<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
(X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1997
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 NO. 001-13037
SERVICE EXPERTS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 62-1639453
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
111 WESTWOOD PLACE, SUITE 420, BRENTWOOD, TENNESSEE 37027
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (615) 371-9990
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.
CLASS OUTSTANDING AS OF AUGUST 12, 1997
COMMON STOCK, $.01 PAR VALUE 14,186,941
1
<PAGE> 2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------ ---------
(Unaudited)
(In thousands)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,779 $ 18,795
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $620 in 1996 and $752 in 1997 9,351 20,815
Related party 130 38
Employee 113 268
Other 208 1,749
-------- ---------
9,802 22,870
Inventories 4,041 7,413
Costs and estimated earnings in excess of billings 283 723
Prepaid expenses and other current assets 697 1,797
Current portion of notes receivable - related parties 14 14
Current portion of notes receivable - other 286 260
Deferred income taxes 1,893 2,461
-------- ---------
Total current assets 27,795 54,333
Property, buildings and equipment:
Land 10 105
Buildings 67 1,661
Furniture and fixtures 878 2,998
Machinery and equipment 1,954 2,931
Vehicles 5,473 8,563
Leasehold improvements 648 1,531
-------- ---------
9,030 17,789
Less accumulated depreciation and amortization (2,628) (4,285)
-------- ---------
6,402 13,504
Notes receivable - related parties, net of
current portion 352 330
Notes receivable - other, net of current portion 500 509
Investment in affiliate 674 573
Goodwill 33,032 68,981
Other assets 297 785
-------- ---------
Total assets $ 69,052 $ 139,015
======== =========
</TABLE>
See accompanying notes.
2
<PAGE> 3
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------ ---------
(Unaudited)
(In thousands, except share data)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable $ -- $ 27
Trade accounts payable and accrued liabilities 5,288 9,939
Cash consideration payable 1,495 --
Accrued compensation 1,631 4,586
Accrued warranties 970 1,646
Income taxes payable 1,726 1,295
Deferred revenue 3,557 6,849
Billings in excess of costs and estimated earnings 340 1,100
Current portion of long-term debt and capital
lease obligations 154 460
-------- ---------
Total current liabilities 15,161 25,902
Long-term debt and capital lease obligations, net
of current portion 149 252
Deferred income taxes 390 583
Commitments and contingencies (see note 9)
Stockholders' equity:
Preferred stock, $.01 par value; 10,000,000
shares authorized, no shares issued and
outstanding -- --
Common stock, $.01 par value; 30,000,000
shares authorized, 11,142,879 shares
issued and outstanding at December 31, 1996
and 14,165,092 shares issued and outstanding
at June 30, 1997 111 142
Additional paid-in-capital 48,567 101,658
Retained earnings 4,689 10,478
Equity notes receivable (15) --
-------- ---------
Total stockholders' equity 53,352 112,278
-------- ---------
Total liabilities and stockholders' equity $ 69,052 $ 139,015
======== =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1996 1997 1996 1997
------- -------- -------- --------
<S> <C> <C> <C> <C>
(Unaudited) (Unaudited)
(In thousands, except per share data)
Net revenues $ 8,417 $ 52,345 $ 14,060 $ 86,235
Cost of goods sold 5,605 33,327 9,349 54,606
------- -------- -------- --------
Gross margin 2,812 19,018 4,711 31,629
Selling, general and
administrative expenses 2,695 12,523 4,536 22,310
------- -------- -------- --------
Income from operations 117 6,495 175 9,319
Other income (expense):
Interest expense (44) (21) (53) (109)
Interest income 14 314 16 441
Other income 17 89 34 190
------- -------- -------- --------
(13) 382 (3) 522
------- -------- -------- --------
Income before income taxes 104 6,877 172 9,841
Provision (benefit) for income taxes:
Current 61 2,568 67 4,256
Deferred (154) 67 (154) (501)
------- -------- -------- --------
(93) 2,635 (87) 3,755
------- -------- -------- --------
Net income $ 197 $ 4,242 $ 259 $ 6,086
======= ======== ======== ========
Net income per common share $ 0.12 $ 0.30 $ 0.16 $ 0.46
======= ======== ======== ========
Weighted average shares
used in net income per
common share computation 1,653 14,204 1,653 13,237
======= ======== ======== ========
</TABLE>
See accompanying notes.
