<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 SEPTEMBER 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 Identification No.)
of incorporation or organization)
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 AT NOVEMBER 13, 1997
COMMON STOCK, $.01 PAR VALUE 14,776,030
1
<PAGE> 2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
-------- ---------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 10,805 $ 14,537
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $620 in 1996 and $1,169 in 1997 13,615 25,800
Related party 130 5
Employee 117 267
Other 219 1,649
-------- ---------
14,081 27,721
Inventories 5,245 9,463
Costs and estimated earnings in excess of billings 872 1,203
Prepaid expenses and other current assets 724 2,449
Investments 24 44
Current portion of notes receivable - related parties 14 14
Current portion of notes receivable - other 286 251
Deferred income taxes 1,918 3,548
-------- ---------
Total current assets 33,969 59,230
Property, buildings and equipment:
Land 1,198 1,277
Buildings 1,495 2,813
Furniture and fixtures 1,776 4,689
Machinery and equipment 3,290 4,807
Vehicles 7,115 12,156
Leasehold improvements 1,431 2,792
-------- ---------
16,305 28,534
Less accumulated depreciation and amortization (4,535) (7,571)
-------- ---------
11,770 20,963
Notes receivable - related parties, net of
current portion 378 343
Notes receivable - other, net of current portion 672 668
Investment in affiliate 674 574
Long term deferred income taxes 29 434
Goodwill 33,032 83,439
Other assets 603 839
-------- ---------
Total assets $ 81,127 $ 166,490
======== =========
</TABLE>
See accompanying notes
2
<PAGE> 3
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
-------- ---------
(UNAUDITED)
(IN THOUSANDS EXCEPT SHARE DATA)
<S> <C> <C>
LIABILITIES AND STOCKHOLERS' EQUITY
Current liabilities:
Notes payable $ 1,510 $ 665
Trade accounts payable and accrued liabilities 7,457 11,158
Cash consideration payable 1,495 --
Accrued compensation 1,933 5,371
Accrued warranties 1,037 2,106
Income taxes payable 1,697 1,965
Deferred revenue 3,580 7,226
Billings in excess of costs and estimated earnings 450 971
Current portion of long-term debt and capital
lease obligations 598 439
-------- ---------
Total current liabilities 19,757 29,901
Long-term debt and capital lease obligations, net
of current portion 3,995 10,725
Deferred income taxes 390 1,017
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, 11,621,847 shares
issued and outstanding at December 31, 1996
and 14,932,084 shares issued and outstanding
at September 30, 1997 116 149
Additional paid-in-capital 50,056 106,355
Retained earnings 6,828 18,343
Equity notes receivable (15) --
-------- ---------
Total stockholders' equity 56,985 124,847
-------- ---------
Total liabilities and stockholders' equity $ 81,127 $ 166,490
======== =========
</TABLE>
See accompanying notes.
3
<PAGE> 4
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1996 1997 1996 1997
-------- -------- -------- ---------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues $ 20,539 $ 65,646 $ 46,144 $ 167,647
Cost of goods sold 13,876 41,184 31,572 107,400
-------- -------- -------- ---------
Gross margin 6,663 24,462 14,572 60,247
Selling, general and
administrative expenses 4,747 17,239 12,523 42,967
-------- -------- -------- ---------
Income from operations 1,916 7,223 2,049 17,280
Other income (expense):
Interest expense (32) (33) (95) (160)
Interest income 69 162 91 608
Other income (106) 191 (164) 382
-------- -------- -------- ---------
(69) 320 (168) 830
Income before income taxes 1,847 7,543 1,881 18,110
Provision (benefit) for income taxes:
Current 422 3,287 489 7,656
Deferred (88) (493) (243) (1,061)
-------- -------- -------- ---------
334 2,794 246 6,595
-------- -------- -------- ---------
Net income $ 1,513 $ 4,749 $ 1,635 $ 11,515
======== ======== ======== =========
Net income per common share $ 0.28 $ 0.32 $ 0.50 $ 0.81
======== ======== ======== =========
Weighted average shares
used in net income per
common share computation 5,455 14,932 3,252 14,152
======== ======== ======== =========
</TABLE>
See accompanying notes.
