<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 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 1-13565
----------------
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; 63,194,290 shares outstanding as
of July 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................................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 24
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.............. 25
Item 5. Other Information................................................ *
Item 6. Exhibits and Reports on Form 8-K................................. 25
</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, in accordance with the Agreement and Plan of Merger,
dated as of November 2, 1999, as amended (the "Agreement and Plan of Merger"),
between Group Maintenance America Corp. ("GroupMAC") and Building One Services
Corporation ("Building One"), Building One was merged with and into 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 of Encompass Services Corporation and
Subsidiaries.
Because the Merger is accounted for as a reverse acquisition of GroupMAC by
Building One, the financial statements included herein for periods prior to the
Merger reflect the historical operations 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 the right of the 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>
June 30, December 31,
2000 1999
ASSETS ---------- ------------
<S> <C> <C>
Current assets:
Cash and cash equivalents........................... $ 20,233 $ 17,085
Marketable securities............................... -- 2,275
Accounts receivable, net............................ 858,300 400,326
Inventories......................................... 35,135 10,324
Costs and estimated earnings in excess of billings
on uncompleted contracts........................... 140,408 59,418
Deferred tax assets................................. 14,704 4,168
Refundable income taxes............................. -- 1,757
Prepaid expenses and other current assets........... 33,072 13,260
---------- ----------
Total current assets............................... 1,101,852 508,613
Property and equipment, net........................... 120,058 63,288
Goodwill and other intangible assets, net............. 1,329,339 713,346
Deferred debt issue costs............................. 18,454 20,411
Other assets.......................................... 12,559 8,096
---------- ----------
Total assets....................................... $2,582,262 $1,313,754
========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Short-term borrowings and current maturities of long
term debt.......................................... $ 7,795 $ 7,950
Accounts payable.................................... 241,873 107,319
Billings in excess of costs and estimated earnings
on uncompleted contracts........................... 172,328 86,122
Due to related parties.............................. 20,117 10,290
Accrued compensation................................ 81,836 39,873
Income tax payable.................................. 3,594 --
Accrued liabilities................................. 87,039 36,628
---------- ----------
Total current liabilities.......................... 614,582 288,182
Revolving credit facility............................. 381,750 166,500
Term credit facilities................................ 394,500 124,063
Senior subordinated notes, net of unamortized
discount............................................. 196,018 195,793
Junior subordinated notes............................. 4,113 --
Convertible junior subordinated debentures............ -- 105,103
Deferred tax liabilities.............................. 8,223 2,085
Other liabilities..................................... 3,671 3,271
Commitments and contingencies
Mandatorily redeemable, convertible preferred stock,
$0.001 par value, 50,000,000 shares authorized,
256,191 and zero shares issued and outstanding,
respectively......................................... 252,545 --
Shareholders' equity:
Common stock, $.001 par value, 100,000,000 shares
authorized, 63,173,350 and 35,134,773 shares issued
and outstanding, respectively........................ 63 35
Additional paid-in capital............................ 614,435 329,118
Retained earnings..................................... 112,362 100,317
Accumulated other comprehensive loss.................. -- (713)
---------- ----------
Total shareholders' equity......................... 726,860 428,757
---------- ----------
Total liabilities and shareholders' equity......... $2,582,262 $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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2000 1999 2000 1999
---------- -------- ---------- --------
<S> <C> <C> <C> <C>
Revenues.......................... $1,090,229 $436,804 $1,768,746 $787,646
Cost of services.................. 891,432 350,713 1,449,150 631,405
---------- -------- ---------- --------
Gross profit.................... 198,797 86,091 319,596 156,241
Selling, general and
administrative expenses.......... 115,555 49,775 193,650 92,489
Merger and related charges........ -- -- 7,800 --
Costs to exit certain activities
and integration costs............ -- -- 12,200 --
Amortization of goodwill.......... 9,050 3,804 15,119 7,273
Restructuring and recapitalization
charges.......................... -- 8,020 -- 8,020
---------- -------- ---------- --------
Income from operations.......... 74,192 24,492 90,827 48,459
Other income (expense):
Interest income................. 158 1,698 283 4,206
Interest expense................ (23,044) (8,122) (39,686) (8,218)
Loss on sale of marketable
securities..................... -- -- (1,018) --
Other, net...................... 170 118 721 399
---------- -------- ---------- --------
Income before income tax
provision........................ 51,476 18,186 51,127 44,846
Income tax provision.............. 23,061 8,223 24,229 20,150
---------- -------- ---------- --------
Income before extraordinary loss.. 28,415 9,963 26,898 24,696
Extraordinary loss, net of tax.... -- -- (8,057) --
---------- -------- ---------- --------
Net income........................ 28,415 9,963 18,841 24,696
Less convertible preferred stock
dividends........................ (4,758) -- (6,796) --
---------- -------- ---------- --------
Net income available to common
