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, 1998
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)
SIX CADILLAC DRIVE - SUITE 400, 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 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 AUGUST 12, 1998
COMMON STOCK, $.01 PAR VALUE 16,629,085
1
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, JUNE 30,
1997 1998
---- ----
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 11,192 $ 5,962
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $1,550 in 1997 and $1,764 in 1998 29,129 42,407
Related party 202 370
Employee 365 495
Other, including federal income tax receivable 2,099 4,325
-------- --------
31,795 47,597
Inventories 11,570 22,035
Costs and estimated earnings in excess of billings 1,805 2,348
Prepaid expenses and other current assets 2,458 4,595
Current portion of notes receivable - related parties 14 14
Current portion of notes receivable - other 284 277
Deferred income taxes 3,896 3,945
-------- --------
Total current assets 63,014 86,773
Property, buildings and equipment:
Land 1,365 1,559
Buildings 3,252 3,539
Furniture and fixtures 5,900 10,773
Machinery and equipment 5,718 5,642
Vehicles 14,754 18,829
Leasehold improvements 2,477 3,282
-------- --------
33,466 43,624
Less accumulated depreciation and amortization (8,986) (12,163)
-------- --------
24,480 31,461
Notes receivable - related parties, net of
current portion 338 334
Notes receivable - other, net of current portion 591 610
Unallocated purchase price -- 5,383
Goodwill 105,158 148,695
Other assets 1,229 2,000
-------- --------
Total assets $194,810 $275,256
======== ========
See accompanying notes.
2
3
DECEMBER 31, JUNE 30,
1997 1998
---- ----
(UNAUDITED)
(IN THOUSANDS,
EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $ 17,821 $ 15,271
Accrued compensation 6,129 5,546
Accrued warranties 2,139 2,993
Income taxes payable 608 --
Deferred revenue 6,816 8,697
Billings in excess of costs and estimated earnings 1,282 1,640
Current portion of long-term debt and capital
lease obligations 274 274
-------- --------
Total current liabilities 35,069 34,421
Long-term debt and capital lease obligations, net
of current portion 15,663 61,606
Deferred income taxes 1,676 1,785
Commitments and contingencies (see note 8)
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, 15,422,269 shares
issued and outstanding at December 31, 1997
and 16,386,387 shares issued and outstanding
at June 30, 1998 154 164
Additional paid-in-capital 122,673 147,852
Retained earnings 19,575 29,428
-------- --------
Total stockholders' equity 142,402 177,444
-------- --------
Total liabilities and stockholders' equity $194,810 $275,256
======== ========
See accompanying notes.
3
4
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
1997 1998 1997 1998
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenue $60,140 $100,101 $102,103 $168,761
Cost of goods sold 39,553 64,289 67,072 109,447
------- -------- -------- --------
Gross margin 20,587 35,812 35,031 59,314
Selling, general and
administrative expenses 13,396 23,943 24,590 42,121
------- -------- -------- --------
Income from operations 7,191 11,869 10,441 17,193
Other income (expense):
Interest expense (319) (920) (409) (1,180)
Interest income 324 188 453 285
Other income 108 165 213 285
------- -------- -------- --------
113 (567) 257 (610)
Income before income taxes 7,304 11,302 10,698 16,583
Provision (benefit) for income taxes:
Current 2,648 4,593 4,433 6,670
Deferred 67 (27) (501) 60
------- -------- -------- --------
2,715 4,566 3,932 6,730
------- -------- -------- --------
Net income $ 4,589 $ 6,736 $ 6,766 $ 9,853
======= ======== ======== ========
Net income per share:
Basic $ 0.32 $ 0.41 $ 0.50 $ 0.62
======= ======== ======== ========
Diluted $ 0.31 $ 0.41 $ 0.49 $ 0.61
======= ======== ======== ========
Weighted average shares outstanding:
Basic 14,558 16,270 13,602 16,003
======= ======== ========= =========
Diluted 14,683 16,518 13,724 16,258
======= ======== ========= =========
See accompanying notes.
