<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 31, 1996
REGISTRATION NO. 333-07037
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
AMENDMENT NO. 1 TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
---------------------
SERVICE EXPERTS, INC.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 7623 62-1639453
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
1134 MURFREESBORO ROAD
NASHVILLE, TENNESSEE 37217
(615) 391-4600
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
---------------------
ALAN R. SIELBECK
CHIEF EXECUTIVE OFFICER
SERVICE EXPERTS, INC.
1134 MURFREESBORO ROAD
NASHVILLE, TENNESSEE 37217
(615) 391-4600
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
COPIES TO:
<TABLE>
<S> <C>
J. CHASE COLE, ESQ. DONALD I.N. MCKENZIE, ESQ.
WALLER LANSDEN DORTCH & DAVIS, PLLC SHERRARD & ROE, PLC
2100 NASHVILLE CITY CENTER 424 CHURCH STREET
511 UNION STREET SUITE 2000
NASHVILLE, TENNESSEE 37219-1760 NASHVILLE, TENNESSEE 37219
(615) 244-6380 (615) 742-4200
</TABLE>
---------------------
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as
practicable after the effective date of this Registration Statement.
If any of the securities being registered on this form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, check the following box. / /
If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, check the following box and
list the Securities Act registration statement number of the earlier effective
registration statement for the same offering. / /
- ------------------
If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. / /
- ---------------
If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. / /
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933, OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING
PURSUANT TO SECTION 8(A), MAY DETERMINE.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
SERVICE EXPERTS, INC.
CROSS-REFERENCE TABLE
CROSS-REFERENCE SHEET SHOWING LOCATION IN THE PROSPECTUS OF
INFORMATION REQUIRED BY ITEMS OF PART I OF FORM S-1
(PURSUANT TO ITEM 501 OF REGULATION S-K)
<TABLE>
<CAPTION>
ITEM REGISTRATION STATEMENT ITEM CAPTION OR LOCATION
NUMBER AND HEADING IN PROSPECTUS
- ------ ----------------------------------------- -----------------------------------------
<C> <S> <C>
1. Forepart of the Registration Statement
and Outside Front Cover Page of
Prospectus............................. Outside Front Cover Page
2. Inside Front and Outside Back Cover Pages
of Prospectus.......................... Inside Front and Outside Back Cover
Pages; "Available Information"
3. Summary Information, Risk Factors and
Ratio of Earnings to Fixed Charges..... "Prospectus Summary;" "Risk Factors"
4. Use of Proceeds.......................... "Use of Proceeds"
5. Determination of Offering Price.......... "Underwriting"
6. Dilution................................. "Dilution"
7. Selling Security Holders................. Not Applicable
8. Plan of Distribution..................... Outside Front Cover Page; "Underwriting"
9. Description of Securities to be
Registered............................. "Description of Capital Stock"
10. Interests of Named Experts and Counsel... Not Applicable
11. Information with Respect to the
Registrant............................. "Prospectus Summary;" "Risk Factors;"
"Use of Proceeds;" "S Corporation
Distributions;" "Dividend Policy;"
"Dilution;" "Capitalization;" "Pro
Forma Combining Financial Statements;"
"Selected Combined Financial Data;"
"Management's Discussion and Analysis
of Financial Condition and Results of
Operations;" "Business;" "The
Combination;" "Management;" "Certain
Transactions;" "Principal
Stockholders;" "Description of Capital
Stock;" "Shares Eligible for Future
Sale;" Index to Combined Financial
Statements; Report of Independent
Accountants; Combined Financial
Statements
12. Disclosure of Commission Position on
Indemnification for Securities Act
Liabilities............................ Not Applicable
</TABLE>
<PAGE> 3
INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION OR AMENDMENT. A
REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE
SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR
MAY OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT
BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR
THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE
SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE
UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS
OF ANY SUCH STATE.
SUBJECT TO COMPLETION, DATED JULY 31, 1996
2,250,000 SHARES
[LOGO] SERVICE EXPERTS (R)
COMMON STOCK
---------------------
All of the shares of Common Stock of Service Experts, Inc. (the "Company"
or "Service Experts") offered hereby (the "Offering") are being offered by the
Company. Prior to this Offering, there has been no public market for the Common
Stock of the Company (the "Common Stock"). It is currently anticipated that the
initial offering price will be between $12.00 and $14.00 per share. See
"Underwriting" for information relating to the factors to be considered in
determining the initial offering price. The Company has submitted an application
for the Common Stock to be quoted and traded on the Nasdaq National Market under
the symbol "SERX."
SEE "RISK FACTORS" BEGINNING ON PAGE 8 FOR CERTAIN FACTORS THAT SHOULD BE
CONSIDERED BY PROSPECTIVE PURCHASERS OF THE COMMON STOCK OFFERED HEREBY.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
<CAPTION>
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
PRICE TO UNDERWRITING PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2)
- ------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
Per Share....................................... $ $ $
- ------------------------------------------------------------------------------------------------
Total(3)........................................ $ $ $
- ------------------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------------------------
</TABLE>
(1) See "Underwriting" for a description of the indemnification arrangements
with the Underwriters.
(2) Before deducting expenses estimated at $1,150,000 payable by the Company.
(3) The Company has granted to the Underwriters a 30-day option to purchase up
to an additional 337,500 shares of Common Stock at the Price to Public,
less the Underwriting Discount, solely to cover over-allotments, if any. If
such option is exercised in full, the total Price to Public, Underwriting
Discount and Proceeds to Company will be $ , $ and
$ , respectively. See "Underwriting."
---------------------
The Common Stock is offered by the several Underwriters named herein,
subject to prior sale, when, as and if delivered to and accepted by them. The
Underwriters reserve the right to reject orders in whole or in part and to
withdraw, cancel or modify the offer without notice. It is expected that
delivery of certificates representing the Common Stock will be made on or about
August , 1996.
EQUITABLE SECURITIES CORPORATION MORGAN KEEGAN & COMPANY, INC.
August , 1996
<PAGE> 4
The map appearing on this page is a map of the 48 contiguous states
identifying the location of the Company's 12 Service Centers and current CSG
markets.
[INSERT MAP AND/OR PHOTOGRAPHS]
---------------------
IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT
TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICE OF THE COMMON STOCK
OFFERED HEREBY AT A LEVEL ABOVE THAT WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN
MARKET. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME.
2
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information and financial
statements, including the notes thereto, appearing elsewhere in this Prospectus.
Simultaneously with, and as a condition to, the closing of the Offering, the
Company will acquire, in separate transactions, 12 heating, ventilating and air
conditioning ("HVAC") service and replacement businesses and Contractor Success
Group, Inc. ("CSG") (collectively, the "Predecessor Companies") in exchange for
shares of Common Stock and cash (the "Combination"). Unless the context
otherwise requires, all references herein to the "Company" or "Service Experts"
shall mean Service Experts, Inc., a Delaware corporation, and the Predecessor
Companies, taken as a whole, and assume that the Combination has been
consummated. The term "Service Centers" refers to HVAC service and replacement
businesses owned and operated by the Company after the Offering. Unless
otherwise indicated, the information in this Prospectus (i) does not give effect
to the Underwriters' over-allotment option, (ii) gives effect to a 1.4621 for 1
stock split effected as of July 11, 1996, (iii) assumes an initial offering
price of $13.00 per share and (iv) assumes that consideration of 4,545,301
shares of Common Stock and $17.1 million is paid by the Company pursuant to the
Combination. See "The Combination."
THE COMPANY
Simultaneously with, and as a condition to, the completion of the Offering,
the Company will purchase all of the outstanding capital stock of the
Predecessor Companies. Upon completion of the Combination, management believes
that the Company will be one of the leading providers of residential HVAC
services and replacement equipment in the United States. See "The Combination."
The Company's 1995 pro forma net revenues were approximately $59.7 million and
1995 pro forma cost of goods sold was approximately $36.2 million resulting in a
gross margin of approximately $23.4 million. See "Summary Combined Financial
Data." The Predecessor Companies have experienced compounded annual revenue
growth of approximately 31.6% from 1991 to 1995.
The Service Centers install, service and maintain central air conditioners,
furnaces and heat pumps, primarily in existing homes. Management estimates that
in 1995 over 80% of the Company's pro forma net revenue was derived from
replacing, maintaining and servicing HVAC equipment at existing residences and
commercial businesses and less than 20% was derived from installing new
equipment at newly constructed homes and businesses. The Company focuses on the
service and replacement segment of the HVAC industry rather than the new
construction segment because management believes that the service and
replacement segment exposes the Company to less credit risk and offers higher
margins as a result of opportunities for more attractive pricing because of
customers' demands for immediate, convenient and reliable service.
CSG was formed in 1991 to offer HVAC companies proprietary products as well
as marketing, management, educational and advisory services not available from
industry trade associations. CSG currently has over 270 members serving distinct
market areas of the United States. Management estimates that the aggregate
annual revenues of the CSG members not owned by the Company are in excess of
$500 million. CSG seeks to provide its members with a competitive advantage over
other HVAC contractors in each member's market area by enabling members to
operate their businesses with a higher degree of professionalism and by
providing proven marketing and operational strategies designed for the HVAC
industry. All of the Service Centers are members of CSG and operate in
accordance with its recommended methods and procedures.
The market for HVAC services and replacement equipment is large and
growing. Management estimates, based on industry information, that the market
for the service and replacement of HVAC systems in existing homes is
approximately $24 billion annually. The installation and replacement segment of
the industry has increased in size as a result of the aging of the installed
base of residential systems, the introduction of new, energy efficient systems
and the upgrading of existing homes to central air conditioning.
The residential HVAC industry is highly fragmented, and management believes
that this creates an opportunity for further acquisitions of HVAC businesses.
Management believes these businesses are typically closely held, single-center
operations that serve a limited geographic area. The businesses are heavily
dependent upon referrals to generate businesses. In many cases, these businesses
are operated by service technicians who lack the business and marketing
expertise to expand their businesses, increase their profitability and compete
effectively with larger operators.
3
<PAGE> 6
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. The
Company intends to implement an aggressive acquisition strategy which will
target for acquisition as "hubs" CSG members that are geographically desirable,
financially stable, experienced in the industry and CSG operating methods and
characterized by strong management. The Company also plans to increase market
presence through acquisitions of other HVAC businesses that have long operating
histories, large customer bases, experienced management and present
opportunities to reduce overhead expenses or dispose of fixed assets to improve
profitability. In addition, management believes that it will be able to improve
the financial performance of acquired companies through the implementation of
the methods and procedures developed by CSG.
THE COMBINATION
The Company was formed in March 1996 and has conducted no business
operations prior to the Combination. Simultaneously with, and as a condition to,
the closing of the Offering, the Company will consummate the Combination. The
consideration to be paid by the Company in the Combination will consist of
shares of Common Stock and cash as set forth in the agreements that the Company
has entered into with the Predecessor Companies and their owners (the
"Combination Agreements"), which provide for the allocation of the shares of
Common Stock among the Predecessor Companies and their owners based primarily on
the respective amounts of adjusted after tax net income of the Predecessor
Companies for the 1995 calendar year, as defined in the Combination Agreements.
The aggregate consideration to be paid by the Company in the Combination will
consist of 4,545,301 shares of Common Stock (valued at $59.1 million) and $17.1
million in cash, assuming an initial offering price of $13.00 per share.
Approximately 2,236,059 shares of Common Stock (valued at $29.1 million) and
$9.7 million in cash, assuming an initial offering price of $13.00 per share,
will be paid to Alan R. Sielbeck, James D. Abrams, John R. Young, R. Edward
Hutton, Jr. and Norman T. Rolf, Jr. who are owners of certain Predecessor
Companies and executive officers, directors or 5% stockholders of the Company as
a result of which such persons will beneficially own approximately 44.9% of the
outstanding Common Stock immediately following the Offering. See "Risk
Factors -- Control by Management and Principal Stockholders," "Use of Proceeds,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Combined Predecessor Companies -- Liquidity and Capital
Resources," "Certain Transactions," "The Combination," "Shares Eligible for
Future Sale," and the Pro Forma Combining Financial Statements of the Company
and notes thereto appearing elsewhere in this Prospectus.
The Company's principal executive offices are located at 1134 Murfreesboro
Road, Nashville, Tennessee 37217, and its telephone number is (615) 391-4600.
THE OFFERING
Common Stock offered hereby......... 2,250,000 shares
Common Stock to be outstanding after
the Offering........................ 8,257,401 shares(1)
Use of Proceeds..................... To fund the cash portion of the
purchase price for the Predecessor
Companies, to finance the development
and acquisition of additional Service
Centers, to repay certain indebtedness
arising from the Combination and for
general corporate purposes. See "Use of
Proceeds."
Proposed Nasdaq National Market
Symbol.............................. SERX
- ---------------
(1) Does not include 82,574 shares of Common Stock issuable upon the exercise of
warrants and stock options granted under the Company's stock option plans.
See "Management -- Compensation Pursuant to Plans" and "Underwriting."
4
<PAGE> 7
SUMMARY COMBINED FINANCIAL DATA
The following table presents summary combined financial and operating data
of the Combined Predecessor Companies. Prior to the Combination, each of the
Predecessor Companies operated independently and was not under common control or
management and some were not taxable entities; accordingly, the data may not be
comparable to or indicative of post-combination results. Management believes
that a combined presentation of financial information is most meaningful to
investors' understanding of the results of operations, financial condition, and
cash flows of the Predecessor Companies. The following should be read with the
historical financial statements, the Pro Forma Combining Financial Statements
and Notes thereto appearing elsewhere in this Prospectus.
COMBINED PREDECESSOR COMPANIES(1)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
----------------------------------------------------- --------------------------------------
PRO FORMA PRO FORMA
AS ADJUSTED AS ADJUSTED
1993 1994 1995 1995(2) 1995 1996 1996(2)
----------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue.......... $35,784,297 $48,476,838 $59,651,163 $59,651,163 $28,122,642 $32,204,438 $32,204,438
Cost of goods sold... 22,512,299 30,918,161 36,216,043 36,095,710 17,545,078 19,498,220 19,498,220
Gross margin......... 13,271,998 17,558,677 23,435,120 23,555,453 10,577,564 12,706,218 12,706,218
Selling, general and
administrative
expenses........... 12,180,033 15,268,679 18,706,596 15,550,975 9,017,911 11,077,695 8,964,503
Income from
operations......... 1,091,965 2,289,998 4,728,524 8,004,478 1,559,653 1,628,523 3,741,715
Interest (expense)
income, net........ (49,276) (109,826) (102,696) 256,206 (81,352) (71,283) 140,396
Pro forma net
income(3).......... 883,339 1,426,427 2,966,153 5,276,187 1,100,617 1,061,379 2,527,487
Pro forma net income
per share(4)....... $ 0.68 $ 0.33
Pro forma weighted
average shares
outstanding(4)..... 7,742,348 7,742,348
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
-------------------------
PRO FORMA
AS ADJUSTED
1996 1996(2)
----------- -----------
<S> <C> <C>
BALANCE SHEET DATA:
Working capital............................................................. $ 4,680,318 $11,181,890
Total assets................................................................ 21,206,486 26,925,452
Total debt.................................................................. 2,536,402 --
Stockholders' equity........................................................ 7,992,616 16,261,966
</TABLE>
- ---------------
(1) The Combination will be accounted for using the historical cost basis of the
Combined Predecessor Companies, in accordance with Securities and Exchange
Commission Staff Accounting Bulletin No. 48 ("SAB 48"), because the
shareholders of each of the Predecessor Companies are considered to be
promoters.
(2) Pro forma, as adjusted, gives effect to the sale of the shares of Common
Stock offered hereby and the application of the net proceeds therefrom as
described in "Use of Proceeds" as if such sale had occurred as of January 1,
1995. In addition, the pro forma information is based on certain assumptions
and adjustments. See "The Combination" and Notes to the Pro Forma Combining
Financial Statements.
(3) Historical net income and income tax expense have been omitted because these
amounts are not meaningful due to different tax status of the Predecessor
Companies. Pro forma net income represents the effect of taxing the entity
under Subchapter C of the Internal Revenue Code.
(4) The computation of pro forma net income per share is based upon 7,742,348
weighted average shares of Common Stock outstanding, which includes (i)
4,545,301 shares distributed to the shareholders of the Predecessor
Companies, (ii) 1,462,100 shares held by existing shareholders of Service
Experts, Inc. and (iii) 1,734,947 shares being sold in the offering to cover
the cash portion of the distribution to be paid to the promoters, debt to be
paid at closing, and associated costs of the offering on shares used for the
distribution and the paydown of debt.
5
<PAGE> 8
CERTAIN INDIVIDUAL PREDECESSOR COMPANIES
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------- -------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
CONTRACTOR SUCCESS GROUP, INC.
Net revenue........................................ $ 2,414,497 $ 2,740,976 $ 3,229,558 $1,570,089 $1,693,636
Cost of goods sold................................. 466,196 414,938 615,245 263,124 300,528
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 1,948,301 2,326,038 2,614,313 1,306,965 1,393,108
Selling, general and administrative expenses(1).... 1,224,819 1,456,424 1,339,221 537,366 732,524
----------- ----------- ----------- ----------- -----------
Income from operations............................. 723,482 869,614 1,275,092 769,599 660,584
Interest (expense) income, net..................... 118,004 104,537 115,295 49,092 61,869
Pro forma net income(2)............................ 555,749 602,151 861,187 480,061 454,696
COMBINED AC SERVICE & INSTALLATION CO., INC. AND
DONELSON AIR CONDITIONING COMPANY, INC.
Net revenue........................................ $10,292,295 $14,298,906 $16,452,622 $7,671,638 $8,634,712
Cost of goods sold................................. 7,280,075 10,245,039 11,122,350 5,316,352 5,741,935
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 3,012,220 4,053,867 5,330,272 2,355,286 2,892,777
Selling, general and administrative expenses(1).... 2,908,741 3,786,221 4,591,636 2,252,947 3,024,184
----------- ----------- ----------- ----------- -----------
Income (loss) from operations...................... 103,479 267,646 738,636 102,339 (131,407 )
Interest (expense) income, net..................... (69,637) (64,541) (53,963) (30,703 ) (28,621 )
Pro forma net income (loss)(2)..................... 88,746 162,129 423,354 55,709 (93,087 )
HARDWICK AIR MASTERS, INC.
Net revenue........................................ $ 3,989,626 $ 4,797,873 $ 6,377,285 $2,964,718 $3,877,541
Cost of goods sold................................. 2,986,702 3,418,062 4,556,146 2,083,397 2,856,457
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 1,002,924 1,379,811 1,821,139 881,821 1,021,084
Selling, general and administrative expenses(1).... 917,796 1,310,967 1,577,312 742,156 778,801
----------- ----------- ----------- ----------- -----------
Income from operations............................. 85,128 68,844 243,827 139,165 242,283
Interest (expense) income, net..................... (57,064) (68,947) (71,587) (32,423 ) (51,526 )
Net income......................................... 35,217 8,319 138,060 83,281 127,940
NORRELL HEATING & AIR CONDITIONING, INC.
Net revenue........................................ $ 3,274,267 $ 3,508,903 $ 4,265,726 $1,971,802 $2,047,437
Cost of goods sold................................. 2,285,621 2,436,732 2,852,690 1,334,641 1,406,695
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 988,646 1,072,171 1,413,036 637,161 640,742
Selling, general and administrative expenses(1).... 992,486 1,071,992 1,383,949 686,185 587,754
----------- ----------- ----------- ----------- -----------
Income (loss) from operations...................... (3,840) 179 29,087 (49,024 ) 52,988
Interest (expense) income, net..................... 10,360 17,949 26,772 6,673 22,313
Net income (loss).................................. 34,527 27,088 79,550 (2,260 ) 75,643
VISION HOLDING COMPANY, INC.(3)
Net revenue........................................ $ 2,792,574 $ 3,525,119 $ 4,261,485 $2,008,262 $2,309,356
Cost of goods sold................................. 1,751,998 2,400,309 2,738,022 1,385,883 1,542,173
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 1,040,576 1,124,810 1,523,463 622,379 767,183
Selling, general and administrative expenses(1).... 771,085 847,319 1,093,175 475,393 483,353
----------- ----------- ----------- ----------- -----------
Income from operations............................. 269,491 277,491 430,288 146,986 283,830
Interest (expense) income, net..................... (14,518) (58,068) (49,919) (28,859 ) (28,234 )
Net income......................................... 189,957 163,388 261,881 89,307 142,732
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
Net revenue........................................ $ 3,532,089 $ 3,715,214 $ 4,232,962 $1,904,167 $2,551,967
Cost of goods sold................................. 2,031,910 2,113,176 2,271,332 1,106,727 1,293,770
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 1,500,179 1,602,038 1,961,630 797,440 1,258,197
Selling, general and administrative expenses(1).... 1,859,319 1,468,513 1,652,784 765,863 855,268
----------- ----------- ----------- ----------- -----------
Income (loss) from operations...................... (359,140) 133,525 308,846 31,577 402,929
Interest (expense) income, net..................... 17,007 32,677 21,142 7,061 13,712
Pro forma net income (loss)(2)..................... (190,963) 95,174 187,629 18,908 222,961
</TABLE>
6
<PAGE> 9
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, SIX MONTHS ENDED JUNE 30,
--------------------------------------- -------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
ROLF COAL AND FUEL CORP.
Net revenue........................................ $ 3,036,009 $ 3,977,013 $ 4,104,580 $2,161,613 $2,448,305
Cost of goods sold................................. 1,516,213 1,940,213 1,866,607 1,058,267 949,703
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 1,519,796 2,036,800 2,237,973 1,103,346 1,498,602
Selling, general and administrative expenses(1).... 1,568,095 1,941,143 2,142,778 1,290,320 1,528,166
----------- ----------- ----------- ----------- -----------
Income (loss) from operations...................... (48,299) 95,657 95,195 (186,974 ) (29,564 )
Interest (expense) income, net..................... (13,576) (7,560) (2,043) (20,159 ) (19,867 )
Net income (loss).................................. (19,954) 69,952 44,107 (143,177 ) (15,481 )
ALL REMAINING PREDECESSOR COMPANIES(4)(5)
Net revenue........................................ $ 6,592,940 $12,052,834 $16,866,945 $7,940,353 $8,711,484
Cost of goods sold................................. 4,193,584 7,949,692 10,193,651 4,996,687 5,406,959
----------- ----------- ----------- ----------- -----------
Gross margin....................................... 2,399,356 4,103,142 6,673,294 2,943,666 3,304,525
Selling, general and administrative expenses(1).... 2,077,692 3,526,100 5,065,741 2,337,681 3,157,645
----------- ----------- ----------- ----------- -----------
Income from operations............................. 321,664 577,042 1,607,553 605,985 146,880
Interest (expense) income, net..................... (39,852) (65,873) (88,393) (32,036 ) (40,929 )
Pro forma net income(2)............................ 190,060 298,226 970,385 387,713 145,975
</TABLE>
- ---------------
(1) Includes bad debt expense.
(2) Pro forma net income (loss) represents the effect of taxing the entity under
Subchapter C of the Internal Revenue Code.
(3) 1993 represents period from March 1, 1993 through December 31, 1993.
(4) Air Experts, a United Services Co., Inc., Arrow Heating & Air Conditioning,
Inc., Brand Heating & Air Conditioning, Inc., Coastal Air Conditioning
Service, Inc., Gilley's Heating & Cooling, Inc., and Service Experts of Palm
Springs, Inc.
(5) The selected financial data above represents the six smallest (by revenue)
Predecessor Companies which have been combined for the period from January
1, 1993 through June 30, 1996 except for the following Predecessor Companies
which are included from the date operations commenced as follows: Air
Experts, a United Services Co., Inc. -- January 1, 1994; Arrow Heating & Air
Conditioning, Inc. -- January 29, 1993; and Service Experts of Palm Springs,
Inc. -- October 15, 1993.
7
<PAGE> 10
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully in evaluating an
investment in the shares of Common Stock offered hereby. This discussion also
identifies important cautionary factors that could cause the Company's actual
results to differ materially from those projected in forward looking statements
of the Company made by, or on behalf of, the Company. In particular, the
Company's forward looking statements, including those regarding the successful
integration of the businesses of the Predecessor Companies, the effective
implementation of the Company's operating strategy, the availability of
additional HVAC businesses for acquisition, the adequacy of the Company's
capital resources and other statements regarding trends relating to various
revenue and expense items, could be affected by a number of risks and
uncertainties including those described below.
ABSENCE OF COMBINED OPERATING HISTORY; PRIOR PREDECESSOR COMPANY OPERATING
LOSSES AND DEFICITS
Although the Company was founded in March 1996, it will not conduct any
operations of the Predecessor Companies as a combined entity until the
Combination is consummated. Accordingly, there can be no assurance that the
Company will be able to integrate successfully the businesses of the Predecessor
Companies or to operate profitably. There can be no assurance that the Company's
management group will be able to effectively manage the combined entity and
effectively implement the Company's operating and acquisition strategies.
Failure to integrate successfully the Predecessor Companies and to implement the
Company's operating and acquisition strategies could have a material adverse
effect on the Company's net revenue and earnings. See "Business -- Strategy" and
"The Combination." In addition, certain Predecessor Companies have experienced
operating losses and working capital deficits in the last several years. For the
six months ended June 30, 1996, AC Service & Installation Co., Inc., Rolf Coal
and Fuel Corp., Coastal Air Conditioning Service, Inc. and, Brand Heating & Air
Conditioning, Inc. had operating losses of $131,407, $29,564, $136,899 and
$221,905 respectively. At June 30, 1996 and December 31, 1995, Air Experts, a
United Services Co., Inc. had working capital deficits of $71,965 and $245,381,
respectively. There can be no assurance that such operating losses and working
capital deficits will not continue. See the historical financial statements of
the Predecessor Companies and the notes thereto appearing elsewhere in this
Prospectus.
RISKS ASSOCIATED WITH EXPANSION
The success of the Company's acquisition strategy will depend on a number
of factors, including (i) the Company's ability to locate existing HVAC service
and replacement businesses for acquisitions and to successfully integrate the
operations of companies acquired in the future into the Company's operations and
(ii) the availability of adequate financing to develop or acquire additional
HVAC service and replacement businesses. There can be no assurance that the
Company's acquisition strategy will be successful, that modifications to the
Company's strategy will not be required, that the Company will be able to
effectively manage and enhance the profitability of additional Service Centers
or that the Company will be able to obtain adequate financing on reasonable
terms to develop or acquire additional HVAC service businesses. See
"Business -- Strategy."
COMPETITION
The HVAC service and replacement industry is highly competitive. The
Company's Service Centers will compete with other full-service HVAC businesses
primarily on the basis of quality, reliability, customer service and price. In
certain markets, the Company competes with utility companies which have access
to capital, personnel, marketing and technological resources that are equal to
or greater than those of the Company. Because of the fragmented nature of the
industry and relatively low barriers to entry, additional competitors, including
companies that offer other home improvement services in addition to HVAC
services,
8
<PAGE> 11
may emerge that have greater access than the Company to capital, personnel and
technological resources. There can be no assurance that the Company will be able
to compete successfully with such competitors.
DEPENDENCE ON KEY PERSONNEL
The success of the Company will depend upon the continued services of the
Company's senior management, particularly upon its Chairman of the Board and
Chief Executive Officer, Alan R. Sielbeck, and its President and Chief Operating
Officer, James D. Abrams. The loss of the services of Messrs. Sielbeck, Abrams
or any of the Company's senior management would have a material adverse effect
upon the Company's business and prospects. See "Management."
LABOR AVAILABILITY
The timely provision of high-quality service by the Service Centers
requires an adequate supply of skilled labor. In addition, the operating costs
of each Service Center may be adversely affected by high turnover in skilled
positions. Accordingly, the Company's ability to increase productivity and net
earnings will be limited to a degree by its ability to employ the skilled
laborers necessary to meet the Company's service requirements. There can be no
assurance that the Company will be able to maintain an adequate skilled labor
force necessary to efficiently operate its Services Centers or that the
Company's labor expenses will not increase as a result of a shortage in the
supply of skilled workers.
SEASONAL AND CYCLICAL NATURE OF THE INDUSTRY
The HVAC service industry generally experiences increased demand during the
summer and winter months. The Company may, in certain periods, be affected by
these seasonal trends. The residential HVAC service and replacement industry
historically has been highly cyclical and is influenced by many of the same
national and regional economic and demographic factors which affect demand for
durable consumer goods, including consumer confidence, interest rates,
availability of financing, regional population and employment trends, and
general economic conditions. There can be no assurance that the HVAC service and
replacement industry will not experience future declines or that such declines
will not have a material adverse affect on the Company. See "Business -- HVAC
Service and Replacement Industry."
CONTROL BY MANAGEMENT AND PRINCIPAL STOCKHOLDERS
Following completion of the Offering, directors, officers and 5%
stockholders of the Company will beneficially own approximately 44.9% of the
outstanding Common Stock. See "Principal Stockholders." Accordingly, these
persons will have substantial influence over the affairs of the Company,
including the ability to influence the election of directors and other matters
requiring stockholder approval.
BENEFITS TO MANAGEMENT AND PRINCIPAL STOCKHOLDERS
Approximately $17.1 million of the net proceeds of the Offering will be
used to pay the cash portion of the purchase price payable to the stockholders
of the Predecessor Companies at closing. Approximately $9.7 million of such
amount, representing approximately 37.2% of the estimated net proceeds, will be
paid in cash to former stockholders of the Predecessor Companies who are
executive officers, directors or 5% stockholders of the Company as consideration
for the Combination and in payment of indebtedness of certain Predecessor
Companies to such persons. In addition, these individuals will receive an
aggregate of 2,236,059 shares of Common Stock as consideration in the
Combination, assuming an initial offering price of $13.00 per share. See "Use of
Proceeds" and "Certain Transactions." Because of their positions as executive
officers and directors of the Company, the consideration to be paid in the
Combination to stockholders of certain Predecessor Companies was not determined
by arm's length negotiations. See "The Combination" for a discussion of the
consideration being paid to the stockholders of each Predecessor Company.
9
<PAGE> 12
CONFLICTS OF INTEREST
Certain executive officers of the Company are owners of HVAC companies that
are not affiliated with the Company. While such executive officers have agreed
to devote their full time efforts to the operations of the Company, there can be
no assurance that they will not periodically devote time and attention to the
operations of HVAC companies that are not affiliated with the Company. Currently
none of the unaffiliated companies owned by such executive officers are located
in geographic areas served by the Company. There can be no assurance that the
Company will not enter the markets served by these companies in the future. See
"Management" and "Certain Transactions."
ABSENCE OF INTEGRATED OPERATING SYSTEMS
After the closing of the Combination and the Offering, the Company intends
to implement and integrate certain information and operating systems of the
Predecessor Companies. The Company may experience delays, complications and
expenses in implementing, integrating and operating such systems, any of which
could have a material adverse affect on the Company's operations, net revenue
and earnings. See "Business -- Services and Operations."
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, as amended, relating to minimum energy efficiency standards of HVAC systems
and the production, servicing and disposal of certain ozone depleting
refrigerants used in such systems. In connection with the entry into new
markets, the Company may become subject to compliance with additional
regulations, and there can be no assurance that the regulatory environment in
which the Company operates will not change significantly in the future.
Various local, state and federal laws and regulations, including, but not
limited to, laws and regulations implementing the Clean Air Act, as amended,
impose licensing standards on technicians who service heating and air
conditioning units. While the installers and technicians employed by the Service
Centers are duly certified by applicable local, state and federal agencies and
have been able to meet or exceed such standards to date, there can be no
assurance that they will be able to meet future standards.
In some states, warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies thereby subjecting the Company and the service agreements to the
insurance laws and regulations of such state.
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws and Delaware law may make a change in the control of the Company more
difficult to effect, even if a change in control were in the stockholders'
interest. Section 203 of the Delaware General Corporation Law would prevent an
"interested stockholder" (defined in Section 203, generally, as a person owning
15% or more of the Company's outstanding voting stock) from engaging in a
"business combination" (as defined in Section 203) with the Company for three
years following the date such person became an interested stockholder unless
certain conditions, including approval by the Company's Board of Directors, are
met. The Company's Restated Certificate of Incorporation and Bylaws include
certain super-majority voting requirements and, in addition, the Company's
Restated Certificate of Incorporation allows the Board to determine the terms of
the preferred stock which may be issued by the Company without approval of the
holders of the Common Stock. The ability of the Company to issue preferred stock
in such manner could enable the Board to prevent changes in management and
control of the Company. The Board of the Company is divided into three classes
of directors, with directors being elected for staggered three-year terms. Such
staggered terms may affect the ability of the holders of the Common Stock to
change control of the Company. See "Description of Capital Stock -- Anti-
Takeover Provisions." In addition, certain provisions of the employment
agreements between the Company and the executive officers of the Company may
make a change of control more difficult. Pursuant to these employment
agreements, upon a change in control of the Company, each executive officer
shall be paid as
10
<PAGE> 13
severance pay such officer's base salary for the remaining term of the
employment agreement. See "Management -- Employment Agreements."
ABSENCE OF PRIOR PUBLIC MARKET; RELATIONSHIP OF OFFERING PRICE TO MARKET PRICE
Prior to the Offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
or continue after the Offering or that the market price of the Common Stock will
not decline below the initial public offering price. The initial public offering
price of the Common Stock has been determined by negotiation among the Company,
Equitable Securities Corporation and Morgan Keegan & Company, Inc., as the
representatives of the Underwriters (the "Representatives"), and may not be
indicative of the market price for shares of Common Stock after the Offering.
Prices for the shares of Common Stock after the Offering will be determined in
the market and may be influenced by many factors, including the depth and
liquidity of the market for the Common Stock, investor perception of the
Company, the HVAC industry as a whole and general economic and market
conditions. See "Underwriting."
VOLATILITY OF MARKET PRICE
From time to time after the Offering, there may be significant volatility
in the market price of the Common Stock. Quarterly operating results of the
Company, changes in earnings estimated by analysts, changes in general
conditions in the economy or the financial markets or other developments
affecting the Company could cause the market price of the Common Stock to
fluctuate substantially. In addition, in recent years the stock market has
experienced extreme price and volume fluctuations. This volatility has had a
significant effect on the market prices of securities issued by many companies
for reasons unrelated to their operating performance.
DILUTION
The purchasers of the Common Stock offered hereby will experience immediate
and significant dilution of $11.14 per share, the amount by which the purchase
price of the Common Stock offered hereby will exceed the net tangible book value
of the Common Stock immediately following the Offering. See "Dilution." In the
event the Company issues additional Common Stock in the future, including shares
which may be issued in connection with future acquisitions, purchasers of Common
Stock in this Offering may experience further dilution in net tangible book
value per share of the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE
Sales of a substantial number of shares of Common Stock in the public
market following the Offering could adversely affect the market price for the
Common Stock. The number of shares of Common Stock available for sale in the
public market is limited by restrictions under the Securities Act of 1933, as
amended (the "Securities Act"), and lock-up agreements under which the holders
of such shares have agreed not to sell or otherwise dispose of any of their
shares for a period of 180 days after the date of this Prospectus without the
prior written consent of Equitable Securities Corporation on behalf of the
Underwriters. On the date of this Prospectus, no shares other than the 2,250,000
shares offered hereby will be eligible for sale. A total of 2,815,935 additional
shares are subject to lock-up agreements and will be eligible for sale subject
to the volume and holding period limitations of Rule 144 beginning two years
after the date of this Prospectus. See "Shares Eligible for Future Sale."
11
<PAGE> 14
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 2,250,000 shares of
Common Stock offered hereby (assuming an initial public offering price of $13.00
per share and after deducting underwriting discounts and commissions and
estimated offering expenses payable by the Company) are estimated to be
approximately $26.1 million ($30.4 million if the Underwriters' over-allotment
option is exercised in full).
In connection with the Combination, the Company plans to use approximately
$17.1 million of the net proceeds of the Offering to pay cash to the
stockholders of the Predecessor Companies in connection with the Combination, to
repay approximately $1.8 million of certain indebtedness assumed pursuant to the
Combination and incurred by the Predecessor Companies prior to the Combination
primarily for the purchase of equipment and to purchase for $604,000
approximately 38% of the outstanding common stock of Future University, Inc.
("Future University(R)"). See "Business -- Contractor Success Group." At June
30, 1996, such indebtedness had a weighted average interest rate of 12.8%. Such
indebtedness, if not repaid, would otherwise mature at various dates through
December 1999. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Combined Predecessor Companies -- Liquidity and
Capital Resources" and "The Combination."
The remaining $6.6 million of the net proceeds is expected to be used,
together with internally generated funds and proposed borrowings, to fund the
acquisition and development of additional Service Centers and for general
corporate purposes. The Company is not engaged in any negotiations with respect
to any acquisitions, and there can be no assurance that any such developments or
acquisitions will be completed or that the terms of any such transactions will
be favorable to the Company.
Pending application of the net proceeds as described above, the Company
intends to invest the net proceeds in short-term, investment grade or
government, interest-bearing securities.
S CORPORATION DISTRIBUTIONS
Certain of the Predecessor Companies have been treated for federal and
certain state income tax purposes as S corporations under the Internal Revenue
Code of 1986, as amended (the "Code"). As a result, earnings of such
corporations have been subject to taxation at the stockholder rather than the
corporate level for federal and certain state income tax purposes. Prior to the
completion of the Combination, the Predecessor Companies that are S corporations
made distributions to their stockholders of previously earned and undistributed
earnings through June 30, 1996, subject to the terms of the Combination
Agreements. The Company will make another distribution as promptly as
practicable after the closing of the Combination to each of the stockholders of
the Predecessor Companies that are S corporations equal to such corporations'
earned but undistributed earnings in accordance with each such corporation's
final tax return, subject to the terms of the Combination Agreement.
12
<PAGE> 15
DIVIDEND POLICY
As a newly formed corporation, the Company has never declared or paid
dividends on its Common Stock. The Company expects that future earnings, if any,
will be retained to finance the growth and development of the Company's business
and, accordingly, except as described under "S Corporation Distributions" above,
does not intend to declare or pay any dividends on the Common Stock for the
foreseeable future. The declaration, payment and amount of future dividends, if
any, will be subject to the discretion of the Company's Board of Directors and
will depend upon the future earnings, results of operations, financial condition
and capital requirements of the Company, among other factors. Under Delaware
law, the Company is prohibited from paying any dividends unless it has capital
surplus or net profits available for this purpose. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations -- Combined
Predecessor Companies -- Liquidity and Capital Resources."
CAPITALIZATION
The following table sets forth the capitalization of the Company as of June
30, 1996 (i) on a pro forma basis to reflect the Combination and (ii) on a pro
forma as adjusted basis to give effect to the Combination and the sale of the
2,250,000 shares of Common Stock offered by the Company in the Offering at an
assumed offering price of $13.00 per share and the application of the net
proceeds therefrom, which are estimated to be approximately $26.1 million (after
deducting underwriting discounts and commissions and estimated Offering
expenses). The following table should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Combined Predecessor Companies" and the Combined Financial
Statements of the Company and the related Notes thereto included elsewhere in
this Supplement.
<TABLE>
<CAPTION>
JUNE 30, 1996
----------------------------
PRO FORMA
COMBINED AS ADJUSTED
---------- -----------
(IN THOUSANDS)
<S> <C> <C>
Short-term debt, including current portion of long-term debt,
capital lease obligations and notes payable to related
parties........................................................ $1,018,667 $ --
========= ==========
Long-term debt and capital lease obligations, less current
portion........................................................ 650,708 --
Notes payable to related parties................................. 867,027 --
Stockholders' equity:
Preferred Stock, $.01 par value per share; 10,000,000 shares
authorized, no shares outstanding........................... -- --
Common Stock, $.01 par value per share; 30,000,000 shares
authorized; 8,257,401 shares outstanding, pro forma......... 82,574
Additional paid-in capital....................................... 7,992,616 16,129,392
---------- -----------
Total stockholders' equity............................. 7,992,616 16,211,966
---------- -----------
Total capitalization................................... $9,510,351 $16,211,966
========= ==========
</TABLE>
13
<PAGE> 16
DILUTION
At June 30, 1996, after giving effect to the Combination, the pro forma net
tangible combined book deficit of the Company was $(9,349,992), or $(1.56) per
share. Such pro forma net tangible book combined deficit is the tangible net
worth (tangible assets less total liabilities) of the Combined Predecessor
Companies prior to the Combination, less $16,530,650 in cash and other items to
be distributed or contributed to by the owners of the Predecessor Companies. The
number of shares used for the per share calculation includes the 6,007,401
shares outstanding prior to the Offering. After giving effect to the
Combination, the sale by the Company of the 2,250,000 shares of Common Stock
offered hereby (assuming an initial public offering price of $13.00 per share
and after deducting underwriting discounts and commissions and estimated
Offering expenses payable by the Company) and the distribution of the cash
portion of the purchase price of the Predecessor Companies, the pro forma
combined net tangible book value of the Company would have been $15,400,008, or
$1.86 per share. This represents an immediate increase in pro forma net tangible
book value of $3.42 per share to existing stockholders and an immediate dilution
in net tangible book value of $11.14 per share to new investors purchasing the
shares of Common Stock in the Offering. The following table illustrates this per
share dilution:
<TABLE>
<S> <C> <C>
Assumed initial public offering price................................ $13.00
------
Pro forma net tangible book deficit prior to the Offering(1)....... $(1.56)
Increase attributable to new investors............................. 3.42
------
Pro forma net tangible book value after the Offering................. 1.86
------
Dilution in net tangible book value to new investors................. $11.14
======
</TABLE>
The following table sets forth, at June 30, 1996, the number of shares of
Common Stock purchased from the Company, the total consideration and the average
price per share paid to the Company by existing stockholders and by the new
investors purchasing shares of Common Stock in the Offering at an assumed
initial public offering price of $13.00 per share:
<TABLE>
<CAPTION>
SHARES PURCHASED TOTAL CONSIDERATION
------------------- ------------------------ AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- ------- ----------- ------- -------------
<S> <C> <C> <C> <C> <C>
Existing stockholders.......... 6,007,401 72.8% $(8,538,036)(2) (41.2)% $ (1.42)
New investors.................. 2,250,000 27.2 29,250,000 141.2 13.00
--------- ------- ----------- -------
Total(2)............. 8,257,401 100.0% $20,711,964 100.0%
======== ===== ========== =====
</TABLE>
- ---------------
(1) The calculation is based on the shares to be issued in the Combination
(4,545,301) and shares held by existing shareholders of the Company
(1,462,100).
(2) Total consideration for the owners of the Predecessor Companies represents
the combined stockholders' investment before the Offering, less $16,530,650
in cash and other items to be distributed or contributed to the existing
stockholders.
14
<PAGE> 17
SELECTED COMBINED FINANCIAL DATA
Simultaneously with, and as a condition to, the closing of the Offering,
the Company will acquire the Predecessor Companies (as combined, the "Combined
Predecessor Companies"). The Combination will be accounted for using the
historical cost basis of the Combined Predecessor Companies, in accordance with
SAB No. 48, because the shareholders of each of the Predecessor Companies are
considered to be promoters. Prior to the Combination, each of the Predecessor
Companies operated independently and were not under common control or management
and some were not taxable entities; accordingly, the data may not be comparable
to or indicative of post-combination results. Management believes that a
combined presentation of financial information is most meaningful to investors
understanding of the results of operations, financial condition, and cash flows
of the Predecessor Companies. The Company has adopted a December 31 fiscal year
and has obtained audits for all of the Predecessor Companies' financial
statements for the years ended December 31, 1993, 1994 and 1995, or from the
date operations commenced if subsequent to January 1, 1993.
The Selected Combined Financial Data for the fiscal years ended December
31, 1993, 1994 and 1995 (except for pro forma amounts) have been derived from
the financial statements of the Predecessor Companies which have been audited by
Ernst & Young LLP, independent auditors. The Selected Combined Financial Data
for the six months ended June 30, 1995 and 1996 have been derived from unaudited
combined financial statements that appear elsewhere in this Prospectus. The
Selected Combined Financial Data for the fiscal years ended December 31, 1991
and 1992 have been derived from unaudited combined financial statements not
included elsewhere in this Prospectus. The unaudited combined financial
statements have been prepared on the same basis as the audited combined
financial statements and, in the opinion of management, contain all adjustments,
consisting only of normal recurring accruals, necessary for a fair presentation
of the combined financial position and combined results of operations for the
periods presented. The pro forma data gives effect to the merger and promoter
distributions. The pro forma data, as adjusted, gives effect to the sale of the
shares of Common Stock offered hereby and the application of the net proceeds
thereof as described in "Use of Proceeds" and the consummation of the
Combination, as if each transaction had occurred at the beginning of the periods
presented. In addition, the pro forma information is based on available
information and certain assumptions and adjustments. See Notes to the Pro Forma
Combining Financial Statements. The following data should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the historical financial statements of the Combined Predecessor
Companies, including the related Notes thereto, that appear elsewhere in this
Prospectus.
The selected financial data presented for each of the Predecessor Companies
for the years ended December 31, 1993, 1994 and 1995, or from the date
operations commenced if subsequent to January 1, 1993, have been derived from
the audited financial statements of each of these companies that have been
audited by Ernst & Young LLP, independent auditors. The selected financial data
presented for each of the Predecessor Companies for the six months ended June
30, 1995 and 1996 have been derived from the unaudited financial statements of
each of these companies that appear elsewhere in this Prospectus. The selected
financial data presented for each of the Predecessor Companies for the years
ended December 31, 1991 and 1992, or from the date operations commenced if
subsequent to January 1, 1991, have been derived from the unaudited financial
statements of each of these companies not included elsewhere in this Prospectus.
The unaudited financial statements have been prepared on the same basis as the
audited financial statements, and in the opinion of the Predecessor Companies'
management, contain all adjustments, consisting only of normal recurring
accruals, necessary for a fair presentation of the financial position and
results of operations for the periods presented. The selected financial data of
the Predecessor Companies have been presented as follows:
- Combined Predecessor Companies, including pro forma information
- Contractor Success Group, Inc.
- Combined AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc.
- Hardwick Air Masters, Inc.
- Norrell Heating & Air Conditioning, Inc.
- Vision Holding Company, Inc.
- Comerford's Heating and Air Conditioning, Inc.
- Rolf Coal and Fuel Corp.
- All remaining Predecessor Companies are included on a combined basis and
include the following:
- Air Experts, a United Services Co., Inc.
- Arrow Heating & Air Conditioning, Inc.
- Brand Heating & Air Conditioning, Inc.
- Coastal Air Conditioning Service, Inc.
- Gilley's Heating & Cooling, Inc.
- Service Experts of Palm Springs, Inc.
