGE...................................... -- -- -- 1,270
-------- -------- -------- --------
INCOME FROM OPERATIONS.............................. 8,375 6,176 22,218 17,674
OTHER INCOME (EXPENSE):
Interest expense.................................. (2,147) (3,716) (4,955) (9,443)
Interest income................................... 56 31 140 201
Other, net........................................ 123 (99) 683 714
-------- -------- -------- --------
INCOME FROM OPERATIONS BEFORE INCOME TAXES AND
EXTRAORDINARY ITEM................................ 6,407 2,392 18,086 9,146
PROVISION FOR INCOME TAXES.......................... 2,819 1,627 7,838 4,768
-------- -------- -------- --------
NET INCOME BEFORE EXTRAORDINARY ITEM................ 3,588 765 10,248 4,378
EXTRAORDINARY ITEM -- LOSS ON REFINANCING OF
REVOLVING CREDIT FACILITY, NET OF INCOME TAX
BENEFIT........................................... -- -- -- (300)
-------- -------- -------- --------
NET INCOME.......................................... $ 3,588 $ 765 $ 10,248 $ 4,078
======== ======== ======== ========
BASIC WEIGHTED AVERAGE SHARES OUTSTANDING........... 14,811 15,884 14,008 15,635
======== ======== ======== ========
BASIC EARNINGS PER SHARE BEFORE EXTRAORDINARY
ITEM.............................................. $ 0.24 $ 0.05 $ 0.73 $ 0.28
EXTRAORDINARY ITEM.................................. -- -- -- (0.02)
-------- -------- -------- --------
BASIC EARNINGS PER SHARE............................ $ 0.24 $ 0.05 $ 0.73 $ 0.26
======== ======== ======== ========
DILUTED WEIGHTED AVERAGE SHARES OUTSTANDING......... 15,262 15,884 14,457 15,683
======== ======== ======== ========
DILUTED EARNINGS PER SHARE BEFORE EXTRAORDINARY
ITEM.............................................. $ 0.24 $ 0.05 $ 0.71 $ 0.28
EXTRAORDINARY ITEM.................................. -- -- -- (0.02)
-------- -------- -------- --------
DILUTED EARNINGS PER SHARE.......................... $ 0.24 $ 0.05 $ 0.71 $ 0.26
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 4
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
---------------------
1997 1998
--------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 10,248 $ 4,078
Adjustments to reconcile net income to net cash provided
by (used in) operating activities --
Depreciation and amortization......................... 8,104 9,427
Deferred tax expense.................................. 761 355
Gain on sale of property and equipment................ (229) (489)
Current taxes on acquired S corporations.............. 826 --
Special charge and other costs........................ -- 1,270
Extraordinary item.................................... -- 300
Changes in operating assets and liabilities --
(Increase) decrease in --
Accounts receivable, net......................... (10,059) (10,082)
Costs and estimated earnings in excess of
billings on uncompleted contracts............... (2,805) (2,966)
Inventories...................................... (2,117) 2,791
Prepaid expenses and other current assets........ (2,726) (4,170)
Other noncurrent assets.......................... 328 (2,433)
Increase (decrease) in --
Accounts payable and accrued liabilities......... (10,847) 503
Unearned revenue on service and warranty
contracts....................................... 3,460 345
Billings in excess of costs and estimated
earnings on uncompleted contracts............... 166 (876)
Other, net............................................ -- (1,679)
--------- --------
Net cash used in operating activities.............. (4,890) (3,626)
--------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to property and equipment....................... (7,763) (5,609)
Proceeds from sales of property and equipment............. 508 3,037
Cash paid for business acquisitions, net of cash
acquired................................................ (37,692) (10,840)
--------- --------
Net cash used in investing activities.............. (44,947) (13,412)
--------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Principal payments on long-term debt...................... (133,659) (73,093)
Proceeds from borrowings on long-term debt................ 183,119 87,913
S corporation dividends paid by the Restated Businesses... (3,222) --
Other, net................................................ (2,661) (43)
--------- --------
Net cash provided by financing activities.......... 43,577 14,777
--------- --------
NET DECREASE IN CASH AND CASH EQUIVALENTS................... (6,260) (2,261)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD............ 9,984 5,190
--------- --------
CASH AND CASH EQUIVALENTS AT END OF PERIOD.................. $ 3,724 $ 2,929
========= ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.................................. $ 1,799 $ 6,207
Cash paid (received) for income taxes, net.............. 4,274 (901)
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE> 5
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
SEPTEMBER 30, 1998
(UNAUDITED)
1. BASIS OF PRESENTATION
In October 1995, American Residential Services, Inc. ("ARS" and,
collectively with its subsidiaries, the "Company") was founded to create a
leading national provider of (i) comprehensive maintenance, repair and
replacement services for heating, ventilating and air conditioning ("HVAC"),
plumbing, electrical, indoor air quality and other systems and major home
appliances in homes and small commercial buildings and (ii) new installation of
those systems in homes and small commercial facilities under construction
(collectively "residential services"). Through its wholly owned subsidiary,
American Mechanical Services, ARS also provides comprehensive maintenance,
repair, replacement, reconfiguration and monitoring services for HVAC, plumbing,
electrical and other systems and controls in existing large commercial,
industrial and institutional facilities such as office buildings, health care
facilities, educational facilities and retail centers (collectively, "commercial
maintenance services").
