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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 JUNE 30, 2000
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 August
10, 2000, was 37,129,747.
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<PAGE>
COMFORT SYSTEMS USA, INC.
INDEX TO FORM 10-Q
FOR THE QUARTER ENDED JUNE 30, 2000
PAGE
----
Part I -- Financial Information
Item 1 -- Financial Statements
COMFORT SYSTEMS USA, INC.
Consolidated Balance Sheets.............................. 1
Consolidated Statements of Operations.................... 2
Consolidated Statements of Stockholders' Equity.......... 3
Consolidated Statements of Cash Flows.................... 4
Condensed Notes to Consolidated Financial Statements..... 5
Item 2 -- Management's Discussion and Analysis of Financial
Condition and Results of Operations.................... 11
Item 3 -- Quantitative and Qualitative Disclosures about Market
Risk................................................... 15
Part II -- Other Information
Item 1 -- Legal Proceedings......................................... 16
Item 2 -- Recent Sales of Unregistered Securities................... 16
Item 4 -- Submission of Matters to a Vote of Security Holders....... 16
Item 6 -- Exhibits and Reports on Form 8-K.......................... 16
Item 9 -- Changes and Disagreements with Accountants on
Accounting and Financial Disclosure.................... 17
Signature........................................................... 18
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
DECEMBER 31, JUNE 30,
1999 2000
------------ -----------
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents....... $ 3,664 $ 8,902
Accounts receivable............. 314,599 354,922
Less -- Allowance......... 5,568 6,661
-------- --------
Accounts receivable,
net................ 309,031 348,261
Other receivables............... 4,575 5,711
Inventories..................... 20,907 20,581
Prepaid expenses and other...... 19,891 23,221
Costs and estimated earnings in
excess of billings............. 54,575 52,868
-------- --------
Total current assets.. 412,643 459,544
PROPERTY AND EQUIPMENT, net.......... 41,964 45,315
GOODWILL, less accumulated
amortization of $20,665 and $26,997 474,529 468,179
OTHER NONCURRENT ASSETS.............. 14,136 5,543
-------- --------
Total assets.......... $943,272 $978,581
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Current maturities of long-term
debt........................... $ 3,353 $ 254
Current maturities of notes to
affiliates and former owners... 24,536 19,472
Accounts payable................ 96,032 114,727
Accrued compensation and
benefits....................... 36,187 35,807
Billings in excess of costs and
estimated earnings............. 52,170 69,929
Other current liabilities....... 27,799 27,904
-------- --------
Total current
liabilities........ 240,077 268,093
DEFERRED INCOME TAXES................ 4,547 6,844
LONG-TERM DEBT, NET OF CURRENT
MATURITIES......................... 225,471 246,119
NOTES TO AFFILIATES AND FORMER
OWNERS, NET OF CURRENT MATURITIES.. 52,473 36,637
OTHER LONG-TERM LIABILITIES.......... 1,739 1,257
-------- --------
Total liabilities..... 524,307 558,950
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,
39,258,913 shares issued....... 393 393
Treasury stock, at cost,
1,695,524 and 2,129,166 shares,
respectively................... (11,978) (14,273)
Additional paid-in capital...... 342,655 342,513
Retained earnings............... 87,895 90,998
-------- --------
Total stockholders'
equity............. 418,965 419,631
-------- --------
Total liabilities and
stockholders'
equity............. $943,272 $978,581
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
1
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
----------------------- -----------------------
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
REVENUES............................. $341,493 $404,970 $633,419 $767,536
COST OF SERVICES..................... 265,254 334,332 494,002 626,031
-------- -------- -------- --------
Gross profit............... 76,239 70,638 139,417 141,505
SELLING, GENERAL AND ADMINISTRATIVE
EXPENSES........................... 43,333 56,687 88,191 111,515
GOODWILL AMORTIZATION................ 2,883 3,149 5,667 6,332
-------- -------- -------- --------
Operating income........... 30,023 10,802 45,559 23,658
OTHER INCOME (EXPENSE):
Interest income................. 225 207 392 378
Interest expense................ (4,628) (6,681) (8,816) (12,778)
Other........................... 61 (12) 103 90
-------- -------- -------- --------
Other income (expense)..... (4,342) (6,486) (8,321) (12,310)
-------- -------- -------- --------
REDUCTIONS IN NON-OPERATING
ASSETS AND LIABILITIES, NET........ -- (5,190) -- (5,190)
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES.... 25,681 (874) 37,238 6,158
PROVISION FOR INCOME TAXES........... 11,036 31 16,029 3,055
-------- -------- -------- --------