15
<PAGE> 18
COMBINED PREDECESSOR COMPANIES(1)(2)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------ SIX MONTHS ENDED
PRO FORMA JUNE 30,
AS ADJUSTED(3) -------------------------
1991 1992 1993 1994 1995 1995 1995 1996
----------- ----------- ----------- ----------- ----------- -------------- ----------- -----------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT
DATA:
Net revenue.... $19,868,724 $26,447,455 $35,784,297 $48,476,838 $59,651,163 $ 59,651,163 $28,122,642 $32,204,438
Cost of goods
sold......... 12,496,200 16,650,146 22,512,299 30,918,161 36,216,043 36,095,710 17,545,078 19,498,220
----------- ----------- ----------- ----------- ----------- -------------- ----------- -----------
Gross margin... 7,372,524 9,797,309 13,271,998 17,558,677 23,435,120 23,555,453 10,577,564 12,706,218
Selling,
general and
administrative
expenses..... 6,661,535 8,796,135 12,180,033 15,268,679 18,706,596 15,550,975 9,017,911 11,077,695
----------- ----------- ----------- ----------- ----------- -------------- ----------- -----------
Income from
operations... 710,989 1,001,174 1,091,965 2,289,998 4,728,524 8,004,478 1,559,653 1,628,523
Other income
(expense):
Interest
expense.... (137,002) (134,504) (217,695) (298,359) (358,902) -- (162,205) (211,679)
Interest
income..... 63,983 157,007 168,419 188,533 256,206 256,206 80,853 140,396
Other
income..... (12,881) 81,388 311,387 178,296 207,730 298,736 123,618 73,124
----------- ----------- ----------- ----------- ----------- -------------- ----------- -----------
85,900 103,891 262,111 68,470 105,034 554,942 42,266 1,841
Income before
tax.......... 625,089 1,105,065 1,354,076 2,358,468 4,833,558 8,559,420 1,601,919 1,630,364
Pro forma
income tax
expense(4)... 198,007 431,347 470,737 932,041 1,867,405 3,283,233 632,376 568,985
----------- ----------- ----------- ----------- ----------- -------------- ----------- -----------
Pro forma net
income(4).... $ 427,082 $ 673,718 $ 883,339 $ 1,426,427 $ 2,966,153 $ 5,276,187 $ 969,543 $ 1,061,379
========== ========== ========== ========== ========== ============ ========== ==========
Pro forma net
income per
share(5)..... $ 0.68
Pro forma
weighted
average
shares
outstanding(5).. 7,742,348
<CAPTION>
PRO FORMA
AS ADJUSTED(3)
1996
--------------
<S> <C>
INCOME STATEMEN
DATA:
Net revenue.... $ 32,204,438
Cost of goods
sold......... 19,498,220
--------------
Gross margin... 12,706,218
Selling,
general and
administrative
expenses..... 8,964,503
--------------
Income from
operations... 3,741,715
Other income
(expense):
Interest
expense.... --
Interest
income..... 140,396
Other
income..... 112,944
--------------
253,340
Income before
tax.......... 3,995,055
Pro forma
income tax
expense(4)... 1,467,563
--------------
Pro forma net
income(4).... $ 2,527,487
============
Pro forma net
income per
share(5)..... $ 0.33
Pro forma
weighted
average
shares
outstanding(5 7,742,348
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------------------------------
1991 1992 1993 1994 1995
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
BALANCE
SHEET
DATA:
Working
capital
(deficiency)... $ 1,570,674 $ 2,407,192 $ 2,293,460 $ 1,988,586 $ 4,184,173
Total
assets........... 5,403,858 8,149,778 12,414,642 15,147,321 19,330,594
Total
debt........... 1,374,654 2,388,607 3,325,092 3,791,329 4,096,175
Stockholders'
equity
(deficit)....... 2,223,977 3,416,677 3,558,984 4,783,815 7,275,395
<CAPTION>
JUNE 30,
---------------------------
PRO FORMA
AS ADJUSTED(3)
1996 1996
----------- --------------
<S> <C> <C>
BALANCE
SHEET
DATA:
Working
capital
(deficiency)... $ 4,680,318 $ 11,181,890
Total
assets........... 21,206,486 26,925,452
Total
debt........... 2,536,402 --
Stockholders'
equity
(deficit)....... 7,992,616 16,211,966
</TABLE>
16
<PAGE> 19
- ---------------
(1) The selected financial data above represents the Combined Predecessor
Companies for the period from January 1, 1991 through June 30, 1996 except
for the following Predecessor Companies which are included from the date
operations commenced as follows: Donelson Air Conditioning Company, Inc.,
December 2, 1991; Air Experts, a United Services Co., Inc., January 1, 1994;
Arrow Heating & Air Conditioning, Inc., January 29, 1993; Service Experts of
Palm Springs, Inc., October 15, 1993; and Vision Holding Company, Inc.,
March 1, 1993.
(2) The Combination will be accounted for using historical cost basis of the
Combined Predecessor Companies, in accordance with SAB 48, because the
shareholders of each of the Predecessor Companies are considered to be
promoters. Accordingly, the Company will record the net assets acquired at
the Predecessor Companies' historical cost basis, as determined by generally
accepted accounting principles.
(3) Pro forma information gives effect to the Combination prior to the Offering.
Pro forma data, as adjusted, gives effect to the Offering, the sale of the
shares of Common Stock offered hereby and the application of the net
proceeds therefrom as described in "Use of Proceeds" as if such sale had
occurred at the beginning of the periods presented. See "The Combination"
and the Notes to the Pro Forma Combining Financial Statements.
(4) Historical net income and income tax expense have been omitted because these
amounts are not meaningful due to the different tax status of the
Predecessor Companies. Pro forma net income represents the effect of taxing
the entity under Subchapter C of the Internal Revenue Code.
(5) The computation of pro forma net income per share is based upon $7,742,348
weighted average shares of Common Stock outstanding, which includes (i)
4,545,301 shares distributed to the shareholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of Service Experts, Inc. and (iii) $1,734,947 shares being sold in the
Offering to cover the cash portion of the distribution to be paid to the
promoters, debt to be paid at closing, and associated costs of the offering
on shares used for the distribution and the paydown of debt.
17
<PAGE> 20
CONTRACTOR SUCCESS GROUP, INC.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------------------------------- -----------------------
1991 1992 1993 1994 1995 1995 1996
----------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue....................... $1,105,805 $2,445,839 $2,414,497 $2,740,976 $3,229,558 $1,570,089 $1,693,636
Cost of goods sold................ 341,823 195,161 466,196 414,938 615,245 263,124 300,528
----------- ---------- ---------- ---------- ---------- ---------- ----------
Gross margin...................... 763,982 2,250,678 1,948,301 2,326,038 2,614,313 1,306,965 1,393,108
Selling, general and
administrative expenses......... 397,106 1,422,338 1,224,819 1,456,424 1,339,221 537,366 732,524
----------- ---------- ---------- ---------- ---------- ---------- ----------
Income from operations............ 366,786 828,340 723,482 869,614 1,275,092 769,599 660,584
Interest (expense) income,
net............................. -- 101,341 118,004 104,537 115,295 49,092 61,869
Pro forma net income(2)........... 226,276 576,402 555,749 602,151 861,187 480,061 454,696
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
----------- ---------- ---------- ---------- ---------- -------------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............... $ 35,613 $ 337,829 $ 314,315 $ 418,050 $ 250,703 $ 527,301
Total assets.................. 42,449 795,452 788,063 995,212 1,410,691 1,174,821
Total debt.................... -- 1,658 5,295 5,835 263,277 --
Stockholders' equity.......... 42,449 736,044 660,821 784,972 731,159 986,612
</TABLE>
- ---------------
(1) Pro forma net income represents the effect of taxing the entity under
Subchapter C of the Internal Revenue Code.
COMBINED AC SERVICE & INSTALLATION CO., INC. AND
DONELSON AIR CONDITIONING COMPANY, INC.
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
------------------------------------------------------------------- -----------------------
1991(1) 1992 1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue.................. $5,781,768 $8,197,690 $10,292,295 $14,298,906 $16,452,622 $7,671,638 $8,634,712
Cost of goods sold........... 3,977,827 5,991,098 7,280,075 10,245,039 11,122,350 5,316,352 5,741,935
----------- ----------- ----------- ----------- ----------- ---------- ----------
Gross margin................. 1,803,941 2,206,592 3,012,220 4,053,867 5,330,272 2,355,286 2,892,777
Selling, general and
administrative expenses.... 1,602,061 2,163,084 2,908,741 3,786,221 4,591,636 2,252,947 3,024,184
----------- ----------- ----------- ----------- ----------- ---------- ----------
Income (loss) from
operations................. 201,880 43,508 103,479 267,646 738,636 102,339 (131,407)
Interest (expense) income,
net........................ (14,071 ) (19,413 ) (69,637) (64,541) (53,963) (30,703) (28,621)
Pro forma net income
(loss)(2).................. 101,377 32,912 88,746 162,129 423,354 55,709 (93,087)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
---------- ---------- ----------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.............. $ 527,905 $ 870,155 $ 758,049 $ 614,770 $ 1,182,653 $1,101,872
Total assets................. 1,507,497 2,796,279 3,313,115 3,931,581 4,569,910 5,028,844
Total debt................... 356,982 1,163,006 1,141,709 1,070,812 1,289,602 43,901
Stockholders' equity......... 471,858 940,514 921,060 1,100,104 1,728,658 1,676,424
</TABLE>
- ---------------
(1) The selected financial data above includes AC Service & Installation Co.,
Inc. from the period January 1, 1991 through June 30, 1996 and Donelson Air
Conditioning Company, Inc. from the period beginning December 2, 1991
through June 30, 1996.
(2) Pro forma net income represents the effect of taxing the entity under
Subchapter C of the Internal Revenue Code.
18
<PAGE> 21
HARDWICK AIR MASTERS, INC.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------------------- -----------------------
1991 1992 1993 1994 1995 1995 1996
----------- ----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue..................... $2,595,495 $3,007,132 $3,989,626 $4,797,873 $6,377,285 $2,964,718 $3,877,541
Cost of goods sold.............. 1,975,923 2,315,556 2,986,702 3,418,062 4,556,146 2,083,397 2,856,457
----------- ----------- ---------- ---------- ---------- ---------- ----------
Gross margin.................... 619,572 691,576 1,002,924 1,379,811 1,821,139 881,821 1,021,084
Selling, general and
administrative expenses....... 563,099 720,758 917,796 1,310,967 1,577,312 742,156 778,801
----------- ----------- ---------- ---------- ---------- ---------- ----------
Income (loss) from operations... 56,473 (29,182 ) 85,128 68,844 243,827 139,165 242,283
Interest (expense) income,
net........................... (49,607 ) (40,493 ) (57,064) (68,947) (71,587) (32,423) (51,526)
Net income (loss)............... 32,060 (31,175 ) 35,217 8,319 138,060 83,281 127,940
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
----------- ----------- ---------- ---------- ---------- ----------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............. $ 36,209 $ 87,376 $ (114,513) $ (32,955) $ 164,691 $ 288,063
Total assets................ 812,860 935,769 1,398,397 1,494,644 1,979,439 2,394,270
Total debt.................. 323,226 351,278 520,662 473,094 607,237 441,867
Stockholders' equity........ 101,471 70,296 105,513 113,832 251,892 596,849
</TABLE>
NORRELL HEATING & AIR CONDITIONING, INC.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------------------- -------------------------
1991 1992 1993 1994 1995 1995 1996
----------- ----------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue................. $2,010,678 $2,752,019 $3,274,267 $3,508,903 $4,265,726 $1,971,802 $2,047,437
Cost of goods sold.......... 1,262,311 1,963,704 2,285,621 2,436,732 2,852,690 1,334,641 1,406,695
----------- ----------- ---------- ---------- ---------- ---------- ----------
Gross margin................ 748,367 788,315 988,646 1,072,171 1,413,036 637,161 640,742
Selling, general and
administrative expenses... 745,321 781,042 992,486 1,071,992 1,383,949 686,185 587,754
----------- ----------- ---------- ---------- ---------- ---------- ----------
Income (loss) from
operations................ 3,046 7,273 (3,840) 179 29,087 (49,024) 52,988
Interest (expense) income,
net....................... (2,171 ) 3,251 10,360 17,949 26,772 6,673 22,313
Net income (loss)........... 16,716 22,702 34,527 27,088 79,550 (2,260) 75,643
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------ JUNE 30,
1991 1992 1993 1994 1995 1996
---------- ---------- ---------- ---------- ---------- ---------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............... $ (43,564) $ (6,634) $ 23,270 $ 46,105 $ 171,001 $ 350,460
Total assets.................. 431,936 514,769 770,727 776,738 1,594,242 1,318,443
Total debt.................... 40,000 -- -- -- -- --
Stockholders' equity.......... 138,275 120,977 155,504 177,812 268,300 343,943
</TABLE>
19
<PAGE> 22
VISION HOLDING COMPANY, INC.
<TABLE>
<CAPTION>
PERIOD FROM YEAR ENDED SIX MONTHS ENDED
MARCH 1, 1993 DECEMBER 31, JUNE 30,
THROUGH ----------------------- -----------------------
DECEMBER 31, 1993 1994 1995 1995 1996
----------------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue....................................... $ 2,792,574 $3,525,119 $4,261,485 $2,008,262 $2,309,356
Cost of goods sold................................ 1,751,998 2,400,309 2,738,022 1,385,883 1,542,173
----------------- ---------- ---------- ---------- ----------
Gross margin...................................... 1,040,576 1,124,810 1,523,463 622,379 767,183
Selling, general and administrative expenses...... 771,085 847,319 1,093,175 475,393 483,353
----------------- ---------- ---------- ---------- ----------
Income from operations............................ 269,491 277,491 430,288 146,986 283,830
Interest (expense) income, net.................... (14,518) (58,068) (49,919) (28,859) (28,234)
Net income........................................ 189,957 163,388 261,881 89,307 142,732
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------------------- JUNE 30,
1993 1994 1995 1996
----------------- ---------- ---------- ---------------
<S> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital................................... $ 188,308 $ 46,537 $ 348,606 $ 518,707
Total assets...................................... 1,883,541 1,952,778 2,128,703 2,582,475
Total debt........................................ 1,091,136 906,688 783,431 763,648
Stockholders' equity.............................. 209,557 372,945 634,826 777,558
</TABLE>
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------------------- -----------------------
1991 1992 1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue........................ $1,748,734 $2,542,455 $3,532,089 $3,715,214 $4,232,962 $1,904,167 $2,551,967
Cost of goods sold................. 944,305 1,555,190 2,031,910 2,113,176 2,271,332 1,106,727 1,293,770
---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross margin....................... 804,429 987,265 1,500,179 1,602,038 1,961,630 797,440 1,258,197
Selling, general and administrative
expenses......................... 859,036 857,398 1,859,319 1,468,513 1,652,784 765,863 855,268
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from operations...... (54,607) 129,867 (359,140) 133,525 308,846 31,577 402,929
Interest (expense) income,
net.............................. 39,375 23,470 17,007 32,677 21,142 7,061 13,712
Pro forma net income (loss)(1)..... 1,984 98,982 (190,963) 95,174 187,629 18,908 222,961
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
---------- ---------- ---------- ---------- ---------- -----------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.................... $ 629,897 $ 709,011 $ 316,350 $ 466,420 $ 655,395 $ 738,022
Total assets....................... 786,820 1,127,656 1,633,407 1,277,526 1,348,321 1,614,829
Total debt......................... -- -- -- 43,185 31,699 47,805
Stockholders' equity............... 722,077 840,627 542,391 717,884 851,038 922,765
</TABLE>
- ---------------
(1) Pro forma net income (loss) represents the effect of taxing the entity under
Subchapter C of the Internal Revenue Code.
20
<PAGE> 23
ROLF COAL AND FUEL CORP.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------------------- -----------------------
1991 1992 1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue........................ $2,880,070 $2,860,888 $3,036,009 $3,977,013 $4,104,580 $2,161,613 $2,448,305
Cost of goods sold................. 1,539,195 1,527,438 1,516,213 1,940,213 1,866,607 1,058,267 949,703
---------- ---------- ---------- ---------- ---------- ---------- ----------
Gross margin....................... 1,340,875 1,333,450 1,519,796 2,036,800 2,237,973 1,103,346 1,498,602
Selling, general and administrative
expenses......................... 1,269,951 1,361,967 1,568,095 1,941,143 2,142,778 1,290,320 1,528,166
---------- ---------- ---------- ---------- ---------- ---------- ----------
Income (loss) from operations...... 70,924 (28,517) (48,299) 95,657 95,195 (186,974) (29,564)
Interest (expense) income, net..... (16,881) (16,113) (13,576) (7,560) (2,043) (20,159) (19,867)
Net income (loss).................. 40,045 (33,836) (19,954) 69,952 44,107 (143,177) (15,481)
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
---------- ---------- ---------- ---------- ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.................... $ 123,514 $ 182,473 $ 205,142 $ 110,102 $ 93,231 $ 55,633
Total assets....................... 794,309 760,296 761,224 1,031,011 1,405,081 1,312,853
Total debt......................... 278,000 175,518 83,424 118,148 39,037 151,277
Stockholders' equity............... 285,544 251,708 231,754 301,706 345,813 300,332
</TABLE>
ALL REMAINING PREDECESSOR COMPANIES(1)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------------------- -----------------------
1991(2) 1992(2) 1993(2) 1994(2) 1995 1995 1996
---------- ---------- ---------- ----------- ----------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue...................... $3,746,174 $4,641,432 $6,592,940 $12,052,834 $16,866,945 $7,940,353 $8,711,484
Cost of goods sold............... 2,454,816 3,101,999 4,193,584 7,949,692 10,193,651 4,996,687 5,406,959
---------- ---------- ---------- ----------- ----------- ---------- ----------
Gross margin..................... 1,291,358 1,539,433 2,399,356 4,103,142 6,673,294 2,943,666 3,304,525
Selling, general and
administrative expenses........ 1,224,871 1,489,548 2,077,692 3,526,100 5,065,741 2,337,681 3,157,645
---------- ---------- ---------- ----------- ----------- ---------- ----------
Income from operations........... 66,487 49,885 321,664 577,042 1,607,553 605,985 146,880
Interest (expense) income,
net............................ (29,664) (29,540) (39,852) (65,873) (88,393) (32,036) (40,929)
Pro forma net income(3).......... 8,624 7,732 190,060 298,226 970,385 387,713 145,975
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------------------- JUNE 30,
1991 1992 1993 1994 1995 1996
---------- ---------- ---------- ----------- ----------- -------------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital............... $ 261,100 $ 226,982 $ 602,539 $ 319,557 $ 1,317,893 $1,100,260
Total assets.................. 1,028,014 1,219,557 1,866,168 3,709,972 4,992,214 5,779,951
Total debt.................... 376,446 697,147 482,866 1,173,567 1,081,892 1,087,904
Stockholders' equity.......... 462,303 456,511 732,384 1,214,560 2,463,709 2,388,133
</TABLE>
- ---------------
(1) Air Experts, a United Services Co., Inc., Arrow Heating & Air Conditioning,
Inc., Brand Heating & Air Conditioning, Inc., Coastal Air Conditioning
Service, Inc., Gilley's Heating & Cooling, Inc., and Service Experts of Palm
Springs, Inc.
(2) The selected financial data above represents the six smallest (by revenue)
Predecessor Companies which have been combined for the period from January
1, 1991 through June 30, 1996 except for the following Predecessor Companies
which are included from the date operations commenced as follows: Air
Experts, a United Services Co., Inc. -- January 1, 1994; Arrow Heating & Air
Conditioning, Inc. -- January 29, 1993; Service Experts of Palm Springs,
Inc. -- October 15, 1993.
(3) Pro forma net income represents the effect of taxing the entity under
Subchapter C of the Internal Revenue Code.
21
<PAGE> 24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the information
contained in the combined Financial Statements and Pro Forma Combining Financial
Information, including the Notes thereto, and the other financial information
appearing elsewhere in this Prospectus.
COMBINED PREDECESSOR COMPANIES
Overview
Simultaneously with, and as a condition to, the completion of the Offering,
the Company will acquire all of the outstanding capital stock of the Predecessor
Companies. Because the Predecessor Companies are independent entities that have
not been operated by the Company's management prior to the Combination, the
historical combined results do not reflect the Company's actual operations on a
consolidated basis and therefore may not be indicative of future performance.
For all periods presented, the Combined Financial Statements include the
financial information of the Predecessor Companies on a historical basis, as if
they had always been members of the same operating entity without giving effect
to the Combination, the Offering, or the realization of any operating
efficiencies that the Company believes typically would be attainable in an
integrated organization. Although the Predecessor Companies are not under common
control prior to the Combination, management believes that a combined
presentation of financial information is most meaningful to investors'
understanding of the results of operations, financial condition, and cash flows
of the Predecessor Companies.
Management believes that the Predecessor Companies, on an individual basis,
generally have been successful by implementing the strategies and
recommendations of CSG. All of the Service Centers are members of CSG and
operate in accordance with its recommended methods and procedures. Management
further believes that certain efficiencies will be derived once the Predecessor
Companies are consolidated. These efficiencies will include centralized
negotiation of contracts with major suppliers and insurance carriers,
consolidation of certain accounting and administration functions, implementation
of a more efficient cash management system and consolidation of employee
benefits programs. A portion of any operating efficiencies will be offset by
increased general and administrative expenses at the Company's corporate
headquarters. There can be no assurance that the Company will be able to
integrate successfully the businesses of the Predecessor Companies or to operate
profitably. In addition, there can be no assurance that management will be able
to effectively manage the combined entity and effectively implement the
Company's operating and acquisition strategies. Failure to integrate
successfully the Predecessor Companies and to implement the Company's operating
and acquisition strategies could have a material adverse effect on the Company's
net revenue and earnings.
The Predecessor Companies have been managed throughout the periods
presented 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. These owners and
certain key employees have agreed to certain reductions in their compensation in
connection with the Combination. These reductions equaled approximately $3.5
million based upon 1995 actual compensation expense.
Management believes that the Company will, upon completion of the
Combination, be positioned to capitalize on the fragmentation and growth of the
HVAC service and replacement industry. The Company intends to implement an
aggressive acquisition strategy which will target for acquisition as "hubs" CSG
members with strong management that are within a desirable geographic area,
financially stable, experienced in the industry and familiar with CSG operating
methods. The Company also plans to increase its market presence through
acquisitions of other HVAC businesses that have long operating histories, large
customer bases, experienced management and who present opportunities to reduce
overhead expenses or dispose of fixed assets to improve profitability. In
addition, management believes that it will be able to improve the financial
performance of acquired companies through the implementation of the methods and
procedures developed by CSG. There can be no assurance the Company's acquisition
strategy will be successful, that modifications to
22
<PAGE> 25
the Company's strategy will not be required or that the Company will be able to
obtain adequate financing on reasonable terms to develop or acquire additional
HVAC service businesses.
Components of Income
Net revenue of the Predecessor Companies has been derived primarily from
the following sources (i) the installation of central air conditioners, furnaces
and heat pumps primarily in existing homes; (ii) the service and maintenance of
central air conditioners, furnaces and heat pumps primarily in existing homes;
and (iii) the marketing of proprietary products by CSG. 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 consist of purchased
materials such as replacement air conditioning units and heat pumps and the
labor associated with both installations and repair orders. The main components
of selling, general and administrative expenses include administrative salaries,
insurance expense and promotion and advertising expenses.
Results of Operations
The following tables set forth certain income statement items as a
percentage of net revenue for the fiscal years ended December 31, 1993, 1994,
and 1995 and for the six months ended June 30, 1995 and 1996 for the combined
Predecessor Companies.
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
----------------------- --------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net revenue............................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold..................................... 62.9 63.8 60.7 62.4 60.5
----- ----- ----- ----- -----
Gross margin........................................... 37.1 36.2 39.3 37.6 39.5
Selling, general and administrative expenses........... 34.0 31.5 31.4 32.1 34.4
----- ----- ----- ----- -----
Income from operations................................. 3.1% 4.7% 7.9% 5.5% 5.1%
===== ===== ===== ===== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $4.1 million, or 14.5%, from $28.1
million for the six months ended June 30, 1995 to $32.2 million for the six
months ended June 30, 1996. Management believes that the increase in net
revenues was primarily attributable to continued focus on the promotion of
service contracts, continued implementation of CSG programs and techniques and
increased advertising.
Cost of Goods Sold. Cost of goods sold increased $2.0 million or 11.1%,
from $17.5 million for the six months ended June 30, 1995 to $19.5 million for
the six months ended June 30, 1996. As a percentage of net revenue, cost of
goods sold decreased 1.8% from 62.4% for the six months ended June 30, 1995 to
60.5% for the six months ended June 30, 1996. The decrease as a percentage of
net revenue is attributable to increased control of the fixed component of cost
of goods sold, the increase in net revenue and a favorable product mix.
Gross Margin/Profit. Gross margin increased $2.1 million, or 20.1%, from
$10.6 million for the six months ended June 30, 1995 to $12.7 million for the
six months ended June 30, 1996. As a percentage of net revenue, gross margin
increased 1.9% from 37.6% for the six months ended June 30, 1995 to 39.5% for
the six months ended June 30, 1996,
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $2.0 million, or 22.8%, from $9.1 million for
the six months ended June 30, 1995 to $11.1 million for the six months ended
June 30, 1996. As a percentage of net revenue, selling, general and
administrative expenses increased 2.3% from 32.1% for the six months ended June
30, 1995 to 34.4% for the six months ended June 30, 1996. This increase as a
percentage of net revenue was primarily attributable to an increase in
compensation expense resulting primarily from special S corporation
distributions in anticipation of the Combination.
23
<PAGE> 26
Income from Operations. Income from operations for the six months ended
June 30, 1996 increased $69,000, or 4.4%, compared to the six months ended June
30, 1995. Increases in selling, general and administrative expenses described
above offset gains in gross margin from revenue increases.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $11.2 million, or 23.1%, from $48.5
million for the twelve months ended December 31, 1994 to $59.7 million for the
twelve months ended December 31, 1995. Management believes that the increase in
net revenues was primarily attributable to the Company's continued focus on the
promotion of service contracts, continued implementation of CSG programs and
techniques and increased advertising.
Cost of Goods Sold. Cost of goods sold increased $5.3 million, or 17.1%,
from $30.9 million for the twelve months ended December 31, 1994 to $36.2
million for the twelve months ended December 31, 1995. As a percentage of net
revenue, cost of goods sold decreased 3.1% from 63.8% for the twelve months
ended December 31, 1994 to 60.7% for the twelve months ended December 31, 1995.
The decrease as a percentage of net revenue is attributable to increased control
of the fixed component of cost of goods sold, the increase in net revenue and
favorable product mix.
Gross Margin/Profit. Gross margin increased $5.8 million, or 33.5%, from
$17.6 million for the twelve months ended December 31, 1994 to $23.4 million for
the twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 3.1% from 36.2% for the twelve months ended December 31, 1994
to 39.3% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue is attributable to increased control of the fixed
component of cost of goods sold, the increase in net revenue and favorable
product mix.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $3.4 million, or 22.5%, from $15.3 million for
the twelve months ended December 31, 1994 to $18.7 million for the twelve months
ended December 31, 1995. As a percentage of net revenue, selling, general and
administrative expenses decreased marginally to 31.4% for the twelve months
ended December 31, 1995.
Income from Operations. Income from operations for the twelve months ended
December 31, 1995 increased $2.4 million, or 106.5%, from $2.3 million for the
twelve months ended December 31, 1994 to $4.7 million for the twelve months
ended December 31, 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $12.7 million, or 35.5%, from $35.8
million for the twelve months ended December 31, 1993 to $48.5 million for the
twelve months ended December 31, 1994. Management believes that the increase in
net revenues was primarily attributable to continued focus on the promotion of
service contracts and increased advertising.
Cost of Goods Sold. Cost of goods sold increased $8.4 million, or 37.3%,
from $22.5 million for the twelve months ended December 31, 1993 to $30.9
million for the twelve months ended December 31, 1994. As a percentage of net
revenue, cost of goods sold increased slightly to 63.8% for the twelve months
ended December 31, 1994.
Gross Margin/Profit. Gross margin increased $4.3 million, or 32.3%, from
$13.3 million for the twelve months ended December 31, 1993 to $17.6 million for
the twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin was relatively flat, decreasing .9% from 37.1% for the twelve months
ended December 31, 1993 to 36.2% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $3.1 million, or 25.4%, from $12.2 million for
the twelve months ended December 31, 1993 to $15.3 million for the twelve months
ended December 31, 1994. As a percentage of net revenue, selling, general and
administrative expenses decreased 2.5% from 34.0% for the twelve months ended
December 31, 1993 to 31.5%
24
<PAGE> 27
for the twelve months ended December 31, 1994. The decrease as a percentage of
net revenue was attributable to the increase in net revenues and the relatively
fixed nature of these expenses.
Income from Operations. Income from operations increased $1.2 million, or
109.7%, from $1.1 million for the twelve months ended December 31, 1993 to $2.3
million for the twelve months ended December 31, 1994.
Liquidity and Capital Resources
Historically, the operations and growth of the Predecessor Companies have
been financed through internally generated working capital and borrowings from
commercial banks or other lenders. Management expects that approximately $1.0
million of the net proceeds of the Offering will be used to repay substantially
all of the outstanding indebtedness of the Predecessor Companies. These
borrowings are generally secured by substantially all of the assets of the
respective Predecessor Company as well as personal guarantees of the respective
owners. The Company intends to enter into an agreement with a commercial bank to
establish a revolving credit facility upon the completion of the Offering. The
Company has received a commitment from The Boatmen's National Bank of St. Louis
for a revolving credit facility in the principal amount of $5 million and a
credit facility for acquisitions in the principal amount of $20 million.
Borrowings under the credit facility will be secured by first priority liens on
all assets of the Company, including stock of its subsidiaries, and will bear
interest at the lender's base rate or LIBOR (at the Company's option) plus a
percentage determined based upon the ratio of cash flow to total funded debt.
The definitive loan documents will contain standard representations, covenants,
conditions, events of defaults and indemnities. The Company will be required to
pay a facility fee at closing of 1/4% of the aggregate commitment amount and an
annual commitment fee in the same amount. Principal and interest will be payable
quarterly.
For the years ended December 31, 1993, 1994 and 1995, net cash provided by
operating activities was $3.1 million, $2.3 million and $5.0 million,
respectively. For the six months ended June 30, 1996, net cash provided by
operating activities was approximately $1.7 million.
The Company's primary requirements for capital (other than those related to
acquisitions) consist of purchasing inventory, supplies and vehicles used in the
operation of the business. For the years ended December 31, 1993, 1994 and 1995,
net cash used by investing activities was $793,000, $1.7 million and $1.6
million, respectively. For the six months ended June 30, 1996, net cash used by
investing activities was approximately $637,000.
Management intends to increase the Company's service area primarily through
the acquisition of additional Service Centers. Because of the fragmented nature
of the industry and the size of CSG's membership, management believes that a
number of acquisition opportunities are available within the residential HVAC
service industry. Acquisitions will vary in size and the Company may consider
larger acquisition opportunities which could be material to the Company. There
can be no assurance that the Company will be able to acquire additional Service
Centers, or that any Service Centers that might be acquired would be
successfully and profitably integrated into the Company's operations.
Management believes that the proceeds of the Offering, together with
internally generated working capital and any additional borrowings, will be
adequate to fund operations and expansion plans of the Company for at least the
next twenty-four months. To provide any additional funds necessary for the
continued pursuit of the Company's growth strategy, the Company may incur, from
time to time, additional bank indebtedness and may issue, in public or private
transactions, its equity and debt securities, the availability and terms of
which will depend upon market and other conditions. Although the Company
recently obtained a commitment for a revolving credit facility from The
Boatmen's National Bank of St. Louis, as disclosed above, there can be no
assurance that sufficient additional financing will be available on terms
acceptable 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 service businesses.
25
<PAGE> 28
Newly Issued Accounting Standards
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
CERTAIN INDIVIDUAL PREDECESSOR COMPANIES
The following presents management's discussion of the results of
operations, as presented in the financial statements of certain Predecessor
Companies appearing elsewhere in this Prospectus, of CSG and the six largest
Predecessor Companies for the fiscal years ended December 31, 1993, 1994 and
1995 and for the three months ended March 31, 1995 and 1996.
CONTRACTOR SUCCESS GROUP, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------------------- -------------------------------
1993 1994 1995 1995 1996
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue................................. $2,414 100.0% $2,741 100.0% $3,229 100.0% $1,570 100.0% $1,694 100.0%
Cost of goods sold.......................... 466 19.3 415 15.2 615 19.1 263 16.8 301 17.7
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin................................ 1,948 80.7 2,326 84.8 2,614 80.9 1,307 83.2 1,393 82.3
Selling, general and administrative
expenses.................................. 1,225 50.7 1,456 53.1 1,339 41.5 537 34.2 732 43.3
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income from operations...................... $ 723 30.0% $ 870 31.7% $1,275 39.5% $ 770 49.0% $ 661 39.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. CSG derives its net revenue from initial membership fees,
quarterly dues from members and from sales of proprietary products. Net revenue
increased $124,000, or 7.9%, from $1.6 million for the six months ended June 30,
1995 to $1.7 million for the six months ended June 30, 1996. The increase in net
revenue was primarily attributable to expanding the number of licensed
territories and increased marketing of new products.
Cost of Goods Sold. Cost of goods sold increased $37,000, or 14.2%, from
$263,000 for the six months ended June 30, 1995 to $301,000 for the six months
ended June 30, 1996. As a percentage of net revenue, cost of goods sold
increased from 16.8% for the six months ended June 30, 1995 to 17.7% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to the product mix.
Gross Margin/Profit. Gross margin increased $86,000, or 6.6%, from $1.3
million for the six months ended June 30, 1995 to $1.4 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
remained relatively flat decreasing .9% from 83.2% for the six months ended June
30, 1995 to 82.3% for the six months ended June 30, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $195,000, or 36.3%, from $537,000 for the six
months ended June 30, 1995 to $732,000 for the six months ended June 30, 1996.
As a percentage of net revenue, selling, general and administrative expenses
increased from 34.2% for the six months ended June 30, 1995 to 43.3% for the six
months ended June 30, 1996. The increase as a percentage of net revenue was
primarily attributable to increases in legal, rental, travel, printing and
promotional expenses.
Income from Operations. Income from operations decreased $109,000, or
14.2%, from $770,000 for the six months ended June 30, 1995 to $661,000 for the
six months ended June 30, 1996. As a percentage of net
26
<PAGE> 29
revenue, income from operations decreased from 49.0% for the six months ended
June 30, 1995 to 39.0% for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $489,000, or 17.8%, from $2.7 million
in 1994 to $3.2 million in 1995. The increase in net revenue was primarily
attributable to expanding the number of licensed territories and increased
marketing of new products.
Cost of Goods Sold. Cost of goods sold increased $200,000, or 48.3%, from
$415,000 in 1994 to $615,000 in 1995. As a percentage of net revenue, cost of
goods sold increased from 15.2% in 1994 to 19.1% in 1995. The increase as a
percentage of net revenue was primarily attributable to costs associated with
several new products produced during 1995.
Gross Margin/Profit. Gross margin increased $300,000, or 12.4%, from $2.3
million for the twelve months ended December 31, 1994 to $2.6 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin decreased 4.0% from 84.9% for the twelve months ended December 31, 1994
to 80.9% for the twelve months ended December 31, 1995. The decrease as a
percentage of net revenue is attributable to the costs associated with several
new products produced during 1995.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $117,000, or 8.0%, from $1.5 million in 1994
to $1.3 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses decreased from 53.1% in 1994 to 41.5% in 1995. The
decrease as a percentage of net revenue was primarily attributable to the
increase in net revenue and the relatively fixed nature of CSG's expenses.
Income from Operations. Income from operations increased $405,000, or
46.6%, from $870,000 in 1994 to $1.3 million in 1995. As a percentage of net
revenue, income from operations increased from 31.7% in 1994 to 39.5% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $326,000, or 13.5%, from $2.4 million
in 1993 to $2.7 million in 1994. The increase in net revenue was primarily
attributable to expanding the number of territories licensed and increased
marketing of proprietary products.
Cost of Goods Sold. Cost of goods sold decreased $51,000, or 11.0%, from
$466,000 in 1993 to $415,000 in 1994. As a percentage of net revenue, cost of
goods sold decreased from 19.3% in 1993 to 15.2% in 1994. The decrease as a
percentage of net revenue was primarily attributable to the increase in net
revenue and the relatively fixed nature of CSG's expenses.
Gross Margin/Profit. Gross margin increased $378,000, or 19.4%, from $1.9
million for the twelve months ended December 31, 1993 to $2.3 million for the
twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin increased 4.2% from 80.7% for the twelve months ended December 31, 1993
to 84.9% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $231,000, or 18.9%, from $1.2 million in 1993
to $1.5 million in 1994. As a percentage of net revenue, selling, general and
administrative expenses increased from 50.7% in 1993 to 53.1% in 1994. The
increase as a percentage of net revenue was primarily attributable to increased
compensation expense.
Income from Operations. Income from operations increased $147,000, or
20.2%, from $723,000 in 1993 to $870,000 in 1994. As a percentage of net
revenue, income from operations increased from 30.0% in 1993 to 31.7% in 1994.
27
<PAGE> 30
Liquidity and Capital Resources
The following table sets forth selected information from CSG's statement of
cash flows (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
------------------------- -------------
1993 1994 1995 1995 1996
----- ------- ------- ----- -----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities.......... $ 995 $ 1,063 $ 1,552 $ 773 $ 437
Net cash used in investing activities................... (34) (10) (127) (120) (8)
Net cash used in financing activities................... (957) (1,014) (1,290) (328) (511)
----- ------- ------- ----- -----
Increase decrease in cash and cash equivalents.......... $ 4 $ 39 $ 135 $ 325 $ 82
====== ======== ======== ====== ======
</TABLE>
From 1993 through the six months ended June 30, 1996, CSG generated $4.0
million in net cash from operating activities. During this period, $4.2 million
was generated from net income plus non-cash charges. Cash used in investing
activities was primarily attributable to the purchase and replacement of office
equipment and other property and equipment. Cash used in financing activities
consists primarily of distributions to stockholders. From 1993 through the six
months ended June 30, 1996, CSG distributed $3.8 million to stockholders.
AC SERVICE & INSTALLATION CO., INC. AND DONELSON AIR CONDITIONING COMPANY, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------- --------------------------------
1993 1994 1995 1995 1996
-------------- -------------- -------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue............... $10,292 100.0% $14,299 100.0% $16,453 100.0% $7,671 100.0% $8,635 100.0%
Cost of goods sold........ 7,280 70.7 10,245 71.6 11,122 67.6 5,316 69.3 5,742 66.5
------- ----- ------- ----- ------- ----- ------ ----- ------ ------
Gross margin.............. 3,012 29.3 4,054 28.4 5,331 32.4 2,355 30.7 2,893 33.5
Selling, general and
administrative
expenses................ 2,909 28.3 3,786 26.5 4,592 27.9 2,253 29.4 3,024 35.0
------- ----- ------- ----- ------- ----- ------ ----- ------ ------
Income (loss) from
operations.............. $ 103 1.0% $ 268 1.9% $ 739 4.5% $ 102 1.3% $ (131) (1.5)%
======== ===== ======== ===== ======== ===== ====== ===== ====== ======
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $1.0 million, or 12.6%, from $7.7
million for the six months ended June 30, 1995 to $8.7 million for the six
months ended June 30, 1996. The increase in net revenue is primarily
attributable to promotion of service contracts and increased advertising.
Cost of Goods Sold. Cost of goods sold increased $426,000, or 8.0%, from
$5.3 million for the six months ended June 30, 1995 to $5.7 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
decreased from 69.3% for the six months ended June 30, 1995 to 66.5% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to the promotion of higher margin service contracts and
volume purchasing discounts.
Gross Margin/Profit. Gross margin increased $537,000, or 22.8%, from $2.4
million for the six months ended June 30, 1995 to $2.9 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
increased 2.8% from 30.7% for the six months ended June 30, 1995 to 33.5% for
the six months ended June 30, 1996. The increase as a percentage of net revenue
was primarily attributable to the promotion of higher margin service contracts
and volume purchasing discounts.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $771,000, or 34.2%, from $2.2 million for the
six months ended June 30, 1995 to $3.0 million for the six
28
<PAGE> 31
months ended June 30, 1996. As a percentage of net revenue, selling, general and
administrative expenses increased from 29.4% for the six months ended June 30,
1995 to 35.0% for the six months ended June 30, 1996. The increase as a
percentage of net revenue was primarily attributable to an increase in
compensation expense resulting from special S corporation distributions in
anticipation of the Combination.
Income (Loss) from Operations. Income from operations decreased $233,000,
or 228.4%, from $102,000 for the six months ended June 30, 1995 to ($131,000)
for the six months ended June 30, 1996. As a percentage of net revenue, income
from operations decreased from 1.3% for the six months ended June 30, 1995 to
(1.5)% for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $2.2 million, or 15.1%, from $14.3
million in 1994 to $16.5 million in 1995. The increase in net revenue was
primarily attributable to promotion of service contracts and increased
advertising.
Cost of Goods Sold. Cost of goods sold increased $877,000, or 8.6%, from
$10.2 million in 1994 to $11.1 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 71.6% in 1994 to 67.6% in 1995. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on more
profitable products, improved employee training and volume purchasing discounts.
Gross Margin/Profit. Gross margin increased $1.3 million, or 31.5%, from
$4.0 million for the twelve months ended December 31, 1994 to $5.3 million for
the twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 4.0% from 28.4% for the twelve months ended December 31, 1994
to 32.4% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to the emphasis on more
profitable products, improved employee training and volume purchasing discounts.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $805,000, or 21.3%, from $3.8 million in 1994
to $4.6 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses increased from 26.5% in 1994 to 27.9% in 1995. The
increase as a percentage of net revenue was primarily attributable to increased
management personnel added to support recent growth.
Income from Operations. Income from operations increased $471,000, or
176.0%, from $268,000 in 1994 to $739,000 in 1995. As a percentage of net
revenue, income from operations increased from 1.9% in 1994 to 4.5% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $4.0 million, or 38.9%, from $10.3 in
1993 to $14.3 in 1994. The increase in net revenue was primarily attributable to
the implementation of a 24-hour service policy, promotion of service contracts
and increased advertising.
Cost of Goods Sold. Cost of goods sold increased $2.9 million, or 40.7%,
from $7.3 million in 1993 to $10.2 million in 1994. As a percentage of net
revenue, cost of goods sold increased slightly from 70.7% in 1993 to 71.6% in
1994.
Gross Margin/Profit. Gross margin increased $1.0 million, or 34.6%, from
$3.0 million for the twelve months ended December 31, 1993 to $4.0 million for
the twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin decreased .9% from 29.3% for the twelve months ended December 31, 1993 to
28.4% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $877,000, or 30.2%, from $2.9 million in 1993
to $3.8 million in 1994. As a percentage of net revenue, selling, general and
administrative expenses decreased from 28.3% in 1993 to 26.5% in 1994. The
decrease as a percentage of net revenue was primarily attributable to the
increase in net revenue and the relatively fixed nature of these expenses.
29
<PAGE> 32
Income from Operations. Income from operations increased $165,000, or
158.6%, from $103,000 in 1993 to $268,000 in 1994. As a percentage of net
revenue, income from operations increased from 1.0% in 1993 to 1.9% in 1994.
Liquidity and Capital Resources
The following table sets forth selected information from the combined
statement of cash flows of AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER ENDED
31, JUNE 30,
--------------------- -------------
1993 1994 1995 1995 1996
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities... $ 548 $ 264 $ 579 $ 179 $ 783
Net cash used in investing activities............ (242) (504) (613) (468) (42)
Net cash provided by (used in) financing
activities..................................... (221) 63 219 291 (448)
----- ----- ----- ----- -----
Increase (decrease) in cash and cash
equivalents.................................... $ 85 $(177) $ 185 $ 2 $ 293
===== ===== ===== ===== =====
</TABLE>
From 1993 through the six months ended June 30, 1996, AC Service &
Installation Co., Inc. and Donelson Air Conditioning Company, Inc. generated
$2.2 million in net cash from operating activities. During this period, $1.9
million was generated from net income plus noncash charges, and working capital
did not require any net cash. Cash used in investing activities was primarily
attributable to the purchase and replacement of service and delivery trucks.
Cash used in financing activities consists primarily of payments on long-term
debt and the proceeds from notes payable to stockholders.
HARDWICK AIR MASTERS, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------------------- ---------------------------------
1993 1994 1995 1995 1996
--------------- --------------- --------------- --------------- ---------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue.................. $3,990 100.0% $4,798 100.0% $6,377 100.0% $2,965 100.0% $3,878 100.0%
Cost of goods sold........... 2,987 74.9 3.418 71.2 4,556 71.4 2,083 70.3 2,856 73.7
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin................. 1,003 25.1 1,380 28.8 1,821 28.6 882 29.7 1,022 26.3
Selling, general and
administrative expenses.... 918 23.0 1,311 27.4 1,577 24.8 742 25.0 779 20.1
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income from operations....... $ 85 2.1% $ 69 1.4% $ 244 3.8% $ 140 4.7% $ 243 6.2%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $913,000, or 30.8%, from $3.0 million
for the six months ended June 30, 1995 to $3.9 million for the six months ended
June 30, 1996. The increase in net revenue was primarily attributable to
increased advertising, sales training and a focus on providing customers a
complete service package, resulting in higher average revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $773,000, or 37.1%, from
$2.1 million for the six months ended June 30, 1995 to $2.9 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
increased from 70.3% for the six months ended June 30, 1995 to 73.7% for the six
months ended June 30, 1996.
30
<PAGE> 33
Gross Margin/Profit. Gross margin increased $140,000, or 15.9%, from
$900,000 for the six months ended June 30, 1995 to $1.0 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
decreased 3.4% from 29.7% for the six months ended June 30, 1995 to 26.3% for
the six months ended June 30, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $37,000, or 4.9%, from $742,000 for the six
months ended June 30, 1995 to $779,000 for the six months ended June 30, 1996.
As a percentage of net revenue, selling, general and administrative expenses
decreased from 25.0% for the six months ended June 30, 1995 to 20.1% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to the increase in net revenue and the relatively fixed
nature of these expenses.
Income from Operations. Income from operations increased $103,000, or
74.1%, from $140,000 for the six months ended June 30, 1995 to $243,000 for the
six months ended June 30, 1996. As a percentage of net revenue, income from
operations increased from 4.7% for the six months ended June 30, 1995 to 6.2%
for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $1.6 million, or 32.9%, from $4.8
million in 1994 to $6.4 million in 1995. The increase in net revenue was
primarily attributable to increased advertising, sales training and a focus on
providing customers a complete service package, resulting in higher average
revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $1.2 million, or 33.3%,
from $3.4 million in 1994 to $4.6 million in 1995. As a percentage of net
revenue, cost of goods sold remained relatively constant at 71.4%.
Gross Margin/Profit. Gross margin increased $441,000, or 32.0%, from $1.4
million for the twelve months ended December 31, 1994 to $1.8 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin was relatively flat decreasing .2% from 28.8% for the twelve months ended
December 31, 1994 to 28.6% for the twelve months ended December 31, 1995.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $266,000, or 20.3%, from $1.3 million in 1994
to $1.6 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses decreased from 27.4% in 1994 to 24.8% in 1995. The
decrease as a percentage of net revenue was primarily attributable to the
increase in net revenue and the relatively fixed nature of these expenses.
Income from Operations. Income from operations increased $175,000, or
254.2%, from $69,000 in 1994 to $244,000 in 1995. As a percentage of net
revenue, income from operations increased from 1.4% in 1994 to 3.9% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $808,000, or 20.3%, from $4.0 million
in 1993 to $4.8 million in 1994. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $431,000, or 14.4%, from
$3.0 million in 1993 to $3.4 million in 1994. As a percentage of net revenue,
cost of goods sold decreased from 74.9% in 1993 to 71.2% in 1994. The decrease
as a percentage of net revenue was primarily attributable to increased emphasis
on higher margin products and services.
Gross Margin/Profit. Gross margin increased $377,000, or 37.6%, from $1.0
million for the twelve months ended December 31, 1993 to $1.4 million for the
twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin increased 3.7% from 25.1% for the twelve months ended December 31, 1993
to 28.8% for the twelve months ended December 31, 1994.
31
<PAGE> 34
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $393,000, or 42.8%, from $918,000 in 1993 to
$1.3 million in 1994. As a percentage of net revenue, selling, general and
administrative expenses increased from 23.0% in 1993 to 27.4% in 1994. The
increase as a percentage of net revenue was primarily attributable to increased
compensation expense.
Income from Operations. Income from operations decreased $16,000, or
19.1%, from $85,000 in 1993 to $69,000 in 1994. As a percentage of net revenue,
income from operations decreased from 2.1% in 1993 to 1.4% in 1994.
Liquidity and Capital Resources
The following table sets forth selected information from the statement of
cash flows of Hardwick Air Masters, Inc. (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER ENDED
31, JUNE 30,
-------------------- ------------
1993 1994 1995 1995 1996
----- ---- ----- ----- ----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities..... $ 60 $154 $ 133 $ 67 $336
Net cash used in investing activities.............. (192) (90) (290) (172) (37)
Net cash provided by (used in) financing
activities....................................... 169 (48) 134 95 (241)
----- ---- ----- ----- ----
Increase (decrease) in cash and cash equivalents... $ 37 $ 16 $ (23) $ (10) $ 58
===== ==== ===== ===== ====
</TABLE>
From 1993 through the six months ended March 31, 1996, Hardwick Air
Masters, Inc. generated $683,000 in net cash from operating activities. During
this period, $833,000 was generated from net income plus non-cash charges, and
was reduced by $150,000 of cash used to fund increases in working capital. Cash
used in investing activities was primarily attributable to the purchase and
replacement of service and delivery trucks. Cash provided by (used in) financing
activities consists primarily of proceeds from long-term debt.
NORRELL HEATING & AIR CONDITIONING, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------------------- --------------------------------
1993 1994 1995 1995 1996
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue.................. $3,274 100.0% $3,509 100.0% $4,266 100.0% $1,972 100% $2,048 100%
Cost of goods sold........... 2,286 69.8 2,437 69.4 2,853 66.9 1,335 67.7 1,407 68.7
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin................. 988 30.2 1,072 30.6 1,413 33.1 637 32.3 641 31.3
Selling, general and
administrative expenses.... 992 30.3 1,072 30.6 1,384 32.4 686 34.8 588 28.7
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss) from
operations................. $ (4) (0.1)% $ 0 0.0% $ 29 0.7% $ (49) (2.5)% $ 53 2.6%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $76,000, or 3.8%, from $2.0 million for
the six months ended June 30, 1995 to $2.1 million for the six months ended June
30, 1996.
Cost of Goods Sold. Cost of goods sold increased $72,000, or 5.4%, from
$1.3 million for the six months ended June 30, 1995 to $1.4 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
increased from 67.7% for the six months ended June 30, 1995 to 68.7% for the six
months ended June 30, 1996.
