UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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 MARCH 31, 1999
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: 1-13011
COMFORT SYSTEMS USA, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 76-0526487
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
777 POST OAK BOULEVARD
SUITE 500
HOUSTON, TEXAS 77056
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)
Registrant's telephone number, including area code: (713) 830-9600
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 [ ]
The number of shares outstanding of the issuer's common stock, as of May 11,
1999, was 38,719,605.
<PAGE>
COMFORT SYSTEMS USA, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED MARCH 31, 1999
Part I - Financial Information
Item 1 - Financial Statements
PAGE
COMFORT SYSTEMS USA, INC.
Introduction to Financial Statements............................. 1
Consolidated Balance Sheets...................................... 2
Consolidated Statements of Operations............................ 3
Consolidated Statements of Stockholders' Equity.................. 4
Consolidated Statements of Cash Flows............................ 5
Notes to Consolidated Financial Statements....................... 6
Item 2 - Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 11
Part II - Other Information
Item 1 - Legal Proceedings............................................. 15
Item 2 - Recent Sales of Unregistered Securities....................... 15
Item 6 - Exhibits and Reports on Form 8-K.............................. 15
Item 9 - Changes and Disagreements with Accountants on Accounting and
Financial Disclosure............................................ 15
Signature.............................................................. 16
<PAGE>
COMFORT SYSTEMS USA, INC.
PART I, ITEM 1 - FINANCIAL INFORMATION
GENERAL INFORMATION
INTRODUCTION TO FINANCIAL STATEMENTS
Comfort Systems USA, Inc., a Delaware corporation ("Comfort Systems" and
collectively with its subsidiaries, the "Company") is a leading national
provider of comprehensive heating, ventilation and air conditioning ("HVAC")
installation, maintenance, repair and replacement services. Founded in December
1996, the Company is consolidating the fragmented commercial and industrial HVAC
markets, and performs most of its services within manufacturing plants, office
buildings, retail centers, apartment complexes, and healthcare, education and
government facilities. In addition to standard HVAC services, the Company also
provides specialized applications such as process cooling, control systems,
electronic monitoring and process piping. Certain locations also perform related
services such as electrical and plumbing.
On July 2, 1997, the Company completed the initial public offering (the
"IPO") of its common stock (the "Common Stock") and simultaneously acquired
twelve companies (collectively referred to as the "Founding Companies") engaged
in providing HVAC services. The Founding Companies had 18 operating locations in
ten states. Subsequent to the IPO, and through March 31, 1999, the Company
acquired 92 additional HVAC and complementary businesses (collectively with the
Founding Companies, the "Acquired Companies"). The companies acquired subsequent
to the IPO added 96 operating locations in 20 additional states. These
acquisitions included 18 "tuck-in" operations that have been or are currently
being integrated with existing Company operations.
Historical interim period results are not necessarily indicative of future
results because, among other things, these Acquired Companies were not under
common control or management prior to their acquisition by the Company. The
Company's results of operations historically have been subject to seasonal
fluctuations. These interim statements should be read in conjunction with the
historical Consolidated Financial Statements and related notes of Comfort
Systems included in the Annual Report on Form 10-K as filed with the Securities
and Exchange Commission for the year ended December 31, 1998.
1
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
1998 1999
------------ ---------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ....................................... $ 6,985 $ 3,773
Accounts receivable ............................................. 241,332 243,353
Less - Allowance ............................................. 4,758 4,973
------------ ---------
Accounts receivable, net .................................. 236,574 238,380
Other receivables ............................................... 2,733 3,605
Inventories ..................................................... 14,768 16,408
Prepaid expenses and other ...................................... 14,264 13,583
Costs and estimated earnings in excess of billings .............. 37,228 42,747
------------ ---------
Total current assets ...................................... 312,552 318,496
PROPERTY AND EQUIPMENT, net ........................................ 34,413 35,802
GOODWILL, less accumulated amortization of $8,983 and $11,767 ...... 430,526 445,686
OTHER NONCURRENT ASSETS ............................................ 11,802 12,482
------------ ---------
Total assets .............................................. $ 789,293 $ 812,466
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term debt ............................ $ 1,568 $ 271
Current maturities of notes to affiliates and former owners ..... 7,509 6,530
Accounts payable ................................................ 74,161 74,299
Accrued compensation and benefits ............................... 25,869 22,775
Billings in excess of costs and estimated earnings .............. 43,968 40,174
Income taxes payable ............................................ 1,299 3,472
Other current liabilities ....................................... 24,788 26,869
------------ ---------
Total current liabilities ................................. 179,162 174,390
DEFERRED INCOME TAXES .............................................. 1,124 1,144
LONG-TERM DEBT, NET OF CURRENT MATURITIES .......................... 171,039 182,976
NOTES TO AFFILIATES AND FORMER OWNERS .............................. 56,330 61,802
OTHER LONG-TERM LIABILITIES ........................................ 1,706 1,708
------------ ---------
Total liabilities ......................................... 409,361 422,020
COMMITMENTS AND CONTINGENCIES ...................................... -- --
STOCKHOLDERS' EQUITY:
Preferred stock, $.01 par, 5,000,000 shares authorized, none