On September 27, 1996, ARS acquired in separate transactions seven
residential services businesses (the "Founding Companies") in exchange for
consideration consisting of a combination of cash and shares of its common
stock, par value $.001 per share (the "Common Stock"). The initial public
offering (the "IPO") of the Common Stock closed simultaneously with the closing
of those acquisitions. The Company purchased an additional 13 businesses during
the remainder of 1996. Since January 1, 1997 and through September 30, 1998, the
Company acquired an additional 80 businesses, of which 56 (the "Purchased
Businesses") were accounted for under the purchase method of accounting, and the
remainder (the "Pooled Businesses") were accounted for under the
pooling-of-interests method of accounting. The allocation of the purchase price
to the assets acquired and liabilities assumed in certain purchase transactions
has been recorded initially based on preliminary estimates of fair value and may
be revised as additional information concerning the valuation of such assets and
liabilities becomes available.
The historical financial statements of the Company have been retroactively
restated to give effect to the operations of 15 of the 24 Pooled Businesses (the
"Restated Businesses"). The nine remaining Pooled Businesses are not
individually significant to prior historical periods and are included in the
consolidated results of the Company beginning on their respective dates of
acquisition.
The consolidated financial statements presented herein have been prepared
by the Company without audit pursuant to the rules and regulations of the
Securities and Exchange Commission that permit certain information and footnote
disclosures normally included in financial statements prepared in accordance
with generally accepted accounting principles to be condensed or omitted. The
Company believes the presentation and disclosures herein are adequate to make
the information not misleading, and the financial statements reflect all
elimination entries and normal recurring adjustments that are necessary for a
fair presentation of the results for the three and nine months ended September
30, 1997 and 1998.
Operating results for interim periods are not necessarily indicative of the
results for a full year. These consolidated financial statements should be read
in conjunction with the consolidated financial statements of the Company and the
related notes thereto included in ARS's Annual Report on Form 10-K for the year
ended December 31, 1997 (the "1997 Form 10-K").
2. SPECIAL CHARGE AND EXTRAORDINARY ITEM
In the second quarter of 1998, the Company recorded a special one-time
charge to earnings of approximately $1.3 million which was attributable
primarily to severance costs arising from the resignation of a Company senior
executive.
In addition, the Company recorded an extraordinary charge of $560,000
($300,000 net of tax) related to the write-off of unamortized loan costs under
the Company's previous credit facility. See Note 4.
4
<PAGE> 6
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
There have been no significant changes in the accounting policies of the
Company during the periods presented. For a description of these policies, see
Note 3 of the Notes to Consolidated Financial Statements of the Company in the
1997 Form 10-K.
New Accounting Pronouncements
In April 1998, the American Institute of Certified Public Accountants
issued Statement of Position ("SOP") 98-5, "Reporting on the Costs of Start-Up
Activities." At adoption, SOP 98-5 requires the write-off of any unamortized
start-up costs as a cumulative effect of a change in accounting principle and,
going forward, the expensing of all start-up activity costs as they are
incurred. The Company plans to adopt SOP 98-5 in the first quarter of 1999 and
believes that adoption will not have a material effect on its consolidated
financial statements.
4. LONG-TERM DEBT
In the second quarter of 1998, the Company negotiated a new secured credit
facility (the "Credit Facility") with a syndicate of commercial banks and an
insurance company which increased the Company's maximum borrowing capacity from
$100 million under the Company's previous credit facility to $165 million. The
Credit Facility is comprised of a $115 million three-year revolving credit
facility (the "Revolving Credit") and a $50 million five-year term loan (the
"Term Loan"). The Company used the proceeds of the Term Loan and borrowings
under the Revolving Credit to repay the outstanding borrowings under its prior
$100 million credit facility. Subject to certain limitations, the Company may
use borrowings under the Revolving Credit for general corporate purposes,
funding the purchases of businesses and the refinancing of their indebtedness,
capital expenditures and working capital.
At the Company's option, loans under the Revolving Credit bear interest at
a designated variable base rate plus a margin ranging from 0 to 75 basis points
or at the London Interbank Offered Rate ("LIBOR") plus a margin ranging from 125
to 275 basis points. The margin varies with the ratio of the Company's total
debt to its pro forma trailing 12-month earnings before interest, taxes,
depreciation and amortization ("EBITDA"). The margin is reset on a quarterly
basis. Commitment fees of 25 to 50 basis points per annum are payable on the
unused portion of the Revolving Credit. The Revolving Credit will terminate and
all amounts borrowed, if any, will be due and payable on June 30, 2001. The
Revolving Credit also contains a $5 million sub-limit for standby letters of
credit.