4
<PAGE> 5
SERVICE EXPERTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
1996 1997
-------- ---------
(Unaudited)
(In thousands)
<S> <C> <C>
NET CASH FLOW PROVIDED BY OPERATING ACTIVITIES $ 1,416 $ 1,242
INVESTING ACTIVITIES:
Payments on notes receivable -- 140
Purchase of property, buildings and equipment (117) (3,611)
Purchase of investments (39) 3
Cash acquired through purchase of business -- 1,979
Payment of cash for acquired companies -- (26,046)
Decrease in other assets 38 10
-------- ---------
Net cash provided by (used in)
investing activities (118) (27,525)
FINANCING ACTIVITIES:
Issuance of stock, net of issuance costs -- 35,518
Proceeds of long-term debt 87 836
Payments of long-term debt and capital leases (614) (558)
Payments on notes payable to related parties -- (1,495)
-------- ---------
Net cash provided by (used in)
financing activities (527) 34,301
-------- ---------
Increase in cash and cash equivalents 771 8,018
Cash and cash equivalents at beginning of period 468 10,777
-------- ---------
Cash and cash equivalents at end of period $ 1,239 $ 18,795
======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 53 $ 109
======== =========
Income taxes paid $ 67 $ 3,901
======== =========
Acquisition of companies:
Fair value of assets acquired $ -- $ 60,434
Cash paid -- 22,798
Common stock issued -- 26,046
-------- ---------
Liabilities assumed $ -- $ 23,999
======== =========
</TABLE>
See accompanying notes.
5
<PAGE> 6
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED
JUNE 30, 1997 (UNAUDITED)
1 - BASIS OF PRESENTATION
OVERVIEW
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the six months ended June 30, 1997 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1997.
Service Experts, Inc. (the "Company") was incorporated on March 27, 1996. As a
result of the adoption of Securities and Exchange Commission Staff Accounting
Bulletin No. 97 ("SAB 97") on July 31, 1996, the historical financial
statements of the Company for periods prior to August 21, 1996 are the combined
financial statements of AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. (collectively, the "Acquiring Company") and
subsequent acquisitions accounted for as poolings of interests (See Note 3). On
August 21, 1996 and simultaneous with the closing of its initial public
offering, the Company acquired in separate transactions, 12 heating,
ventilating and air conditioning ("HVAC") replacement and service businesses
and Contractor Success Group, Inc. (collectively, the "Predecessor Companies")
in exchange for shares of the Company's Common Stock and cash (the
"Combination"). The Acquiring Company was treated as the acquiror entity in
this transaction in accordance with SAB 97. The operations of the acquired
companies have been included in the Company's financial statements from the
date of acquisition. The above mentioned acquisitions have been accounted for
using the historical cost basis of the acquired companies in accordance with
Securities and Exchange Commission Staff Accounting Bulletin No. 48 ("SAB 48").
The Company operates in one industry segment and is primarily engaged in the
replacement and servicing of HVAC systems for residential and commercial
customers. The Company operates HVAC businesses located in cities across the
United States.
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of the Company include the accounts of the
Company and its subsidiaries. All intercompany transactions have been eliminated
in consolidation. Investments in affiliates less than 50% owned are generally
recorded on the equity method.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
NEWLY ISSUED ACCOUNTING STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement No. 128, "Earnings per Share" ("Statement 128"), which
6
<PAGE> 7
is required to be adopted on December 31, 1997. At that time, the Company will
be required to change the method currently used to compute earnings per share
and to restate all prior periods. Under the new requirements for calculating
primary earnings per share, the dilutive effect of stock options will be
excluded. The pro forma primary earnings per share for the second quarter ended
June 30, 1996 and June 30, 1997 would be $0.12 and $0.30 per share,
respectively, and the pro forma primary earnings per share for the six months
ended June 30, 1996 and June 30, 1997 would be $0.16 and $0.46, respectively.
The impact of Statement 128 on the calculation of fully diluted earnings per
share is not expected to be material.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("Statement 130"). Statement 130 establishes standards for reporting and
displaying comprehensive income and its components in a full set of general
purpose financial statements. Statement 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions with
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of Statement 130 to have
a material impact on the Company's financial statements.
