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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, 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 NOVEMBER 5, 1998
COMMON STOCK, $.01 PAR VALUE 17,416,679
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PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, SEPTEMBER 30,
1997 1998
----------- -----------
(UNAUDITED)
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents $ 11,297 $ 6,024
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $1,625 in 1997 and $1,966 in 1998 30,258 46,454
Related party 243 340
Employee 366 533
Other 2,117 4,999
--------- ---------
32,984 52,326
Inventories 11,949 25,594
Costs and estimated earnings in excess of billings 2,352 4,885
Prepaid expenses and other current assets 2,458 5,675
Current portion of notes receivable - related parties 14 14
Current portion of notes receivable - other 284 177
Deferred income taxes 3,984 3,972
--------- ---------
Total current assets 65,322 98,667
Property, buildings and equipment:
Land 1,709 1,904
Buildings 3,290 3,811
Furniture and fixtures 6,157 12,014
Machinery and equipment 6,192 6,974
Vehicles 15,920 20,897
Leasehold improvements 2,561 3,928
--------- ---------
35,829 49,528
Less accumulated depreciation and amortization (10,278) (14,588)
--------- ---------
25,551 34,940
Notes receivable - related parties, net of
current portion 338 334
Notes receivable - other, net of current portion 591 567
Goodwill 105,158 169,766
Other assets 1,248 6,889
--------- ---------
Total assets $ 198,208 $ 311,163
========= =========
See accompanying notes.
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DECEMBER 31, SEPTEMBER 30,
1997 1998
----------- -----------
(UNAUDITED)
(IN THOUSANDS,
EXCEPT SHARE DATA)
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $ 18,344 $ 16,292
Accrued compensation 6,215 8,287
Accrued warranties 2,287 3,260
Income taxes payable 787 1,118
Deferred revenue 6,837 10,295
Deferred income taxes -- 80
Billings in excess of costs and estimated earnings 1,547 1,663
Current portion of long-term debt and capital
lease obligations 446 274
--------- ---------
Total current liabilities 36,463 41,269
Long-term debt and capital lease obligations, net
of current portion 16,133 73,302
Deferred income taxes 1,805 1,875
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, 15,890,859 shares
issued and outstanding at December 31, 1997
and 17,246,093 shares issued and outstanding
at September 30, 1998 159 171
Additional paid-in-capital 122,671 155,424
Retained earnings 20,977 39,122
--------- ---------
Total stockholders' equity 143,807 194,717
--------- ---------
Total liabilities and stockholders' equity $ 198,208 $ 311,163
========= =========
See accompanying notes.
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SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
1997 1998 1997 1998
---- ---- ---- ----
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenue $ 67,676 $ 120,048 $ 174,873 $ 293,604
Cost of goods sold 42,738 76,834 113,513 188,083
-------- --------- --------- ---------
Gross margin 24,938 43,214 61,360 105,521
Selling, general and
administrative expenses 17,344 29,382 42,899 73,660
-------- --------- --------- ---------
Income from operations 7,594 13,832 18,461 31,861
Other income (expense):
Interest expense (145) (1,188) (595) (2,395)
Interest income 169 64 633 355
Other income 181 194 403 483
-------- --------- --------- ---------
205 (930) 441 (1,557)
Income before income taxes 7,799 12,902 18,902 30,304
Provision (benefit) for income taxes:
Current 3,301 4,935 7,833 11,637
Deferred (493) 237 (994) 504
-------- --------- --------- ---------
2,808 5,172 6,839 12,141
-------- --------- --------- ---------
Net income $ 4,991 $ 7,730 $ 12,063 $ 18,163
======== ========= ========= =========
Net income per common share:
Basic $ 0.33 $ 0.45 $ 0.83 $ 1.09
======== ========= ========= =========
Diluted $ 0.32 $ 0.45 $ 0.82 $ 1.07
======== ========= ========= =========
Weighted average shares outstanding:
Basic 15,228 17,103 14,484 16,684
======== ========= ========= =========
Diluted 15,401 17,303 14,647 16,922
======== ========= ========= =========
See accompanying notes.