shareholders..................... $ 23,657 $ 9,963 $ 12,045 $ 24,696
========== ======== ========== ========
BASIC EARNINGS PER SHARE:
Income before extraordinary
loss........................... $ .37 $ .23 $ .37 $ .49
Extraordinary loss, net of tax.. -- -- (.15) --
---------- -------- ---------- --------
Net income...................... $ .37 $ .23 $ .22 $ .49
========== ======== ========== ========
Weighted average shares
outstanding.................... 63,362 43,192 54,156 50,290
========== ======== ========== ========
DILUTED EARNINGS PER SHARE:
Income before extraordinary
loss........................... $ .35 $ .22 $ .37 $ .47
Extraordinary loss, net of tax.. -- -- (.15) --
---------- -------- ---------- --------
Net income...................... $ .35 $ .22 $ .22 $ .47
========== ======== ========== ========
Weighted average shares
outstanding.................... 81,926 47,862 54,274 53,737
========== ======== ========== ========
</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 six months ended June 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
number and par value of
Building One shares to
shares of Encompass.... 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..... 1 -- 6 -- -- 6
Common stock issued or
to be issued in
acquisitions........... 312 -- 3,966 -- -- 3,966
Shares received in
settlement of
litigation............. (184) -- (1,059) -- -- (1,059)
Net income.............. -- -- -- 18,841 -- 18,841 18,841
Convertible preferred
stock dividends........ -- -- -- (6,796) -- (6,796)
Reclassification
adjustment, net of
other comprehensive
loss realized in net
income................. -- -- -- -- 713 713 713
-------
Total comprehensive
income................. -- -- -- -- -- -- $19,554
------ --- -------- -------- ----- -------- =======
Balance, June 30, 2000.. 63,173 $63 $614,435 $112,362 $ -- $726,860
====== === ======== ======== ===== ========
</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>
Six Months Ended
June 30,
--------------------
2000 1999
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income.............................................. $ 18,841 $ 24,696
Adjustments to reconcile net income to net cash provided
by (used in) operating activities:
Depreciation and amortization.......................... 29,193 13,716
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.................................................. 1,814 --
Changes in operating assets and liabilities:
Accounts receivable.................................... (102,699) (40,734)
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. (23,489) (10,497)
Prepaid expenses and other current assets.............. 10,932 (9,897)
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. 21,087 4,780
Refundable income taxes................................ 12,173 --
Accounts payable....................................... 26,310 1,897
Accrued liabilities.................................... (5,240) 6,092
Change in other assets and liabilities................. 1,708 866
--------- ---------
Net cash provided by (used in) operating activities... 1,405 (6,452)
--------- ---------
Cash flows from investing activities:
Cash paid for acquisitions, net of cash acquired........ (30,659) (88,129)
Purchases of property and equipment..................... (19,665) (13,043)
Proceeds on sale of equipment........................... 935 253
Proceeds from sale of marketable securities............. 2,422 --
Cost basis investment................................... (2,020) --
Other................................................... -- (324)
--------- ---------
Net cash used in investing activities................. (48,987) (101,243)
--------- ---------
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.............................. (868,045) (5,483)
Proceeds from long-term debt............................ 934,420 504,648
Payment of debt issuance costs.......................... (11,901) (22,219)
Repurchase of common stock including related expenses... -- (564,407)
Distribution to Minority Shareholders................... -- (842)
Proceeds from stock options exercised................... 6 132
Proceeds from issuance of stock under employee stock
purchase plan.......................................... -- 802
--------- ---------
Net cash provided by (used in) financing activities... 50,730 (87,369)
--------- ---------
Net increase (decrease) in cash and cash equivalents..... 3,148 (195,064)
Cash and cash equivalents, beginning of period........... 17,085 213,096
--------- ---------
Cash and cash equivalents, end of period................. $ 20,233 $ 18,032
========= =========
Supplemental Disclosure of Cash Flow Information:
Interest paid........................................... $ 41,867 $ 1,834
Income taxes paid....................................... $ 4,908 $ 30,311
========= =========
</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 is deemed to be the acquiror and,
accordingly, the Merger is 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 revised to reflect the exchange ratio on a retroactive basis. See Note
2 for discussion of the Merger.
As of June 30, 2000, the Company was comprised of approximately 250
operating locations performing services in each of the top 100 cities across
the United States. The Company derives approximately 90% of its revenues from
commercial/industrial customers and has initiated a targeted effort to rapidly
grow its national accounts initiatives.
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 six-month periods ended June 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, subject
to pro ration, at $13.50 per share. As a result of this option, 11,052,377
shares of GroupMAC common stock were canceled in the Merger.
Concurrent with the closing of the Merger, affiliates of Apollo Management,
L.P. exchanged approximately $106,191 of Building One convertible junior
subordinated debentures and $150,000 in cash for approximately
6
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands except share and per share amounts)
(unaudited)
$256,191 of Encompass Convertible Preferred Stock. See Note 6 for further
discussion of the Convertible Preferred Stock. The proceeds from the issuance
of the Convertible Preferred Stock were used to fund the cash election feature
of the Merger.