issued and outstanding ........................................ -- --
Common stock, $.01 par, 102,969,912 shares authorized, 38,141,180
and 38,578,430 shares issued and outstanding, respectively .... 381 386
Additional paid-in capital ...................................... 333,978 337,923
Retained earnings ............................................... 45,573 52,137
------------ ---------
Total stockholders' equity ................................ 379,932 390,446
------------ ---------
Total liabilities and stockholders' equity ................ $ 789,293 $ 812,466
============ =========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
2
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
THREE MONTHS ENDED
MARCH 31,
-----------------------
1998 1999
--------- ---------
REVENUES ........................................... $ 132,608 $ 291,926
COST OF SERVICES ................................... 101,269 228,748
--------- ---------
Gross profit .............................. 31,339 63,178
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ....... 23,130 44,858
GOODWILL AND OTHER AMORTIZATION .................... 1,170 2,784
--------- ---------
Operating income .......................... 7,039 15,536
OTHER INCOME (EXPENSE):
Interest income ................................. 206 166
Interest expense ................................ (805) (4,187)
Other ........................................... (277) 42
--------- ---------
Other income (expense) .................... (876) (3,979)
--------- ---------
INCOME BEFORE INCOME TAXES ......................... 6,163 11,557
PROVISION FOR INCOME TAXES ......................... 2,778 4,993
--------- ---------
NET INCOME ......................................... $ 3,385 $ 6,564
========= =========
NET INCOME PER SHARE:
Basic ........................................... $ 0.12 $ 0.17
========= =========
Diluted ......................................... $ 0.11 $ 0.17
========= =========
SHARES USED IN COMPUTING NET INCOME PER SHARE:
Basic ........................................... 29,325 38,311
========= =========
Diluted ......................................... 29,756 39,769
========= =========
The accompanying notes are an integral part of
these consolidated financial statements.
3
<PAGE>
<TABLE>
<CAPTION>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
COMMON STOCK ADDITIONAL TOTAL
----------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS EQUITY
---------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1997 ................................. 28,013,436 $ 280 $ 205,829 $ 11,526 $ 217,635
Issuance of Common Stock:
Proceeds of the Second Public Offering ........... 861,479 9 15,892 -- 15,901
Acquisition of Purchased Companies ............... 9,212,573 92 111,456 -- 111,548
Issuance of Employee Stock Purchase
Plan shares ................................ 29,362 -- 482 -- 482
Issuance of shares for options exercised ......... 24,330 -- 319 -- 319
S Corporation distributions made by certain
Pooled Companies ................................. -- -- -- (966) (966)
Net income ............................................. -- -- -- 35,013 35,013
---------- ---------- ---------- ---------- -------------
BALANCE AT DECEMBER 31, 1998 ................................. 38,141,180 381 333,978 45,573 379,932
Issuance of Common Stock:
Acquisition of Purchased Companies
(unaudited) ................................. 381,689 4 3,096 -- 3,100
Issuance of Employee Stock Purchase
Plan shares (unaudited) .................... 55,561 1 849 -- 850
Net income (unaudited) ................................. -- -- -- 6,564 6,564
---------- ---------- ---------- ---------- -------------
BALANCE AT MARCH 31, 1999 (unaudited) ........................ 38,578,430 $ 386 $ 337,923 $ 52,137 $ 390,446
========== ========== ========== ========== =============
The accompanying notes are an integral part of
these consolidated financial statements.
</TABLE>
4
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------
1998 1999
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income ...................................................... $ 3,385 $ 6,564
Adjustments to reconcile net income to net cash provided by
(used in) operating activities -
Depreciation and amortization expense ........................ 2,268 5,320
Bad debt expense ............................................. 153 158
Deferred tax benefit ......................................... (802) (584)
Gain on sale of property and equipment ....................... (24) (40)
Changes in operating assets and liabilities, net of effects of
acquisitions of Purchased Companies -
(Increase) decrease in -
Receivables, net ....................................... (2,540) (95)
Inventories ............................................ (57) (1,468)
Prepaid expenses and other current assets .............. (331) 944
Costs and estimated earnings in excess of billings ..... (2,090) (5,335)
Other noncurrent assets ................................ (312) (652)
Increase (decrease) in -
Accounts payable and accrued liabilities ............... (5,292) 532
Billings in excess of costs and estimated earnings ..... 553 (3,810)
Other, net ................................................... (961) (73)
-------- --------
Net cash provided by (used in) operating activities ....... (6,050) 1,461
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment .......................... (1,790) (3,875)
Proceeds from sales of property and equipment ................ 94 319
Cash paid for Purchased Companies, net of cash acquired ...... (15,449) (9,775)
-------- --------
Net cash used in investing activities ..................... (17,145) (13,331)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt ................................... (29,382) (44,474)
Borrowings of long-term debt ................................. 41,736 52,282
S Corporation distributions paid by certain Pooled Companies . (137) --
Proceeds from issuance of common stock ....................... -- 850
Other ........................................................ 144 --
-------- --------
Net cash provided by financing activities ................. 12,361 8,658
-------- --------
NET DECREASE IN CASH ............................................ (10,834) (3,212)
CASH AND CASH EQUIVALENTS, beginning of period .................. 18,097 6,985
-------- --------
CASH AND CASH EQUIVALENTS, end of period ........................ $ 7,263 $ 3,773
======== ========
</TABLE>
The accompanying notes are an integral part of
these consolidated financial statements.
