<PAGE>
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------
FORM 10-Q
----------------
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the quarterly period ended September 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 1-13565
----------------
ENCOMPASS SERVICES CORPORATION
(Exact name of registrant as specified in its charter)
----------------
Texas 76-0535259
(State of incorporation) (I.R.S. Employer Identification No.)
3 Greenway Plaza, Suite 2000
Houston, Texas 77046
(Address of principal executive offices, including Zip Code)
Registrant's telephone number, including area code: (713) 860-0100
----------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date.
Common Stock, par value $0.001 per share; 63,532,975 shares outstanding as
of October 31, 2000.
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<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Part I Financial Information
Item 1. Financial Statements............................................. 1
General Information.................................................... 1
Consolidated Condensed Balance Sheets.................................. 2
Consolidated Condensed Statements of Operations........................ 3
Consolidated Condensed Statement of Shareholders' Equity............... 4
Consolidated Condensed Statements of Cash Flows........................ 5
Notes to Consolidated Condensed Financial Statements................... 6
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations................................................... 15
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 23
Part II Other Information
Item 1. Legal Proceedings................................................ *
Item 2. Changes in Securities and Use of Proceeds........................ *
Item 3. Defaults Upon Senior Securities.................................. *
Item 4. Submission of Matters to a Vote of Security Holders.............. *
Item 5. Other Information................................................ *
Item 6. Exhibits and Reports on Form 8-K................................. 24
</TABLE>
--------
* No response to this item is included herein for the reason that it is
inapplicable or the answer to such item is negative.
i
<PAGE>
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements.
General Information
Encompass Services Corporation ("Encompass"), a Texas corporation
incorporated in 1997, is the leading nationwide provider of facilities services
to commercial, industrial and residential customers. As used herein, the
"Company" refers to Encompass and its consolidated subsidiaries.
On February 22, 2000, Building One ("Building One") was merged with and into
GroupMAC ("GroupMAC") (the "Merger"). In connection with the Merger, GroupMAC
changed its name to Encompass Services Corporation. As a result of the Merger,
the Company is approximately twice the size of each of GroupMAC and Building
One and has the capability of providing mechanical, electrical and janitorial
services, either alone or in combination with another service, in more
locations than either constituent company could perform on its own. For
additional information concerning the Merger, see Item 2, "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
Note 2 to the Consolidated Condensed Financial Statements.
The Merger was accounted for as a "reverse acquisition" under generally
accepted accounting principles and, accordingly, the financial statements and
other information included herein for periods prior to the Merger reflect the
historical results of Building One rather than GroupMAC.
In connection with the Merger, Encompass issued to affiliates of Apollo
Management, L.P. approximately $256 million of 7.25% Convertible Preferred
Stock in exchange for $150 million in cash and approximately $106 million
aggregate principal amount of Building One convertible junior subordinated
debentures. Based upon the current conversion price of $14.00 per share, the
preferred stock is convertible into approximately 18.8 million shares of
Encompass common stock, representing approximately 23% of the voting power of
Encompass. Encompass used the cash proceeds from the issuance of the
Convertible Preferred Stock to fund obligations pursuant to the rights of
former GroupMAC shareholders to elect to receive in the Merger cash for up to
50% of their shares of Encompass common stock at $13.50 per share, subject to
proration. The cash election was over-subscribed, resulting in a cancellation
of 11,052,377 shares of Encompass common stock.
1
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED BALANCE SHEETS
(In thousands, except par value)
(Unaudited)
<TABLE>
<CAPTION>
September 30, December 31,
2000 1999
------------- ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents........................ $ 1,779 $ 17,085
Marketable securities............................ -- 2,275
Accounts receivable, net......................... 985,934 400,326
Inventories...................................... 32,276 10,324
Costs and estimated earnings in excess of
billings on uncompleted contracts............... 135,888 59,418
Deferred tax assets.............................. 14,704 4,168
Refundable income taxes.......................... -- 1,757
Prepaid expenses and other current assets........ 43,449 13,260
---------- ----------
Total current assets........................... 1,214,030 508,613
Property and equipment, net........................ 122,442 63,288
Goodwill and other intangible assets, net.......... 1,345,052 713,346
Deferred debt issue costs.......................... 17,927 20,411
Other assets....................................... 13,230 8,096
---------- ----------
Total assets................................... $2,712,681 $1,313,754
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Short-term borrowings and current maturities of
long term debt.................................. $ 7,065 $ 7,950
Accounts payable................................. 269,482 107,319
Billings in excess of costs and estimated
earnings on uncompleted contracts............... 229,451 86,122
Due to related parties........................... 19,790 10,290
Accrued compensation............................. 101,463 39,873
Income tax payable............................... 2,261 --
Accrued liabilities.............................. 82,814 36,628
---------- ----------
Total current liabilities...................... 712,326 288,182
Revolving credit facility.......................... 388,150 166,500
Term credit facilities............................. 393,250 124,063
Senior subordinated notes, net of unamortized
discount.......................................... 196,131 195,793
Junior subordinated notes.......................... 4,113 --
Convertible junior subordinated debentures......... -- 105,103
Deferred tax liabilities........................... 8,223 2,085
Other liabilities.................................. 14,207 3,271
Commitments and contingencies
Mandatorily redeemable convertible preferred stock,
$0.001 par value, 50,000 shares authorized, 256
and zero shares issued and outstanding,
respectively...................................... 252,623 --
Shareholders' equity:
Common stock, $.001 par value, 100,000 shares
authorized, 63,381 and 35,135 shares issued and
outstanding, respectively 63 35
Additional paid-in capital....................... 621,055 329,118
Retained earnings................................ 122,540 100,317
Accumulated other comprehensive loss............. -- (713)
---------- ----------
Total shareholders' equity..................... 743,658 428,757
---------- ----------
Total liabilities and shareholders' equity..... $2,712,681 $1,313,754
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
2
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------- ----------------------
2000 1999 2000 1999
---------- -------- ---------- ----------
<S> <C> <C> <C> <C>
Revenues........................ $1,167,512 $477,875 $2,936,258 $1,265,521
Cost of services................ 979,609 379,900 2,428,759 1,011,305
---------- -------- ---------- ----------
Gross profit.................. 187,903 97,975 507,499 254,216
Selling, general and
administrative expenses........ 123,861 53,375 317,511 145,863
Merger and related charges...... -- -- 7,800 --
Costs to exit certain activities
and integration costs.......... -- -- 12,200 --
Amortization of goodwill and
other intangibles.............. 9,050 4,238 24,169 11,511
Restructuring and
recapitalization charges....... -- -- -- 8,020
---------- -------- ---------- ----------
Income from operations........ 54,992 40,362 145,819 88,822
Other income (expense):
Interest income............... 275 468 558 4,674
Interest expense.............. (24,031) (13,062) (63,717) (21,279)
Loss on sale of marketable
securities................... -- -- (1,018) --
Other, net.................... (394) (270) 327 128
---------- -------- ---------- ----------
Income before income tax
provision...................... 30,842 27,498 81,969 72,345
Income tax provision............ 15,821 12,110 40,050 32,261
---------- -------- ---------- ----------
Income before extraordinary
loss........................... 15,021 15,388 41,919 40,084
Extraordinary loss, net of tax.. -- -- (8,057) --
---------- -------- ---------- ----------
Net income...................... 15,021 15,388 33,862 40,084
Less convertible preferred stock
dividends...................... (4,843) -- (11,639) --
---------- -------- ---------- ----------
Net income available to common
shareholders................... $ 10,178 $ 15,388 $ 22,223 $ 40,084
========== ======== ========== ==========
Basic earnings per share:
Income before extraordinary
loss......................... $ .16 $ .48 $ .52 $ .91
Extraordinary loss, net of
tax.......................... -- -- (.14) --
---------- -------- ---------- ----------