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:
<TABLE>
<CAPTION>
Common Warrants/
Stock Options
-------- ---------
<S> <C> <C>
GroupMAC number of shares, options and warrants outstanding
or due at date of the
Merger.................................................... 38,961 5,358
Shares canceled in the cash election right................. (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 $13,000 primarily relate to workforce and customer
lists. Preliminary goodwill of approximately $569,488 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 and 2000 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
------------------------------------
Six Months Ended
Three Months June 30
Ended June 30, ---------------------
1999 2000 1999
-------------- ---------- ----------
<S> <C> <C> <C>
Revenues................................. $915,651 $2,056,751 $1,710,930
Net income............................... $ 26,352 $ 32,725 $ 44,018
Net income available to common
shareholders............................ $ 21,594 $ 23,198 $ 34,491
Net income per share:
Basic.................................. $ .34 $ .37 $ .55
Diluted................................ $ .32 $ .37 $ .54
</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 first and second quarters 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.
Pro forma net income for the six months ended June 30, 2000 includes the
costs to exit certain activities and integration costs of $12,200 discussed
more fully in Note 3, a loss on sale of marketable securities held by one of
the Company's subsidiaries of $1,018 and a non-cash compensation charge of
$1,571 incurred by GroupMAC prior to the Merger in connection with the
modification of certain option agreements. Excluding these charges, net income,
net income available to common shareholders, and net income per share (both
basic and diluted) for the six months ended June 30, 2000 would be $42,425,
$32,898 and $.52, respectively.
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 six months ended June
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 June 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 June 30,
2000. The total disposition of assets and other costs include approximately
$400 in non-cash related charges. The reconciliation below reflects the
accruals recorded and payments applied during the quarter.
<TABLE>
<CAPTION>
Balance at
Total June 30,
Reserve Payments 2000
------- -------- ----------
<S> <C> <C> <C>
Severance and Office Closing Costs:
Severance................................... $6,100 $(5,677) $ 423
Office Closing Costs........................ 1,000 (272) 728
Disposition of assets and other exit
activities costs........................... 300 (20) 280
------ ------- ------
Total..................................... $7,400 $(5,969) $1,431
====== ======= ======
</TABLE>
Costs to Exit Certain Activities and Integration Costs
During the six months ended June 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 janitorial group's 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 June 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 placement offering of
$200,000 of 10 1/2% senior subordinated notes. The senior subordinated notes
are unsecured, guaranteed by Building One'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 over the term of the notes. Additionally, debt
issuance costs of $8,388 incurred in connection with the offering, have been
capitalized and are being amortized over the 10-year term of the notes. The
unamortized portion of these costs were approximately $7,294 and $7,828 at June
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 can redeem up to 35% of the outstanding senior subordinated notes
with money raised in one or more 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 six months ended June 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 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 approximately $256,000 of
convertible preferred stock. In addition, the related debt issuance costs were
written off at that time and are reflected as an extraordinary charge for the
six months ended June 30, 2000 in the accompanying consolidated condensed
statements of operations.
Old Credit Facility
As of December 31, 1999, Building One's credit facility, which was with a
syndicate of banks led by Bankers' Trust Company, consisted of a $125,000 term
loan and a $225,000 revolving credit facility and matured in April 2004 (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 being amortized over the 5-year term of the credit
facility.
In conjunction with the Merger, the Old Credit Facility was paid off 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 charge for the six months ended June 30, 2000 in the
accompanying consolidated condensed statements of operations.
New Credit Agreement
In connection with the Merger, the Company entered into a new $800,000
credit facility (the "New Credit Agreement") and borrowed funds under the New
Credit Agreement to repay (i) the 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 revolving credit facility. The New
Credit Agreement, which is with a syndicate of banks led by Bank of America,
N.A. and Chase Bank of Texas, National Association (as Administrative Agent and
Syndication Agent, respectively) was expanded to $900,000 during the second
10
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands except share and per share amounts)
(unaudited)
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 at the time to meet certain specified
conditions. These conditions include 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.
Debt issuance costs associated with the origination, syndication, and
expansion of the New Credit Agreement approximating $11,901 have been
capitalized 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
approximate $11,160 at June 30, 2000 and are included in deferred debt issue
costs in the accompanying consolidated condensed balance sheets.
NOTE 5--Other Business Combinations and Contingent Consideration Agreements
During the six months ended June 30, 2000, the Company completed the
acquisition of one company which includes cash paid or to be paid of $10.2
million and 296,296 shares of common stock. The Company assumed approximately
$1.5 million of debt in this transaction.
In conjunction with acquisitions consummated to date, 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 performance of such
acquired companies. During the six months ended June 30, 2000, $31,249 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 $29,063 in cash and 304,877
shares of common stock. The cash payable is reflected as due to related parties
at June 30, 2000 in the accompanying consolidated condensed balance sheets and
the shares to be issued have been reflected as common shares to be issued in
the consolidated condensed statement of shareholders' equity. These common
shares to be issued have been included in the weighted average shares
outstanding for purposes of computing basic and diluted earnings per share for
the three and six months ended June 30, 2000.