In June 1997, the FASB issued Statement No. 131, "Disclosures about Segments of
an Enterprise and Related Information" ("Statement 131"). Statement 131
establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and requires
those enterprises to report selected information about operating segments in
interim financial reports issued to stockholders. It also establishes standards
for related disclosures about products and services, geographic areas and major
customers. Statement 131 is effective for periods beginning after December 15,
1997. Management of the Company is currently reviewing the applicability of
Statement 131.
3 - ACQUISITIONS
In December 1996, the Company completed mergers with Custom Air Conditioning,
Inc. ("Custom") and Freschi Air Systems, Inc. ("Freschi"), through the exchange
of 230,049 and 177,765 shares, respectively, of the Company's Common Stock. In
May 1997, the Company completed the acquisition of all of the capital stock of
C. Iapaluccio Company, Inc. ("Iapaluccio") (collectively, with Custom and
Freschi, the "Pooled Companies"), in exchange for 92,553 shares of the
Company's Common Stock.
These acquisitions have been accounted for as poolings of interests and,
accordingly, the consolidated financial statements for the periods presented
have been restated to include the accounts of the Pooled Companies. The
following is a summary of results of operations of the Pooled Companies, for
the periods prior to the business combinations.
7
<PAGE> 8
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS FOUR MONTHS
ENDED ENDED ENDED
JUNE 30, 1996 JUNE 30, 1996 APRIL 30, 1997
------------- ------------- --------------
(In thousands) (In thousands) (In thousands)
<S> <C> <C> <C>
Net Revenues $ 8,417 $14,060 $ 9,295
======= ======= =======
Net Income $ 197 $ 259 $ 751
======= ======= =======
</TABLE>
4 - RECAPITALIZATION, INITIAL PUBLIC OFFERING AND SECONDARY STOCK OFFERING
On August 21, 1996, the Company completed an initial public offering ("IPO") of
2,587,500 shares of Common Stock at $13.00 per share. Simultaneously with the
closing of the IPO, the Company issued 3,369,358 shares of Common Stock and
distributed $18.7 million cash for the stock of the Predecessor Companies
(exclusive of 1,153,098 shares of Common Stock and $5,027,947 cash distributed
to the former stockholders of the Acquiring Company). The exchange was accounted
for utilizing the historical cost basis in accordance with SAB 48 with the stock
being valued at the historical cost of the net assets exchanged. Cash
consideration given in these acquisitions was treated for accounting purposes as
a dividend from the Company.
On March 18, 1997, the Company completed a public offering of 1,850,000 shares
of Common Stock at $22.00 per share which resulted in $37.7 million in net
proceeds to the Company. A portion of the net proceeds was used to pay the cash
portion of the consideration for acquisitions and to repay certain indebtedness
arising from acquisitions. The remaining proceeds will be used to fund the
Company's planned capital expenditures, future acquisitions and for general
corporate purposes.
On June 6, 1997, the Company's Common Stock began trading on the New York Stock
Exchange under the symbol "SVE". The Company's Common Stock was previously
traded on The Nasdaq Stock Market's National Market under the symbol "SERX".
5 - ACQUISITIONS
From January 1, 1997 through June 30, 1997, the Company acquired 32 HVAC
businesses. The following displays pertinent information regarding these
acquisitions:
<TABLE>
<CAPTION>
Service Total Total
Centers Companies Shares Cash Total
Acquired Acquired Issued Consideration Consideration
-------- ---------- ------ ------------- -------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
First Quarter 7 14 790,000 $15,126 $28,287
Second Quarter 9 18 457,000 10,920 21,758
</TABLE>
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase method
of accounting, except as indicated in Note 3. The allocation of the purchase
price associated with the acquisitions has been determined
8
<PAGE> 9
by the Company based upon available information and is subject to further
refinement. In computing the purchase price for accounting purposes, the value
of shares of the Company's Common Stock is determined using the value of shares
set forth in the acquisition agreement, less a discount ranging from 0% to 20%
(as determined by an independent investment banking firm), due to restrictions
on the sale and transferability of the shares issued. The discount to the
purchase price on acquisitions completed through June 30, 1997 is $4.8 million.