4
<PAGE> 5
SERVICE EXPERTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
1996 1997
-------- --------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
NET CASH FLOW PROVIDED BY OPERATING ACTIVITIES $ 4,828 $ 6,017
INVESTING ACTIVITIES:
Payments on notes receivable 751 171
Purchase of property, buildings, and equipment (383) (7,097)
Purchase of investments (646) (16)
Cash acquired through purchase of businesses 2,500 2,857
Payment of cash for acquired companies (18,533) (30,799)
Decrease in other assets 27 308
-------- --------
Net cash (used in) investing activities (16,284) (34,576)
FINANCING ACTIVITIES:
Issuance of stock, net of issuance costs 28,174 35,518
Proceeds of long-term debt 184 10,333
Payments of long-term debt and capital leases (4,440) (12,065)
Payments on notes payable to related parties -- (1,495)
-------- --------
Net cash provided by financing
activities 23,918 32,291
Increase in cash and cash equivalents 12,462 3,732
Cash and cash equivalents at beginning of period 785 10,805
-------- --------
Cash and cash equivalents at end of period $ 13,247 $ 14,537
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 95 $ 160
======== ========
Income taxes paid $ 247 $ 6,945
======== ========
Acquisition of companies:
Fair value of assets acquired $ -- $ 71,356
Cash paid -- 30,799
Common stock issued -- 25,894
-------- --------
Liabilities assumed $ -- $ 14,663
======== ========
</TABLE>
See accompanying notes.
5
<PAGE> 6
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
SEPTEMBER 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 nine months ended September 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. (AC/DAC) (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 has service
centers located in cities across the United States.
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The condensed 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 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 third quarter ended September 30, 1996 and
September 30, 1997 would be $0.28 and $0.32 per share, respectively; and the pro
forma primary earnings per share for the nine months ended September 30, 1996
and September 30, 1997 would be $0.50 and $0.81,
6
<PAGE> 7
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 shareholders' 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 since there are
currently no items of comprehensive income that are not reported in its
Consolidated Statement of Operations.
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 shareholders. 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 impact of Statement
131.
3 - BUSINESS COMBINATIONS
Since December 1996, the Company has completed business combinations with seven
HVAC replacement and service businesses that were accounted for as poolings of
interests (collectively, the "Pooled Companies"). The Company purchased all of
the shares of capital stock of the Pooled Companies in exchange for 979,335
shares of the Company's Common Stock. A schedule of the Pooled Companies
follows.
<TABLE>
<CAPTION>
Name Merger Date # shares
---- ----------- --------
<S> <C> <C>
Custom Air Conditioning, Inc. 12/96 230,049
Freschi Air Systems, Inc. 12/96 177,765
C. Iapaluccio Company, Inc. 5/97 92,553
Parrott Mechanical, Inc. 9/97 171,230
TML, Inc. 9/97 240,526
Hawk Heating & Air Conditioning, Inc. 9/97 34,426
McAlister Heat & Air, Inc. 9/97 32,786
</TABLE>
Because these business combinations have been accounted for as poolings of
interests, 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 mergers.
<TABLE>
<CAPTION>
Three Months Nine Months Nine Months
Ended Ended Ended
September 30, September 30, September 30,
1996 1996 1997
-------------- -------------- --------------
(In thousands) (In thousands) (In thousands)
<S> <C> <C> <C>
Net Revenues $ 15,097 $ 32,284 $ 23,464
======== ======== ========
Net Income $ 264 $ 142 $ 1,937
======== ======== ========
</TABLE>
7
<PAGE> 8
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 secondary public stock offering,
which involved a sale to the public 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 were used to fund the Company's capital
expenditures, acquisitions and for general corporate purposes.
On June 6, 1997, the Company's stock began trading on the New York Stock
Exchange under the symbol "SVE". The Company's stock was previously traded on
the Nasdaq National Market under the symbol "SERX".
5 - ACQUISITIONS
From January 1, 1997 through September 30, 1997 the Company acquired 51 HVAC
replacement and service businesses. The following displays certain information
regarding these acquisitions:
<TABLE>
<CAPTION>
Service Total Total
Centers Companies Shares Cash Total
Acquired Acquired Issued Consideration Consideration
-------- -------- ------ ------------- -------------
(in thousands)
<S> <C> <C> <C> <C> <C>
First Quarter 7 13 790,000 $15,126 $28,287
Second Quarter 9 18 457,000 10,788 21,625
Third Quarter 10 20 717,000 10,252 30,254
</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 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 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 through September 30,
1997 is $5.7 million. Asset and equity balances have been reduced accordingly,
with no impact on net income. This reduction in goodwill will impact
amortization expense in future periods. The operating results of the
acquisitions, 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 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.