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SERVICE EXPERTS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
NINE MONTHS ENDED
SEPTEMBER 30,
1997 1998
---- ----
(UNAUDITED)
(IN THOUSANDS)
NET CASH FLOW PROVIDED BY (USED IN)
OPERATING ACTIVITIES $ 7,442 $ (6,807)
INVESTING ACTIVITIES:
Payments on notes receivable 96 135
Purchase of property, buildings, and equipment (7,873) (9,541)
Cash acquired through purchase of business 2,848 3,333
Payment of cash for acquired companies (38,377) (42,581)
Decrease (increase) in other assets 419 (5,580)
--------- ---------
Net cash used in
investing activities (42,887) (54,234)
FINANCING ACTIVITIES:
Issuance of stock, net of issuance costs 38,220 --
Proceeds of long-term debt 5,726 118,160
Payments of long-term debt and capital leases (3,152) (62,392)
Payments on notes payable to related parties (1,509) --
--------- ---------
Net cash provided by
financing activities 39,285 55,768
Increase (decrease) in cash and cash equivalents 3,840 (5,273)
Cash and cash equivalents at beginning of period 10,841 11,297
--------- ---------
Cash and cash equivalents at end of period $ 14,681 $ 6,024
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 611 $ 2,555
========= =========
Income taxes paid $ 6,056 $ 12,087
========= =========
See accompanying notes.
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SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE NINE MONTHS ENDED
SEPTEMBER 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 nine months ended
September 30, 1998 are not necessarily indicative of the results that may be
expected for the year ended December 31, 1998.
2 - BUSINESS COMBINATIONS
On September 24, 1998, the Company completed a business combination
with Dodge Heating and Air Conditioning, Inc. and DH&A, Inc. (collectively,
"Dodge") that was accounted for as a pooling of interests. Dodge merged with and
into a wholly-owned subsidiary of the Company in exchange for 468,590 shares of
the Company's Common Stock. Because this business combination has been accounted
for as a pooling of interests, the consolidated financial statements for the
periods presented have been restated to include the accounts of Dodge. The
following is a summary of the results of operations of Dodge for the period
prior to the business combination:
Nine Months Ended
September 30,
1997 1998
------ ------
(unaudited)
(In thousands)
Net Revenue
Service Experts $167,573 $284,365
Dodge 7,300 9,239
-------- --------
Combined $174,873 $293,604
======== ========
Net Income
Service Experts $ 11,515 $ 16,548
Dodge 548 1,615
-------- --------
Combined $ 12,063 $ 18,163
======== ========
3 - SECONDARY STOCK OFFERING
On March 18, 1997, the Company completed a secondary public stock
offering whereby 1,850,000 shares of Common Stock were sold at $22.00 per share,
which resulted in net proceeds of $38.0 million to the Company. A portion of the
net proceeds was used to pay the cash portion of the consideration for certain
pending acquisitions and to repay certain indebtedness arising from such
acquisitions. The remaining proceeds were used to fund the Company's capital
expenditures, future acquisitions and for general corporate purposes.
