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, 1996
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. 000-21173
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)
1134 Murfreesboro Road, Nashville, Tennessee 37217
(Address of principal executive offices) (zip code)
Registrant's telephone number, including area code: (615) 391-4600
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 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 14, 1996
- --------------------------------------------------------------------------------
Common Stock, $.01 par value 8,572,236
2
PART I
FINANCIAL INFORMATION
Item 1. Financial Statements
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
Three Months Ended September 30 Nine Months Ended September 30
------------------------------- ------------------------------
1995 1996 1995 1996
---------- ----------- ----------- -------------
Net revenues $4,828,910 $9,690,331 $12,500,548 $18,325,043
Cost of goods sold 3,358,639 6,200,226 8,674,991 11,942,161
---------- ---------- ----------- -----------
Gross margin 1,470,271 3,490,105 3,825,557 6,382,882
Selling, general and administrative expenses 1,181,524 2,365,004 3,434,471 5,389,188
---------- ---------- ----------- -----------
Income from operations 288,747 1,125,101 391,086 993,694
Other income (expense):
Interest expense (15,934) (15,880) (48,632) (56,364)
Interest income 20,000 64,785 21,995 76,648
Other income 5,075 (10,466) 26,176 10,389
---------- ---------- ----------- -----------
9,141 38,439 (461) 30,673
---------- ---------- ----------- -----------
Income before income taxes 297,888 1,163,540 390,625 1,024,367
Provision (benefit) for income taxes:
Current 62,814 375,777 72,374 443,119
Deferred (4,390) (88,704) (37,804) (242,985)
---------- ---------- ----------- -----------
58,424 287,073 34,570 200,134
---------- ---------- ----------- -----------
Net income $ 239,464 $ 876,467 $ 356,055 $ 824,233
========== ========== =========== ===========
Income per common share $ 0.21 $ 0.20 $ 0.31 $ 0.36
========== ========== =========== ===========
Weighted average shares used in
income per common share computation 1,153,098 4,459,453 1,153,098 2,263,261
========== ========== =========== ===========
See accompanying notes.
3
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
December 31, September 30,
1995 1996
(Note) (Unaudited)
------------ ------------
ASSETS
Current assets:
Cash and cash equivalents $ 275,720 $12,904,442
Receivables:
Trade, net 1,975,449 5,289,164
Related party 207,259 46,989
Employee 63,092 88,791
Other 77,473 256,075
---------- -----------
2,323,273 5,681,019
Inventories 234,439 1,883,501
Costs and estimated earnings in excess of billings 30,740 199,395
Prepaid expenses and other current assets 9,143 437,291
Current portion of notes receivable, net - 277,604
Deferred income taxes 16,817 567,484
---------- -----------
Total current assets 2,890,132 21,950,736
Property, buildings and equipment:
Land 105,000 -
Buildings 766,677 -
Furniture and fixtures 396,278 1,050,579
Machinery and equipment 162,883 1,837,051
Vehicles 1,300,369 4,676,919
Leasehold improvements 67,224 442,330
---------- -----------
2,798,431 8,006,879
Less accumulated depreciation and amortization (1,183,066) (4,686,421)
---------- -----------
1,615,365 3,320,458
Notes receivable -- related parties, net of current portion - 393,609
Notes receivable -- other, net of current portion - 287,919
Investments - 592,775
Goodwill - 821,548
Other assets 64,413 274,182
---------- -----------
Total assets $4,569,910 $27,641,227
========== ===========
LIABILITIES AND STOCKHOLERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $403,442 $3,034,801
Accrued compensation 487,900 1,499,604
Accrued taxes, other than income 12,728 161,436
Accrued warranties 98,379 473,352
Income taxes payable 66,793 949,638
Deferred revenue 189,108 1,895,578
Billings in excess of costs and estimated earnings 228,283 287,777
Liability to Company benefit plans 56,581 94,349
Current portion of long-term debt and capital lease obligations 164,265 149,811
---------- -----------
Total current liabilities 1,707,479 8,546,346
Long-term debt and capital lease obligations, net of current portion 463,529 174,679
Notes payable to related parties, net of current portion 661,808 -
Deferred compensation - 112,557
Deferred income taxes 8,436 119,100
Commitments and contingencies (see note)
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,
8,572,236 shares issued and outstanding 85,722
Additional paid-in-capital - 16,049,932
Retained earnings 1,728,658 2,552,891
---------- -----------
Total stockholders' equity 1,728,658 18,688,545
---------- -----------
Total liabilities and stockholders# equity $4,569,910 $27,641,227
========== ===========
See accompanying notes.