8
<PAGE> 9
PRO FORMA RESULTS OF OPERATIONS
<TABLE>
<CAPTION>
Nine Months
Ended
September 30,
-------------------------
1996 1997
-------- --------
(In thousands,
except per
share data)
<S> <C> <C>
Net revenues $168,554 $191,596
Net income 9,604 12,217
Net income per common share $0.74 $0.81
</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 nine months ended September 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
nine months ended September 30, 1996 differs from the expected income tax
provision due to election 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 renegotiated a Line of Credit agreement with a banking
syndication from $20 million up to $50 million to be used for working capital
purposes, acquisitions, or such other purposes as may be approved by the bank.
The Line of Credit is available through September 3, 1999.
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.
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 in 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 $103.8 million and
contributed operating income of approximately $9.8 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 2.5 million shares of common stock and paid
$3.0 million in cash. Two of these acquisitions were accounted for as poolings
of interests, as discussed in Note 3, and the remainder were accounted for using
the purchase method.
During the first quarter of 1997, the Company acquired 13 HVAC businesses, with
seven of these businesses being Service Centers. In connection with these
acquisitions, the
9
<PAGE> 10
Company issued 790,000 shares of Common Stock and paid $15.1 million in 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 of these businesses being Service Centers. The
consideration paid by the Company for these businesses consisted of 457,000
shares of Common Stock and $10.8 million in cash. One of these acquisitions was
accounted for as a pooling of interests, as discussed in Note 3, and the
remainder were accounted for using the purchase method.
During the third quarter of 1997, the Company acquired 20 additional HVAC
businesses, with 10 of these businesses being Service Centers. In connection
with these acquisitions, the Company issued 717,000 shares of Common Stock and
paid $10.3 million in cash. Four of these acquisitions were accounted for as
poolings of interests, as discussed in Note 3, 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 those companies accounted for as poolings of interests)
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 owner's compensation.
Components of Income
Net revenue of the Service Centers has been derived primarily from the following
sources: (i) the installation of central air conditioners, furnaces and heat
pumps primarily in existing homes and (ii) the 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 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 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 promotion and advertising
expenses.
Results of Operations
Because of the significant effect of the Combination, acquisitions subsequent to
the Combination and the anticipated effect of pending 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 September 30, 1997, has acquired 68 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 acquisition.
10
<PAGE> 11
Three Months Ended September 30, 1997 Compared to Three Months Ended
September 30, 1996
Net Revenue. Net revenue increased $45.1 million or 219.6% from $20.5
million for the three months ended September 30, 1996 to $65.6 million for the
three months ended September 30, 1997. Approximately $33.9 million of the
increase is attributed to the acquisition of new Service Centers between
October, 1996 and September, 1997. In addition, $10.1 million of the increase is
attributed to the acquisition of Service Centers in August, 1996 and their
inclusion for the full three months in 1997.
Cost of Goods Sold. Cost of goods sold increased $27.3 million or
196.8% from $13.9 million for the three months ended September 30, 1996 to $41.2
million for the three months ended September 30, 1997. Approximately $22.4
million of this increase is attributed to the acquisition of new Service Centers
between October, 1996 and September, 1997. As a percentage of net revenue, cost
of goods sold decreased 4.9% from 67.5% for the three months ended September 30,
1996 to 62.7% for the three months ended September 30, 1997. The primary factor
for this decrease is a more favorable product mix with a higher percentage
content of residential business.
Gross Margin. Gross margin increased $17.8 million or 267.1% from $6.7
million for the three months ended September 30, 1996 to $24.5 million for the
three months ended September 30, 1997. As a percentage of net revenue, gross
margin increased from 32.5% for the three months ended September 30, 1996 to
37.3% for the three months ended September 30, 1997. The primary factor for this
increase in percent of revenue is a more favorable product mix with a higher
percentage content of residential business.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $12.5 million or 263.2% from $4.8 million for
the three months ended September 30, 1996 to $17.2 million for the three months
ended September 30, 1997. As a percentage of net revenue, selling, general and
administrative expenses increased from 23.1% for the three months ended
September 30, 1996 to 26.3% for the three months ended September 30, 1997.