Net income.................... $ .16 $ .48 $ .38 $ .91
========== ======== ========== ==========
Weighted average shares
outstanding.................. 64,782 32,039 58,497 44,139
========== ======== ========== ==========
Diluted earnings per share:
Income before extraordinary
loss......................... $ .16 $ .43 $ .52 $ .87
Extraordinary loss, net of
tax.......................... -- -- (.14) --
---------- -------- ---------- ----------
Net income.................... $ .16 $ .43 $ .38 $ .87
========== ======== ========== ==========
Weighted average shares
outstanding.................. 64,946 38,567 58,612 48,625
========== ======== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
3
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENT OF SHAREHOLDERS' EQUITY
For the nine months ended September 30, 2000
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Common Stock Accumulated
------------------ Additional Other Total Total
Shares Paid-in- Retained Comprehensive Shareholders' Comprehensive
Outstanding Amount Capital Earnings Loss Equity Income
----------- ------ ---------- -------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31,
1999................... 28,108 $ 28 $329,125 $100,317 $ (713) $ 428,757
Adjustment to convert
Building One shares to
Encompass shares....... 7,027 7 (7) -- -- --
--------- ------ -------- -------- ----------- ----------
Restated balance,
December 31, 1999...... 35,135 $ 35 $329,118 $100,317 $ (713) $ 428,757
Acquisition of
GroupMAC............... 27,909 28 282,404 -- -- 282,432
Exercise of options..... 5 -- 22 -- -- 22
Shares purchased in
Employee Stock Purchase
Plan................... 117 -- 542 -- -- 542
Common stock issued or
to be issued in
acquisitions........... 399 -- 10,028 -- -- 10,028
Shares received in
settlement of
litigation............. (184) -- (1,059) -- -- (1,059)
Net income.............. -- -- -- 33,862 -- 33,862 $ 33,862
Convertible preferred
stock dividends........ -- -- -- (11,639) -- (11,639)
Reclassification
adjustment, net of
other comprehensive
loss realized in net
income................. -- -- -- -- 713 713 713
----------
Total comprehensive
income................. $ 34,575
--------- ------ -------- -------- ----------- ---------- ==========
Balance, September 30,
2000................... 63,381 $ 63 $621,055 $122,540 $ -- $ 743,658
========= ====== ======== ======== =========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
4
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
--------------------
2000 1999
---------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income............................................. $ 33,862 $ 40,084
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization........................ 46,888 22,436
Compensation expense related to options exercised.... -- 2,629
Extraordinary loss, net of tax....................... 8,057 --
Impairment of property and equipment................. 1,700 --
Loss on sale of marketable securities................ 1,018 --
Other................................................ 2,702 --
Changes in operating assets and liabilities:
Accounts receivable................................ (232,519) (70,729)
Costs and estimated earnings in excess of billings
on uncompleted contracts.......................... (19,132) (14,873)
Prepaid expenses and other current assets.......... (1,164) (9,928)
Billings in excess of costs and estimated earnings
on uncompleted contracts.......................... 78,254 12,828
Accounts payable and accrued liabilities........... 68,160 22,668
Change in other assets and liabilities............. 18,416 981
---------- --------
Net cash provided by operating activities........ 6,242 6,096
---------- --------
Cash flows from investing activities:
Cash paid for acquisitions, net of cash acquired....... (45,759) (131,037)
Purchases of property and equipment.................... (32,947) (19,656)
Proceeds on sale of equipment.......................... 3,600 362
Proceeds from sale of marketable securities............ 2,422 --
Cost basis investments................................. (4,520) --
Other.................................................. -- (28)
---------- --------
Net cash used in investing activities............ (77,204) (150,359)
---------- --------
Cash flows from financing activities:
Issuance of preferred stock, net of issuance costs..... 146,250 --
Retirement of GroupMAC common stock in the Merger...... (150,000) --
Payments on long-term debt............................. (1,160,476) (18,072)
Proceeds from long-term debt........................... 1,231,270 549,875
Payment of debt issuance costs......................... (11,952) (22,219)
Repurchase of common stock including related expenses.. -- (564,407)
Distribution to Minority Shareholders.................. -- (842)
Proceeds from issuance of stock under employee stock
purchase and stock option plans....................... 564 1,354
---------- --------
Net cash provided by (used in) financing
activities...................................... 55,656 (54,311)
---------- --------
Net decrease in cash and cash equivalents................ (15,306) (198,574)
Cash and cash equivalents, beginning of period........... 17,085 213,096
---------- --------
Cash and cash equivalents, end of period................. $ 1,779 $ 14,522
========== ========
Supplemental Disclosure of Cash Flow Information:
Interest paid.......................................... $ 60,967 $ 6,445
Income taxes paid...................................... 22,292 41,777
</TABLE>
The accompanying notes are an integral part of these consolidated condensed
financial statements.
5
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(In thousands, except share and per share amounts)
(Unaudited)
NOTE 1--Business and Organization
Encompass Services Corporation ("Encompass", and together with its
consolidated subsidiaries, the "Company"), formerly Group Maintenance America
Corp. ("GroupMAC") was incorporated as a Texas corporation to build a national
company providing mechanical and electrical services in the commercial,
industrial and residential markets.
On February 22, 2000, the shareholders of GroupMAC and Building One Services
Corporation ("Building One") approved a merger of the two companies (the
"Merger"). In connection with the closing of the Merger, GroupMAC amended its
articles of incorporation to change its name to Encompass Services Corporation.
GroupMAC was the surviving legal entity in the Merger. However, for
accounting purposes, Building One was deemed to be the acquiror and,
accordingly, the Merger was accounted for as a "reverse acquisition". Under
this method of accounting, Encompass' historical results for periods prior to
the Merger are the same as Building One's historical results. The consolidated
condensed statement of shareholders' equity has been converted from Building
One's capital structure to the Company's capital structure to reflect the
exchange of shares pursuant to the Merger. All share and per share information
has been restated to reflect the exchange ratio on a retroactive basis. See
Note 2 for discussion of the Merger.
The accompanying unaudited consolidated condensed financial statements of
the Company have been prepared in accordance with Rule 10-01 of Regulation S-X
promulgated by the Securities and Exchange Commission and do not include all of
the information and footnotes required by generally accepted accounting
principles for complete financial statements. In the opinion of management, the
Company has made all adjustments necessary for a fair presentation of the
results of the interim periods, and such adjustments consist of only normal
recurring adjustments. The results of operations for such interim periods are
not necessarily indicative of results of operations for a full year. The
unaudited consolidated condensed financial statements should be read in
conjunction with the separate audited consolidated financial statements and
notes thereto of GroupMAC and Building One for the year ended December 31, 1999
as filed in the Company's Annual Report on Form 10-K and Current Report on Form
8-K/A dated April 17, 2000, respectively.
Certain amounts recorded in the three and nine month periods ended September
30, 1999 and at December 31, 1999, have been reclassified to conform with the
current period presentation.
NOTE 2--Merger and Related Transactions
As noted above, on February 22, 2000, the shareholders of GroupMAC and
Building One approved a merger of the two companies. Under the terms of the
Merger, each outstanding share of Building One common stock was converted into
1.25 shares of GroupMAC common stock. As part of the Merger, GroupMAC
shareholders could elect to receive cash for up to 50% of their shares of
Encompass common stock at $13.50 per share, subject to proration. As a result
of this election, 11,052,377 shares of Encompass common stock were canceled in
the Merger.
Concurrent with the closing of the Merger, affiliates of Apollo Management,
L.P. ("Apollo") exchanged approximately $106,191 of Building One convertible
junior subordinated debentures and $150,000 in cash for 256,191 shares of
Encompass Convertible Preferred Stock. See Note 6 for further discussion of the
Convertible Preferred Stock. The cash proceeds from the issuance of the
Convertible Preferred Stock were used to fund the cash election feature of the
Merger discussed above.
6
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
On February 22, 2000, Encompass entered into a new credit agreement to
provide a total of $800,000 in financing. The proceeds of this new credit
agreement were used to refinance the existing revolving credit facilities of
GroupMAC and Building One, as well as GroupMAC's senior subordinated notes. See
Note 4 for further discussion of the new credit agreement.