NET INCOME (LOSS).................... $ 14,645 $ (905) $ 21,209 $ 3,103
======== ======== ======== ========
NET INCOME (LOSS) PER SHARE:
Basic........................... $ 0.38 $ (0.02) $ 0.55 $ 0.08
======== ======== ======== ========
Diluted......................... $ 0.37 $ (0.02) $ 0.54 $ 0.08
======== ======== ======== ========
SHARES USED IN COMPUTING NET INCOME
(LOSS) PER SHARE:
Basic........................... 38,734 37,496 38,524 37,528
======== ======== ======== ========
Diluted......................... 40,644 37,496 40,725 37,538
======== ======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
COMMON STOCK TREASURY STOCK ADDITIONAL TOTAL
------------------- --------------------- PAID-IN RETAINED STOCKHOLDERS'
SHARES AMOUNT SHARES AMOUNT CAPITAL EARNINGS EQUITY
---------- ------ ---------- -------- ---------- --------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE AT DECEMBER 31, 1998......... 38,141,180 $381 -- $ -- $ 333,978 $ 45,573 $379,932
Issuance of Common Stock:
Acquisition of purchased
companies...................... 958,533 10 125,197 885 6,164 -- 7,059
Issuance of Employee Stock
Purchase Plan shares........... 142,276 2 -- -- 2,036 -- 2,038
Issuance of shares for options
exercised...................... 16,924 -- -- -- 477 -- 477
Common Stock repurchases........... -- -- (1,820,721) (12,863) -- -- (12,863)
Net income......................... -- -- -- -- -- 42,322 42,322
---------- ---- ---------- -------- -------- --------- ---------
BALANCE AT DECEMBER 31, 1999......... 39,258,913 393 (1,695,524) (11,978) 342,655 87,895 418,965
Issuance of Common Stock:
Issuance of Employee Stock
Purchase Plan shares
(unaudited).................... -- -- 127,867 904 (142) -- 762
Common Stock repurchases
(unaudited)...................... -- -- (175,513) (1,224) -- -- (1,224)
Shares exchanged in repayment of
notes
receivable (unaudited)........... -- -- (385,996) (1,975) -- -- (1,975)
Net income (unaudited)............. -- -- -- -- -- 3,103 3,103
---------- ---- ---------- -------- -------- --------- ---------
BALANCE AT JUNE 30, 2000
(unaudited)........................ 39,258,913 $393 (2,129,166) $(14,273) $342,513 $90,998 $419,631
========== ==== ========== ======== ======== ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
3
<PAGE>
COMFORT SYSTEMS USA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
JUNE 30,
------------------------
1999 2000
--------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income........................... $ 21,209 $ 3,103
Adjustments to reconcile net income
to net cash provided by operating
activities --
Depreciation and amortization
expense........................ 11,033 12,191
Bad debt expense................ 315 1,875
Deferred tax expense
(benefit)...................... (542) 203
Gain on sale of property and
equipment...................... (190) (156)
Reduction in non-operating
assets and liabilities, net.... -- 5,190
Changes in operating assets and
liabilities, net of effects of
acquisitions of purchased
companies --
(Increase) decrease in --
Receivables, net...... (32,480) (40,570)
Inventories........... (2,219) 194
Prepaid expenses and
other current
assets............ 2,508 4,649
Costs and estimated
earnings in excess
of billings....... (6,375) 1,898
Other noncurrent
assets............ 1,376 927
Increase (decrease) in --
Accounts payable and
accrued
liabilities....... 10,647 10,913
Billings in excess of
costs and
estimated
earnings.......... (573) 17,605
Other, net............ (188) (524)
--------- ---------
Net cash provided by
operating activities.... 4,521 17,498
--------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and
equipment...................... (7,692) (9,430)
Proceeds from sales of property
and equipment.................. 862 485
Cash paid for purchased
companies, net of cash
acquired....................... (17,202) --
Other........................... (500) --
--------- ---------
Net cash used in investing
activities.............. (24,532) (8,945)
--------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on long-term debt...... (100,063) (148,519)
Borrowings of long-term debt.... 116,582 145,666
Proceeds from issuance of common
stock.......................... 913 762
Repurchases of common stock..... -- (1,224)
--------- ---------
Net cash provided by (used
in) financing
activities.............. 17,432 (3,315)
--------- ---------
NET INCREASE (DECREASE) IN CASH AND
CASH EQUIVALENTS................... (2,579) 5,238
CASH AND CASH EQUIVALENTS, beginning
of period.......................... 6,985 3,664
--------- ---------
CASH AND CASH EQUIVALENTS, end of
period............................. $ 4,406 $ 8,902
========= =========
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000
(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. The Company operates
primarily in the 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 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.