32
<PAGE> 35
Gross Margin/Profit. Gross margin increased $4,000, or .6%, from $637,000
for the six months ended June 30, 1995 to $641,000 for the six months ended June
30, 1996. As a percentage of net revenue, gross margin decreased 1.0% from 32.3%
for the six months ended June 30, 1995 to 31.3% for the six months ended June
30, 1996.
Income from Operations. Income from operations increased $102,000, or
208.1%, from $(49,000) for the six months ended June 30, 1995 to $53,000 for the
six months ended June 30, 1996. As a percentage of net revenue, income from
operations increased from (2.5)% for the six months ended June 30, 1995 to 2.6%
for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $757,000, or 21.6%, from $3.5 million
in 1994 to $4.3 million in 1995. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $416,000, or 17.1%, from
$2.4 million in 1994 to $2.9 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 69.4% in 1994 to 66.9% in 1995. The decrease
as a percentage of net revenue was primarily attributable to a focus on higher
margin products and services.
Gross Margin/Profit. Gross margin increased $341,000, or $31.8, from $1.1
million for the twelve months ended December 31, 1994 to $1.4 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 2.5% from 30.6% for the twelve months ended December 31, 1994
to 33.1% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to a focus on higher margin
products and services.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $312,000, or 29.1%, from $1.1 million in 1994
to $1.4 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses increased from 30.6% in 1994 to 32.4% in 1995. The
increase as a percentage of net revenue was primarily attributable to increased
compensation expense.
Income from Operations. Income from operations increased $29,000 from $0
in 1994 to $29,000 in 1995. As a percentage of net revenue, income from
operations increased from 0.0% in 1994 to 0.7% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $235,000, or 7.2%, from $3.3 million in
1993 to $3.5 million in 1994. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $151,000, or 6.6%, from
$2.3 million in 1993 to $2.4 million in 1994. As a percentage of net revenue,
cost of goods sold was relatively unchanged at 69.4%.
Gross Margin/Profit. Gross margin increased $84,000, or 8.4%, from $1.0
million for the twelve months ended December 31, 1993 to $1.1 million for the
twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin increased .4% from 30.2% for the twelve months ended December 31, 1993 to
30.6% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased slightly to $1.1 million in 1994.
Income (Loss) from Operations. Income (loss) from operations increased
$4,000 from ($4,000) in 1993 to $0 in 1994.
33
<PAGE> 36
Liquidity and Capital Resources
The following table sets forth selected information from the statement of
cash flows of Norrell Heating & Air Conditioning, Inc. (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
------------------ -----------
1993 1994 1995 1995 1996
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities........ $310 $ 27 $639 $292 $(63)
Net cash provided by (used in) investing activities... (80) (85) (56) (61) 45
---- ---- ---- ---- ----
Increase (decrease) in cash and cash equivalents...... $230 $(58) $583 $231 $(18)
==== ==== ==== ==== ====
</TABLE>
From 1993 through the six months ended June 30, 1996, Norrell Heating & Air
Conditioning, Inc. generated $913,000 in net cash from operating activities.
During this period, $475,000 was generated from net income plus non-cash
charges, and was enhanced by $438,000 of cash from reductions in working
capital. Cash used in investing activities was primarily attributable to the
purchase and replacement of service and delivery trucks.
VISION HOLDING COMPANY, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------- ---------------------------------
1993(1) 1994 1995 1995 1996
-------------- -------------- -------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue............. $2,792 100.0% $3,525 100.0% $4,261 100.0% $2,008 100.0% $2,309 100.0%
Cost of goods sold...... 1,752 62.7 2,401 68.1 2,738 64.3 1,386 69.0 1,542 66.8
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin............ 1,040 37.3 1,124 31.9 1,523 35.7 622 31.0 767 33.2
Selling, general and
administrative
expenses.............. 771 27.6 847 24.0 1,093 25.6 475 23.7 483 20.9
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss) from
operations............ $ 269 9.7% $ 277 7.9% $ 430 10.1% $ 147 7.3% $ 284 12.3%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
- ---------------
(1) Period from March 1, 1993 through December 31, 1993.
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $301,000, or 15.0%, from $2.0 million
for the six months ended June 30, 1995 to $2.3 million for the six months ended
June 30, 1996. The increase in net revenue was primarily attributable to
increased advertising, sales training and a focus on providing customers a
complete service package, resulting in higher average revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $156,000, or 11.3%, from
$1.4 million for the six months ended June 30, 1995 to $1.5 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
decreased from 69.0% for the six months ended June 30, 1995 to 66.8% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on higher margin products and services.
Gross Margin/Profit. Gross margin increased $145,000, or 23.3%, from
$622,000 for the six months ended June 30, 1995 to $767,000 for the six months
ended June 30, 1996. As a percentage of net revenue, gross margin increased 2.2%
from 31.0% for the six months ended June 30, 1995 to 33.2% for the six months
ended June 30, 1996.
34
<PAGE> 37
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $8,000, or 1.7%, from $475,000 for the six
months ended June 30, 1995 to $483,000 for the six months ended June 30, 1996.
As a percentage of net revenue, selling, general and administrative expenses
decreased from 23.7% for the six months ended June 30, 1995 to 20.9% for the six
months ended June 30, 1996.
Income (Loss) from Operations. Income (loss) from operations increased
from $147,000 for the six months ended June 30, 1995 to $284,000 for the six
months ended June 30, 1996. As a percentage of net revenue, income (loss) from
operations increased from 7.3% for the six months ended June 30, 1995 to 12.3%
for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $736,000, or 20.9%, from $3.5 million
in 1994 to $4.3 million in 1995. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $338,000, or 14.1%, from
$2.4 million in 1994 to $2.7 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 68.1% in 1994 to 64.3% in 1995. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on
higher margin products and services.
Gross Margin/Profit. Gross margin increased $399,000, or 35.4%, from $1.1
million for the twelve months ended December 31, 1994 to $1.5 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 3.8% from 31.9% for the twelve months ended December 31, 1994
to 35.7% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to an emphasis on higher
margin products and services.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $246,000, or 29.0%, from $847,000 in 1994 to
$1.1 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses increased from 24.0% in 1994 to 25.6% in 1995.
Income from Operations. Income from operations increased $153,000, or
55.1%, from $277,000 in 1994 to $430,000 in 1995. As a percentage of net
revenue, income from operations increased from 7.9% in 1994 to 10.1% in 1995.
1994 Compared to Period from March 1, 1993 through December 31, 1993
Net Revenue. Net revenue increased $732,000, or 26.2%, from $2.8 million
in 1993 to $3.5 million in 1994. The increase in net revenue was primarily
attributable to an additional three months of operation in 1994.
Cost of Goods Sold. Cost of goods sold increased $648,000, or 37.0%, from
$1.8 million in 1993 to $2.4 million in 1994. As a percentage of net revenue,
cost of goods sold increased from 62.7% in 1993 to 68.1% in 1994.
Gross Margin/Profit. Gross margin increased $84,000 million, or 8.1%, from
$1.0 million for the twelve months ended December 31, 1993 to $1.1 million for
the twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin decreased 5.4% from 37.3% for the twelve months ended December 31, 1993
to 31.9% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $76,000, or 9.9%, from $771,000 in 1993 to
$847,000 in 1994. As a percentage of net revenue, selling, general and
administrative expenses decreased from 27.6% in 1993 to 24.0% in 1994. The
decrease as a percentage of net revenue was primarily attributable to increased
net revenue in 1994.
Income from Operations. Income from operations increased $8,000, or 3.0%,
from $269,000 in 1993 to $277,000 in 1994. As a percentage of net revenue,
income from operations decreased from 9.7% in 1993 to 7.9% in 1994.
35
<PAGE> 38
Liquidity and Capital Resources
The following table sets forth selected information from the statement of
cash flows of Vision Holding Company, Inc. (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
----------------------- -----------
1993(1) 1994 1995 1995 1996
------- ----- ----- ---- ----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities..... $ 317 $ 445 $ 531 $118 $208
Net cash provided by (used in) investing
activities....................................... (33) (330) 113 145 (90)
Net cash provided by (used in) financing
activities....................................... (88) (250) (123) 12 (20)
------- ----- ----- ---- ----
Increase (decrease) in cash and cash equivalents... $ 196 $(135) $ 521 $275 $ 98
====== ===== ===== ==== ====
</TABLE>
- ---------------
(1) Period from March 1, 1993 through December 31, 1993.
From March 1, 1993 through the six months ended June 30, 1996, Vision
Holding Company, Inc. generated $1.5 million in net cash from operating
activities. During this period, $1.3 million was generated from net income plus
non-cash charges, and was enhanced by $165,000 of cash from reductions in
working capital. Cash used in investing activities was primarily attributable to
the purchase and replacement of service and delivery trucks. Cash used in
financing activities consists primarily of payments on long-term debt.
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------------- ------------------------------
1993 1994 1995 1995 1996
-------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue.................... $3,532 100.0% $3,715 100.0% $4,233 100.0% $1,904 100.0% $2,552 100.0%
Cost of goods sold............. 2,032 57.6 2,113 56.9 2,271 53.7 1,107 58.1 1,294 50.7
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin................... 1,500 42.4 1,602 43.1 1,962 46.3 797 41.9 1,258 49.3
Selling, general and
administrative expenses...... 1,859 52.6 1,468 39.5 1,653 39.0 766 40.2 855 33.5
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss) from
operations................... $ (359) (10.2)% $ 134 3.6% $ 309 7.3% $ 31 1.7% $ 403 15.8%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $648,000, or 34%, from $1.9 million for
the six months ended June 30, 1995 to $2.6 million for the six months ended June
30, 1996. The increase in net revenue was primarily attributable to increased
advertising, sales training and a focus on providing customers a complete
service package, resulting in higher average revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $187,000, or 16.9%, from
$1.1 million for the six months ended June 30, 1995 to $1.3 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
decreased from 58.1% for the six months ended June 30, 1995 to 50.7% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on higher margin products and services.
Gross Margin/Profit. Gross margin increased $461,000, or 57.8%, from
$797,000 for the six months ended June 30, 1995 to $1.3 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
increased 7.4% from 41.9% for the six months ended June 30, 1995 to 49.3% for
the six months ended June 30, 1996.
36
<PAGE> 39
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $89,000, or 11.7%, from $766,000 for the six
months ended June 30, 1995 to $855,000 for the six months ended June 30, 1996.
As a percentage of net revenue, selling, general and administrative expenses
decreased from 40.2% for the six months ended June 30, 1995 to 33.5% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to the increase in net revenue.
Income from Operations. Income from operations increased $372,000, or
1,176%, from $31,000 for the six months ended June 30, 1995 to $403,000 for the
six months ended June 30, 1996. As a percentage of net revenue, income from
operations increased from 1.7% for the six months ended June 30, 1995 to 15.8%
for the six months ended June 30, 1996.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $518,000, or 13.9%, from $3.7 million
in 1994 to $4.2 million in 1995. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $158,000, or 7.5%, from
$2.1 million in 1994 to $2.3 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 56.9% in 1994 to 53.7% in 1995. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on
higher margin products and services.
Gross Margin/Profit. Gross margin increased $359,000, or 22.4%, from $1.6
million for the twelve months ended December 31, 1994 to $2.0 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 3.2% from 43.1% for the twelve months ended December 31, 1994
to 46.3% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to an emphasis on higher
margin products and services.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $184,000, or 12.5%, from $1.5 million in 1994
to $1.7 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses remained relatively constant at 39.0%.
Income from Operations. Income from operations increased $175,000, or
131.3%, from $134,000 in 1994 to $309,000 in 1995. As a percentage of net
revenue, income from operations increased from 3.6% in 1994 to 7.3% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $183,000, or 5.2%, from $3.5 million in
1993 to $3.7 million in 1994. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $81,000, or 4.0%, from
$2.0 million in 1993 to $2.1 million in 1994. As a percentage of net revenue,
cost of goods sold decreased from 57.6% in 1993 to 56.9% in 1994. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on
higher margin products and services.
Gross Margin/Profit. Gross margin increased $102,000, or 6.8%, from $1.5
million for the twelve months ended December 31, 1993 to $1.6 million for the
twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin increased .6% from 42.5% for the twelve months ended December 31, 1993 to
43.1% for the twelve months ended December 31, 1994, the increase as a
percentage of net revenue was primarily attributable to an emphasis on higher
margin products and services.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses decreased $391,000, or 21.0%, from $1.9 million in 1993
to $1.5 million in 1994. As a percentage of net revenue, selling, general and
administrative expenses decreased from 52.6% in 1993 to 39.5% in 1994.
37
<PAGE> 40
Income (Loss) from Operations. Income (loss) from operations increased
$493,000 to $134,000 in 1994 from ($359,000) in 1993. As a percentage of net
revenue, income (loss) from operations increased from (10.2%) in 1993 to 3.6% in
1994.
Liquidity and Capital Resources
The following table sets forth selected information from the statement of
cash flows of Comerford's Heating and Air Conditioning, Inc. (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER ENDED
31, JUNE 30,
--------------------- ------------
1993 1994 1995 1995 1996
----- ----- ----- ---- -----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by (used in) operating
activities...................................... $ 294 $(275) $ 614 $ 69 $(431)
Net cash used in investing activities............. (135) (104) (104) (104) (9)
Net cash used in financing activities............. (6) (10) (213) (6) (305)
----- ----- ----- ---- -----
Increase (decrease) in cash and cash
equivalents..................................... $ 153 $(389) $ 297 $(41) $(745)
===== ===== ===== ==== =====
</TABLE>
From 1993 through the six months ended June 30, 1996, Comerford's Heating
and Air Conditioning, Inc. generated $202,000 in net cash from operating
activities. During this period, $927,000 was generated from net income plus
non-cash charges, and was decreased by $724,000 of cash from reductions in
working capital. Cash used in investing activities was primarily attributable to
the purchase and replacement of service and delivery trucks. Cash used in
financing activities consists primarily of distributions to shareholders. In
1995, Comerford's Heating and Air Conditioning, Inc. distributed $201,000 to
shareholders.
ROLF COAL AND FUEL CORP.
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------------------ -------------------------------
1993 1994 1995 1995 1996
------------- ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue..................... $3,036 100.0% $3,977 100.0% $4,105 100.0% $2,162 100.0% $2,448 100.0%
Cost of goods sold.............. 1,516 50.0 1,940 48.8 1,867 45.5 1,059 49.0 950 38.8
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Gross margin.................... 1,520 50.0 2,037 51.2 2,238 54.5 1,103 51.0 1,498 61.2
Selling, general and
administrative expenses..... 1,568 51.6 1,941 48.8 2,143 52.2 1,290 59.7 1,528 62.4
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Income (loss) from operations... $ (48) (1.6%) $ 96 2.4% $ 95 2.3% $ (187) (8.7%) $ (30) (1.2%)
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $287,000 or 13.3%, from $2.2 million
for the six month period ending June 30, 1995 to $2.5 million for the six month
period ending June 30, 1996.
Cost of Goods Sold. Cost of goods sold decreased $109,000, or 10.3%, from
$1.1 million for the six months ended June 30, 1995 to $1.0 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
decreased from 49.0% for the six months ended June 30, 1995 to 38.8% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on higher margin products, particularly
service contracts.
38
<PAGE> 41
Gross Margin/Profit Gross margin increased $395,000, or 35.8%, from $1.1
million for the six months ended June 30, 1995 to $1.5 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
increased 10.2% from 51.0% for the six months ended June 30, 1995 to 61.2% for
the six months ended June 30, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $238,000, or 18.4%, from $1.3 million for the
six months ended June 30, 1995 to $1.5 million for the six months ended June 30,
1996. As a percentage of net revenue, selling, general and administrative
expenses increased from 59.7% for the six months ended June 30, 1995 to 62.4%
for the six months ended June 30, 1996. The increase as a percentage of net
revenue was primarily attributable to increased compensation expense.
Income (Loss) from Operations. Income (loss) from operations was ($30,000)
for the six months ended June 30, 1996 as compared to ($187,000) for the six
months ended June 30, 1995.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $128,000, or 3.2%, from $4.0 million in
1994 to $4.1 million in 1995. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold was relatively unchanged at $1.9
million in 1995. As a percentage of net revenue, cost of goods sold decreased
from 48.8% in 1994 to 45.5% in 1995. The decrease as a percentage of net revenue
was primarily attributable to the increase in net revenue and a focus on higher
margin products.
Gross Margin/Profit. Gross margin increased $201,000, or 9.9%, from $2.0
million for the twelve months ended December 31, 1994 to $2.2 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 3.3% from 51.2% for the twelve months ended December 31, 1994
to 54.5% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to the increase in net
revenue and a focus on higher margin products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $202,000, or 10.4%, from $1.9 million in 1994
to $2.1 million in 1995. As a percentage of net revenue, selling, general and
administrative expenses increased from 48.8% in 1994 to 52.2% in 1995. The
increase as a percentage of net revenue was primarily attributable to the
increase in compensation expense.
Income from Operations. Income from operations remained relatively
unchanged at $95,000.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $941,000, or 31.0%, from $3.0 million
in 1993 to $4.0 million in 1994. The increase in net revenue was primarily
attributable to increased advertising, sales training and a focus on providing
customers a complete service package, resulting in higher average revenue per
service visit.
Cost of Goods Sold. Cost of goods sold increased $424,000, or 28.0%, from
$1.5 million in 1993 to $1.9 million in 1994. As a percentage of net revenue,
cost of goods sold decreased from 50.0% in 1993 to 48.8% in 1994. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on
higher margin products.
Gross Margin/Profit. Gross margin increased $517,000, or 34.0%, from $1.5
million for the twelve months ended December 31, 1993 to $2.0 million for the
twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin increased 1.1% from 50.1% for the twelve months ended December 31, 1993
to 51.2% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $373,000, or 23.8%, from $1.6 million in 1993
to $1.9 million in 1994. As a percentage of net revenue, selling, general and
administrative expenses decreased from 51.6% in 1993 to 48.8% in 1994. The
decrease as a
39
<PAGE> 42
percentage of net revenue was primarily attributable to the increase in net
revenue and the relatively fixed nature of these expenses.
Income (Loss) from Operations. Income (loss) from operations increased to
$96,000 in 1994 from ($48,000) in 1993. As a percentage of net revenue, income
(loss) from operations increased from (1.6%) in 1993 to 2.4% in 1994.
Liquidity and Capital Resources
The following table sets forth selected information from the statement of
cash flows of Rolf Coal and Fuel Corp. (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
------------------- -------------
1993 1994 1995 1995 1996
----- ---- ---- ----- -----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities..... $ 249 $313 $210 $(120) $ (92)
Net cash used in investing activities.............. (24) (76) (62) (75) (175)
Net cash provided by (used in) financing
activities....................................... (103) (52) (79) 104 82
----- ---- ---- ----- -----
Increase (decrease) in cash and cash equivalents... $ 122 $185 $ 69 $ (91) $(185)
===== ==== ==== ===== =====
</TABLE>
From 1993 through the six months ended June 30, 1996, Rolf Coal and Fuel
Corp. generated $680,000 in net cash from operating activities. During this
period, $207,000 was generated from net income plus non-cash charges, and was
enhanced by $473,000 of cash from reductions in working capital. Cash used in
investing activities was primarily attributable to the purchase and replacement
of service and delivery trucks. Cash used in financing activities consists
primarily of proceeds from and payments on long-term debt.
REMAINING COMPANIES
The following presents management's discussion of the results of
operations, as presented in the financial statements of certain Predecessor
Companies appearing elsewhere in the Prospectus. The companies which are
combined are Air Experts, a United Services Co., Inc., Arrow Heating & Air
Conditioning, Inc., Brand Heating & Air Conditioning, Inc., Coastal Air
Conditioning Service, Inc., Gilley's Heating & Cooling, Inc. and Service Experts
of Palm Springs, Inc. (collectively, the "Remaining Companies").
Results of Operations
The following table sets forth certain selected financial data and data as
a percentage of net revenue for the periods indicated (dollar amounts in
thousands):
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
---------------------------------------------------- --------------------------------
1993 1994 1995 1995 1996
-------------- --------------- --------------- -------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenue........ $6,593 100.0% $12,053 100.0% $16,867 100.0% $7,940 100.0% $8,711 100.0%
Cost of goods
sold............. 4,193 63.6 7,950 65.9 10,194 60.4 4,997 62.9 5,407 62.1
------ ----- ------- ----- ------- ----- ------ ----- ------ -----
Gross margin....... 2,400 36.4 4,103 34.1 6,673 39.6 2,943 37.1 3,304 37.9
Selling, general
and
administrative
expenses....... 2,078 31.5 3,526 29.3 5,065 30.1 2,337 29.4 3,157 36.2
------ ----- ------- ----- ------- ----- ------ ----- ------ -----
Income from
operations....... $ 322 4.9% $ 577 4.8% $ 1,608 9.5% $ 606 7.6% $ 147 1.7%
====== ===== ======== ===== ======== ===== ====== ===== ====== =====
</TABLE>
Six Months Ended June 30, 1996 Compared to Six Months Ended June 30, 1995
Net Revenue. Net revenue increased $771,000, or 9.7%, from $7.9 million
for the six months ended June 30, 1995 to $8.7 million for the six months ended
June 30, 1996. The increase in net revenue was
40
<PAGE> 43
primarily attributable to increased advertising, sales training and a focus on
providing customers a complete service package, resulting in higher average
revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $410,000, or 8.2%, from
$5.0 million for the six months ended June 30, 1995 to $5.4 million for the six
months ended June 30, 1996. As a percentage of net revenue, cost of goods sold
decreased from 62.9% for the six months ended June 30, 1995 to 62.1% for the six
months ended June 30, 1996. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on higher margin products and services.
Gross Margin/Profit. Gross margin increased $361,000, or 12.3%, from $2.9
million for the six months ended June 30, 1995 to $3.3 million for the six
months ended June 30, 1996. As a percentage of net revenue, gross margin
increased .8% from 37.1% for the six months ended June 30, 1995 to 37.9% for the
six months ended June 30, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $820,000, or 35.1%, from $2.3 million for the
six months ended June 30, 1995 to $3.1 million for the six months ended June 30,
1996. As a percentage of net revenue, selling, general and administrative
expenses increased from 29.4% for the six months ended June 30, 1995 to 36.2%
for the six months ended June 30, 1996. The increase as a percentage of net
revenue was primarily attributable to increase in compensation expense resulting
primarily from special S corporation distributions in anticipation of the
Combination.
Income from Operations. Income from operations decreased $459,000, or
75.8%, from $606,000 for the six months ended June 30, 1995 to $147,000 for the
six months ended June 30, 1996. As a percentage of net revenue, income from
operations decreased from 7.6% for the six months ended June 30, 1995 to 1.7%
for the six months ended June 30, 1996. The decrease as a percentage of net
revenue was primarily attributable to the increase in compensation expense noted
above.
Year Ended December 31, 1995 Compared to December 31, 1994
Net Revenue. Net revenue increased $4.8 million, or 39.9%, from $12.1
million in 1994 to $16.9 million in 1995. The increase in net revenue was
primarily attributable to increased advertising, sales training and a focus on
providing customers a complete service package, resulting in higher average
revenue per service visit.
Cost of Goods Sold. Cost of goods sold increased $2.2 million, or 28.2%,
from $8.0 million in 1994 to $10.2 million in 1995. As a percentage of net
revenue, cost of goods sold decreased from 65.9% in 1994 to 60.4% in 1995. The
decrease as a percentage of net revenue was primarily attributable to an
emphasis on higher margin products.
Gross Margin/Profit. Gross margin increased $2.6 million, or 62.6%, from
$4.1 million for the twelve months ended December 31, 1994 to $6.7 million for
the twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 5.6% from 34.0% for the twelve months ended December 31, 1994
to 39.6% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to the emphasis on higher
margin products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $1.6 million, or 43.7%, from $3.5 million in
1994 to $5.1 million in 1995. As a percentage of net revenue, selling, general
and administrative expenses increased slightly from 29.3% in 1994 to 30.1% in
1995.
Income from Operations. Income from operations increased $1.0 million, or
178.6%, from $577,000 in 1994 to $1.6 million in 1995. As a percentage of net
revenue, income from operations increased from 4.8% in 1994 to 9.5% in 1995.
Year Ended December 31, 1994 Compared to December 31, 1993
Net Revenue. Net revenue increased $5.5 million, or 82.8%, from $6.6
million in 1993 to $12.1 million in 1994. The increase in net revenue was
primarily attributable to the start-up of several of the Remaining Companies in
1994.
41
<PAGE> 44
Cost of Goods Sold. Cost of goods sold increased $3.8 million, or 89.6%,
from $4.2 million in 1993 to $8.0 million in 1994. As a percentage of net
revenue, cost of goods sold increased from 63.6% in 1993 to 65.9% in 1994. The
increase as a percentage of net revenue is attributable to an emphasis on higher
margin products.
Gross Margin/Profit. Gross margin increased $1.7 million, or 71.0%, from
$2.4 million for the twelve months ended December 31, 1993 to $4.1 million for
the twelve months ended December 31, 1994. As a percentage of net revenue, gross
margin decreased 2.4% from 36.4% for the twelve months ended December 31, 1993
to 34.0% for the twelve months ended December 31, 1994.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $1.4 million, or 69.7%, from $2.1 million in
1993 to $3.5 million in 1994. As a percentage of net revenue, selling, general
and administrative expenses decreased from 31.5% in 1993 to 29.3% in 1994.
Income from Operations. Income from operations increased $255,000, or
79.4%, from $322,000 in 1993 to $577,000 in 1994. As a percentage of net
revenue, income from operations remained relatively constant at 4.8%.
Liquidity and Capital Resources
The following table sets forth selected information from the Remaining
Companies' combined statement of cash flows (dollar amounts in thousands):
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED DECEMBER ENDED
31, JUNE 30,
-------------------- -------------
1993 1994 1995 1995 1996
---- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net cash flow provided by operating activities.... $360 $ 314 $ 755 $ 590 $ 510
Net cash used in investing activities............. (85) (526) (456) (264) (337)
Net cash provided by (used in) financing
activities...................................... 109 275 (163) (162) (291)
---- ----- ----- ----- -----
Increase (decrease) in cash and cash
equivalents..................................... $384 $ 63 $ 136 $(164) $(118)
==== ===== ===== ===== =====
</TABLE>
From 1993 through the six months ended June 30, 1996, the Remaining
Companies generated $1,939,000 in net cash from operating activities. Cash used
in investing activities was primarily attributable to the purchase and
replacement of service and delivery trucks. Cash used in financing activities
consists primarily of distributions to shareholders and proceeds from long-term
notes.
42
<PAGE> 45
BUSINESS
GENERAL
Simultaneously with, and as a condition to, the completion of the Offering,
the Company will acquire all of the outstanding capital stock of the Predecessor
Companies. Upon completion of the Combination, management believes that the
Company will be one of the leading providers of residential HVAC services and
replacement equipment in the United States. See "The Combination."
The Service Centers install, service and maintain central air conditioners,
furnaces and heat pumps, primarily in existing homes. In 1995, management
estimates that over 80% of the Company's pro forma net revenue was derived from
replacing, maintaining and servicing HVAC equipment at existing residences and
commercial businesses and less than 20% was derived from installing new
equipment at newly constructed homes and businesses. The Company focuses on the
service and replacement segment of the HVAC industry rather than the new
construction segment because management believes that the service and
replacement segment exposes the Company to less credit risk and offers higher
margins as a result of opportunities for more attractive pricing because of
customers' demands for immediate, convenient and reliable service.
CSG was formed in 1991 to offer HVAC companies proprietary products as well
as marketing, management, educational and advisory services not available from
industry trade associations. CSG currently has over 270 members serving distinct
market areas of the United States. Management estimates that the aggregate
annual revenues of the CSG members not owned by the Company are in excess of
$500 million. CSG seeks to provide its members with a competitive advantage over
other HVAC contractors in each member's market area by enabling members to
operate their businesses with a higher degree of professionalism and by
providing proven marketing and operational strategies designed for the HVAC
industry. All of the Service Centers are members of CSG and operate in
accordance with its recommended methods and procedures.
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. The
Company intends to implement an aggressive acquisition strategy which will
target for acquisition as "hubs" CSG members that are geographically desirable,
financially stable, experienced in the industry, familiar with CSG operating
methods and characterized by strong management. The Company also plans to
increase market presence through acquisitions of other HVAC businesses that have
long operating histories, large customer bases, experienced management and
present opportunities to reduce overhead expenses or dispose of fixed assets to
improve profitability. In addition, management believes that it will be able to
improve the financial performance of acquired companies through the
implementation of the policies and procedures developed by CSG.
HVAC SERVICE AND REPLACEMENT INDUSTRY
The HVAC industry consists of (i) the installation, replacement,
maintenance, service and repair of HVAC systems at existing residences and
commercial businesses and (ii) the installation of HVAC systems at newly
constructed homes and businesses. The Company primarily provides installation
and replacement services to existing homes and small to medium-sized businesses.
According to Air Conditioning, Heating and Refrigeration News, there are
approximately 43 million central air conditioners, 54 million furnaces and 9
million heat pumps in operation in homes in the United States. Management
estimates, based on industry information, that the market for the service and
replacement of HVAC systems in existing homes is approximately $24 billion
annually. The installation and replacement segment of the industry has increased
in size as a result of the aging of the installed base of residential systems,
the introduction of new, energy efficient systems and the upgrading of existing
homes to central air conditioning. According to the Air Conditioning and
Refrigeration Institute, over 61 million central air conditioners have been
installed in the United States since 1975. Many of the units installed from the
mid-1970s to the mid-1980s are reaching the end of their useful lives, thus
providing a growing replacement market. In addition, in recent years, increased
governmental regulation restricting the use of ozone depleting refrigerants in
HVAC systems has contributed to the growing replacement market. See
"Regulation."
43
<PAGE> 46
Management believes that HVAC businesses are typically closely held,
single-center operations that serve a limited geographic area and are heavily
dependent upon referrals to generate business. Management believes that, in many
cases, these businesses are operated by former service technicians who lack the
business and marketing expertise to expand their businesses, increase their
profitability and compete effectively with larger operators. Management believes
that larger companies are able to operate more efficiently, offer customers a
broader array of products and services and provide a higher level of customer
service than smaller operators. These competitive advantages are the result of
greater managerial and financial resources as well as economies of scale in
purchasing and marketing expenses. Management believes that these factors will
continue to promote a trend toward consolidation in the industry and present an
opportunity for well-capitalized operators to acquire additional businesses on
favorable terms.
STRATEGY
The Company's goal is to become the leading provider of residential HVAC
services and replacement equipment in the United States through the acquisition
of CSG members in new markets, the integration of other HVAC business in
existing markets and the continued revenue and profit growth of its Service
Centers.
Acquisition Strategy
The Company intends to implement an aggressive acquisition program
utilizing a "hub and spoke" strategy for expansion into new geographic areas and
further penetration into existing markets. The U.S. residential HVAC service
industry is currently highly fragmented. Management believes that many HVAC
businesses, which lack the capital necessary to expand operations and the
ability to exit their business profitably, will desire to affiliate with the
Company because the Company will provide (i) business and marketing systems that
enable a company to operate more profitably, (ii) the opportunity to increase
the operator's focus on customer service rather than administration, (iii) the
potential for national name recognition and (iv) the opportunity for the owner
to gain liquidity while, in some cases, continuing to manage the operations of
the business. By expanding geographically, management believes the Company will
be able to offset certain seasonal and economic trends that affect different
regions of the country periodically. See "Risk Factors -- Seasonal and Cyclical
Nature of the Industry" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Combined Predecessor Companies."
Expanding Geographic Presence through Hub Acquisitions of CSG Members. The
Company plans to make "hub" acquisitions of existing HVAC businesses in new
markets that are not being served by the Company. Management plans to target for
acquisition HVAC businesses that are members of CSG and familiar with the
Company's policies and procedures. See the map appearing on page two indicating
the location of the current members of CSG. Typically, these businesses have
annual net revenue ranging from $2.0 million to $5.0 million. In evaluating such
acquisitions, the Company will consider candidates that are in attractive
markets, financially stable, experienced in the industry, familiar with CSG's
operating methods and characterized by strong management.
Expanding Market Penetration through the Acquisition of Other HVAC
Businesses. The Company expects to increase market share through acquisitions
of other HVAC businesses that have long operating histories, large customer
bases, experienced management and that present opportunities to reduce overhead
or dispose of fixed assets to improve profitability. When acquired, the
operations of such businesses will be integrated into the operations of existing
hubs, enabling the Company to reduce overhead costs, sell redundant assets and
consolidate operations within existing areas served by the Company. The Company
does not intend to acquire non-CSG members in territories currently served by a
CSG member unless and until that CSG member is acquired by the Company.
44
<PAGE> 47
Operating Strategy
The Company intends to implement an operating strategy that incorporates
the successful methods developed by CSG and capitalizes on the operating
efficiencies resulting from the integration of the operations of the Predecessor
Companies. The key elements of the Company's operating strategy are as follows:
Providing Superior, High Quality Service in a Professional Manner. The
Service Centers provide superior, high quality service at a competitive price
and in a friendly, professional manner. In order to provide such service, the
Company requires that all service technicians, maintenance technicians and
installers employed by the Company complete comprehensive training programs
designed to teach employees the Company's operating procedures. Such procedures
are described in CSG's training manuals which provide detailed instructions in
areas such as residential replacement sales, residential installation,
preventive maintenance agreements, service and routine maintenance. The Company
has standard policies and operating procedures intended to result in a uniform
level of professional, high quality service, including installation and
maintenance procedures, random drug-testing of all employees, the technician's
appearance and the use of "Carpet Saver" shoe coverings when inside a customer's
home. The Service Centers utilize a flat rate billing system that advises the
customer of the cost of service before work begins and charges the quoted price
regardless of the actual time necessary to repair the system. The Service
Centers are generally open for business from 8:00 a.m. to 8:00 p.m. on weekdays,
and most are open on Saturday from 8:00 a.m. to 4:00 p.m. Management believes
that by providing evening and Saturday service, in addition to 24 hour emergency
service, the Service Centers are able to better accommodate customers than most
of its competitors. In addition, the Company guarantees complete customer
satisfaction and offers a toll-free "Customer Can't Lose" phone line to address
customer complaints and questions.
Increasing Revenue at Service Centers. The Company intends to actively
promote its maintenance agreements to both new and existing customers. See
"Service Centers -- Maintenance and Service Agreements." The sale of maintenance
agreements not only generates recurring revenue through the payment of fees, but
also helps the Company develop a committed, loyal customer base and provides the
opportunity for cross-marketing of the Company's other services and products.
The Company offers a wide assortment of financing packages designed to enable
customers to purchase equipment and services from the Company in the most
convenient and cost-effective manner possible. The Company also offers its
customers a Professional Courtesy(TM) credit card solely for use in purchasing
equipment and services from the Company. Such financing, including the
Professional Courtesy credit card, is offered through a number of third party
lenders. Pursuant to its arrangements with such financing companies, the Company
receives an origination fee based on the amount financed, but does not bear any
credit risk from such financing.
The Service Centers utilize local print advertising and targeted marketing
promotions designed by CSG, including maintenance technician referrals, service
technician referrals, yellow page advertising and direct mail campaigns followed
up by telemarketing. During the off-peak spring and fall months, the Service
Centers aggressively market products and services which generate revenue during
such months and help to offset increased demand historically experienced in the
summer and winter months. Management believes that such marketing efforts will
result in increased business for its Service Centers. In 1995, advertising and
marketing expenditures were 1.6% as a percentage of the Company's pro forma net
revenue.
The Company offers a number of services and products that are not available
from most HVAC contractors. Indoor air quality ("IAQ") has become an
increasingly popular and profitable segment of the industry. According to
industry sources, the market for IAQ products and services in the United States
was estimated to be $1.8 billion in 1994 and is expected to double by the year
2000 as public awareness of indoor air pollution, which the U.S. Environmental
Protection Agency now ranks as one of the top five environmental health threats,
continues to grow. As technology has improved, HVAC businesses have begun to
utilize equipment that monitors the levels of certain harmful substances in the
air of a customer's home. The Company's technicians are trained to educate
customers on the harmful effects of these substances, which can cause fatigue,
inattentiveness, allergies, asthma, hyper-sensitivity and respiratory diseases.
The Company offers and actively promotes a variety of IAQ services designed to
detect and correct unhealthy air quality.
45
<PAGE> 48
Among these services are duct cleaning, fresh air ventilation and heat recovery
systems, ultraviolet light processes and the sale and installation of ozonators.
Achieving Operating Efficiencies. Manufacturers of HVAC equipment have
historically offered more favorable prices and rebates to high volume
purchasers. Management believes that the Company will be able to increase the
discounts and rebates available to the Predecessor Companies prior to the
Combination. In addition, the Company expects to achieve increased operating
efficiencies by consolidating certain functions at the corporate level,
including negotiating purchase terms for HVAC equipment, sales management,
purchasing and leasing of service vehicles and accounting, insurance, financial
management, marketing and legal support.
The Company intends to implement a uniform system of budgets, forecasts,
reports and financial controls for its Service Centers. In addition, each of the
Service Centers generates and provides to the Company a daily management report
of revenue and expense information and certain billing and collection data. The
Company will use such information to prepare and provide to each Service Center
monthly and quarterly comparative financial data, which will enable each Service
Center to track and compare its performance with the other Service Centers.
Attracting and Retaining Quality Employees. Management believes the
Service Centers attract and retain quality employees by providing (i) an
environment that emphasizes professionalism and customer satisfaction, (ii)
extensive training that allows employees to advance to higher-earning positions
and (iii) stability of income because the Service Centers do not experience the
cyclical lay-offs typically found in the HVAC industry. The Company has a cash
bonus program for each Service Center pursuant to which managers may earn
bonuses based on the performance of the Service Center and the Company relative
to established goals set by the Service Center's president and the Company. The
Service Centers are operated by managers who are trained in the CSG operating
methods and procedures and who management believes are better educated than a
typical HVAC service business operator.
Potential employees must pass extensive interviews and background checks,
where permitted, as well as technical tests prior to being hired. All service
technicians, maintenance technicians and installers employed by the Company are
required to complete comprehensive training programs designed to teach employees
the Company's operating procedures. Such training programs are conducted both at
the Service Centers and at CSG sponsored seminars. Management believes that its
policies have resulted in a low rate of employee turnover. See "Contractor
Success Group."
Developing a National Reputation. Management believes that successful
implementation of the Company's operating strategy will enable it to establish a
national reputation for superior, high quality service. By developing a national
reputation, management believes the Company will appeal to a large number of
customers who are familiar with and rely upon a large, stable company with a
national reputation for providing high quality service.
CONTRACTOR SUCCESS GROUP
CSG, a wholly-owned subsidiary of the Company, was formed in 1991 to offer
HVAC companies proprietary products and marketing, management, educational and
advisory services not available from industry trade associations. Currently,
there are over 270 members of CSG serving distinct market areas in the United
States and Canada defined primarily by zip codes. CSG offers its members a
competitive edge over other contractors in the market by providing useful
management and technical skills, training programs and proprietary products. In
exchange, CSG members pay an initial fee upon joining CSG and a quarterly fee
thereafter. In 1995, CSG collected fees totaling approximately $3.1 million. CSG
members are granted exclusive rights to the territory in which they operate. The
Company intends to continue to build and expand the membership of CSG.
CSG licenses to its members copyrighted training manuals that cover in
specific detail every aspect of owning and operating an HVAC service and
replacement company, including residential replacement sales, residential
maintenance, service contracts, residential installation, business planning and
service dispatch. In
46
<PAGE> 49
addition, CSG members receive materials containing, and attend conferences
discussing, methods and procedures to operate an efficient, profitable company,
including (i) daily report forms designed to provide accurate and timely sales
and cost information essential to determining the performance of an HVAC
business, (ii) "Scorecard," a monthly report distributed to CSG members
comparing top producers among members, (iii) contracts and forms, including
non-competition agreements for employees, sales and service contracts, (iv)
marketing promotions that are tested and proven with specific instructions on
how to tailor advertising for the member's market and (v) quarterly projects
introducing to CSG members new products and services designed to increase
productivity.
Seminars and Services
Potential CSG subscribers are invited to attend an informational seminar at
CSG's facility in St. Louis, Missouri where they are introduced to the CSG
concept and are invited to join the organization. Upon paying the initial fee,
CSG subscribers attend "Boot Camp" which is an intensive four-day workshop
conducted by CSG three times each year. At Boot Camp, HVAC contractors are
educated on all aspects of operating an HVAC service and replacement business.
Attendees receive presentations and materials that explain in specific detail
the methods and procedures successfully utilized by CSG members. Topics covered
include administration, sales, service, advertising, direct marketing,
maintenance, service contracts, acquisitions and accounting. CSG members may
also attend "Success Convention," which is a quarterly two-day convention of CSG
members designed to allow the members to compare ideas and projects and at which
quarterly projects are presented, and "Sales Extravaganza," which is an annual
convention designed to encourage and motivate a member's salespeople, selling
technicians and telemarketers.
Future University
In connection with the Combination, the Company will acquire approximately
38% of the issued and outstanding Common Stock of Future University in exchange
for $2,000 per share in cash, an aggregate of $604,000. Future University is a
corporation that offers to CSG members for an additional enrollment fee
technical and operational educational programs designed to improve the
profitability of the CSG member's business. The technical programs offer
installers and technicians a combination of classroom and on-the-job-training
during one and two week sessions. Technicians receive skills training that will
enable them to effectively analyze customer problems and offer efficient
solutions. In the maintenance training classes, for example, technicians are
trained to maximize the operating efficiency of HVAC systems, assure safe
operation of systems and reduce the chances of future breakdowns. In the sales
training classes, technicians are trained to deal with customer expectations,
use and promote various products and services, develop leads, explain financing
programs and improve on various customer relations skills. In sending
technicians to the Future University program, CSG members are able to develop a
high level of commitment in their employees. The technical programs are held in
Little Rock, Arkansas under an exclusive licensing arrangement with Hardwick Air
Masters, Inc., one of the Predecessor Companies. Pursuant to the current
licensing arrangement, Hardwick Air Masters, Inc. receives 70% of the revenue
from the technical programs and Future University receives 30% of such revenue.
The operational programs offer to general managers and salespeople a variety of
classes covering residential sales training, replacement sales, marketing and
promotions, telemarketing and general operations. These programs are held in
Houston, Texas.
Management believes that Future University is the only comprehensive
training school for management, salespeople, installers and technicians in the
residential HVAC industry. Since its formation in 1991, over 1,000 students per
year have completed Future University's technical and operational training
programs.
SERVICE CENTERS
General
Management estimates that during 1995 the Service Centers' service and
maintenance technicians responded to over 120,000 maintenance, repair and
service calls. The services offered by each Service Center include (i) the sale
of replacement central air conditioners, furnaces and heat pumps, (ii) the
maintenance
47
<PAGE> 50
and repair of HVAC units, (iii) diagnostic analysis of the condition of existing
unit and (iv) the sale of ancillary products such as IAQ devices and monitors.
Most of the Service Centers employ an in-house sales force that sells
replacement units, installation technicians who install replacement equipment in
existing homes, service technicians who service and maintain the equipment, and
an administrative staff to perform dispatching, purchasing and other
administrative functions. In addition, some of the Service Centers offer
plumbing services. Management believes that in 1995 the installation and
servicing of plumbing systems represented less than 5% of the Company's pro
forma net revenue. The Company anticipates that such Service Centers will
continue to offer plumbing services, but currently does not intend to expand
such business.
All of the Service Centers' technicians are trained to promote the
Company's preventive maintenance agreements and to cross-market IAQ equipment
and other ancillary services and products offered by the Company. Service
technicians are trained to perform service and maintenance in a professional
manner, to identify problems with existing HVAC systems and to offer customers
the most practical, cost-effective solution to their problem, whether that
involves repairing the existing system or suggesting a replacement system or
part. Often this involves providing customers with information on products to
upgrade their system and improve efficiency as well as informing them about the
advantages and disadvantages of a particular product or service. Maintenance
technicians perform routine maintenance examinations of HVAC systems in an
effort to keep the systems in working order and to identify potential problems
before they become too costly to correct.
Management believes that most HVAC contractors charge the cost of the
materials and the hourly rate for the actual time it takes to install or repair
the system. In contrast, the Company utilizes a flat rate pricing system that
advises the customer of the cost of service before work begins and charges the
quoted price regardless of the time necessary to repair the system. The
Company's experience is that customers generally prefer this pricing method
because it eliminates surprise or hidden costs. This pricing method also creates
an incentive for the Company to hire quality technicians and to provide them
with the training necessary to service customer needs efficiently.
Sale of Replacement Units
The replacement market for residential HVAC equipment is dependent upon the
installed base of units, the mechanical life and usage of the equipment and
technological advances in the efficiency of newer units. The Company believes
the replacement market for HVAC units offers the potential for high growth and
profitability in the future given the potential number of HVAC systems that will
need replacement in the coming years and the Company's ability to effectively
service that need. The market for replacement units is highly fragmented, with
no single manufacturer dominating the market. In order to service the
replacement market, the Company intends to establish relationships with several
national, regional and local manufacturers of replacement units in order to
offer a wide variety of products to its customers. The Company is not dependent
on any manufacturers or distributors of replacement units, but rather has access
to products from all over the country allowing the Company to offer products
that its competition may be unable to provide.
At the time of sale, a customer is offered a wide assortment of financing
packages by the Service Center. A Service Center's installers and technicians,
in addition to the salespeople, are trained to educate customers as to the
financing options available, assist the customer in completing the credit
application forms and determine whether the customer's financing is approved.
The Company also offers its customers a Professional Courtesy credit card solely
for use in purchasing equipment and services from the Company. Such financing,
including the Professional Courtesy credit card, is offered through a number of
third party lenders. Pursuant to its arrangements with such financing companies,
the Company receives an origination fee based on the amount financed, but does
not bear any credit risk from such financing.
Maintenance and Service Agreements
The Company currently has approximately 27,600 maintenance agreements with
customers. These agreements are for a term of one to three years and provide for
two diagnostic and precision maintenance visits during the year at an average
cost to the customer of approximately $135 per year. The sale of maintenance
48
<PAGE> 51
agreements not only generates recurring revenue through the payment of fees, but
also helps the Company develop a committed, loyal customer base and provides the
opportunity for cross-marketing of the Company's other services and products.
Management believes that customers with maintenance agreements are the Company's
most satisfied customers because of the many benefits offered by such
agreements, including (i) energy savings resulting from a more efficient HVAC
system, (ii) fewer and less costly emergency repairs, (iii) longer useful life
for the HVAC system, (iv) discounted rates for service and (v) guaranteed
same-day service in the event of an emergency repair. Maintenance agreements
also allow the Company to more fully utilize its technicians during the
historically slower spring and fall months by scheduling maintenance
appointments during such time. Because systems under maintenance agreements are
less likely to require emergency repairs, the Service Centers are able to
provide more prompt service to emergency and new service calls.
The Company's service agreements are generally for a term of one year and
provide for the repair of any problem with the customer's system at no
additional cost to the customer. Pursuant to the terms of such service
agreements, if the cost of repair exceeds the value of the customer's HVAC
system, the Company is not required to repair the system and the customer
receives a $300 discount if he purchases a replacement unit from the Company. In
some states, warranties provided for in the Company's service agreements may be
deemed insurance contracts by applicable state insurance regulatory agencies
thereby subjecting the Company and the service agreements to the insurance laws
and regulations of any such state. In such states, the Company insures its
service agreements through licensed insurers. Management believes that the
Company has made adequate provision for potential claims under these agreements.
See "Regulation."
Locations
The Company currently operates 12 Service Centers in nine states. The
following table sets forth certain information regarding these Service Centers:
<TABLE>
<CAPTION>
AREA OF YEAR
SERVICE CENTER STATE OPERATION FOUNDED
------------------------------------------------- ----------- ------------- ---------
<S> <C> <C> <C>
Norrell Heating & Air Conditioning, Inc.......... Alabama Birmingham 1953
Hardwick Air Masters, Inc........................ Arkansas Little Rock 1970
Service Experts of Palm Springs, Inc............. California Palm Springs 1993
Comerford's Heating and Air Conditioning, Inc.... California Pleasanton 1974
Coastal Air Conditioning Service, Inc............ Georgia Savannah 1976
Rolf Coal and Fuel Corp.......................... Indiana Fort Wayne 1904
Brand Heating & Air Conditioning, Inc............ Indiana Lafayette 1991
Gilley's Heating & Cooling, Inc.................. Louisiana Monroe 1980
Vision Holding Company, Inc...................... Missouri Kansas City 1982
Air Experts, a United Services Co., Inc.......... Missouri St. Louis 1981
AC Service & Installation Co., Inc./
Donelson Air Conditioning Company, Inc....... Tennessee Nashville 1974/1968
Arrow Heating & Air Conditioning, Inc............ Wisconsin Racine 1992
</TABLE>
Commercial Service and Replacement
Some of the Service Centers offer HVAC services to small and medium-sized
businesses. In 1995, revenues generated from the provision of services and sale
of products to commercial customers represented less than 20% of the Company's
pro forma net revenue. The Service Centers target restaurants, small office
buildings, warehouses and theaters as potential prospects for its commercial
services. The Company's commercial sales representatives receive extensive
training designed to enable the representatives to promote the Company's
services and products effectively. The services offered to commercial customers
are generally the same as services offered to residential customers, including
the analysis, maintenance and repair of existing HVAC systems, the sale of
replacement systems and the sale of ancillary products, including IAQ devices
and services. While management does not plan to further develop its plumbing and
commercial HVAC businesses
49
<PAGE> 52
beyond existing operations given the potential for growth in the residential
service and replacement market, the Company intends to continue to provide
plumbing and commercial HVAC services.