The Merger has been accounted for as a purchase under generally accepted
accounting principles. The purchase consideration for the Merger has been
calculated as follows (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Common Warrants/
Stock Options
-------- ---------
<S> <C> <C>
GroupMAC shares, options and warrants outstanding or due
at date of the Merger.................................. 38,961 5,358
Shares canceled in the cash election feature............ (11,052) (76)
-------- --------
Shares issued or due at date of the Merger.............. 27,909 5,282
Building One five-day share price average with 11/03/99
as midpoint/Black-Scholes option valuation, adjusted
for the 1.25 exchange ratio of the Merger.............. $ 9.06 $ 5.60
-------- --------
Fair value of shares, options and warrants issued....... $252,850 $ 29,582
======== ========
Total value of shares, options and warrants issued...... $282,432
Add: transaction costs.................................. 7,358
--------
Total purchase consideration............................ $289,790
========
</TABLE>
The total consideration has been allocated to the assets and liabilities of
GroupMAC based on certain estimates of fair values. Identifiable intangible
assets of approximately $18,000 primarily relate to workforce and customer
lists. Preliminary goodwill of approximately $569,607 is being amortized over
40 years. The purchase price allocation is subject to change based on the final
determination of the fair value of GroupMAC's net assets on the effective date
of the Merger. Management does not believe the final purchase price allocation
will differ materially from the preliminary purchase price allocation.
The following unaudited pro forma combined income statement data utilize the
financial information of GroupMAC and Building One for the periods indicated,
which give effect to the Merger and the acquisitions made by each company
during 1999 including amounts owed in connection with those acquisitions, as if
the Merger and all of the acquisitions were effective as of the period being
presented.
<TABLE>
<CAPTION>
Pro Forma Data
-----------------------------------
Three Months Nine Months Ended
Ended September 30,
September 30, ---------------------
1999 2000 1999
------------- ---------- ----------
<S> <C> <C> <C>
Revenues.................................. $ 969,741 $3,224,263 $2,680,672
Net income................................ 31,073 47,615 75,091
Net income available to common
shareholders............................. 26,230 33,196 60,672
Net income per share:
Basic................................... $ .42 $ .51 $ .96
Diluted................................. .38 .51 .91
</TABLE>
7
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
Significant pro forma adjustments included in the amounts above consist of
(i) compensation differentials, (ii) adjustment for goodwill amortization over
a period of 40 years, (iii) adjustment for interest expense as if borrowings
outstanding as of March 31, 2000 had been outstanding for the first quarter of
2000 and for the interim periods of 1999 at interest rates in effect on March
31, 2000, (iv) the issuance of the Convertible Preferred Stock concurrent with
the Merger and (v) adjustment to the federal and state income tax provisions
based on pro forma operating results. Net income per share assumes all shares
issued for the Merger and the acquisitions were outstanding from the beginning
of the periods presented.
NOTE 3--Charges Associated with Merger Transaction and Restructuring
Merger and Related Charges
In connection with the Merger and related transactions, the Company has
recorded costs and expenses related to the extinguishment of Building One's
existing financing arrangements, severance and office closing costs and other
exit activities costs. These costs and expenses are included in the
consolidated condensed statements of operations for the nine months ended
September 30, 2000 as follows:
<TABLE>
<S> <C>
Merger and Related Charges:
Severance costs................................................... $6,100
Office closing costs.............................................. 1,000
Disposition of assets and other costs............................. 700
------
Total charge.................................................... 7,800
Tax benefit at 38.5%.............................................. 3,003
------
Net of tax impact............................................... $4,797
------
Extraordinary Items:
Deferred debt issue costs on Building One convertible debt........ $4,367
Deferred debt issue costs on Building One existing revolving and
term credit facility............................................. 8,028
------
Total charge.................................................... 12,395
Tax benefit at 35.0%.............................................. 4,338
------
Net of tax impact............................................... $8,057
======
</TABLE>
The severance and office closing costs relate to the closing of Building
One's corporate headquarters in Minnetonka, MN and the resulting consolidation
with the GroupMAC corporate office in Houston, TX. As a result of this plan,
the Company incurred severance costs for substantially all of the employees in
the Building One corporate office, identified certain assets which are no
longer of service and incurred lease termination costs. Severance costs covered
20 employees, all of which have been terminated as of September 30, 2000.
8
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
The following table is a reconciliation of the cash portion of the reserve
related to the severance and office closing costs incurred through September
30, 2000. The total disposition of assets and other costs include approximately
$400 of non-cash related charges. The reconciliation below reflects the
accruals recorded and payments applied since establishing the provision.
<TABLE>
<CAPTION>
Balance at
Total September 30,
Reserve Payments 2000
------- -------- -------------
<S> <C> <C> <C>
Severance and office closing costs:
Severance................................ $6,100 $ (5,798) $ 302
Office closing costs..................... 1,000 (419) 581
Disposition of assets and other exit
activities costs........................ 300 (29) 271
------ -------- ----------
Total.................................. $7,400 $ (6,246) $ 1,154
====== ======== ==========
</TABLE>
Costs to Exit Certain Activities and Integration Costs
During the nine months ended September 30, 2000 the Company recorded a
charge for the shutdown of certain operations, the reorganization of other
operations and integration efforts resulting from the Merger. The following
table sets forth a summary of these costs:
<TABLE>
<S> <C>
Shutdown of demolition and site preparation operations.............. $ 9,800
Relocation of janitorial management offices......................... 1,600
Integration costs resulting from Merger............................. 800
-------
Total............................................................. $12,200
=======
</TABLE>
The costs related to the shutdown of the demolition and site preparation
operations include (i) $5,200 related to obligations under existing jobs in
progress, (ii) $2,000 estimated for uncollectible accounts receivable, (iii)
$1,100 related to claims against the Company, (iv) $800 for impaired assets,
and (v) $700 related to lease termination costs and other expenses. The Company
is continuing to wind-down these operations with the final shutdown expected to
occur by late 2000.
The Company relocated the janitorial management offices from January through
May 2000. The related costs include (i) $600 for severance and related costs,
(ii) $500 for impaired assets, (iii) $300 related to lease termination and
related costs, and (iv) $200 for other miscellaneous items. As of September 30,
2000, substantially all of these amounts have been paid, with the exception of
future lease obligations.
NOTE 4--Borrowing Activity
10 1/2% Senior Subordinated Notes
In April 1999, Building One completed a private offering of $200,000 of 10
1/2% senior subordinated notes. The senior subordinated notes are unsecured and
guaranteed by the Company's subsidiaries, require interest to be paid semi-
annually on May 1 and November 1 of each year and mature on May 1, 2009. The
senior subordinated notes were issued at 97.746%, or a discount of $4,508,
which is being amortized to interest expense over the term of the notes.
Additionally, debt issuance costs of $8,470 incurred in connection with the
offering have been deferred and are being amortized to interest expense over
the 10-year term of the notes. The unamortized portion of these costs was
approximately $7,270 and $7,828 at September 30, 2000 and December 31, 1999,
respectively, and are included in deferred debt issue costs in the accompanying
consolidated condensed balance sheets.
9
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
The Company may redeem the senior subordinated notes, in whole or in part,
at any time on or after May 1, 2004 at specified redemption prices, plus
accrued interest. At any time (which may be more than once) before May 1, 2002,
the Company may redeem up to 35% of the outstanding senior subordinated notes
with money raised in equity offerings under certain circumstances. Upon a
change in control of the Company (as defined in the indenture for the senior
subordinated notes), the holders of the senior subordinated notes will have the
right to sell the notes to the Company at 101% of the face amount plus accrued
interest.
The indenture governing the senior subordinated notes contains certain
covenants relating to, among other things, the Company's ability to incur
indebtedness, pay dividends or repurchase capital stock, incur liens, sell or
otherwise dispose of a substantial portion of its assets or merge or
consolidate with another entity.
7 1/2% Convertible Junior Subordinated Debentures
The convertible junior subordinated debentures were scheduled to mature on
May 1, 2012 and provided for interest payments at a rate of 7 1/2% to be paid
in additional convertible junior subordinated debentures or cash, at the
Company's election, for the first five years after their issuance, and in cash
thereafter. During the nine months ended September 30, 2000, $2,387 of interest
was paid in additional convertible junior subordinated debentures. Debt
issuance costs of $4,634 incurred in connection with the debentures were
deferred and were being amortized to interest expense over the 13-year term of
the debentures.
In conjunction with the Merger, the convertible junior subordinated
debentures and $150,000 of cash were exchanged for 256,191 shares of
Convertible Preferred Stock. In addition, the related debt issuance costs were
written off at that time and are reflected as an extraordinary loss in the
accompanying consolidated condensed statements of operations.
Old Credit Facility
As of December 31, 1999, Building One's primary bank credit facility
consisted of a $125,000 term loan and a $225,000 revolving credit facility (the
"Old Credit Facility"). The revolving credit facility bore interest at various
rates, which were subject to change based on certain levels of financial
performance. Debt issuance costs of $9,445 incurred in connection with this
credit facility were deferred and were being amortized over the 5-year term of
the credit facility.