4
5
SERVICE EXPERTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
SIX MONTHS ENDED
JUNE 30,
1997 1998
---- ----
(UNAUDITED)
(IN THOUSANDS)
NET CASH FLOW PROVIDED BY (USED IN) OPERATING ACTIVITIES $ 2,582 ($13,651)
INVESTING ACTIVITIES:
Advances on notes receivable (2) (8)
Purchase of property, buildings, and equipment (5,135) (6,488)
Cash acquired through purchase of business 1,979 2,365
Payment of cash for acquired companies (25,914) (31,917)
(Increase) decrease in other assets 117 (721)
-------- ---------
Net cash used in
investing activities (28,955) (36,769)
FINANCING ACTIVITIES:
Issuance of stock, net of issuance costs 38,220 --
Proceeds of long-term debt 185 64,082
Payments of long-term debt and capital leases (2,084) (18,892)
Payments on notes payable to related parties (1,508) --
-------- --------
Net cash provided by
financing activities 34,813 45,190
Increase (decrease) in cash and cash equivalents 8,440 (5,230)
Cash and cash equivalents at beginning of period 10,806 11,192
-------- --------
Cash and cash equivalents at end of period $ 19,246 $ 5,962
======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 319 $ 1,340
======== ========
Income taxes paid $ 2,648 $ 7,772
======== ========
See accompanying notes.
5
6
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE SIX MONTHS ENDED
JUNE 30, 1998 (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, 1998 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 1998.
2 - NEWLY ISSUED ACCOUNTING STANDARDS
Service Experts, Inc. ("the Company") adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income" on January 1, 1998 which had
no impact on the Company's financial statements.
In June 1997, the Financial Accounting Standards Board ("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. The Company will
adopt Statement 131 beginning with its year ending December 31, 1998. Management
of the Company is presently evaluating the new standard in order to determine
its effect, if any, on the way the Company might report its operations in the
future.
In June 1998, the FASB issued Statement No. 133, "Accounting for Derivative
Instruments and Hedging Activities" ("Statement 133"). Statement 133 establishes
accounting and reporting standards for derivative instruments and for hedging
activities. Adoption of Statement 133 is required for all quarters of all years
beginning after June 15, 1999, although earlier adoption is encouraged. The
Company is currently evaluating the potential impact of Statement 133.
3 - SECONDARY STOCK OFFERING
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 $38.0 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.
4 - SENIOR NOTES PAYABLE
On June 23, 1998, the Company issued $32.5 million of 6.97% senior unsecured
notes, due June 15, 2003, and $17.5 million of 7.13% senior unsecured notes,
due June 15, 2005 (collectively, the "Notes"), in a private placement to a group
of institutional investors. The notes call for interest to be paid on December
15 and June 15 of each year, with principal due at maturity. All of the
Company's subsidiaries have guaranteed the repayment of the Notes. The Notes
contain covenants with respect to the maintenance of certain financial ratios
and specified net worth and limiting the incurrence of additional indebtedness
and the sale of substantial assets, consolidations or mergers by the Company.
5 - ACQUISITIONS
The following table sets forth certain information regarding acquisitions in
1997 and 1998:
Service Total Total
Centers Companies Shares Cash Total
Acquired Acquired Issued Consideration Consideration
-------- -------- ------ ------------- -------------
(in thousands)
1997
First Quarter 7 13 772,000 $15,126 $28,287
Second Quarter 9 18 470,000 10,788 21,625
Third Quarter 10 20 717,000 10,252 30,254
Fourth Quarter 12 20 540,000 6,949 22,612
1998
First Quarter 10 19 389,000 8,626 19,242
Second Quarter 12 34 485,000 25,375 40,996
6
7
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase method
of accounting, except for five acquisitions in 1997 which were accounted for as
poolings of interests. 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 from January 1, 1998 through June 30, 1998 is
$2.7 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 five 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 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 corporate support expenses, as well as 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
SIX MONTHS
ENDED
JUNE 30,
--------
1997 1998
---- ----
(IN THOUSANDS,
EXCEPT PER
SHARE DATA)
Net revenue $162,216 $176,891
Net income 9,576 10,270
Net income per common share:
Basic $ 0.62 $ 0.63
Diluted $ 0.61 $ 0.62
6 - INCOME TAXES
The income tax provisions recorded for the three and six months ended June 30,
1997 and 1998 differ from the expected income tax provision due primarily to
goodwill amortization, a portion of which is not deductible for federal income
tax purposes, and the provision for state taxes.