SERVICES AND OPERATIONS
The Company provides management, financial and accounting services for all
of the Service Centers' operations. Management intends to provide certain
financial control support, including budgets, forecasts and reports, while
allowing each general manager of a Service Center to manage its day-to-day
operations. The Company intends to provide the following services:
Purchasing
Because of the number of Service Centers operated by the Company,
management believes the Company will be able to negotiate at a lower cost (i)
the purchase of HVAC units, parts and supplies, (ii) the purchase and lease of
service vehicles and (iii) the provision of accounting, insurance, financial
management, marketing and legal support. The principal manufacturers of the
products sold by the Company include The Trane Company, Carrier Air
Conditioning, Inc., Lennox Industries, Inc. and Rheem Manufacturing Company.
Each Service Center will order products from the manufacturers or distributors
at the discounted rate negotiated by the Company. The Service Centers generally
order equipment only upon receipt of a contract for purchase from a customer,
enabling them to maintain low inventory.
Management Information Systems
The Service Centers currently utilize various compatible management and
financial information systems. The Company intends to convert the Service
Centers' current systems to an integrated system within the next 18 months. The
implementation of an integrated system will allow the Company to maintain
greater control over the operations of its Service Centers. The Company intends
to track important data related to the Service Centers' operations and financial
performance and to monitor all advertising expenditures. In addition, the
Service Centers will generate and provide to the Company a daily management
report of revenue and expense information and certain billing and collection
data. The Company will use such information to prepare and provide to each
Service Center monthly and quarterly comparative financial data, which will
enable each Service Center to track and compare its performance with the other
Service Centers.
Employee Screening and Training
Prior to employment, potential employees of the Company must take
comprehensive tests to determine their technical expertise. In addition, all
employees of the Company are required to pass a drug test prior to employment
and are thereafter subject to random drug testing. Failure to take or pass a
drug test results in immediate termination of employment. Once hired, employees
of the Company are required to complete various training programs covering
technical skills and communication and sales techniques. In addition, employees
periodically attend educational seminars and conventions conducted by CSG. See
"Contractor Success Group."
Advertising and Marketing
The Company's advertising and marketing programs are designed to attract
new customers and to stimulate increased demand from existing customers. Each
Service Center, utilizing materials produced by CSG, develops customized
marketing programs tailored to meet the needs of its local customer base.
Emphasizing superior, high quality service, the Service Centers market directly
to prospective and existing customers through local print advertising, yellow
page advertising and direct mail campaigns followed up by telemarketing. In
1995, advertising and marketing expenditures were 1.6% as a percentage of the
Company's pro forma net revenue.
50
<PAGE> 53
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, as amended, relating to minimum energy efficiency standards of HVAC systems
and the production, servicing and disposal of certain ozone depleting
refrigerants used in such systems. In connection with the entry into new
markets, the Company may become subject to compliance with additional
regulations. Although, there can be no assurance that the regulatory environment
in which the Company operates will not change significantly in the future, to
date compliance with such regulatory requirements has not had a material effect
on the Company.
Various local, state and federal laws and regulations, including, but not
limited to, laws and regulations implementing the Clean Air Act, as amended,
impose licensing standards on technicians who service heating and air
conditioning units. While the installers and technicians employed by the Service
Centers are duly certified by applicable local, state and federal agencies and
have been able to meet or exceed such standards to date, there can be no
assurance that they will be able to meet stricter future standards. In addition,
installers must comply with local building codes when installing HVAC units in
residences and commercial buildings.
In some states, warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies thereby subjecting the Company and the service agreements to the
insurance laws and regulations of any such state.
TRADEMARKS
"Service Experts" is registered as a federal trademark with the United
States Patent and Trademark Office. The Company currently licenses the Service
Experts name and logo to two companies that are members of CSG. The Company owns
and licenses numerous proprietary products used by the Service Centers and other
CSG members. See "Contractor Success Group." In addition, the Company owns
approximately 38% of the issued and outstanding common stock of "Future
University," which is registered as a federal trademark with the United States
Patent and Trademark Office. See "Contractor Success Group -- Future
University." The Company regards its trademarks as having significant value and
being an important factor in the development and marketing of its operations.
The Company's policy is to pursue registration of its trademarks whenever
possible and to oppose vigorously any infringement of its trademarks.
COMPETITION
The HVAC service and replacement industry is highly competitive in each of
the markets in which the Company operates. The Company's Service Centers will
compete with other full-service HVAC businesses primarily on the basis of
quality, reliability, customer service and price. In one of its markets, Kansas
City, Missouri, the Company competes with utility companies which have access to
capital, personnel, marketing and technological resources that are equal to or
greater than those of the Company. Because of the fragmented nature of the
industry and relative low barriers to entry, additional competitors, including
companies that offer other home improvement services in addition to HVAC
services, may emerge that have greater access than the Company to capital,
personnel and technological resources.
EMPLOYEES
Upon completion of the Combination, Management estimates that the Company
will have approximately 600 employees. None of the Company's employees is
represented by a collective bargaining agreement.
PROPERTIES
The Company currently leases the building and underlying real estate on
which 11 of its 12 Service Centers are located pursuant to leases with terms
generally ranging from five to ten years on terms the Company believes to be
commercially reasonable. Total rental expense for the Company's leased centers
in 1995 was approximately $400,000. The building and underlying real estate
where one of the Company's Service Centers is located is owned by one of the
Predecessor Companies and is subject to a mortgage note
51
<PAGE> 54
payable which is secured by the related office building and land. This loan
requires monthly installments of $8,400, including principal and imputed
interest (6.1% at December 31, 1995) through July 15, 1992. Prior to the
Combination, the property will be sold by the Company and leased back from the
purchaser. In the future, the Company plans to lease rather than purchase space
for the Service Centers to maximize the Company's available capital.
The Company leases approximately 24,000 square feet of office space in
Nashville, Tennessee for its corporate headquarters. The remaining term of the
lease on this office space is approximately 10 years, and the Company pays
annual rent of $140,000. The Company also maintains an office in approximately
3,600 square feet of office space leased in Chesterfield, Missouri. The
remaining term of the lease on this office space is approximately 18 months, and
the Company pays annual rent of approximately $60,000.
INSURANCE
The Company maintains general liability and property insurance. The costs
of insurance coverage varies, and the availability of certain coverage has
fluctuated in recent years. The Company intends to consolidate the purchase of
insurance for its operations, which management believes will result in savings
from the amounts paid by the Predecessor Companies prior to the Combination.
While management believes, based upon its claims experience, that the Company's
present insurance coverage is adequate for its current operations, there can be
no assurance that the coverage is sufficient for all future claims or will
continue to be available in adequate amounts or at reasonable rates.
LEGAL PROCEEDINGS
The Company does not have pending any litigation that, separately or in the
aggregate, if adversely determined, would have a material adverse effect on the
Company. The Company and its Service Centers may, from time to time, be a party
to litigation or administrative proceedings which arise in the normal course of
its business.
52
<PAGE> 55
THE COMBINATION
OVERVIEW
Simultaneously with, and as a condition to, the closing of the Offering,
the Company will consummate the Combination. The consideration to be paid by the
Company in the Combination will consist of shares of Common Stock and cash, as
set forth in the Combination Agreements, which provide for the allocation of
shares of Common Stock among the Predecessor Companies and their owners based on
the relative amounts of "Adjusted Net Income" of the Predecessor Companies for
the 1995 calendar year. Adjusted Net Income is defined in the Combination
Agreements as the Predecessor Company's net income presented in its financial
statements for the 1995 calendar year, adjusted to exclude all nonrecurring
income and expense and to include (i) all adjustments necessary to present rents
at market, (ii) such adjustments to salary as are agreed to by the parties,
(iii) all adjustments necessary to give effect to federal and state income taxes
as if a Predecessor Company that is not a C corporation had been a C corporation
during the 1995 calendar year and (iv) certain other adjustments agreed to by
the parties. In the event a Predecessor Company's stockholders' equity as a
percentage of net revenue was less than 10% as presented in its financial
statements for the 1995 calendar year, the consideration to be paid by the
Company will be reduced by an amount equal to the capital contribution required
to result in stockholders' equity as a percentage of net revenue equal to 10%.
The consideration to be paid by the Company also will be reduced by (i) the
amount of outstanding indebtedness of the Predecessor Companies at the time of
the closing of the Combination, other than indebtedness incurred after December
31, 1995 for the purchase of fixed assets, and (ii) in the case of any
shareholder, the amount of any indebtedness of such shareholder payable to the
Predecessor Company at the time of closing. The aggregate consideration to be
paid by the Company in the Combination will consist of 4,545,301 shares of
Common Stock (valued at $59.1 million) and $17.1 million in cash, assuming an
initial offering price of $13.00 per share and that there is no reduction in the
consideration to be paid by the Company as described above. The Company plans to
use approximately $19.6 million of the net proceeds from the Offering to pay the
cash portion of the consideration due at closing and certain outstanding
indebtedness arising from the Combination. Approximately 2,236,059 shares of
Common Stock (valued at $29.1 million) and $9.7 million in cash, assuming an
initial offering price of $13.00 per share, will be paid to stockholders of the
Predecessor Companies who are executive officers, directors or 5% stockholders
of the Company as a result of which such persons will beneficially own
approximately 44.9% of the outstanding Common Stock immediately following the
Offering. See "Risk Factors -- Control by Management and Principal
Stockholders," "Use of Proceeds," "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Combined Predecessor
Companies -- Liquidity and Capital Resources," "Certain Transactions," "Shares
Eligible for Future Sale," and the Pro Forma Combining Financial Statements and
notes thereto appearing elsewhere in this Prospectus.
53
<PAGE> 56
The following table sets forth the consideration to be paid by the Company
to the stockholders of each of the Predecessor Companies in the Combination:
<TABLE>
<CAPTION>
SHARES OF
COMMON
PREDECESSOR COMPANY STOCK CASH(1)(2)
-------------------------------------------------------------- --------- -----------
<S> <C> <C>
AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc................................... 1,153,096 $ 4,996,755
Air Experts, a United Services Co., Inc....................... 114,081 494,352
Arrow Heating & Air Conditioning, Inc......................... 223,775 969,690
Brand Heating & Air Conditioning, Inc......................... 185,163 802,371
Coastal Air Conditioning Service, Inc......................... 243,987 166,939
Comerford's Heating and Air Conditioning, Inc................. 350,178 1,417,934
Contractor Success Group, Inc................................. 781,224 3,385,304
Gilley's Heating & Cooling, Inc............................... 164,745 535,421
Hardwick Air Masters, Inc..................................... 350,587 58,860
Norrell Heating & Air Conditioning, Inc....................... 356,284 1,543,899
Rolf Coal and Fuel Corp....................................... 274,672 1,190,247
Service Experts of Palm Springs, Inc.......................... 91,704 397,383
Vision Holding Company, Inc................................... 255,805 1,108,489
--------- -----------
Total............................................... 4,545,301 $17,067,644
======== ==========
</TABLE>
- ---------------
(1) Assumes an initial offering price of $13.00 per share and that there is no
reduction in the consideration to be paid by the Company as described
above.
(2) All of the cash consideration payable in the Combination will be paid from
the proceeds of the Offering and, in accordance with SAB 48, will for
accounting purposes be treated as a dividend distribution to the owners of
the Predecessor Companies. See "Use of Proceeds" and the Pro Forma
Combining Financial Statements and the Notes thereto.
Although the former owners of certain of the Predecessor Companies are
directors and/or executive officers of the Company and the consideration to be
paid to such Predecessor Companies was not determined by arm's length
negotiations, the terms of the Combination Agreements entered into by each of
the Predecessor Companies are the same in all respects, including the procedures
used to determine the consideration to be paid to each Predecessor Company,
other than CSG, based on its Adjusted Net Income. The same procedures were used
to determine the consideration to be paid to CSG, except that the Company has
agreed to pay at least $2.5 million to CSG in exchange for its copyrights,
trademarks and other proprietary interests. See "Certain Transactions." The
factors considered by the Company in determining the consideration to be paid
included, among others, the historical operating results, the net worth, the
levels and type of indebtedness and the future prospects of each of the
Predecessor Companies.
Upon consummation of the Combination, each of the Predecessor Companies
will become a wholly owned subsidiary of the Company.
THE COMBINATION AGREEMENTS
Restricted Stock
The Common Stock issued to the Predecessor Companies will not be registered
under the Securities Act, in reliance upon exemptions from registration
contained in the Securities Act. Accordingly, the Common Stock received by the
Predecessor Companies will be subject to certain resale restrictions, including
a two-year holding period prior to any public resales (three years in the case
of "affiliates", or controlling persons, of the Company). In addition, certain
of the shares received will be subject to a 180 day restriction imposed by the
Underwriters. See "Shares Eligible for Future Sale" and "Underwriting."
54
<PAGE> 57
Representations and Warranties of the Predecessor Companies
Each of the Combination Agreements contains customary representations and
warranties relating to, among other things, due organization and good standing
of the Predecessor Company, good and marketable title to the shares of stock in
the Predecessor Company exchanged in the Combination, the investment intent of
the stockholders of the Predecessor Company, the absence of preemptive rights,
the absence of any options, warrants or other rights to acquire the stock of the
Predecessor Company, good and marketable title to all of the Predecessor
Company's assets, adequate insurance, the accuracy of the Predecessor Company's
financial statements, the absence of litigation and compliance with applicable
laws.
Indemnification
Pursuant to the Combination Agreements, each Predecessor Company and its
stockholders agree to indemnify, defend and hold harmless the Company and its
officers, directors, shareholders and affiliates against any and all damages,
liabilities and expenses, including reasonable attorney's fees, suffered because
of (i) the untruth, inaccuracy, misrepresentation, omission, or breach or
nonfulfillment by the Predecessor Company or its stockholders of any
representation, warranty, covenant or other agreement contained in the
Combination Agreement or (ii) any untrue statement of a material fact relating
to the Predecessor Company or its stockholders that is contained in any
preliminary prospectus, the Registration Statement or any prospectus forming a
part thereof, or any amendment thereof or supplement thereto, or any omission to
state therein a material fact relating to the Predecessor Company or its
stockholders required to be stated therein or necessary to make such statements
therein not misleading. Each Predecessor Company and its stockholders have
indemnification obligations only to the extent that the aggregate of all
indemnifiable damages, losses, settlement payments, obligations and liabilities,
including reasonable attorney's fees, for such Predecessor Company exceeds
$25,000.
The Company agrees to indemnify, defend and hold harmless each of the
stockholders of the Predecessor Companies and their respective successors and
assigns against any and all claims, losses, damages, liabilities and expenses,
including reasonable attorney's fees, suffered because of (i) the untruth,
inaccuracy, misrepresentation, omission, breach or nonfulfillment by the Company
of any representation, warranty, covenant or other agreement contained in the
Combination Agreements or (ii) any untrue statement of a material fact relating
to the Company that is contained in the preliminary prospectus, the Registration
Statement or any prospectus forming a part thereof, or any amendment thereof or
supplement thereto, or arising out of or based on any omission or alleged
omission to state therein a material fact relating to the Company required to be
stated therein or necessary to make the statements therein not misleading.
Escrow Agreement
Pursuant to the Combination Agreements, each of the stockholders of the
Predecessor Companies entered into an escrow agreement (the "Escrow Agreement")
with the Company and The Boatmen's National Bank of St. Louis (the "Escrow
Agent"). Each Escrow Agreement provides that the stockholders of the Predecessor
Companies will deliver to the Escrow Agent stock certificates (the "Escrow
Stock") representing 10% of the shares of Common Stock issued to such
stockholders in the Combination. Under the terms of the Escrow Agreement, the
Escrow Agent will hold the Escrow Stock for a period of one year commencing upon
consummation of the Combination, and during such period, the Company will be
entitled to receive reimbursement and recovery from the Escrow Stock for any
loss, liability, damage or expense for which the Company is indemnified under
the Combination Agreement. The Escrow Stock will not be the Company's exclusive
remedy in the event of such loss, liability, damage or expense. During the
period the Escrow Stock is held by the Escrow Agent, the stockholders of the
Predecessor Companies will be entitled to receive any dividends paid on the
Escrow Stock and have the right to vote the Escrow Stock.
Conditions Precedent to Closing of the Combination Agreements
The obligation of the Company to consummate the Combination is subject to
certain conditions, including the stockholders of a Predecessor Company having
good and marketable title, free and clear of any
55
<PAGE> 58
material liens, encumbrances or restrictions, to the stock of such Predecessor
Company, that the Predecessor Company's audited financial statements for the
fiscal years 1993, 1994 and 1995 complying in all material respects with all
applicable accounting requirements and being fairly presented in conformity with
generally accepted accounting principles, favorable opinions of counsel to the
stockholders of the Predecessor Company, the spin-off of real estate and other
non-operating assets owned by the Predecessor Company, the receipt of all
necessary consents, the closing of the Combination resulting in revenue and net
income before income taxes on a pro forma basis for the Company of at least $50
million and $7.5 million, respectively, and the effectiveness of the
Registration Statement. The obligation of a Predecessor Company and its
stockholders to consummate the Combination is subject to certain conditions,
including the accuracy of the representations and warranties of the Company
contained in the Combination Agreement, a favorable opinion of counsel to the
Company and receipts of consideration in the Combination of at least nine (9)
times such Predecessor Company's Adjusted Net Income.
Expenses
Each of the Combination Agreements provides that each of the parties shall
bear its respective expenses incurred in connection with the preparation,
execution and performance of the Combination Agreement and the transactions
contemplated therein, provided that the Company will, from the net proceeds of
the Offering, reimburse each of the Predecessor Companies for fees paid by it
for professional accounting services.
EMPLOYMENT AGREEMENTS AND COVENANTS NOT TO COMPETE
In connection with the Combination, the president/general manager of each
Service Center has entered into an employment agreement with the Company. The
annual salaries pursuant to such agreements range from $40,000 to $250,000 based
upon the size of the market served by such Service Center and the duties of the
president/general manager. In addition, each president/general manager will be
eligible for cash bonuses based on the performance of his Service Center and the
Company relative to established goals set by the president/general manager and
the Company. Such employment agreements have a term of three years and generally
provide, among other things, that such employee will not compete with the
Company during the term of such employment and for a period of two years
thereafter within 50 miles of any Service Center. The obligations of the parties
under the employment agreements are conditioned upon the consummation of the
Combination and the closing of the Offering. For a discussion of the employment
agreements between the Company and its executive officers, see "Management --
Employment Agreements."
DISPOSAL OF REAL ESTATE
Prior to the Combination, the buildings and underlying real estate owned by
certain of the Predecessor Companies were sold or otherwise disposed of.
Management expects that such Predecessor Companies will lease back from the
owners thereof the buildings and underlying real estate necessary for the
operation of its Service Centers.
56
<PAGE> 59
MANAGEMENT
EXECUTIVE OFFICERS AND DIRECTORS
The table below sets forth certain information concerning each of the
executive officers and directors of the Company.
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------------------- ---- -------------------------------------------
<S> <C> <C>
Alan R. Sielbeck........................... 43 Chairman of the Board and Chief Executive
Officer
James D. Abrams............................ 48 President, Chief Operating Officer and
Director
Anthony M. Schofield....................... 42 Chief Financial Officer and Treasurer
Raymond J. De Riggi........................ 48 Director
Timothy G. Wallace......................... 38 Director
William G. Roth............................ 58 Director
Norman T. Rolf, Jr......................... 50 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
Prior to the completion of the Offering, the Company anticipates increasing
the size of the Board of Directors from six to seven directors. The Company has
not yet determined who will serve as the additional director in the event of
such increase in size. In addition, the Company will divide its Board of
Directors into three classes, with directors being elected for staggered
three-year terms. Each class is to consist, as nearly as practicable, of
one-third of the total number of directors serving on the Board of Directors.
Alan R. Sielbeck has served as Chairman of the Board and Chief Executive
Officer of the Company since its inception in March 1996. Mr. Sielbeck has
served as Chairman of the Board and President of AC Service and Installation
Co., Inc. and Donelson Air Conditioning Company, Inc., each of which is a
Predecessor Company, since 1990 and 1991, respectively. From 1985 to 1990, Mr.
Sielbeck served as President of RC Mathews Contractor, Inc., a commercial
building general contractor, and Chief Financial Officer of RCM Interests, Inc.,
a commercial real estate developing company.
James D. Abrams has served as President, Chief Operating Officer and as a
director of the Company since its inception in March 1996. Mr. Abrams has served
as Chief Executive Officer and a director of CSG, one of the Combining
Companies, since 1990. Mr. Abrams has served as President and sole director of
Air Experts and Service Experts of Palm Springs, Inc., each a Predecessor
Company, since 1993. Mr. Abrams has served as President and sole director of Air
Comfort Services, Inc., an HVAC service and replacement business located in
Sarasota, Florida, since 1988. Mr. Abrams has served, since 1992, as Chairman
and President of Service Now, Inc. ("Service Now"), a holding company that owns
several HVAC businesses, including Air Experts and Service Experts of Palm
Springs, Inc. He plans to resign from his positions with Service Now prior to
the closing of the Combination and the Offering. Mr. Abrams previously served as
Chief Executive Officer and a director of Future University from 1991 to 1995.
Mr. Abrams currently serves on the Advisory Board of Boatmen's National Bank
(Southern Region).
Anthony M. Schofield has served as Chief Financial Officer of the Company
and Treasurer since June 1996. From 1982 to 1996, Mr. Schofield served as Cost
Manager, Vice-President-Controller, Senior Vice-President of Finance, and
Division Controller for Perrigo Company of Tennessee, formerly Cumberland-Swan,
Inc., a manufacturer of personal care health and beauty aid products. Mr.
Schofield is certified by the American Institute of Certified Public Accountants
as well as the Institute of Management Accountants holding both CPA and CMA
designations.
Raymond J. De Riggi has served as a director of the Company since June
1996. Mr. De Riggi has served as President of United Specialty Food Ingredients
Companies, a subsidiary of ConAgra Food Products, a
57
<PAGE> 60
diversified food processing company, since November 1995. From 1992 to 1995, Mr.
De Riggi served as Executive Vice President of Pet, Incorporated, a diversified
food processing company, and from 1990 to 1992, he served as its Vice President
of Operations. From 1987 to 1990, Mr. De Riggi served as President of Whitman's
Chocolates, a division of Pet, Incorporated.
Timothy G. Wallace has served as a director of the Company since June 1996.
Mr. Wallace has served as Vice President of Finance and Chief Financial Officer
of Healthcare Realty Trust Incorporated, a company operating as a real estate
investment trust, since January 1993. Mr. Wallace was a Senior Manager with
responsibility for healthcare and real estate in the Nashville, Tennessee office
of Ernst & Young LLP from June 1989 to January 1993. Prior to joining Ernst &
Young LLP, he was employed by Arthur Andersen & Co. from September 1980 to June
1989.
William G. Roth has served as a director of the Company since July 1996.
Mr. Roth has served as a director of Dravo Corporation, a natural resources
company that is the largest producer of lime in the United States, since 1987,
including serving as chairman of the Board from 1987 to 1993. Mr. Roth also
served as Chief Executive of Dravo Corporation from 1987 to 1989. Prior to that
time, Mr. Roth served as President, Chief Operating Officer and a director of
American Standard, Inc., a worldwide manufacturer of air conditioning, plumbing
and transportation system products, from 1985 to 1987. From 1978 to 1985, Mr.
Roth served as Chairman and Chief Executive Officer of The Trane Company, an
international manufacturer and marketer of HVAC systems.
Norman T. Rolf, Jr. has served as a director of the Company since July
1996. Mr. Rolf currently serves as President and a director of Rolf Coal and
Fuel Corp., a Predecessor Company, where he has been employed in various
positions since 1966.
Prior to the Offering, the Board of Directors of the Company will establish
an Executive Committee, Compensation Committee and an Audit Committee. The
Executive Committee of the Board of Directors will be authorized by the Board of
Directors to take all action which may be delegated by the Board of Directors
under Delaware law. The Compensation Committee will be responsible for
establishing salaries, bonuses and other compensation for the Company's
executive officers and administering stock option and other employee benefit
plans of the Company. The Audit Committee will recommend the annual appointment
of the Company's auditors and reviews the scope of audit and non-audit
assignments and related fees, accounting principles used by the Company in
financial reporting, internal auditing procedures and the adequacy of the
Company's internal control procedures with the Company's auditors.
EXECUTIVE COMPENSATION
The Company was organized in March 1996, and its operation since that time
has related primarily to its formation and to the Combination.
The Company has not awarded stock appreciation rights to any of its
executive officers, directors or employees. The Company has no long-term
incentive, defined benefit or actuarial plans, as those terms are defined in
Commission regulations, covering employees of the Company.
EMPLOYMENT AGREEMENTS
Pursuant to employment agreements, effective as of the closing of the
Combination, Messrs. Sielbeck, Abrams and Schofield (the "executive officers")
are employed as executive officers of the Company. The employments agreements of
Messrs. Sielbeck, Abrams and Schofield provide for annual base salaries of
$250,000, $250,000 and $110,000, respectively, which salaries are subject to
annual review by the Compensation Committee, and bonuses, which amounts will be
determined by the Compensation Committee. The term of each employment agreement
is three years.
Each of the executive officers may terminate his respective employment
agreement without cause by giving the Company 90 days prior written notice.
Pursuant to the terms of his respective employment agreement, each executive
officer has agreed not to disclose the Company's confidential information and
not to
58
<PAGE> 61
compete against the Company during the term of his employment agreement and for
a period of two years thereafter.
In the event the executive officer is terminated upon a "change-in-control"
(as defined in the employment agreement), each of the executive officers will be
paid all accrued base salary, bonus compensation to the extent earned, vested
deferred compensation (other than plan benefits which will be paid in accordance
with the applicable plan) and other benefits through the date of termination. In
addition, each executive officer will receive as severance pay his base salary
in monthly installments through the remaining term of the agreement, or at his
election, a lump sum severance payment equal to the present value of the flow of
severance payments that would otherwise be paid to him. Notwithstanding the
foregoing, the Company is not required to pay any amount which is not deductible
for federal income tax purposes.
Each executive officer is entitled to receive his accrued base salary,
earned bonus, vested deferred compensation (other than plan benefits which will
be paid in accordance with the applicable plan) and other benefits through the
date of termination in the event that the Company terminates his employment
without cause. In addition, he will receive as severance compensation his base
salary for the greater of two years or the remaining term of his employment
agreement.
In the event the executive officer is terminated for cause (as defined in
the agreement), he is entitled to receive all accrued base salary, earned bonus
compensation, vested deferred compensation (other than plan benefits which will
be payable in accordance with the applicable plan) and other benefits through
the date of termination, but shall receive no other severance benefits. Each
executive officer's employment agreements may also be terminated if he dies, in
which event his estate will receive these same payments and severance payments
equal to three months' salary.
In the event the executive officer becomes disabled for a period of 60
consecutive days, he is entitled to receive his base salary, insurance, bonus
and other benefits for a period of six months from the date such disability
began or for such shorter period as he is unable to perform his duties
hereunder. In the event he is unable to perform his duties hereunder after the
expiration of the six-month period, his employment agreement will terminate.
COMPENSATION OF DIRECTORS
Directors who are employees of the Company do not receive additional
compensation for serving as directors of the Company. Non-employee directors of
the Company are entitled to receive a fee of $10,000 per year. All directors are
also entitled to reimbursement for their actual out-of-pocket expenses incurred
in connection with attending meetings. In addition, each of the non-employee
directors of the Company is entitled to participate in the Service Experts, Inc.
1996 Non-Employee Director Stock Option Plan (the "Director Plan").
COMPENSATION PURSUANT TO PLANS
Incentive Stock Plan. In June 1996, the Company adopted the 1996 Incentive
Stock Plan (the "Incentive Plan"). The Company has reserved 700,000 of the
authorized shares of Common Stock for issuance pursuant to stock options and
stock appreciation rights ("SARs") to be granted under the Incentive Plan. Under
the Incentive Plan and pursuant to action of the Board, the Compensation
Committee appointed by the Board of Directors will administer the Incentive Plan
and may grant to officers and key employees (i) non-transferable options to
purchase shares of Common Stock and (ii) SARs. The options are for terms not
longer than ten years (five years in the case of incentive stock options granted
to an individual who, at the time of the grant, owns more than 10% of the total
combined voting power of all classes of stock of the Company), at prices to be
determined by the Board of Directors or the Compensation Committee. Such prices
may not be less than 100% of the fair market value of the Common Stock on the
date of grant (110% in the case of an individual who, at the time of grant of
incentive stock options, owns more than 10% of the total combined voting power
of all classes of stock of the Company) in the case of incentive stock options
under Section 422 of the Internal Revenue Code of 1986, as amended (the "Code").
Incentive stock options may be granted only to employees and may not be less
than 85% of the fair market value of the Common Stock on the
59
<PAGE> 62
date of grant in the case of non-qualified stock options. Options granted under
the Incentive Plan may be exercisable in installments. The Company is authorized
to loan, or guarantee loans of, the purchase price of shares issuable upon
exercise of options granted under the Incentive Plan. Unless terminated earlier,
the Incentive Plan will terminate in 2006. The aggregate fair market value of
Common Stock with regard to which incentive stock options are exercisable by an
individual for the first time during any calendar year may not exceed $100,000.
SARs will entitle the holder to receive an amount equal to the excess of
the fair market value of a specified number of shares of Common Stock as of the
date such right is exercised over a specified price which shall not be less than
85% of the fair market value of the Common Stock at the time the SAR is granted.
SARs may be granted separately or in connection with a non-qualified stock
option. No SAR is exercisable more than ten years after it is granted.
Non-Employee Director Stock Option Plan. In June 1996, the Company adopted
the Director Plan. The Company has reserved for issuance under the Director Plan
100,000 shares of Common Stock. The Director Plan provides for the granting of
nonqualified stock options to each director of the Company who is not also an
employee or officer of the Company ("Non-Employee Directors") at an exercise
price equal to the fair market value of the Common Stock on the date the options
are granted. The Director Plan contains provisions providing for adjustment of
the number of shares available for option and subject to unexercised options in
the event of stock splits, dividends payable in Common Stock, business
combinations or certain other events. The Board shall have no authority,
discretion or power to select the participants who will receive options pursuant
to the Director Plan, to set the number of shares of Common Stock to be covered
by each option, to set the exercise price or the period within which the options
may be exercised or to alter other terms or conditions specified in the options.
The Director Plan provides for the grant of options to purchase 5,000
shares of Common Stock to (i) each nonemployee director of the Company on the
effective date of this Offering at an exercise price equal to the public
offering price and (ii) each non-employee director elected after the effective
date of this Offering on the date of such director's election to the Board of
Directors at an exercise price equal to the fair market value of the Common
Stock on the date the options are granted. In addition, the Director Plan
provides for the grant to each non-employee director of the Company of options
to purchase 1,000 shares of Common Stock on each January 1 (each date of grant
being referred to as the "Grant Date"). The Board of Directors may revoke, on or
prior to each January 1, the next automatic grant of options otherwise provided
for by the Director Plan if no options have been granted to employees since the
preceding January 1 under the Incentive Plan or any other employee stock option
plan that the Company might adopt. Each option shall be exercisable in full upon
receipt and shall expire ten years after the Grant Date (the "Option Period"),
unless cancelled sooner due to termination of service or death, or unless the
option is fully exercised prior to the end of the Option Period.
Employee Stock Purchase Plan. The Service Experts, Inc. 1996 Employee
Stock Purchase Plan (the "Purchase Plan") was adopted in June 1996 and will
become effective simultaneously with the Offering. A total of 100,000 shares of
Common Stock have been reserved for issuance under the Purchase Plan, which is
intended to qualify under Section 423 of the Code. The Purchase Plan allows
participants to purchase shares of Common Stock in connection with option
periods commencing on the first trading date of each year and ending the
following December 31 (except the first option period which will commence the
date of the Offering and end December 31, 1996).
The Purchase Plan permits eligible employees of the Company and certain of
its subsidiaries to purchase Common Stock through payroll deductions, which may
not exceed 10% of the employee's base compensation, at a price equal to 85% of
the fair market value of the Common Stock at the beginning of the option period
or at the end of the option period, whichever is lower (subject to a minimum
price specified in the Purchase Plan). Employees are eligible to participate in
the Purchase Plan if they are employed by the Company or a participating
subsidiary for at least 20 hours a week and more than five months in any
calendar year and have been employed for at least six months since their last
date of hire.
60
<PAGE> 63
In the event of a change of control of the Company (as defined in the
Purchase Plan), each option under the Purchase Plan will (if the Company is the
surviving corporation) pertain to and apply to the securities to which a holder
of the number of shares of the Company subject to such option would have been
entitled in such transaction. If the Company is not the surviving corporation in
such change in control, then all options under the Purchase Plan will terminate
provided that the Compensation Committee may determine that such options shall
be exercisable on the day prior to such change in control transaction.
401(k) Plan. In 1996, the Company adopted a Savings and Profit Sharing
Plan (the "Savings Plan") which is intended to be qualified under Sections
401(a) and 401(k) of the Code. To be eligible, an employee must have been
employed by the Company for at least one year. The Savings Plan permits
employees who have completed one year of service to defer from 1% to 15% of
their compensation into the Savings Plan up to specified limits per year ($9,500
during 1996). Additional annual contributions may be made at the discretion of
the Company which will vest according to a schedule set forth in the Savings
Plan.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee is comprised of directors who are not employees
of the Company. The Compensation Committee is responsible for establishing
salaries, bonuses and other compensation for the Company's officers.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Pursuant to the Company's Restated Certificate of Incorporation and Bylaws,
the Company is obligated to indemnify each of its directors and officers to the
fullest extent permitted by law with respect to all liability and losses
suffered and reasonable expenses incurred by such person in any action, suit or
proceeding in which such person was or is made or threatened to be made a party
or is otherwise involved by reason of the fact that such person is or was a
director or officer of the Company. The Company is obligated to pay the
reasonable expenses of the directors or officers incurred in defending such
proceedings if the indemnified party agrees to repay all amounts advanced by the
Company if it is ultimately determined that such indemnified party is not
entitled to indemnification. See "Description of Capital Stock -- Limitations on
Liability of Officers and Directors."
CERTAIN TRANSACTIONS
Prior to the Offering, Mr. Abrams, Mr. Sielbeck, John R. Young, a principal
stockholder of CSG, and R. Edward Hutton, Jr., a principal stockholder of AC
Service & Installation Co., Inc. and Donelson Air Conditioning Company, Inc.,
two of the Service Centers, received 500,695, 243,706, 473,992 and 243,707
shares of Common Stock, respectively, as founders of the Company for their
services in forming the Company, developing its business plans and procedures
and in acquiring the Predecessor Companies. These shares do not include the
shares of Common Stock to be received in exchange for their interests in the
Predecessor Companies.
Pursuant to the Combination, and as consideration for their interests in
the Predecessor Companies, certain officers, directors and holders of 5% or more
of the outstanding Common Stock will receive cash and shares of Common Stock as
follows: Mr. Sielbeck -- $2,498,378 and 576,548 shares; Mr. Abrams -- $2,056,129
and 471,491 shares; Mr. Young -- $2,036,744 and 470,018 shares; Mr.
Hutton -- $2,498,378 and 576,548 shares; and Norman T. Rolf, Jr. -- $599,970 and
138,454 shares,, assuming an initial offering price of $13.00 per share. See
"The Combination." Such amounts were determined on the basis of the evaluation
by the Company and the Representatives of the following factors: the financial
and operational history and trends of the Predecessor Company, the experience of
the Company's management, the position of the Company in the HVAC service and
replacement industry, the Company's prospects and financial results, the status
of the securities markets, market conditions for new offerings of securities and
the prices of similar securities of comparable companies.
61
<PAGE> 64
In connection with the Combination, the Company acquired approximately 38%
of the issued and outstanding common stock of Future University in exchange for
$2,000 per share in cash, an aggregate of $604,000. The consideration paid was
determined by arms length negotiations between the Company and the stockholders
of Future University who sold their shares to the Company. Mr. Abrams and Mr.
Young, who are principal stockholders of Future University, each received
$248,000 in the transaction. The Company intends to continue to send its
employees to Future University for training after the Combination. See
"Business -- Contractor Success Group."
Service Now, of which Mr. Abrams and Mr. Young are principal shareholders,
is a 48% shareholder of SuccessWare, a corporation that provides management and
financial information systems software to certain of the Predecessor Companies.
See "Business -- Services and Operations -- Management Information Systems." In
connection with the Combination, the Company acquired all of the capital stock
of Air Experts, a United Services Co., Inc. and Service Experts of Palm Springs,
Inc., both of which were wholly owned subsidiaries of Service Now. After the
Combination, Service Now will continue to own and operate other HVAC companies,
none of which are located in geographic areas served by existing Service
Centers. In addition, the Company purchased from Service Now the exclusive
rights to the name "Service Experts" in exchange for $60,000.
Mr. Abrams and Mr. Young are the sole shareholders of Fusion Filters, Inc.
("Fusion"), which licenses air filters and other products from manufacturers and
sublicenses them to HVAC contractors, including certain of the Predecessor
Companies. The Company has not entered into any definitive agreements with
Fusion, but may purchase filters from Fusion in the future.
At March 31, 1996, Mr. Sielbeck had outstanding indebtedness payable to AC
Service & Installation Co., Inc. and Donelson Air Conditioning Company, Inc. in
the amount of $133,800, consisting of a note payable in the principal amount of
$100,000, bearing annual interest at 5% and payable upon demand, and an
interest-free advance of $33,800. At March 31, 1996, Mr. Hutton had outstanding
indebtedness payable to AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. in the amount of $133,800, consisting of a note
payable in the principal amount of $100,000, bearing annual interest at 5% and
payable upon demand, and an interest-free advance of $33,800. All of such
indebtedness has been repaid.
On June 20, 1996, the Board of Directors adopted a policy that any
transactions between the Company and any of its officers, directors or principal
stockholders or affiliates thereof, must be on terms no less favorable than
those which could be obtained from unaffiliated parties and must be approved by
a majority of the disinterested members of the Board of Directors. The Audit
Committee of the Board of Directors will be responsible for reviewing all
related party transactions on a continuing basis and potential conflict of
interest situations where appropriate.
62
<PAGE> 65
PRINCIPAL STOCKHOLDERS
The table below sets forth information regarding the beneficial ownership
of the Common Stock, as of the date hereof and giving effect to the Combination
and the Offering (assuming an initial offering price of $13.00 per share), by
(i) each person known to the Company to be the beneficial owner of more than 5%
of the outstanding shares of Common Stock, (ii) each director and executive
officer of the Company and (iii) all directors and executive officers of the
Company as a group. Unless otherwise indicated, each of the stockholders listed
below has sole voting and investment power with respect to the shares
beneficially owned.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY
OWNED PRIOR TO THE SHARES TO BE BENEFICIALLY
OFFERING OWNED AFTER THE OFFERING
------------------- -----------------------------
BENEFICIAL OWNER NUMBER PERCENT NUMBER PERCENT
- --------------------------------------------- ------- ------- --------- -------
<S> <C> <C> <C> <C>
James D. Abrams(1)........................... 409,262 27.99% 1,396,271(4) 16.91%
Alan R. Sielbeck(2).......................... 243,706 16.67 1,396,802(5) 16.92
John R. Young(3)............................. 387,436 26.50 1,374,445(4) 16.65
R. Edward Hutton, Jr.(2)..................... 243,707 16.67 1,396,803(5) 16.92
Anthony M. Schofield......................... -- --
Raymond J. De Riggi.......................... -- --
Timothy G. Wallace........................... -- --
William G. Roth.............................. -- --
Norman T. Rolf, Jr........................... -- 281,087(6) 3.40
All executive officers and directors as a
group (seven persons)...................... 652,968 44.66 3,074,160(4)(5)(6) 37.23
</TABLE>
- ---------------
(1) Mr. Abrams's address is c/o Contractor Success Group, 16141 North Outer
Forty Drive, Suite 310, Chesterfield, Missouri 63017.
(2) The indicated person's address is c/o AC Service & Installation Co., Inc.,
1134 Murfreesboro Road, Nashville, Tennessee 37217.
(3) Mr. Young's address is c/o John Young & Associates, 13950 Switzer, Overland
Park, Kansas 66221.
(4) Includes 205,785 shares to be issued to Service Now, the sole stockholder of
two of the Predecessor Companies, in connection with the Combination.
Messrs. Abrams and Young are principal shareholders of Service Now.
Includes 781,224 shares to be issued to CSG in connection with the
Combination. Messrs. Abrams and Young are the sole shareholders of CSG.
(5) Includes 1,153,096 shares to be issued to AC Service & Installation Co.,
Inc. and Donelson Air Conditioning Company, Inc., of which Messrs. Sielbeck
and Hutton are the sole shareholders.
(6) Includes 274,672 shares to be issued to Rolf Coal and Fuel Corp., of which
Mr. Rolf is a principal shareholder.
63
<PAGE> 66
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company is authorized to issue 30,000,000 shares of Common Stock, $.01
par value per share, and 10,000,000 shares of preferred stock, $.01 par value
per share (the "Preferred Stock"). Upon completion of the Offering and giving
effect to the Combination, the Company will have 8,257,401 shares of Common
Stock (assuming an initial offering price of $13.00 per share) and no shares of
Preferred Stock outstanding. The following description of capital stock of the
Company is qualified in its entirety by reference to the Company's Restated
Certificate of Incorporation, a copy of which is filed as an exhibit to the
Registration Statement of which this Prospectus forms a part. An additional
900,000 shares of Common Stock are reserved for issuance upon exercise of
employee and director stock options, of which options to purchase shares have
been granted as of the date hereof. See "Management -- Compensation Pursuant to
Plans." As of June 30, 1996, there are approximately 40 holders of Common Stock.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share on all matters
submitted to a vote of stockholders. Stockholders have no right to cumulate
their votes in the election of directors. Accordingly, holders of a majority of
the shares of Common Stock entitled to vote in any election of directors may
elect all of the directors standing for election. Holders of Common Stock are
entitled to receive dividends and other distributions when, as and if declared
from time to time by the Board of Directors out of funds legally available
therefor. In the event of a voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, including all
distributions to holders of Preferred Stock having a liquidation preference over
the Common Stock. The Company's Restated Certificate of Incorporation gives the
holders of Common Stock no preemptive or other subscription or conversion
rights, and there are no redemption provisions with respect to such shares. All
outstanding shares of Common Stock are, and the shares offered hereby will be,
when issued and paid for, fully paid and non-assessable. The rights, preferences
and privileges of holders of Common Stock are subject to, and may be adversely
effected by, the rights of holders of shares of any series of Preferred Stock
which the Company may designate and issue in the future. For a description of
certain registration rights attached to warrants to purchase Common Stock, see
"Underwriting."
PREFERRED STOCK
The Board of Directors has the authority, without any further vote or
action of the stockholders of the Company, to issue shares of the Preferred
Stock in one or more series and to fix the number of shares, designations,
relative rights (including voting rights), preferences and limitations of such
series to the fullest extent now or hereafter permitted by Delaware law. The
Company has no present intention to issue any series of Preferred Stock.
LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS
The Company's Restated Certificate of Incorporation and Bylaws provide for
indemnification of the officers and directors of the Company to the fullest
extent permitted by Delaware law, including some instances in which
indemnification is otherwise discretionary under Delaware law. The Restated
Certificate of Incorporation contains provisions that eliminate the personal
liability of the Company's directors for monetary damages resulting from
breaches of their fiduciary duty other than liability for breaches of the
director's duty of loyalty to the Company or its stockholders, for acts or
omissions not in good faith or which involve intentional misconduct or a knowing
violation of law, violations under Section 174 of the Delaware General
Corporation Law, or for any transaction from which the director derived an
improper personal benefit. The Company believes that these provisions are
essential to attracting and retaining qualified persons as officers and
directors.
64
<PAGE> 67
There is no pending litigation or proceeding involving a director or
officer of the Company as to which indemnification is being sought, nor is the
Company aware of any threatened litigation that may result in claims for
indemnification by any officer or director.
ANTI-TAKEOVER PROVISIONS
Section 203 of the Delaware General Corporation Law prevents an "interested
stockholder" (defined in Section 203, generally, as a person owning 15% or more
of a corporation's outstanding voting stock) from engaging in a "business
combination" (as defined in Section 203) with a publicly-held Delaware
corporation for three years following the date such person became an interested
stockholder unless (i) before such person became an interested stockholder, the
board of directors of the corporation approved the transaction in which the
interested stockholder became an interested stockholder or approved the business
combination; (ii) upon consummation of the transaction that resulted in the
interested stockholder's becoming an interested stockholder, the interested
stockholder owns at least 85% of the voting stock of the corporation outstanding
at the time the transaction commenced (excluding stock held by directors who are
also officers of the corporation and by employee stock plans that do not provide
employees with the right to determine confidentially whether shares held subject
to the plan will be tendered in a tender or exchange offer); or (iii) following
the transaction in which such person became an interested stockholder, the
business combination is approved by the board of directors of the corporation
and authorized at a meeting of stockholders by the affirmative vote of the
holders of two-thirds of the outstanding voting stock of the corporation not
owned by the interested stockholder.
Certain provisions of the Company's Restated Certificate of Incorporation
and Bylaws may make a change in the control of the Company difficult to effect,
even if a change in control were in the stockholders' interest. These include
certain super-majority vote requirements to amend or repeal certain provisions
of the Company's Restated Certificate of Incorporation or Bylaws, including
provisions relating to the election of a staggered Board of Directors and the
limitation that directors be removed only for cause by a majority of the
outstanding voting stock. See "Management -- Executive Officers and Directors."
The Company's Restated Certificate of Incorporation eliminates the right of
stockholders to take action by written consent. In addition, the Company's
Restated Certificate of Incorporation allows the Board to determine the terms of
the Preferred Stock which may be issued by the Company without approval of the
holders of the Company's Common Stock. The ability of the Company to issue
Preferred Stock in such manner could enable the Board of Directors to prevent
changes in management and control of the Company. These provisions are expected
to discourage certain types of coercive takeover practices and inadequate
takeover bids and to encourage persons seeking to acquire control of the Company
first to negotiate with the Company. Management believes that the benefits of
increased protection of the Company's potential ability to negotiate with the
proponent of an unfriendly or unsolicited proposal to acquire or restructure the
Company outweigh the disadvantages of discouraging such proposals. Management
believes that negotiations of such proposals, among other things, could result
in an improvement of their terms.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is The
Boatmen's National Bank of St. Louis.
65
<PAGE> 68
SHARES ELIGIBLE FOR FUTURE SALE
Prior to the Offering, there has been no market for the Common Stock and no
precise predictions can be made as to the effect, if any, that sales of shares
or the availability of such shares for sale in the public market will have on
the market prices prevailing from time to time. Nevertheless, sales of
substantial amounts of Common Stock in the public market could adversely affect
prevailing market prices and impair the Company's ability to raise capital
through the sale of equity securities.
Upon completion of the Offering, the Company will have outstanding
8,257,401 shares of Common Stock (assuming an initial offering price of $13.00
per share) of which the 2,250,000 shares sold in the Offering (2,587,500 shares
if the Underwriters' over-allotment option is exercised in full) will be freely
tradeable without restrictions or further registration under the Securities Act,
unless purchased by "affiliates" of the Company as that term is defined in Rule
144 under the Securities Act ("Rule 144").
All the remaining shares were issued and sold by the Company in private
transactions in reliance upon the exemption from registration contained in
Section 4(2) of the Securities Act and are restricted securities under Rule 144.