5
<PAGE>
COMFORT SYSTEMS USA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
MARCH 31, 1999
(UNAUDITED)
1. BUSINESS AND ORGANIZATION:
Comfort Systems USA, Inc., a Delaware corporation ("Comfort Systems" and
collectively with its subsidiaries, the "Company"), is a leading national
provider of comprehensive heating, ventilation and air conditioning ("HVAC")
installation, maintenance, repair and replacement services. Founded in December
1996, the Company is consolidating the fragmented commercial and industrial HVAC
markets, and performs most of its services within manufacturing plants, office
buildings, retail centers, apartment complexes, and healthcare, education and
government facilities. In addition to standard HVAC services, the Company also
provides specialized applications such as process cooling, control systems,
electronic monitoring and process piping. Certain locations also perform related
services such as electrical and plumbing.
On July 2, 1997, Comfort Systems completed the initial public offering (the
"IPO") of its common stock (the "Common Stock") and simultaneously acquired
twelve companies (collectively referred to as the "Founding Companies") engaged
in providing HVAC services. The Founding Companies had 18 operating locations in
ten states. Subsequent to the IPO, and through March 31, 1999, the Company
acquired 92 additional HVAC and complementary businesses (collectively with the
Founding Companies, the "Acquired Companies"). Of these additional businesses
acquired, 17 were accounted for as poolings-of-interests (the "Pooled
Companies"). The remaining businesses acquired were accounted for as purchases
(the "Purchased Companies"). The companies acquired subsequent to the IPO added
96 operating locations in 20 additional states. These acquisitions included 18
"tuck-in" operations that have been or are currently being integrated with
existing Company operations.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
BASIS OF PRESENTATION
These interim statements should be read in conjunction with the historical
Consolidated Financial Statements and related notes of Comfort Systems included
in the Annual Report on Form 10-K as filed with the Securities and Exchange
Commission for the year ended December 31, 1998.
There were no significant changes in the accounting policies of the Company
during the periods presented. For a description of the significant accounting
policies of the Company, refer to Note 2 of Notes to Consolidated Financial
Statements of Comfort Systems included in the Company's Annual Report on Form
10-K for the year ended December 31, 1998.
The regulations for unaudited interim financial statements such as those in
this report allow certain information and footnotes required by generally
accepted accounting principles for year end financial statements to be excluded.
The Company believes all adjustments necessary for a fair presentation of
these interim statements have been included and are of a normal and recurring
nature.
The results of operations for interim periods are not necessarily indicative
of the results for the fiscal year.
6
<PAGE>
CASH FLOW INFORMATION
Cash paid for interest for the three months ended March 31, 1998 and 1999 was
approximately $0.3 million and $3.9 million, respectively. Cash paid for income
taxes for the three months ended March 31, 1998 and 1999 was approximately $6.9
million and $2.9 million, respectively.
3. BUSINESS COMBINATIONS:
POOLINGS
During 1998, the Company acquired all of the outstanding stock of the Pooled
Companies in exchange for 1,437,767 shares of Common Stock. These acquisitions
have been accounted for as poolings-of-interests as described in Note 2 of Notes
to Consolidated Financial Statements of Comfort Systems included in the Annual
Report on Form 10-K as filed with the Securities and Exchange Commission for the
year ended December 31, 1998. These companies provide HVAC and related services.
There were no acquisitions for the three months ended March 31, 1999 which
were accounted for as poolings-of-interests.
PURCHASES
During 1998, the Company acquired 52 of the Purchased Companies. These
companies provide HVAC and related services. The aggregate consideration paid in
these transactions was $161.2 million in cash, 9,212,573 shares of Common Stock
with a market value at the date of acquisition totaling $111.5 million, $57.4
million in the form of convertible subordinated notes and $3.1 million in the
form of subordinated notes (collectively the "Notes"). The convertible notes are
convertible at various dates in 1999, 2000, 2001, and 2002 and thereafter into
1,243,673, 1,699,729, 1,797,937, and 53,655 shares of Common Stock,
respectively. Prior to 1998, convertible subordinated notes were issued to
Purchased Companies and are convertible at various dates in 1999 and thereafter
into 220,449 shares of Common Stock.