4 - ACQUISITIONS
The following table sets forth certain information regarding
acquisitions in 1997 and 1998:
Service Total Total
Centers Companies Shares Cash Convertible Total
Acquired Acquired Issued Consideration Debt Consideration
-------- -------- ------ ------------- ------------ -------------
(In thousands, except number of acquisitions)
1997
First Quarter 7 13 772 $15,126 $ 0 $28,287
Second Quarter 9 18 470 10,788 0 21,625
Third Quarter 10 20 717 10,252 0 30,254
Fourth Quarter 12 20 540 6,949 0 22,612
1998
First Quarter 10 19 389 8,626 0 19,242
Second Quarter 12 34 485 25,375 0 40,996
Third Quarter 9 30 681 11,679 667 29,073
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OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions (the "Acquired Companies") were
accounted for using the purchase method of accounting, except for five
acquisitions in 1997 and one acquisition in 1998 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), as a result of
restrictions on the transferability of the shares issued. The discount to the
purchase price on acquisitions from January 1, 1998 through September 30, 1998
is $3.9 million. Asset and equity balances have been reduced accordingly, with
no effect on net income. This reduction in goodwill will affect amortization
expense in future periods. The operating results of the acquisitions, except for
the six 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 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
NINE MONTHS
ENDED
SEPTEMBER 30,
1997 1998
---- ----
(IN THOUSANDS,
EXCEPT PER
SHARE DATA)
Net revenue $279,914 $315,884
Net income 18,307 19,514
Net income per common share:
Basic $ 1.12 $ 1.14
Diluted $ 1.10 $ 1.13
5 - CONVERTIBLE DEBT
On September 30, 1998, the Company issued 5.62% convertible
subordinated notes in an aggregate principal amount of $667,445 in connection
with certain acquisitions (the "Convertible Notes"). Each Convertible Note is
convertible at the option of either the Company or the holder into shares of
Common Stock at a conversion price of $31.56 per share. The Convertible Notes
are due in full in September 2002 and provide for quarterly interest payments.
6 - INCOME TAXES
The income tax provisions recorded for the three months and the nine
months ended September 30, 1997 and 1998 differ from the income tax provision
computed at the federal statutory tax rate of 35% primarily due to goodwill
amortization, a portion of which is not deductible for federal income tax
purposes, state income taxes, and pooled income of S corporations not subject to
federal income tax.
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7 - NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted
income per share:
NINE MONTHS ENDED
SEPTEMBER 30,
-------------
1997 1998
---- ----
(IN THOUSANDS,
EXCEPT PER
SHARE DATA)
Numerator:
Net income $12,063 $18,163
------- -------
Numerator for basic income per share - income available
to common stockholders 12,063 18,163
------- -------
Numerator for diluted income per share - income available
to common stockholders after assumed conversions 12,063 18,163
------- -------
Denominator:
Denominator for basic income per share - weighted average
shares 14,484 16,684
Effect of dilutive securities:
Employee stock options 123 144
Warrants 40 55
Contingent shares -- 39
------- -------
Dilutive potential common shares 163 238
Denominator for diluted income per share - adjusted
weighted-average shares and assumed conversions 14,647 16,922
======= =======
Basic income per share $ 0.83 $ 1.09
======= =======
Diluted income per share $ 0.82 $ 1.07
======= =======
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 - RECLASSIFICATIONS
Certain reclassifications have been made to the accompanying financial
statements to conform to the September 30, 1998 presentation.
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") service and replacement 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.
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From April 1, 1998 through June 30, 1998, the Company acquired 34 HVAC
businesses, 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.
From July 1, 1998 through September 30, 1998, the Company acquired 30
HVAC businesses (collectively, with the above businesses, the "1998 Acquired
Companies"), of which nine are Service Centers. The consideration paid by the
Company for these businesses was approximately $29.1 million, consisting of
approximately 681,000 shares of Common Stock, warrants to purchase 17,500 shares
of Common Stock, convertible subordinated notes in the aggregate principal
amount of approximately $667,000 and approximately $11.7 million in cash. One of
the transactions was accounted for using the pooling of interests method of
accounting, and the remainder were accounted for using the purchase method.
Approximately $21.6 million of the consideration paid by the Company was
allocated to intangible assets which are to be 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 other things, their historical levels of owner's compensation.
Owners and certain 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 SEPTEMBER 30, 1998 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 1997
Net Revenue. Net revenue increased $52.4 million, or 77.4%, from $67.7
million for the three months ended September 30, 1997 to $120.0 million for the
three months ended September 30, 1998. Approximately $45.7 million of the
increase is attributable to the acquisition of new Service Centers between
October 1997 and September 1998.