In conjunction with the Merger, the Old Credit Facility was repaid with the
proceeds from a new credit agreement described below. In addition, the related
debt issuance costs were written off at that time and are reflected as an
extraordinary loss in the accompanying consolidated condensed statements of
operations.
New Credit Agreement
On February 22, 2000, in connection with the Merger, the Company entered
into a new $800,000 credit facility (the "New Credit Agreement") and borrowed
funds thereunder to repay (i) the outstanding borrowings under the Old Credit
Facility, (ii) $130,000 of senior subordinated notes issued by GroupMAC in
January 1999, and (iii) borrowings of GroupMAC under its previous revolving
credit facility. The New Credit Agreement was expanded to $900,000 during the
second quarter of 2000, and includes a $500,000 revolving credit facility, a
$130,000 term loan, a $170,000 term loan and a $100,000 institutional term
loan. Borrowings under the New Credit Agreement bear interest at variable
rates, as defined. The availability of borrowings under the New Credit
Agreement is subject to the Company's ability to meet certain specified
conditions, including compliance with the financial covenants and ratios
required by the New Credit Agreement, absence of default under the facility and
continued accuracy of the representations and warranties contained in the New
Credit Agreement.
10
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
Subsequent to September 30, 2000, the Company entered into interest rate
swap agreements with several banks to lock in fixed interest rates over periods
ranging from three to four years on a notional amount totaling $90,000 in order
to partially hedge against variations in interest rates on borrowings under the
New Credit Agreement. The fixed rate that the Company will pay is based on the
three month LIBOR rate as of October 20, 2000. Under the agreements the
variable rate that the Company receives, also based on three month LIBOR rates,
is reset every three months.
Debt issuance costs associated with the origination, syndication, and
expansion of the New Credit Agreement approximating $11,952 have been deferred
and are being amortized over the five-year, six-year and seven-year terms of
the revolving credit, the term loans, and the institutional term loan portions
of the facility, respectively. The unamortized portion of these costs was
approximately $10,657 at September 30, 2000 and is included in deferred debt
issue costs in the accompanying consolidated condensed balance sheets.
NOTE 5--Other Business Combinations--Contingent Consideration Agreements
During the nine months ended September 30, 2000, the Company completed the
acquisition of one company which includes cash paid or to be paid of $10,207
and 296,296 shares of common stock. The Company assumed approximately $1,518 of
debt in this transaction.
In conjunction with acquisitions consummated since its inception, the
Company has entered into certain contingent consideration agreements which
provide for the payment of cash and/or shares of common stock based on the
financial performance of such acquired operations. During the nine months ended
September 30, 2000, $52,136 of consideration has been recorded to goodwill
related to contingent consideration and final purchase price settlements on
acquisitions completed to date. This consideration mix is expected to be paid
out as $43,893 in cash and 1,467,855 shares of common stock. The cash payable
is reflected as due to related parties at September 30, 2000 in the
accompanying consolidated condensed balance sheets and the shares to be issued
have been reflected as common stock to be issued in the consolidated condensed
statement of shareholders' equity. These common shares to be issued have been
included in weighted average shares outstanding for purposes of computing basic
and diluted earnings per share for the three and nine months ended September
30, 2000.
Additionally, during the nine months ended September 30, 2000, $47,600 of
cash has been paid and 102,692 shares have been issued related to previously
recorded contingent consideration and final purchase price settlements. The
Company currently estimates the unearned contingent consideration under the
remaining agreements to be $21,876 as of September 30, 2000.
A rollforward of the due to related parties balance in the accompanying
consolidated condensed balance sheets related to the above activity is as
follows:
<TABLE>
<S> <C>
Balance at December 31, 1999...................................... $10,290
Acquisition of GroupMAC........................................... 13,207
Record contingent consideration and final purchase price
settlements...................................................... 43,893
Payments.......................................................... (47,600)
-------
Balance at September 30, 2000..................................... $19,790
=======
</TABLE>
11
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
NOTE 6--Convertible Preferred Stock
In connection with the Merger, the Company issued 256,191 shares of 7.25%
Convertible Preferred Stock (the "Convertible Preferred Stock") to affiliates
of Apollo at a value of $1,000 per share in exchange for $150,000 in cash and
all of the outstanding convertible junior subordinated debentures of Building
One (approximately $106,191).
The Convertible Preferred Stock has a par value of $.001 per share and is
convertible into shares of the Company's common stock at any time by the
holders at a conversion price of $14.00 per common share, subject to adjustment
under certain circumstances. Upon their maturity in February 2012, the Company
is required to redeem all shares of Convertible Preferred Stock then
outstanding at the redemption price per share equal to the Liquidation Amount
(defined as the original cost of $1,000 per share plus all accrued and
accumulated and unpaid dividends). The Company has the right to redeem, at any
time after February 22, 2005, all, but not less than all, of the shares of
Convertible Preferred Stock then outstanding at an amount per share of 103% of
the Liquidation Amount; this amount declines to 102% after February 22, 2006
and 101% after February 22, 2008. The Convertible Preferred Stock bears a
preferred cumulative dividend at the rate of 7.25% per year, payable quarterly.
However, for the first three years, dividends on the Convertible Preferred
Stock may be paid in cash on a current basis or accumulated at the option of
the Company. At September 30, 2000, accrued dividends were approximately
$11,456. Holders of the Convertible Preferred Stock are also entitled to share
in any dividends the Company may declare on its common stock.
Holders of Convertible Preferred Stock are entitled to vote on all matters
presented to the holders of common stock. Each share of Convertible Preferred
Stock entitles the holder thereof to cast the number of votes such holder would
have been entitled to cast had such holder converted such share of Convertible
Preferred Stock into shares of common stock (common stock equivalents). The
holders of the Convertible Preferred Stock, voting as a separate class, are
entitled to elect directors to the Board at the greater of 3 directors or the
number of directors that represents 30% of the Board (subject to Apollo's
ownership percentage of common stock equivalents). As of September 30, 2000,
the Convertible Preferred Stock comprised approximately 23% of the voting power
of Encompass.
Convertible Preferred Stock issuance costs of approximately $3,750 are being
amortized against retained earnings over the 12-year term of the Convertible
Preferred Stock. The unamortized portion of these costs of approximately $3,568
at September 30, 2000 is recorded against mandatorily redeemable convertible
preferred stock in the accompanying consolidated condensed balance sheets.
NOTE 7--Operating Segments
The Company's reportable segments are strategic business units that offer
products and services to distinct customer groups. They are managed separately
because each business requires different operating and marketing strategies.
The Company has three reportable segments: electrical/mechanical/industrial,
residential and janitorial markets. The electrical/mechanical/industrial
segment provides services in manufacturing and processing facilities, power
generation facilities, hospitals and other critical care facilities, colleges
and universities, hotels, commercial office buildings and complexes, retail
stores and restaurants, supermarkets and convenience stores. The residential
segment provides services in single family and low-rise multifamily housing
units. The janitorial segment provides a wide variety of facility cleaning and
maintenance management services nationwide.
12
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
The Company evaluates performance based on income from operations before
amortization of goodwill and other intangibles of the respective operating
segments prior to unallocated corporate expenses, merger and related charges,
costs to exit certain activities and integration costs and restructuring and
recapitalization charges. The presentation for 1999 has been conformed to the
new measurement evaluation criteria after the Merger.
Unallocated corporate expenses primarily include (i) corporate overhead,
(ii) corporate and operating company management bonuses, and (iii) savings from
national purchase agreements relating to materials and property/casualty
insurance.