Asset and equity balances have been reduced accordingly, with no impact on net
income. This reduction in goodwill will affect amortization expense in future
periods. The operating results of the acquired companies, except for the Pooled
Companies, have been included in the accompanying consolidated statements of
income from the respective dates of acquisition. The following unaudited pro
forma results of operations give effect to the operations of these entities, as
well as entities acquired during 1996, as if the respective transactions had
occurred as of the beginning of the periods presented. The pro forma results of
operations have been adjusted for additional income tax provisions for state
and federal taxes as certain of the acquired companies previously were taxed as
subchapter S corporations. The pro forma results of operations neither purport
to represent what the Company's results of operations would have been had such
transactions in fact occurred at the beginning of the periods presented nor
purport to project the Company's results of operations in any future period.
PRO FORMA RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS
ENDED
JUNE 30,
----------------------
1996 1997
------- -------
(In thousands, except per share data)
<S> <C> <C>
Net revenues $84,175 $88,408
Net income 5,115 6,992
Net income per common share $ 0.42 $ 0.50
</TABLE>
6 - NET INCOME PER COMMON SHARE
Net income per share has been computed based on the weighted average shares
outstanding.
7 - INCOME TAXES
The income tax provision recorded for the six months ended June 30, 1997 differs
from the expected income tax provision due to permanent differences and the
provision for state income taxes. The income tax provision recorded for the six
months ended June 30, 1996 differs from the expected income tax provision due to
elections under subchapter S of the Internal Revenue Code by AC Service &
Installation Co., Inc. and the Pooled Companies, permanent differences and the
provision for state income taxes.
8 - FINANCING ARRANGEMENTS
The Company has a Revolving Line of Credit agreement with a Nashville, Tennessee
bank for up to $10 million to be used for working capital purposes and
acquisitions. The Company also has a Discretionary Line of Credit agreement with
a Nashville, Tennessee bank for up to $10 million to be used for acquisitions or
such other purposes as may be approved by the bank. Management believes that its
existing cash balances, cash generated from operations and additional borrowings
will be sufficient to fund the Company's planned capital expenditures through
the remainder of 1997.
9 - COMMITMENTS AND CONTINGENCIES
The Company currently, and from time to time, is expected to be subject to
claims and suits arising in the ordinary course of business. Management
continually evaluates contingencies based on the best available evidence and
believes that adequate provision for losses has been provided to the extent
necessary.
9
<PAGE> 10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
OVERVIEW
During the third quarter of 1996 and simultaneous with the IPO, the Company
acquired the Predecessor Companies in the Combination. Prior to the Combination,
the Company had no operations. The consideration paid by the Company for the
Predecessor Companies was approximately $77.5 million, consisting of 4.5 million
shares of Common Stock and $18.7 million cash. No intangible assets were
recorded as a result of the Combination due to the accounting treatment in
accordance with SAB 48. On a pro forma basis, these companies, together with the
Pooled Companies, generated revenue in 1996 of approximately $79.6 million and
contributed operating income of approximately $8.8 million.
During the fourth quarter of 1996, the Company acquired 17 HVAC businesses,
with 13 of these businesses being Service Centers. In connection with these
acquisitions, the Company issued approximately 2.5 million shares of Common
Stock and paid approximately $3.0 million cash. Two of these acquisitions were
accounted for as poolings of interests, as discussed in Note 3 to the Notes to
Consolidated Financial Statements, and the remainder were accounted for using
the purchase method.
During the first quarter of 1997, the Company acquired 14 HVAC businesses, with
7 of these businesses being Service Centers. In connection with these
acquisitions, the Company issued approximately 790,000 shares of Common Stock
and paid approximately $15.1 million cash. All of these acquisitions were
accounted for using the purchase method.
During the second quarter of 1997, the Company acquired 18 additional HVAC
businesses, with nine being Service Centers. The consideration paid by the
Company for these businesses consisted of approximately 457,000 shares of
Common Stock and approximately $10.9 million cash. One of these acquisitions
was accounted for as a pooling of interests, as discussed in Note 3 to the
Notes to Consolidated Financial Statements, and the remainder were accounted
for using the purchase method.
FINANCIAL STATEMENT PRESENTATION
The Combination was accounted for using the historical cost basis of the
Predecessor Companies in accordance with SAB 48. On July 31, 1996, SAB 97 was
adopted to replace SAB 48 for certain combination transactions. In accordance
with the provisions of SAB 97, the presentation of financial information for the
Company reflects the Acquiring Company as the acquiror of the other Predecessor
Companies. The operation of the Predecessor Companies and other acquired
companies (except for the Pooled Companies) have been included in the Company's
financial statements from their respective effective dates of acquisition.