Cost of Goods Sold. Cost of goods sold increased $34.1 million, or
79.8%, from $42.7 million for the three months ended September 30, 1997 to $76.8
million for the three months ended September 30, 1998. Approximately $29.9
million of this increase is attributable to the acquisition of new Service
Centers between October 1997 and
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September 1998. As a percentage of net revenue, cost of goods sold increased
0.8% from 63.2% for the three months ended September 30, 1997 to 64.0% for the
three months ended September 30, 1998.
Gross Margin. Gross margin increased $18.3 million, or 73.3%, from
$24.9 million for the three months ended September 30, 1997 to $43.2 million for
the three months ended September 30, 1998. Approximately $15.7 million of this
increase is attributable to the acquisition of new Service Centers between
October 1997 and September 1998. As a percentage of net revenue, gross margin
decreased 0.8% from 36.8% for the three months ended September 30, 1997 to 36.0%
for the three months ended September 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $12.0 million, or 69.4%, from $17.3 million
for the three months ended September 30, 1997 to $29.4 million for the three
months ended September 30, 1998. Approximately $8.9 million of this increase is
attributable to the acquisition of new Service Centers between October 1997 and
September 1998. The remaining increase is primarily attributable to the rise in
goodwill amortization from 1997 to 1998 and additional administrative expenses.
As a percentage of net revenue, selling, general and administrative expenses
decreased 1.1% from 25.6% for the three months ended September 30, 1997 to 24.5%
for the three months ended September 30, 1998.
Income from Operations. Income from operations increased $6.2 million,
or 82.1%, from $7.6 million for the three months ended September 30, 1997 to
$13.8 million for the three months ended September 30, 1998. Income from
operations as a percentage of net revenue increased 0.3% from 11.2% for the
three months ended September 30, 1997 to 11.5% for the three months ended
September 30, 1998.
Other Income (Expense). Other income decreased $1.1 million from
$205,000 for the three months ended September 30, 1997 to ($930,000) for the
three months ended September 30, 1998. Other income as a percentage revenue
decreased 1.1% from 0.3% for the three months ended September 30, 1997 to (0.8%)
for the three months ended September 30, 1998. This decrease is primarily
because of interest costs incurred on debt used to fund acquisitions.
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1997
Net Revenue. Net revenue increased $118.7 million, or 67.9%, from
$174.9 million for the nine months ended September 30, 1997 to $293.6 million
for the nine months ended September 30, 1998. Approximately $96.3 million of the
increase is attributable to the acquisition of new Service Centers between
October 1997 and September 1998.
Cost of Goods Sold. Cost of goods sold increased $74.6 million, or
65.7%, from $113.5 million for the nine months ended September 30, 1997 to
$188.1 million for the nine months ended September 30, 1998. Approximately $63.6
million of this increase is attributable to the acquisition of new Service
Centers between October 1997 and September 1998. As a percentage of net revenue,
cost of goods sold decreased 0.8% from 64.9% for the nine months ended September
30, 1997 to 64.1% for the nine months ended September 30, 1998.
Gross Margin. Gross margin increased $44.1 million, or 72.0%, from
$61.4 million for the nine months ended September 30, 1997 to $105.5 million for
the nine months ended September 30, 1998. Approximately $32.7 million of this
increase is attributable to the acquisition of new Service Centers between
October 1997 and September 1998. As a percentage of net revenue, gross margin
increased 0.8% from 35.1% for the nine months ended September 30, 1997 to 35.9%
for the nine months ended September 30, 1998. This percentage increase is
attributable to an increased demand for higher margin products and services
during the nine months ended September 30, 1998.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $30.8 million, or 71.7%, from $42.9 million
for the nine months ended September 30, 1997 to $73.7 million for the nine
months ended September 30, 1998. Approximately $19.2 million of this increase is
attributable to
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the acquisition of new Service Centers between October 1997 and September 1998.
As a percentage of net revenue, selling, general and administrative expenses
increased 0.6% from 24.5% for the nine months ended September 30, 1997 to 25.1%
for the nine months ended September 30, 1998.