7 - NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted income per
share:
SIX MONTHS ENDED
JUNE 30,
1997 1998
---- ----
(IN THOUSANDS,
EXCEPT PER
SHARE DATA)
Numerator:
Net income $ 6,766 $ 9,853
------- -------
Numerator for basic income per share - income available
7
8
to common stockholders 6,766 9,853
------- -------
Numerator for diluted income per share - income available
to common stockholders after assumed conversions 6,766 9,853
------- -------
Denominator:
Denominator for basic income per share - weighted average
shares 13,602 16,003
Effect of dilutive securities:
Employee stock options 97 144
Warrants 25 56
Contingent stock-acquisitions -- 55
------- -------
Dilutive potential common shares 122 255
Denominator for diluted income per share - adjusted
weighted-average shares and assumed conversions 13,724 16,258
======= =======
Basic income per share $ 0.50 $ 0.62
======= =======
Diluted income per share $ 0.49 $ 0.61
======= =======
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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
OVERVIEW
In 1997, the Company acquired 71 heating, ventilating and air conditioning
("HVAC") businesses and one consulting business (the "1997 Acquired Companies"),
of which 38 are Service Centers. The consideration paid by the Company for the
1997 Acquired Companies was approximately $102.8 million, consisting of
approximately 2.5 million shares of Common Stock, warrants to purchase 200,000
shares of Common Stock and approximately $43.1 million in cash. Five of the
transactions were accounted for using the pooling of interests method of
accounting, and the remainder were accounted for using the purchase method.
Approximately $73.9 million of the consideration paid by the Company was
allocated to intangible assets which are amortized over a 40-year period.
From January 1, 1998 through March 31, 1998, the Company acquired 19 HVAC
businesses, of which 10 are Service Centers. The consideration paid by the
Company for these businesses was approximately $19.2 million, consisting of
approximately 389,000 shares of Common Stock and approximately $8.6 million in
cash. All of these acquisitions were accounted for using the purchase method.
Approximately $15.0 million of the consideration paid by the Company was
allocated to intangible assets which are amortized over a 40-year period.
From April 1, 1998 through June 30, 1998, the Company acquired 34 HVAC
businesses (collectively, with the above businesses, the "1998 Acquired
Companies"), of which 12 are Service Centers. The consideration paid by the
Company for these businesses was approximately $41.0 million, consisting of
approximately 485,000 shares of Common Stock, warrants to purchase 100,000
shares of Common Stock and approximately $25.4 million in cash. All of these
acquisitions were accounted for using the purchase method. Approximately $27.5
million of the consideration paid by the Company was allocated to intangible
assets which are amortized over a 40-year period.
The 1997 and 1998 Acquired Companies (collectively, the "Acquired Companies")
historically have been managed as independent private companies and, as such,
their results of operations reflect different tax structures which have
influenced, among
8
9
other things, their historical levels of owner's compensation. Certain owners
and key employees of the Acquired Companies have agreed to certain reductions in
their compensation in connection with the acquisitions.
COMPONENTS OF INCOME
Net revenue of the Acquired Companies has been derived primarily from the
installation, service and maintenance of central air conditioners, furnaces and
heat pumps 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,
promotion and advertising expenses and goodwill amortization.
RESULTS OF OPERATIONS
Because of the significant effect of the acquisitions of the Acquired Companies
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. 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.
THREE MONTHS ENDED JUNE 30, 1998 COMPARED TO THREE MONTHS ENDED JUNE 30, 1997
Net Revenue. Net revenue increased $40.0 million, or 66.4%, from $60.1
million for the three months ended June 30, 1997 to $100.1 million for the three
months ended June 30, 1998. Approximately $36.7 million of the increase is
attributable to the acquisition of new Service Centers between July 1997 and
June 1998.