The $50 million Term Loan consists of two $25 million tranches. One tranche
bears interest at a fixed rate of 8.96% while the other tranche bears interest
at the variable LIBOR plus a fixed margin of 325 basis points. Beginning April
2000, the Company is required to make quarterly principal payments of
approximately $3.6 million on the Term Loan. The final payment on the Term Loan
is due July 1, 2003.
The Credit Facility requires the consent of the lenders for acquisitions
exceeding a certain level of cash consideration, prohibits the payment of cash
dividends by ARS, limits the incurrence of other indebtedness (other than
approved subordinated indebtedness) and requires the Company to comply with
certain financial covenants, including a minimum net worth requirement, maximum
senior and total debt to pro forma EBITDA limit and minimum fixed charge and
interest coverage ratios.
Management anticipates that the Company's margin of compliance for certain
financial covenants under the Credit Facility for its reporting period for the
fourth quarter in 1998 and its reporting periods in 1999 may be lower than it
was in the reporting period in the fourth quarter of 1997 and corresponding
reporting periods in 1998. Depending on the Company's future results of
operations, the Company may attempt to negotiate a modification of certain of
these financial covenants with its Credit Facility lenders.
5
<PAGE> 7
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
The Credit Facility restricts the cash consideration (including assumed
debt) that the Company may pay for a business to be acquired if ARS does not
generate a specified minimum level of EBITDA. The Company did not meet such
minimum level of EBITDA for the quarter ended September 30, 1998. As a result,
effective as of November 15, 1998, the Company will be required to obtain the
prior written consent of the lenders under the Credit Facility prior to
consummating an acquisition in which the amount of cash consideration (including
assumed debt) that the Company would pay exceeds one times the historical
adjusted EBITDA of the acquired business. Virtually all of the Company's
acquisitions to date have involved consideration (including assumed debt) in
excess of one times the acquired business' historical adjusted EBITDA. As a
result, the Company expects that this restriction will cause the number of
future acquisitions by the Company to decrease very materially when compared to
the Company's past rate of acquisition activity. The Company currently expects
that this restriction under the Credit Facility will remain in place at least
until the second or third quarter of 1999.
The Company's subsidiaries have guaranteed the repayment of all amounts
under the Credit Facility and the Company has pledged the accounts receivable,
inventory and stock of its operating subsidiaries as collateral for the
repayment of its obligations under the Credit Facility. The Company is obligated
to pay all principal and interest outstanding on the Credit Facility in the
event of a change in control of the Company, as defined in the Credit Facility.
As of September 30, 1998, the Company's outstanding borrowings under the Credit
Facility were $99.5 million, bearing interest at a weighted average rate of
8.77%. At November 13, 1998, the Company's outstanding borrowings under the
Credit Facility were $116.9 million, bearing interest at a weighted average rate
of 8.6%.
ARS also has outstanding $55.0 million aggregate principal amount of its
7 1/4% Convertible Subordinated Notes due 2004 (the "7 1/4% Notes"). The 7 1/4%
Notes are unsecured obligations of ARS and are convertible at $25.50 per share,
subject to adjustment in certain events, into an aggregate of 2,156,863 shares
of Common Stock. The 7 1/4% Notes contain cross-default provisions that give the
holders of the 7 1/4% Notes the right to accelerate payment in the event of a
default under certain of the Company's debt agreements, including the Credit
Facility. In the event of a change in control of the Company, as defined in the
indenture governing the 7 1/4% Notes, the holders of the 7 1/4% Notes have the
right to require the Company to repurchase the 7 1/4% Notes.
As of September 30, 1998, ARS also had outstanding $3.5 million aggregate
principal amount of its Convertible Senior Subordinated Notes, Series A, due
2004 (the "Series A Notes"). The Series A Notes are unsecured obligations of ARS
and the outstanding Series A Notes are convertible into an aggregate of 250,333
shares of Common Stock. As of September 30, 1998, the weighted average price per
share at which the outstanding Series A Notes are convertible into Common Stock
was $13.94 per share and the weighted average interest rate payable on the
outstanding Series A Notes was 7.15% per annum. In the event of a change in
control of the Company, as defined in the indenture governing the Series A
Notes, the holders of the Series A Notes have the right to require the Company
to repurchase the Series A Notes.
6
<PAGE> 8
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
5. EARNINGS PER SHARE
The following table summarizes weighted average shares of Common Stock
outstanding for each of the periods presented (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
------------- -------------
<S> <C> <C>
Shares outstanding, beginning of period..................... 15,871 15,321
Weighted average shares issued in acquisitions.............. 13 314
------ ------
Shares used in computing basic earnings per share......... 15,884 15,635
Dilutive effect of stock options, net of assumed purchase of
treasury stock............................................ -- 48
------ ------
Shares used in computing diluted earnings per share....... 15,884 15,683
====== ======
</TABLE>
The table below includes the total number of antidilutive shares of Common
Stock that potentially could be issued for options, 7 1/4% Notes and Series A
Notes, for each of the periods presented (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1998 1998
------------- -------------
<S> <C> <C>
Options..................................................... 2,554 2,176
7 1/4% Notes................................................ 2,157 2,157
Series A Notes.............................................. 250 250
</TABLE>
6. INCOME TAXES
The Company files a consolidated federal income tax return, which includes
the operations of all businesses acquired for periods subsequent to their
respective dates of acquisition. The acquired businesses file "short period"
federal income tax returns through their respective acquisition dates.