Income from Operations. Income from operations increased $13.4 million,
or 72.6%, from $18.5 million for the nine months ended September 30, 1997 to
$31.9 million for the nine months ended September 30, 1998. Income from
operations as a percentage of net revenue increased 0.3% from 10.6% for the nine
months ended September 30, 1997 to 10.9% for the nine months ended September 30,
1998.
Other Income (Expense). Other income decreased $2.0 million, or 453.1%,
from $441,000 for the nine months ended September 30, 1997 to ($1,557,000) for
the nine months ended September 30, 1998. Other income as a percentage of net
revenue decreased 0.8% from 0.3% for the nine months ended September 30, 1997 to
(0.5%) for the nine months ended September 30, 1998. This decrease is primarily
because of interest costs incurred on debt used to fund acquisitions.
LIQUIDITY AND CAPITAL RESOURCES
At September 30, 1998, the Company had working capital of $57.5
million, including cash and cash equivalents of $6.0 million. The ratio of
current assets to current liabilities was 2.4 to 1.0 at September 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 $7.4 million for the
nine months ended September 30, 1997 to ($6.8) million for the nine months ended
September 30, 1998. This decrease was primarily the result of a $10.4 million
increase in inventory and a $13.5 million increase in receivables. Cash used in
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"), of which approximately $30.2 million was outstanding on
November 9, 1998. 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
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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.
On September 30, 1998, the Company issued 5.62% convertible
subordinated notes in an aggregate principal amount of $667,445 in connection
with certain acquisitions. Each Convertible Note is convertible at the option of
either the Company or the holder into shares of Common Stock at a conversion
price of $31.56 per share. The Convertible Notes are due in full in September
2002 and provide for quarterly interest payments.
The Company currently has on file with the 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 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 debt securities or 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.
Year 2000
Many computer systems in use today were designed and developed using
two digits, rather than four, to specify the year. As a result, such systems
will recognize the Year 2000 as "00" and may assume that the year is 1900 rather
than 2000. This could cause many computer applications to fail completely or to
create erroneous results unless corrective measures are taken. The Company
recognizes the need to minimize the risk that its operations will be adversely
affected by Year 2000 software failures and is in the process of preparing for
the Year 2000.
The Company has evaluated its Year 2000 risk in three separate
categories: information technology systems ("IT"), non-IT systems ("Non-IT") and
material third party relationships. The Company has developed a plan in which
the risks in each of these categories are being reviewed and addressed by the
appropriate level of management as follows:
IT. The Company is actively engaged in developing and installing new
financial, information and operational systems which are expected to be
completed and installed by December 31, 1999. In connection with this
implementation, system programs have been designed so that the Year 2000 will be
recognized as a valid date and will not affect the processing of date-sensitive
information. Certain systems have already been installed in certain Service
Centers and at the corporate level. Systems will be installed in all Service
Centers by June 30, 1999. Through September 30, 1998, the Company has incurred
approximately $125,000 of systems and related costs that address Year 2000
compliance. The Company expects to spend an additional $475,000 to complete its
Year 2000 compliance plans. These costs include some normal system software
and equipment upgrades or replacements separate from the Year 2000 issue, which
the Company anticipated incurring and budgeted in the normal course of business.
Non-IT. Non-IT systems involve embedded technologies, such as
microcontrollers or microprocessors. Examples of Non-IT systems include
telephones, time clocks and security systems. Management believes the Company's
Non-IT risks are minimal. Most of the costs of addressing Non-IT risks are
included in normal upgrade and replacement expenditures which were planned
outside of the Company's Year 2000 review.
Third Party Risk. The Company's review of its third party risk includes
detailed reviews of material relationships with vendors and certain business
partners. The Company is monitoring and assessing the progress of its material
vendors and business partners to determine whether they will be able to
successfully interact with the Company in the Year 2000. The Company has
contacted and received oral or written responses from at least 25% of its
material vendors, all of which are in various stages of addressing the Year
2000 issue, and is currently awaiting responses from the remainder of its
material vendors.