Cost of Goods Sold. Cost of goods sold increased $24.7 million, or
62.5%, from $39.6 million for the three months ended June 30, 1997 to $64.3
million for the three months ended June 30, 1998. Approximately $24.1 million of
this increase is attributable to the acquisition of new Service Centers between
July 1997 and June 1998. As a percentage of net revenue, cost of goods sold
decreased 1.6% from 65.8% for the three months ended June 30, 1997 to 64.2% for
the three months ended June 30, 1998.
Gross Margin. Gross margin increased $15.2 million, or 74.0%, from
$20.6 million for the three months ended June 30, 1997 to $35.8 million for the
three months ended June 30, 1998. Approximately $12.5 million of this increase
is attributable to the acquisition of new Service Centers between July 1997 and
June 1998. As a percentage of net revenue, gross margin increased 1.6% from
34.2% for the three months ended June 30, 1997 to 35.8% for the three months
ended June 30, 1998. This percentage increase is attributable to an increased
demand for higher margin products and services in 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $10.5 million, or 78.7%, from $13.4 million
for the three months ended June 30, 1997 to $23.9 million for the three months
ended June 30, 1998. Approximately $7.2 million of this increase is attributable
to the acquisition of new Service Centers between July 1997 and June 1998. The
remaining increase is primarily attributable to an increase in goodwill
amortization and additional administrative expenses. As a percentage of net
revenue, selling, general and administrative expenses increased from 22.3% for
the three months ended June 30, 1997 to 23.9% for the three months ended June
30, 1998.
Income from Operations. Income from operations increased from $7.2
million for the three months ended June 30, 1997 to $11.9 million for the three
months ended June 30, 1998, an increase of 65.1%. Income from operations as a
percentage of net revenue
9
10
decreased from 12.0% for the three months ended June 30, 1997 to 11.9% for the
three months ended June 30, 1998.
Other Income (Expense). Other income decreased $680,000 from $113,000
for the three months ended June 30, 1997 to ($567,000) for the three months
ended June 30, 1998. Other income as a percentage of net revenue decreased from
0.2% for the three months ended June 30, 1997 to (0.6%) for the three months
ended June 30, 1998. This decrease is primarily due to interest costs incurred
on debt used to fund acquisitions.
Provision (Benefit) for Income Taxes. Income tax expense increased to
$4.6 million for the three months ended June 30, 1998 from $2.7 million for the
three months ended June 30, 1997. This increase is primarily attributable to
growth in earnings and the increase in goodwill amortization, a portion of which
is not deductible for federal income tax purposes.
SIX MONTHS ENDED JUNE 30, 1998 COMPARED TO SIX MONTHS ENDED JUNE 30, 1997
Net Revenue. Net revenue increased $66.7 million, or 65.3%, from $102.1
million for the six months ended June 30, 1997 to $168.8 million for the six
months ended June 30, 1998. Approximately $58.2 million of the increase is
attributable to the acquisition of new Service Centers between July 1997 and
June 1998.
Cost of Goods Sold. Cost of goods sold increased $42.4 million, or
63.2%, from $67.1 million for the six months ended June 30, 1997 to $109.4
million for the six months ended June 30, 1998. Approximately $38.5 million of
this increase is attributable to the acquisition of new Service Centers between
July 1997 and June 1998. As a percentage of net revenue, cost of goods sold
decreased 0.8% from 65.7% for the six months ended June 30, 1997 to 64.9% for
the six months ended June 30, 1998.
Gross Margin. Gross margin increased $24.3 million, or 69.3%, from
$35.0 million for the six months ended June 30, 1997 to $59.3 million for the
six months ended June 30, 1998. Approximately $19.7 million of this increase is
attributable to the acquisition of new Service Centers between July 1997 and
June 1998. As a percentage of net revenue, gross margin increased 0.8% from
34.3% for the six months ended June 30, 1997 to 35.1% for the six months ended
June 30, 1998. This percentage increase is attributable to an increased demand
for higher margin products and services during the second quarter of 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $17.5 million, or 71.3%, from $24.6 million
for the six months ended June 30, 1997 to $42.1 million for the six months ended
June 30, 1998. Approximately $12.4 million of this increase is attributable to
the acquisition of new Service Centers between July 1997 and June 1998. As a
percentage of net revenue, selling, general and administrative expenses
increased from 24.1% for the six months ended June 30, 1997 to 25.0% for the six
months ended June 30, 1998.