Certain of the Restated Businesses were S corporations for income tax
purposes prior to their acquisition by the Company. Accordingly, any income tax
liabilities for the periods prior to their acquisition dates are the
responsibility of the former owners. For purposes of these consolidated
financial statements, federal and state income taxes have been reflected as if
those Restated Businesses had filed C corporation tax returns for the
pre-acquisition periods, with the current income tax expense of those S
corporations reflected as an increase to additional paid-in capital.
7
<PAGE> 9
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
7. BUSINESS COMBINATIONS
Poolings
From January 1, 1997 through September 30, 1998, the Company acquired the
24 Pooled Businesses under the pooling-of-interests method of accounting in
exchange for 3,746,987 shares of Common Stock. The results of operations of the
15 Restated Businesses are included throughout both periods presented herein,
while the results of operations of the other nine Pooled Businesses are included
from their respective effective acquisition dates. The combined revenues and net
income of the 15 Restated Businesses prior to their acquisitions by the Company
for the three and nine months ended September 30, 1997 are presented below (in
millions). Because all Restated Businesses were acquired during 1997, there is
no impact on the revenues and net income of the Company in 1998.
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1997
------------- -------------
<S> <C> <C>
Revenues.................................................... $ 7.2 $41.5
Net Income.................................................. 0.3 2.4
</TABLE>
Purchases
From January 1, 1997 through September 30, 1998, the Company acquired the
56 Purchased Businesses under the purchase method of accounting. The aggregate
consideration paid in those transactions consisted of $59.5 million in cash,
1,694,216 shares of Common Stock, $3.5 million aggregate principal amount of the
Series A Notes and a promissory note in the principal amount of $1.8 million.
The accompanying consolidated balance sheet as of September 30, 1998 includes
preliminary estimates of fair value relating to certain of the acquired
businesses that may be revised as additional information concerning the
valuation of the assets and liabilities of the businesses acquired becomes
available. See Note 1 above.
Pro Forma Results of Operations
Set forth below are unaudited pro forma combined revenue and net income
before extraordinary item data reflecting the pro forma effect of the
acquisitions of the Purchased Businesses and Pooled Businesses as if they were
effective on January 1, 1997 (in millions, except per share amounts).
<TABLE>
<CAPTION>
NINE MONTHS
ENDED SEPTEMBER 30,
-------------------
1997 1998
-------- --------
<S> <C> <C>
Revenues.................................................... $ 389.4 $ 391.9
======= =======
Net income before extraordinary item........................ $ 15.6 $ 5.9
======= =======
Basic earnings per share before extraordinary item.......... $ 0.99 $ 0.37
======= =======
Diluted earnings per share before extraordinary item........ $ 0.96 $ 0.37
======= =======
</TABLE>
Pro forma adjustments included in the amounts above primarily relate to:
(i) compensation differentials, reflecting reduced compensation amounts agreed
to in connection with certain acquisitions, (ii) adjustments for rent expense on
certain leased facilities, reflecting reductions in rent agreed to in connection
with certain acquisitions, (iii) adjustments for the effects of assets
distributed to and costs of certain leases assumed by former owners of certain
of the businesses acquired, (iv) adjustments for pro forma goodwill amortization
expense using a 40-year estimated life, (v) eliminations of historical interest
expense related to certain obligations that were repaid or not assumed by the
Company, offset by interest expense on borrowed funds
8
<PAGE> 10
AMERICAN RESIDENTIAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(UNAUDITED)
used to pay the cash portion of the purchase price of the businesses acquired,
(vi) the issuance and sale of the $55.0 million aggregate principal amount of
7 1/4% Notes by ARS and the application of the proceeds from that sale and (vii)
adjustments to the federal and state income tax provisions on pro forma
operating results. Basic and diluted earnings per share for the nine months
ended September 30, 1997 and 1998 assume all shares issued for the acquisitions
of the businesses acquired had been outstanding at the beginning of the periods
presented.
The pro forma results presented above are not necessarily indicative of
actual results that might have occurred had the operations and management teams
of ARS and the businesses acquired been combined at the beginning of the periods
presented and are not necessarily indicative of future consolidated operating
results.
8. SUBSEQUENT EVENTS
Subsequent Acquisitions
Subsequent to September 30, 1998 through November 13, 1998, the Company
completed five additional acquisitions for approximately $8.5 million in cash
and approximately $4.0 million aggregate principal amount of Series A Notes. The
Company will account for these acquisitions under the purchase method of
accounting. As a result of these acquisitions, the outstanding Series A Notes
are convertible into an aggregate of 600,333 shares of Common Stock (at the
weighted average price per share of $12.48) and have a weighted average interest
rate of 7.53% per annum.