For the three months ended March 31, 1999, Comfort Systems acquired 10
additional companies, which were accounted for as purchase transactions. These
companies also provide HVAC and related services. The aggregate consideration
paid in these transactions was approximately $9.9 million in cash, 381,689
shares of Common Stock with a market value at the date of acquisition totaling
$5.6 million, approximately $2.2 million in the form of convertible subordinated
notes and $3.3 million in the form of subordinated notes (collectively the
"Notes"). The convertible notes are convertible at various dates in 2000 and
2001 into 91,868 shares of Common Stock and in 2002 into 76,562 shares of Common
Stock. The allocation of the respective purchase prices to the assets assumed
and liabilities acquired resulted in $17.9 million of goodwill related to the
companies acquired during the first quarter of 1999.
The accompanying balance sheets include allocations of the respective
purchase prices to the assets acquired and liabilities assumed based on
preliminary estimates of fair value and is subject to final adjustment.
The unaudited pro forma data presented below consist of the income statement
data presented in these consolidated financial statements plus income statement
data for the Purchased Companies as if the acquisitions were effective on
January 1, 1998 through the respective dates of acquisitions (in thousands,
except per share data):
7
<PAGE>
THREE MONTHS ENDED
MARCH 31,
-------------------
1998 1999
-------- --------
Revenues ............................................ $283,766 $293,001
Net income .......................................... $ 7,467 $ 6,411
Net income per share - diluted ...................... 0.20 0.16
Shares used in computing net income per share - diluted $ 38,039 $ 39,994
Pro forma adjustments included in the preceding table regarding the Acquired
Companies primarily relate to (a) certain reductions in salaries and benefits to
the former owners (the "Compensation Differential") of the Pooled Companies and
Purchased Companies which the former owners agreed would take effect as of the
acquisition date, (b) amortization of goodwill related to the Purchased
Companies and (c) interest expense on borrowings of $11.0 million that would
have been necessary to fund certain S Corporation distributions if they had
occurred at the beginning of each period presented. In addition, an incremental
tax provision has been recorded as if all applicable Purchased Companies and
Pooled Companies which were C Corporations had been subject to federal and state
income taxes.
The pro forma results presented above are not necessarily indicative of
actual results which might have occurred had the operations and management teams
of the Company, the Purchased Companies and Pooled Companies been combined at
the beginning of the periods presented.
4. LONG-TERM DEBT OBLIGATIONS:
Long-term debt obligations consist of the following (in thousands):
DECEMBER 31, MARCH 31,
1998 1999
------------ --------
(UNAUDITED)
Revolving credit facility ....................... $ 170,700 $182,750
Notes to affiliates and former owners ........... 63,839 68,332
Other ........................................... 1,907 497
------------ --------
Total debt ...................................... 236,446 251,579
Less: current maturities ........................ 9,077 6,801
------------ --------
$ 227,369 $244,778
============ ========
REVOLVING CREDIT AGREEMENT
In July 1997, the Company entered into a credit agreement with Bank One,
Texas, N.A. (the "Credit Facility"). The Credit Facility was amended and
restated in September 1997 primarily to provide for additional banks to lend to
the Company under the Credit Facility. At that time, the Credit Facility
provided the Company with an unsecured revolving line of credit of $75 million.
The Credit Facility was further amended in April 1998 and again in December 1998
in order to increase borrowing capacity and to provide for additional banks to
lend to the Company under the Credit Facility. The Credit Facility currently
provides the Company with a revolving line of credit up to $300 million secured
by accounts receivable, inventory and the shares of capital stock of the
Company's subsidiaries. The Company currently has a choice of two interest rate
options when borrowing under the Credit Facility. Under one option, the interest
rate is determined based on the higher of the Federal Funds Rate plus 0.5% or
the bank's prime rate. An additional
8
<PAGE>
margin of zero to 1.25% is then added to the higher of these two rates. Under
the other interest rate option, borrowings bear interest based on designated
short-term Eurodollar rates (which generally approximate LIBOR) plus 1.0% to
2.5%. The additional margin for both options depends on the ratio of the
Company's debt to EBITDA. Commitment fees of 0.25% to 0.5% per annum, also
depending on the ratio of debt to EBITDA, are payable on the unused portion of
the facility. The Credit Facility prohibits the payment of dividends by the
Company without the lenders' approval and requires the Company to comply with
certain financial covenants. The amended Credit Facility expires on November 1,
2001, at which time all amounts outstanding under the Credit Facility are due.
As of March 31, 1999, the Company had borrowed $182.8 million under the
Credit Facility at an average interest rate of approximately 6.8% per annum for
the first quarter of 1999. As of May 11, 1999, $194.7 million was outstanding
under this facility.
NOTES TO AFFILIATES AND FORMER OWNERS
The Notes in the amount of $68.3 million, net of $2.6 million of repayments,
referred to above were issued to former owners of certain Purchased Companies as
partial consideration of the acquisition purchase price. Of these Notes, $67.8
million bear interest, payable quarterly, at a weighted average interest rate of
5.42% and $64.5 million are convertible by the holder into shares of the
Company's Common Stock at a weighted average price of $25.78 per share. The
remaining Notes in the amount of $0.5 million are non-interest bearing, and
require principal payments in four equal annual installments beginning in 2000.