Note: The balance sheet at December 31, 1995 has been derived from the
combined audited financial statements of AC Service & Installation Co.,
Inc. and Donelson Air Conditioning Company at that date.
4
SERVICE EXPERTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
Nine Months Ended September 30
------------------------------
1995 1996
------------- -----------
NET CASH FLOW PROVIDED BY OPERATING ACTIVITIES $1,255,368 $ 2,221,651
CASH FLOWS USED IN INVESTING ACTIVITIES:
Purchase of property, buildings, and equipment (580,541) (55,400)
Proceeds from sale of property, buildings, and
equipment 19,441 -
Purchase of investments - (590,000)
Cash acquired through purchase of business - 2,499,509
Payment of cash portion of consideration to predecessor companies - (18,533,241)
Decrease in other assets 22,623 5,942
---------- ------------
Net cash used in investing activities (538,477) (16,673,230)
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES:
Issuance of stock, net of issuance costs - 28,173,859
Proceeds of long-term debt and capital leases 266,139 -
Payments of long-term debt and capital leases (257,387) (481,710)
Proceeds on notes payable to related parties 159,990 -
Payments on notes payable to related parties (105,013) (611,848)
---------- ------------
Net cash provided by financing activities 63,729 27,080,301
Increase in cash and cash equivalents 780,620 12,628,722
Cash and cash equivalents at beginning of period 91,096 275,720
---------- ------------
Cash and cash equivalents at end of period $ 871,716 $ 12,904,442
========== ============
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 48,632 $ 56,364
========== ============
Income taxes paid $ 38,032 $ -
========== ============
DISTRIBUTION OF ASSETS TO STOCKHOLDERS
Book value of assets distributed $ - $ 1,095,548
========== ============
Long-term debt assumed by stockholders $ - $ 488,110
========== ============
Notes payable to stockholders retired $ - $ 343,395
========== ============
5
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
September 30, 1996 (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, 1996 are not necessarily indicative of the results that may
be expected for the year ended December 31, 1996.
As a result of the adoption of Securities and Exchange Commission Staff
Accounting Bulletin No. 97 (SAB 97) on July 31, 1996, the financial statements
of Service Experts, Inc. (the Company) for periods prior to August 21, 1996 are
the combined financial statements of AC Service & Installation Co., Inc. and
Donelson Air Conditioning, Inc. (the Acquiring Company). AC Service &
Installation Co., Inc. and Donelson Air Conditioning, Inc. were under common
control. 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 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. The
Company operates in one industry segment and is primarily engaged in the
replacement and servicing of HVAC for residential and commercial customers.
6
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
September 30, 1996 (Unaudited)
2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements of Service Experts, Inc. include the
accounts of the Company and its subsidiaries. All intercompany transactions
have been eliminated in consolidation.
Effective August 21, 1996, the Company purchased 37% of the outstanding stock
of Future University for $590,000. The Company accounts for the investment
using the equity method.
3 - INITIAL PUBLIC OFFERING
On August 21, 1996, the Company completed an initial public offering, which
involved a sale to the public of 2,587,500 shares of Common Stock at $13.00 per
share. The $28,173,859 in net proceeds from the offering were used to pay the
cash portion of the consideration for the Predecessor Companies, to repay
certain indebtedness arising form the Combination and to fund the Company's
planned capital expenditures.
The Company's stock is currently traded on the Nasdaq Stock Market's National
Market under the symbol SERX.
4 - ACQUISITIONS
As discussed in Note 1, the Company acquired the Predecessor Companies on
August 21, 1996. The following unaudited pro forma results of operations give
effect to the operations of the Predecessor Companies as if the transaction
occured at the beginning of the periods presented, adjusted for additional
income tax provision for state and federal taxes as certain of the Predecessor
Companies previously were taxed as Subchapter S corporations. The pro forma
results of operations do not purport to represent what the Company's results of
operations would have been had such transaction in fact occured at the
beginning of the periods presented or to project the Company's results of
operations in any future period.