The Company's Service Centers historically have been managed as independent
private companies and, as such, their results of operations reflect different
tax structures which have influenced, among other things, their historical
levels of owners' compensation.
COMPONENTS OF INCOME
Net revenue of the Company's HVAC businesses has been derived primarily from
the installation, service and maintenance of central air conditioners, furnaces
and heat pumps primarily in existing homes. Net revenue and associated income
from operations are subject to seasonal fluctuations resulting from increased
demand for the Company's services during warmer weather in the summer months
and during colder weather in the winter months, particularly in the beginning
of each season. Cost of goods sold primarily consists of purchased materials
such as replacement air conditioning units and heat
10
<PAGE> 11
pumps and the labor associated with both installations and repair orders. The
main components of selling, general and administrative expenses include
administrative salaries, insurance expense and marketing and advertising
expenses.
RESULTS OF OPERATIONS
Because of the significant effect of the Combination, acquisitions subsequent to
the Combination and the anticipated effect of future acquisitions on the
Company's results of operations, the Company's historical results of operations
and period-to-period comparisons will not be indicative of future results and
may not be meaningful. The Company plans to continue acquiring HVAC businesses
in the future, and through June 30, 1997, has acquired 49 HVAC businesses. The
integration of acquired HVAC businesses and the addition of management personnel
to support existing and future acquisitions may positively or negatively affect
the Company's results of operations during the period immediately following
acquisitions.
THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30,
1996
Net Revenue. Net revenue increased $43.9 million, or 521.9%, from $8.4
million for the three months ended June 30, 1996 to $52.3 million for the three
months ended June 30, 1997. Approximately $41.5 million of the increase is
attributed to the acquisition of new HVAC businesses between August 1996 and
June 1997.
Cost of Goods Sold. Cost of goods sold increased $27.7 million, or
494.6%, from $5.6 million for the three months ended June 30, 1996 to $33.3
million for the three months ended June 30, 1997. Approximately $25.5 million of
this increase is attributed to the acquisition of new HVAC businesses between
August 1996 and June 1997. As a percentage of net revenue, cost of goods sold
decreased 2.9% from 66.6% for the three months ended June 30, 1996 to 63.7% for
the three months ended June 30, 1997. The primary factor for this decrease is a
more favorable product mix with a higher percentage of residential business.
Gross Margin. Gross margin increased $16.2 million, or 576.3%, from
$2.8 million for the three months ended June 30, 1996 to $19.0 million for the
three months ended June 30, 1997. As a percentage of net revenue, gross margin
increased from 33.4% for the three months ended June 30, 1996 to 36.3% for the
three months ended June 30, 1997. The primary factor for this increase as a
percentage of net revenue is a more favorable product mix with a higher
percentage of residential business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $9.8 million, or 364.7%, from $2.7 million
for the three months ended June 30, 1996 to $12.5 million for the three months
ended June 30, 1997. As a percentage of net revenue, selling, general and
administrative expenses decreased from 32.0% for the three months ended June
30, 1996 to 23.9% for the three months ended June 30, 1997. Management believes
this decrease as a percentage of net revenue is primarily attributable to
economies of scale resulting from acquisitions, as well as a reduction in
former owners' compensation expense following acquisitions.
Income from Operations. Income from operations increased from $117,000
for the three months ended June 30, 1996 to $6.5 million for the three months
ended June 30, 1997, an increase of 5,451.3%. Income from operations as a
percentage of net revenue increased from 1.4% for the three months ended June
30, 1996 to 12.4% for the three months ended June 30, 1997. Management believes
this increase as a percentage of net revenues is primarily attributable to the
factors discussed above.
11
<PAGE> 12
Other Income (Expense). Other income (expense) increased $395,000
from ($13,000) for the three months ended June 30, 1996 to $382,000 for the
three months ended June 30, 1997. Other income (expense) as a percentage of net
revenue increased from (0.2%) for the three months ended June 30, 1996 to 0.7%
for the three months ended June 30, 1997. This increase is primarily a result
of interest income realized on investment of proceeds from the Company's
public offering in March 1997.