Management believes this increase in percent of revenue is primarily attributed
to an increase in marketing expenses.
Income from Operations. Income from operations increased from $1.9
million for the three months ended September 30, 1996 to $7.2 million for the
three months ended September 30, 1997, an increase of 277.0%. Income from
operations as a percent of net revenue increased from 0.9% for the three months
ended September 30, 1996 to 11.0% for the three months ended September 30, 1997.
Other Income (Expense). Other income (expense) increased $389,000 or
563.8% from ($69,000) for the three months ended September 30, 1996 to $320,000
for the three months ended September 30, 1997. Other income (expense) as a
percent of net revenue increased from (0.3%) for the three months ended
September 30, 1996 to 0.5% for the three months ended September 30, 1997. This
increase is primarily due to interest income realized on investment of proceeds
from the Company's secondary offering in March 1997.
Nine Months Ended September 30, 1997 Compared to Nine Months Ended September 30,
1996
Net Revenue. Net revenue increased $121.5 million or 263.3% from $46.1
million for the nine months ended September 30, 1996 to $167.6 million for the
nine months ended September 30, 1997. Approximately $79.5 million of the
increase is attributed to the acquisition of new Service Centers between
October, 1996 and September, 1997. In addition, $36.3 million of the increase is
attributed to the acquisition of Service Centers in August, 1996 and their
inclusion for the full nine months in 1997.
Cost of Goods Sold. Cost of goods sold increased $75.8 million or
240.2% from $31.6 million for the nine months ended September 30, 1996 to $107.4
million for the nine months ended September 30, 1997. Approximately $51.6
million of this increase is attributed to the acquisition of new Service Centers
between October, 1996 and September, 1997. As a percentage of net revenue, cost
of goods sold decreased 4.3% from 68.4% for the nine months ended September 30,
1996 to 64.1% for the nine months ended September 30, 1997. The primary factor
for this decrease is a more favorable product mix with a higher percentage
content of residential business for the nine months ended September 30, 1997
compared to the nine months ended September 30, 1996.
Gross Margin. Gross margin increased $45.7 million or 313.4% from $14.6
million for the nine months ended September 30, 1996 to $60.2 million for the
nine months ended September 30, 1997. As a percentage of net revenue, gross
margin increased
11
<PAGE> 12
from 31.6% for the nine months ended September 30, 1996 to 35.9% for the nine
months ended September 30, 1997. The primary factor for this increase in percent
of revenue is a more favorable product mix with a higher percentage content of
residential business for the nine months ended September 30, 1997 compared to
the nine months ended September 30, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $30.4 million or 243.1% from $12.5 million for
the nine months ended September 30, 1996 to $43.0 million for the nine months
ended September 30, 1997. As a percentage of net revenue, selling, general and
administrative expenses decreased from 27.1% for the nine months ended September
30, 1996 to 25.6% for the nine months ended September 30, 1997. Management
believes this decrease in percent of revenue is primarily attributed to a
leverage of administrative cost due to consolidation along with a reduction in
former owners' compensation expense post acquisition.
Income from Operations. Income from operations increased from $2.0
million for the nine months ended September 30, 1996 to $17.3 million for the
nine months ended September 30, 1997, an increase of 743.3%. Income from
operations as a percent of net revenue increased from 4.4% for the nine months
ended September 30, 1996 to 10.3% for the nine months ended September 30, 1997.
Other Income (Expense). Other income (expense) increased $998,000 or
594.0% from ($168,000) for the nine months ended September 30, 1996 to $830,000
for the nine months ended September 30, 1997. Other income (expense) as a
percent of net revenue increased from (0.4%) for the nine months ended September
30, 1996 to 0.5% for the nine months ended September 30, 1997. This increase is
primarily due to interest income realized on investment of proceeds from the
Company's secondary offering in March 1997.
Liquidity and Capital Resources
The Company's principal capital needs arise from the acquisition of new HVAC
businesses and the costs associated with such expansion. Cash used in investing
activities was primarily attributable to the acquisition of HVAC businesses.
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 replacement and service businesses.
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. In addition, there can be no assurance that the
Company will be successful in identifying and acquiring Service Centers, that
the Company can integrate such new Service Centers into the Company's operations
or that the Company's new Service Centers will generate sales revenue or profit
margins consistent with those of the Company's existing Service Centers.