The terms of the convertible subordinated notes require $6.5 million of
principal payments in 1999, $10.9 million of principal payments in 2000, $43.5
million of principal payments in 2001, $3.2 million of principal payments in
2002 and $0.4 million of principal payments in 2003. The terms of the
nonconvertible interest-bearing subordinated notes require $3.3 million of
principal payments in 2002.
5. COMMITMENTS AND CONTINGENCIES:
CLAIMS AND LAWSUITS
The Company is from time to time party to litigation in the ordinary course
of business. There are currently no pending legal proceedings that, in
management's opinion, would have a material adverse effect on the Company's
operating results or financial condition. The Company maintains various
insurance coverages in order to minimize financial risk associated with certain
claims. The Company has provided accruals for probable losses and legal fees
associated with certain of these actions in the accompanying consolidated
financial statements. A wholly-owned insurance company subsidiary reinsures a
portion of the risk associated with surety bonds issued by a third party
insurance company. Because no claims have been made against these financial
instruments in the past, management does not expect these instruments will have
a material effect on the Company's consolidated financial statements.
6. STOCKHOLDERS' EQUITY:
COMMON STOCK AND PREFERRED STOCK
During 1998, the Company increased the number of authorized shares of Common
Stock to 102,969,912. On June 16, 1998, the Company completed a second public
offering (the "Second Public Offering") of 400,000 shares of its Common Stock.
The net proceeds from this offering of $7.6 million, after deducting
underwriting commissions, were used to repay debt. On July 21, 1998, the
underwriters exercised their overallotment option in connection with the Second
Public Offering completed in June 1998. An additional 461,479 shares of Common
Stock were sold and the net proceeds of $8.8 million, after deducting
underwriting commissions, were used to repay debt.
RESTRICTED COMMON STOCK
In March 1997, Notre Capital Ventures II, L.L.C. ("Notre") exchanged
2,742,912 shares of Common
9
<PAGE>
Stock for an equal number of shares of restricted voting common stock
("Restricted Voting Common Stock"). The holder of Restricted Voting Common Stock
is entitled to elect one member of the Company's Board of Directors and to 0.55
of one vote for each share on all other matters on which they are entitled to
vote. Holders of Restricted Voting Common Stock are not entitled to vote on the
election of any other directors.
Each share of Restricted Voting Common Stock will automatically convert to
Common Stock on a share-for-share basis (i) in the event of a disposition of
such share of Restricted Voting Common Stock by the holder thereof (other than a
distribution which is a distribution by a holder to its partners or beneficial
owners, or a transfer to a related party of such holders (as defined in Sections
267, 707, 318 and/or 4946 of the Internal Revenue Code of 1986, as amended)),
(ii) in the event any person acquires beneficial ownership of 15% or more of the
total number of outstanding shares of Common Stock of the Company, or (iii) in
the event any person offers to acquire 15% or more of the total number of
outstanding shares of Common Stock of the Company. After July 1,1998, the Board
of Directors may elect to convert any remaining shares of Restricted Voting
Common Stock into shares of Common Stock in the event 80% or more of the
originally outstanding shares of Restricted Voting Common Stock have been
previously converted into shares of Common Stock. As of March 31, 1999, 306,724
shares of Restricted Voting Common Stock had been converted to shares of Common
Stock.
EARNINGS PER SHARE
In February 1997, the Financial Accounting Standards Board issued SFAS No.
128, "Earnings Per Share." SFAS No. 128 revises the methodology to be used in
computing earnings per share ("EPS") such that the computations previously
required for primary and fully diluted EPS are to be replaced with "basic" and
"diluted" EPS. Basic EPS is computed by dividing net income by the weighted
average number of shares of common stock outstanding during the year. Diluted
EPS is computed in a similar manner as fully diluted EPS, except that, among
other changes, the average share price for the period is used in all cases when
applying the treasury stock method to potentially dilutive outstanding options.
Diluted EPS is also computed by adjusting both net earnings and shares
outstanding as if the conversion of the convertible subordinated notes occurred
on the first day of the year. The after tax interest expense related to the
assumed conversion of the convertible subordinated notes during the first three
months of 1999 was $190,000. The effect of the assumed conversion of the
convertible subordinated notes during the first three months of 1998 was
antidilutive.
The following table summarizes weighted average shares outstanding for each
of the periods presented (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------
1998 1999
------ ------
<S> <C> <C>
Shares issued in connection with the acquisitions of the Founding Companies 9,721 9,721
Shares sold pursuant to the IPO ........................................... 6,100 6,100
Shares held by Notre, management and consultants .......................... 4,240 4,240
Shares issued in connection with the acquisitions of the Pooled Companies . 5,946 5,946
Weighted average shares issued in connection with the underwriter's
overallotment .......................................................... 915 1,376
Weighted average shares issued in connection with the acquisitions of the
Purchased Companies .................................................... 2,403 10,437
Weighted average shares sold in the Second Public Offering ................ -- 400
Weighted average portion of shares issued in connection with the Employee
Stock Purchase Plan .................................................... -- 66
Weighted average portion of shares issued in connection with the exercise
of stock options .......................................................... -- 25
------ ------
Weighted average shares outstanding - Basic .............................. 29,325 38,311
Weighted average portion of shares related to stock options
under the treasury stock method ........................................ 431 166
Weighted average shares related to the issuance of convertible notes ...... -- 1,292
------ ------
Weighted average shares outstanding - Diluted ............................. 29,756 39,769
====== ======
</TABLE>
10
<PAGE>
COMFORT SYSTEMS USA, INC.