Income from Operations. Income from operations increased from $10.4
million for the six months ended June 30, 1997 to $17.2 million for the six
months ended June 30, 1998, an increase of 64.7%. Income from operations as a
percentage of net revenue remained unchanged at 10.2% for the six months ended
June 30, 1997 and 1998.
Other Income (Expense). Other income decreased $867,000 from $257,000
for the six months ended June 30, 1997 to ($610,000) for the six months ended
June 30, 1998. Other income as a percentage of net revenue decreased from 0.3%
for the six months ended June 30, 1997 to (0.4%) for the six months ended June
30, 1998. This decrease is primarily due to interest costs incurred on debt used
to fund acquisitions.
Provision (Benefit) for Income Taxes. Income tax expense increased to
$6.7 million for the six months ended June 30, 1998 from $3.9 million for the
six months ended June 30, 1997. This increase is primarily attributable to
growth in earnings and the increase in goodwill amortization, a portion of
which is not deductible for federal income tax purposes.
LIQUIDITY AND CAPITAL RESOURCES
At June 30, 1998, the Company had working capital of $52.4 million including
cash and cash equivalents of $6.0 million. The ratio of current assets to
current liabilities was 2.5 to 1.0 at June 30, 1998 and 1.8 to 1.0 at December
31, 1997.
The Company's principal capital needs arise from the acquisition of new HVAC
businesses and the costs associated with such expansion. Net cash flow provided
by (used in) operating activities decreased from $2.6 million for the six months
ended June 30, 1997 to ($13.7) million for the six months ended June 30, 1998.
This use of funds in 1998 is primarily the net of cash provided from net income
of $14.7 million, as adjusted for depreciation and amortization, and cash used
for an $8.6 million increase in inventory, an $11.8 million increase in
receivables, and a $5.7 million decrease in trade payables and accrued
liabilities.
10
11
investing activities was primarily attributable to the acquisition of HVAC
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
$38.0 million. The Company used the proceeds for planned capital expenditures,
acquisitions and general corporate purposes.
The Company currently has a $100.0 million unsecured revolving credit facility
with a banking syndication available through April 30, 2001 (the "Credit
Facility"). Borrowings under the Credit Facility bear interest at either (i) the
higher of the agent's base lending rate or the federal funds rate plus one-half
of one percent per annum or (ii) a variable rate equal to the 30, 60, 90 or
180-day LIBOR, as such rate changes from time to time, plus a variable margin of
from 62.5 to 150 basis points depending on the Company's funded debt to EBITDA
ratio determined on a quarterly basis, at the election of the Company. All of
the Company's subsidiaries have guaranteed the repayment of indebtedness under
the Credit Facility. 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 payment of dividends.
On June 23, 1998, the Company issued $32.5 million of 6.97% senior unsecured
notes, due June 15, 2003, and $17.5 million of 7.13% senior unsecured notes, due
June 15, 2005 (collectively, the "Notes"), in a private placement to a group of
institutional investors. The Notes provide for interest to be paid on December
15 and June 15 of each year, with principal due at maturity. All of the
Company's subsidiaries have guaranteed the repayment of the Notes. The Note
Purchase Agreement pursuant to which the Notes were issued contains covenants
with respect to the maintenance of certain financial ratios and specified net
worth and limiting the incurrence of additional indebtedness and the sale of
substantial assets, consolidations or mergers by the Company.
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 and available
lines of credit 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
11
12
additional financing on reasonable terms could have a negative effect on the
Company's plans to acquire additional HVAC businesses.
YEAR 2000
The Company is utilizing both internal and external resources to reprogram, or
replace, and test its software for Year 2000 modifications. The Company
anticipates completing the Year 2000 project no later than June 30, 1999, which
is prior to any anticipated impact on its operating systems. The total cost of
the Year 2000 project is estimated at $600,000 and is being funded through
operating cash flows. Of the total project cost, approximately $400,000 is
attributable to the purchase of new software, which will be capitalized. The
remaining $200,000, which will be expensed as incurred, is not expected to have
a material effect on the results of operations. To date, the Company has
incurred approximately $100,000 related to the assessment of, and preliminary
efforts on, its Year 2000 project and the development of a modification plan,
purchase of new systems and systems modifications.