7
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
September 30, 1996 (Unaudited)
PRO FORMA RESULTS OF OPERATIONS
Three months ended Three months ended
September 30, 1995 September 30, 1996
------------------ ------------------
Net revenues $16,718,179 $16,248,543
Net income $ 1,173,201 $ 1,377,346
Weighted shares
outstanding 7,740,773 8,111,316
Income per common
share $ .15 $ .17
<Cation>
Nine months ended Nine months ended
September 30, 1995 September 30, 1996
------------------ ------------------
Net revenues $44,840,821 $48,452,981
Net income $ 2,166,391 $ 2,388,172
Weighted shares
outstanding 7,740,773 7,865,189
Income per common
share $ .28 $ .30
5 - INCOME PER COMMON SHARE
Net income per share has been computed based on the weighted average shares
outstanding.
8
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
September 30, 1996 (Unaudited)
6 - INCOME TAXES
The income tax provision recorded for the three months and nine months ended
September 30, 1996 and 1995 differs from the expected income tax provision due
to permanent differences and the provision for state income taxes.
7 - FINANCING ARRANGEMENTS
The Company has a commitment from a bank to borrow up to $20 million to be used
for acquisitions, working capital and capital expenditures. Management
believes that its existing cash balances and cash generated from operations
will be sufficient to fund the Company's planned capital expenditures through
the remainder of 1996.
8 - 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 - SUBSEQUENT EVENT
Between October 24, 1996 and November 14, 1996, the Company entered into
definitive agreements to acquire 23 HVAC service centers throughout the United
States. Pursuant to these agreements, the Company will merge with or acquire
the stock of the 18 companies for an aggregate of approximately $11 million
cash and approximately 2.9 million shares of Common Stock. Closing of the
transactions is subject to customary conditions and is expected to take place
prior to year end. Pro forma results of the acquisitions have not been
presented as the Company has not obtained all the necessary information to
prepare the pro forma financial statements.
9
Item 2. Management's Discussion And Analysis of Financial Condition And
Results of Operations.
Overview
As discussed in Item 1, the presentation of financial information of the
Company reflects combined AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. as the Acquiring Comapany of the other Predecessor
Companies because the stockholders of these companies received the largest
ownership interest in the Company of any Predecessor Company pursuant to the
Combination. The Combination was effected on August 21, 1996 and is reflected
in the financial statements accordingly. As a result, the historical financial
data of the Company is not meaningfully comparable because the period prior to
August 21, 1996 reflects only the results of operations of combined AC Service
& Installation Co., Inc. and Donelson Air Conditioning Company, Inc., and the
period from August 21, 1996 to September 30, 1996 reflects the results of
operations of all of the Predecessor Companies. Management believes that the
increases in the components of revenues and expenses discussed below are
primarily a result of the Combination effected on August 21, 1996.
Results of Operations
Three Months Ended September 30, 1996 Compared to Three Months Ended September
30, 1995
Net Revenue. Net revenue increased from $4.8 million for the three months
ended September 30, 1995 to $9.7 million for the three months ended September
30, 1996, an increase of $4.9 million or 100.7%.
Cost of Goods Sold. Cost of goods sold increased from $3.4 million for
the three months ended September 30, 1995 to $6.2 million for the three months
ended September 30, 1996, an increase of $2.8 million or 84.6%. As a percentage
of net revenue, cost of goods sold decreased from 69.6% for the three months
ended September 30, 1995 to 64.0% for the three months ended September 30, 1996.
Gross Margin. Gross Margin increased from $1.5 million for the three
months ended September 30, 1995 to $3.5 million for the three months ended
September 30, 1996, an increase of $2.0 million or 137.4%. As a percentage of
net revenue, gross margin increased from 30.5% for the three months ended
September 30, 1995 to 36.0% for the three months ended September 30, 1996.
General and Administrative Expenses. General and administrative expenses
increased $1.2 million or 100.2% from $1.2 million for the three months ended
September 30, 1995 to $2.4 million for the three months ended September 30,
1996. As a percentage of net revenue, general and administrative expenses
decreased from 24.5% for the three months ended September 30, 1995 to 24.4% for
the three months ended September 30, 1996.
Income from Operations. Income from operations increased from $289,000
for the three months ended September 30, 1995 to $1.1 million for the three
months ended September 30, 1996, an increase of $836,000 or 289.6%. Income
from operations as a
10
percent of net revenue increased from 6.0% in the 1995 period to 11.6% in the
1996 period.
Nine Months Ended September 30, 1996 Compared to Nine Months Ended September
30, 1995
Net Revenue. Net revenue increased from $12.5 million for the nine months
ended September 30, 1995 to $18.3 million for the nine months ended September
30, 1996, an increase of $5.8 million or 46.6%.