These shares may not be sold unless they are registered under the Securities Act
or are sold pursuant to an applicable exemption from registration, pursuant to
Rule 144. In general, under Rule 144 as currently in effect, beginning 90 days
after the Offering a person who has beneficially owned these shares for at least
two years, including "affiliates" of the Company, would be entitled to sell in
broker's transactions or to market makers within any three-month period a number
of shares that does not exceed the greater of 1% of the then outstanding shares
of Common Stock or the average weekly trading volume of the Common Stock on the
Nasdaq National Market during the four calendar weeks preceding the date on
which notice of the sale is filed with the Commission. Sales under Rule 144 are
also subject to certain manner of sale restrictions and notice requirements and
to the availability of current public information concerning the Company. A
person (or person whose shares are aggregated) who is not an "affiliate" of the
Company at any time during the 90 days preceding a sale, and who has
beneficially owned such shares for at least three years, is currently entitled
to sell such shares under Rule 144(k) without regard to the availability of
current public information, volume limitations, manner of sale provisions or
notice requirements. The above is a summary of Rule 144 and is not intended to
be a complete description thereof. Notwithstanding the eligibility of certain
shares to be sold after the expiration of the 90 day period, such shares are
subject to certain lockup agreements described below.
The Company, its officers and directors and certain of its present
stockholders have agreed that they will not, directly or indirectly, offer,
sell, offer to sell, contract to sell, grant any option to purchase or otherwise
sell or dispose (or announce any offer, sale, offer of sale, contract of sale,
grant of any option to purchase or other sale or disposition) of any shares of
Common Stock or any securities convertible into or exercisable or exchangeable
therefor or other capital stock of the Company or any right to purchase or
acquire Common Stock or other capital stock of the Company for a period of 180
days after the date of this Prospectus without the prior written consent of
Equitable Securities Corporation on behalf of the Underwriters. See
"Underwriting."
66
<PAGE> 69
UNDERWRITING
The Underwriters named below (the "Underwriters"), for whom Equitable
Securities Corporation and Morgan Keegan & Company, Inc. are acting as
representatives (the "Representatives"), have severally agreed, subject to the
terms and conditions of an underwriting agreement (the "Underwriting
Agreement"), to purchase from the Company the numbers of shares of Common Stock
set forth below opposite their respective names:
<TABLE>
<CAPTION>
NUMBER
UNDERWRITER OF SHARES
-------------------------------------------------------------------------- ---------
<S> <C>
Equitable Securities Corporation..........................................
Morgan Keegan & Company, Inc. ............................................
---------
Total........................................................... 2,250,000
========
</TABLE>
The Underwriting Agreement provides that the obligations of the several
Underwriters thereunder are subject to the approval of certain legal matters by
counsel and to various other conditions. The nature of the Underwriters'
obligations is such that they are committed to purchase all of the shares of
Common Stock offered hereby if any are purchased.
The Underwriters propose to offer the shares of Common Stock being
purchased directly to the public at the initial offering price set forth on the
cover page of this Prospectus, and to certain dealers at such price less a
concession not in excess of $ per share. The Underwriters may allow, and
such dealers may reallow, a concession not in excess of $ per share to
certain other dealers. After the Offering, the offering price and other selling
terms may be changed.
The Company has granted the Underwriters a 30-day option to purchase up to
an additional 337,500 shares of Common Stock at the initial offering price less
the underwriting discount set forth on the cover page of this Prospectus to
cover over-allotments, if any. If the Underwriters exercise their over-allotment
option to purchase any of the 337,500 additional shares of Common Stock from the
Company, the Underwriters have severally agreed, subject to certain conditions,
to purchase approximately the same percentage thereof that the number of shares
of Common Stock to be purchased by each of them as shown in the above table
bears to the 2,250,000 shares of Common Stock offered hereby. The Underwriters
may exercise this option only to cover over-allotments made in connection with
the sale of the Common Stock offered hereby.
Prior to this Offering, there has been no market for the Common Stock. The
initial offering price has been determined by negotiations between the Company
and the Representatives. The factors considered in determining such initial
offering price included the financial and operational history and trends of the
Company, the history of and the prospects for the industry in which the Company
competes, an assessment of the Company's management, its past and present
operations, its past and present earnings and the trend of such earnings, the
general condition of the securities markets at the time of the Offering and the
price-earnings multiples and market prices of publicly traded securities of
comparable companies. The Representatives have informed the Company that the
Underwriters do not intend to confirm sales of Common Stock to any accounts over
which they exercise discretionary authority. The Representatives intend to make
a market in the Common Stock after completion of the offering.
The Company, its directors and executive officers and certain other persons
have agreed that they will not offer, pledge, issue, sell, contract to sell,
grant any option for the sale of or otherwise dispose of any shares of Common
Stock or any securities convertible into, or exercisable or exchangeable for,
any shares of Common Stock for a period of 180 days after the date of this
Prospectus without the prior written consent of Equitable Securities Corporation
on behalf of the Representatives; provided, however, the Company may grant stock
67
<PAGE> 70
options under, and issue shares of Common Stock upon the exercise of outstanding
stock options granted under, the Company's Incentive Stock Plan.
The Company has agreed to indemnify the Underwriters and controlling
persons, if any, against, certain liabilities, including liabilities under the
Securities Act or will contribute to the payments the Underwriters or any
controlling persons may be required to make in respect thereof.
Equitable Securities Corporation ("ESC") was engaged jointly by AC Service
& Installation Co., Inc. and CSG to provide financial advisory and investment
banking services in the formation of the Company and the structuring of the
Combination. The Company assumed the obligations of AC Service & Installation
Co., Inc. and CSG after its formation. In connection with the engagement, ESC
has received a financial advisory fee of $25,000. Upon completion of the
Combination, ESC will receive an additional financial advisory fee of $250,000,
and warrants (the "ESC Warrants") to purchase that number of shares of the
Common Stock which equals 1% of the Common Stock outstanding after the Offering
(before exercise of the Underwriters' over-allotment option), at a per share
price equal to the initial offering price. The ESC Warrants will be exercisable
for a period of five years, in whole or in part, will be subject to
anti-dilution adjustments resulting from stock splits, stock dividends and
recapitalizations, will not be transferable during the initial 12 months (except
in certain limited circumstances), and will grant one demand registration right
for the underlying Common Stock exercisable for five years from the date of
issuance of the ESC Warrants and incidental registration rights exercisable for
seven years from the date of the issuance of the ESC Warrants. As a result of
the advisory fees paid and to be paid to ESC in connection with the Combination
and receipt of the ESC Warrants, ESC will be deemed to have received $623,875 in
additional compensation in connection with this Offering.
LEGAL MATTERS
Certain legal matters with respect to the validity of the shares of Common
Stock are being passed upon for the Company by Waller Lansden Dortch & Davis, a
Professional Limited Liability Company, Nashville, Tennessee, counsel to the
Company. Certain legal matters will be passed upon for the Underwriters by
Sherrard & Roe, PLC, Nashville, Tennessee.
EXPERTS
The financial statements appearing in this Prospectus and Registration
Statement have been audited by Ernst & Young LLP, independent auditors, as set
forth in their reports thereon appearing elsewhere herein, and are included in
reliance upon such reports given upon the authority of such firm as experts in
accounting and auditing.
68
<PAGE> 71
AVAILABLE INFORMATION
The Company has filed with the Commission a Registration Statement on Form
S-1 under the Securities Act with respect to the Common Stock offered hereby.
This Prospectus, which is a part of the Registration Statement, does not contain
all of the information set forth in the Registration Statement and the exhibits
and schedules thereto. For further information with respect to the Company and
the Common Stock, reference is hereby made to the Registration Statement and the
exhibits and schedules filed as a part thereof. Statements contained in this
Prospectus concerning the provisions or contents of any contract, agreement or
any other document referred to herein are not necessarily complete. With respect
to each such contract, agreement or document filed as an exhibit to the
Registration Statement, reference is made to such exhibit for a more complete
description of the matters involved, and each statement shall be deemed
qualified in its entirety by such reference to the copy of the applicable
document filed with the Commission. A copy of the Registration Statement,
including the exhibits and schedules thereto, may be inspected without charge at
the Public Reference Section of the Commission at Room 1024, Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549 and at the following Regional
Offices of the Commission: New York Regional Office, 7 World Trade Center, 13th
Floor, New York, New York 10048; and Chicago Regional Office, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. Copies of the Registration
Statement and the exhibits and schedules thereto can be obtained from the Public
Reference Section of the Commission upon payment of prescribed fees. The
Commission maintains an Internet web site that contains reports, proxy and
information statements and other information regarding issuers that file
electronically with the Commission. The address of that site is
http://www.sec.gov.
Prior to filing the Registration Statement of which this Prospectus is a
part, the Company was not subject to the reporting requirements of Section 13 or
15(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act").
Upon effectiveness of the Registration Statement, the Company will become
subject to the informational and periodic reporting requirements of the Exchange
Act, and in accordance therewith, will file periodic reports, proxy statements
and other information with the Commission. Such periodic reports, proxy
statements and other information will be available for inspection and copying at
the public reference facilities and other regional offices referred to above.
The Company intends to register the securities offered by the Registration
Statement under the Exchange Act simultaneously with the effectiveness of the
Registration Statement and to furnish its shareholders with annual reports
containing audited financial statements and quarterly reports for the first
three fiscal quarters of each fiscal year containing unaudited interim financial
information.
69
<PAGE> 72
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
UNAUDITED PRO FORMA COMBINING FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
Basis of Presentation................................................................ F-4
Unaudited Pro Forma Combining Balance Sheet as of June 30, 1996...................... F-5
Unaudited Pro Forma Combining Statement of Income for the Twelve Months ended
December 31, 1995.................................................................. F-6
Unaudited Pro Forma Combining Statement of Income for the Six Months ended June 30,
1996............................................................................... F-7
Notes to Unaudited Pro Forma Combining Financial Statements.......................... F-8
SERVICE EXPERTS, INC. -- AUDITED BALANCE SHEET
MARCH 31, 1996
Report of Independent Auditors....................................................... F-11
Balance Sheet........................................................................ F-12
Statements of Operations............................................................. F-13
Statements of Stockholders' Equity................................................... F-14
Statements of Cash Flows............................................................. F-15
Notes to Balance Sheet............................................................... F-16
COMBINED PREDECESSOR COMPANIES -- AUDITED COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-19
Combined Balance Sheets.............................................................. F-20
Combined Statements of Income........................................................ F-21
Combined Statements of Stockholders' Equity.......................................... F-22
Combined Statements of Cash Flows.................................................... F-23
Notes to Combined Financial Statements............................................... F-24
AC SERVICE & INSTALLATION CO., INC. AND DONELSON AIR CONDITIONING COMPANY,
INC. -- AUDITED COMBINED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-34
Combined Balance Sheets.............................................................. F-35
Combined Statements of Income........................................................ F-36
Combined Statements of Stockholders' Equity.......................................... F-37
Combined Statements of Cash Flows.................................................... F-38
Notes to Combined Financial Statements............................................... F-39
HARDWICK AIR MASTERS, INC. D/B/A AIRMASTERS, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-46
Balance Sheets....................................................................... F-47
Statements of Income................................................................. F-48
Statements of Stockholders' Equity................................................... F-49
Statements of Cash Flows............................................................. F-50
Notes to Financial Statements........................................................ F-51
NORRELL HEATING & AIR CONDITIONING, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-58
Balance Sheets....................................................................... F-59
Statements of Income................................................................. F-60
Statements of Stockholders' Equity................................................... F-61
Statements of Cash Flows............................................................. F-62
Notes to Financial Statements........................................................ F-63
</TABLE>
F-1
<PAGE> 73
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
VISION HOLDING COMPANY, INC. -- AUDITED CONSOLIDATED FINANCIAL STATEMENTS
PERIOD FROM MARCH 1, 1993 (DATE OPERATIONS COMMENCED) THROUGH DECEMBER 31, 1993,
YEARS ENDED DECEMBER 31, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996 (UNAUDITED)
Report of Independent Auditors....................................................... F-68
Consolidated Balance Sheets.......................................................... F-69
Consolidated Statements of Operations................................................ F-70
Consolidated Statements of Stockholder's Equity...................................... F-71
Consolidated Statements of Cash Flows................................................ F-72
Notes to Consolidated Financial Statements........................................... F-73
COMERFORD'S HEATING AND AIR CONDITIONING, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-80
Balance Sheets....................................................................... F-81
Statements of Operations............................................................. F-82
Statements of Stockholders' Equity................................................... F-83
Statements of Cash Flows............................................................. F-84
Notes to Financial Statements........................................................ F-85
ROLF COAL AND FUEL CORP. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-89
Balance Sheets....................................................................... F-90
Statements of Operations............................................................. F-91
Statements of Stockholders' Equity................................................... F-92
Statements of Cash Flows............................................................. F-93
Notes to Financial Statements........................................................ F-94
BRAND HEATING & AIR CONDITIONING, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-100
Balance Sheets....................................................................... F-101
Statements of Operations............................................................. F-102
Statements of Stockholders' Equity................................................... F-103
Statements of Cash Flows............................................................. F-104
Notes to Financial Statements........................................................ F-105
COASTAL AIR CONDITIONING SERVICE, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-110
Balance Sheets....................................................................... F-111
Statements of Income................................................................. F-112
Statements of Stockholder's Equity................................................... F-113
Statements of Cash Flows............................................................. F-114
Notes to Financial Statements........................................................ F-115
CONTRACTOR SUCCESS GROUP, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-122
Balance Sheets....................................................................... F-123
Statements of Income................................................................. F-124
Statements of Stockholders' Equity................................................... F-125
Statements of Cash Flows............................................................. F-126
Notes to Financial Statements........................................................ F-127
</TABLE>
F-2
<PAGE> 74
<TABLE>
<CAPTION>
PAGE
-----
<S> <C>
ARROW HEATING & AIR CONDITIONING, INC. -- AUDITED FINANCIAL STATEMENTS
PERIOD FROM JANUARY 29, 1993 (DATE OPERATIONS COMMENCED) THROUGH DECEMBER 31, 1993,
YEARS ENDED DECEMBER 31, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996 (UNAUDITED)
Report of Independent Auditors....................................................... F-132
Balance Sheets....................................................................... F-133
Statements of Income................................................................. F-134
Statements of Stockholders' Equity................................................... F-135
Statements of Cash Flows............................................................. F-136
Notes to Financial Statements........................................................ F-137
AIR EXPERTS, A UNITED SERVICES CO., INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996 (UNAUDITED)
Report of Independent Auditors....................................................... F-142
Balance Sheets....................................................................... F-143
Statements of Operations............................................................. F-144
Statements of Stockholders' Equity................................................... F-145
Statements of Cash Flows............................................................. F-146
Notes to Financial Statements........................................................ F-147
GILLEY'S HEATING & COOLING, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1993, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-152
Balance Sheets....................................................................... F-153
Statements of Income................................................................. F-154
Statements of Stockholder's Equity................................................... F-155
Statements of Cash Flows............................................................. F-156
Notes to Financial Statements........................................................ F-157
SERVICE EXPERTS OF PALM SPRINGS, INC. -- AUDITED FINANCIAL STATEMENTS
PERIOD FROM OCTOBER 15, 1993 (DATE OPERATIONS COMMENCED) THROUGH DECEMBER 31, 1993,
AND YEARS ENDED DECEMBER 31, 1994 AND 1995 AND PERIOD ENDED MARCH 31, 1996
(UNAUDITED)
Report of Independent Auditors....................................................... F-161
Balance Sheets....................................................................... F-162
Statements of Operations............................................................. F-163
Statements of Stockholders' Equity................................................... F-164
Statements of Cash Flows............................................................. F-165
Notes to Financial Statements........................................................ F-166
</TABLE>
F-3
<PAGE> 75
PRO FORMA COMBINING FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
The following unaudited pro forma combining financial statements give
effect to the acquisition by Service Experts, Inc., a Delaware Corporation, of
the following companies ("Predecessor Companies"), in exchange for shares of the
Company's common stock, cash, and the assumption of certain debt (the
"Combination").
Combined AC Service & Installation Co., Inc. and Donelson Air Conditioning
Company, Inc.
Hardwick Air Masters, Inc.
Norrell Heating & Air Conditioning, Inc.
Vision Holding Company, Inc.
Comerford's Heating and Air Conditioning, Inc.
Rolf Coal and Fuel Corp.
Brand Heating & Air Conditioning, Inc.
Coastal Air Conditioning Service, Inc.
Contractor Success Group, Inc.
Arrow Heating & Air Conditioning, Inc.
Air Experts, a United Services Co., Inc.
Gilley's Heating & Cooling, Inc.
Service Experts of Palm Springs, Inc.
The unaudited pro forma combining financial statements have been prepared
by the Company based on the historical financial statements of Service Experts,
Inc. and the Predecessor Companies included elsewhere in this Prospectus, and
certain preliminary estimates and assumptions deemed appropriate by management
of the Company. These pro forma combining financial statements may not be
indicative of actual results as if the transaction had occurred on the dates
indicated or which may be realized in the future. Neither expected benefits nor
cost reductions anticipated by the Predecessor Companies following consummation
of the Combination have been reflected in such pro forma combining financial
statements. The pro forma combining balance sheet as of June 30, 1996, gives
effect to the Combination and this Offering as if such transactions had occurred
on June 30, 1996. The pro forma combining statements of income for the six
months ended June 30, 1996 and year ended December 31, 1995, assume the
Combination was completed on January 1, 1995.
The pro forma combining financial statements should be read in conjunction
with the historical combined financial statements of the Combined Predecessor
Companies, including the related notes thereto, and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" that appear elsewhere
in this prospectus.
F-4
<PAGE> 76
PRO FORMA COMBINING BALANCE SHEET OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINING BALANCE SHEET
JUNE 30, 1996
<TABLE>
<CAPTION>
COMBINING COMPANIES
---------------------------
COMBINED PRO FORMA PRO FORMA
SERVICE PREDECESSOR COMBINATION OFFERING PRO FORMA
EXPERTS, INC. COMPANIES COMBINED ADJUSTMENTS PRO FORMA ADJUSTMENTS AS ADJUSTED
------------- ----------- ----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash and cash
equivalents.......... $ 13,386 $ 3,194,807 $ 3,208,193 (702,599 )(a) $ 2,505,594 26,050,000 (g) $10,368,346
(17,067,644)(i)
1,438,122 (j)
(384,566 )(k)
(2,173,160 )(l)
Certificates of
deposit.............. 100,000 100,000 100,000 100,000
Receivables:
Trade, net........... 5,809,083 5,809,083 5,809,083 5,809,083
Related Party........ -- 1,306,578 1,306,578 1,306,578 (1,306,578 )(j) --
Employee............. 118,779 118,779 118,779 118,779
Other................ 220,895 220,895 (30,001 )(c) 190,894 190,894
------------- ----------- ----------- ----------- ----------- ----------- -----------
-- 7,455,335 7,455,335 (30,001 ) 7,425,334 (1,306,578 ) 6,118,756
Inventories............ 2,108,559 2,108,559 2,108,559 2,108,559
Costs and estimated
earnings in excess of
billings............. 276,706 276,706 276,706 276,706
Investments............ 357,634 357,634 357,634 357,634
Prepaid expenses and
other current
assets............... 473,385 1,079,795 1,553,180 1,553,180 (1,300,000 )(g) 253,180
Current portion of
notes receivable,
net.................. 224,161 224,161 384,970 (d) 609,131 609,131
Deferred income
taxes................ 990,308 990,308 236,165 (e) 1,226,473 1,226,473
------------- ----------- ----------- ----------- ----------- ----------- -----------
Total current
assets......... 486,771 15,787,305 16,274,076 111,465 16,162,611 5,256,174 21,418,785
Property, buildings and
equipment, net......... 3,845,260 3,845,260 (384,970 )(d) 3,460,290 3,460,290
Notes
receivable -- related
parties, net........... 131,544 131,544 131,544 (131,544 )(i) --
Notes
receivable -- other,
net.................... 300,806 300,806 300,806 300,806
Equity investment in
Future University,
Inc.................... 604,000 (b) 604,000 604,000
Deferred income taxes.... 16,927 16,927 16,927 16,927
Goodwill, net............ 811,958 811,958 811,958 811,958
Other assets............. 312,686 312,686 312,686 312,686
------------- ----------- ----------- ----------- ----------- ----------- -----------
Total assets..... $ 486,771 $21,206,486 $21,693,257 $ 107,565 $21,800,822 $5,124,630 $26,925,452
=========== ========== ========== =========== ========== =========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........ $ -- $ 127,143 $ 127,143 $ -- $ 127,143 $ (127,143 )(l) $ --
Trade accounts payable
and accrued
liabilities.......... 456,770 3,582,471 4,039,241 4,039,241 4,039,241
Accrued compensation... 2,490,221 2,490,221 2,490,221 2,490,221
Accrued taxes, other
than income.......... 220,887 220,887 220,887 220,887
Accrued warranties..... 439,330 439,330 439,330 439,330
Income taxes payable... 1,080,730 1,080,730 (127,223 )(a) 953,507 953,507
Deferred revenue....... 1,580,152 1,580,152 1,580,152 1,580,152
Billings in excess of
costs and estimated
earnings............. 400,512 400,512 400,512 400,512
Liabilities to
Companies' benefit
plans................ 113,045 113,045 113,045 113,045
Due to related
parties.............. 30,001 180,972 210,973 (30,001 )(c) 180,972 (180,972 )(k) --
Notes payable to
related parties --
current.............. 100,215 100,215 604,000 (b) 661,917 (604,000 )(l) --
(42,298 )(d) (57,917 )(k)
Current portion of
long-term debt and
capital lease
obligations.......... 791,309 791,309 791,309 (791,309 )(l) --
Distributions payable
to Founders.......... 17,067,644 (a) 17,067,644 (17,067,644)(i) --
------------- ----------- ----------- ----------- ----------- ----------- -----------
Total current
liabilities.... 486,771 11,106,987 11,593,758 17,472,122 29,065,880 (18,828,985) 10,236,895
Long-term debt and
capital lease
obligations, net of
current portion........ 650,708 650,708 650,708 (650,708 )(l) --
Notes payable to related
parties, net........... 867,027 867,027 (721,350 )(d) 145,677 (145,677 )(k) --
Deferred compensation.... 112,557 112,557 (112,557 )(f) -- --
Deferred income taxes.... 476,591 476,591 476,591 476,591
Stockholders' equity:
Common stock........... 22,500 (g) 82,574
60,074 (h)
Additional paid-in
capital (owners'
equity).............. 7,992,616 7,992,616 (17,643,020)(a) (8,538,036) 24,727,500 (g) 16,129,392
(60,074 )(h)
763,648 (d)
236,165 (e)
112,557 (f)
Retained earnings........
------------- ----------- ----------- ----------- ----------- ----------- -----------
$ 486,771 $21,206,486 $21,693,257 $ 107,565 $21,800,822 $5,124,630 $26,925,452
=========== ========== ========== =========== ========== =========== ==========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combining Financial Statements.
F-5
<PAGE> 77
PRO FORMA COMBINING FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINING STATEMENT OF INCOME
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1995
<TABLE>
<CAPTION>
COMBINING COMPANIES
-------------------------
SERVICE COMBINED
EXPERTS, PREDECESSOR PRO FORMA PRO FORMA
INC. COMPANIES PRO FORMA ADJUSTMENTS AS ADJUSTED
----------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net revenues................. $ $59,651,163 $59,651,163 $59,651,163
Cost of goods sold........... 36,216,043 36,216,043 (120,333)(m) 36,095,710
----------- ----------- ----------- ----------- -----------
Gross margin................. -- 23,435,120 23,435,120 120,333 23,555,453
Selling, general and
administrative expenses.... 18,706,596 18,706,596 (3,155,621)(n) 15,550,975
----------- ----------- ----------- ----------- -----------
Income from operations....... -- 4,728,524 4,728,524 3,275,954 8,004,478
Other income (expense):
Interest expense........... (358,902) (358,902) 358,902(o) --
Interest income............ 256,206 256,206 256,206
Other income............... 207,730 207,730 91,006(p) 298,736
----------- ----------- ----------- ----------- -----------
-- 105,034 105,034 449,908 554,942
----------- ----------- ----------- ----------- -----------
Income before taxes.......... -- 4,833,558 4,833,558 3,725,862 8,559,420
Provision for income
taxes:..................... 613,912 613,912 2,669,321(q) 3,283,233
----------- ----------- ----------- ----------- -----------
Net income................... $ -- $ 4,219,646 $ 4,219,646 $ 1,056,541 $ 5,276,187
========== ========== ========== ========== ==========
Pro forma net income per
share...................... $0.68
Pro forma weighted average
shares outstanding......... 7,742,348
</TABLE>
See accompanying notes to Unaudited Pro Forma Combining Financial Statements.
F-6
<PAGE> 78
PRO FORMA COMBINING FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINING STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1996
<TABLE>
<CAPTION>
COMBINING COMPANIES
---------------------------
COMBINED
SERVICE PREDECESSOR PRO FORMA PRO FORMA
EXPERTS, INC. COMPANIES PRO FORMA ADJUSTMENTS AS ADJUSTED
------------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Net revenues................. $ -- $32,204,438 $32,204,438 $ -- $32,204,438
Cost of goods sold........... 19,498,220 19,498,220 19,498,220
------------- ----------- ----------- ----------- -----------
Gross margin................. -- 12,706,218 12,706,218 -- 12,706,218
Selling, general and
administrative expenses.... 11,077,695 11,077,695 (2,113,192)(n) 8,964,503
------------- ----------- ----------- ----------- -----------
Income from operations....... -- 1,628,523 1,628,523 2,113,192 3,741,715
Other income (expense):
Interest expense........... (211,679) (211,679) 211,679(o) --
Interest income............ 140,396 140,396 140,396
Other income............... 73,124 73,124 39,820(p) 112,944
------------- ----------- ----------- ----------- -----------
-- 1,841 1,841 251,499 253,340
------------- ----------- ----------- ----------- -----------
Income before taxes.......... -- 1,630,364 1,630,364 2,364,691 3,995,055
Provision for income taxes... 120,943 120,943 1,346,625(q) 1,467,568
------------- ----------- ----------- ----------- -----------
Net income................... $ -- $ 1,509,421 $ 1,509,421 $ 1,018,066 $ 2,527,487
========== ========== ========== ========== ==========
Pro forma net income per
share...................... $0.33
Pro forma weighted average
shares outstanding......... 7,742,348
</TABLE>
See accompanying notes to Unaudited Pro Forma Combining Financial Statements.
F-7
<PAGE> 79
PRO FORMA COMBINING FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINING FINANCIAL STATEMENTS
PRO FORMA BALANCE SHEET ADJUSTMENTS
(a) Reflects the liability for payments to owners of Predecessor Companies of
$17,770,243 in connection with the Combination, which in the opinion of
Management Staff Accounting Bulletin No. 48 applies. The liability for
payments to owners is accounted for as distributions to the owners of the
Predecessor Companies. This results in: (i) $17,643,020 reduction in
additional paid-in capital, (ii) $17,067,644 increase in distributions
payable to the owners of the Predecessor Companies, (iii) a reduction of
cash of $702,599, and (iv) a reduction of income taxes payable of $127,223.
A detail of such distributions is as follows:
DIVIDENDS
<TABLE>
<CAPTION>
CASH
RETAINED
CASH FROM (CONTRIBUTED) TOTAL CASH
PREDECESSOR COMPANIES OFFERING BY OWNERS DISTRIBUTION
------------------------------------------------- ------------ ---------- -----------
<S> <C> <C> <C>
Combined AC Service & Installation Co., Inc. and
Donelson Air Conditioning Company, Inc......... $ 4,996,755 $ (29,469 ) $ 4,967,286
Hardwick Air Masters, Inc........................ 58,860 (72,739 ) (13,879)
Norrell Heating & Air Conditioning, Inc.......... 1,543,899 (133,730 ) 1,410,169
Vision Holding Company, Inc...................... 1,108,489 267,455 1,375,944
Comerford's Heating and Air Conditioning, Inc.... 1,417,934 (285,500 ) 1,132,434
Rolf Coal and Fuel Corp.......................... 1,190,247 (110,126 ) 1,080,121
Brand Heating & Air Conditioning, Inc............ 802,371 (190,023 ) 612,348
Coastal Air Conditioning Service, Inc............ 166,939 (116,867 ) 50,072
Contractor Success Group, Inc.................... 3,385,304 615,706 4,001,010
Arrow Heating & Air Conditioning, Inc............ 969,690 -- 969,690
Air Experts, a United Services Co., Inc.......... 494,352 294,130 788,482
Gilley's Heating & Cooling, Inc.................. 535,421 462,727 998,148
Service Experts of Palm Springs, Inc............. 397,383 1,035 398,418
------------ ---------- -----------
$17,067,644 $ 702,599 $17,770,243
============ ========== ==========
</TABLE>
(b) Reflects the purchase of a 38% interest in Future University in exchange
for a note payable that will be repaid from the net proceeds of the
Offering, resulting in: (i) $604,000 investment in Future University, Inc.,
and (ii) $604,000 in notes payable to related parties.
(c) Reflects the elimination of amounts due to predecessor companies by Service
Experts, Inc. This results in a reduction in due to related parties of
$30,001 and a decrease in accounts receivable -- other of $30,001.
(d) Reflects the distribution of Vision Holding Company, Inc.'s building to a
stockholder in exchange for a note receivable and the elimination of the
mortgage payable to a former stockholder that is assumed by the stockholder
of Vision Holding Company, Inc. This results in (i) an increase in note
receivable from stockholder of $384,970, (ii) a decrease in property, plant
and equipment of $384,970; (iii) a decrease in notes payable of $763,648
and an increase in equity of $763,648 to reflect the assumption by the
stockholder.
(e) Reflects the resulting deferred income taxes in accordance with SFAS 109
for the Predecessor Companies organized as Subchapter S corporations and
not subject to federal income tax under the Internal Revenue Code. This
results in: (i) $236,165 increase in deferred income taxes and (ii)
$236,165 increase in additional paid-in capital.
F-8
<PAGE> 80
PRO FORMA COMBINING FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINING FINANCIAL STATEMENTS -- (CONTINUED)
(f) Reflects the reversal of deferred compensation at Norrell Heating & Air
Conditioning, Inc. resulting in: (i) a reduction of deferred compensation
of $112,557 and (ii) an increase in additional paid-in capital of $112,557.
The deferred compensation arrangement is being cancelled subject to the
Offering.
(g) Reflects the proceeds of the Offering, net of estimated expenses
($2,452,500) and underwriting commissions ($2,047,500), some of which are
included in prepaid expenses and other current assets at June 30, 1996. The
net proceeds are reflected as: (i) $26,050,000 of cash, (ii) $22,500 of
2,250,000 shares of common stock, (iii) $24,727,500 of additional paid-in
capital, and (iv) a reduction of prepaid expenses and other current assets
of $1,300,000.
(h) Reflects the reclassification of Owners' equity of the Predecessor
Companies into 6,007,401 shares of Common Stock, resulting in: (i) $60,074
increase in Common Stock, and (ii) $60,074 reduction of additional paid-in
capital (owners' equity).
(i) Reflects the use of net proceeds from the Offering for payment of
distributions payable to Predecessor Company stockholders (see pro forma
balance sheet adjustment a), resulting in: (i) $17,067,644 reduction in
dividends payable to Predecessor Company stockholders, and (ii) $17,067,644
reduction in cash.
(j) Reflects the collection of receivables to related parties. This results in
(i) a decrease in accounts receivable from related parties of $1,306,578;
(ii) a decrease in notes receivable from related parties of $131,544; and
(iii) an increase in cash of $1,438,122.
(k) Reflects the payment to the stockholders for the notes payable due them.
This results in (i) a decrease of $203,594 in notes payable to related
parties; (ii) a decrease in due to related parties of $180,972; and (iii) a
decrease in cash of $384,566.
(l) Reflects the use of proceeds from the Offering for the repayment of
$1,569,160 of debt assumed in the Combination and $604,000 of notes payable
to related parties, resulting in: (i) a reduction in total debt of
$1,569,160, of which $791,309 is current and $127,143 classified as
short-term debt, (ii) reduction in notes payable to related parties of
$604,000 and (iii) $2,173,160 reduction in cash.
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1995 1996
------------ ---------------
<S> <C> <C>
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS
(m)
Reflects the following adjustment to cost of goods sold:
(i) Elimination of extra payment to employee profit sharing
plan.................................................... $ (120,333) $ --
(n)
Reflects the following adjustments to selling, general, and
administrative:
(i) Elimination of historical owner's compensation.......... (5,990,468) (3,518,767)
(ii) Additional compensation relating to new agreements with
previous owners......................................... 1,773,006 886,503
(iii) Elimination of medicare taxes on the net change in
owner's compensation.................................... (69,588) (43,432)
(iv) Additional lease expense on real estate sold by AC
Service & Installation Co., Inc. and Vision Holding
Company, Inc............................................ 178,690 89,346
(v) Elimination of depreciation expense on real estate sold
by
AC Service & Installation Co., Inc. and Vision Holding
Company, Inc............................................ (48,239) (24,120)
(vi) Elimination of non-competition fees resulting from
buyout of non-competition agreements.................... (85,723) (42,862)
(vii) Elimination of extra payment to employee profit sharing
plan.................................................... (60,167) --
(viii) Corporate office overhead expenses...................... 540,000 270,000
</TABLE>
F-9
<PAGE> 81
PRO FORMA COMBINING FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
NOTES TO UNAUDITED PRO FORMA COMBINING FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1995 1996
------------ ---------------
<S> <C> <C>
(ix) Corporate office compensation........................... 729,000 366,000
(x) Elimination of management and consulting fees paid by
Air Experts, a United Services Co., Inc., Service
Experts of Palm Springs, Inc., and Coastal Air
Conditioning Service, Inc. to parent companies or
affiliates which will not be paid in the future......... (191,720) (95,860)
------------ -------------
(3,155,621) (2,113,192)
(o)
Reflects the following adjustments to interest expense related
to:
(i) Elimination of debt distributed to shareholder of Vision
Holding Company, Inc.................................... $ 72,830 $ 44,678
(ii) Elimination of interest on debt distributed to
shareholders of AC Service & Installation Co., Inc...... 33,499 14,722
(iii) Elimination of all other debt assumed in the transaction
to be paid at closing................................... 252,573 152,279
------------ -------------
358,902 211,679
(p)
Reflects the following adjustment to other income
(i) The addition of income from its 38% investment in Future
University.............................................. 91,006 39,820
(q)
Reflects the following adjustment to income taxes
(i) Additional income tax provision for state and federal
taxes at a combined effective rate of 38% as the
Predecessor Companies previously were taxed as
Subchapter S corporations............................... 1,253,493 448,042
(ii) Additional income taxes on adjustments m-p.............. 1,415,828 898,583
------------ -------------
$ 2,669,321 $ 1,346,625
(r)
The computation of pro forma net income per share is based upon 7,742,348 weighted average
shares of Common Stock outstanding, which includes (i) 4,545,301 shares distributed to the
shareholders of the Predecessor Companies, (ii) 1,462,100 shares outstanding to shareholders of
Service Experts, Inc. and (iii) 1,734,947 shares being sold in the Offering to cover the cash
portion of the distribution to be paid to the promoters, debt to be paid at closing, and
associated costs of the offering on shares used for the distribution and the paydown of debt.
</TABLE>
F-10
<PAGE> 82
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholder
Service Experts, Inc.
We have audited the accompanying balance sheet of Service Experts, Inc. as
of June 30, 1996, and the related statements of operations, stockholders'
equity, and cash flows for the period from March 27, 1996 (date of inception)
through June 30, 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Service Experts, Inc. at
June 30, 1996, and the results of operations and cash flows for the period from
March 27, 1996 (date of inception) through June 30, 1996 in conformity with
generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
July 29, 1996
F-11
<PAGE> 83
SERVICE EXPERTS, INC.
BALANCE SHEET
JUNE 30, 1996
<TABLE>
<S> <C>
ASSETS
Current assets:
Cash............................................................................ $ 13,386
Prepaid offering expenses....................................................... $473,385
--------
Total current assets.................................................... $486,771
========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accrued expenses................................................................ $456,770
Due to related parties.......................................................... 30,001
--------
Total current liabilities............................................... 486,771
Stockholders' equity:
Preferred stock -- $.01 par value:
Authorized -- 10,000,000 shares; outstanding -- none......................... --
Common Stock, $.01 par value;
Authorized -- 30,000,000; outstanding -- 1,462,100 shares.................... 14,621
Less: Notes receivable from stockholders........................................ (14,621)
Retained earnings............................................................... --
--------
Total stockholders' equity.............................................. --
--------
$486,771
========
</TABLE>
See accompanying notes.
F-12
<PAGE> 84
SERVICE EXPERTS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 26, 1996
(DATE OF INCEPTION)
THROUGH JUNE 30, 1996
---------------------
<S> <C>
Net revenues.............................................................. $ --
Cost of goods sold........................................................ --
-----------
Gross margin.............................................................. --
Selling, general and administrative expenses.............................. --
Bad debt expense.......................................................... --
-----------
Income from operations.................................................... --
Other income (expense):
Interest expense........................................................ --
Other income............................................................ --
-----------
Income before provision for income taxes.................................. --
Provision (benefit) for income taxes:
Current................................................................. --
Deferred................................................................ --
-----------
--
-----------
Net income................................................................ $ --
================
</TABLE>
See accompanying notes.
F-13
<PAGE> 85
SERVICE EXPERTS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK $.01 NOTES
PAR VALUE ADDITIONAL RECEIVABLE
------------------- PAID-IN RETAINED FROM
SHARES AMOUNT CAPITAL EARNINGS SHAREHOLDER TOTAL
--------- ------- ---------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Date of inception -- March 27,
1996............................. 1,000,000 $10,000 $ -- $ -- $ (10,000) --
Retroactive Stock dividend......... 462,100 4,621 -- -- (4,621) --
Net income (loss).................. -- -- -- -- -- --
--------- ------- ---------- -------- ----------- --------
Balance at June 30, 1996........... 1,462,100 $14,621 $ -- $ -- $ (14,621) $ --
======== ======= ======= ======== ========= ========
</TABLE>
See accompanying notes.
F-14
<PAGE> 86
SERVICE EXPERTS, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 27, 1996
(DATE OF INCEPTION)
THROUGH JUNE 30, 1996
---------------------
<S> <C>
FINANCING ACTIVITIES
Changes in assets and liabilities:
Prepaid offering expenses............................................ (473,385)
Accrued expenses..................................................... 456,770
Funds loaned to the Company.......................................... 30,001
---------------------
Net cash provided by operating activities and increase in cash............ 13,386
Increase in cash.......................................................... 13,386
Cash at beginning of period............................................... --
---------------------
Cash at end of year....................................................... $ 13,386
================
</TABLE>
See accompanying notes.
F-15
<PAGE> 87
SERVICE EXPERTS, INC.
NOTES TO BALANCE SHEET
JUNE 30, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Service Experts, Inc. (of Delaware) ("the Company") was formed on March 27,
1996, primarily for the purpose of acquiring 12 unrelated heating and air
conditioning businesses and Contractor Success Group, Inc., in exchange for
shares of its common stock and cash from the proceeds of sale of its stock in
the initial public offering of the Company ("the Offering"). The Offering is to
be effected in accordance with executed combination agreements with the 13
acquired businesses and is subject to the closing of the Offering. The companies
to be acquired are primarily engaged in the installation and servicing of air
conditioning and heating systems for residential and commercial customers in the
United States. The 13 unrelated businesses to be acquired, their city of
operations and the consideration to be paid by the Company to the stockholders
of each of the businesses to be acquired, are as follows:
<TABLE>
<CAPTION>
UNAUDITED
---------------------------
SHARES OF
COMPANY NAME LOCATION COMMON STOCK CASH
- ------------------------------------------- ------------------------ ------------ -----------
<S> <C> <C> <C>
Combined AC Service & Installation Co.,
Inc. and Donelson Air Conditioning
Company, Inc............................. Nashville, Tennessee 1,153,096 $ 4,996,755
Air Experts, a United Services Co., Inc.... St. Louis, Missouri 114,081 494,352
Hardwick Air Masters, Inc.................. Little Rock, Arkansas 350,587 58,860
Arrow Heating & Air Conditioning, Inc...... Racine, Wisconsin 223,775 969,690
Brand Heating & Air Conditioning, Inc...... Lafayette, Indiana 185,163 802,371
Coastal Air Conditioning Service, Inc...... Savannah, Georgia 243,987 166,939
Contractor Success Group, Inc.............. St. Louis, Missouri 781,224 3,385,304
Comerford's Heating and Air Conditioning,
Inc...................................... Pleasanton, California 350,178 1,417,934
Gilley's Heating & Cooling, Inc............ Monroe, Louisiana 164,745 535,421
Norrell Heating & Air Conditioning, Inc.... Birmingham, Alabama 356,284 1,543,899
Rolf Coal and Fuel Corp.................... Fort Wayne, Indiana 274,672 1,190,247
Service Experts of Palm Springs, Inc....... Palm Springs, California 91,704 397,383
Vision Holding Company, Inc................ Kansas City, Missouri 255,805 1,108,489
------------ -----------
4,545,301 $17,067,644
=========== ==========
</TABLE>
FAIR VALUE OF FINANCIAL INSTRUMENTS
Notes Receivable from Stockholders and Accrued Expenses
The carrying amounts reported in the balance sheet for notes receivable and
accrued expenses approximates fair value.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and For Long-Lived Assets to
Be Disposed Of" and does not believe the adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-16
<PAGE> 88
SERVICE EXPERTS, INC.
NOTES TO BALANCE SHEET -- (CONTINUED)
2. RELATED PARTY TRANSACTIONS
The Company has notes receivable outstanding of $10,000 from four
stockholders of the Company as of March 31, 1996. The notes are payable on July
31, 1996 and bear interest at 7.5%. The Company also has a payable to various of
the 13 unrelated businesses to be acquired for the reimbursement of professional
service fees related to the offering. The Company will settle this payable from
the proceeds of the offering.
3. COMPENSATION PURSUANT TO PLANS
Incentive Stock Plan. In June 1996, the Company's Board of Directors
adopted the Incentive Plan which is subject to approval by the stockholders. The
Company has reserved 700,000 of the authorized shares of Common Stock for
issuance pursuant to options to be granted under the Incentive Plan. Under the
Incentive Plan and pursuant to action of the Board, the Compensation Committee
appointed by the Board of Directors will administer the Incentive Plan and may
grant to officers and key employees non-transferable options to purchase shares
of Common Stock. The options are for terms not longer than ten years (five years
in the case of incentive stock options granted to an individual who, at the time
of the grant, owns more than 10% of the total combined voting power of all
classes of stock of the Company), at prices to be determined by the Board of
Directors or the Compensation Committee. Such prices may not be less than 100%
of the fair market value of the Common Stock on the date of grant (110% in the
case of an individual who, at the time of grant of incentive stock options, owns
more than 10% of the total combined voting power of all classes of stock of the
Company) in the case of incentive stock options under Section 422 of the
Internal Revenue Code of 1986, as amended (the "Code"). Incentive stock options
may be granted only to employees and may not be less than 85% of the fair market
value of the Common Stock on the date of grant in the case of non-qualified
stock options. Options granted under the Incentive Plan may be exercisable in
installments. The Company is authorized to loan, or guarantee loans of, the
purchase price of shares issuable upon exercise of options granted under the
Incentive Plan. Unless terminated earlier, the Incentive Plan will terminate in
2006. The aggregate fair market value of Common Stock with regard to which
incentive stock options are exercisable by an individual for the first time
during any calendar year may not exceed $100,000. The Company has granted
options to purchase 330,000 shares of Common Stock under the Incentive Plan.
Such options are exercisable at the initial public offering price and vest
one-third per year commencing on the second anniversary of the date of grant.
4. NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
In June 1996, the Company adopted the Director Plan. The Company has
reserved for issuance under the Director Plan 100,000 shares of Common Stock.
The Director Plan provides for the granting of nonqualified stock options and
awards of restricted stock to each director of the Company who is not also an
employee or officer of the Company ("Non-Employee Directors") at an exercise
price, in the case of options, equal to the fair market value of the Common
Stock on the date the options are granted. The Director Plan contains provisions
providing for adjustment of the number of shares available for option and
subject to unexercised options in the event of stock splits, dividends payable
in Common Stock, business combinations or certain other events. The Board shall
have no authority, discretion or power to select the participants who will
receive options or restricted stock pursuant to the Director Plan, to set the
number of shares of Common Stock to be covered by each option or issuance of
restricted stock, to set the exercise price or the period within which the
options may be exercised or modify the restrictions applicable to restricted
stock awards or to alter other terms or conditions specified in the options.
The Director Plan provides for the grant of options to purchase 5,000
shares of Common Stock to (i) each nonemployee director of the Company on the
effective date of this Offering at an exercise price equal to the public
offering price and (ii) each non-employee director elected after the effective
date of this Offering
F-17
<PAGE> 89
SERVICE EXPERTS, INC.
NOTES TO BALANCE SHEET -- (CONTINUED)
on the date of such director's election to the Board of Directors at an exercise
price equal to the fair market value of the Common Stock on the date the options
are granted. In addition, the Director Plan provides for the grant to each
non-employee director of the Company of options to purchase 1,000 shares of
Common Stock on each January 1 (each date of grant being referred to as the
"Grant Date"). The Board of Directors may revoke, on or prior to each January 1,
the next automatic grant of options otherwise provided for by the Director Plan
if no options have been granted to employees since the preceding January 1 under
the Incentive Plan or any other employee stock option plan that the Company
might adopt. Each option shall be exercisable in full beginning one year after
the Grant Date and shall expire ten years after the Grant Date (the "Option
Period"), unless cancelled sooner due to termination of service or death, or
unless the option is fully exercised prior to the end of the Option Period.
5. EMPLOYEE STOCK PURCHASE PLAN
The Service Experts, Inc. Employee Stock Purchase Plan (the "Purchase
Plan") was adopted in June 1996 by the Company's Board of Directors and will
become effective simultaneously with the Offering subject to stockholder
approval. A total of 100,000 shares of Common Stock have been reserved for
issuance under the Purchase Plan, which is intended to qualify under Section 423
of the Code. The Purchase Plan allows participants to purchase shares of Common
Stock in connection with option periods commencing on the first trading date of
each year and ending the following December 31 (except the first option period
which will commence the date of the Offering and end December 31, 1996).
The Purchase Plan permits eligible employees of the Company and certain of
its subsidiaries to purchase Common Stock through payroll deductions, which may
not exceed 10% of the employee's base compensation, at a price equal to 85% of
the fair market value of the Common Stock at the beginning of the option period
or at the end of the option period, whichever is lower (subject to a minimum
price specified in the Purchase Plan). Employees are eligible to participate in
the Purchase Plan if they are employed by the Company or a participating
subsidiary for at least 20 hours a week and more than five months in any
calendar year and have been employed for at least six months since their last
date of hire.
In the event of a change of control of the Company (as defined in the
Purchase Plan), each option under the Purchase Plan will (if the Company is the
surviving corporation) pertain to and apply to the securities to which a holder
of the number of shares of the Company subject to such option would have been
entitled in such transaction. If the Company is not the surviving corporation in
such change in control, then all options under the Purchase Plan will terminate
provided that the Compensation Committee may determine that such options shall
be exercisable on the day prior to such change in control transaction.
6. 401(K) PLAN
In 1996, the Company adopted a Savings and Profit Sharing Plan (the
"Savings Plan") which is intended to be qualified under Sections 401(a) and
401(k) of the Code. To be eligible, an employee must have been employed by the
Company for at least one year. The Savings Plan permits employees who have
completed one year of service to defer from 1% to 15% of their compensation into
the Savings Plan up to specified limits per year ($9,500 during 1996).
Additional annual contributions may be made at the discretion of the Company
which will vest according to a schedule set forth in the Savings Plan.
7. SUBSEQUENT EVENT
On July 11, 1996 the Company's Board of Directors declared a dividend of
0.4621 shares of Common Stock for each share of common stock outstanding to all
common stock holders of record as of July 1, 1996. In connection with the
dividend the Company contributed an additional $4,621 in capital.
The number of shares of common stock in the financial statements have been
adjusted to give effect to the stock dividend.