9
<PAGE> 11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
The following discussion should be read in conjunction with the
consolidated financial statements and notes thereto included in Item 1 of this
Report and the consolidated financial statements and notes thereto included in
the 1997 Form 10-K. Statements herein regarding future financial or operational
performance and results of the Company or other similar matters that are not
historical facts constitute forward-looking statements and are subject to
numerous risks and uncertainties, including but not limited to the availability
of attractive acquisition opportunities, the successful integration and
profitable management of businesses acquired, the improvement of operating
efficiencies, weather conditions, the availability of working capital and
funding for future acquisitions, restriction under the Credit Facility for
future acquisitions, the ability to grow internally through expansion of
services and customer bases and reduction of overhead and the level and nature
of competition from other residential services and commercial maintenance
services providers. For additional information, see "Factors That May Affect
Future Results" in Item 1 of the 1997 Form 10-K.
The Company derives its revenues primarily from (i) owners and occupants of
homes and small commercial buildings, (ii) builders and developers of new homes,
residential developments and small commercial buildings and (iii) owners and
managers of large commercial, industrial, educational, institutional and retail
facilities and federal and local governments. Cost of services consists
primarily of salaries and benefits of service and installation personnel, parts
and materials, subcontracted services, depreciation, maintenance, fuel and
equipment rentals. Selling, general and administrative expenses consist
primarily of compensation and related benefits payable to management and
administrative personnel, and expenses attributable to advertising, office rent
and utilities, communications and professional fees.
ARS conducted no operations prior to September 27, 1996 other than in
connection with the IPO and the acquisitions of the Founding Companies. Between
then and September 30, 1998, the Company acquired an additional 93 businesses.
Each of the businesses acquired operated as a separate, independent business
prior to its acquisition by the Company. The integration of the operations and
administrative functions of the businesses acquired with those of the Company
may present opportunities to reduce costs as a percentage of revenues through
the elimination of duplicative functions and through economies of scale,
particularly in obtaining additional contracts through shared customer lists and
greater volume discounts from material suppliers, but will necessitate
additional costs and expenditures for corporate management and administration,
corporate expenses related to being a public company, systems integration and
facilities expansion. The success of the Company will depend, in part, on the
extent to which the Company is able to effectively integrate the businesses that
the Company has acquired and those that it may acquire in the future. In
addition, the various costs and possible cost savings resulting from the
integration process may make historical operating results not comparable to, or
indicative of, future performance.
As used in this discussion, the term "Additional Businesses" means
businesses that the Company has acquired between January 1, 1997 and September
30, 1998 whose results of operations are included in the Company's consolidated
results of operations from their respective acquisition dates.
10
<PAGE> 12
RESULTS OF OPERATIONS
The following table sets forth various items as a percentage of the
Company's revenues:
<TABLE>
<CAPTION>
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------- ---------------
1997 1998 1997 1998
----- ----- ----- -----
<S> <C> <C> <C> <C>
Revenues................................................ 100.0% 100.0% 100.0% 100.0%
Cost of services........................................ 72.3 76.5 71.3 75.2
----- ----- ----- -----
Gross profit.......................................... 27.7 23.5 28.7 24.8
Selling, general and administrative expenses............ 20.0 19.0 20.5 19.7
Special charge.......................................... -- -- -- 0.3
----- ----- ----- -----
Income from operations................................ 7.7 4.5 8.2 4.8
Interest expense........................................ (2.0) (2.7) (1.8) (2.5)
Interest income and other, net.......................... 0.2 -- 0.3 0.2
----- ----- ----- -----
Income before income taxes.............................. 5.9 1.8 6.7 2.5
Provision for income taxes.............................. 2.6 1.2 2.9 1.3
----- ----- ----- -----
Net income.............................................. 3.3% 0.6% 3.8% 1.2%
===== ===== ===== =====
</TABLE>
Revenues -- Revenues increased 26.8% and 35.8% to $138.8 million and $370.4
million for the three and nine months ended September 30, 1998, respectively, as
compared to the corresponding periods in the prior year. These increases were
primarily attributable to the inclusion of additional revenues in the 1998
periods of approximately $28.2 million and $94.9 million, respectively, from
Additional Businesses acquired during 1997. The remainder of the increase was
primarily attributable to increased demand for the Company's services.
Cost of services -- Cost of services increased 34.0% and 43.1% to $106.1
million and $278.3 million for the three and nine months ended September 30,
1998, respectively, as compared to the corresponding periods in the prior year,
reflecting increased costs associated with the higher level of revenues. Gross
profit, as a percentage of revenues, decreased from 27.7% and 28.7% for the
three and nine months ended September 30, 1997 to 23.5% and 24.8% for the three
and nine months ended September 30, 1998. These reductions for 1998 were
primarily attributable to lower demand for the Company's higher margin
residential maintenance, repair and replacement services in the southeastern,
midwest and southwestern United States and increased revenues from commercial
maintenance repair and replacement services.
Selling, general and administrative expenses -- Selling, general and
administrative expenses increased 20.5% and 32.7% to $26.4 million and $74.4
million for the three and nine months ended September 30, 1998, respectively, as
compared to the corresponding periods in the prior year. These increases were
primarily due to the inclusion of selling, general and administrative expenses
of Additional Businesses acquired during 1997 and goodwill amortization
associated with the purchase of Additional Businesses.