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996
Net Revenue. Net revenue increased $72.2 million, or 513.3%, from $14.1
million for the six months ended June 30, 1996 to $86.2 million for the six
months ended June 30, 1997. Approximately $70.9 million of the increase is
attributable to the acquisition of new HVAC businesses between August 1996 and
June 1997.
Cost of Goods Sold. Cost of goods sold increased $45.3 million, or
484.0%, from $9.4 million for the six months ended June 30, 1996 to $54.6
million for the six months ended June 30, 1997. Approximately $43.8 million of
this increase is attributed to the acquisition of new HVAC businesses between
August 1996 and June 1997. As a percentage of net revenue, cost of goods sold
decreased 3.2% from 66.5% for the six months ended June 30, 1996 to 63.3% for
the six months ended June 30, 1997. The primary factor for this decrease is a
more favorable product mix with a higher percentage of residential business.
Gross Margin. Gross margin increased $26.9 million, or 571.5%, from
$4.7 million for the six months ended June 30, 1996 to $31.6 million for the six
months ended June 30, 1997. As a percentage of net revenue, gross margin
increased from 33.5% for the six months ended June 30, 1996 to 36.7% for the six
months ended June 30, 1997. The primary factor for this increase is a more
favorable product mix with a higher percentage of residential business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $17.8 million, or 391.8%, from $4.5 million
for the six months ended June 30, 1996 to $22.3 million for the six months ended
June 30, 1997. As a percentage of net revenue, selling, general and
administrative expenses decreased from 32.3% for the six months ended June 30,
1996 to 25.9% for the six months ended June 30, 1997. Management believes this
decrease as a percentage of net revenue is primarily attributable to economies
of scale resulting from acquisitions, as well as a reduction in former owners'
compensation expense following acquisitions.
Income from Operations. Income from operations increased from $174,000
for the six months ended June 30, 1996 to $9.3 million for the six months ended
June 30, 1997, an increase of 5,255.7%. Income from operations as a percent of
net revenue increased from 1.2% for the six months ended June 30, 1996 to 10.8%
for the six months ended June 30, 1997. Management believes this increase as a
percentage of net revenue is primarily attributable to the factors discussed
above.
Other Income (Expense). Other income (expense) increased $525,000
from ($3,000) for the six months ended June 30, 1996 to $522,000 for the
six months ended June 30, 1997. Other income (expense) as a percentage of net
revenue increased from (0.02%) for the six months ended June 30, 1996 to 0.6%
for the six months ended June 30, 1997. This increase is primarily a result of
interest income realized on investment of proceeds from the Company's public
offering in March 1997.
12
<PAGE> 13
LIQUIDITY AND CAPITAL RESOURCES
On August 21, 1996, the Company completed the IPO at $13.00 per share. The
proceeds to the Company, net of expenses and underwriting discounts and
commissions, were approximately $28.1 million. Of the net proceeds, $18.7
million was used to pay the cash portion of the consideration for the
Predecessor Companies, including $1.2 million which was used to repay certain
indebtedness arising from the Combination. The Company used the remaining
proceeds for working capital and capital expenditures, including the acquisition
of additional HVAC businesses.
On March 18, 1997, the Company completed a public offering of 1,850,000 shares
of its Common Stock at $22.00 per share. The proceeds to the Company, net of
expenses and underwriters' discounts and commissions, were approximately $37.7
million. A portion of the net proceeds was used to pay the cash portion of the
consideration for certain pending acquisitions and to repay certain
indebtedness arising such acquisitions. The remaining proceeds are being used
to fund the Company's planned capital expenditures, additional acquisitions and
for general corporate purposes.
The Company's ability to acquire new HVAC businesses will depend on a number of
factors, including the ability of management of the Company to identify
favorable target businesses and to negotiate favorable acquisition terms, the
availability of adequate financing and other factors, many of which are beyond
the control of the Company. Thus far, the Company has been very active in
acquiring HVAC businesses. There can be no assurance that the Company will be
successful in identifying and acquiring HVAC businesses, that the Company can
integrate such new HVAC businesses into the Company's operations or that the
Company's new HVAC businesses will generate sales revenue or profit margins
consistent with those of the Company's existing HVAC businesses.
Working capital at June 30, 1997 was $28.4 million and cash, cash equivalents
and short-term investments were $18.8 million. Net cash generated from
operations in the six months ended June 30, 1997 was $1.2 million.