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, 1999 (the "Form 10-K").
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 Form 10-K.
The accompanying unaudited consolidated financial statements were prepared
using generally accepted accounting principles for interim financial information
and the instructions to Form 10-Q and applicable rules of Regulation S-X.
Accordingly, these financial statements do not include all information or
footnotes required by generally accepted accounting principles for complete
financial statements and should be read in conjunction with the Form 10-K. 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.
The preparation of financial statements in conformity with generally
accepted accounting principles requires the use of estimates and assumptions by
management in determining the reported amounts of revenues, expenses, assets,
liabilities and contingent assets and liabilities at the date of the financial
statements. Actual results could differ from those estimates.
CASH FLOW INFORMATION
Cash paid for interest for the six months ended June 30, 1999 and 2000 was
approximately $7.3 million and $11.9 million, respectively. Cash paid for income
taxes for the six months ended June 30, 1999 and 2000 was approximately
$14.8 million and $10.8 million, respectively.
3. REDUCTIONS IN NON-OPERATING ASSETS AND LIABILITIES, NET
During the quarter ended June 30, 2000, the Company recorded a non-cash
charge of approximately $5.2 million primarily related to the impairment of
certain non-operating assets. These assets primarily related to notes receivable
from former business owners. In addition, the Company recorded an impairment of
approximately $0.8 million to its minority investment in two entities associated
with the distribution and implementation of high-end engineering and design
software. The Company also recorded a gain of approximately $0.6 million on the
reduction of its subordinated note payable to a former owner in connection with
the settlement of claims with this former owner.
5
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 -- (CONTINUED)
4. BUSINESS COMBINATIONS:
During fiscal 1999, the Company acquired 25 businesses which were accounted
for as purchases. These companies provide HVAC and related services. The
aggregate consideration paid in these transactions was $38.0 million in cash,
1,151,907 shares of the Company's common stock ("Common Stock") with a fair
value at the dates of acquisition totaling $8.5 million, $2.2 million in the
form of convertible subordinated notes and $21.3 million in the form of
subordinated notes. In addition, the Company received 68,177 shares from a
former owner related to a prior year acquisition. Subsequent to the issuance of
certain of the convertible subordinated notes, the Company entered into
agreements with certain of the convertible noteholders to modify the terms of
$2.1 million of these notes in order to eliminate the provisions relating to
convertibility into Common Stock. The remaining convertible subordinated notes
are convertible in 2000 into 5,133 shares of Common Stock.
There were no acquisitions during the six months ended June 30, 2000.
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 are subject to final adjustment.
The unaudited pro forma data presented below consists 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, 1999 through the respective dates of acquisitions (in thousands,
except per share data):
SIX MONTHS ENDED
JUNE 30, 1999
----------------
Revenues............................. $680,269
Net income........................... $ 21,998
Net income per share -- diluted..... $ 0.55
Shares used in computing net income
per share -- diluted.............. 41,466
Pro forma adjustments included in the preceding table regarding the
purchased companies primarily relate to (a) certain reductions in salaries and
benefits to the former owners of the purchased companies which the former owners
agreed would take effect as of the acquisition date, (b) amortization of
goodwill related to the purchased companies, (c) interest expense on borrowings
of $38.0 million related to the purchase price of the purchased companies
acquired during 1999 and (d) interest expense related to subordinated notes
issued in connection with the acquisition of certain purchased companies. In
addition, an incremental tax provision has been recorded as if all applicable
purchased companies 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 and the purchased companies been combined at the beginning of the
period presented.