As the Company has not yet completed the allocation of the purchase price
consideration from the Merger to its individual operating companies, asset
allocation by segment is not available at this time. Segment information for
the three- and nine-month periods ended September 30, 2000 and 1999 was as
follows:
<TABLE>
<CAPTION>
Electrical/
Mechanical/
Industrial Residential Janitorial Total
----------- ----------- ---------- ----------
<S> <C> <C> <C> <C>
Three-month period ended
September 30, 2000:
Revenues........................ $1,008,363 $ 93,385 $ 65,764 $1,167,512
Operating costs................. 952,389 82,490 63,435 1,098,314
---------- -------- -------- ----------
Segment operating earnings...... $ 55,974 $ 10,895 $ 2,329 69,198
Amortization of goodwill and
other intangibles.............. (9,050)
Unallocated corporate expenses.. (5,156)
----------
Income from operations.......... $ 54,992
==========
Three-month period ended
September 30, 1999:
Revenues........................ $ 412,458 $ -- $ 65,417 $ 477,875
Operating costs................. 369,517 -- 59,830 429,347
---------- -------- -------- ----------
Segment operating earnings...... $ 42,941 $ -- $ 5,587 48,528
Amortization of goodwill and
other intangibles.............. (4,238)
Unallocated corporate expenses.. (3,928)
----------
Income from operations.......... $ 40,362
==========
Nine-month period ended
September 30, 2000:
Revenues........................ $2,525,544 $213,483 $197,231 $2,936,258
Operating costs................. 2,355,235 189,145 185,443 2,729,823
---------- -------- -------- ----------
Segment operating earnings...... $ 170,309 $ 24,338 $ 11,788 206,435
Amortization of goodwill and
other intangibles.............. (24,169)
Merger and related charges and
costs to exit certain
activities and integration
costs.......................... (20,000)
Unallocated corporate expenses.. (16,447)
----------
Income from operations.......... $ 145,819
==========
Nine-month period ended
September 30, 1999:
Revenues........................ $1,087,821 $ -- $177,700 $1,265,521
Operating costs................. 983,932 -- 162,883 1,146,815
---------- -------- -------- ----------
Segment operating earnings...... $ 103,889 $ -- $ 14,817 118,706
Amortization of goodwill and
other intangibles.............. (11,511)
Restructuring and
recapitalization charges....... (8,020)
Unallocated corporate expenses.. (10,353)
----------
Income from operations.......... $ 88,822
==========
</TABLE>
13
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands, except share and per share amounts)
(Unaudited)
NOTE 8--Earnings Per Share
The following table reconciles the numerators and denominators of the basic
and diluted earnings per share computations for the three- and nine-month
periods ended September 30, 2000 and 1999.
<TABLE>
<CAPTION>
Three Months Nine Months
Ended Ended
September 30, September 30,
---------------- ----------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Basic earnings per share:
Net income................................. $15,021 $15,388 $33,862 $40,084
Less: convertible preferred stock
dividends................................. (4,843) -- (11,639) --
------- ------- ------- -------
Net income available to common
shareholders.............................. $10,178 $15,388 $22,223 $40,084
------- ------- ------- -------
Weighted average shares outstanding--Basic
(in thousands)............................ 64,782 32,039 58,497 44,139
------- ------- ------- -------
Net income per share--Basic................ $ .16 $ .48 $ .38 $ .91
======= ======= ======= =======
Diluted earnings per share:
Net income available to common
shareholders.............................. $10,178 $15,388 $22,223 $40,084
Plus: interest expense on 7 1/2%
convertible junior subordinated debentures
and related amortization of debt issue
costs net of applicable income taxes...... -- 1,218 -- 2,003
------- ------- ------- -------
Net income on an as-if converted basis..... $10,178 $16,606 $22,223 $42,087
------- ------- ------- -------
Weighted average shares outstanding--
Diluted (in thousands).................... 64,946 38,567 58,612 48,625
------- ------- ------- -------
Net income per share--Diluted.............. $ .16 $ .43 $ .38 $ .87
======= ======= ======= =======
Weighted average shares (in thousands):
Weighted average shares outstanding--
Basic..................................... 64,782 32,039 58,497 44,139
Common stock equivalents from stock options
and warrants.............................. 164 105 115 191
Contingently issuable shares............... -- 798 -- 1,178
Convertible junior subordinated debentures,
on an as-if converted basis............... -- 5,625 -- 3,117
------- ------- ------- -------
Total weighted average shares outstanding--
Diluted................................... 64,946 38,567 58,612 48,625
======= ======= ======= =======
</TABLE>
The Convertible Preferred Stock, including accumulated dividends, which is
convertible into approximately 19,117,706 shares of common stock as of
September 30, 2000, was not included in the computation of diluted earnings per
share for the three months and the nine months ended September 30, 2000 because
the effect was anti-dilutive. Additionally, outstanding options and warrants to
purchase 14,308,165 shares of common stock were excluded from the computation
of diluted earnings per share for the three months ended September 30, 2000 and
outstanding options and warrants to purchase 14,215,998 shares of common stock
were excluded from the computation of diluted earnings per share for the nine
months ended September 30, 2000, because the effect was anti-dilutive.
Outstanding stock options and warrants to purchase 4,642,201 shares of common
stock as of September 30, 1999 were not included in the computation of diluted
earnings per share because the effect was anti-dilutive.
14
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
INTRODUCTION
Encompass Services Corporation ("Encompass", and together with its
consolidated subsidiaries, the "Company"), formerly Group Maintenance America
Corp. ("GroupMAC") was incorporated as a Texas corporation to build a national
company providing mechanical and electrical services in the commercial,
industrial and residential markets.
On February 22, 2000, the shareholders of GroupMAC and Building One Services
Corporation ("Building One") approved a merger of the two companies (the
"Merger"). In connection with the closing of the Merger, GroupMAC amended its
articles of incorporation to change its name to Encompass Services Corporation.
GroupMAC was the surviving legal entity in the Merger. However, for
accounting purposes, Building One was deemed to be the acquiror and,
accordingly, the Merger was accounted for as a "reverse acquisition". Under
this method of accounting, Encompass' historical results for periods prior to
the Merger are the same as Building One's historical results. See the notes to
consolidated condensed financial statements appearing elsewhere herein for
further discussion of the Merger.
The following discussion should be read in conjunction with the consolidated
condensed financial statements, including the related notes thereto, appearing
elsewhere in this Quarterly Report on Form 10-Q, as well as the separate
consolidated financial statements and notes thereto of GroupMAC and Building
One for the year ended December 31, 1999 as filed in the Company's Annual
Report on Form 10-K and Current Report on Form 8-K/A dated April 17, 2000,
respectively.
The Company has historically derived revenues from providing services for
electrical, mechanical and other systems to electrical/mechanical/industrial
customers and providing janitorial and maintenance management services. The
Merger allowed the Company to further expand its electrical and mechanical
offerings and to provide such services for residential customers.
The Company recognizes maintenance, repair and replacement revenues,
including janitorial and maintenance management services, as services are
performed, except for service contract revenue, which is recognized ratably
over the life of the contract. The Company generally accounts for revenues from
fixed price installation and retrofit contracts on a percentage-of-completion
basis using the cost-to-cost method. Changes in job performance, job
conditions, estimated profitability and final contract settlements may result
in revisions to costs and income and are recognized in the period in which the
revisions are determined.
Cost of services consists primarily of components, parts and supplies,
salaries and benefits of service and installation technicians, subcontracted
services, depreciation, fuel and other vehicle expenses and equipment rentals.
Selling, general and administrative expenses consist primarily of compensation
and related benefits for management, administrative salaries and benefits,
advertising, office rent and utilities, communications and professional fees.
15
<PAGE>
RESULTS OF OPERATIONS
Three months ended September 30, 2000 compared to three months ended
September 30, 1999
Revenues. Revenues increased $689.6 million, or 144%, to $1,167.5 million
for the three months ended September 30, 2000 from $477.9 million for the three
months ended September 30, 1999. This increase in revenues is attributable to
the following:
. $599.1 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in the Merger.
. $35.4 million relates to the incremental revenues contributed in the
three months ended September 30, 2000 by
electrical/mechanical/industrial companies acquired during or subsequent
to the three months ended September 30, 1999.
. $55.1 million relates to internal growth in the electrical/mechanical/
industrial group. This increase primarily relates to volume increases in
the Midwest, Colorado and Texas markets.
Gross profit. Gross profit increased $89.9 million, or 92% to $187.9 million
for the three months ended September 30, 2000 from $98.0 million for the three
months ended September 30, 1999. This increase in gross profit is attributable
to the following:
. $105.5 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in the Merger.
. $5.8 million relates to the incremental gross profit contributed in the
three months ended September 30, 2000 by
electrical/mechanical/industrial companies acquired during or subsequent
to the three months ended September 30, 1999.
. Partially offsetting the above increases was a $21.4 million decrease in
same store results related primarily to the negative impact of job
contract losses in the California operations of the
electrical/mechanical/industrial group and economic softness in the
Southeastern United States.