F-18
<PAGE> 90
REPORT OF INDEPENDENT AUDITORS
The Boards of Directors and Stockholders
The Combined Predecessor Companies
We have audited the accompanying combined balance sheets of the Combined
Predecessor Companies (see Note 1) as of December 31, 1994 and 1995, and the
related combined statements of income, stockholders equity, and cash flows for
each of the three years in the period ended December 31, 1995. These financial
statements are the responsibility of the Companies' management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of Combined
Predecessor Companies (see Note 1) at December 31, 1994 and 1995, and the
combined results of their operations and their cash flows for each of the three
years in the period ended December 31, 1995, in conformity with generally
accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
June 7, 1996
F-19
<PAGE> 91
COMBINED PREDECESSOR COMPANIES
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- JUNE 30,
1994 1995 1996
----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents....................................... $ 1,995,001 $ 3,896,182 $ 3,194,807
Certificates of deposit......................................... 100,000 200,000 100,000
Receivables:
Trade, net of allowance for doubtful accounts of $239,814 in
1994 and $255,983 in 1995................................... 3,926,742 4,831,380 5,809,083
Related party................................................. 481,599 876,753 1,306,578
Employee...................................................... 74,838 128,072 118,779
Other......................................................... 163,292 366,553 220,895
----------- ----------- -----------
4,646,471.. 6,202,758 7,455,335
Inventories..................................................... 1,572,875 1,720,313 2,108,559
Costs and estimated earnings in excess of billings.............. 187,569 187,280 276,706
Investments..................................................... 294,217 136,541 357,634
Prepaid expenses and other current assets....................... 145,240 172,532 1,079,795
Current portion of notes receivable, net of allowance for
doubtful accounts of $56,387 in 1995.......................... 270,795 231,232 224,161
Deferred income taxes........................................... 122,810 265,126 990,308
----------- ----------- -----------
Total current assets..................................... 9,334,978 13,011,964 15,787,305
Property, buildings and equipment:
Land............................................................ 130,000 130,000 25,000
Buildings....................................................... 1,301,058 1,373,658 628,528
Furniture and fixtures.......................................... 734,076 1,016,014 1,047,307
Machinery and equipment......................................... 1,231,252 1,637,984 1,803,893
Vehicles........................................................ 3,728,727 4,471,458 4,653,952
Leasehold improvements.......................................... 281,289 292,640 301,621
----------- ----------- -----------
7,406,402 8,921,754 8,460,301
Less accumulated depreciation and amortization.................. (3,438,062) (4,316,880) (4,615,041)
----------- ----------- -----------
3,968,340 4,604,874 3,845,260
Notes receivable -- related parties, net of current portion....... 150,763 135,944 131,544
Notes receivable -- other, net of current portion................. 309,725 310,294 300,806
Deferred income taxes............................................. 31,423 39,092 16,927
Goodwill, net..................................................... 877,780 833,898 811,958
Other assets...................................................... 474,312 394,528 312,686
----------- ----------- -----------
Total assets............................................. $15,147,321 $19,330,594 $21,206,486
============ ============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt................................................. $ 131,138 $ 334,034 $ 127,143
Trade accounts payable and accrued liabilities.................. 2,695,658 2,658,019 3,582,471
Accrued compensation............................................ 1,026,927 1,888,202 2,490,221
Accrued taxes, other than income................................ 246,181 84,120 220,887
Accrued warranties.............................................. 265,476 405,323 439,330
Income taxes payable............................................ 263,503 604,838 1,080,730
Deferred revenue................................................ 1,309,232 1,545,998 1,580,152
Billings in excess of costs and estimated earnings.............. 263,204 235,797 400,512
Liability to Companies' benefit plans........................... 133,082 158,770 113,045
Due to related parties.......................................... 20,000 20,000 180,972
Notes payable to related parties -- current portion............. 162,891 173,586 100,215
Current portion of long-term debt and capital lease
obligations................................................... 829,100 719,104 791,309
----------- ----------- -----------
Total current liabilities................................ 7,346,392 8,827,791 11,106,987
Long-term debt and capital lease obligations, net of current
portion......................................................... 1,070,587 1,202,196 650,708
Notes payable to related parties, net of current portion.......... 1,597,613 1,667,255 867,027
Deferred compensation............................................. 91,725 105,191 112,557
Deferred income taxes............................................. 244,370 252,766 476,591
Deferred credit................................................... 12,819 -- --
Stockholders' equity.............................................. 4,783,815 7,275,395 7,992,616
----------- ----------- -----------
Total liabilities and stockholders' equity............... $15,147,321 $19,330,594 $21,206,486
============ ============ ============
</TABLE>
See accompanying notes.
F-20
<PAGE> 92
COMBINED PREDECESSOR COMPANIES
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- -------------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ----------- -----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues.................... $35,784,297 $48,476,838 $59,651,163 $28,122,642 $32,204,438
Cost of goods sold.............. 22,512,299 30,918,161 36,216,043 17,545,078 19,498,220
----------- ----------- ----------- ----------- -----------
Gross margin.................... 13,271,998 17,558,677 23,435,120 10,577,564 12,706,218
Selling, general and
administrative expenses....... 12,180,033 15,268,679 18,706,596 9,017,911 11,077,695
----------- ----------- ----------- ----------- -----------
Income from operations.......... 1,091,965 2,289,998 4,728,524 1,559,653 1,628,523
Other income (expense):
Interest expense.............. (217,695) (298,359) (358,902) (162,205) (211,679)
Interest income............... 168,419 188,533 256,206 80,853 140,396
Other income.................. 311,387 178,296 207,730 123,618 73,124
----------- ----------- ----------- ----------- -----------
262,111 68,470 105,034 42,266 1,841
----------- ----------- ----------- ----------- -----------
Income before taxes............. 1,354,076 2,358,468 4,833,558 1,601,919 1,630,364
Provision (benefit) for income
taxes:
Current....................... 46,700 360,112 760,841 221,015 402,294
Deferred...................... 146,310 42,995 (146,929) (89,941) (281,351)
----------- ----------- ----------- ----------- -----------
Total income taxes.... 193,010 403,107 613,912 131,074 120,943
----------- ----------- ----------- ----------- -----------
Net income............ $ 1,161,066 $ 1,955,361 $ 4,219,646 $ 1,470,845 $ 1,509,421
========== ========== ========== ========== ==========
Pro Forma income taxes
(Unaudited -- See Note 9)..... 277,727 528,934 1,253,493 501,302 448,042
----------- ----------- ----------- ----------- -----------
Pro Forma Net Income
(Unaudited)................... $ 883,339 $ 1,426,427 $ 2,966,153 $ 969,543 $ 1,061,379
========== ========== ========== ========== ==========
</TABLE>
See accompanying notes.
F-21
<PAGE> 93
COMBINED PREDECESSOR COMPANIES
COMBINED STATEMENTS OF STOCKHOLDERS EQUITY
<TABLE>
<S> <C>
Balance at December 31, 1992.................................................... $ 3,416,677
Capital distributions......................................................... (1,008,359)
Issuance of stock............................................................. (10,400)
Net income............................................................ 1,161,066
-----------
Balance at December 31, 1993.................................................... 3,558,984
Capital distributions......................................................... (906,000)
Issuance of stock............................................................. 181,500
Adjustment to unrealized losses on available-for-sale securities, net of
tax........................................................................ (6,030)
Net income............................................................ 1,955,361
-----------
Balance at December 31, 1994.................................................... 4,783,815
Capital distributions......................................................... (1,745,498)
Adjustment to unrealized gains on available-for-sale securities, net of tax... 17,432
Net income............................................................ 4,219,646
-----------
Balance at December 31, 1995.................................................... 7,275,395
Capital distributions (unaudited)............................................. (797,701)
Adjustment to unrealized gains on available-for-sale securities, net of tax
(unaudited)................................................................ 5,501
Net income (unaudited)................................................ 1,509,421
-----------
Balance at June 30, 1996 (unaudited)............................................ $ 7,992,616
==========
</TABLE>
See accompanying notes.
F-22
<PAGE> 94
COMBINED PREDECESSOR COMPANIES
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- -----------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............................................. $ 1,161,066 $ 1,955,361 $ 4,219,646 $1,470,845 $1,509,421
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization......................... 650,028 948,523 1,212,891 594,971 727,300
Provision for deferred income taxes (benefit)......... 146,310 42,995 (146,929) (89,941) (281,351)
Provisions for loss on accounts receivable............ 117,775 184,591 210,592 44,464 65,866
(Gain) loss on asset disposals........................ (63,962) 10,724 (28,676) (14,335) 60,964
Changes in assets and liabilities:
Receivables......................................... (960,086) (1,188,907) (1,679,651) (1,326,980) (1,723,647)
Inventories......................................... (123,261) (439,111) (147,438) 6,012 (297,529)
Prepaid expenses and other current assets........... 20,481 4,047 23,358 (104,846) (683,091)
Trade accounts payable and accrued liabilities...... 772,192 (121,026) (139,218) 423,717 910,481
Accrued compensation................................ 770,922 79,437 900,429 507,958 830,411
Accrued taxes, other than income.................... 58,872 59,354 (162,061) (136,435) 136,767
Accrued warranties.................................. 60,631 95,751 139,847 28,549 29,007
Deferred revenue.................................... 296,122 464,733 236,766 75,647 5,317
Income taxes payable................................ (33,431) 247,645 341,334 48,558 274,473
Costs and estimated earnings in excess of billings
and billings in excess of costs and estimated
earnings.......................................... 228,227 (59,706) (27,118) 358,429 106,931
----------- ----------- ----------- ---------- ----------
Net cash flow provided by operating
activities.................................... 3,101,886 2,284,411 4,953,772 1,886,613 1,671,320
INVESTING ACTIVITIES
Purchase of property, buildings, and equipment.......... (935,240) (1,564,491) (1,707,310) (1,154,710) (773,010)
Proceeds from sale of property, buildings, and
equipment............................................. 236,199 34,640 76,618 19,441 184,482
Purchase of investments................................. (34,185) (222,476) (23,719) (14,745) (212,010)
Proceeds from sale of investments....................... -- -- 200,994 200,994 --
Purchases of certificates of deposit.................... (100,000) (100,000) (200,000) (200,000) --
Proceeds from sale of certificates of deposit........... 100,000 100,000 100,000 100,000 100,000
Advances on notes receivable............................ -- -- (40,222) -- --
Collections on notes receivable......................... 32,514 20,663 -- 81,736 16,559
Cash acquired through purchase of business.............. -- 76,906 -- -- 54,401
Other deferred credits.................................. 65,350 -- -- -- --
(Increase) decrease in other assets..................... (157,735) (50,332) (41,549) (70,112) (7,822)
----------- ----------- ----------- ---------- ----------
Net cash used in investing activities........... (793,097) (1,705,090) (1,635,188) (1,037,396) (637,400)
FINANCING ACTIVITIES
Proceeds from short-term debt........................... 15,000 -- 250,000 50,000 --
Payments on short-term debt............................. (6,060) (236,231) (71,474) (21,748) (269,783)
Retirement of stock..................................... (100,000) -- -- -- --
Issuance of stock....................................... 60,000 -- -- -- --
Proceeds of long-term debt and capital leases........... 1,315,946 2,058,415 1,704,877 972,243 551,102
Payments of long-term debt and capital leases........... (1,370,909) (1,850,462) (1,909,999) (789,495) (868,769)
Proceeds on notes payable to related parties............ 29,039 376,058 479,879 214,206 40,428
Payments on notes payable to related parties............ (49,187) (275,889) (238,281) (20,000) (467,313)
Distribution to stockholders............................ (1,008,359) (906,000) (1,745,498) (387,462) (1,108,018)
Accounts receivable and accounts payable to related
parties............................................... 17,292 (200,679) 113,093 (12,949) 387,058
----------- ----------- ----------- ---------- ----------
Net cash provided by (used in) financing
activities.................................... (1,097,238) (1,034,788) (1,417,403) 4,795 (1,735,295)
----------- ----------- ----------- ---------- ----------
Increase (decrease) in cash and cash equivalents........ 1,211,551 (455,467) 1,901,181 854,012 (701,375)
Cash and cash equivalents at beginning of period........ 1,238,917 2,450,468 1,995,001 1,995,001 3,896,182
----------- ----------- ----------- ---------- ----------
Cash and cash equivalents at end of period...... $ 2,450,468 $ 1,995,001 $ 3,896,182 $2,849,013 $3,194,807
========== ========== ========== ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................................... $ 215,460 $ 314,289 $ 325,435 $ 150,181 $ 179,692
========== ========== ========== ========= =========
Income taxes paid....................................... $ 65,975 $ 82,704 $ 419,301 $ 179,565 $ 193,094
========== ========== ========== ========= =========
Purchase of equipment through capital leases............ $ 139,456 $ 155,694 $ 93,910 $ 31,438 $ 177,459
========== ========== ========== ========= =========
Covenant not-to-compete exchanged for debt.............. $ 90,000 $ -- $ -- $ -- $ --
========== ========== ========== ========= =========
ACQUISITION OF COMPANY
Fair value of assets acquired excluding cash......................... $ 717,883
Fair value of liabilities assumed.................................... (613,289)
Stock issued......................................................... (181,500)
-----------
Cash acquired................................................ $ 76,906
==========
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
=========
</TABLE>
See accompanying notes.
F-23
<PAGE> 95
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Service Experts, Inc. (of Delaware) ("the Company") was formed on March 27,
1996, primarily for the purpose of acquiring 13 unrelated heating and air
conditioning companies, in exchange for shares of its common stock and cash from
the proceeds of the sale of its stock in the initial public offering of the
Company ("the Offering"). The Combination is to be effected in accordance with
executed combination agreements with the 13 heating and air conditioning
companies and is subject to the closing of the Offering. The 13 unrelated
businesses to be acquired, first day of operations presented, and their city of
operations, are as follows:
<TABLE>
<CAPTION>
FIRST DAY
COMPANY NAME PRESENTED LOCATION
------------------------------------------ ----------------- ------------------------
<S> <C> <C>
Combined AC Service & Installation Co.,
Inc. and Donelson Air Conditioning
Company, Inc............................ January 1, 1993 Nashville, Tennessee
Hardwick Air Masters, Inc................. January 1, 1993 Little Rock, Arkansas
Air Experts, a United Services Co.,
Inc..................................... January 1, 1994 St. Louis, Missouri
Arrow Heating & Air Conditioning, Inc..... January 29, 1993 Racine, Wisconsin
Brand Heating & Air Conditioning, Inc..... January 1, 1993 Lafayette, Indiana
Coastal Air Conditioning Service, Inc..... January 1, 1993 Savannah, Georgia
Contractor Success Group, Inc............. January 1, 1993 St. Louis, Missouri
Comerford's Heating and Air Conditioning,
Inc..................................... January 1, 1993 Pleasanton, California
Gilley's Heating & Cooling, Inc........... January 1, 1993 Monroe, Louisiana
Norrell Heating & Air Conditioning,
Inc..................................... January 1, 1993 Birmingham, Alabama
Rolf Coal and Fuel Corp................... January 1, 1993 Fort Wayne, Indiana
Service Experts of Palm Springs, Inc...... October 15, 1993 Palm Springs, California
Vision Holding Company, Inc............... March 1, 1993 Kansas City, Missouri
</TABLE>
The financial statements of these companies have been combined for all
periods presented. The companies operate in one industry segment and are
primarily engaged in the installation and servicing of air conditioning and
heating systems for residential and commercial customers in their respective
cities.
The Combined Predecessor Companies were not under common control or
management and some were not subject to corporate income taxes (see Note 9);
accordingly, the data may not be comparable to or indicative of post-combination
results.
RECOGNITION OF INCOME
Revenues on all of the Combined Predecessor Companies' heating and air
conditioning installation contracts (Contracts) for commercial buildings are
recognized on the percentage-of-completion method in the ratio that total
incurred costs bear to total estimated costs. Revenues for all of the Combined
Predecessor Companies' heating and air conditioning installation for residential
installation and service and maintenance revenue are recognized upon completion
of the services, which is usually within one to two days.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined.
F-24
<PAGE> 96
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Most Contracts are completed within 6 to 18 months. Nonidentifiable selling,
general, and administrative expenses are charged to income as incurred and are
not allocated to Contract costs.
Trade accounts receivable includes billings and billed retainage on
Contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $134,986 and $118,130 at December 31, 1994 and 1995, respectively.
The Combined Predecessor Companies classify these amounts as current assets
because all balances are expected to be collected in the current year.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Combined Predecessor Companies
customer base, and their dispersions across many different industries and
geographies.
The asset, "costs and estimated earnings in excess of billings" represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings" represent
billings in excess of revenue recognized on in-progress contracts.
Contractor Success Group, Inc. provides management consulting, marketing
services, reporting mechanisms, lead generation tools, sales techniques,
implementation materials and customized training for its member companies in the
heating, ventilation and air conditioning contracting ("HVAC") industry. This
company currently has over 270 members throughout the United States and Canada.
Initial membership fees paid to Contractor Success Group, Inc., less a
provision for estimated uncollectible amounts, are recognized on the date the
membership agreement is signed given that the fees are nonrefundable, and all
obligations have been substantially performed. Initial membership fees included
in net revenue totaled $1,071,000, $1,120,000 and $900,000 during 1993, 1994 and
1995, respectively. Quarterly dues, less a provision for estimated uncollectible
amounts, are recognized in the same period the services and obligations are
performed. Revenue from sales of copyrighted literature is recognized on the
date of sale.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents and certificates of deposit approximate fair value.
Accounts Receivable, Notes Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts
receivable, notes receivable and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Combined
Predecessor Companies, the carrying amounts reported in the balance sheets for
long-term debt and capital lease obligations approximate fair value.
CASH EQUIVALENTS
The Combined Predecessor Companies considers all highly liquid investments
with an original maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
F-25
<PAGE> 97
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
NOTES RECEIVABLE
Contractor Success Group, Inc. accepts notes receivable from members who
desire to finance a portion of their initial membership fee. The original
principal balance generally does not exceed $15,000 and the notes typically
involve a three-year term, accrue interest at 18% and are payable in equal
monthly installments of principal and interest. The notes are periodically
reviewed for collectibility and reserves are established at the time it appears
that collectibility is uncertain. Included in current portion of notes
receivable is $270,795 and $231,232 at December 31, 1994 and 1995, respectively,
related to these notes. Included in notes receivable -- other is $309,725 and
$310,294 at December 31, 1994 and 1995, respectively, related to these notes.
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $53,358, $2,611 and $79,216, respectively and accounts
written off, net of recoveries were $0, $0 and $79,216, respectively.
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
------
<S> <C>
Buildings................................................................... 31.5
Furniture and fixtures...................................................... 3-11
Machinery and equipment..................................................... 3-11
Vehicles.................................................................... 3-10
Leasehold improvements...................................................... 7-40
</TABLE>
WARRANTIES
The Combined Predecessor Companies provide the retail customer with a one,
two, three, or ten-year warranty on parts and labor from the date of
installation of the heating and air conditioning unit. This warranty runs
concurrent with the manufacturer's warranty on parts for two years and for the
first year on labor. The Combined Predecessor Companies provide an accrual for
future warranty costs based upon the relationship of prior years' sales to
actual warranty costs. It is the Combined Predecessor Companies practice to
classify the entire warranty accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
Those Combined Predecessor Companies subject to corporate income taxes use
the liability method of accounting for federal and state income taxes as
provided by SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, the deferred tax liability or asset is based on temporary differences
between the financial statement and income tax bases of assets and liabilities,
measured at tax rates that will be in effect when the differences reverse.
The shareholders of the other Combined Predecessor Companies have elected
under Subchapter S of the Internal Revenue Code to include their respective
company's income in their own income for federal income tax purposes.
Accordingly, these companies are not subject to federal income taxes. This
election is not
F-26
<PAGE> 98
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
available for some state income tax reporting; accordingly, the Combined
Predecessor Companies uses the liability method of accounting for state income
taxes in these jurisdictions.
ADVERTISING COSTS
Certain of the Combined Predecessor Companies expense advertising costs as
incurred. During 1993, 1994 and 1995, the Combined Predecessor Companies
expensed $696,180, $884,318 and $906,326, respectively. Advertising costs for
Air Experts, Inc. primarily relate to brochures which are accounted for as
prepaid supplies and expensed as distributed. This company had no prepaid
advertising at December 31, 1994. This company had $20,014 of prepaid
advertising at December 31, 1995. Advertising expense was $87,175 and $158,350
in 1994 and 1995, respectively for this company.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $126,354, $178,414 and $137,674, respectively and
accounts written off, net of recoveries were $142,121, $57,963 and $121,505,
respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Combined Predecessor Companies have considered the impact of newly
issued financial accounting pronouncements, principally Statement of Financial
Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed Of," and does not believe that
adoption of this and any other newly issued pronouncements would have a
significant impact on the Combined Predecessor Companies' financial statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
---------- ----------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts........................ $1,721,557 $1,424,905
Estimated earnings.......................................... 751,727 769,823
---------- ----------
2,473,284 2,194,728
Less applicable billings...................................... 2,548,919 2,243,245
---------- ----------
$ (75,635) $ (48,517)
========= =========
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................... $ 187,569 $ 187,280
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................... (263,204) (235,797)
---------- ----------
$ (75,635) $ (48,517)
========= =========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
F-27
<PAGE> 99
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Combined Predecessor Companies adopted SFAS
No. 115. The Combined Predecessor Companies' investment in securities are
classified as available-for-sale under SFAS No. 115. On securities classified as
available-for-sale, the carrying amount is a reasonable estimate of fair value.
The adoption of SFAS No. 115 did not have a significant impact on the Combined
Predecessor Companies' financial statements. The securities available-for-sale
as of December 31 were as follows:
<TABLE>
<CAPTION>
1994 1995
--------------------- ---------------------
ESTIMATED ESTIMATED
COST FAIR VALUE COST FAIR VALUE
-------- ---------- -------- ----------
<S> <C> <C> <C> <C>
U.S. Treasury Bills........................... $200,994 $ 200,994 $ -- $ --
Other debt securities......................... 63,575 48,496 72,428 59,943
Equity securities............................. 38,379 44,727 54,852 76,598
-------- ---------- -------- ----------
$302,948 $ 294,217 $127,280 $ 136,541
======== ======== ======== ========
</TABLE>
There were no gross realized gains or losses from the sale of
available-for-sale securities.
4. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
---------- ----------
<S> <C> <C>
Lines of credit............................................... $ 274,116 $ 177,821
Mortgage note payable......................................... 616,998 516,010
Installment and equipment notes............................... 727,414 952,615
Other long-term debt.......................................... 97,015 59,693
---------- ----------
1,715,543 1,706,139
Less current portion.......................................... 827,025 625,723
---------- ----------
$ 888,518 $1,080,416
========= =========
</TABLE>
The Combined Predecessor Companies have various lines of credit with
various financial institutions with a total borrowing limit of $1,625,000. These
lines of credit bear interest at various fixed rates ranging from 8.5% to 10.25%
and variable rates ranging from 8.5% to 9.75% at December 31, 1995.
One of the Combined Predecessor Companies has a mortgage note payable which
is secured by the related office building and land. This loan requires monthly
installments of $8,400, including principal and imputed interest (6.1% at
December 31, 1995) through July 15, 1997.
The Combined Predecessor Companies have various installment and equipment
loans to various lenders which are secured by vehicles and equipment. These
loans bear interest at various fixed rates ranging from 6.45% to 9.4% per annum
or at variable rates ranging from 7.5% to 11.0% at December 31, 1995. These
loans require monthly payments ranging from $339 to $6,458 and are due through
December 1999.
F-28
<PAGE> 100
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996............................................................. $ 625,723
1997............................................................. 821,781
1998............................................................. 160,836
1999............................................................. 79,601
2000............................................................. 18,198
----------
$1,706,139
=========
</TABLE>
5. LEASES
Total rental expense for all operating leases was $434,210, $609,128 and
$650,542 for 1993, 1994 and 1995, respectively. The Companies lease certain
vehicles, equipment, and office and warehouse facilities under terms of
noncancelable operating and capital lease agreements which expire at various
dates through January 2000. Minimum rental commitments at December 31, 1995
under capital and operating leases having an initial noncancelable term of one
year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------- ----------
<S> <C> <C>
1996........................................................... $112,184 $ 555,500
1997........................................................... 72,399 359,882
1998........................................................... 41,588 224,648
1999........................................................... 16,554 166,918
2000........................................................... 3,581 52,594
-------- ----------
246,306 $1,359,542
=========
Amounts representing interest.................................. 31,145
--------
Present value of net minimum rentals (including $93,381
classified as current)....................................... $215,161
========
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1995
--------- ---------
<S> <C> <C>
Machinery and equipment........................................ $ 310,633 $ 395,858
Less accumulated amortization.................................. (115,655) (161,897)
--------- ---------
Net equipment under capital leases............................. $ 194,978 $ 233,961
========= =========
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
6. EMPLOYEE BENEFIT PLANS
Several of the Combined Predecessor Companies have various
defined-contribution employee benefit plans incorporating provisions of section
401(k) of the Internal Revenue Code ("the Code"). Substantially all employees of
these companies are eligible to participate in the plans. Under the various
plans' provisions, a plan member may annually contribute, on a tax deferred
basis, amounts typically ranging from 1% to 20% of total compensation, not to
exceed the maximum established by the Internal Revenue Service. Certain
companies provide discretionary or do not match contributions while others
provide matching contributions ranging from 25% to 50% of total contributions by
a plan member, to a maximum ranging from 2% to 6% of
F-29
<PAGE> 101
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
the employee's total calendar year compensation. The Combined Predecessor
Companies' matching contributions totaled $179,656, $199,678 and $250,164 for
the years ended December 31, 1993, 1994 and 1995, respectively.
7. COMMITMENTS AND CONTINGENT LIABILITIES
The Combined Predecessor Companies are parties to a number of legal
proceedings arising in the ordinary course of their business. In the opinion of
management, the resolution of these proceedings will not have a material adverse
effect on the financial position or results of operations of the Combined
Predecessor Companies.
The Combined Predecessor Companies maintain general liability insurance
coverage and umbrella policies to ensure themselves against any liabilities
occurring in the normal course of business. The Combined Predecessor Companies
believe that their insurance coverage is adequate.
One of the companies within the Combined Predecessor Companies has entered
into a salary continuation agreement with the President of that company. Under
this agreement, the president will be paid $1,667 per month for 180 months
following the retirement date of August 1, 2003. The amount charged to expense
was $6,356, $7,347 and $8,466 at December 31, 1993, 1994 and 1995, respectively.
The liability classified as long-term is $45,191 at December 31, 1995.
8. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $4,340,482,
$3,889,251 and $5,618,455 in 1993, 1994 and 1995, respectively.
9. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1993 1994 1995
-------- -------- ---------
<S> <C> <C> <C>
Current:
Federal............................................. $ 33,032 $303,593 $ 619,245
State............................................... 13,668 56,519 141,596
Deferred.............................................. 146,310 42,995 (146,929)
-------- -------- ---------
$193,010 $403,107 $ 613,912
======== ======== =========
</TABLE>
F-30
<PAGE> 102
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the deferred tax assets and liabilities as of
December 31, 1994 and 1995, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization.................................. $224,542 $234,177
Unrealized gain on available-for-sale securities............... -- 2,463
Deferred revenue............................................... 52,200 29,700
Contract billings.............................................. 34,068 21,918
Capitalized overhead........................................... 24,631 20,210
Prepaids....................................................... 10,508 6,506
-------- --------
Deferred tax liabilities......................................... 345,949 314,974
Deferred tax assets:
Net operating loss carryforwards............................... 39,500 --
Accounts receivable............................................ 40,799 50,882
Unrealized loss on available-for-sale securities............... 2,879 --
Compensation and warranty reserves............................. 65,183 156,196
Deferred revenue............................................... 72,697 57,011
Accrued expenses............................................... 10,152 13,562
Depreciation and amortization.................................. 16,143 18,828
Passive activity loss carryforwards............................ 9,490 9,490
Employee compensation.......................................... 17,587 22,165
Contributions.................................................. 33,340 46,097
Other.......................................................... 31,882 38,292
-------- --------
Total gross deferred tax assets........................ 339,652 412,523
Valuation allowance............................................ (83,840) (46,097)
-------- --------
Net deferred tax assets........................................ 255,812 366,426
-------- --------
Net deferred tax liabilities (assets).......................... $ 90,137 $(51,452)
======== ========
</TABLE>
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------
1993 1994 1995
-------- ---------- ---------
<S> <C> <C> <C>
Tax provision at statutory rate...................... $211,241 $ 364,841 $ 771,219
State income tax less applicable federal tax
benefit............................................ 16,857 48,184 93,110
Effects of graduated tax rates....................... (17,451) (52,333) (199,263)
Surtax exemption..................................... (2,152) (15,490) (26,672)
Change in valuation allowance........................ -- 29,500 (37,743)
NOL for which no benefit recognized.................. 14,700 24,800 --
Goodwill amortization................................ -- 11,346 11,346
Other, net........................................... (30,185) (7,741) 1,915
-------- ---------- ---------
$193,010 $ 403,107 $ 613,912
======== ========= =========
</TABLE>
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously in this note, certain of the Combined Predecessor
Companies operate under Subchapter S of the Internal Revenue Code and are not
subject to corporate federal income tax. In connection
F-31
<PAGE> 103
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
with the contemplated initial public offering (See Note 1), the Subchapter S
election will be terminated for these companies. As a result, these companies
will be subject to corporate income taxes subsequent to the termination of S
corporation status. These companies had net operating income for income tax
purposes of $744,179, $708,003 and $2,642,912 for 1993, 1994 and 1995,
respectively. Had these companies filed federal and state income tax returns as
regular corporations for 1993, 1994 and 1995, income tax expense under the
provisions of Financial Accounting Standard No. 109 would have been $277,727,
$528,934 and $1,253,493, respectively.
At the date of termination of S corporation status, these companies will be
required to provide deferred taxes for cumulative temporary differences between
financial reporting and tax reporting basis of assets and liabilities. Such
deferred taxes will be based on the cumulative temporary differences at the date
of termination of S corporation status. The effect of recognizing the deferred
taxes will be included in income from continuing operations. If the termination
of S corporation status had occurred at March 31, 1996, the deferred tax
liability would have been approximately $177,500.
The following unaudited pro forma information reflects income tax expense
of the Combined Predecessor Companies as if the S corporation companies had been
subject to federal and state income taxes:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------
1993 1994 1995
-------- -------- ----------
<S> <C> <C> <C>
Current:
Federal............................................. $352,632 $668,793 $1,518,729
State............................................... 57,668 106,706 292,664
Deferred.............................................. 60,437 156,542 56,012
-------- -------- ----------
Pro forma income taxes................................ 470,737 932,041 1,867,405
Income taxes as reported.............................. 193,010 403,107 613,912
-------- -------- ----------
Pro forma income tax adjustment....................... $277,727 $528,934 $1,253,493
======== ======== =========
</TABLE>
10. RELATED PARTY TRANSACTIONS
Notes Payable to Related Parties
Certain of the Combined Predecessor Companies have notes payable to related
parties, including current and former shareholders, which bear annual interest
ranging from 0.0% to 12.5% and are due through January 2009. The aggregate
amount of principal maturities are $173,586, $737,013, $97,163, $93,990, $69,488
and $669,601 in 1996, 1997, 1998, 1999, 2000, and thereafter, respectively.
Notes Receivable from Related Parties
Certain of the Combined Predecessor Companies have various notes receivable
from related parties, including current shareholders. These notes have various
payment terms and bear annual interest ranging from 5.0% to 8.0%.
Other Related Party Transaction
Certain of the Combined Predecessor Companies lease facility space from
stockholders and employees of those companies and from various corporations and
partnerships which are owned by stockholders of the Combined Predecessor
Companies. Rental expense on these related party operating leases amount to
$286,292, $347,258 and $348,935 for the years 1993, 1994 and 1995, respectively.
F-32
<PAGE> 104
COMBINED PREDECESSOR COMPANIES
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
11. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income and cash flows for the six months ended
June 30, 1995 and 1996 (interim financial statements) have been prepared by the
Combined Predecessor Companies' management and are unaudited. The interim
financial statements include all adjustments, consisting of only normal
recurring adjustments necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statement should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
12. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
F-33
<PAGE> 105
REPORT OF INDEPENDENT AUDITORS
The Stockholders
AC Service & Installation Co., Inc.
and Donelson Air Conditioning Company, Inc.
We have audited the accompanying combined balance sheets of AC Service &
Installation Co., Inc. and Donelson Air Conditioning Company, Inc. as of
December 31, 1994 and 1995, and the related combined statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of AC Service &
Installation Co., Inc. and Donelson Air Conditioning Company, Inc. at December
31, 1994 and 1995, and the combined results of their operations and their cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 5, 1996
F-34
<PAGE> 106
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------ JUNE 30,
1994 1995 1996
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.............................. $ 91,096 $ 275,720 $ 568,643
Receivables:
Trade, net of allowance for doubtful accounts of
$135,786 in 1994 and $135,000 in 1995............. 1,944,403 1,975,449 2,501,600
Related party....................................... -- 207,259 60,631
Employee............................................ 13,411 63,092 51,642
Other............................................... 140,593 77,473 99,230
---------- ---------- -----------
2,098,407 2,323,273 2,713,103
Inventories............................................ 209,340 234,439 269,474
Costs and estimated earnings in excess of billings..... 55,936 30,740 109,495
Prepaid expenses and other current assets.............. 12,264 9,143 94,828
Deferred income taxes.................................. -- 16,817 541,509
---------- ---------- -----------
Total current assets........................... 2,467,043 2,890,132 4,297,052
Property, buildings and equipment:
Land................................................... 105,000 105,000 --
Buildings.............................................. 707,999 766,677 --
Furniture and fixtures................................. 182,516 396,278 407,684
Machinery and equipment................................ 121,500 162,883 169,897
Vehicles............................................... 1,047,710 1,300,369 1,317,616
Leasehold improvements................................. 77,451 67,224 67,224
---------- ---------- -----------
2,242,176 2,798,431 1,962,421
Less accumulated depreciation and amortization......... (872,184) (1,183,066) (1,261,242)
---------- ---------- -----------
1,369,992 1,615,365 701,179
Other assets............................................. 94,546 64,413 30,613
---------- ---------- -----------
Total assets................................... $3,931,581 $4,569,910 $ 5,028,844
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities......... $ 665,209 $ 403,442 $ 715,471
Accrued compensation................................... 463,995 487,900 1,208,125
Accrued taxes, other than income....................... 39,293 12,728 160,225
Accrued warranties..................................... 54,174 98,379 94,283
Income taxes payable................................... 25,641 66,793 352,551
Deferred revenue....................................... 215,585 189,108 185,426
Billings in excess of costs and estimated earnings..... 235,450 228,283 400,512
Liability to Company benefit plan...................... 46,332 56,581 34,686
Current portion of long-term debt...................... 106,594 164,265 43,901
---------- ---------- -----------
Total current liabilities...................... 1,852,273 1,707,479 3,195,180
Long-term debt, net of current portion................... 516,010 463,529 --
Notes payable to stockholders............................ 448,208 661,808 --
Deferred income taxes.................................... 14,986 8,436 157,240
Stockholders' equity..................................... 1,100,104 1,728,658 1,676,424
---------- ---------- -----------
Total liabilities and stockholders' equity..... $3,931,581 $4,569,910 $ 5,028,844
========= ========= =========
</TABLE>
See accompanying notes.
F-35
<PAGE> 107
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------------- -----------------------
1993 1994 1995 1995 1996
----------- ----------- ----------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues...................... $10,292,295 $14,298,906 $16,452,622 $7,671,638 $8,634,712
Cost of goods sold................ 7,280,075 10,245,039 11,122,350 5,316,352 5,741,935
----------- ----------- ----------- ---------- ----------
Gross margin...................... 3,012,220 4,053,867 5,330,272 2,355,286 2,892,777
Selling, general and
administrative expenses......... 2,865,476 3,701,883 4,563,134 2,219,598 2,978,149
Bad debt expense.................. 43,265 84,338 28,502 33,349 46,035
----------- ----------- ----------- ---------- ----------
Income (loss) from operations..... 103,479 267,646 738,636 102,339 (131,407)
Other income (expense):
Interest expense................ (74,631) (71,600) (77,149) (32,698) (40,484)
Interest income................. 4,994 7,059 23,186 1,995 11,863
Other income.................... 68,450 17,065 25,569 21,101 20,855
----------- ----------- ----------- ---------- ----------
(1,187) (47,476) (28,394) (9,602) (7,766)
----------- ----------- ----------- ---------- ----------
Income (loss) before federal and
state income taxes.............. 102,292 220,170 710,242 92,737 (139,173)
Provision (benefit) for income
taxes:
Current......................... 19,505 48,525 105,055 9,560 67,342
Deferred........................ 2,241 (7,399) (23,367) (33,414) (154,281)
----------- ----------- ----------- ---------- ----------
21,746 41,126 81,688 (23,854) (86,939)
----------- ----------- ----------- ---------- ----------
Net income (loss)................. $ 80,546 $ 179,044 $ 628,554 $ 116,591 $ (52,234)
========== ========== ========== ========= =========
</TABLE>
See accompanying notes.
F-36
<PAGE> 108
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<S> <C>
Balance at December 31, 1992..................................................... $ 940,514
Retirement of stock............................................................ (100,000)
Net income..................................................................... 80,546
----------
Balance at December 31, 1993..................................................... 921,060
Net income..................................................................... 179,044
----------
Balance at December 31, 1994..................................................... 1,100,104
Net income..................................................................... 628,554
----------
Balance at December 31, 1995..................................................... 1,728,658
Net loss (unaudited)........................................................... (52,234)
Balance at June 30, 1996 (unaudited)............................................. $1,676,424
=========
</TABLE>
See accompanying notes.
F-37
<PAGE> 109
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- ----------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)............................. $ 80,546 $ 179,044 $ 628,554 $ 116,591 $ (52,234)
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization............... 214,789 286,988 411,438 202,574 193,425
Current deferred income taxes............... 2,241 (7,399) (23,367) (33,414) (154,281)
Provisions for loss on accounts
receivable............................... 43,265 84,338 28,502 7,524 46,035
Gain on asset disposals..................... (53,455) (3,711) (14,018) (14,335) (9,790)
Changes in assets and liabilities:
Receivables.............................. (260,964) (731,644) (253,368) (662,391) (691,518)
Inventories.............................. (44,848) (76,656) (25,099) 23,295 (35,035)
Prepaid expenses and other current
assets................................. 8,026 27,581 3,121 (8,559) (85,685)
Trade accounts payable and accrued
liabilities............................ (83,156) 193,280 (261,767) 142,367 312,029
Accrued compensation..................... 458,326 24,734 34,154 94,551 962,363
Accrued taxes, other than income......... 6,184 9,272 (26,565) 9,281 147,497
Accrued warranties....................... 20,516 28,439 44,205 (24,994) (4,096)
Deferred revenue......................... 12,767 187,768 (26,477) 5,567 (3,682)
Income taxes payable..................... (10,779) 3,604 41,152 (8,861) 64,151
Costs and estimated earnings in excess of
billings and billings in excess of
costs and estimated earnings........... 155,052 58,864 18,029 330,460 93,474
--------- --------- --------- --------- ----------
Net cash flow provided by operating
activities.................................. 548,510 264,502 578,494 179,656 782,653
INVESTING ACTIVITIES
Purchase of property, buildings, and
equipment................................... (283,278) (508,769) (642,470) (487,657) (55,440)
Proceeds from sale of property, buildings, and
equipment................................... 165,685 4,491 29,810 19,441 14,011
Increase in other assets...................... (124,162) -- -- -- --
--------- --------- --------- --------- ----------
Net cash used in investing activities......... (241,755) (504,278) (612,660) (468,216) (41,429)
FINANCING ACTIVITIES
Retirement of stock........................... (100,000) -- -- -- --
Proceeds of long-term debt.................... 205,845 119,000 266,139 266,139 --
Payments of long-term debt.................... (336,545) (192,922) (260,949) (115,557) (80,988)
Proceeds on notes payable to stockholders..... 9,403 220,378 280,000 159,990 --
Payments on notes payable to stockholders..... -- (83,248) (66,400) (20,000) (367,313)
--------- --------- --------- --------- ----------
Net cash provided by (used in) financing
activities.................................. (221,297) 63,208 218,790 290,572 (448,301)
--------- --------- --------- --------- ----------
Increase (decrease) in cash and cash
equivalents................................. 85,458 (176,568) 184,624 2,012 292,923
Cash and cash equivalents at beginning of
period...................................... 182,206 267,664 91,096 91,096 275,720
--------- --------- --------- --------- ----------
Cash and cash equivalents at end of period.... $ 267,664 $ 91,096 $ 275,720 $ 93,108 $ 568,643
========= ========= ========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid................................. $ 62,053 $ 84,178 $ 77,054 $ 32,698 $ 25,045
========= ========= ========= ========= =========
Income tax paid............................... $ 9,490 $ 49,460 $ 67,003 $ 19,000 $ 48,797
========= ========= ========= ========= =========
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
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-38
<PAGE> 110
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
AC Service & Installation Co., Inc. and Donelson Air Conditioning Company,
Inc. hereafter referred to as ("the Combined Company") are under common
ownership. The financial statements of these companies have been combined for
all periods presented. The Combined Company operates in one industry segment and
is primarily engaged in the installation and servicing of air conditioning and
heating systems for residential and commercial customers in Nashville,
Tennessee.
RECOGNITION OF INCOME
Revenues on all of the Combined Company's heating and air conditioning
installation contracts (Contracts) for commercial buildings are recognized on
the percentage of completion method in the ratio that total incurred costs bear
to total estimated costs. Revenues on all of the Combined Company's heating and
air conditioning installation for residential installation and service and
maintenance revenue are recognized upon completion of the services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within 6 to 18 months. Nonidentifiable
selling, general, and administrative expenses are charged to income as incurred
and are not allocated to Contract costs.
Trade accounts receivable includes billings and billed retainage on
Contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $124,298 and $75,504 at December 31, 1994 and 1995, respectively. The
Combined Company classifies these amounts as current assets because all balances
are expected to be collected in the current year. Concentrations of credit risk
with respect to trade receivables are limited due to the large number of
customers comprising the Combined Company's customer base, and their dispersions
across many different industries and geographies.
The asset, "costs and estimated earnings in excess of billings" represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings" represent
billings in excess of revenue recognized on in-progress contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt approximate
fair value.
F-39
<PAGE> 111
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
CASH EQUIVALENTS
The Combined Company considers all highly liquid inventory investments with
an original maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings.................................................................... 31.5
Furniture and fixtures....................................................... 5-7
Machinery and equipment...................................................... 5
Vehicles..................................................................... 5
</TABLE>
WARRANTIES
The Combined Company provides the retail customer with a two-year warranty
on parts and labor from the date of installation of the heating and air
conditioning unit. This warranty runs concurrent with the manufacturer's
warranty on parts and for the first year on labor. The Combined Company provides
an accrual for future warranty costs based upon the relationship of prior years'
sales to actual warranty costs. It is the Combined Company's practice to
classify the entire warranty accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
Donelson Air Conditioning Company, Inc. uses the liability method of
accounting for federal and state income taxes as provided by SFAS No. 109,
"Accounting for Income Taxes." Under the liability method, the deferred tax
liability or asset is based on temporary differences between the financial
statement and income tax bases of assets and liabilities, measured at tax rates
that will be in effect when the differences reverse.
The stockholders of AC Service & Installation Co., Inc. have elected under
Subchapter S of the Internal Revenue Code to include the Company's income in
their own income for federal income tax purposes. Accordingly, AC Service &
Installation Co., Inc. is not subject to federal income taxes. This election is
not available for Tennessee state income tax reporting; accordingly, AC Service
& Installation Co., Inc. uses the liability method of accounting for Tennessee
state income taxes.
F-40
<PAGE> 112
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING COSTS
The Combined Company expenses advertising costs as incurred. During 1993,
1994 and 1995, the Combined Company expensed $235,360, $304,417 and $207,802,
respectively.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $43,265, $84,338 and $28,502, respectively and accounts
written off, net of recoveries were $22,057, $(77) and $29,288, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
---------- ----------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts........................ $1,264,339 $ 911,195
Estimated earnings.......................................... 420,053 486,693
---------- ----------
1,684,392 1,397,888
Less applicable billings...................................... 1,863,906 1,595,431
---------- ----------
$ (179,514) $ (197,543)
========= =========
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................... $ 55,936 $ 30,740
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................... (235,450) (228,283)
---------- ----------
$ (179,514) $ (197,543)
========= =========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
F-41
<PAGE> 113
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
Long-term debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1994 1995
---------- ----------
<S> <C> <C>
Mortgage note payable......................................... $ 582,350 $ 516,010
Notes payable -- stockholders................................. 482,313 695,913
Installment note -- SunTrust Bank............................. -- 68,884
Installment note -- Bank of Nashville......................... 28,921 19,158
Other......................................................... 11,333 23,742
---------- ----------
1,104,917 1,323,707
Less current portion.......................................... 106,594 164,265
---------- ----------
$ 998,323 $1,159,442
========= =========
</TABLE>
The Combined Company has a mortgage note payable to Free Will Baptist, Inc.
that is secured by the Combined Company's office building and related land. The
loan requires monthly installments of $8,400, including fixed principal and
imputed interest (6.1% at December 31, 1995), through July 15, 1997, at which
time the remaining balance of $403,160 is due.
The Combined Company has an installment note payable to SunTrust Bank that
expires April 15, 1997. The loan is secured by vehicles and requires monthly
payments of $4,593, including principal and interest at the SunTrust Bank base
rate plus .25% (8.75% at December 31, 1995).
The Combined Company has an installment note payable to the Bank of
Nashville that expires March 16, 1996. The loan is secured by vehicles and
requires monthly payments of $6,458, including principal and interest at 8.50%.
The notes payable to stockholders represents amounts loaned to the Combined
Company for working capital needs. The Combined Company has signed unsecured
promissory notes payable to the stockholders for $482,313 and $695,913 at
December 31, 1994 and 1995, respectively, all due December 31, 1997. The notes
bear interest of 4.8% per year.
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996............................................................. $ 164,265
1997............................................................. 1,159,442
----------
$1,323,707
=========
</TABLE>
4. EMPLOYEE BENEFIT PLANS
The Combined Company has a defined-contribution employee benefit plan
incorporating provisions of section 401(k) of the Internal Revenue Code.
Employees of the Combined Company must have one year of service and work 500
hours during the plan year to be eligible. Under the plan's provisions, a plan
member may make contributions, on a tax-deferred basis, not to exceed the
maximum established annually by the Internal Revenue Service. Matching
contributions are made by the Combined Company equal to 1/3 of total
contributions by a plan member, to a maximum of 6% of the employee's total
calendar year compensation. The Combined Company's accrued matching
contributions totaled $16,160, $30,340 and $45,678 as of December 31, 1993, 1994
and 1995, respectively.
F-42
<PAGE> 114
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Combined Company is a party to a number of legal proceedings arising in
the ordinary course of its business. In the opinion of management, the
resolution of these proceedings will not have a material adverse effect on the
financial position or results of operations of the Combined Company.
The Combined Company maintains general liability insurance coverage and an
umbrella policy to ensure itself against any liabilities occurring in the normal
course of business. The Combined Company believes that its insurance coverage is
adequate.
6. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $1,402,085,
$1,674,280 and $2,093,240 in 1993, 1994 and 1995, respectively.
7. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1994 1995
------- ------- --------
<S> <C> <C> <C>
Current:
Federal................................................ $12,675 $39,913 $ 64,582
State.................................................. 6,830 8,612 40,473
Deferred................................................. 2,241 (7,399) (23,367)
------- ------- --------
$21,746 $41,126 $ 81,688
======= ======= ========
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
------- -------
<S> <C> <C>
Deferred tax liabilities:
Contract billings.............................................. $34,068 $21,918
------- -------
Deferred tax liabilities......................................... 34,068 21,918
Deferred tax assets:
Depreciation and amortization.................................. 2,307 1,901
Bad debts...................................................... 12,375 17,754
Warranty reserves.............................................. 4,400 10,644
------- -------
Total gross deferred tax assets.................................. 19,082 30,299
Valuation allowance.............................................. -- --
------- -------
Net deferred tax assets.......................................... 19,082 30,299
------- -------
Net deferred tax liabilities (assets)............................ $14,986 $(8,381)
======= =======
</TABLE>
F-43
<PAGE> 115
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will be more likely than not realized. Accordingly, no valuation allowance has
been recognized for the year ended December 31, 1995.
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------------
1993 1994 1995
-------- -------- ---------
<S> <C> <C> <C>
Tax provision at statutory rate........................... $ 34,689 $ 74,858 $ 241,482
State income tax less applicable federal tax benefit...... 4,508 5,684 26,712
Less benefit of graduated tax notes and adjustments to
eliminate S corporation................................. (17,451) (39,416) (186,506)
-------- -------- ---------
$ 21,746 $ 41,126 $ 81,688
======== ======== =========
</TABLE>
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously in this note, AC Service & Installation Co., Inc.
operates under Subchapter S of the Internal Revenue Code and is not subject to
corporate federal income tax. In connection with the contemplated initial public
offering (See Note 9), the Subchapter S election will be terminated. As a
result, AC Service and Installation Co., Inc. will be subject to corporate
income taxes subsequent to the termination of S corporation status. AC Service
and Installation Co., Inc. had net operating income for income tax purposes of
$74,800, $(142,000), $521,000 and $1,122,360 for 1993, 1994, 1995 and the six
months ended June 30, 1996, respectively. Had AC Service & Installation Co.,
Inc. filed federal and state income tax returns as a regular corporation for
1993, 1994, 1995 and the six months ended June 30, 1996, income tax expense
under the provisions of Financial Accounting Standard No. 109 would have been
$(8,200), $16,915, $205,200 and $40,853, respectively.