6
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 -- (CONTINUED)
5. LONG-TERM DEBT OBLIGATIONS:
Long-term debt obligations consist of the following (in thousands):
DECEMBER 31, JUNE 30,
1999 2000
------------ ------------
(UNAUDITED)
Revolving credit facility............ $225,215 $246,000
Notes to affiliates and former
owners............................. 77,009 56,109
Other................................ 3,609 373
-------- --------
Total debt........................... 305,833 302,482
Less: current maturities............. 27,889 19,726
-------- --------
$277,944 $282,756
======== ========
REVOLVING CREDIT FACILITY
The Company has a revolving credit facility ("Credit Facility") provided by
Bank One, Texas, N.A. and other banks (the "Bank Group"). The Credit Facility
provides the Company with a revolving line of credit of up to $300 million
secured by accounts receivable, inventory and the shares of capital stock of the
Company's subsidiaries. The Credit Facility expires on November 1, 2001, at
which time all amounts outstanding under the Credit Facility are due. 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 0.25% to 1.75% 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
1.25% to 3.00%. The additional margin for both options depends on the ratio of
the Company's debt to EBITDA (as defined). 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 payment of dividends by the Company, limits
certain non-Bank Group debt, and restricts outlays of cash by the Company
relating to certain investments, capital expenditures, vehicle leases,
acquisitions and principal repayments of subordinate debt. The Credit Facility
also provides for the maintenance of certain levels of shareholder equity and
EBITDA, and for the maintenance of certain ratios of the Company's EBITDA to
interest expense and debt to EBITDA. Under the terms of the Credit Facility that
were in effect as of June 30, 2000, the Company was in violation of the ratio
requirements of senior debt to EBITDA and subordinate debt repayments, in both
cases by small amounts. The Bank Group has waived these violations. In
connection with these waivers, the Bank Group has agreed to reduce the required
ratios of EBITDA to interest expense and debt to EBITDA through the maturity of
the Credit Facility.
As of June 30, 2000, the Company had borrowed $246.0 million under the
Credit Facility at an average interest rate of approximately 8.3% per annum for
the first six months of 2000. The Credit Facility's interest rate terms as
summarized above are effective as of August 11, 2000 and will result in an
increase of approximately 0.50% in the additional margin and related costs the
Company pays in excess of the indicated market interest rate in either of the
interest rate options. The Company's unused committed borrowing capacity under
the Credit Facility was $51.6 million at June 30, 2000. As of August 10, 2000,
$257.0 million was outstanding under this facility.
7
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 -- (CONTINUED)
INTENDED REFINANCINGS
Earlier this year, the Company intended to refinance a portion of its
variable-rate debt under the Credit Facility with fixed-rate private placement
debt. In anticipation of this transaction, the Company entered into interest
rate lock agreements to hedge against increases in market interest rates. In the
second quarter, the Company elected not to complete this refinancing and
terminated the interest lock agreements at a nominal gain. In connection with
this refinancing, the Company also had intended to decrease the size of the
Credit Facility. As disclosed by the Company in May, if this had occurred, the
Company would have recognized extraordinary charges of approximately $0.01 to
$0.02 per share for the write-off of a portion of the deferred issuance costs of
the Credit Facility. Because the Company no longer intends to reduce the Credit
Facility, it no longer expects such charges will be necessary.
The Company is considering steps to extend the maturity of, or otherwise
refinance, its borrowings under the Credit Facility. These amounts currently
mature in November 2001.
NOTES TO AFFILIATES AND FORMER OWNERS
Subordinated notes were issued to former owners of certain purchased
companies as partial consideration of the acquisition purchase price and had an
outstanding balance of $56.1 million as of June 30, 2000. Of these notes,
$55.8 million bear interest, payable quarterly, at a weighted average interest
rate of 5.81% and $1.4 million of these notes are convertible by the holders
into shares of the Company's Common Stock at a weighted average price of $25.40
per share. The remaining notes in the amount of $0.3 million are non-interest
bearing and require principal payments in equal annual installments in 2001,
2002 and 2003. The terms of the convertible subordinated notes require
$0.2 million of principal payments in 2000, $0.6 million of principal payments
in 2001 and $0.6 million of principal payments in 2002. The terms of the
nonconvertible interest bearing subordinated notes require $5.3 million of
principal payments in 2000, $26.9 million of principal payments in 2001, $21.3
million of principal payments in 2002 and $0.9 million of principal payments in
2003.
Under the current terms of the Credit Facility, the Company may be
restricted from making scheduled repayments of subordinate debt beginning in
October 2000. If this occurs, the Company has at least one year to regain
compliance with the terms of the subordinate debt. The Company intends to
negotiate the disposition of this issue in connection with pursuing an extension
of the maturity of borrowings outstanding under the Credit Facility as discussed
above.
6. COMMITMENTS AND CONTINGENCIES:
CLAIMS AND LAWSUITS
The Company is 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 limit 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.
8
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 -- (CONTINUED)
7. STOCKHOLDERS' EQUITY:
TREASURY STOCK
On October 5, 1999, the Company announced that its Board of Directors had
approved a share repurchase program authorizing the Company to buy up to 4.0
million shares of its Common Stock. During 1999, the Company purchased
approximately 1.8 million shares at a cost of approximately $12.9 million.
During the first six months of 2000, the Company purchased approximately 0.2
million shares at a cost of approximately $1.2 million. The Company does not
expect significant further share repurchases under this program for the
foreseeable future.