Interest expense -- Interest expense increased 73.1% and 90.6% to $3.7
million and $9.4 million for the three and nine months ended September 30, 1998,
respectively, as compared to the corresponding periods in the prior year. These
increases were attributable principally to increased levels of outstanding
indebtedness, resulting from the use of borrowings to fund the cash portion of
the purchase prices the Company paid for businesses acquired since September 30,
1997 and the issuance by ARS of its 7 1/4% Notes in April 1997.
Interest income and other, net -- Interest income and other, net, decreased
by $0.3 million from the three months ended September 30, 1997 to the
corresponding period in 1998 while it increased by $0.1 million from the nine
months ended September 30, 1997 to the corresponding period in 1998.
Provision for income taxes -- For the three and nine months ended September
30, 1998, the Company recorded a provision for income taxes of $1.6 million and
$4.8 million, respectively, as compared to a provision for income taxes of $2.8
million and $7.8 million recorded for the three and nine months ended September
30, 1997, respectively. The effective tax rate for the nine months ended
September 30, 1998 was 52.5%, representing management's estimate of the
effective tax rate for 1998.
11
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended September 30, 1998, net cash used in operating
activities was $3.6 million, which was primarily attributable to an increase in
accounts receivable since December 31, 1997. The increase in accounts receivable
related primarily to the seasonal nature of the Company's operations, which
generally results in increased levels of services provided in the second and
third quarters as compared to the first and fourth quarters. Also during the
nine months ended September 30, 1998, capital expenditures totaled $5.6 million
and net borrowings of debt amounted to $14.8 million. The Company anticipates
capital expenditures of approximately $2.5 million during the remainder of 1998,
primarily for computer systems, leasehold improvements and furniture and
fixtures. The Company believes its cash flow from operations and the borrowings
available under the Credit Facility (as defined below) will be sufficient to
support its ongoing operations and anticipated capital expenditures for the
remainder of 1998 and 1999. Management anticipates that the Company's margin of
compliance for certain financial covenants under the Credit Facility for its
reporting period for the fourth quarter in 1998 and its reporting periods in
1999 may be lower than it was in the reporting period in the fourth quarter of
1997 and corresponding reporting periods in 1998. Depending on the Company's
future results of operations, the Company may attempt to negotiate a
modification of certain of these financial covenants with its Credit Facility
lenders.
In the second quarter of 1998, the Company negotiated a new secured credit
facility (the "Credit Facility") with a syndicate of commercial banks and an
insurance company which increased the Company's maximum borrowing capacity from
$100 million under the Company's previous credit facility to $165 million. The
Credit Facility is comprised of a $115 million three-year revolving credit
facility (the "Revolving Credit") and a $50 million five-year term loan (the
"Term Loan"). The Company used the proceeds of the Term Loan and borrowings
under the Revolving Credit to repay the outstanding borrowings under its prior
$100 million credit facility. Subject to certain limitations, the Company may
use borrowings under the Revolving Credit for general corporate purposes,
funding the purchases of businesses and the refinancing of their indebtedness,
capital expenditures and working capital.
At the Company's option, loans under the Revolving Credit bear interest at
a designated variable base rate plus a margin ranging from 0 to 75 basis points
or at the London Interbank Offered Rate ('LIBOR") plus a margin ranging from 125
to 275 basis points. The margin varies with the ratio of the Company's total
debt to its pro forma trailing 12-month earnings before interest, taxes,
depreciation and amortization ("EBITDA"). The margin is reset on a quarterly
basis. Commitment fees of 25 to 50 basis points per annum are payable on the
unused portion of the Revolving Credit. The Revolving Credit will terminate and
all amounts borrowed, if any, will be due and payable on June 30, 2001. The
Revolving Credit also contains a $5 million sub-limit for standby letters of
credit.
The $50 million Term Loan consists of two $25 million tranches. One tranche
bears interest at a fixed rate of 8.96% while the other tranche bears interest
at the variable LIBOR plus a fixed margin of 325 basis points. Beginning April
2000, the Company is required to make quarterly principal payments of
approximately $3.6 million on the Term Loan. The final payment on the Term Loan
is due July 1, 2003.
The Credit Facility requires the consent of the lenders for acquisitions
exceeding a certain level of cash consideration, prohibits the payment of cash
dividends by ARS, limits the incurrence of other indebtedness (other than
approved subordinated indebtedness) and requires the Company to comply with
certain financial covenants, including a minimum net worth requirement, maximum
senior and total debt to pro forma EBITDA limits, and minimum fixed charge and
interest coverage ratios.