Additionally, during the six months ended June 30, 2000, $32,443 of cash has
been paid and 15,704 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 $42,000 as of June 30, 2000.
11
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands except share and per share amounts)
(unaudited)
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...................................................... 29,063
Payments.......................................................... (32,443)
-------
Balance at June 30, 2000.......................................... $20,117
=======
</TABLE>
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 Management, L.P. ("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 share, subject to adjustment under
certain circumstances. At 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 five years
from the date of issuance, 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 six years and 101%
after eight years. 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 June
30, 2000, accrued dividends were approximately $6,692. The Convertible
Preferred Stock is also entitled to share in any dividends the Company may
declare on its common stock.
The holders of the Convertible Preferred Stock are entitled to vote on all
matters presented to the holders of the 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
June 30, 2000, the Convertible Preferred Stock comprised approximately 23% of
the voting power of Encompass.
Convertible Preferred Stock issuance costs approximating $3,750 are being
amortized over the 12-year term of the Convertible Preferred Stock. The
unamortized portion of these costs approximates $3,646 at June 30, 2000 and is
recorded against mandatorily redeemable, convertible preferred stock in the
accompanying consolidated condensed balance sheets.
12
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands except share and per share amounts)
(unaudited)
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 maintenance, repair and replacement services and new
installation 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 maintenance, repair and replacement and new installation
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.
The Company evaluates performance based on income from operations before
amortization expense 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 (1) corporate overhead, (2)
corporate and operating company management bonuses, and (3) savings from
national purchase agreements relating to materials and property/casualty
insurance.
13
<PAGE>
ENCOMPASS SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS--(Continued)
(In thousands except share and per share amounts)
(unaudited)
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 six month periods ended June 30, 2000 and 1999 was as follows:
<TABLE>
<CAPTION>
Inter-
Electrical/Mechanical/ Segment
Industrial Residential Janitorial Elimination Total
---------------------- ----------- ---------- ----------- ----------
<S> <C> <C> <C> <C> <C>
THREE MONTH PERIOD ENDED
JUNE 30, 2000
Revenues................ $ 947,265 $ 90,936 $ 66,898 $(14,870) $1,090,229
Operating costs......... 873,480 80,167 61,460 (14,870) 1,000,237
---------- -------- -------- -------- ----------
Segment operating
earnings............... 73,785 10,769 5,438 -- 89,992
========== ======== ======== ========
Goodwill amortization... (9,050)
Unallocated corporate
expenses............... (6,750)
----------
Income from operations.. $ 74,192
==========
THREE MONTH PERIOD ENDED
JUNE 30, 1999
Revenues................ $ 378,731 $ -- $ 58,073 $ -- $ 436,804
Operating costs......... 344,423 -- 52,798 -- 397,221
---------- -------- -------- -------- ----------
Segment operating
earnings............... 34,308 -- 5,275 -- 39,583
========== ======== ======== ========
Goodwill amortization... (3,804)
Restructuring and
recapitalization
charges................ (8,020)
Unallocated corporate
expenses............... (3,267)
----------
Income from operations.. $ 24,492
==========
SIX MONTH PERIOD ENDED
JUNE 30, 2000
Revenues................ $1,532,051 $120,098 $131,467 $(14,870) $1,768,746
Operating costs......... 1,417,716 106,654 122,008 (14,870) 1,631,508
---------- -------- -------- -------- ----------
Segment operating
earnings............... 114,335 13,444 9,459 -- 137,238
========== ======== ======== ========
Goodwill amortization... (15,119)
Merger and related
charges and costs to
exit certain activities
and integration costs.. (20,000)
Unallocated corporate
expenses............... (11,292)
----------
Income from operations.. $ 90,827
==========
SIX MONTH PERIOD ENDED
JUNE 30, 1999
Revenues................ $ 675,363 $ -- $112,283 $ -- $ 787,646
Operating costs......... 614,415 -- 103,053 -- 717,468
---------- -------- -------- -------- ----------
Segment operating
earnings............... 60,948 -- 9,230 -- 70,178
========== ======== ======== ========
Goodwill amortization... (7,273)
Restructuring and
recapitalization
charges................ (8,020)
Unallocated corporate
expenses............... (6,426)
----------
Income from
operations............. $ 48,459
==========
</TABLE>
14
<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 EPS computations for the three and six-month periods ended June 30,
2000 and 1999.