RESTRICTED COMMON STOCK
In March 1997, Notre Capital Ventures II, L.L.C. exchanged 2,742,912 shares
of Common Stock for an equal number of shares of restricted voting common stock
("Restricted Voting Common Stock"). The holders of Restricted Voting Common
Stock are entitled to elect one member of the Company's Board of Directors and
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 June 30, 2000, 1,270,328
shares of Restricted Voting Common Stock had been converted to shares of Common
Stock.
EARNINGS PER SHARE
Basic earnings per share ("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 considering the dilutive effect of stock options and
convertible subordinated notes. Options to purchase 4.0 million shares of Common
Stock at prices ranging from $7.625 to $21.438 per share were outstanding for
the six months ended June 30, 2000, but were not included in the computation of
diluted earnings per share because the options' exercise prices were greater
than the respective average market price of the Common Stock. Options had an
anti-dilutive effect for the three months ended June 30, 2000 because the
Company reported a net loss during this period, and therefore, are not included
in the diluted EPS calculation. 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 three months and six months ended June 30, 1999 was $0.3 million and
$0.7 million, respectively. The convertible subordinated notes had an
anti-dilutive effect during the three months and six months ended June 30, 2000,
and therefore, are not included in the diluted EPS calculation.
9
<PAGE>
COMFORT SYSTEMS USA, INC.
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2000 -- (CONTINUED)
The following table reconciles the number of shares outstanding with the
number of shares used in computing basic and diluted earnings per share for each
of the periods presented (in thousands):
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------- --------------------
1999 2000 1999 2000
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Common shares outstanding, end of period ......... 38,878 37,130 38,878 37,130
Effect of using weighted average common shares
outstanding .................................... (144) 366 (354) 398
-------- -------- -------- --------
Shares used in computing earnings per share --
basic .......................................... 38,734 37,496 38,524 37,528
Effect of shares issuable under stock option plans
based on the treasury stock method ............. 286 -- 223 10
Effect of shares issuable related to convertible
notes .......................................... 1,624 -- 1,978 --
-------- -------- -------- --------
Shares used in computing earnings per share --
diluted ........................................ 40,644 37,496 40,725 37,538
======== ======== ======== ========
</TABLE>
10
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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 historical
consolidated financial statements of Comfort Systems USA, Inc. ("Comfort
Systems' and collectively with its subsidiaries, the "Company") and related
notes thereto included elsewhere in this Form 10-Q and the Annual Report on Form
10-K as filed with the Securities and Exchange Commission for the year ended
December 31, 1999 (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. The Company operates
primarily in the 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 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.
Historical results are not necessarily indicative of future results of the
Company because, among other things, the businesses acquired 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 interim 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 Form 10-K.
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<PAGE>
RESULTS OF OPERATIONS -- (IN THOUSANDS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------------------- --------------------------------------
1999 2000 1999 2000
----------------- ----------------- ----------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenues............................. $341,493 100.0% $404,970 100.0% $633,419 100.0% $767,536 100.0%
Cost of services..................... 265,254 77.7 334,332 82.6 494,002 78.0 626,031 81.6
-------- -------- -------- --------
Gross profit......................... 76,239 22.3 70,638 17.4 139,417 22.0 141,505 18.4
Selling, general and administrative
expenses........................... 43,333 12.7 56,687 14.0 88,191 13.9 111,515 14.5
Goodwill amortization................ 2,883 0.8 3,149 0.8 5,667 0.9 6,332 0.8
-------- -------- -------- --------
Operating income..................... 30,023 8.8 10,802 2.7 45,559 7.2 23,658 3.1
Other income (expense)............... (4,342) 1.3 (6,486) (1.6) (8,321) 1.3 (12,310) (1.6)
Reductions in non-operating assets
and liabilities, net............... -- -- (5,190) (1.3) -- -- (5,190) (0.7)
-------- -------- -------- --------
Income (loss) before income taxes.... 25,681 7.5 (874) (0.2) 37,238 5.9 6,158 0.8
Provision for income taxes........... 11,036 -- 31 -- 16,029 -- 3,055 --
-------- -------- -------- --------
Net income (loss).................... $ 14,645 4.3 $ (905) (0.2) $ 21,209 3.3 $ 3,103 0.4
======== ======== ======== ========
</TABLE>
REVENUES -- Revenues increased $63.5 million, or 18.6%, to $405.0 million
for the second quarter of 2000 and increased $134.1 million, or 21.2%, to
$767.5 million for the first six months of 2000, compared to the same periods in
1999. For the three months ended June 30, 2000, approximately 13.8% of the
increase in revenues related to internal growth and the remaining 4.8% resulted
from acquisition activity in 1999. Approximately 13.8% of the increase in
revenues for the first six months of 2000 related to internal growth and the
remaining 7.4% resulted from acquisition activity during 1999. Approximately 3%
of the total increase in revenues for both the three and six months ended
June 30, 2000 resulted from the Company's ability to increase volume by
subcontracting portions of projects to other contractors. The Company believes
that the construction industry is continuing to experience capacity issues,
principally relating to shortages of labor, which could hinder the Company's
ability to increase its revenue volume while maintaining its historical margins.