The Company's principal capital needs arise from the acquisition of new HVAC
businesses and the costs associated with such expansion. During the first six
months of 1997, the Company's capital expenditures were $3.6 million. At June
30, 1997, the Company had $712,000 of outstanding notes payable. Cash used in
investing activities was primarily attributable to the acquisition of HVAC
businesses.
The Company has a $10 million unsecured revolving credit facility and an
additional $10 million unsecured discretionary revolving credit facility with
SunTrust Bank, Nashville, N.A. ("SunTrust") available through September 10, 1998
(together, the "Credit Facilities"). Borrowings under the Credit Facilities bear
interest at a variable rate equal to the 30-day LIBOR, as such rate changes from
time to time, plus a variable margin of from 125 to 250 basis points depending
on the Company's funded debt to EBITDA ratio determined on a quarterly basis.
Certain of the Company's subsidiaries have guaranteed the repayment of
indebtedness under the Credit Facilities. At June 30, 1997, there were no
amounts outstanding on the Credit Facilities. The Credit Facilities contain
covenants with respect to the maintenance of certain financial ratios and
specified net worth and limiting the incurrence of additional indebtedness, the
sale of substantial assets, consolidations or mergers
13
<PAGE> 14
by the Company and the payment of dividends. The Company currently is
negotiating with SunTrust to increase the amount available under the Credit
Facilities, but there can be no assurance that such negotiations will be
successful.
The Company currently has on file with the Securities and Exchange Commission a
shelf Registration Statement on Form S-4 (Registration No. 333-12319) (the
"Shelf Registration Statement") covering securities with a collective aggregate
offering price of $50.0 million for use in future acquisitions of HVAC
businesses. Under the Shelf Registration Statement, the Company may issue shares
of Common Stock, warrants to purchase Common Stock and debt securities in
connection with acquisitions.
Management believes that the Company's existing cash balances, cash generated
from operations and additional borrowings will be sufficient to fund the
Company's operating needs, planned capital expenditures and debt service
requirements for the next 12 months. Management continually evaluates potential
strategic acquisitions as part of the Company's growth strategy. To date, such
acquisitions have been predominantly funded by issuing shares of Common Stock,
although future acquisitions could be effected using greater amounts of cash.
Although the Company believes that its financial resources will enable it to
consider potential acquisitions, should the Company's actual results of
operations fall short of, or its rate of expansion significantly exceed, its
plans, or should its costs or capital expenditures exceed expectations, the
Company may need to seek additional financing in the future. In negotiating such
financing, there can be no assurance that the Company will be able to raise
additional capital on terms satisfactory to the Company. Failure to obtain
additional financing on reasonable terms could have a negative effect on the
Company's plans to acquire additional HVAC businesses.
This discussion contains certain forward-looking statements, including those
relating to the acquisition of additional HVAC service and replacement
businesses, each of which is accompanied by specific, cautionary language that
could cause different results than expected by the Company.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No disclosure is required.
14
<PAGE> 15
PART II
OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
The annual meeting of stockholders of the Company was held on Friday,
May 2, 1997. At this meeting, the following matters were voted upon by the
Company's stockholders:
(a) AMENDMENT TO THE COMPANY'S 1996 INCENTIVE STOCK PLAN
The Company's stockholders approved the amendment to the Company's
1996 Incentive Stock Plan to (i) increase from 700,000 to 1,300,000 the number
of shares of Common Stock authorized thereunder, (ii) require that no more than
250,000 shares of Common Stock be awarded to any person in a three-year period
and (iii) eliminate the requirement of stockholder approval of certain
administrative amendments by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
8,835,640 1,081,477 15,198
(b) AMENDMENT TO THE COMPANY'S 1996 EMPLOYEE STOCK PURCHASE PLAN
The Company's stockholders approved the amendment to the Company's 1996
Employee Stock Purchase Plan to increase from 100,000 to 200,000 the number of
shares authorized thereunder by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