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
historical and pro forma combined financial statements of the Company and
related notes thereto included elsewhere in this Form 10-Q and the Annual Report
on Form 10-K for the year ended December 31, 1998 (the "Form 10-K"). This
discussion contains forward-looking statements regarding the business and
industry of Comfort Systems within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are based on the current plans
and expectations of the Company and involve risks and uncertanties that could
cause actual future activities and results of operations to be materially
different from those set forth in the forward-looking statements. Important
factors that could cause actual results to differ include risks set forth in
"Factors Which May Affect Future Results," included in the Form 10-K.
The Company is a leading national provider of comprehensive HVAC
installation, maintenance, repair and replacement services. Founded in December
1996, the Company is consolidating the fragmented commercial and industrial HVAC
markets and performs most of its services within manufacturing plants, office
buildings, retail centers, apartment complexes, and healthcare, education and
government facilities. In addition to standard HVAC services, the Company also
provides specialized applications such as process cooling, control systems,
electronic monitoring and process piping. Certain locations also perform related
services such as electrical and plumbing.
On July 2, 1997, the Company completed the IPO and simultaneously acquired
the twelve Founding Companies, which are engaged in providing HVAC services.
Subsequent to the IPO, and through March 31, 1999, the Company acquired 92
additional HVAC and complementary businesses. Of these additional acquisitions,
17 acquisitions were accounted for as poolings-of-interests and the remaining 75
acquisitions were accounted for as purchases. The consolidated historical
financial statements of the Company have been retroactively restated to give
effect to the operations of the Pooled Companies.
Historical results are not necessarily indicative of future results of the
Company because, among other things, the Acquired Companies were not under
common control or management prior to their acquisition. The results of the
Company have historically been subject to seasonal fluctuations. The timing and
magnitude of acquisitions, assimilation costs and the seasonal nature of the
HVAC industry may materially affect operating results. Accordingly, the
operating results for any period are not necessarily indicative of the results
that may be achieved for any subsequent period. These historical statements of
operations should be read in conjunction with the historical Consolidated
Financial Statements and related notes of Comfort Systems, filed herewith, and
the additional information and the respective financial statements and related
notes of Comfort Systems included in the Annual Report on Form 10-K as filed
with the Securities and Exchange Commission for the year ended December 31,
1998.
11
<PAGE>
RESULTS OF OPERATIONS - HISTORICAL
THREE MONTHS ENDED
MARCH 31,
-----------------------------------------
(IN THOUSANDS)
1998 1999
------------------ ------------------
Revenues .......................... $ 132,608 100.0% $ 291,926 100.0%
Cost of services .................. 101,269 76.4 228,748 78.4
--------- ----- --------- -----
Gross profit ...................... 31,339 23.6 63,178 21.6
Selling, general and administrative
expenses ......................... 23,130 17.4 44,858 15.4
Goodwill amortization ............. 1,170 0.9 2,784 1.0
--------- ----- --------- -----
Operating income .................. 7,039 5.3 15,536 5.3
Other income (expense) ............ (876) (0.7) (3,979) (1.4)
--------- ----- --------- -----
Income before taxes ............... 6,163 4.6 11,557 4.0
Provision for income taxes ........ 2,778 -- 4,993 --
--------- ----- --------- -----
Net income ........................ $ 3,385 2.6% $ 6,564 2.2%
========= ===== ========= =====
REVENUES - Revenues increased $159.3 million, or 120.1%, to $291.9 million
for first quarter of 1999 compared to 1998. The increase in revenues was
primarily due to the acquisition of Purchased Companies.
GROSS PROFIT - Gross profit increased $31.8 million, or 101.6%, to $63.2
million for first quarter of 1999 compared to 1998. This increase was primarily
due to the acquisitions described above. As a percentage of revenues, gross
profit decreased from 23.6% for the three months ended March 31, 1998 to 21.6%
for the three months ended March 31, 1999. This decrease primarily resulted from
the reclassification of certain costs from selling, general and administrative
expenses to cost of services. These costs relate to activities that directly
support project or service work. This reclassification better aligns the
presentation of cost of services and selling, general and administrative
expenses across all our acquired operations. Excluding the effect of this
reclassification of approximately $5.8 million, gross profit as a percent of
revenues was unchanged from the first quarter of 1998 at 23.6%.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") - SG&A increased
$21.7 million, or 93.9%, to $44.9 million for the first quarter of 1999 compared
to 1998. Most of this increase was related to Purchased Companies acquired
subsequent to first quarter 1998 along with corporate office and management
expenses associated with the Company's establishment as a public company. As a
percentage of revenues, selling, general and administrative expenses decreased
from 17.4% for the three months ended March 31, 1998 to 15.4% for the three
months ended March 31, 1999. This decrease is primarily attributable to the
reclassification of costs as described above. Excluding the effect of this
reclassification of approximately $5.8 million, SG&A expenses as a percent of
revenues was unchanged from the first quarter of 1998 at 17.4%. SG&A for the
first quarter of 1998 includes $0.4 million of salaries and benefits paid to the
former owners of the Pooled Companies which the former owners contractually
agreed would not continue following their acquisition by Comfort Systems.