<TABLE>
<CAPTION>
Three Months Six Months
Ended June 30, Ended June 30,
---------------- ----------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Basic earnings per share:
Net income................................. $28,415 $ 9,963 $18,841 $24,696
Less: dividends/amortization of issuance
costs on convertible preferred stock...... (4,758) -- (6,796) --
------- ------- ------- -------
Net income available to common
shareholders.............................. $23,657 $ 9,963 $12,045 $24,696
======= ======= ======= =======
Weighted average shares outstanding--Basic
(in thousands)............................ 63,362 43,192 54,156 50,290
------- ------- ------- -------
Net income per share--Basic................ $ .37 $ .23 $ .22 $ .49
======= ======= ======= =======
Diluted earnings per share:
Net income available to common
shareholders.............................. $23,657 $ 9,963 $12,045 $24,696
Plus: interest expense on 7 1/2%
convertible junior subordinated debentures
and related amortization expense on debt
issue costs net of applicable income
taxes..................................... -- 785 -- 785
Plus: dividends/amortization of issuance
costs on convertible preferred stock...... 4,758 -- -- --
------- ------- ------- -------
Net income on an as-if converted basis..... $28,415 $10,748 $12,045 $25,481
======= ======= ======= =======
Weighted average shares outstanding--
Diluted (in thousands).................... 81,926 47,862 54,274 53,737
------- ------- ------- -------
Net income per share--Diluted.............. $ .35 $ .22 $ .22 $ .47
======= ======= ======= =======
Weighted average shares (in thousands):
Weighted average shares outstanding--
Basic..................................... 63,362 43,192 54,156 50,290
Common stock equivalents from stock options
and warrants.............................. 117 122 118 234
Contingently issuable shares............... -- 885 -- 1,371
Convertible preferred stock, on an as-if
converted basis........................... 18,447 -- -- --
Convertible junior subordinated debentures,
on an as-if converted basis............... -- 3,663 -- 1,842
------- ------- ------- -------
Total weighted average shares outstanding--
Diluted................................... 81,926 47,862 54,274 53,737
======= ======= ======= =======
</TABLE>
The Convertible Preferred Stock, which includes accumulated dividends, is
convertible into approximately 18,777,365 shares of common stock and
outstanding stock options and warrants to purchase 13,929,478 shares of common
stock were outstanding as of June 30, 2000, but were not included in the
computation of diluted earnings per share for the six months ended June 30,
2000 because the effect was anti-dilutive. Additionally, the convertible junior
subordinated debentures were not included in the computation of diluted
earnings per share for the six months ended June 30, 2000 because the effect
was anti-dilutive. Outstanding stock options and warrants to purchase 7,694,330
shares of common stock as of June 30, 1999 were not included in the computation
of diluted earnings per share because the effect was anti-dilutive.
15
<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 is deemed to be the acquiror and,
accordingly, the Merger is 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 maintenance,
repair and replacement services and new installation 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 maintenance, repair and replacement services and new installation
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
related to new installation and maintenance, repair and replacement services,
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.
The Company has realized savings from (1) greater volume discounts from
suppliers of components, parts and supplies; (2) consolidation of insurance and
bonding programs; and (3) its ability to borrow at lower interest rates than
most, if not all, of its subsidiaries. These savings are offset by costs
related to corporate management structure, costs associated with being a public
company and integration costs.
16
<PAGE>
RESULTS OF OPERATIONS
Three months ended June 30, 2000 compared to the three months ended June 30,
1999
Revenues. Revenues increased $653.4 million, or 150%, to $1,090.2 million
for the three months ended June 30, 2000 from $436.8 million for the three
months ended June 30, 1999. This increase in revenues is attributable to the
following:
. $534.6 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $51.0 million relates to the incremental revenues contributed in the
three months ended June 30, 2000 by electrical/mechanical/industrial
companies acquired during or subsequent to the three months ended June
30, 1999.
. $59.0 million relates to internal growth in the electrical/mechanical/
industrial group. This increase primarily relates to volume increases in
the Arizona, Colorado, Wisconsin and Texas markets.
. $8.8 million relates to internal growth in the janitorial group.
Gross profit. Gross profit increased $112.7 million, or 131% to $198.8
million for the three months ended June 30, 2000 from $86.1 million for the
three months ended June 30, 1999. This increase in gross profit is attributable
to the following:
. $101.7 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $11.0 million relates to the incremental gross profit contributed in the
three months ended June 30, 2000 by electrical/mechanical/industrial
companies acquired during or subsequent to the three months ended June
30, 1999.
. $1.4 million relates to lower materials and equipment costs due to
increased purchasing synergies.
Partially offsetting the above increases was a $1.4 million decrease related
primarily to economic softness in the Southeastern United States offset by
volume increases in the Arizona, Colorado, Wisconsin and Texas markets.
Gross profit margin decreased to 18.2% for the three months ended June 30,
2000 compared to 19.7% for the three months ended June 30, 1999. This decline
resulted 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, excluding restructuring and recapitalization charges
and goodwill amortization, increased $65.8 million, or 132% to $115.6 million
for the three months ended June 30, 2000 from $49.8 million for the three
months ended June 30, 1999. This increase in these expenses is attributable to
the following:
. $57.1 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $5.3 million relates to the incremental selling, general and
administrative expense incurred in the three months ended June 30, 2000
by electrical/mechanical/industrial companies acquired during or
subsequent to the three months ended June 30, 1999.
. $5.0 million relates to incremental corporate overhead, net of certain
insurance synergies recorded at the corporate level, resulting from the
acquisition of GroupMAC.