GROSS PROFIT -- Gross profit decreased $5.6 million, or 7.3%, to
$70.6 million for the second quarter of 2000 and increased $2.1 million, or
1.5%, to $141.5 million for the first six months of 2000, compared to the same
periods in 1999. As a percentage of revenues, gross profit decreased from 22.3%
for the three months ended June 30, 1999 to 17.4% for the three months ended
June 30, 2000 and from 22.0% for the first six months of 1999 to 18.4% for the
first six months of 2000. During the second quarter of 2000, the Company
reported negative gross profit of approximately $4.6 million related to its
operations at a company in the Midwest. These losses were realized in connection
with several projects priced significantly below cost, execution problems and
other management shortfalls. The remaining decrease in gross profit as a
percentage of revenues resulted from increased labor costs, pricing pressures in
certain markets and scheduling and efficiency challenges associated with labor
availability and productivity at the high levels of activity at most of our
operations. The Company has also realized a change in its mix of revenue volume
to include more subcontracting activities which generally carry lower margins.
In addition, the Company also experienced weak performance at several locations
relating to ongoing turnaround efforts and execution difficulties.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("SG&A") -- SG&A increased
$13.4 million, or 30.8%, to $56.7 million for the second quarter of 2000 and
increased $23.3 million, or 26.4%, to $111.5 million for the first six months of
2000, compared to the same periods in 1999. As a percentage of revenues,
selling, general and administrative expenses increased from 12.7% for the three
months ended June 30, 1999 to 14.0% for the three months ended June 30, 2000 and
from 13.9% for the first six months of 1999 to 14.5% for the first six months of
2000. This increase in SG&A as a percentage of revenues resulted primarily from
1999 acquisitions including Outbound Services where the Company has incurred
additional SG&A to support expansion of its e-commerce
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<PAGE>
activities. The Company also increased corporate and regional office spending to
support the requirements of a larger organization and expand its focus on
serving national accounts. In addition, as discussed above, the Company has
experienced weak performance at several locations relating to turnaround efforts
and execution difficulties and these companies have realized a disproportionate
amount of SG&A as compared to their revenue volumes.
OTHER INCOME (EXPENSE) -- Other expense, net, increased $2.1 million, or
49.4%, to $6.5 million for the second quarter of 2000 and increased $4.0
million, or 47.9%, to $12.3 million for the first six months of 2000, compared
to the same periods in 1999. This increase was primarily due to the increase in
interest expense related to the acquisition of purchased companies in 1999 and
repurchases of the Company's common stock ("Common Stock").
REDUCTIONS IN NON-OPERATING ASSETS AND LIABILITIES, NET -- During the
quarter ended June 30, 2000, the Company recorded a non-cash charge of
approximately $5.2 million primarily related to the impairment of certain
non-operating assets. These assets primarily related to notes receivable from
former business owners. In addition, the Company recorded an impairment of
approximately $0.8 million to its minority investment in two entities associated
with the distribution and implementation of high-end engineering and design
software. The Company also recorded a gain of approximately $0.6 million on the
reduction of its subordinated note payable to a former owner in connection with
the settlement of claims with this former owner.
LIQUIDITY AND CAPITAL RESOURCES
For the six months ended June 30, 2000, net cash provided by operating
activities was $17.5 million and represents an increase of $13.0 million over
the comparable period of the prior year. During the current year, the Company
has focused on improving its cash flow. The increase is primarily as a result of
the increase in accounts payable and accrued liabilities and the increase in
billings in excess of costs and estimated earnings. Cash provided by operating
activities for the six months ended June 30, 1999 was $4.5 million primarily due
to an increase in accounts payable and accrued liabilities.
Cash used in investing activities was $8.9 million for the six months ended
June 30, 2000, primarily in connection with purchases of property and equipment
for $9.4 million. Cash used in investing activities for the six months ended
June 30, 1999 was $24.5 million, primarily for the acquisition of purchased
companies.