OPERATING INCOME - Operating income increased $8.5 million, or 120.7% to
$15.5 million for the first quarter of 1999 compared to 1998 primarily due to
the addition of Purchased Companies. As a percentage of revenues, operating
income remained at 5.3% for the first quarter of 1998 and 1999.
OTHER INCOME (EXPENSE) - Other expense, net, increased to $4.0 million for
the first quarter of 1999 primarily due to the increase in interest expense
related to the acquisition of Purchased Companies subsequent to the first
quarter of 1998.
12
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES - HISTORICAL
For the three months ended March 31, 1999, net cash provided by operating
activities was $1.5 million primarily due to a decrease in prepaid expenses and
other current assets of $0.9 million and an increase in accounts payable and
accrued liabilities of $0.5 million. Cash used in operating activities for the
three months ended March 31, 1998 was $6.1 million, primarily as a result of a
decrease in accounts payable.
Cash used in investing activities was $13.3 million for the three months
ended March 31, 1999, primarily in connection with the acquisition of Purchased
Companies for $9.8 million, net of cash acquired. Cash used in investing
activities for the three months ended March 31, 1998 was $17.1 million,
primarily for the acquisition of Purchased Companies.
Cash provided by financing activities for the three months ended March 31,
1999 was $8.7 million and was primarily attributable to net borrowings of
long-term debt of $7.8 million, which were primarily used to fund acquisitions.
Net cash provided by financing activities for the three months ended March 31,
1998 was $12.4 million and was primarily attributable to net borrowings of
long-term debt related to the acquisition of Purchased Companies.
In July 1997, the Company entered into a credit agreement with Bank One,
Texas, N.A. (the "Credit Facility"). The Credit Facility was amended and
restated in September 1997 primarily to provide for additional banks to lend to
the Company under the Credit Facility. At that time, the Credit Facility
provided the Company with an unsecured revolving line of credit of $75 million.
The Credit Facility was further amended in April 1998 and again in December 1998
in order to increase borrowing capacity and to provide for additional banks to
lend to the Company under the Credit Facility. The Credit Facility currently
provides the Company with a revolving line of credit up to $300 million secured
by accounts receivable, inventory and the shares of capital stock of the
Company's subsidiaries. The Company currently has a choice of two interest rate
options when borrowing under the Credit Facility. Under one option, the interest
rate is determined based on the higher of the Federal Funds Rate plus 0.5% or
the bank's prime rate. An additional margin of zero to 1.25% is then added to
the higher of these two rates. Under the other interest rate option, borrowings
bear interest based on designated short-term Eurodollar rates (which generally
approximate LIBOR) plus 1.0% to 2.5%. The additional margin for both options
depends on the ratio of the Company's debt to EBITDA. Commitment fees of 0.25%
to 0.5% per annum, also depending on the ratio of debt to EBITDA, are payable on
the unused portion of the facility. The Credit Facility prohibits the payment of
dividends by the Company without the lenders' approval and requires the Company
to comply with certain financial covenants. The amended Credit Facility expires
on November 1, 2001, at which time all amounts outstanding under the Credit
Facility are due.
As of March 31, 1999, the Company had borrowed $182.8 million under the
Credit Facility at an average interest rate of approximately 6.8% per annum for
the first quarter of 1999. As of May 11, 1999, $194.7 million was outstanding
under this facility.
The Company anticipates that available borrowings under its Credit
Facility and cash flow from operations will provide cash in excess of the
Company's normal working capital and capital expenditure needs, debt service
requirements and additional acquisition opportunities. Should the Company
accelerate or revise its acquisition program, the Company may need to seek
additional financing through the public or private sale of equity or debt
securities or increase its Credit Facility. There can be no
13
<PAGE>
assurance that the Company will secure such financing if and when it is needed,
or that such financing will be available on terms that the Company deems
acceptable.
YEAR 2000
Computers, software, and other equipment utilizing embedded technology
that use only two digits to identify a year in a date field may be unable to
process accurately certain date-based information at or after the year 2000.
This is commonly referred to as the "Year 2000 issue." The Company has
implemented a Year 2000 program and is using both internal and external
resources to assess and replace or reprogram computers, software and other
equipment as needed. Key areas of the Company's operations that are being
addressed include external customers, external suppliers and internal computers,
software and potential back-up and contingency plans.