During the third quarter, the Company announced that, as part of its
continuing integration process, management has identified 11 operating units
that it will eliminate due to underperformance or strategic incompatibility.
The Company will eliminate the units by closing three of them, selling six and
merging two with other Encompass locations. Excluding the results of the units
to be eliminated, the gross profit of the Company would have been $199.0
million for the three months ended September 30, 2000, $11.1 million higher
than reported results including these units, and $96.5 million for the three
months ended September 30, 1999, $1.4 million lower than reported results
including these units.
Gross profit margin decreased to 16.1% for the three months ended September
30, 2000 compared to 20.5% for the three months ended September 30, 1999. This
decline primarily resulted from the decreased profitability of the businesses
to be eliminated and from a local management focus on achieving targeted growth
levels that drove significant revenue growth at the expense of margin
preservation.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $70.5 million, or 132% to $123.9 million for
the three months ended September 30, 2000 from $53.4 million for the three
months ended September 30, 1999. This increase in these expenses is
attributable to the following:
. $62.7 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $4.0 million relates to the incremental selling, general and
administrative expense incurred in the three months ended September 30,
2000 by electrical/mechanical/industrial companies acquired during or
subsequent to the three months ended September 30, 1999.
16
<PAGE>
. $2.8 million relates to incremental corporate overhead, net of certain
insurance synergies recorded at the corporate level, resulting from the
acquisition of GroupMAC.
. $1.0 million relates to internal growth in the
electrical/mechanical/industrial group.
As previously discussed, the Company will eliminate 11 operating units by
closing, selling or merging them with other Encompass locations. Excluding the
results of these units, the selling, general and administrative expenses of the
Company would have been $116.9 million for the three months ended September 30,
2000, $7.0 million lower than reported results including these units, and $52.2
million for the three months ended September 30, 1999, $1.2 million lower than
reported results including these units. The costs eliminated include normal
operating costs, bad debt expenses and other costs related to eliminating the
businesses.
As a percentage of revenues, selling, general and administrative expenses
decreased to 10.6% for the three months ended September 30, 2000 from 11.2% for
the three months ended September 30, 1999. This decrease is a result of
leveraging corporate, regional and operating unit overhead over a larger
revenue base.
Amortization of goodwill and other intangibles. Amortization of goodwill and
other intangibles for the three months ended September 30, 2000 increased $4.8
million, or 114%, to $9.1 million from $4.2 million for the three months ended
September 30, 1999. This increase primarily relates to (i) the GroupMAC
operating locations that were acquired in the Merger and (ii) the companies
acquired during or subsequent to the three months ended September 30, 1999.
Other income and expense. Changes in other income and expense activity is
primarily a result of net interest expense increasing $11.2 million to $23.8
million for the three months ended September 30, 2000 from $12.6 million for
the three months ended September 30, 1999. This change is primarily the result
of increased borrowings related to the Merger and other acquisitions. As of
September 30, 1999, the Company had $545.2 million of debt outstanding from
acquisitions and the tender offer that occurred during the first nine months of
1999. This compares to $988.7 million at September 30, 2000 as a result of the
Merger and increased working capital levels needed to support strong internal
growth during the third quarter of 2000.
Income tax provision. The income tax provision increased $3.7 million to
$15.8 million for the three months ended September 30, 2000 from $12.1 million
for the three months ended September 30, 1999. This increase primarily relates
to a corresponding increase of $3.3 million in pre-tax income for the same
period, as well as a higher effective tax rate for the three months ended
September 30, 2000. The effective tax rate was 51.3% and 44.0% for the three
months ended September 30, 2000 and 1999, respectively. The effective tax rate
exceeds the Company's statutory federal and state tax rate primarily due to
non-deductible goodwill amortization. The increase in the effective tax rate
results primarily from higher non-deductible goodwill amortization as a
proportion of pre-tax income.
17
<PAGE>
RESULTS OF OPERATIONS
Nine months ended September 30, 2000 compared to nine months ended September
30, 1999
Revenues. Revenues increased $1,670.7 million, or 132% to $2,936.2 million
for the nine months ended September 30, 2000 from $1,265.5 million for the nine
months ended September 30, 1999. This increase in revenues is attributable to
the following:
. $1,313.6 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in the Merger.
. $117.4 million relates to the incremental revenues contributed in the
nine months ended September 30, 2000 by electrical/mechanical/industrial
companies acquired during or subsequent to the nine months ended
September 30, 1999.
. $220.2 million relates to internal growth in the
electrical/mechanical/industrial group. This increase primarily relates
to volume increases in the Midwest, California, Arizona, Colorado and
Texas markets.
. $19.5 million relates to internal growth in the janitorial group.
Gross profit. Gross profit increased $253.3 million, or 100% to $507.5
million for the nine months ended September 30, 2000 from $254.2 million for
the nine months ended September 30, 1999. This increase in gross profit is
attributable to the following:
. $237.0 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in the Merger.
. $24.6 million relates to the incremental gross profit contributed in the
nine months ended September 30, 2000 by electrical/mechanical/industrial
companies acquired during or subsequent to the nine months ended
September 30, 1999.
. Partially offsetting the above increases was a $8.3 million decrease in
same store results related primarily to the negative impact of job
contract losses in the California operations of the
electrical/mechanical/industrial group and economic softness in the
Southeastern United States.
As previously discussed, the Company will eliminate 11 operating units by
closing, selling or merging them with other Encompass locations. Excluding the
results of the units to be eliminated, the gross profit of the Company would
have been $516.5 million for the nine months ended September 30, 2000, $9.0
million higher than reported results including these units, and $250.7 million
for the nine months ended September 30, 1999, $3.5 million lower than reported
results including these units.
Gross profit margin decreased to 17.3% for the nine months ended September
30, 2000 compared to 20.1% for the nine months ended September 30, 1999. This
decline primarily resulted from the decreased profitability of the businesses
to be eliminated and from a local management focus on achieving targeted growth
levels that drove significant revenue growth at the expense of margin
preservation. In addition, management believes that, during the first half of
2000, issues related to the Merger caused a significant amount of distraction
among the operating leadership of the Company.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $171.6 million, or 118% to $317.5 million for
the nine months ended September 30, 2000 from $145.9 million for the nine
months ended September 30, 1999. This increase in these expenses is
attributable to the following:
. $138.7 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
18
<PAGE>
. $11.5 million relates to the incremental selling, general and
administrative expense incurred in the nine months ended September 30,
2000 by electrical/mechanical/industrial companies acquired during or
subsequent to the nine months ended September 30, 1999.
. $10.1 million relates to internal growth in the
electrical/mechanical/industrial group. This increase primarily relates
to supporting the revenue growth in the Texas, California, Arizona and
Colorado markets.
. $11.3 million relates to incremental corporate overhead, net of certain
insurance synergies recorded at the corporate level, resulting from the
acquisition of GroupMAC.
As previously discussed, the Company will eliminate 11 operating units by
closing, selling or merging them with other Encompass locations. Excluding the
results of these units, the selling, general and administrative expenses of the
Company would have been $302.4 million for the nine months ended September 30,
2000, $15.1 million lower than reported results including these units, and
$142.6 million for the nine months ended September 30, 1999, $3.2 million lower
than reported results including these units. The costs eliminated include
normal operating costs, bad debt expenses and other costs related to
eliminating the businesses.
As a percentage of revenues, selling, general and administrative expenses
decreased to 10.8% for the nine months ended September 30, 2000 from 11.5% for
the nine months ended September 30, 1999. This decrease is a result of
leveraging corporate, regional and operating unit overhead over a larger
revenue base.
Merger and related charges. In connection with the Merger, the Company
recorded $7.8 million of costs and expenses related to severance and office
closing costs. These costs relate to the closing of Building One's corporate
headquarters in Minnetonka, MN and the resulting consolidation with the
GroupMAC corporate office in Houston, TX. These costs are more fully described
in Note 3 to the Notes to Consolidated Condensed Financial Statements included
herein.
Costs to exit certain activities and integration costs. In the first quarter
of 2000, the Company recorded $12.2 million of costs and expenses related to
the shutdown of certain operations, the reorganization of other operations and
integration efforts resulting from the Merger. These costs are more fully
described in Note 3 to the Notes to Consolidated Condensed Financial Statements
included herein.