Partially offsetting the above increases was a $1.6 million decrease related
to lower field location overhead costs due to increased efficiencies in the
second quarter of 2000.
17
<PAGE>
As a percentage of revenues, selling, general and administrative expense,
excluding restructuring and recapitalization charges and goodwill amortization,
decreased to 10.6% for the three months ended June 30, 2000 from 11.4% for the
three months ended June 30, 1999. This decrease is a result of leveraging
corporate, regional and operating unit overhead over a larger revenue base.
Goodwill amortization. Goodwill amortization for the three months ended June
30, 2000 increased $5.3 million, or 138%, to $9.1 million from $3.8 million for
the three months ended June 30, 1999. This increase primarily relates to (1)
the GroupMAC operating locations that were acquired in connection with the
Merger and (2) the companies acquired during or subsequent to the three months
ended June 30, 1999.
Other income and expense. Changes in other income and expense activity is
primarily a result of net interest expense increasing $16.5 million to $22.9
million for the three months ended June 30, 2000 from $6.4 million for the
three months ended June 30, 1999. This change is the result of the Company
having significantly less debt outstanding during the three months ended June
30, 1999. As of June 30, 1999, the Company had $510.9 million of debt
outstanding from the acquisitions and the tender offer that occurred during the
first six months of 1999. This compares to $984.2 million at June 30, 2000 as a
result of the Merger and increased working capital levels needed to support
strong internal growth during the second quarter of 2000.
Income tax provision. The income tax provision increased $14.8 million to
$23.1 million for the three months ended June 30, 2000 from $8.2 million for
the three months ended June 30, 1999. This increase primarily relates to a
corresponding increase of $33.3 million in pre-tax income for the same period.
The effective tax rate was 44.8% and 45.2% for the three months ended June 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 overall decrease in the effective tax rate results from
certain income tax strategies, including structuring seven of the Company's
acquisitions as taxable asset acquisitions, resulting in the deductibility of
goodwill for these entities.
18
<PAGE>
RESULTS OF OPERATIONS
Six months ended June 30, 2000 compared to the six months ended June 30,
1999
Revenues. Revenues increased $981.1 million, or 125% to $1,768.7 million for
the six months ended June 30, 2000 from $787.6 million for the six months ended
June 30, 1999. This increase in revenues is attributable to the following:
. $713.0 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $88.9 million relates to the incremental revenues contributed in the six
months ended June 30, 2000 by electrical/mechanical/industrial companies
acquired during or subsequent to the six months ended June 30, 1999.
. $160.0 million relates to internal growth in the
electrical/mechanical/industrial group. This increase primarily relates
to volume increases in the California, Arizona, Colorado, Wisconsin and
Texas markets.
. $19.2 million relates to internal growth in the janitorial group.
Gross profit. Gross profit increased $163.4 million, or 105% to $319.6
million for the six months ended June 30, 2000 from $156.2 million for the six
months ended June 30, 1999. This increase in gross profit is attributable to
the following:
. $133.8 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $18.8 million relates to the incremental gross profit contributed in the
six months ended June 30, 2000 by electrical/mechanical/industrial
companies acquired during or subsequent to the six months ended June 30,
1999.
. $7.5 million relates to internal growth in the
electrical/mechanical/industrial group. This increase primarily relates
to volume increases in the Arizona, Colorado, Wisconsin and Texas
markets, offset by economic softness in the Southeastern United States
and losses from two particular jobs in a California location.
. $1.6 million relates to internal growth in the janitorial group.
. $1.7 million relates to lower materials and equipment costs due to
increased purchasing synergies.
Gross profit margin decreased to 18.1% for the six months ended June 30,
2000 compared to 19.8% for the six months ended June 30, 1999. This decline
resulted 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 the Merger during the six months ended June
30, 2000 caused a significant amount of distraction among the operating
leadership of the Company.
Selling, general and administrative expenses. Selling, general and
administrative expenses, excluding merger and related charges, costs to exit
certain activities and integration costs, goodwill amortization and
restructuring and recapitalization charges increased $101.2 million, or 109% to
$193.7 million for the six months ended June 30, 2000 from $92.5 million for
the six months ended June 30, 1999. This increase in these expenses is
attributable to the following:
. $77.0 million relates to the GroupMAC operating locations in the
electrical/mechanical/industrial and residential groups that were
acquired in connection with the Merger.
. $9.4 million relates to the incremental selling, general and
administrative expense incurred in the six months ended June 30, 2000 by
electrical/mechanical/industrial companies acquired during or subsequent
to the six months ended June 30, 1999.
19
<PAGE>
. $7.8 million relates to internal growth in the
electrical/mechanical/industrial group. This increase primarily relates
to supporting the revenue growth in the Texas, Florida, Arizona and
Colorado markets.
. $7.0 million relates to incremental corporate overhead, net of certain
insurance synergies recorded at the corporate level, resulting from the
acquisition of GroupMAC.