Cost of Goods Sold. Cost of goods sold increased from $8.7 million for
the nine months ended September 30, 1995 to $11.9 million for the nine months
ended September 30, 1996, an increase of $3.2 million or 37.7%. As a percentage
of net revenue, cost of goods sold decreased from 69.4% for the nine months
ended September 30, 1995 to 65.2% for the nine months ended September 30, 1996.
Gross Margin. Gross Margin increased from $3.8 million for the nine
months ended September 30, 1995 to $6.4 million for the nine months ended
September 30, 1996, an increase of $2.6 million or 66.8%. As a percentage of
net revenue, gross margin increased from 30.6% for the nine months ended
September 30, 1995 to 34.8% for the nine months ended September 30, 1996.
General and Administrative Expenses. General and administrative expenses
increased $2.0 million or 56.9% from $3.4 million for the nine months ended
September 30, 1995 to $5.4 million for the nine months ended September 30,
1996. As a percentage of net revenue, general and administrative expenses
increased from 27.5% for the nine months ended September 30, 1995 to 29.4% for
the nine months ended September 30, 1996.
Income from Operations. Income from operations increased from $391,000
for the nine months ended September 30, 1995 to $994,000 for the nine months
ended September 30, 1996, an increase of $603,000 or 154.1%. Income from
operations as a percent of net revenue increased from 3.1% in the 1995 period
to 5.4% in the 1996 period.
Liquidity and Capital Resources
On August 21, 1996, the Company completed an initial public offering, of
2,587,500 shares of its Common Stock at $13.00 per share. The proceeds to
the Company, net of expenses and underwriting discounts and commissions, were
approximately $28,173,859. Of the net
11
proceeds, $18,533,241 was used to pay the cash portion of the consideration for
the Predecessor Companies, including $1,025,770 which was used to repay certain
indebtedness arising from the Combination. The Company plans to use the
remaining proceeds for working capital and capital expenditures, including the
acquisition of additional HVAC service and replacement businesses. The
Company's ability to acquire new service centers 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 service centers. Management does not expect, however, to continue to
acquire service centers at its current rate. 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.
Working capital at September 30, 1996 was $13,404,390 and cash, cash
equivalents and short term investments were $12,904,442. Net cash generated
from operations during the first period of operations was $2,221,651.
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 of 1996, the Company's capital expenditures were $55,440. The Company
repaid $1,093,558 of debt. At September 30, 1996 the Company had $324,490 of
outstanding notes payable.
The Company has a commitment from a bank to borrow up to $20 million to be used
for acquisitions, working capital and capital expenditures. 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 1996 and 1997. 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.
Between October 24, 1996 and November 14, 1996, the Company entered into
definitive agreements to acquire 23 HVAC service centers throughout the United
States. Pursuant to these agreements, the Company will merge with or acquire
the stock of the 23 companies for an aggregate of approximately $11 million
cash and approximately 2.9 million shares of Common Stock of the Company.
Closing of the transactions is subject to customary conditions and is expected
to take place prior to year end.
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.
12
PART II
OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders.
A special meeting of stockholders of the Company was held on Friday,
August 16, 1996. At this meeting, the following matters were voted upon by the
Company's stockholders:
(a) Approval of the Company's 1996 Incentive Stock Plan
The Company's 1996 Incentive Stock Plan was adopted by the stockholders
of the Company with 1,379,461 shares voting for the motion, no shares voting
against the motion and no shares abstaining.
(b) Approval of the Company's 1996 Non-Employee Director Stock Option Plan
The Company's 1996 Non-Employee Director Stock Option Plan was adopted
by the stockholders of the Company with 1,379,461 shares voting for the motion,
no shares voting against the motion and no shares abstaining.
(c) Approval of the Company's 1996 Employee Stock Purchase Plan
The Company's 1996 Employee Stock Purchase Plan was adopted by the
stockholders of the Company with 1,379,461 shares voting for the motion, no
shares voting against the motion and no shares abstaining.
Item 6. Exhibits and Reports on Form 8-K.
(a) Exhibits.
Exhibit
Number Description of Exhibits
------- -----------------------
11 -- Statement re Computation of Per Share Earnings
27 -- Financial Data Schedule (for SEC use only)
(b) Reports on Form 8-K.
The Company did not file any Current Reports on Form 8-K during the
quarter ended September 30, 1996.
13
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 14, 1996