Amortization of goodwill and other intangibles. Amortization of goodwill and
other intangibles for the nine months ended September 30, 2000 increased $12.7
million, or 110%, to $24.2 million from $11.5 million for the nine months ended
September 30, 1999. This increase primarily relates to (i) the GroupMAC
operating locations that were acquired in the Merger and (ii) the companies
acquired during or subsequent to the nine months ended September 30, 1999.
Restructuring and recapitalization charges. Restructuring and
recapitalization charges were $8.0 million for the nine months ended September
30, 1999. These charges included $2.8 million relating to compensation expense
for stock options exercised and the underlying shares of common stock
repurchased in the Company's recapitalization plan, and $5.2 million of
restructuring charges pertaining to the relocation of the Company's then
existing corporate headquarters and integration of the janitorial and
maintenance management operations.
Other income and expense. Other income and expense activity can be
summarized as follows:
. Net interest expense increased $46.6 million to $63.2 million for the
nine months ended September 30, 2000 from $16.6 million for the nine
months ended September 30, 1999. This change is primarily the result of
increased borrowings related to the Merger and other acquisitions. As of
September 30, 1999 the Company had $545.2 million of debt outstanding
from acquisitions and the tender offer that occurred during the first
nine months of 1999. This compares to $988.7 million at September 30,
2000 as a result of the Merger and increased working capital levels
needed to support strong internal growth during 2000.
19
<PAGE>
. The loss on sale of marketable securities of $1.0 million relates to the
sale of a marketable security held by one of the Company's subsidiaries
during the first quarter of 2000.
Income tax provision. The income tax provision increased $7.8 million to
$40.0 million for the nine months ended September 30, 2000 from $32.3 million
for the nine months ended September 30, 1999. This increase primarily relates
to the Merger offset by related charges, the costs to exit certain activities
and integration costs and a loss on sale of marketable securities incurred
during the first quarter of 2000. Excluding these charges and the non-recurring
recapitalization and restructuring charges incurred in the second quarter of
1999, the income tax provision increased $12.8 million for the nine months
ended September 30, 2000, which corresponds with the pre-tax income increase of
$22.6 million that results before such charges. Excluding these charges, the
effective tax rate was 46.7% and 44.0% for the nine months ended September 30,
2000 and 1999, respectively. The effective tax rate exceeds the Company's
statutory federal and state tax rate primarily due to non-deductible goodwill
amortization. The increase in the effective tax rate results primarily from
higher non-deductible goodwill amortization as a proportion of pre-tax income.
Extraordinary loss, net. The net of tax extraordinary loss of $8.1 million
for the nine months ended September 30, 2000 relates to the write-off of
deferred debt issue costs associated with Building One's revolving credit
facility, term credit facility and junior subordinated notes that were
refinanced in connection with the Merger. These costs are more fully described
in Note 3 to the Notes to Consolidated Condensed Financial Statements included
herein.
Seasonality and Cyclicality
The mechanical and electrical industry is subject to seasonal variations.
Specifically, the demand for new installations is generally lower during the
winter months due to reduced construction activities during inclement weather.
Demand for mechanical and electrical services is generally higher in the second
and third quarters. Accordingly, the Company expects its revenues and operating
results generally will be lower in the first and, to a lesser degree, fourth
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.
A significant portion of the Company's business involves installation of
mechanical and electrical systems in newly constructed commercial, industrial
and residential facilities. The level of new commercial and industrial
installation services is affected by changes in economic conditions and
interest rates. Revenues from new installation services in the residential
market are dependent upon the level of housing starts in the areas in which the
Company operates. The housing industry is cyclical, and the Company's revenues
from residential new installation will be affected by the factors that affect
the housing industry. These factors include changes in employment and income
levels, the availability and cost of financing for new home buyers and general
economic conditions. General downturns in housing starts or new commercial and
industrial construction in the areas in which the Company operates could have a
material adverse effect on the Company's business, including its financial
condition and results of operations.
Inflation
Inflation did not have a significant effect on the results of operations of
the Company for the three- and nine-month periods ended September 30, 2000 and
1999.
20
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
Historically, the Company has financed its operations and growth from
proceeds from Building One's initial public offering, internally generated
working capital and borrowings from commercial banks or other lenders. These
borrowings are generally secured by the accounts receivable and inventory of
the Company.
On February 22, 2000, in connection with the Merger, the Company entered
into a new $800 million credit facility (the "New Credit Agreement") and
borrowed funds thereunder to repay (i) the outstanding borrowings of Building
One under its $350 million credit facility, (ii) $130 million of senior
subordinated notes issued by GroupMAC in January 1999, and (iii) borrowings of
GroupMAC under its previous revolving credit facility. The New Credit Agreement
was expanded to $900 million during the second quarter of 2000, and includes a
$500 million revolving credit facility (the "Revolving Credit Facility"), a
$130 million term loan, a $170 million term loan and a $100,000 institutional
term loan (the "Term Credit Facilities"). Debt under the New Credit Agreement
bears interest at variable rates, as defined. Under the New Credit Agreement,
Encompass is required to maintain (i) a minimum Fixed Charge Coverage Ratio;
(ii) a maximum ratio of senior debt to pro forma EBITDA (as defined); (iii) a
maximum ratio of Funded Debt (as defined) to EBITDA (as defined); (iv) a
minimum amount of Consolidated Net Worth (as defined); and (v) a maximum amount
of capital expenditures in relation to Consolidated Net Worth. At September 30,
2000, the Company was in compliance with all covenants required under the New
Credit Agreement. To date, neither the terms of the New Credit Agreement and
the indenture pursuant to which the senior subordinated notes were issued nor
the debt represented thereby have materially restricted the Company's ability
to finance future operations or capital needs or to respond to changes in the
Company's business or competitive activity.
Subsequent to September 30, 2000, the Company entered into interest rate
swap agreements with several banks to lock in a fixed interest rate, after the
spread calculated based on the Company's Debt to EBITDA ratio, of 8.43% over
periods ranging from three to four years on a notional amount totaling $90
million in order to partially hedge against variations in interest rates on
borrowings under the New Credit Agreement.
As of October 31, 2000, borrowings under the New Credit Agreement were
$766.3 million, providing capacity under the New Credit Agreement, after
certain letter-of-credit commitments, of approximately $127.3 million.
In April 1999, the Company completed a private offering of $200 million of
10 1/2% senior subordinated notes (the "Senior Subordinated Notes"). The Senior
Subordinated Notes are unsecured and guaranteed by the Company's subsidiaries,
require interest to be paid semi-annually on May 1 and November 1 of each year
and mature on May 1, 2009.
The Company may redeem the Senior Subordinated Notes, in whole or in part,
at any time on or after May 1, 2004 at specified redemption prices, plus
accrued interest. At any time (which may be more than once) before May 1, 2002,
the Company may redeem up to 35% of the outstanding Senior Subordinated Notes
with money raised in equity offerings under certain circumstances. Upon a
change of control of the Company, the holders of the Senior Subordinated Notes
will have the right to sell the notes to the Company at 101% of the face amount
plus accrued interest.
Additionally, the indenture governing the Senior Subordinated Notes contains
certain covenants that restrict, among other things, the Company's ability to
incur indebtedness, pay dividends or repurchase capital stock, incur liens,
sell or otherwise dispose of a substantial portion of assets or merge or
consolidate with another entity.
Concurrent with the closing of the Merger, affiliates of Apollo Management,
L.P. exchanged approximately $106 million of Building One convertible junior
subordinated debentures and $150 million of cash for 256,191 shares of the
Company's Convertible Preferred Stock. The Convertible Preferred Stock will
mature in 2012, bears a dividend yield coupon rate of 7.25% and is convertible
into shares of the Company's common stock at
21
<PAGE>
any time by the holders at a conversion price of $14 per common share, subject
to adjustment under certain circumstances. The proceeds from the issuance of
the Convertible Preferred Stock were used to fund the cash election feature of
the Merger.
The Company's primary requirements for capital consist of funding contingent
purchase price obligations from prior acquisitions, making select strategic
investments in businesses and funding internal growth. During the nine months
ended September 30, 2000 and 1999, capital expenditures aggregated $33.7
million and $19.7 million, respectively. The Company anticipates that its cash
flow from operations and its existing credit facility will provide cash in
excess of its normal working capital needs, debt service requirements and
planned capital expenditures for property and equipment.