On March 18, 1997, the Company completed a secondary 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. The Company used the proceeds for planned capital expenditures,
acquisitions and general corporate purposes.
Working capital at September 30, 1997 was $29.3 million including cash, cash
equivalents and short-term investments totaling $14.5 million. Net cash
generated from operations in the nine months ended September 30, 1997 was $6.0
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 nine
months
12
<PAGE> 13
of 1997, the Company's capital expenditures were $7.1 million. At September 30,
1997 the Company had $665,000 of outstanding notes payable.
The Company has a $50 million unsecured revolving credit facility with a banking
syndication available through September 3, 1999 (the "Credit Facility").
Borrowings under the Credit Facility bear interest at either (i) the higher of
(x) the agent's base lending rate and (y) the federal funds rate plus one-half
of one percent per annum or (ii) a variable rate equal to the 30-day LIBOR, as
such rate changes from time to time, plus a variable margin of from 75 to 150
basis points depending on the Company's funded debt to EBIA ratio determined on
a quarterly basis, at the election of the Company. Certain of the Company's
subsidiaries have guaranteed the repayment of indebtedness under the Credit
Facility. At September 30, 1997, there was $10 million outstanding on the above
line of credit. The Credit Facility contains 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 by the Company and the payments of dividends.
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.
13
<PAGE> 14
PART II
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
In connection with the acquisition of Parrott Mechanical, Inc.
("Parrott") on September 30, 1997, 171,230 shares of the Registrant's Common
Stock were issued to shareholders of Parrott in a transaction intended to be
exempt from the registration requirements of the Securities Act of 1933, as
amended, pursuant to Sections 3(a)(11) or 4(2) thereunder. In exchange for its
shares of Common Stock, the Registrant received all of the shares of capital
stock of Parrott and certain real property owned by the shareholders of Parrott
and used in the business of Parrott.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
<TABLE>
<CAPTION>
Exhibit
Number Description of Exhibits
- ------ -----------------------
<S> <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 Company's subsidiaries, a wholly-owned
subsidiary of the Company and the Company(c)
10.2 -- Form of Combination Agreement between certain of the Company's subsidiaries and the Company(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. 000-21173.
(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 September 4, 1997
containing the financial statements of certain HVAC businesses acquired or to
be acquired and pro forma financial statements pursuant to Item 5 of Form 8-K.
The Company also filed a Current Report on Form 8-K on September 26, 1997
containing the financial statements of certain HVAC businesses acquired or to
be acquired and pro forma financial statements pursuant to Item 5 of Form 8-K.
14
<PAGE> 15
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: November 13, 1997
15
<PAGE> 1
EXHIBIT 11
SERVICE EXPERTS, INC.
EXHIBIT 11 - COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1996 1997 1996 1997
------ ------- ------ -------
(Unaudited) (Unaudited)
(In thousands, except per share data)
<S> <C> <C> <C> <C>
Net income $1,513 $ 4,749 $1,635 $11,515
Average shares outstanding 5,455 14,759 3,252 14,005
Net effect of dilutive
stock options based
on the treasury stock
method using average
market price -- 173 -- 147
------ ------- ------ -------
Weighted average shares 5,455 14,932 3,252 14,152
------ ------- ------ -------
Net income per common
share $ 0.28 $ 0.32 $ 0.50 $ 0.81
====== ======= ====== =======
</TABLE>
16
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-1-1997
<PERIOD-END> SEP-30-1997
<CASH> 14,537
<SECURITIES> 0
<RECEIVABLES> 27,721
<ALLOWANCES> 1,169
<INVENTORY> 9,463
<CURRENT-ASSETS> 59,230
<PP&E> 28,534
<DEPRECIATION> 7,571
<TOTAL-ASSETS> 166,490
<CURRENT-LIABILITIES> 29,901
<BONDS> 0
0
0
<COMMON> 149
<OTHER-SE> 124,698
<TOTAL-LIABILITY-AND-EQUITY> 166,490
<SALES> 0
<TOTAL-REVENUES> 167,647
<CGS> 107,400
<TOTAL-COSTS> 150,367
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 160
<INCOME-PRETAX> 18,110
<INCOME-TAX> 6,595
<INCOME-CONTINUING> 11,515
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 11,515
<EPS-PRIMARY> .81
<EPS-DILUTED> .81
</TABLE>