9,738,829 182,518 11,348
(c) ADOPTION OF THE COMPANY'S 1997 NONQUALIFIED STOCK OPTION PLAN
The Company's stockholders adopted the Company's 1997 Nonqualified
Stock Option Plan by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
8,461,603 1,464,337 7,648
(d) ELECTION OF CLASS I DIRECTORS
Raymond J. De Riggi and Norman T. Rolf, Jr. were elected to serve as
Class I directors of the Company. The vote was as follows:
<TABLE>
<CAPTION>
VOTES CAST VOTES CAST
NAME IN FAVOR AGAINST OR WITHHELD
<S> <C> <C>
Raymond J. De Riggi 10,261,491 728,335
Norman T. Rolf, Jr. 10,261,491 728,335
</TABLE>
(e) SELECTION OF AUDITORS
The stockholders of the Company ratified the appointment of Ernst &
Young LLP as the Company's independent auditors for the fiscal year ended
December 31, 1997, by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
10,981,898 2,825 5,103
15
<PAGE> 16
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C> <C>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4 -- Form of Common Stock Certificate(b)
10.1 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(c)
10.2 -- Form of Combination Agreement between certain of the
Registrant's subsidiaries and the Registrant(c)
10.3 -- Form of Employment Agreement between the Registrant and certain
of its employees(a)
10.4 -- Form of Escrow Agreement between the Registrant, each of the
stockholders of the Registrant's subsidiaries and the escrow
agent(a)
10.5 -- 1997 Nonqualified Stock Purchase Plan(c)
11 -- Statement re Computation of Per Share Earnings
27 -- Financial Data Schedule (for SEC use only)
</TABLE>
- ----------------
(a) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form S-1, Registration No.
333-07037.
(b) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form 8-A, File No.
001-13037.
(c) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form S-4, File No.
333-12319.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on April 9, 1997
describing the acquisition of Roland J. Down, Inc. pursuant to Item 2 of
Form 8-K.
16
<PAGE> 17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant caused this report to be signed on its behalf by the undersigned
thereunto duly authorized.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
Anthony M. Schofield
Chief Financial Officer
Date: August 14, 1997
17
<PAGE> 18
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C> <C>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4 -- Form of Common Stock Certificate(b)
10.1 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(c)
10.2 -- Form of Combination Agreement between certain of the
Registrant's subsidiaries and the Registrant(c)
10.3 -- Form of Employment Agreement between the Registrant and certain
of its employees(a)
10.4 -- Form of Escrow Agreement between the Registrant, each of the
stockholders of the Registrant's subsidiaries and the escrow
agent(a)
10.5 -- 1997 Nonqualified Stock Purchase Plan(c)
11 -- Statement re Computation of Per Share Earnings
27 -- Financial Data Schedule (for SEC use only)
</TABLE>
- ----------------
(a) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form S-1, Registration No.
333-07037.
(b) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form 8-A, File No.
001-13037.
(c) Incorporated by reference to the exhibits filed with the
Registrant's Registration Statement on Form S-4, File No.
333-12319.
18
<PAGE> 1
SERVICE EXPERTS, INC.
EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1996 1997 1996 1997
------ ------- ------ -------
(Unaudited) (Unaudited)
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Net income $ 197 $ 4,242 $ 259 $ 6,086
Average shares outstanding 1,653 14,079 1,653 13,103
Net effect of dilutive
stock options based
on the treasury stock
method using average
market price -- 125 -- 134
------ ------- ------ -------
Weighted average shares 1,653 14,204 1,653 13,237
------ ------- ------ -------
Net income per common
share $ 0.12 $ 0.30 $ 0.16 $ 0.46
====== ======= ====== =======
</TABLE>
19
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE SIX MONTHS ENDED JUNE 30,
1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 18,795
<SECURITIES> 0
<RECEIVABLES> 22,870
<ALLOWANCES> 752
<INVENTORY> 7,413
<CURRENT-ASSETS> 54,333
<PP&E> 17,789
<DEPRECIATION> 4,285
<TOTAL-ASSETS> 139,015
<CURRENT-LIABILITIES> 25,902
<BONDS> 0
0
0
<COMMON> 142
<OTHER-SE> 112,136
<TOTAL-LIABILITY-AND-EQUITY> 139,015
<SALES> 0
<TOTAL-REVENUES> 86,235
<CGS> 54,606
<TOTAL-COSTS> 76,916
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 109
<INCOME-PRETAX> 9,841
<INCOME-TAX> 3,755
<INCOME-CONTINUING> 6,086
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 6,086
<EPS-PRIMARY> .46
<EPS-DILUTED> .46
</TABLE>