As a percentage of revenues, selling, general and administrative expense,
excluding merger and related charges, costs to exit certain activities and
integration costs, goodwill amortization and restructuring and recapitalization
charges decreased to 10.9% for the six months ended June 30, 2000 from 11.7%
for the six months ended June 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 has
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. During the six
months ended June 30, 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.
Goodwill amortization. Goodwill amortization for the six months ended June
30, 2000 increased $7.8 million, or 108%, to $15.1 million from $7.3 million
for the six months ended June 30, 1999. This increase primarily relates to (1)
the GroupMAC operating locations that were acquired in connection with the
Merger and (2) the companies acquired during or subsequent to the six months
ended June 30, 1999.
Restructuring and recapitalization charges. Restructuring and
recapitalization charges were $8.0 million for the six months ended June 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 $35.4 million to $39.4 million for the six
months ended June 30, 2000 from $4.0 million for the six months ended
June 30, 1999. This change is the result of the Company having
significantly less debt outstanding during the six months ended June 30,
1999. As of June 30, 1999 the Company had $510.9 million of debt
outstanding from the acquisitions and the tender offer that occurred
during the first six months of 1999. This compares to $984.2 million at
June 30, 2000 as a result of the Merger and increased working capital
levels needed to support strong internal growth during the second quarter
of 2000.
. The loss on sale of marketable securities 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 $4.1 million to
$24.2 million for the six months ended June 30, 2000 from $20.2 million for the
six months ended June 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 $9.1 million for the six months ended June 30, 2000,
which corresponds with the pre-tax income increase of $19.3 million that
results before such charges. Excluding these charges, the effective tax
20
<PAGE>
rate was 44.8% and 44.0% for the six months ended June 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.
Extraordinary loss, net of tax. The net of tax extraordinary loss of $8.1
million for the six months ended June 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 substantial portion of the Company's business involves installation of
mechanical and electrical systems in newly constructed commercial, industrial
and residential facilities. 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. The level of new commercial and
industrial installation services is also affected by changes in economic
conditions and interest rates. 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 six month periods ended June 30, 2000 and 1999.
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.
In connection with the Merger, the Company entered into a new $800 million
credit facility (the "New Credit Agreement") and borrowed funds under the new
facility to repay (i) 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 revolving credit
facility. The New Credit Agreement, which is with a syndicate of banks led by
Bank of America, N.A. and Chase Bank of Texas, National Association (as
Administrative Agent and Syndication Agent, respectively) 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 (1) a minimum Fixed Charge Coverage Ratio; (2) a
21
<PAGE>
maximum ratio of senior debt to pro forma EBITDA (as defined); (3) a maximum
ratio of Funded Debt (as defined) to EBITDA (as defined); (4) a minimum amount
of Consolidated Net Worth (as defined); and (5) a maximum amount of capital
expenditures in relation to Consolidated Net Worth. At June 30, 2000, the
Company was in compliance with those and all other affirmative and negative
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.
As of August 11, 2000, borrowings under the New Credit Agreement were $759.0
million, providing capacity under the New Credit Agreement of approximately
$135.6 million.
In April 1999, the Company completed a private placement offering of
$200,000 of 10 1/2% senior subordinated notes (the "Senior Subordinated
Notes"). The Senior Subordinated Notes are unsecured, 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 can redeem up to 35% of the outstanding Senior Subordinated Notes
with money raised in one or more 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 our 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 approximately $256 million
of the Company's Convertible Preferred Stock. The preferred stock will mature
in 2012, bears a dividend yield coupon rate of 7.25% and will be convertible
into shares of the Company's common stock at a conversion price of $14 per
common share, subject to adjustment. 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 purchasing vehicles, inventory and supplies used
in the operation of the business. During the six months ended June 30, 2000 and
1999, capital expenditures aggregated $19.7 million and $13.0 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 six months ended June 30, 2000 and 1999, the Company generated $1.4
million and used $6.5 million of cash from operating activities, respectively.
For the six months ended June 30, 2000, net income, depreciation, amortization,
write-off of deferred financing costs, impairment charges related to property
and equipment, loss on sale of marketable securities and other items generated
$60.6 million and changes in asset and liability accounts utilized a net $59.2
million. For the six months ended June 30, 1999, net income, depreciation,
amortization and other items generated $41.0 million and changes in asset and
liability accounts utilized a net $47.5 million.
For the six months ended June 30, 2000, the Company used $49.0 million of
cash in investing activities. These activities principally consisted of $30.7
million paid for acquisitions, net of cash acquired, $19.7 million
22
<PAGE>
used for capital expenditures and $2.0 million used for a strategic investment.
Partially offsetting this amount was $2.4 million received from a sale of
marketable securities. For the six months ended June 30, 1999, the Company used
$101.2 million of cash in investing activities. These activities principally
consisted of $88.1 million for acquisitions and $13.0 million for capital
expenditures.
For the six months ended June 30, 2000, the Company generated $50.7 million
of cash from financing activities. These activities principally consisted of
issuance of preferred stock, net of issuance costs, of $146.3 million,
retirement of GroupMAC common stock of $150.0 million, proceeds from long-term
debt of $934.4 million, payments of long term debt of $868.0 million and
payment of debt issuance costs of $11.9 million. For the six months ended June
30, 1999, the Company used $87.4 million of cash from financing activities.