Cash used in financing activities for the six months ended June 30, 2000
was $3.3 million and was primarily attributable to net payments of long-term
debt of $2.9 million. Net cash provided by financing activities for the six
months ended June 30, 1999 was $17.4 million and was primarily attributable to
net borrowings of long-term debt related to the acquisition of purchased
companies.
The Company has a revolving credit facility ("Credit Facility") provided by
Bank One, Texas, N.A. and other banks ("the Bank Group"). The Credit Facility
provides the Company with a revolving line of credit of up to $300 million
secured by accounts receivable, inventory and the shares of capital stock of the
Company's subsidiaries. The Credit Facility expires on November 1, 2001, at
which time all amounts outstanding under the Credit Facility are due. 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 0.25% to 1.75% 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
1.25% to 3.00%. The additional margin for both options depends on the ratio of
the Company's debt to EBITDA (as defined). 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 payment of dividends by the Company, limits
certain non-Bank Group debt, and restricts outlays of cash by the Company
relating to certain investments, capital expenditures, vehicle leases,
acquisitions and principal repayments of subordinate debt. The Credit Facility
also provides for the maintenance of certain levels of shareholder equity and
EBITDA, and for the maintenance of certain ratios of the Company's EBITDA to
interest expense and debt to EBITDA. Under the terms of the Credit Facility that
were in effect as of June 30, 2000, the Company was in violation of the ratio
requirements of
13
<PAGE>
senior debt to EBITDA and subordinate debt repayments, in both cases by small
amounts. The Bank Group has waived these violations. In connection with these
waivers, the Bank Group has agreed to reduce the required ratios of EBITDA to
interest expense and debt to EBITDA through the maturity of the Credit Facility.
As of June 30, 2000, the Company had borrowed $246.0 million under the
Credit Facility at an average interest rate of approximately 8.3% per annum for
the first six months of 2000. The Credit Facility's interest rate terms as
summarized above are effective as of August 11, 2000 and will result in an
increase of approximately 0.50% in the additional margin and related costs the
Company pays in excess of the indicated market interest rate in either of the
interest rate options. The Company's unused committed borrowing capacity under
the Credit Facility was $51.6 million at June 30, 2000. As of August 10, 2000,
$257.0 million was outstanding under this facility.
Earlier this year, the Company intended to refinance a portion of its
variable-rate debt under the Credit Facility with fixed-rate private placement
debt. In anticipation of this transaction, the Company entered into interest
rate lock agreements to hedge against increases in market interest rates. In the
second quarter, the Company elected not to complete this refinancing and
terminated the interest lock agreements at a nominal gain. The Company is
considering steps to extend the maturity of, or otherwise refinance, its
borrowings under the Credit Facility. These amounts currently mature in November
2001.
Subordinated notes were issued to former owners of certain purchased
companies as partial consideration of the acquisition purchase price and had an
outstanding balance of $56.1 million as of June 30, 2000. Of these notes, $55.8
million bear interest, payable quarterly, at a weighted average interest rate of
5.81% and $1.4 million of these notes are convertible by the holders into shares
of the Company's Common Stock at a weighted average price of $25.40 per share.
The remaining notes in the amount of $0.3 million are non-interest bearing and
require principal payments in equal annual installments in 2001, 2002 and 2003.
The terms of the convertible subordinated notes require $0.2 million of
principal payments in 2000, $0.6 million of principal payments in 2001 and $0.6
million of principal payments in 2002. The terms of the nonconvertible interest
bearing subordinated notes require $5.3 million of principal payments in 2000,
$26.9 million of principal payments in 2001, $21.3 million of principal payments
in 2002 and $0.9 million of principal payments in 2003.
Under the current terms of the Credit Facility, the Company may be
restricted from making scheduled repayments of subordinate debt beginning in
October 2000. If this occurs, the Company has at least one year to regain
compliance with the terms of the subordinate debt. The Company intends to
negotiate the disposition of this issue in connection with pursuing an extension
of the maturity of borrowings outstanding under the Credit Facility as discussed
above.
On October 5, 1999, the Company announced that its Board of Directors had
approved a share repurchase program authorizing the Company to buy up to 4.0
million shares of its Common Stock. During 1999, the Company purchased
approximately 1.8 million shares at a cost of approximately $12.9 million.
During the first six months of 2000, the Company purchased approximately 0.2
million shares at a cost of approximately $1.2 million. The Company does not
expect significant further share repurchases under this program for the
foreseeable future.