The Company expects, but cannot provide assurance, that its Year 2000
modifications will be successfully completed on a timely basis. The ability of
third parties with whom the Company transacts business to address adequately
their Year 2000 issues is outside of the Company's control. There can be no
assurance that the failure of the Company, or such third parties, to address
adequately their respective Year 2000 issues will not have a material adverse
effect on the Company's financial condition or results of operations.
The Company has initiated formal communications with its significant suppliers
to determine the extent to which the Company's interface systems are vulnerable
to those third parties' failure to remediate their own Year 2000 issues. The
Company's estimated total Year 2000 project cost includes the estimated costs
and time associated with the impact of third party Year 2000 issues based on
currently available information. However, there can be no guarantee that the
systems of other companies on which the Company's systems rely will be timely
converted and would not have an adverse effect on the Company's systems. The
Company has determined it has no exposure to contingencies related to the Year
2000 issue for the products it has sold.
INFLATION
The HVAC industry is labor intensive. Wages and other expenses increase during
periods of inflation and when shortages in marketplaces occur. In addition,
suppliers pass along rising costs to the Company in the form of higher prices.
The Company has generally been able to offset increases in operating costs by
increasing charges, expanding services and implementing cost control measures to
curb such increases. The Company can not predict its ability to offset or
control future cost increases.
FORWARD LOOKING STATEMENTS
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.
12
13
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 1, 1998. At this meeting, the following matters were voted upon by the
Company's stockholders:
(a) 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 200,000 to 350,000 the number of
shares authorized thereunder by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
11,106,278 64,634 34,713
(b) ELECTION OF CLASS II DIRECTORS
Allen L. Hovious and William G. Roth were elected to serve as
Class II directors of the Company. The vote was as follows:
VOTES CAST VOTES CAST
NAME IN FAVOR AGAINST OR WITHHELD
Allen L. Hovious 11,197,940 7,685
William G. Roth 11,198,667 6,958
(c) 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, 1998, by the following vote:
VOTES CAST IN FAVOR VOTES CAST AGAINST ABSTENTIONS
11,160,421 3,879 41,325
ITEM 5. OTHER INFORMATION.
The deadline for delivering to the Company notice of stockholder
proposals, other than proposals to be included in the proxy statement, for the
1999 Annual Meeting of Stockholders will be February 20, 1999, pursuant to Rule
14a-4. The persons named as proxies in the proxy statement may exercise
discretionary authority to vote on any proposals received after such date.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits.
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ -----------------------
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4.1 -- Form of Common Stock Certificate(b)
4.2 -- Note Purchase Agreement, dated as of June 1, 1998, among the
Registrant and the Purchasers named therein (including a form of
Senior Note and form of Subsidiary Guaranty)
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 Stock Purchase Agreement between the former stockholders
of certain of the Registrant's subsidiaries and the Registrant(d)
10.3 -- Second Amended and Restated Credit Agreement, dated as of April
28, 1998, between the Registrant and SunTrust Bank, Nashville,
N.A., as agent for the lenders
10.4 -- Amendment No. 2 to 1996 Employee Stock Purchase Plan(e)
10.5 -- Amendment No. 1 to 1997 Nonqualified Stock Purchase Plan(e)
27.1 -- Financial Data Schedule June 30, 1998 (for SEC use only)
27.2 -- Restated Financial Data Schedule June 30, 1997 (for SEC use only)
- ---------
(a) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-1, File 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.
(d) Incorporated by reference to the exhibits filed with the Registrant's
annual report on Form 10-K for the fiscal year ended December 31, 1997,
File No. 001-13037.
(e) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-8, File No. 333-59711.
(b) Reports on Form 8-K.
The Company did not file any Current Reports on Form 8-K during the
quarter ended June 30, 1998.
13
14
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
-----------------------------------
Anthony M. Schofield
Chief Financial Officer
Date: August 14, 1998
14