If the steps taken by the Company and its material vendors and business
partners to be Year 2000 compliant are not successful, the Company would likely
experience various operational difficulties resulting in a material adverse
effect upon the Company's financial condition and results of operations. These
could include, among other things, processing transactions to an incorrect
accounting period, difficulties in posting general ledger entries and lapses of
service by vendors. If the Company's plan to install new systems which
effectively address the Year 2000 issue is not successfully or timely
implemented, the Company may need to devote more resources to the process and
additional costs may be incurred. The Company believes that the Year 2000 issue
is being appropriately addressed through the implementation of these new systems
and software development and by its material vendors and business partners and
does not expect the Year 2000 issue to have a material adverse effect on the
financial position, results of operations or cash flows of the Company in future
periods. The Company's forward-looking statements regarding Year 2000 issues are
dependent on many factors, including the ability of the Company's vendors to
achieve Year 2000 compliance, the proper functioning of the new IT and non-IT
systems installed by the Company, the integration of such systems and the
development of software, some of which are beyond the Company's control.
The Company currently does not have a contingency plan to address the
failure of the Company's IT or non-IT systems or the systems of material third
parties to be Year 2000 compliant. Should the remaining review of the Company's
Year 2000 risks reveal potentially non-compliant computer systems or material
third party risks, contingency plans will be developed to address the
deficiencies revealed at that time.
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.
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FORWARD LOOKING STATEMENTS
This Form 10-Q and other information that is provided by the Company
contains forward-looking statements, including those relating to the acquisition
of HVAC businesses, the integration of such businesses, the adequacy of the
Company's capital resources and other statements regarding trends relating to
various revenue and expense items, including Year 2000 related issues. These
statements are subject to a number of risks and uncertainties beyond the
Company's control that could cause the Company's actual results to differ
materially from those projected in such forward-looking statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
No disclosure is required.
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14
PART II
OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
From time to time, the Company issues subordinated notes convertible
into shares of the Company's Common Stock in connection with the acquisition of
HVAC service and replacement businesses. In general, the subordinated notes are
convertible into shares of the Company's Common Stock immediately at a
conversion price equal to 140% of the market price of the Common Stock at the
time the note is issued. The Company issues convertible subordinated notes and
the shares of Common Stock issued upon conversion of notes in transactions
intended to be exempt from the registration requirements of the Securities Act
of 1933, as amended, pursuant to Sections 3(a)(11), 3(b) or 4(2) thereunder.
On September 30, 1998, the Company issued 5.62% convertible
subordinated notes in an aggregate principal amount of $667,445.
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 -- Form of Common Stock Certificate(b)
10.1 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(c)
10.2 -- Form of Stock Purchase Agreement between the former
stockholders of certain of the Registrant's subsidiaries and
the Registrant(d)
10.3 -- First Amendment to Second Amended and Restated Credit
Agreement, dated as of September 30, 1998, between the
Registrant and SunTrust Bank, Nashville, N.A., as agent for the
lenders
10.4 -- Form of Convertible Subordinated Note
27.1 -- Financial Data Schedule September 30, 1998 (for SEC use only)
27.2 -- Restated Financial Data Schedule September 30, 1997 (for SEC
use only)
(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.
(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.
(b) Reports on Form 8-K.
The Company filed a Current Report on Form 8-K on September 24, 1998
containing the financial statements of certain HVAC businesses acquired
and pro forma financial statements pursuant to Item 5 of Form 8-K.
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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 10, 1998
15
16
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4 -- Form of Common Stock Certificate(b)
10.1 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(c)
10.2 -- Form of Stock Purchase Agreement between the former
stockholders of certain of the Registrant's subsidiaries and
the Registrant(d)
10.3 -- First Amendment to Second Amended and Restated Credit
Agreement, dated as of September 30, 1998, between the
Registrant and SunTrust Bank, Nashville, N.A., as agent for the
lenders
10.4 -- Form of Convertible Subordinated Note
27.1 -- Financial Data Schedule September 30, 1998 (for SEC use only)
27.2 -- Restated Financial Data Schedule September 30, 1997 (for SEC
use only)
(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.
(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.