Year 2000 considerations may have an effect on some of the Company's
customers and suppliers, and thus indirectly on the Company. If the Company's
vendors or suppliers of the Company's necessary dispatching, power,
telecommunications, transportation and financial services fail to provide the
Company with equipment and service, the Company will be unable to provide
services to its customers. If any of these uncertainties were to occur, the
Company's business, financial condition and results of operations could be
materially adversely affected. The Company is studying the potential effect on
the Company with respect to customers and suppliers with Year 2000 issues and
does not currently expect a material effect on the Company's financial condition
or results of operations at this time. The Company has initiated communications
with its significant customers and suppliers to assess the extent to which the
Company is vulnerable to those third parties with which the Company transacts
business.
The Company's initial assessment identified Year 2000 issues within the
Company's operating systems. The total cost of anticipated Year 2000
enhancements is approximately $500,000 and is being funded from operating cash
flows. The majority of such costs is for the acquisition of hardware and
software and will be capitalized. The remaining costs will be expensed as
incurred and are not expected to have a material effect on the results of
operations. The Company expects, but cannot be certain, that it will be
substantially complete with Year 2000 enhancements for internal operating
systems by September 1999.
The ability of third parties with which the Company transacts business to
adequately address Year 2000 issues is outside of the Company's control. There
can be no assurance that the failure of the Company, or such third parties, to
adequately address their respective Year 2000 issues will not have a material
adverse effect on the Company's financial condition or results of operations.
Accordingly, as part of the Year 2000 program, contingency plans are being
assessed and developed to respond to any failures as they may occur. Such
contingency plans are scheduled to be completed during 1999. At this time, the
Company does not expect that any failure of the Company or third parties to
achieve Year 2000 compliance will adversely affect the Company.
SEASONALITY AND CYCLICALITY
The HVAC industry is subject to seasonal variations. Specifically, the
demand for new installation and replacement is generally lower during the winter
months due to reduced construction activity during inclement weather and less
use of air conditioning during the colder months. Demands for HVAC services is
generally higher in the second and third calendar quarters due to increased
construction activity and increased use of air conditioning during the warmer
months. Accordingly, the Company expects its revenues and operating results
generally will be lower in the first and fourth calendar quarters.
Historically, the construction industry has been highly cyclical. As a
result, the Company's volume of business may be adversely affected by declines
in new installation projects in various geographic regions of the United States.
14
<PAGE>
COMFORT SYSTEMS USA, INC.
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings that have arisen in
the ordinary course of business. The Company does not believe that any of these
proceedings will have a material adverse effect on the financial position or
results of operations of the Company.
ITEM 2. RECENT SALES OF UNREGISTERED SECURITIES
During the three month period ended March 31, 1999, the Company issued
133,824 unregistered shares of its Common Stock in connection with the
acquisition of two Purchased Companies. These shares were issued under the
Securities Act in reliance on the exemption provided by Section 4(2), no public
offering being involved.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
27.1 - Financial Data Schedule. (Filed herewith)
(b) Reports on Form 8-K
The Company filed a report on Form 8-K with the Securities and Exchange
Commission on November 25, 1998. Under Item 2 of that report, the Company
described its acquisition of Shambaugh and Son, Inc., a mechanical contractor
engaged primarily in HVAC, electrical, plumbing and fire suppression services.
On January 29, 1999, the Company filed an amendment to that report on Form
8-K/A, which supplemented the previous filing with the financial statements of
the above-referenced acquired company and certain pro forma financial
information.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
15
<PAGE>
SIGNATURE
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THE
REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE
UNDERSIGNED THEREUNTO DULY AUTHORIZED.
COMFORT SYSTEMS USA, INC.
By: /s/ J. GORDON BEITTENMILLER
J. Gordon Beittenmiller
Executive Vice President,
Chief Financial Officer and
Director
Dated: May __, 1999
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE FINANCIAL DATA SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED
FROM FORM 10-Q THREE MONTHS ENDED MARCH 31, 1999 AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> MAR-31-1999
<CASH> 3,773
<SECURITIES> 0
<RECEIVABLES> 243,353
<ALLOWANCES> 4,973
<INVENTORY> 16,408
<CURRENT-ASSETS> 318,496
<PP&E> 84,675
<DEPRECIATION> (48,873)
<TOTAL-ASSETS> 812,466
<CURRENT-LIABILITIES> 174,390
<BONDS> 244,778
0
0
<COMMON> 386
<OTHER-SE> 390,060
<TOTAL-LIABILITY-AND-EQUITY> 812,466
<SALES> 291,926
<TOTAL-REVENUES> 291,926
<CGS> 228,748
<TOTAL-COSTS> 228,748
<OTHER-EXPENSES> 47,484
<LOSS-PROVISION> 158
<INTEREST-EXPENSE> 4,187
<INCOME-PRETAX> 11,557
<INCOME-TAX> 4,993
<INCOME-CONTINUING> 6,564
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,564
<EPS-PRIMARY> 0.17
<EPS-DILUTED> 0.17
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