The Company anticipates that available borrowings under its Credit Facility
and cash flow from operations will be sufficient to meet the Company's normal
working capital and capital expenditure needs. The Company will need to extend
the maturity of its borrowings under the Credit Facility, and may also need to
extend maturities of some of its subordinate debt to affiliates and former
owners. As discussed above, the Company is considering alternatives to
accomplish these steps. There can be no assurance that extensions can be
obtained, or that if the Company needs additional financing, that such financing
can be secured when needed or on terms 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
accurately process certain date-based information at or after
14
<PAGE>
the year 2000. This is commonly referred to as the "Year 2000 issue." The
Company implemented a Year 2000 program and used 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 were addressed
included external customers, external suppliers and internal computers, software
and potential back-up and contingency plans. To date, the Company has not
experienced any significant Year 2000 issues.
The Company's initial assessment identified Year 2000 issues within the
Company's operating systems. The total cost of Year 2000 enhancements was
approximately $800,000 and was funded from operating cash flows. The majority of
such costs was for the acquisition of hardware and software and was capitalized.
The remaining costs were expensed as incurred and did not have a material effect
on the results of operations.
The ability of third parties with which the Company transacts business to
adequately address remaining 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 remaining 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 were developed to respond to any failures. 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. Demand 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.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk primarily related to potential
adverse changes in interest rates. Management is actively involved in monitoring
exposure to market risk and continues to develop and utilize appropriate risk
management techniques.
15
<PAGE>
COMFORT SYSTEMS USA, INC.
PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is party to litigation in the ordinary course of business.
There are currently no pending legal proceedings that, in management's opinion,
will have a material adverse effect on the Company's consolidated operating
results or financial condition.
ITEM 2. RECENT SALES OF UNREGISTERED SECURITIES
During the three month period ended June 30, 2000, the Company did not
issue any unregistered shares of its common stock.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its annual meeting of stockholders in Houston, Texas on
May 18, 2000. The following sets forth matters submitted to a vote of
stockholders:
(a) The following individuals were elected to the Board of Directors as
stated in the Company's Proxy Statement dated April 24, 2000, for
terms expiring at the 2003 annual stockholders' meeting or until their
successors have been elected and qualified -- Class III directors are
Alfred J. Giardinelli, Samuel M. Lawrence, Robert M. Powers, Diane D.
Sanders, and Steven S. Harter. Every director was elected by more than
a majority of the outstanding shares of Common Stock of the Company,
except for Mr. Harter who was elected by more than a majority of the
outstanding shares of Restricted Voting Common Stock. Mr. Giardinelli
had 30,304,902 shares voted in favor, with 546,103 shares withheld,
Mr. Harter had 1,273,004 shares voted in favor, with no shares
withheld, Mr. Lawrence had 30,304,844 shares voted in favor, with
546,161 shares withheld, Mr. Powers had 30,304,776 shares voted in
favor, with 546,229 shares withheld, Diane D. Sanders had 31,640,800
shares voted in favor, with 295,926 shares withheld.
(b) A majority of the outstanding shares of Common Stock of the Company
approved the amendment of the 1998 Employee Stock Purchase Plan to
increase the number of shares issuable by 600,000 shares. Shares voted
in favor 24,239,970, with 872,151 shares against, and 108,637 shares
abstained.
(c) A majority of the outstanding shares of Common Stock of the Company
approved the adoption of the 2000 Incentive Plan, and to authorize the
issuance of up to 3,500,000 options to purchase shares. Shares voted
in favor 23,271,825, with 3,071,061 shares against, and 150,839
abstained.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.1 -- Severance and General Release Agreement between Fred M.
Ferreira and the Company dated June 30, 2000. (Filed
herewith).
10.2 -- Employment Agreement between William F. Murdy and the Company
dated June 27, 2000. (Filed herewith).
10.3 -- Note Modification Agreement between Mark Shambaugh and the
Company dated August 8, 2000. (Filed herewith).
10.4 -- Note Termination Agreement among Salvatore Fichera and
Salvatore Giardina, Sorce Properties LLC, and F&G Mechanical
Corporation dated June 23, 2000. (Filed herewith).
10.5 -- Third Amendment to Credit Agreement dated as of August 11,
2000 amending the Third Amended and Restated Credit Agreement
dated December 14, 1998 among the Company and its
subsidiaries, Bank One, Texas, N.A., as agent and the banks
listed therein. (Filed herewith).
16
<PAGE>
10.6 -- Amendment to 1998 Employee Stock Purchase Plan dated May 18,
2000. (Filed herewith).
10.7 -- Comfort Systems USA, Inc. 2000 Incentive Plan. (Filed
herewith).
27.1 -- Financial Data Schedule. (Filed herewith)
(b) Reports on Form 8-K
None.
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
17
<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: August 14, 2000
18