For the nine months ended September 30, 2000 and 1999, the Company generated
$6.2 million and $6.1 million of cash from operating activities, respectively.
For the nine months ended September 30, 2000, net income and other non-cash
charges generated $94.2 million compared to $65.1 million for the nine months
ended September 30, 1999. Net changes in working capital and other operating
accounts utilized $88.0 million for the nine months ended September 30, 2000,
compared to $59.0 million for the same period in 1999.
For the nine months ended September 30, 2000, the Company used $77.2 million
of cash in investing activities compared to $150.4 million for the nine months
ended September 30, 1999. Investing activities in 2000 principally consisted of
$45.8 million paid for acquisitions, net of cash acquired, $32.9 million used
for capital expenditures and $4.5 million used for strategic investments.
Partially offsetting this amount was $2.4 million received from a sale of
marketable securities and $3.6 million in proceeds from sale of equipment.
Investing activities for the 1999 period included $131.0 million for
acquisitions and $19.7 million for capital expenditures. Cash paid for
acquisitions includes the payment of contingent consideration on businesses
acquired in prior periods.
For the nine months ended September 30, 2000, the Company generated $55.7
million of cash from financing activities. These activities principally
consisted of net proceeds from the issuance of preferred stock of $146.3
million, retirement of GroupMAC common stock of $150.0 million, proceeds from
long-term debt of $1,231.3 million, payments of long term debt of $1,160.5
million and payment of debt issuance costs of $11.9 million. For the nine
months ended September 30, 1999, the Company used $54.3 million of cash from
financing activities. These activities principally consisted of proceeds from
long-term debt of $549.9 million, payment of debt issuance costs of $22.2
million, cash used to repurchase common stock of $564.4 million and payments of
long term debt of $18.1 million.
In conjunction with prior acquisitions, the Company entered into contingent
consideration agreements. For the nine months ended September 30, 2000, $43.9
million and 1,467,855 shares have been earned related to contingent
consideration and final purchase price settlements.
The Company currently estimates that $21.9 million of additional contingent
consideration will become payable in 2000 through 2002, of which approximately
$13.2 million is estimated to be payable in cash; however, management has the
option to increase the cash component of the contingent consideration with
respect to certain acquisition transactions, under the terms of the respective
acquisition agreements.
New Accounting Pronouncements
In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("SFAS
133"). This statement establishes new accounting and reporting standards
requiring that all derivative instruments (including certain derivative
instruments embedded in other contracts) be recorded in the balance sheet as
either an asset or liability measured at its fair value. The statement requires
that changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
changes in fair value on the hedged item in the statement of operations or be
22
<PAGE>
recognized in other comprehensive income, depending on the nature of the
hedging relationship, and requires that a company must formally document,
designate, and assess the effectiveness of transactions that receive hedge
accounting. This statement, as amended, is effective for all fiscal years
beginning after June 15, 2000. The Company will adopt SFAS 133 in the first
quarter of fiscal year 2001. Management does not expect the adoption of SFAS
133 to have a material effect on the financial condition or results of
operations of the Company.
Forward Looking Statements
This quarterly report may contain forward-looking statements within the
meaning of the Private Securities Litigation Reform Act of 1995. These
statements are based on the Company's current expectations and involve risks
and uncertainties that could cause the Company's actual results to differ
materially from those set forth in the statements. The Company can give no
assurance that such expectations will prove to be correct. Factors that could
cause the Company's results to differ materially from current expectations
include: the level of demand for its services by multi-site customers; the
level of interest rates which affects demand for the Company's services and its
interest expense; working capital requirements; general economic conditions; as
well as other factors listed in the Company's Form 10-K for the year ended
December 31, 1999, this Form 10-Q and previously filed Form 10-Qs.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
The table below provides information about the Company's market sensitive
financial instruments and constitutes a "forward-looking statement." The
Company's market risk exposure is changing interest rates. With the exception
of the Senior Subordinated Notes, all other debt instruments do not have a
trading market and have not been registered with the Securities and Exchange
Commission (in thousands).
<TABLE>
<CAPTION>
Fair Value at
September 30,
2000 2001 2002 2003 2004 Thereafter Total 2000
------ ------ ------ ------ ------ ---------- -------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revolving Credit
Facility............... -- -- -- -- -- $388,150 $388,150 $388,150
Average Rate.......... (a)
Term Credit Facilities.. $1,000 $4,000 $4,000 $4,000 $4,000 $380,250 $397,250 $397,250
Average Rate.......... (a)
Senior Subordinated
Notes.................. -- -- -- -- -- $200,000 $200,000 $174,000
Average Rate.......... 10.9%(b)
Junior Subordinated
Notes.................. -- -- -- $1,613 $2,500 -- $ 4,113 $ 4,113
Average Rate.......... 6.0% 7.5%
Fixed Rate Debt......... $3,065 -- -- -- -- -- $ 3,065 $ 3,065
Average Rate.......... 8.1%
</TABLE>
(a) Borrowings under the Revolving Credit Facility and the Term Credit
Facilities bear interest at a rate per annum, at the Company's option, of
either (i) the Alternate Base Rate or (ii) the Eurodollar Rate. The
Alternate Base Rate is equal to the greater of the Federal Funds Effective
Rate plus 0.5% or the Prime Rate, plus a Margin depending on the ratio of
indebtedness for borrowed money to pro forma EBITDA (with all capitalized
terms as defined in the New Credit Agreement). The Eurodollar Rate is the
rate defined in the New Credit Agreement plus a Margin depending on the
ratio of indebtedness for borrowed money to pro forma EBITDA. At September
30, 2000, the weighted average interest rate in effect for the Revolving
Credit Facility and the Term Credit Facilities, including amortization of
related debt issuance costs, was 8.83% and 9.36%, respectively.
In October 2000, the Company entered into several interest rate swap
agreements for a notional amount of $90 million for periods ranging from
three to four years, to partially hedge its exposure to variable rates under
the Revolving Credit Facility and the Term Credit Facilities. Under these
agreements, the Company will pay a fixed rate based on the three month LIBOR
at October 20, 2000 and will receive a variable rate which is reset every
three months also based on three month LIBOR.
(b) The Senior Subordinated Notes are unsecured, mature May 1, 2009 and bear
interest at 10.5% payable semi-annually. These notes were issued at
97.746%, or a discount of $4.5 million, which is being amortized to
interest expense over the term of the notes. In addition, there are
approximately $8.4 million in related debt issuance costs which are being
amortized to interest expense over the ten year life of the notes. The
effect of the amortization of the discount and debt issue costs increases
the effective interest rate on the Senior Subordinated Notes to 10.9%.
23
<PAGE>
PART II
OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<C> <S>
2 --None.
3.1* --Certificate of Merger dated February 22, 2000 merging Building
One Services Corporation into Group Maintenance America Corp.,
together with Exhibit A thereto (the Amended and Restated
Articles of Incorporation of Encompass) (Exhibit 3.1 to
Encompass' Annual Report on Form 10-K for the fiscal year ended
December 31, 1999, File No. 1-13565).
3.2* --Statement of Designation dated February 15, 2000 relating to the
7.25% Convertible Preferred Stock of Encompass (Exhibit 3.2 to
Encompass' Annual Report on Form 10-K for the fiscal year ended
December 31, 1999, File No. 1-13565).
3.3* --By-laws of Encompass, as amended (Exhibit 3.2 to Encompass'
Annual Report on Form 10-K/A for the fiscal year ended December
31, 1998, File No. 1-13565).
4 --None.
10.1 --First Amendment to Employment Agreement with J. Patrick
Millinor, Jr.
11 --None.
15 --None.
18 --None.
19 --None.
22 --None.
23 --None.
24 --None.
27 --Financial Data Schedule.
99 --None.
</TABLE>
--------
* Incorporated by reference from a prior filing as indicated.
(b) Reports on Form 8-K.
None.
24
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Encompass Services Corporation
Date: November 14, 2000
/s/ Darren B. Miller
-------------------------------------
Darren B. Miller
Senior Vice President and Chief Financial
Officer
(principal financial officer)
Date: November 14, 2000
/s/ L. Scott Biar
-------------------------------------
L. Scott Biar
Vice President and Chief Accounting
Officer
(principal accounting officer)
25