These activities principally consisted of proceeds from long-term debt of
$504.6 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
$5.5 million.
In conjunction with prior acquisitions, the Company entered into contingent
consideration agreements. For the six months ended June 30, 2000, $29.1 million
and 304,877 shares have been earned related to contingent consideration and
final purchase price settlements.
The Company currently estimates that $42.0 million of additional contingent
consideration will become payable in 2000 through 2002, of which approximately
$24.0 million is estimated to be payable in cash, however, management has the
option to increase the cash component of the contingent consideration 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." 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 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. Under
present conditions, this statement will have no impact on the Company's
financial position or results of operations.
The FASB issued Interpretation No. 44, "Accounting for Certain Transactions
Involving Stock Compensation--an interpretation of APB Opinion No. 25" ("FIN
44"), in March 2000. This interpretation clarifies the application of APB
Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and,
among other issues, addresses the definition of employee for purposes of
applying APB 25, the criteria for determining whether a plan qualifies as a
noncompensatory plan, the accounting consequence of various modifications to
the terms of previously fixed stock options or awards and the accounting for an
exchange of stock compensation awards in a business combination. The provisions
of FIN 44 affecting the Company are effective July 1, 2000 and will be applied
prospectively to the extent that transactions are entered into that are
governed by this interpretation.
23
<PAGE>
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
June 30,
2000 2001 2002 2003 2004 Thereafter Total 2000
------ ------ ------ ------ ------ ---------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revolving Credit
Facility............... -- -- -- -- -- $381,750 $381,750 $381,750
Average Rate........... (a)
Term Credit Facilities.. $2,250 $4,000 $4,000 $4,000 $4,000 $380,250 $398,500 $398,500
Average Rate........... (a)
Senior Subordinated
Notes.................. -- -- -- -- -- $200,000 $200,000 $170,000
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......... $3,795 -- -- -- -- -- $ 3,795 $ 3,795
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 (1) the Alternate Base Rate or (2) 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 June 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 8.46% and 9.38%, respectively.
(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 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 collective effect of the discount
and debt issue costs increases the effective interest rate to 10.9%.
24
<PAGE>
PART II
OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
Encompass held its Annual Meeting of Shareholders on May 25, 2000 (the
"Annual Meeting") for the purpose of electing three directors and approving the
appointment of independent public accountants for the year 2000. The following
summarizes the shareholder voting results:
(a) Election of directors for a term to expire at the year 2001 Annual
Meeting of Shareholders:
<TABLE>
<CAPTION>
For Withheld
---------- ---------
<S> <C> <C>
Scott Kleinman 62,006,912 1,162,952
M. Jude Reyes 62,058,666 1,111,198
John M. Sullivan 62,076,661 1,093,203
</TABLE>
Directors whose terms of office continued after the Annual Meeting include
Andrew Africk, Vincent W. Eades, Michael Gross, Joseph M. Ivey, William P.
Love, Jr., Donald L. Luke, J. Patrick Millinor, Jr. and Lucian L. Morrison.
(b) Approval of the appointment of KPMG LLP as independent accountants
for Encompass for the year 2000:
<TABLE>
<CAPTION>
Broker
For Against Abstained Non-Vote
---------- ------- --------- --------
<S> <C> <C> <C>
62,272,002 333,533 564,329 -0-
</TABLE>
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 dated effective as of March 23, 2000 to Credit
Agreement dated as of February 22, 2000 among Encompass, the
subsidiaries of Encompass named therein, Bank of America, N.A.,
as administrative agent, Chase Bank of Texas, National
Association, as syndication agent, First Union National Bank, as
documentation agent, and the banks named therein.
10.2 --Second Amendment dated effective as of May 10, 2000 to Credit
Agreement dated as of February 22, 2000 among Encompass, the
subsidiaries of Encompass named therein, Bank of America, N.A.,
as administrative agent, Chase Bank of Texas, National
Association, as syndication agent, First Union National Bank, as
documentation agent, and the banks named therein.
</TABLE>
25
<PAGE>
<TABLE>
<CAPTION>
Exhibit No. Description of Exhibit
----------- ----------------------
<C> <S>
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.
On April 17, 2000, Encompass filed an amendment to the Current Report on
Form 8-K that it filed on February 25, 2000 (as amended on April 17, 2000),
with respect to the Merger, which was reported under Item 2 of the original
Form 8-K. The amendment included audited financial statements of Building One
and pro forma financial statements giving effect to the Merger.
26
<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: August 14, 2000
/s/ Darren B. Miller
-------------------------------------
Darren B. Miller
Senior Vice President and Chief Financial
Officer
(principal financial officer)
Date: August 14, 2000
/s/ Daniel W. Kipp
-------------------------------------
Daniel W. Kipp
Senior Vice President, Treasurer and
Chief Information Officer
(principal accounting officer)
27