The Credit Facility restricts the cash consideration (including assumed
debt) that the Company may pay for a business to be acquired if ARS does not
generate a specified minimum level of EBITDA. The Company did not meet such
minimum level of EBITDA for the quarter ended September 30, 1998. As a result,
effective as of November 15, 1998, the Company will be required to obtain the
prior written consent of the lenders under the Credit Facility prior to
consummating an acquisition in which the amount of cash consideration (including
assumed debt) that the Company would pay exceeds one times the historical
adjusted EBITDA of the acquired business. Virtually all of the Company's
acquisitions to date have involved consideration (including assumed debt) in
excess of one times the acquired business' historical adjusted EBITDA. As a
12
<PAGE> 14
result, the Company expects that this restriction will cause the number of
future acquisitions by the Company to decrease very materially when compared to
the Company's past rate of acquisition activity. The Company currently expects
that this restriction under the Credit Facility will remain in place at least
until the second or third quarter of 1999.
The Company's subsidiaries have guaranteed the repayment of all amounts
under the Credit Facility and the Company has pledged the accounts receivable,
inventory and stock of its operating subsidiaries as collateral for the
repayment of its obligations under the Credit Facility. The Company is obligated
to pay all principal and interest outstanding on the Credit Facility in the
event of a change in control of the Company, as defined in the Credit Facility.
As of September 30, 1998, the Company's outstanding borrowings under the Credit
Facility were $99.5 million, bearing interest at a weighted average rate of
8.77%. At November 13, 1998, the Company's outstanding borrowings under the
Credit Facility were $116.9 million, bearing interest at a weighted average rate
of 8.6%.
ARS also has outstanding $55.0 million aggregate principal amount of its
7 1/4% Convertible Subordinated Notes due 2004 (the "7 1/4% Notes"). The 7 1/4%
Notes are unsecured obligations of ARS and are convertible at $25.50 per share,
subject to adjustment in certain events, into an aggregate of 2,156,863 shares
of Common Stock. The 7 1/4% Notes contain cross-default provisions that give the
holders of the 7 1/4% Notes the right to accelerate payment in the event of a
default under certain of the Company's debt agreements, including the Credit
Facility. In the event of a change in control of the Company, as defined in the
indenture governing the 7 1/4% Notes, the holders of the 7 1/4% Notes have the
right to require the Company to repurchase the 7 1/4% Notes.
As of September 30, 1998, ARS also had outstanding $3.5 million aggregate
principal amount of Series A Notes. The Series A Notes are unsecured obligations
of ARS and the outstanding Series A Notes are convertible into an aggregate of
250,333 shares of Common Stock. As of September 30, 1998, the weighted average
price per share at which the outstanding Series A Notes are convertible into
Common Stock was $13.94 per share and the weighted average interest rate payable
on the outstanding Series A Notes was 7.15% per annum. In the event of a change
in control of the Company, as defined in the indenture governing the Series A
Notes, the holders of the Series A Notes have the right to require the Company
to repurchase the Series A Notes.
In the third quarter of 1998, the Company acquired seven businesses for
aggregate consideration of $6.1 million in cash, 31,578 shares of Common Stock
and $0.7 million aggregate principal amount of Series A Notes. Since September
30, 1998 and through November 13, 1998, the Company acquired five businesses for
aggregate consideration of $8.5 million in cash and $4.0 million aggregate
principle amount of Series A Notes. Funding of the cash portion of the purchase
prices and repayment of certain indebtedness assumed in connection with those
acquisitions was provided by funds from operations and borrowings under the
Credit Facility.
The Company intends to continue to pursue attractive acquisition
opportunities of both residential services and commercial maintenance services
businesses, but will do so on a more selective basis that will be less likely to
divert management's focus away from internal growth objectives. The timing, size
and success of any acquisition effort and the associated potential capital
commitments are unpredictable. Effective as of November 15, 1998, the Company
will be required to obtain the prior written consent of its lenders under the
Credit Facility prior to consummating an acquisition in which the amount of cash
consideration (including assumed debt) that the Company would pay exceeds one
times the historical adjusted EBITDA of the acquired business. There can be no
assurance that such lenders will approve any acquisition for which their
approval is required. Subject to the foregoing, the Company expects to fund any
future permitted acquisitions primarily through a combination of Common Stock,
working capital, cash flow from operations and borrowings, issuance of
convertible debt securities and the possible public or private sale of
additional debt or equity securities. The Company maintains an effective shelf
registration statement under the Securities Act of 1933, as amended, that
facilitates the issuance of shares of Common Stock and Series A Notes for use as
consideration in acquisitions.
13
<PAGE> 15
IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs written using two
digits rather than four digits to define the applicable year. The Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000, resulting in a system failure
or material miscalculation, either of which could cause a disruption of
operations. These disruptions could include, among other things, a temporary
inability to process transactions, process invoices or engage in similar routine
business activities.
The Company recognizes the need to ensure that its operations will not be
adversely affected by Year 2000 software failures. Therefore, in 1997 the
Company began examining the Year 2000 issue in an effort to minimize the
disruptions to the Company's business and potential Company liabilities that
could result from Year 2000 software failures. The Company has engaged both
employees and outside experts to identify Year 2000 compliance problems, to
assist in developing estimates and to complete necessary remediation work,
including the reprogramming, replacement and testing of software for Year 2000
compliance.
The Company currently has a plan in place to modify or replace portions of
its administrative and operating software so that its computer systems will
function properly with respect to dates in the year 2000 and thereafter,
providing management with consistent operational and financial information
throughout the Company. The Company currently estimates that this process should
be completed by the third quarter of 1999.
The Company has also initiated efforts to evaluate the status of the Year
2000 readiness of certain of its material vendors and third parties with which
it conducts business. While the Company has received assurances in some cases
that such persons' systems will be Year 2000 compliant, there can be no
guarantee that Year 2000 problems originating with third parties whose systems
affect the Company will not occur. Year 2000 interruptions in customers'
operations could result in reduced sales, increased inventory or receivable
levels and cash flow reductions. The Company is also reviewing its building and
utility systems (elevators, lights, phones, etc.) for the impact of Year 2000.
Many of the systems in this area are believed to already be Year 2000 compliant.
To date, the Company has spent approximately $0.4 million to identify and
correct potential Year 2000 software problems. Costs to be incurred in the
remainder of 1998 and 1999 to correct Year 2000 problems, as well as to upgrade
or replace the Company's information systems in general, are estimated to be
approximately $5.0 million. The Company does not expect costs relating to Year
2000 remediation to have a material adverse effect on its results of operations
or financial condition.
Based on the progress the Company has made in addressing its Year 2000
issues and the Company's plans to complete its compliance program, the Company
does not foresee significant risks associated with its Year 2000 compliance at
this time. Because the Company plans to address any significant Year 2000 issues
before being affected by them, it has not developed a comprehensive contingency
plan. However, if the Company identifies significant risks related to its Year
2000 compliance or its progress deviates from the anticipated program, the
Company will develop contingency plans as necessary. Furthermore, although the
Company does not anticipate any material adverse effect from Year 2000 failures,
there is no guarantee of total compliance. Specific factors that give rise to
uncertainty include failure to identify all susceptible systems, non-compliance
by third parties whose systems and operations impact the Company, a possible
loss of technical resources to perform the work and other similar uncertainties.
Year 2000 non-compliance could result in a material disruption of the Company's
operations, an interruption in its ability to collect amounts due from
customers, loss of accurate accounting records or any number of other
difficulties. Depending on the length of non-compliance and system failure, any
or all of these situations could have a material adverse impact on the Company's
results of operations and financial position.
14
<PAGE> 16
SEASONALITY AND FLUCTUATIONS IN OPERATING RESULTS
The Company has experienced, and expects that it will in the future
experience, quarterly fluctuations in revenues, operating income and cash flows
as a result of changes in weather conditions. Except for certain areas of the
southern United States, the demand for new residential installations is lower in
the winter months because new construction activity is lower as a result of
colder weather (although the Company expects that such reduction in demand may
be partially offset by increases in the demand for commercial replacement
services generally experienced in the winter months). Demand for HVAC services
is generally higher in the second and third quarters. Accordingly, quarterly
comparisons of the Company's revenues and operating results should not be relied
on as an indication of future performance, and the results of any quarterly
period may not be indicative of the results to be expected for a full year.
15
<PAGE> 17
AMERICAN RESIDENTIAL SERVICES, INC.
PART II -- OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27.1 -- Financial Data Schedule.
</TABLE>
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K dated September 25, 1998 to
report that it expected earnings for the quarter ended September 30, 1998 to be
significantly below earnings for the same period last year and consensus analyst
estimates.
16
<PAGE> 18
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant, American Residential Services, Inc., has duly caused this report to
be signed on its behalf by the undersigned, thereunto duly authorized.
AMERICAN RESIDENTIAL SERVICES, INC.
By: /s/ HARRY O. NICODEMUS, IV
------------------------------------
Harry O. Nicodemus, IV
Senior Vice President
(Chief Financial Officer and
Chief Accounting Officer)
Dated: November 13, 1998
17
<PAGE> 19
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
27.1 -- Financial Data Schedule.
</TABLE>
18
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
CONSOLIDATED FINANCIAL STATEMENTS OF AMERICAN RESIDENTIAL SERVICES, INC. AND
SUBSIDIARIES AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JUL-01-1998
<PERIOD-END> SEP-30-1998
<CASH> 2,929
<SECURITIES> 0
<RECEIVABLES> 69,950
<ALLOWANCES> 2,584
<INVENTORY> 16,001
<CURRENT-ASSETS> 109,440
<PP&E> 61,315
<DEPRECIATION> 28,078
<TOTAL-ASSETS> 375,371
<CURRENT-LIABILITIES> 72,449
<BONDS> 0
0
0
<COMMON> 16
<OTHER-SE> 144,005
<TOTAL-LIABILITY-AND-EQUITY> 375,371
<SALES> 138,750
<TOTAL-REVENUES> 138,750
<CGS> 106,144
<TOTAL-COSTS> 106,144
<OTHER-EXPENSES> 26,430
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,716
<INCOME-PRETAX> 2,392
<INCOME-TAX> 1,627
<INCOME-CONTINUING> 765
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 765
<EPS-PRIMARY> 0.05
<EPS-DILUTED> 0.05
</TABLE>