At the date of termination of S corporation status, AC Service &
Installation Co., Inc. will be required to provide deferred taxes for cumulative
temporary differences between financial reporting and tax reporting basis of
assets and liabilities. Such deferred taxes will be based on the cumulative
temporary differences at the date of termination of S corporation status.
The effect of recognizing the deferred taxes will be included in income
from continuing operations. If the termination of S corporation status had
occurred at June 30, 1996, the deferred tax asset would have been approximately
$331,800.
8. RELATED PARTY TRANSACTIONS
The Combined Company has two outstanding notes receivable of $100,000 each
from the two stockholders of the Combined Company as of December 31, 1995 and
March 31, 1996. The notes are payable upon demand and bear annual interest of
5%.
9. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Combined Company, in exchange
for shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
F-44
<PAGE> 116
AC SERVICE & INSTALLATION CO., INC.
AND
DONELSON AIR CONDITIONING COMPANY, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income (operations) and cash flows for the six
months ended June 30, 1995 and 1996 (interim financial statements) have been
prepared by management and are unaudited. The interim financial statements
include all adjustments, consisting of only normal recurring adjustments
necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
11. SUBSEQUENT EVENT
Effective June 30, 1996, the Company distributed land, buildings, accounts
receivable and other assets with a net book value of $1,095,548 in satisfaction
of mortgage notes payable of $488,110, shareholder notes payable of $343,395,
and accrued compensation of $364,846.
F-45
<PAGE> 117
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Hardwick Air Masters, Inc.
d/b/a Airmasters, Inc.
We have audited the accompanying balance sheets of Hardwick Air Masters,
Inc. d/b/a Airmasters, Inc. as of December 31, 1994 and 1995, and the related
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Hardwick Air Masters, Inc.
d/b/a Airmasters, Inc. at December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-46
<PAGE> 118
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- JUNE 30,
1994 1995 1996
---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 80,896 $ 57,512 $ 115,476
Receivables:
Trade, net of allowance for doubtful accounts of
$48,716 in 1994 and $60,299 in 1995................. 588,707 985,311 1,064,300
Related party......................................... 43,725 39,914 31,859
Employee.............................................. 16,377 22,517 37,948
---------- ---------- ----------
648,809 1,047,742 1,134,107
Inventories.............................................. 238,250 178,739 316,112
Costs and estimated earnings in excess of billings....... 72,477 83,203 132,075
Prepaid income taxes..................................... 22,141 401 --
Prepaid expenses and other current assets................ 7,609 17,437 57,006
Deferred income taxes.................................... 69,026 58,693 64,075
---------- ---------- ----------
Total current assets............................. 1,139,208 1,443,727 1,818,851
Property, buildings and equipment:
Furniture and fixtures................................... 83,733 108,262 116,205
Machinery and equipment.................................. 294,995 313,300 329,543
Vehicles................................................. 463,196 681,641 738,579
Leasehold improvements................................... 28,212 36,348 43,182
---------- ---------- ----------
870,136 1,139,551 1,227,509
Less accumulated depreciation and amortization........... (521,448) (610,220) (658,287)
---------- ---------- ----------
348,688 529,331 569,222
Other assets............................................... 6,748 6,381 6,197
---------- ---------- ----------
Total assets..................................... $1,494,644 $1,979,439 $2,394,270
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities........... $ 554,430 $ 796,322 $ 978,427
Accrued compensation..................................... 67,910 66,641 45,284
Accrued warranties....................................... 26,717 35,689 37,650
Income taxes payable..................................... -- -- 45,399
Deferred revenue......................................... 192,326 154,454 179,835
Billings in excess of costs and estimated earnings....... 24,901 7,514 --
Liability to Company benefit plan........................ 1,855 13,270 3,965
Current portion of long-term debt........................ 304,024 205,146 240,228
---------- ---------- ----------
Total current liabilities........................ 1,172,163 1,279,036 1,530,788
Long-term debt, net of current portion..................... 169,070 402,091 201,639
Deferred income taxes...................................... 39,579 46,420 64,994
Stockholders' equity:
Common stock -- $5 par value, 10,000 shares authorized,
2,600 shares issued and outstanding................... 13,000 13,000 13,000
Paid-in capital.......................................... -- -- 217,017
Retained earnings........................................ 100,832 238,892 366,832
---------- ---------- ----------
Total stockholders' equity....................... 113,832 251,892 596,849
---------- ---------- ----------
Total liabilities and stockholders' equity....... $1,494,644 $1,979,439 $2,394,270
========= ========= =========
</TABLE>
See accompanying notes.
F-47
<PAGE> 119
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues......................... $3,989,626 $4,797,873 $6,377,285 $2,964,718 $3,877,541
Cost of goods sold................... 2,986,702 3,418,062 4,556,146 2,083,397 2,856,457
---------- ---------- ---------- ---------- ----------
Gross margin......................... 1,002,924 1,379,811 1,821,139 881,321 1,021,084
Selling, general and administrative
expenses........................... 912,694 1,250,029 1,535,155 722,894 761,789
Bad debt expense..................... 5,102 60,938 42,157 19,262 17,012
---------- ---------- ---------- ---------- ----------
Income from operations............... 85,128 68,844 243,827 139,165 242,283
Other income (expense):
Interest expense................... (59,591) (71,875) (73,788) (33,556) (52,087)
Interest income.................... 2,527 2,928 2,201 1,133 561
Other income....................... 19,989 16,363 10,482 2,933 10,598
---------- ---------- ---------- ---------- ----------
(37,075) (52,584) (61,105) (29,490) (40,928)
---------- ---------- ---------- ---------- ----------
Income before federal and state
income taxes....................... 48,053 16,260 182,722 109,675 201,355
Provision (benefit) for income taxes:
Current............................ 5,471 16,656 27,488 16,060 60,223
Deferred........................... 7,365 (8,715) 17,174 10,334 13,192
---------- ---------- ---------- ---------- ----------
12,836 7,941 44,662 26,394 73,415
---------- ---------- ---------- ---------- ----------
Net income........................... $ 35,217 $ 8,319 $ 138,060 $ 83,281 $ 127,940
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-48
<PAGE> 120
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK,
$5 PAR VALUE
---------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1992.................... 2,600 $13,000 -- $ 57,296 $ 70,296
Net income.................................... -- -- -- 35,217 35,217
------ ------- -------- -------- --------
Balance at December 31, 1993.................... 2,600 13,000 -- 92,513 105,513
Net income.................................... -- -- -- 8,319 8,319
------ ------- -------- -------- --------
Balance at December 31, 1994.................... 2,600 13,000 -- 100,832 113,832
Net income.................................... -- -- -- 138,060 138,060
------ ------- -------- -------- --------
Balance at December 31, 1995.................... 2,600 13,000 -- 238,892 251,892
Net income (unaudited)........................ -- -- -- 127,940 127,940
Contribution (unaudited)...................... 217,017 -- 217,017
------ ------- -------- -------- --------
Balance at June 30, 1996 (unaudited)............ 2,600 $13,000 $217,017 $366,832 $596,849
===== ======= ======== ======== ========
</TABLE>
See accompanying notes.
F-49
<PAGE> 121
HARDWICK AIRMASTERS, INC.
D/B/A AIRMASTERS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.............................. $ 35,217 $ 8,319 $ 138,060 $ 83,281 $127,940
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization......... 87,052 95,771 109,777 59,149 78,267
Deferred income taxes................. 7,365 (8,715) 17,174 10,334 13,192
Provisions for loss on accounts
receivable......................... 5,102 60,938 42,157 19,262 17,012
(Gain) loss on asset disposals........ (2,750) 751 -- -- (122)
Changes in assets and liabilities:
Receivables........................ (308,735) (55,999) (441,090) (223,723) (13,194)
Inventories........................ (40,040) (22,630) 59,511 17,885 (2,773)
Prepaid income taxes and income
taxes payable.................... (19,719) (1,275) 21,740 783 45,800
Prepaid expenses and other current
assets........................... (3,171) 30,214 (9,828) (10,389) (34,922)
Trade accounts payable and accrued
liabilities...................... 247,015 29,017 241,892 96,535 163,913
Accrued compensation............... 15,723 14,794 10,146 42,779 (27,944)
Accrued warranties................. 4,821 5,294 8,972 6,415 (3,039)
Deferred revenue................... 8,543 64,210 (37,872) (17,911) (3,456)
Costs and estimated earnings in
excess of billings and billings
in excess of costs and estimated
earnings......................... 23,701 (66,976) (28,113) (17,431) (24,744)
--------- --------- --------- --------- --------
Net cash flow provided by operating
activities............................ 60,124 153,713 132,526 66,969 335,930
INVESTING ACTIVITIES
Purchase of property, buildings, and
equipment............................. (195,719) (98,577) (301,533) (172,034) (123,910)
Proceeds from sale of property,
buildings, and equipment.............. 2,750 7,776 11,847 -- 32,767
Cash obtained from acquisition of
company............................... -- -- -- -- 54,401
(Increase) decrease in other assets..... 372 367 (367) 184 184
--------- --------- --------- --------- --------
Net cash used in investing activities... (192,597) (90,434) (290,053) (171,850) (36,558)
FINANCING ACTIVITIES
Proceeds of long-term debt.............. 268,284 110,749 324,260 195,997 27,393
Payments of long-term debt and capital
leases................................ (98,898) (158,318) (190,117) (101,290) (268,801)
--------- --------- --------- --------- --------
Net cash provided by (used in) financing
activities............................ 169,386 (47,569) 134,143 94,707 (241,408)
--------- --------- --------- --------- --------
Increase (decrease) in cash and cash
equivalents........................... 36,913 15,710 (23,384) (10,174) 57,964
Cash and cash equivalents at beginning
of year............................... 28,273 65,186 80,896 80,896 57,512
--------- --------- --------- --------- --------
Cash and cash equivalents at end of
year.................................. $ 65,186 $ 80,896 $ 57,512 $ 70,722 $115,476
========= ========= ========= ========= ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................... $ 71,402 $ 74,082 $ 64,922 $ 33,056 $ 47,822
========= ========= ========= ========= ========
Income tax paid (refunded).............. $ 25,900 $ (2,196) $ 6,497 $ -- $ 11,334
========= ========= ========= ========= ========
</TABLE>
See accompanying notes.
F-50
<PAGE> 122
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Hardwick Air Masters, Inc. d/b/a Airmasters, Inc. ("the Company") operates
in one industry segment and is primarily engaged in the installation and
servicing of air conditioning and heating systems for residential and commercial
customers.
Effective April 1, 1996, AMT Enterprises, Inc. ("AMT") was merged with and
into the Company. AMT is under common control, with the Company's shareholders
owning 100% of AMT. The merger was effected by an exchange of stock whereby the
Company exchanged 600 shares of its common stock for 100% of the outstanding
common stock (40 shares) of AMT. This transaction was accounted for similar to a
pooling-of-interests and, accordingly, the accompanying financial statements
have been restated to include the accounts of AMT.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts (Contracts) for commercial buildings are recognized on the
percentage-of-completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues on all of the Company's heating and air
conditioning installation for residential installation and service and
maintenance revenue are recognized upon completion of the services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within 6 to 18 months. Nonidentifiable
selling, general, and administrative expenses are charged to income as incurred
and are not allocated to Contract costs.
Trade accounts receivable includes billings and billed retainage on
Contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $10,688 and $42,626 at December 31, 1994 and 1995, respectively. The
Company classifies these amounts as current assets because all balances are
expected to be collected in the current year. Concentrations of credit risk with
respect to trade receivables are limited due to the large number of customers
comprising the Company's customer base.
The asset, "costs and estimated earnings in excess of billings" represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings" represent
billings in excess of revenue recognized on in-progress contracts.
CASH EQUIVALENTS
The Company considers all highly liquid inventory investments with an
original maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
F-51
<PAGE> 123
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line method over the
following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................................ 3-10
Machinery and equipment....................................................... 3-10
Vehicles...................................................................... 3-10
Leasehold improvements........................................................ 31
</TABLE>
WARRANTIES
The Company provides the retail customer with a choice of one, three or
ten-year warranties on parts and labor from the date of installation of the
heating and air conditioning unit. This warranty runs concurrent with the
manufacturer's warranty on parts and for the first year on labor. The Company
provides an accrual for future warranty costs based upon the relationship of
prior years' sales to actual warranty costs. It is the Company's practice to
classify the entire warranty accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes." Under the liability method, the deferred tax liability or asset
is based on temporary differences between the financial statement and income tax
bases of assets and liabilities, measured at tax rates that will be in effect
when the differences reverse.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash and Cash Equivalents -- The carrying amount reported in the
balance sheet for cash and cash equivalents approximates its fair value.
Long and Short-Term Debt -- The carrying amounts of the Company's
borrowings under its revolving credit agreements and other debt agreements
are estimated using discounted cash flow analyses, using interest rates
currently being offered by banks for similar types of borrowing
arrangements.
The carrying amounts and fair value of the Company's financial instruments
at December 31, 1995 are as follows:
<TABLE>
<CAPTION>
CARRYING FAIR
AMOUNT VALUE
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Cash and cash equivalents........................................ $ 80,896 $ 80,896
Long-term debt, including current portion........................ 607,237 607,237
</TABLE>
F-52
<PAGE> 124
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $5,102, $60,938 and $42,157, respectively and accounts
written off, net of recoveries were $2,214, $28,437 and $30,574, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on completed contracts............................ $105,885 $308,300
Estimated earnings............................................. 65,670 115,070
-------- --------
171,555 423,370
Less applicable billings....................................... 123,979 347,681
-------- --------
$ 47,576 $ 75,689
======== ========
Included in the accompanying balance sheets under the following
captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts....................................... $ 72,477 $ 83,203
Billings in excess of costs and estimated earnings on
uncompleted contracts....................................... 24,901 7,514
-------- --------
$ 47,576 $ 75,689
======== ========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
F-53
<PAGE> 125
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT
Long-term debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Lines of credit with a bank(1)................................... $109,721 $121,721
Notes payable to banks and finance companies(2).................. 282,242 409,716
Debentures payable to stockholder(3)............................. 75,800 75,800
Other............................................................ 5,331 --
-------- --------
473,094 607,237
Less current portion............................................. 304,024 205,146
-------- --------
$169,070 $402,091
======== ========
</TABLE>
- ---------------
(1) The Company has two secured lines of credit with a bank that expire February
5, 1997. Under their terms, the Company can borrow up to $150,000 at
10.25%. The agreement is secured by accounts receivable, inventory, and
real estate.
(2) Notes payable are due in installments through December 2000, with a weighted
average interest rate of 8.9% with substantially all notes collateralized
by vehicles and equipment.
(3) The debentures are payable to the Company's majority shareholder, with
interest at 10.0% and maturing from August 1997 to March 1999.
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996.............................................................. $205,146
1997.............................................................. 223,765
1998.............................................................. 90,534
1999.............................................................. 69,594
2000.............................................................. 18,198
--------
$607,237
========
</TABLE>
4. LEASES
Total rental expense for all operating leases was $27,232, $32,303 and
$42,957 for 1993, 1994 and 1995, respectively. The Company leases certain office
and warehouse facilities under terms of noncancelable operating lease agreements
which expire at various dates through 2000. Minimum rental commitments at
December 31, 1995 under operating leases having an initial noncancelable term of
one year or more are as follows:
<TABLE>
<S> <C>
1996............................................................... $37,881
1997............................................................... 14,091
1998............................................................... 7,491
1999............................................................... 6,891
2000............................................................... 4,594
-------
$70,948
=======
</TABLE>
F-54
<PAGE> 126
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, multiples of 2%
to 15% maximum allowable of total compensation, not to exceed the maximum
established annually by the Internal Revenue Service. Matching contributions are
made by the Company equal to 50% of total contributions by a plan member, to a
maximum of 2% of the employee's total calendar year compensation. The Company's
matching contributions totaled $12,237, $11,540 and $21,312 for the years ended
December 31, 1993, 1994 and 1995, respectively.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
7. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $184,275,
$271,527 and $425,650 in 1993, 1994 and 1995, respectively.
8. INCOME TAXES
Effective January 1, 1993, the Company adopted SFAS No. 109 "Accounting for
Income Taxes." Under the provisions of SFAS No. 109, deferred tax assets and
liabilities are determined based upon differences between financial reporting
and tax basis of assets and liabilities and are measured using the enacted tax
rates and laws that will be in effect when the differences are expected to
reverse. The adoption of this statement had no significant impact on the
Company's financial statements.
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal................................................. $ 3,838 $12,251 $21,286
State................................................... 1,633 4,405 6,202
------- ------- -------
5,471 16,656 27,488
Deferred.................................................. 7,365 (8,715) 17,174
------- ------- -------
$12,836 $ 7,941 $44,662
======= ======= =======
</TABLE>
F-55
<PAGE> 127
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization.................................. $(39,579) $(46,420)
-------- --------
Deferred tax liabilities......................................... (39,579) (46,420)
Deferred tax assets:
Deferred revenue............................................... 40,364 22,218
Accrued expenses............................................... 10,152 13,562
Allowance for doubtful accounts................................ 18,510 22,913
-------- --------
Deferred tax assets.............................................. 69,026 58,693
-------- --------
Net deferred tax assets................................ $ 29,447 $ 12,273
======== ========
</TABLE>
Management has evaluated the need for valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will more likely than not be realized. Accordingly, no valuation allowance has
been recorded for the years ended December 31, 1994 and 1995.
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 38% to income before provision
for deferred income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------------
1993 1994 1995
-------- ------- --------
<S> <C> <C> <C>
Tax provision at statutory rate......................... $ 18,260 $ 6,179 $ 69,434
State income tax less applicable federal tax benefit.... 1,078 2,731 3,845
Impact of surtax exemptions............................. (11,052) (3,740) (14,922)
Other, net.............................................. 4,550 2,771 (13,695)
-------- ------- --------
$ 12,836 $ 7,941 $ 44,662
======== ======= ========
</TABLE>
9. RELATED PARTY TRANSACTIONS
The Company paid rental fees of approximately $6,600 for the years ended
December 31, 1993, 1994 and 1995, to a stockholder in the Company and a company
with common ownership.
10. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
11. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income (operations) and cash flows for the six
months ended June 30, 1995 and 1996 (interim financial statements) have been
prepared by management and are unaudited. The interim financial statements
include all adjustments, consisting of only normal recurring adjustments
necessary for a fair presentation of the interim results.
F-56
<PAGE> 128
HARDWICK AIR MASTERS, INC.
D/B/A AIRMASTERS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
12. SUBSEQUENT EVENTS
Effective May 1, 1996, the Company's stockholders purchased all of the
outstanding common stock of Cummings Air Conditioning, Inc. ("Cummings") for
approximately $135,000, with the final purchase price subject to final
negotiations. This stock was then contributed to capital of the Company, with
Cummings becoming a wholly owned subsidiary of the Company. This transaction
will be treated as a purchase. Pro forma unaudited information, as if the
acquisition were completed at the beginning of 1995 for the year ended December
31, 1995 and the six months ended June 30, 1996 is reflected as follows:
<TABLE>
<CAPTION>
YEAR SIX MONTHS
ENDED ENDED
DECEMBER 31, JUNE 30,
1995 1996
------------ -------------
(UNAUDITED)
<S> <C> <C>
Operating revenues......................................... $7,148,718 $ 4,242,965
========== ==========
Net income................................................. $ 189,691 $ 158,370
========== ==========
</TABLE>
F-57
<PAGE> 129
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Norrell Heating & Air Conditioning, Inc.
We have audited the accompanying balance sheets of Norrell Heating & Air
Conditioning Company, Inc. as of December 31, 1994 and 1995, and the related
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Norrell Heating & Air
Conditioning, Inc. at December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 6, 1996
F-58
<PAGE> 130
NORRELL HEATING & AIR CONDITIONING, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31
---------------------- JUNE 30,
1994 1995 1996
--------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 233,214 $ 815,975 $ 797,371
Receivables:
Trade, net of allowance for doubtful accounts of $8,000
in 1994 and $3,000 in 1995............................ 62,636 148,374 161,291
Related party............................................ 2,394 64,421 51,100
--------- ---------- ----------
65,030 212,795 212,391
Note receivable from related party....................... -- 200,000 --
Inventories.............................................. 192,805 86,727 59,454
Investments.............................................. 57,075 75,946 77,365
Deferred income taxes.................................... 5,182 309 25,689
Prepaid expenses and other current assets................ -- -- 40,133
--------- ---------- ----------
Total current assets............................. 553,306 1,391,752 1,212,403
Property, buildings and equipment:
Furniture and fixtures................................... 44,267 45,079 45,530
Machinery and equipment.................................. 57,653 57,653 57,653
Vehicles................................................. 460,509 484,366 366,905
Leasehold improvements................................... 12,290 12,290 12,290
--------- ---------- ----------
574,719 599,388 482,378
Less accumulated depreciation and amortization........... (408,466) (466,781) (425,295)
--------- ---------- ----------
166,253 132,607 57,083
Deferred income taxes...................................... 31,423 39,092 16,927
Other assets............................................... 25,756 30,791 32,030
--------- ---------- ----------
Total assets..................................... $ 776,738 $1,594,242 $1,318,443
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities........... $ 96,455 $ 122,679 $ 115,933
Accrued compensation..................................... 11,274 646,202 219,696
Accrued taxes, other than income......................... 143,811 11,701 7,047
Income taxes payable..................................... 466 24,755 54,941
Accrued warranties....................................... 80,066 139,747 162,464
Deferred revenue......................................... 125,129 225,667 276,862
Liability to profit sharing plan......................... 50,000 50,000 25,000
--------- ---------- ----------
Total current liabilities........................ 507,201 1,220,751 861,943
Deferred compensation...................................... 91,725 105,191 112,557
Commitments and contingent liabilities..................... -- --
Stockholders' equity:
Common stock, par value $2 per share; 2,000 shares
authorized and issued................................. 2,000 2,000 2,000
Paid-in capital.......................................... 52,400 52,400 52,400
Unrealized gain (loss) on investments.................... (4,780) 6,158 6,158
Retained earnings........................................ 168,192 247,742 323,385
Treasury stock (300 shares, at cost)..................... (40,000) (40,000) (40,000)
--------- ---------- ----------
Total stockholders' equity....................... 177,812 268,300 343,943
--------- ---------- ----------
Total liabilities and stockholders' equity....... $ 776,738 $1,594,242 $1,318,443
========= ========= =========
</TABLE>
See accompanying notes.
F-59
<PAGE> 131
NORRELL HEATING & AIR CONDITIONING, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
-------------------------------------- ------------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues..................... $3,274,267 $3,508,903 $4,265,726 $1,971,802 $2,047,437
Cost of goods sold............... 2,285,621 2,436,732 2,852,690 1,334,641 1,406,695
---------- ---------- ---------- ---------- ----------
Gross margin..................... 988,646 1,072,171 1,413,036 637,161 640,742
Selling, general and
administrative
expenses....................... 990,601 1,066,158 1,380,306 686,652 587,135
Bad debt expense................. 1,885 5,834 3,643 (467) 619
---------- ---------- ---------- ---------- ----------
Income (loss) from operations.... (3,840) 179 29,087 (49,024) 52,988
Other income (expense):
Interest expense............... -- (1,412) (110) (110) --
Interest income................ 10,360 19,361 26,882 6,783 22,313
Other income................... 34,650 12,898 64,207 38,055 27,313
---------- ---------- ---------- ---------- ----------
45,010 30,847 90,979 44,728 49,626
---------- ---------- ---------- ---------- ----------
Income (loss) before income
taxes.......................... 41,170 31,026 120,066 (4,296) 102,614
Provision (benefit) for income
taxes:
Current........................ 8,961 5,058 46,485 253 29,475
Deferred....................... (2,318) (1,120) (5,969) (2,289) (2,504)
---------- ---------- ---------- ---------- ----------
6,643 3,938 40,516 (2,036) 26,971
---------- ---------- ---------- ---------- ----------
Net income (loss)................ $ 34,527 $ 27,088 $ 79,550 $ (2,260) $ 75,643
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-60
<PAGE> 132
NORRELL HEATING & AIR CONDITIONING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
UNREALIZED
GAINS
COMMON STOCK, (LOSSES) ON
$2 PAR VALUE AVAILABLE-
--------------- PAID-IN FOR-SALE RETAINED TREASURY
SHARES AMOUNT CAPITAL SECURITIES EARNINGS STOCK TOTAL
------ ------ ------- ----------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1992........................ 1,000 $2,000 $52,400 $ -- $106,577 $(40,000) $120,977
Net income.................. -- -- -- 34,527 -- 34,527
------ ------ ------- ----------- -------- -------- --------
Balance at December 31,
1993........................ 1,000 2,000 52,400 -- 141,104 (40,000) 155,504
Net income.................. -- -- -- -- 27,088 -- 27,088
Adjustment to unrealized
losses on
available-for-sale
securities, net of tax... -- -- -- (4,780) -- -- (4,780)
------ ------ ------- ----------- -------- -------- --------
Balance at December 31,
1994........................ 1,000 2,000 52,400 (4,780) 168,192 (40,000) 177,812
Net income.................. -- -- -- -- 79,550 -- 79,550
Adjustment to unrealized
gains on
available-for-sale
securities, net of tax... -- -- -- 10,938 -- -- 10,938
------ ------ ------- ----------- -------- -------- --------
Balance at December 31,
1995........................ 1,000 2,000 52,400 6,158 247,742 (40,000) 268,300
Net income (unaudited)...... -- -- -- -- 75,643 -- 75,643
------ ------ ------- ----------- -------- -------- --------
Balance at June 30, 1996
(unaudited)................. 1,000 $2,000 $52,400 $ 6,158 $323,385 $(40,000) $343,943
===== ====== ======= ========= ======== ======== ========
</TABLE>
See accompanying notes.
F-61
<PAGE> 133
NORRELL HEATING & AIR CONDITIONING, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
---------------------
1993 1994 1995 1995 1996
-------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)....................... $ 34,527 $ 27,088 $ 79,550 $ (2,260) $ 75,643
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization......... 68,756 56,666 77,989 28,870 31,649
Deferred income taxes................. (2,318) (1,120) (5,969) (2,289) (2,504)
Provisions for loss on (recoveries of)
accounts receivable................ 1,885 5,834 3,643 (467) 619
Loss (gain) on asset disposals........ 1,462 25,099 (1,300) -- (3,329)
Changes in assets and liabilities:
Receivables........................ 9,343 (5,793) (348,235) (52,563) 199,785
Inventories........................ (24,311) (65,065) 106,078 91,937 27,273
Prepaid expenses and other current
assets........................... (1,039) 1,039 -- -- (40,133)
Trade accounts payable and accrued
liabilities...................... 88,251 (114,536) 26,224 34,923 (6,746)
Accrued compensation............... 49,757 (34,371) 648,394 267,712 (444,140)
Accrued taxes, other than income... 27,932 58,353 (132,110) (130,609) (4,654)
Accrued warranties................. 31,082 38,985 59,681 25,311 22,717
Deferred revenue................... 30,936 34,806 100,538 28,736 51,195
Income taxes payable............... (6,527) 466 24,289 2,249 29,475
-------- --------- --------- --------- ---------
Net cash flow provided by (used in)
operating activities.................. 309,736 27,451 638,772 291,550 (63,150)
INVESTING ACTIVITIES
Purchase of property, buildings, and
equipment............................. $(67,648) $ (74,757) $ (44,343) $ (7,784) $ (450)
Proceeds from sale of property,
buildings, and equipment.............. -- -- 1,300 -- 47,654
Purchase of investments................. (8,978) (7,877) (7,933) (6,827) (1,419)
Increase in other assets................ (3,546) (2,408) (5,035) (46,684) (1,239)
-------- --------- --------- --------- ---------
Net cash provided by (used in) investing
activities............................ (80,172) (85,042) (56,011) (61,295) 44,546
-------- --------- --------- --------- ---------
Increase (decrease) in cash and cash
equivalents........................... 229,564 (57,591) 582,761 230,255 (18,604)
Cash and cash equivalents at beginning
of period............................. 61,241 290,805 233,214 233,214 815,975
-------- --------- --------- --------- ---------
Cash and cash equivalents at end of
period................................ $290,805 $ 233,214 $ 815,975 $ 463,469 $ 797,371
======== ========= ========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................... $ -- $ 1,412 $ 110 $ 110 $ --
======== ========= ========= ========= =========
Income tax paid......................... $ 16,527 $ 8,853 $ 25,539 $ -- $ --
======== ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-62
<PAGE> 134
NORRELL HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Norrell Heating & Air Conditioning, Inc. ("the Company") is a "C"
corporation and operates in one industry segment. The Company is primarily
engaged in the installation and servicing of air conditioning and heating
systems for residential and commercial customers. The Company purchases
inventories from two suppliers. Concentrations of credit risk with respect to
trade receivables are limited due to the large number of customers comprising
the Company's customer base.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
for residential installation and service and maintenance revenue are recognized
upon completion of the services.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
SHORT-TERM INVESTMENTS
Short-term investments include investments in mutual funds. These
investments are accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." It is the Company's intent not to hold these
investments to maturity.
F-63
<PAGE> 135
NORRELL HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................................ 5
Machinery and equipment....................................................... 5
Vehicles...................................................................... 5
Leasehold improvements........................................................ 10
</TABLE>
WARRANTIES
The Company provides the residential customer a one-year warranty and
offers extended warranties for select models on parts and labor from the date of
installation of the heating and air conditioning unit. These warranties run
concurrent with the manufacturer's warranty on parts. The Company provides an
accrual for future warranty costs based upon historical experience. It is the
Company's practice to classify the entire warranty accrual as a current
liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes." Under the liability method, the deferred tax liability or asset
is based on temporary differences between the financial statement and income tax
bases of assets and liabilities, measured at tax rates that will be in effect
when the differences reverse.
ADVERTISING
The cost of advertising is expensed as incurred. The Company incurred
$200,255, $176,014 and $167,595 in such costs during 1993, 1994 and 1995,
respectively.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $1,884, $5,834 and $3,644, respectively and accounts
written off, net of recoveries were $7,884, $(1,166) and $8,644, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-64
<PAGE> 136
NORRELL HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Company adopted SFAS No. 115. The Company's
investment securities are classified as available for sale under SFAS No. 115
and, as a result, the carrying amount is a reasonable estimate of fair value.
The cost of available-for-sale securities was $64,139 and $73,679 at December
31, 1994 and 1995, respectively. The adoption of SFAS No. 115 did not have a
significant impact on the Company's financial statements in 1994.
All investments are classified as current because the Company views its
portfolio as available for use in its current operations.
3. LONG-TERM DEBT
The Company has the ability to borrow up to $100,000 under the terms of an
unsecured line of credit that expires September 13, 1996. At December 31, 1994
and 1995, the Company had no borrowings outstanding under the agreement.
4. LEASES
Total rental expense for all operating leases was $68,013, $87,485 and
$89,833 for 1993, 1994 and 1995, respectively. The Company leases certain office
and warehouse facilities and vehicles under terms of noncancelable operating
lease agreements which expire at various dates through the year 1999. Minimum
rental commitments at December 31, 1995 under operating leases having an initial
noncancellable term of one year or more are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
---------
<S> <C>
1996........................................................... $ 106,056
1997........................................................... 5,196
1998........................................................... 3,528
1999........................................................... 3,528
---------
$ 118,308
========
</TABLE>
5. EMPLOYEE BENEFIT PLANS
Substantially all of the Company's employees are eligible to participate in
a profit sharing plan. Contributions are made to the plan at the discretion of
the Board of Directors. Contributions to the plan totaled $100,000, $50,000 and
$50,000 for the years ended December 31, 1993, 1994 and 1995, respectively.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to legal proceedings arising in the ordinary course
of its business. In the opinion of management, the resolution of these
proceedings will not have a material adverse effect on the financial position or
results of operations of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
The Company has entered into a salary continuation agreement with the
President of the Company whereby the Company will pay the President following
the retirement date of August 1, 2003, $1,667 per month for 180 months. The
amount charged to expense was $6,356, $7,347 and $8,466 at December 31, 1993,
1994 and 1995, respectively. The liability classified as long-term is $45,191 at
December 31, 1995.
F-65
<PAGE> 137
NORRELL HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company has entered into a deferred compensation agreement with an
employee (nonshareholder) whereby the Company makes $5,000 payments through
December 31, 1997 into an account designated by the employer. Beginning December
31, 1998, additional payments of $23,000 are to be made until the earlier of the
termination of the agreement, termination of employment or a change in control
of the Company. Such amounts are expensed as earned.
7. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $390,000,
$442,000 and $727,000 in 1993, 1994 and 1995, respectively.
8. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Current:
Federal................................................. $ 6,902 $ 3,896 $40,861
State................................................... 2,059 1,162 5,624
Deferred.................................................. (2,318) (1,120) (5,969)
------- ------- -------
$ 6,643 $ 3,938 $40,516
======= ======= =======
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Deferred tax liabilities:
Unrealized gain on investments................................... $ -- $ 711
------- -------
Deferred tax liabilities........................................... -- 711
Deferred tax assets:
Employee compensation............................................ 17,587 22,165
Depreciation and amortization.................................... 13,836 16,927
Accounts receivable.............................................. 2,720 1,020
Unrealized loss on investment.................................... 2,462 --
------- -------
Total deferred tax assets.......................................... 36,605 40,112
Valuation allowance................................................ -- --
------- -------
Net deferred tax assets............................................ $36,605 $39,401
======= =======
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will be more likely than not realized during the carry forward period.
Accordingly, no valuation allowance has been recorded.
F-66
<PAGE> 138
NORRELL HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes and cumulative effect of accounting change. The differences are summarized
as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Tax provision at statutory rate........................... $13,998 $10,549 $40,822
State income tax less applicable federal tax benefit...... 1,359 2,170 3,712
Other, net -- principally effects of graduated rates...... (8,714) (8,781) (4,018)
------- ------- -------
$ 6,643 $ 3,938 $40,516
======= ======= =======
</TABLE>
9. RELATED PARTY TRANSACTIONS
The Company leases the office building and real estate from the president
and majority shareholder under one year operating lease agreements during 1993,
1994 and 1995. The Company paid rental fees of $60,000, $84,000 and $86,000
during 1993, 1994 and 1995, respectively, to the president and majority
stockholder.
10. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
11. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income (operations) and cash flows for the six
months ended June 30, 1995 and 1996 (interim financial statements) have been
prepared by management and are unaudited. The interim financial statements
include all adjustments, consisting of only normal recurring adjustments
necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-67
<PAGE> 139
REPORT OF INDEPENDENT AUDITORS
The Stockholder
Vision Holding Company, Inc.
We have audited the accompanying consolidated balance sheets of Vision
Holding Company, Inc. as of December 31, 1994 and 1995, and the related
statements of operations, stockholder's equity, and cash flows for the period
from March 1, 1993 (date operations commenced) through December 31, 1993, and
the years ended December 31, 1994 and 1995. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Vision
Holding Company, Inc. at December 31, 1994 and 1995, and the results of their
operations and their cash flows for the period from March 1, 1993 (date
operations commenced) through December 31, 1993, and the years ended December
31, 1994 and 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 24, 1996
F-68
<PAGE> 140
VISION HOLDING COMPANY, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- JUNE 30,
1994 1995 1996
---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 94,543 $ 615,873 $ 713,880
Receivables:
Trade, net of allowance for doubtful accounts of
$3,800 in 1994, 1995 and 1996....................... 174,177 163,678 291,320
Related party......................................... 10,276 11,273 83,955
Employee.............................................. 2,352 1,044 5,939
Other................................................. 242 -- --
---------- ---------- ----------
187,047 175,995 381,214
Inventories.............................................. 105,516 116,175 183,761
Investments.............................................. 200,994 -- --
Prepaid expenses and other current assets................ 28,802 17,837 140,347
---------- ---------- ----------
Total current assets............................. 616,902 925,880 1,419,202
Property, buildings and equipment:
Land..................................................... 25,000 25,000 25,000
Buildings and leasehold improvements..................... 593,059 606,981 628,528
Furniture and fixtures................................... 36,396 37,192 37,884
Machinery and equipment.................................. 73,524 102,697 112,503
Vehicles................................................. 149,047 193,830 252,186
---------- ---------- ----------
877,026 965,700 1,056,101
Less accumulated depreciation and amortization........... (125,522) (230,015) (287,664)
---------- ---------- ----------
751,504 735,685 768,437
Goodwill, net of accumulated amortization of $19,272 in
1994, $29,784 in 1995, and $40,296 in 1996............... 410,604 400,092 394,836
Other intangible assets, net of accumulated amortization of
$55,000 in 1994, $85,000 in 1995, and $90,000 in 1996.... 35,000 5,000 --
Other assets............................................... 138,768 62,046 --
---------- ---------- ----------
Total assets..................................... $1,952,778 $2,128,703 $2,582,475
========= ========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities........... $ 186,598 $ 148,480 $ 432,756
Accrued compensation..................................... 82,195 90,936 83,244
Accrued warranties....................................... 3,085 3,940 6,516
Income taxes payable..................................... 60,012 108,239 134,352
Deferred revenue......................................... 162,558 178,281 191,935
Liability to profit sharing plan......................... 4,443 8,919 9,394
Current portion of long-term debt and capital leases..... 71,474 38,479 42,298
---------- ---------- ----------
Total current liabilities........................ 570,365 577,274 900,495
Long-term debt, net of current portion..................... 783,431 744,952 721,350
Due to former stockholder.................................. 51,783 -- --
Deferred income taxes...................................... 174,254 171,651 183,072
Stockholder's equity:
Common Stock, $10 par value; 3,000 shares authorized,
1,960 shares issued and outstanding................... 19,600 19,600 19,600
Retained earnings........................................ 353,345 615,226 757,958
---------- ---------- ----------
Total stockholder's equity....................... 372,945 634,826 777,558
---------- ---------- ----------
Total liabilities and stockholder's equity....... $1,952,778 $2,128,703 $2,582,475
========= ========= =========
</TABLE>
See accompanying notes.
F-69
<PAGE> 141
VISION HOLDING COMPANY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 1, 1993 SIX MONTHS ENDED
THROUGH YEAR ENDED DECEMBER 31, JUNE 30,
DECEMBER 31, ------------------------ ------------------------
1993 1994 1995 1995 1996
------------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues.................... $ 2,792,574 $3,525,119 $4,261,485 $2,008,262 $2,309,356
Cost of goods sold.............. 1,751,998 2,400,309 2,738,022 1,385,883 1,542,173
------------- ---------- ---------- ---------- ----------
Gross margin.................... 1,040,576 1,124,810 1,523,463 622,379 767,183
Selling, general and
administrative
expenses...................... 762,505 851,348 1,090,916 471,301 482,215
Bad debt expense................ 8,580 (4,029) 2,259 4,092 1,138
------------- ---------- ---------- ---------- ----------
Income from operations.......... 269,491 277,491 430,288 146,986 283,830
Other income (expense):
Interest expense.............. (14,767) (60,278) (72,830) (33,928) (44,678)
Interest income............... 249 2,210 22,911 5,069 16,444
Other income (expense)........ 44,550 55,450 49,034 23,795 (10,273)
------------- ---------- ---------- ---------- ----------
30,032 (2,618) (885) (5,064) (38,507)
------------- ---------- ---------- ---------- ----------
Income before income taxes...... 299,523 274,873 429,403 141,922 245,323
Provision (benefit) for income
taxes:
Current....................... -- 76,755 170,125 50,524 91,170
Deferred...................... 109,566 34,730 (2,603) 2,091 11,421
------------- ---------- ---------- ---------- ----------
109,566 111,485 167,522 52,615 102,591
------------- ---------- ---------- ---------- ----------
Net income...................... $ 189,957 $ 163,388 $ 261,881 $ 89,307 $ 142,732
========== ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-70
<PAGE> 142
VISION HOLDING COMPANY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
----------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------- -------- --------
<S> <C> <C> <C> <C>
Balance at March 1, 1993............................... -- $ -- $ -- $ --
Issuance of common stock............................. 1,960 19,600 -- 19,600
Net income........................................... -- -- 189,957 189,957
------ ------- -------- --------
Balance at December 31, 1993........................... 1,960 19,600 189,957 209,557
Net income........................................... -- -- 163,388 163,388
------ ------- -------- --------
Balance at December 31, 1994........................... 1,960 19,600 353,345 372,945
Net income........................................... -- -- 261,881 261,881
------ ------- -------- --------
Balance at December 31, 1995........................... 1,960 19,600 615,226 634,826
Net income (unaudited)............................... -- -- 142,732 142,732
------ ------- -------- --------
Balance at June 30, 1996 (unaudited)................... 1,960 $19,600 $757,958 $777,558
===== ======= ======== ========
</TABLE>
See accompanying notes.
F-71
<PAGE> 143
VISION HOLDING COMPANY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 1, 1993 YEAR ENDED DECEMBER SIX MONTHS ENDED
THROUGH 31, JUNE 30,
DECEMBER 31, --------------------- --------------------
1993 1994 1995 1995 1996
------------- --------- --------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income............................. $ 189,957 $ 163,388 $ 261,881 $ 89,307 $ 142,732
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization........ 81,207 131,252 144,346 74,605 67,905
Deferred income taxes................ 109,566 34,730 (2,603) 2,091 11,421
Other assets......................... 18,694 (45,178) 76,722 (12,116) 62,046
Changes in assets and liabilities:
Receivables....................... (129,831) 9,025 11,052 (20,756) (205,219)
Inventories....................... 5,595 2,941 (10,659) (42,376) (67,586)
Prepaid expenses and other current
assets.......................... (4,188) 1,065 10,965 9,188 (16,919)
Trade accounts payable and accrued
liabilities..................... (72,403) 67,120 (38,118) 84,268 178,685
Accrued compensation.............. 59,432 14,419 8,741 5,479 (7,692)
Accrued warranties................ (340) 425 855 277 2,576
Income taxes payable.............. -- 59,976 48,227 (50,686) 26,113
Deferred revenue.................. 64,319 4,876 15,723 (23,961) 13,654
Liability to profit sharing
plan............................ (5,080) 468 4,476 2,776 475
------------- --------- --------- -------- ---------
Net cash flow provided by operating
activities........................... 316,928 444,507 531,608 118,096 208,191
INVESTING ACTIVITIES
Purchase of property, buildings, and
equipment............................ (56,368) (128,615) (88,015) (55,909) (90,401)
Proceeds from sale of fixed assets..... 23,402 -- -- -- --
Purchase of investments................ -- (200,994) -- -- --
Proceeds from sale of investments...... -- -- 200,994 200,994 --
------------- --------- --------- -------- ---------
Net cash provided by (used in)
investing activities................. (32,966) (329,609) 112,979 145,085 (90,401)
FINANCING ACTIVITIES
Proceeds from short-term debt.......... 15,000 -- -- -- --
Payments on short-term debt............ (6,060) -- -- -- --
Proceeds from long-term debt........... 30,069 -- -- -- --
Payments of long-term debt and capital
leases............................... (102,720) (236,231) (71,474) (21,748) (19,783)
Due to former stockholder.............. (24,500) (13,717) (51,783) 33,332 --
------------- --------- --------- -------- ---------
Net cash used in (provided by)
financing activities................. (88,211) (249,948) (123,257) 11,584 (19,783)
------------- --------- --------- -------- ---------
Increase (decrease) in cash and cash
equivalents.......................... 195,751 (135,050) 521,330 274,765 98,007
Cash at beginning of year.............. 33,842 229,593 94,543 94,543 615,873
------------- --------- --------- -------- ---------
Cash at end of year.................... $ 229,593 $ 94,543 $ 615,873 $369,308 $ 713,880
========== ========= ========= ======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.......................... $ 19,056 $ 60,278 $ 72,830 $ 33,928 $ 44,678
========== ========= ========= ======== =========
Income tax paid........................ $ 800 $ 14,470 $ 141,204 $ 85,210 $ 55,388
========== ========= ========= ======== =========
Covenant not-to-compete exchanged for
debt................................. $ 90,000 $ -- $ -- $ -- $ --
========== ========= ========= ======== =========
</TABLE>
See accompanying notes.
F-72
<PAGE> 144
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
On March 1, 1993, Vision Holding Company, Inc. (the Company), a
newly-formed corporation, purchased all of the outstanding common stock of Neal
Harris Heating and Air Conditioning Company, Inc. (NHHACC), an existing
business, for $938,600. The acquisition was financed from the issuance of 1,960
shares of the Company's common stock for $19,600, from $19,000 in cash and from
seller debt totaling $900,000.
The acquisition was accounted for as a purchase in accordance with
generally accepted accounting principles, with goodwill of approximately
$430,000 recorded for the excess of the purchase price over the fair market
values of the net assets at the date of acquisition. The goodwill is being
amortized over 40 years using the straight-line method. The Company periodically
reviews goodwill to assess recoverability, and impairments would be recognized
in operating results if a permanent diminution in value were to occur.
NHHACC operates in one industry segment and is primarily engaged in the
installation and servicing of air conditioning and heating systems for
residential and commercial customers in eastern Kansas and western Missouri.
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
the Company and its wholly-owned subsidiary. All material intercompany
transactions and balances have been eliminated.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts (Contracts) for commercial buildings are recognized on the
percentage-of-completion method in the ratio that incurred costs bear to total
estimated costs. Revenues on all of the Company's heating and air conditioning
installation and service and maintenance revenue are recognized upon completion
of the services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the period in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within three to six months.
Nonidentifiable selling, general and administrative expenses are charged to
income as incurred and are not allocated to contract costs. As of December 31,
1994 and 1995 and March 31, 1996, all Contracts were complete and billed and
there were no billings in excess of costs and estimated earnings.
Concentrations of credit risk with respect to trade receivables are limited
due to the large number of customers comprising the Company's customer base, and
their dispersions across many different industries and geographies. The Company
does not require collateral for its receivables.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
F-73
<PAGE> 145
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
SHORT-TERM INVESTMENTS
Short-term investments consist of U.S. Treasury Bills. U.S. Treasury Bills
have maturity dates of one year from the date of purchase and are accounted for
in accordance with Statement of Financial Accounting Standards ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." It is the
Company's intent to hold the Treasury Bills to maturity.
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings.................................................................... 25
Furniture and fixtures....................................................... 7
Machinery and equipment...................................................... 5
Vehicles..................................................................... 5
Leasehold improvements....................................................... 20-25
</TABLE>
OTHER INTANGIBLE ASSETS
Intangible assets include an agreement not-to-compete with a former
stockholder and are recorded at cost, net of accumulated amortization. Such
assets are amortized on a straight-line basis over the term of the agreement.
WARRANTIES
The Company provides retail customers with a one-year warranty on parts and
labor from the date of installation of the heating and air conditioning unit.
This warranty runs concurrent with the manufacturer's warranty on parts and for
the first year on labor. The Company provides an accrual for future warranty
costs based upon the relationship of prior years' sales to actual warranty
costs. It is the Company's practice to classify the entire warranty accrual as a
current liability.
F-74
<PAGE> 146
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
DEFERRED REVENUE
The Company offers extended service agreements to its customers to provide
periodic maintenance on heating and air conditioning units. The full amount of
the revenues associated with these agreements is initially deferred and
recognized as income over the life of the agreement.
ADVERTISING COSTS
Costs associated with advertising are expensed at the time of the
advertisement's first showing. Advertising expenses totaled approximately
$77,000 for the ten months ended December 31, 1993 and $116,000 and $79,000 for
the years ended December 31, 1994 and 1995, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
For the period March 1, 1993 (date operations commenced), through December
31, 1993, and the years ended December 31, 1994 and December 31, 1995 amounts
charged to bad debt expense totaled $8,580, $(4,029) and $2,259, respectively
and accounts written off, net of recoveries were $8,485, $2,449 and $2,259,
respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
2. SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Company adopted SFAS No. 115. The Company's
investment securities are classified as available for sale under SFAS No. 115.
On securities classified as available for sale, carrying amount is a reasonable
estimate of fair value. The adoption of SFAS No. 115 had no effect on the
Company's financial statements in 1994.
The securities available for sale were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
-------- ----
<S> <C> <C>
U.S. Treasury Bills (cost equals fair value)...................... $200,994 $ --
</TABLE>
There were no gross realized gains or gross realized losses from the sale
of available-for-sale securities. The Company's proceeds from the sale of
available-for-sale securities were $-0- for the ten months ended December 31,
1993, $-0- and $200,994 in 1994 and 1995, respectively.
3. AGREEMENT NOT-TO-COMPETE
The Company has a covenant not-to-compete with a former stockholder dated
March 1, 1993. The agreement is for a three-year period ending February 1996.
Total consideration paid under the noncompete
F-75
<PAGE> 147
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreement was $90,000, payable in the form of $30,000 cash paid in equal monthly
installments over the first twelve months, a vehicle valued at $8,217
transferred in 1994, and $51,783 of life insurance cash surrender value
transferred in 1995. The asset is being amortized evenly over the term of the
agreement. Amortization expense for the ten months ended December 31, 1993 and
the years ended December 31, 1994 and 1995 was $25,000, $30,000 and $30,000,
respectively. Amounts reported as due to former stockholder at December 31, 1994
and 1995 of $51,783 and $-0-, respectively, represent the remaining portion of
the initial $90,000 liability due the former stockholder under this agreement.
4. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1995
-------- --------
<S> <C> <C>
Note payable to former stockholder of NHHACC due in equal
installments from March 1994 through January 2009, interest
at prime plus 1%, collateralized by the common stock of
NHHACC....................................................... $852,307 $783,431
Capital lease obligation, secured by data processing equipment,
expiring in 1995............................................. 2,075 --
Note payable, collateralized by vehicle, paid in 1995.......... 523 --
-------- --------
854,905 783,431
Less current portion........................................... 71,474 38,479
-------- --------
$783,431 $744,952
======== ========
</TABLE>
The Company has a $200,000 revolving line of credit secured by accounts
receivable, inventory and equipment. The line matures October 8, 1996. Interest
is at the bank's prime rate (8.5% at December 31, 1995). There were no
borrowings against this line at December 31, 1994 or 1995.
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996........................................................... $ 38,479
1997........................................................... 34,855
1998........................................................... 38,219
1999........................................................... 41,908
2000........................................................... 45,954
Thereafter..................................................... 584,016
--------
$783,431
========
</TABLE>
The interest paid to the former stockholder of NHHACC was $-0-, $43,286 and
$70,019 for the ten months ended December 31, 1993, and the years ended December
31, 1994 and 1995, respectively.
5. LEASES
Total rental expense for all operating leases was $3,654, $5,117 and $4,701
for the ten months ended at December 31, 1993, and in 1994 and 1995,
respectively.
F-76
<PAGE> 148
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheet, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
-------- ----
<S> <C> <C>
Tools and equipment............................................... $ 33,570 $ --
Less accumulated depreciation..................................... (15,325) --
-------- ----
Net equipment under capital leases................................ $ 18,245 $ --
======== ====
</TABLE>
Depreciation of the assets under capital leases is included in depreciation
expense.
5. LEASES
The Company leases a portion of its building to another company. The lease
is noncancelable and expires in January 1998. Minimum future rentals receivable
under this lease at December 31, 1995 are follows:
<TABLE>
<S> <C>
1996............................................................... $44,118
1997............................................................... 45,004
1998............................................................... 3,756
Thereafter......................................................... --
-------
$92,878
=======
</TABLE>
6. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, up to 15% of
total compensation, not to exceed the maximum established annually by the
Internal Revenue Service. Matching contributions are made by the Company equal
to 50% of total contributions by a plan member, to a maximum of 3% of the
employee's total calendar year compensation. The Company's matching
contributions totaled $12,529, $33,224 and $29,214 for the ten months ended
December 31, 1993, and the years ended 1994 and 1995, respectively. In addition,
the Company made a contribution to the Plan from its profits during 1995 in the
amount of $20,000.
7. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position or the results of operations of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
8. STOCKHOLDER'S COMPENSATION
Compensation to the stockholder of the Company consisting of salary and
cash bonuses, is included in selling, general and administrative expenses and
totaled approximately $58,900, $89,900, and $151,700 for the ten months ended
December 31, 1993 and in 1994, and 1995, respectively.
F-77
<PAGE> 149
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. INCOME TAXES
The Company is a C corporation and accounts for income taxes under the
liability method. Under this method, deferred tax assets and liabilities are
determined based upon differences between financial reporting and tax basis of
assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse.
Income tax expense consists of the following:
<TABLE>
<CAPTION>
TEN MONTHS YEAR ENDED
ENDED DECEMBER 31,
DECEMBER 31, -------------------
1993 1994 1995
------------ -------- --------
<S> <C> <C> <C>
Current:
Federal............................................ $ -- $ 71,766 $159,067
State.............................................. -- 4,989 11,058
------------ -------- --------
$ -- $ 76,755 $170,125
========== ======== ========
Deferred:
Federal............................................ $102,444 $ 32,473 $ (2,434)
State.............................................. 7,122 2,257 (169)
------------ -------- --------
$109,566 $ 34,730 $ (2,603)
========== ======== ========
Provision for income taxes........................... $109,566 $111,485 $167,522
========== ======== ========
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization.................................. $168,912 $170,850
Prepaids....................................................... 10,508 6,506
-------- --------
Deferred tax liabilities......................................... 179,420 177,356
Deferred tax assets:
Other.......................................................... 5,166 5,705
-------- --------
Deferred tax assets.............................................. 5,166 5,705
-------- --------
Net deferred tax liabilities........................... $174,254 $171,651
======== ========
</TABLE>
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before provision
for deferred income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
PERIOD FROM
MARCH 31, 1993
THROUGH DECEMBER 31,
DECEMBER 31, -------------------
1993 1994 1995
-------------- -------- --------
<S> <C> <C> <C>
Tax provision at federal statutory rate............. $101,838 $ 93,456 $145,996
State income tax less applicable federal tax
benefit........................................... 12,850 11,792 18,421
Other, net.......................................... (5,122) 6,237 3,105
-------------- -------- --------
$109,566 $111,485 $167,522
=========== ======== ========
</TABLE>
F-78
<PAGE> 150
VISION HOLDING COMPANY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. RELATED-PARTY TRANSACTIONS
As discussed in Note 3 and in Note 4, the Company has a noncompete
agreement and a note payable with a former stockholder. The former stockholder
is the father of the present owner.
11. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
12. UNAUDITED INTERIM FINANCIAL INFORMATION
The consolidated statements of operations and cash flows for the six months
ended June 30, 1995 and 1996 (interim financial statements) have been prepared
by management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-79
<PAGE> 151
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Comerford's Heating and Air Conditioning, Inc.
We have audited the accompanying balance sheets of Comerford's Heating and
Air Conditioning, Inc. as of December 31, 1994 and 1995, and the related
statements of operations, stockholders' equity, and cash flows for each of the
three years in the period ended December 31, 1995. These financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Comerford's Heating and Air
Conditioning, Inc. at December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 15, 1996
F-80
<PAGE> 152
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- JUNE 30,
1994 1995 1996
---------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 449,298 $ 745,979 $ --
Certificates of deposit.................................. 100,000 200,000 100,000
Receivables:
Trade................................................. 92,378 89,496 210,741
Related party......................................... 204,269 -- 784,969
Employee.............................................. -- 147 1,089
Other................................................. 1,348 -- --
---------- ---------- -----------
297,995 89,643 996,799
Inventories.............................................. 137,172 97,172 143,960
Prepaid expenses and other current assets................ 9,898 874 159,693
---------- ---------- -----------
Total current assets............................. 994,363 1,133,668 1,400,452
Property and equipment:
Furniture and fixtures................................... 24,402 28,567 26,073
Machinery and equipment.................................. 196,830 199,898 219,294
Vehicles................................................. 477,843 469,696 414,681
Leasehold improvements................................... 39,858 43,353 52,391
---------- ---------- -----------
738,933 741,514 712,439
Less accumulated depreciation............................ (455,870) (526,961) (499,536)
---------- ---------- -----------
283,063 214,553 212,903
Other assets............................................... 100 100 1,474
---------- ---------- -----------
Total assets..................................... $1,277,526 $1,348,321 $ 1,614,829
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities........... $ 160,547 $ 112,099 $ 270,899
Accrued compensation..................................... 31,393 27,879 124,937
Accrued taxes, other than income......................... 20,711 3,133 --
Accrued warranties....................................... 8,000 13,000 13,000
Income taxes payable..................................... 2,669 1,239 --
Deferred revenue......................................... 293,137 308,234 235,423
Current portion capital leases........................... 11,486 12,689 18,171
---------- ---------- -----------
Total current liabilities........................ 527,943 478,273 662,430
Capital lease obligations, less current portion............ 31,699 19,010 29,634
Stockholders' equity:
Common stock, no par value, 1,000,000 shares authorized,
75,000 shares issued and outstanding.................. 7,500 7,500 7,500
Retained earnings........................................ 710,384 843,538 915,265
---------- ---------- -----------
Total stockholders' equity....................... 717,884 851,038 922,765
---------- ---------- -----------
Total liabilities and stockholders' equity....... $1,277,526 $1,348,321 $ 1,614,829
========= ========= =========
</TABLE>
See accompanying notes.
F-81
<PAGE> 153
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues......................... $3,532,089 $3,715,214 $4,232,962 $1,904,167 $2,551,967
Cost of goods sold................... 2,031,910 2,113,176 2,271,332 1,106,727 1,293,770
---------- ---------- ---------- ---------- ----------
Gross margin......................... 1,500,179 1,602,038 1,961,630 797,440 1,258,197
Selling, general and administrative
expenses........................... 1,855,038 1,463,587 1,651,773 765,863 855,268
Bad debt expense..................... 4,281 4,926 1,011 -- --
---------- ---------- ---------- ---------- ----------
Income (loss) from operations........ (359,140) 133,525 308,846 31,577 402,929
Other income (expense):
Interest expense................... (4,017) (5,130) (3,802) (1,902) (1,733)
Interest income.................... 21,024 37,807 24,944 8,963 15,445
Other income (expense)............. 44,697 12,673 9,253 2,776 (43,052)
---------- ---------- ---------- ---------- ----------
(61,704) 45,350 30,395 9,837 (29,340)
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes.... (297,436) 178,875 339,241 41,414 373,589
Provision for income taxes........... 800 3,382 4,819 2,500 10
---------- ---------- ---------- ---------- ----------
Net income (loss).................... $ (298,236) $ 175,493 $ 334,422 $ 38,914 $ 373,579
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-82
<PAGE> 154
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
--------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------ ---------- ----------
<S> <C> <C> <C> <C>
Balance at December 31, 1992........................... 75,000 $7,500 $ 833,127 $ 840,627
Net loss............................................. -- -- (298,236) (298,236)
------ ------ ---------- ----------
Balance at December 31, 1993........................... 75,000 7,500 534,891 542,391
Net income........................................... -- -- 175,493 175,493
------ ------ ---------- ----------
Balance at December 31, 1994........................... 75,000 7,500 710,384 717,884
Capital distributions................................ -- -- (201,268) (201,268)
Net income........................................... -- -- 334,422 334,422
------ ------ ---------- ----------
Balance at December 31, 1995........................... 75,000 7,500 843,538 851,038
Capital distributions (unaudited).................... -- -- (301,852) (301,852)
Net income (unaudited)............................... -- -- 373,579 373,579
====== ====== ========= =========
Balance at June 30, 1996 (unaudited)................... 75,000 $7,500 $ 915,265 $ 922,765
</TABLE>
See accompanying notes.
F-83
<PAGE> 155
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- --------------------
1993 1994 1995 1995 1996
--------- --------- --------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)....................... $(298,236) $ 175,493 $ 334,422 $ 38,914 $ 373,579
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization......... 57,665 89,608 72,867 34,831 68,788
Provision for bad debts............... 4,281 4,926 1,011 -- --
Loss on asset disposals............... -- -- -- -- 42,107
Changes in assets and liabilities:
Receivables........................ (163,316) 15,065 207,341 (19,290) (907,156)
Inventories........................ (57,720) (32,547) 40,000 (806) (46,788)
Prepaid expenses and other current
assets........................... 1,493 (6,284) 9,024 (4,621) (140,193)
Trade accounts payable and accrued
liabilities...................... 612,139 (636,823) (48,448) (10,795) 158,800
Accrued compensation............... 9,160 1,464 (3,514) 3,589 97,058
Accrued taxes, other than income... (4,778) 20,711 (17,578) (16,511) (3,133)
Accrued warranties................. (276) (1,000) 5,000 2,502 --
Deferred revenue................... 135,737 92,003 15,097 43,521 (72,811)
Income taxes payable............... (1,578) 2,669 (1,430) (2,669) (1,239)
--------- --------- --------- -------- ---------
Net cash flow provided by (used in)
operating activities.................. 294,571 (274,715) 613,792 68,665 (430,988)
INVESTING ACTIVITIES
Purchase of certificates of deposit..... (100,000) (100,000) (200,000) (200,000) --
Sales of certificates of deposit........ 100,000 100,000 100,000 100,000 100,000
Purchase of property and equipment...... (165,147) (106,098) (10,728) (4,259) (196,345)
Proceeds from sale of property and
equipment............................. 29,935 2,553 6,371 -- 86,850
--------- --------- --------- -------- ---------
Net cash used in investing activities... (135,212) (103,545) (104,357) (104,259) (9,495)
FINANCING ACTIVITIES
Payments of capital leases.............. (6,378) (10,398) (11,486) (5,742) (3,644)
Distributions to shareholders........... -- -- (201,268) -- (301,852)
--------- --------- --------- -------- ---------
Net cash used in financing activities... (6,378) (10,398) (212,754) (5,742) (305,496)
--------- --------- --------- -------- ---------
Increase (decrease) in cash and cash
equivalents........................... 152,981 (388,658) 296,681 (41,336) (745,979)
Cash and cash equivalents at beginning
of period............................. 684,975 837,956 449,298 449,298 745,979
--------- --------- --------- -------- ---------
Cash and cash equivalents at end of
period................................ $ 837,956 $ 449,298 $ 745,979 $407,962 $ --
========= ========= ========= ======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................... $ 3,814 $ 4,890 $ 3,802 $ 1,902 $ 1,733
========= ========= ========= ======== =========
Purchase of equipment through capital
leases................................ $ 59,961 $ -- $ -- $ -- $ 19,750
========= ========= ========= ======== =========
</TABLE>
See accompanying notes.
F-84
<PAGE> 156
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS
MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Comerford's Heating and Air Conditioning, Inc. ("the Company") operates in
one industry segment and is primarily engaged in the installation and servicing
of air conditioning and heating systems for residential and commercial customers
in Northern California.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
for residential installation and service and maintenance revenue are recognized
upon completion of the services.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and Certificates of Deposit
The carrying amounts reported in the balance sheets for cash and cash
equivalents and certificates of deposit approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
TRADE RECEIVABLES
At December 31, 1994 and 1995, the Company does not believe there were any
material amounts considered to be uncollectible. Accordingly, an allowance for
doubtful accounts has not been made.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
F-85
<PAGE> 157
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line and declining-balance methods
over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-------
<S> <C>
Furniture and fixtures..................................................... 5-7
Machinery and equipment.................................................... 5-15
Vehicles................................................................... 5
Leasehold improvements..................................................... 20-31.5
</TABLE>
WARRANTIES
The Company provides the retail customer with a one-year warranty and
offers extended warranties for up to ten years on parts and labor from the date
of installation of the heating and air conditioning unit. The warranty runs
concurrent with the manufacturer's warranty on parts for the first year. The
Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
INCOME TAXES
The stockholders of the Company have elected under Subchapter S of the
Internal Revenue Code to include the Company's income in their own income for
federal income tax purposes and California state income tax purposes.
Accordingly, the Company is not subject to federal income taxes.
DEFERRED REVENUE
The Company offers extended service agreements to its customers to provide
periodic maintenance on heating and air conditioning units. The full amount of
the revenues associated with these agreements is initially deferred and
recognized as income over the life of the agreement.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $4,281, $4,926 and $1,011, respectively and accounts
written off, net of recoveries were $4,281, $4,926 and $1,011, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-86
<PAGE> 158
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. LEASES
Total rental expense for all operating leases was $51,900, $48,356 and
$52,272 for 1993, 1994 and 1995, respectively. The Company leases certain office
and warehouse facilities and vehicles under terms of noncancellable operating
lease agreements which expire at various dates through 2000. Minimum rental
commitments at December 31, 1995 under capital and operating leases having an
initial noncancellable term of one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $15,288 $ 52,272
1997.............................................................. 15,288 52,272
1998.............................................................. 5,096 52,272
1999.............................................................. -- 52,272
2000.............................................................. -- 48,000
Thereafter........................................................ -- --
------- ---------
35,672 $ 257,088
========
Amounts representing interest..................................... 3,973
-------
Present value of net minimum rentals (including $12,689 classified
as current)..................................................... $31,699
=======
</TABLE>
The carrying values of equipment under capital leases, which are included
with owned assets in the accompanying balance sheets at December 31, 1994 and
1995, are $26,383 and $15,850, net of accumulated amortization of $33,578 and
$44,111, respectively. Amortization of the assets under capital leases is
included in depreciation expense.
3. EMPLOYEE BENEFIT PLANS
The Company has a defined contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, up to 15% of
total compensation, not to exceed the maximum established annually by the
Internal Revenue Service. Matching contributions are made by the Company equal
to 25% of total contributions by a plan member, to a maximum of 4% of the
employee's total calendar year compensation. The Company's matching
contributions totaled $9,993, $5,717 and $14,773 for the years ended December
31, 1993, 1994 and 1995, respectively.
4. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and an umbrella
policy to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
5. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $1,000,000,
$347,000, and $574,203 in 1993, 1994 and 1995, respectively.
6. PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
In connection with the contemplated initial public offering (see Note 9),
the Subchapter S election will be terminated. As a result, the Company will be
subject to corporate income taxes subsequent to the
F-87
<PAGE> 159
COMERFORD'S HEATING AND AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
termination of S corporation status. The Company had net operating income (loss)
for income tax purposes of $(276,621), $(91,297), $247,012 and $375,251 for
1993, 1994, 1995 and the six months ended June 30, 1996, respectively. Had the
Company filed federal and state income tax returns as a regular corporation for
1993, 1994, 1995 and the six months ended June 30, 1996, income tax expense
(benefit) under the provisions of Statement of Financial Accounting Standards
No. 109 would have been $(107,273), $80,319, $146,793 and $150,618,
respectively.
At the date of termination of S corporation status, the Company will be
required to provide deferred taxes for cumulative temporary differences between
financial reporting and tax reporting bases of assets and liabilities. Such
deferred taxes will be based on the cumulative temporary difference at the date
of termination of S corporation status. The effect of recognizing the deferred
taxes will be included in income from continuing operations. If the termination
of S corporation status had occurred at June 30, 1996, the net deferred tax
asset would have been approximately $5,200.
7. STOCKHOLDERS' EQUITY
On December 26, 1995, the Company amended and restated its articles of
incorporation to, among other things, authorize the Company to issue two classes
of common stock, the designations and authorized shares of which are Class A
Common Stock (100,000 shares) and Class B Common Stock (900,000 shares). Upon
amendment and restatement of the articles of incorporation, each share of the
then outstanding common stock was split and converted into one share of Class A
Common Stock and nine shares of Class B Common Stock. All share information
presented herein has been adjusted to reflect the stock split. The rights,
preferences, privileges and restrictions of both classes of stock are identical
except that the holders of Class A Common Stock have exclusive voting rights.
There are 7,500 shares of Class A and 67,500 shares of Class B Common Stock
outstanding.
8. RELATED PARTY TRANSACTIONS
The Company paid rental fees of $62,092, $63,644 and $67,560 at December
31, 1993, 1994 and 1995, respectively, to the Company's stockholders.
9. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income and cash flows for the six months ended
June 30, 1995 and 1996 (interim financial statements) have been prepared by
management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-88
<PAGE> 160
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Rolf Coal and Fuel Corp.
We have audited the accompanying balance sheets of Rolf Coal and Fuel Corp.
as of December 31, 1994 and 1995, and the related statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Rolf Coal and Fuel Corp. at
December 31, 1994 and 1995, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 1995, in
conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 17, 1996
F-89
<PAGE> 161
ROLF COAL AND FUEL CORP.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------- JUNE 30,
1994 1995 1996
---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................ $ 429,875 $ 498,608 $ 313,200
Receivables:
Trade, net of allowance for doubtful accounts of
$17,021 in 1994 and $2,410 in 1995.................. 139,343 183,801 176,609
Related party............................................ -- 62,324 --
Employee................................................. 12,891 24,590 9,593
---------- ---------- ----------
152,234 270,715 186,202
Inventories.............................................. 128,941 164,623 202,470
Costs and estimated earnings in excess of billings....... 37,978 63,362 26,639
Prepaid expenses and other current assets................ 13,547 27,048 86,791
Deferred tax asset....................................... 2,900 112,000 142,886
---------- ---------- ----------
Total current assets............................. 765,475 1,136,356 958,188
Property and equipment:
Furniture and fixtures................................... 159,652 164,542 147,507
Machinery and equipment.................................. 113,090 129,528 134,282
Vehicles................................................. 345,391 320,087 418,225
Leasehold improvements................................... 7,107 7,107 20,919
---------- ---------- ----------
625,240 621,264 720,933
Less accumulated depreciation and amortization........... (416,504) (412,880) (426,551)
---------- ---------- ----------
208,736 208,384 294,382
Other assets............................................... 56,800 60,341 60,283
---------- ---------- ----------
Total assets..................................... $1,031,011 $1,405,081 $1,312,853
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Note payable -- related party............................ $ 20,219 $ -- $ 40,428
Trade accounts payable and accrued liabilities........... 186,093 114,620 121,498
Accrued compensation..................................... 229,824 369,167 120,846
Accrued taxes, other than income......................... 13,506 15,439 17,002
Accrued warranties....................................... 8,238 25,000 26,796
Income taxes payable..................................... 20,480 156,484 170,209
Deferred revenue......................................... 144,563 329,321 352,335
Billings in excess of costs and estimated earnings....... 2,853 -- --
Current portion of long-term debt and capital lease
obligations........................................... 29,597 33,094 53,441
---------- ---------- ----------
Total current liabilities........................ 655,373 1,043,125 902,555
Long-term debt, net of current portion..................... 29,395 100 57,408
Capital lease obligations, net of current portion.......... 38,937 5,843 --
Deferred income taxes...................................... 5,600 10,200 52,558
Stockholders' equity:
Common stock, $100 par value, 750 shares authorized, 310
shares issued and outstanding......................... 31,000 31,000 31,000
Retained earnings........................................ 270,706 314,813 269,332
---------- ---------- ----------
Total Stockholders' Equity....................... 301,706 345,813 300,332
---------- ---------- ----------
Total liabilities and stockholders' equity....... $1,031,011 $1,405,081 $1,312,853
========= ========= =========
</TABLE>
See accompanying notes.
F-90
<PAGE> 162
ROLF COAL AND FUEL CORP.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues......................... $3,036,009 $3,977,013 $4,104,580 $2,161,613 $2,448,305
Cost of goods sold................... 1,516,213 1,940,213 1,866,607 1,058,267 949,703
---------- ---------- ---------- ---------- ----------
Gross margin......................... 1,519,796 2,036,800 2,237,973 1,103,346 1,498,602
Selling, general and administrative
expenses........................... 1,538,777 1,924,815 2,137,108 1,288,726 1,527,582
Bad debt expense..................... 29,318 16,328 5,670 1,594 584
---------- ---------- ---------- ---------- ----------
Income from operations............... (48,299) 95,657 95,195 (186,974) (29,564)
Other income (expense):
Interest expense................... (15,320) (14,333) (18,721) (20,159) (19,867)
Interest income.................... 1,744 6,773 16,678 12,325 22,845
Other income....................... 14,917 12,345 9,955 -- --
---------- ---------- ---------- ---------- ----------
1,341 4,785 7,912 (7,834) 2,978
---------- ---------- ---------- ---------- ----------
Income (loss) before income taxes.... (46,958) 100,442 103,107 (194,808) (26,586)
Provision (benefit) for income taxes:
Current............................ 5,396 28,690 163,500 -- --
Deferred........................... (32,400) 1,800 (104,500) (51,631) (11,105)
---------- ---------- ---------- ---------- ----------
(27,004) 30,490 59,000 (51,631) (11,105)
---------- ---------- ---------- ---------- ----------
Net income (loss).................... $ (19,954) $ 69,952 $ 44,107 $ (143,177) $ (15,481)
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-91
<PAGE> 163
ROLF COAL AND FUEL CORP.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK,
$100 PAR VALUE
---------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------- -------- --------
<S> <C> <C> <C> <C>
Balance at December 31, 1992.............................. 310 $31,000 $220,708 $251,708
Net loss................................................ -- -- (19,954) (19,954)
------ ------- -------- --------
Balance at December 31, 1993.............................. 310 31,000 200,754 231,754
Net income.............................................. -- -- 69,952 69,952
------ ------- -------- --------
Balance at December 31, 1994.............................. 310 31,000 270,706 301,706
Net income.............................................. -- -- 44,107 44,107
------ ------- -------- --------
Balance at December 31, 1995.............................. 310 31,000 314,813 345,813
Capital distribution (unaudited)........................ -- -- (30,000) (30,000)
Net loss (unaudited).................................... -- -- (15,481) (15,481)
------ ------- -------- --------
Balance at June 30, 1996 (unaudited)...................... 310 $31,000 $269,332 $300,332
===== ======= ======== ========
</TABLE>
See accompanying notes.
F-92
<PAGE> 164
ROLF COAL AND FUEL CORP.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- ---------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................ $ (19,954) $ 69,952 $ 44,107 $(143,177) $ (15,481)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating
activities:
Depreciation and amortization.................. 49,002 46,934 67,039 45,116 92,678
Deferred income taxes.......................... (32,400) 1,800 (104,500) (51,631) (11,105)
Gain on asset disposals........................ (13,888) (7,353) (8,650) -- (3,200)
Provision for bad debts........................ 29,318 16,328 5,670 1,594 584
Changes in assets and liabilities:
Receivables.................................. 4,193 (10,419) (124,151) (62,184) 83,928
Inventories.................................. 10,630 28,452 (35,682) 44,299 (37,847)
Prepaid expenses and other current assets.... 17,777 (10,875) (13,501) (5,025) (59,743)
Trade accounts payable and accrued
liabilities................................ 12,255 87,402 (71,473) (68,530) 6,878
Accrued compensation......................... 111,095 62,199 139,343 (35,841) (248,321)
Accrued taxes, other than income............. 2,943 (263) 1,933 1,509 1,563
Accrued warranties........................... (2,347) 2,067 16,762 17,514 1,796
Deferred revenue............................. 39,361 26,923 184,758 43,965 23,014
Income taxes payable......................... (14,527) 8,980 136,004 57,142 36,304
Costs and estimated earnings in excess of
billings and billings in excess of costs
and estimated earnings..................... 56,021 (8,803) (28,237) 35,125 36,723
--------- --------- --------- --------- ---------
Net cash flow provided by (used in) operating
activities..................................... 249,479 313,324 209,422 (120,124) (92,229)
INVESTING ACTIVITIES
Purchase of property, buildings and equipment.... (16,400) (87,930) (76,995) (90,503) (178,677)
Proceeds from sale of property, buildings and
equipment...................................... 11,827 14,120 18,958 -- 3,200
Increase in other assets......................... (19,484) (2,555) (3,541) 15,930 58
--------- --------- --------- --------- ---------
Net cash used in investing activities............ (24,057) (76,365) (61,578) (74,573) (175,419)
FINANCING ACTIVITIES
Proceeds from long-term debt and capital
leases......................................... 119,918 170,687 131,414 89,302 77,755
Payments on long-term debt and capital leases.... (217,956) (199,279) (190,306) (6,593) (5,943)
Distribution to stockholders..................... -- -- -- -- (30,000)
Proceeds from note payable -- related party...... 44,136 169,397 151,662 20,884 40,428
Payment on note payable -- related party......... (49,187) (192,641) (171,881) -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in) financing
activities..................................... (103,089) (51,836) (79,111) 103,593 82,240
--------- --------- --------- --------- ---------
Increase (decrease) in cash and cash
equivalents.................................... 122,333 185,123 68,733 (91,104) (185,408)
Cash and cash equivalents at beginning of year... 122,419 244,752 429,875 429,875 498,608
--------- --------- --------- --------- ---------
Cash and cash equivalents at end of year......... $ 244,752 $ 429,875 $ 498,608 $ 338,771 $ 313,200
========== ========== ========== ========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.................................... $ 9,866 $ 19,231 $ 9,241 $ 5,215 $ 5,921
========== ========== ========== ========== ==========
Income tax paid.................................. $ 7,405 $ 3,496 $ 6,243 $ 4,518 $ 42,827
========== ========== ========== ========== ==========
</TABLE>
See accompanying notes.
F-93
<PAGE> 165
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Rolf Coal and Fuel Corp. ("the Company") operates in one industry segment
and is primarily engaged in the installation and servicing of air conditioning
and heating systems for residential and commercial customers.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts (Contracts) for commercial buildings are recognized on the
percentage-of-completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues on all of the Company's heating and air
conditioning installation for residential installation and service and
maintenance revenue are recognized upon completion of the services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within three to six months.
Nonidentifiable selling, general, and administrative expenses are charged to
income as incurred and are not allocated to Contract costs.
Trade accounts receivable includes billings on Contracts. The Company
classifies these amounts as current assets because all balances are expected to
be collected in the current year. Concentrations of credit risk with respect to
trade receivables are limited due to the large number of customers comprising
the Company's customer base, and their dispersions across many different
industries and geographies. The Company does not require collateral for its
receivables.
The asset, "costs and estimated earnings in excess of billings" represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings" represent
billings in excess of revenue recognized on in-progress contracts.
CASH EQUIVALENTS
The Company considers all highly liquid inventory investments with an
original maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt approximate
fair value.
F-94
<PAGE> 166
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line method over the following useful
lives:
<TABLE>
<CAPTION>
YEARS
------
<S> <C>
Furniture and fixtures...................................................... 3-10
Machinery and equipment..................................................... 3-8
Vehicles.................................................................... 3-5
Leasehold improvements...................................................... 7-31.5
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
WARRANTIES
The Company provides the retail customer with a one-year warranty on parts
and labor from the date of installation of the heating and air conditioning
unit. This warranty runs concurrent with the manufacturer's warranty on parts
and labor. The Company provides an accrual for future warranty costs based upon
the relationship of prior years' sales to actual warranty costs. It is the
Company's practice to classify the entire warranty accrual as a current
liability.
ADVERTISING COSTS
Advertising costs, consisting principally of print advertising, are
expensed as incurred. Net advertising expenses for 1993, 1994 and 1995 was
$52,777, $74,114 and $75,548, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in "Statement of Financial Accounting Standards No. 109." Under the
liability method, the deferred tax liability or asset is based on temporary
differences between the financial statement and income tax bases of assets and
liabilities, measured at tax rates that will be in effect when the differences
reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $29,318, $16,328 and $5,670, respectively and accounts
written off, net of recoveries were $94,738, $3,344 and $20,281, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-
F-95
<PAGE> 167
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Lived Assets and for Long-Lived Assets to Be Disposed Of," and does not believe
that adoption of this and any other newly issued pronouncements would have a
significant impact on the Company's financial statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- MARCH 31,
1994 1995 1996
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts................ $214,792 $118,825 $ 134,234
Estimated earnings.................................. 200,787 114,352 124,802
-------- -------- -----------
415,579 233,177 259,036
Less applicable billings.............................. 380,454 169,815 235,577
-------- -------- -----------
$ 35,125 $ 63,362 $ 23,459
======== ======== =========
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings
on uncompleted contracts......................... $ 37,978 $ 63,362 $ 23,459
Billings in excess of costs and estimated earnings
on uncompleted contracts......................... (2,853) -- --
-------- -------- -----------
$ 35,125 $ 63,362 $ 23,459
======== ======== =========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
3. LONG-TERM DEBT
<TABLE>
<CAPTION>
DECEMBER 31,
----------------------
1994 1995
------- ------------
<S> <C> <C>
Secured line of credit.......................................... $29,395 $100
</TABLE>
The Company has three secured lines of credit with a bank that aggregate
$225,000 and that expire in April 1997. The agreements are secured by
substantially all the Company's assets. At December 31, 1994 and 1995, the
Company had aggregate borrowings of $29,395 and $100, respectively, under these
agreements and these are classified as long term.
The Company can borrow at the bank's prime rate plus 2%. At December 31,
1995, the interest rate was 9.75%.
4. LEASES
Total rental expense for all operating leases was $103,396, $107,980 and
$113,348 for 1993, 1994 and 1995, respectively. The Company leases certain
office and warehouse facilities from an entity related through common ownership
and vehicles under terms of noncancelable operating lease agreements which
expire at various dates through September 1999. The building lease has an option
for renewal, in two five-year
F-96
<PAGE> 168
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
increments. Minimum rental commitments at December 31, 1995 under capital and
operating leases having an initial noncancelable term of one year or more are as
follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $35,498 $ 107,920
1997.............................................................. 5,916 91,200
1998.............................................................. -- 84,000
1999.............................................................. -- 63,000
------- ---------
41,414 $ 346,120
========
Amounts representing interest..................................... 2,477
-------
Present value of net minimum rentals (including $33,094 classified
as current)..................................................... $38,937
=======
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Tools and equipment................................................ $92,442 $92,442
Less accumulated amortization...................................... 13,866 32,355
------- -------
Net property, plant and equipment under capital leases............. $78,576 $60,087
======= =======
</TABLE>
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, up to 15% of
total compensation, not to exceed the maximum established annually by the
Internal Revenue Service. Matching contributions are made by the Company equal
to 50% of total contributions by a plan member, to a maximum of 6% of the
employee's total calendar year compensation. The Company may also elect to make
discretionary contributions. The Company's matching contributions totaled
$22,237, $28,879 and $32,987 for the years ended December 31, 1993, 1994 and
1995, respectively.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and an umbrella
policy to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
7. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $277,752,
$397,644 and $619,341 in 1993, 1994 and 1995, respectively.
F-97
<PAGE> 169
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
8. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1993 1994 1995
-------- ------- ---------
<S> <C> <C> <C>
Current:
Federal.............................................. $ 4,356 $23,180 $ 132,790
State................................................ 1,040 5,510 30,710
-------- ------- ---------
5,396 28,690 163,500
Deferred:
Federal.............................................. (26,170) 1,450 (85,130)
State................................................ (6,230) 350 (19,370)
-------- ------- ---------
(32,400) 1,800 (104,500)
-------- ------- ---------
$(27,004) $30,490 $ 59,000
======== ======= =========
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
------- ---------
<S> <C> <C>
Deferred tax liabilities:
Depreciation................................................... $ 4,300 $ 2,600
Deferred revenues.............................................. 52,200 29,700
------- ---------
Deferred tax liabilities......................................... 56,500 32,300
Deferred tax assets:
Compensation and related....................................... 47,200 127,000
Reserve for bad debts.......................................... 4,400 600
Warranty reserve............................................... 2,200 6,500
------- ---------
Deferred tax assets.............................................. 53,800 134,100
------- ---------
Net deferred tax liabilities (assets)............................ $ 2,700 $(101,800)
======= =========
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will more likely than not be realized. Accordingly, no valuation allowance has
been recorded for the years ended December 31, 1994 and 1995.
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income (loss) before
income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Tax provision (benefit) at statutory rate.............. $(16,000) $ 34,150 $ 35,100
State income tax less applicable federal tax benefit... (2,400) 5,000 5,200
Surtax exemption....................................... 8,900 (11,750) (11,750)
Other, net............................................. (17,504) 3,090 30,450
-------- -------- --------
$(27,004) $ 30,490 $ 59,000
======== ======== ========
</TABLE>
9. RELATED PARTY TRANSACTIONS
The Company paid rental fees of $84,000, $84,000 and $84,000 at December
31, 1993, 1994 and 1995, respectively, to a related partnership, whose partners
are stockholders in the Company.
F-98
<PAGE> 170
ROLF COAL AND FUEL CORP.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
10. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
11. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income (operations) and cash flows for the six
months ended June 30, 1995 and 1996 (interim financial statements) have been
prepared by management and are unaudited. The interim financial statements
include all adjustments, consisting of only normal recurring adjustments
necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-99
<PAGE> 171
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Brand Heating & Air Conditioning, Inc.
We have audited the accompanying balance sheets of Brand Heating & Air
Conditioning, Inc., as of December 31, 1994 and 1995, and the related statements
of operations, stockholders' equity, and cash flows for each of the three years
in the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Brand Heating & Air
Conditioning, Inc., at December 31, 1994 and 1995, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 14, 1996
F-100
<PAGE> 172
BRAND HEATING & AIR CONDITIONING, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- JUNE 30,
1994 1995 1996
--------- ---------- ---------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 5,384 $ 6,871 $ 23,119
Receivables:
Trade, net of allowance for doubtful accounts of
$14,950 in 1994 and $18,732 in 1995.................. 296,372 551,475 198,981
Related party.......................................... 16,479 186,985 236,620
Employee............................................... 6,202 8,572 4,853
--------- ---------- ---------
319,053 747,032 440,454
Inventories............................................... 122,904 238,853 201,187
Prepaid expenses and other current assets................. 2,931 135 67,664
--------- ---------- ---------
Total current assets.............................. 450,272 992,891 732,424
Property and equipment:
Furniture and fixtures.................................... 43,107 50,876 66,824
Machinery and equipment................................... 68,947 77,026 77,026
Vehicles.................................................. 172,029 289,175 289,175
Leasehold improvements.................................... 30,000 30,000 0
--------- ---------- ---------
314,083 447,077 433,025
Less accumulated depreciation and amortization............ (105,491) (193,728) (234,234)
--------- ---------- ---------
208,592 253,349 198,791
Other assets................................................ 7,212 11,025 13,513
--------- ---------- ---------
Total assets...................................... $ 666,076 $1,257,265 $ 944,728
========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Cash overdraft............................................ $ 55,772 $ 41,060 $ --
Trade accounts payable and accrued liabilities............ 115,551 171,208 142,624
Accrued compensation...................................... 35,202 38,079 95,964
Note payable to related party............................. -- 100,000 --
Current portion of long-term debt and capital leases...... 193,923 131,018 208,655
--------- ---------- ---------
Total current liabilities......................... 400,448 481,365 447,243
Long-term debt, net of current portion...................... 118,247 75,977 50,742
Stockholders' equity........................................ 147,381 699,923 446,743
--------- ---------- ---------
Total liabilities and stockholders' equity........ $ 666,076 $1,257,265 $ 944,728
========= ========= =========
</TABLE>
See accompanying notes.
F-101
<PAGE> 173
BRAND HEATING & AIR CONDITIONING, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues......................... $1,225,040 $1,841,040 $4,001,461 $2,045,349 $1,267,486
Cost of goods sold................... 889,327 1,584,826 2,754,527 1,545,089 1,123,769
---------- ---------- ---------- ---------- ----------
Gross margin......................... 335,713 256,214 1,246,934 500,260 143,717
Selling, general and administrative
expenses........................... 278,717 231,829 661,193 304,944 365,622
Bad debt expense..................... 9,950 -- 18,732 -- --
---------- ---------- ---------- ---------- ----------
Income (loss) from operations........ 47,046 24,385 567,009 195,316 (221,905)
Other income (expense):
Interest expense................... (6,381) (17,159) (19,157) (7,394) (5,483)
Interest income.................... 3,099 233 3,198 860 1,788
Other income (expense)............. 3,103 -- 1,492 -- (27,580)
---------- ---------- ---------- ---------- ----------
Net income (loss).................... $ 46,867 $ 7,459 $ 552,542 $ 188,782 $ (253,180)
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-102
<PAGE> 174
BRAND HEATING & AIR CONDITIONING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK,
NO PAR VALUE
--------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------ --------- ---------
<S> <C> <C> <C> <C>
Balance at December 31, 1992............................. 200 $1,940 $ 102,002 $ 103,942
Capital distributions.................................. -- -- (10,887) (10,887)
Net income............................................. -- -- 46,867 46,867
------ ------ --------- ---------
Balance at December 31, 1993............................. 200 1,940 137,982 139,922
Net income............................................. -- -- 7,459 7,459
------ ------ --------- ---------
Balance at December 31, 1994............................. 200 1,940 145,441 147,381
Net income............................................. -- -- 552,542 552,542
------ ------ --------- ---------
Balance at December 31, 1995............................. 200 1,940 697,983 699,923
Net loss (unaudited)................................... -- -- (253,180) (253,180)
------ ------ --------- ---------
Balance at June 30, 1996 (unaudited)..................... 200 $1,940 $ 444,803 $ 446,743
===== ====== ========= =========
</TABLE>
See accompanying notes.
F-103
<PAGE> 175
BRAND HEATING & AIR CONDITIONING, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
--------------------------------- ---------------------
1993 1994 1995 1995 1996
--------- --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)...................... $ 46,867 $ 7,459 $ 552,542 $ 188,782 $(253,180)
Adjustments to reconcile net income
(loss) to net cash provided by (used
in) operating activities:
Depreciation and amortization........ 25,846 58,103 95,816 49,906 42,938
Provision for bad debts.............. 9,950 -- 18,732 -- --
(Gain) loss on asset disposals....... 3,140 -- (1,492) -- 27,580
Changes in assets and liabilities:
Receivables....................... (65,951) (160,944) (446,711) 144,576 306,578
Inventories....................... (32,253) (69,251) (115,949) (27,217) 37,666
Prepaid expenses and other current
assets.......................... -- (2,931) 2,796 (55,902) (67,529)
Trade accounts payable and accrued
liabilities..................... 39,989 88,517 40,945 21,740 (69,644)
Accrued compensation.............. 4,724 20,711 2,877 1,217 57,885
--------- --------- --------- --------- ---------
Net cash flow provided by (used in)
operating activities................. 32,312 (58,336) 149,556 323,102 82,294
INVESTING ACTIVITIES
Purchase of property and equipment..... (89,819) (161,586) (141,394) (84,385) (15,948)
Proceeds from sale of property and
equipment............................ 2,600 -- 2,500 -- --
(Increase) in other assets............. (3,000) (4,000) (4,000) (2,000) (2,500)
--------- --------- --------- --------- ---------
Net cash used in investing
activities........................... (90,219) (165,586) (142,894) (86,385) (18,448)
FINANCING ACTIVITIES
Proceeds from notes payable to related
party................................ -- -- 100,000 -- --
Payments on notes payable from related
party................................ -- -- -- -- (100,000)
Proceeds of long-term debt............. 80,125 257,370 42,520 23,868 94,000
Payments of long-term debt and capital
leases............................... (19,070) (37,242) (147,695) (171,339) (41,598)
Distributions to shareholders.......... (10,887) -- -- -- --
--------- --------- --------- --------- ---------
Net cash provided by (used in)
financing activities................. 50,168 220,128 (5,175) (147,471) (47,598)
--------- --------- --------- --------- ---------
Increase (decrease) in cash and cash
equivalents.......................... (7,739) (3,794) 1,487 89,246 16,248
Cash at beginning of year.............. 16,917 9,178 5,384 5,384 6,871
--------- --------- --------- --------- ---------
Cash at end of year.................... $ 9,178 $ 5,384 $ 6,871 $ 94,630 $ 23,119
========= ========= ========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.......................... $ 6,381 $ 15,132 $ 16,140 $ 7,394 $ 5,483
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-104
<PAGE> 176
BRAND HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Brand Heating & Air Conditioning, Inc., ("the Company") operates in one
industry segment and is primarily engaged in the installation and servicing of
air conditioning and heating systems for residential and commercial customers.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts (Contracts) for commercial buildings are recognized on the
percentage-of-completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues on all of the Company's heating and air
conditioning installation for residential installation and service and
maintenance revenue are recognized upon completion of the services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within 3 to 18 months. Nonidentifiable
selling, general, and administrative expenses are charged to income as incurred
and are not allocated to Contract costs.
As discussed in Note 4, the Company had one long-term contract outstanding
at December 31, 1995. This contract qualifies for segmentation under SOP 81-1.
Accordingly, each billing is treated as a separate long-term contract. As of
December 31, 1995, all costs incurred have been billed and there were no
billings in excess of costs incurred on the contract.
Trade accounts receivable includes billings on the sole contract. The
Company classifies its trade accounts receivable as current assets because all
balances are expected to be collected in the current year. Except as discussed
in Note 4, concentrations of credit risk with respect to trade receivables are
limited due to the large number of customers comprising the Company's customer
base, and their dispersions across many different industries and geographies.
The Company does not require collateral for its receivables.
ADVERTISING COSTS
Advertising costs, consisting principally of direct mail advertisements,
are expensed as incurred. Net advertising expense for 1993, 1994 and 1995 was
$32,000, $31,000 and $88,000, respectively.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
F-105
<PAGE> 177
BRAND HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt approximate
fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the declining-balance methods over the following
useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................................ 5-7
Machinery and equipment....................................................... 7
Vehicles...................................................................... 5
Leasehold improvements........................................................ 39
</TABLE>
WARRANTIES
The Company provides the retail customer with a one-year warranty on parts
and labor from the date of installation of the heating and air conditioning
unit. This warranty runs concurrent with the manufacturer's warranty on parts
and for the first year on labor. The Company provides an accrual for future
warranty costs based upon the relationship of prior years' sales to actual
warranty costs. It is the Company's practice to classify the entire warranty
accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The shareholders of the Company have elected under Subchapter S of the
Internal Revenue Code to include the Company's income in their own income for
federal income tax purposes and state income tax purposes. Accordingly, the
Company is not subject to federal and state income taxes.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $9,950, $0 and $18,732, respectively and accounts
written off, net of recoveries were $0, $0 and $14,950, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and
F-106
<PAGE> 178
BRAND HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
any other newly issued pronouncements would have a significant impact on the
Company's financial statements.
2. LONG-TERM DEBT
Long-term debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Line of credit................................................... $135,000 $ 56,000
Various equipment loans, with interest rates of 6.45% to 11.0%,
with maturity through September 25, 1999, requiring monthly
payments of $339 to $1,292, collateralized by the respective
equipment...................................................... 177,170 150,995
-------- --------
312,170 206,995
Less current portion............................................. 193,923 131,018
-------- --------
$118,247 $ 75,977
======== ========
</TABLE>
The Company has a secured line of credit with a bank that expires June 1,
1996. Under its terms, the Company can borrow up to $150,000 at the prime rate
plus 1.5% (10.25% at December 31, 1995). The agreement is secured by accounts
receivable and inventory, and is personally guaranteed by the stockholders. The
agreement requires the Company to maintain a minimum equity base. At December
31, 1994 and 1995, the Company had borrowings of $135,000 and $56,000,
respectively, under this agreement.
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996.............................................................. $131,018
1997.............................................................. 46,187
1998.............................................................. 25,651
1999.............................................................. 4,139
--------
$206,995
========
</TABLE>
3. LEASES
Total rental expense for all operating leases was $12,000, $22,000 and
$25,000 for 1993, 1994 and 1995, respectively. The Company leases vehicles under
terms of noncancelable operating lease agreements which expire at various dates
through 1999. Minimum rental commitments at December 31, 1995 under operating
leases having an initial noncancellable term of one year or more are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
---------
<S> <C>
1996.............................................................. $ 55,702
1997.............................................................. 54,001
1998.............................................................. 39,019
1999.............................................................. 37,807
---------
$ 186,529
========
</TABLE>
The Company leases its office and warehouse space from its stockholders on
a month-to-month basis.
F-107
<PAGE> 179
BRAND HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
4. MAJOR CUSTOMERS
Approximately 45% of the Company's net revenue for 1995 was from one major
customer. Substantially all revenues under such contract were recognized in
1995. The central location has the authority for purchasing. Approximately 69%
of the accounts receivable was from this customer at December 31, 1995.
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
6. STOCKHOLDERS' COMPENSATION
Stockholders' compensation, which consisted of salary and cash bonuses, is
included in selling, general and administrative expenses and totaled $42,000,
$45,000 and $84,000 in 1993, 1994 and 1995, respectively.
7. PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
In connection with the contemplated initial public offering (see Note 9),
the Subchapter S election will be terminated. As a result, the Company will be
subject to corporate income taxes subsequent to the termination of S corporation
status. The Company had net operating income (loss) for income tax purposes of
$(21,000), $(165,000), $216,000 and $200,000 for 1993, 1994, 1995 and the six
months ended June 30, 1996, respectively. Had the Company filed federal and
state income tax returns as a regular corporation for 1993, 1994, 1995 and the
six months ended June 30, 1996, income tax expense under the provisions of
Statement of Financial Accounting Standard No. 109 would have been $26,000,
$3,000, $242,000 and $(99,000), respectively.
At the date of termination of S corporation status, the Company will be
required to provide deferred taxes for cumulative temporary differences between
financial reporting and tax reporting basis of assets and liabilities. Such
deferred taxes will be provided on the cumulative temporary differences at the
date of termination of S corporation status. The effect of recognizing the
deferred taxes will be included in income from continuing operations. If the
termination of S corporation status had occurred at June 30, 1996, the deferred
tax liability would have been approximately $63,000.
8. RELATED PARTY TRANSACTIONS
The Company is involved in various related party transactions, the majority
of which involve payroll related reimbursements to Brand Electric, Inc., a
company owned by one of the board members of the Company. The Company and owner
also had various transactions. The following summarizes these transactions.
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
------- --------
<S> <C> <C>
Notes receivable from owner............................................. $16,479 $186,985
Note receivable from employees.......................................... 6,202 8,572
Note payable to Brand Electric, Inc.
(unsecured and noninterest bearing)................................... -- 100,000
</TABLE>
F-108
<PAGE> 180
BRAND HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1993 1994 1995
------ ------ ------
<S> <C> <C> <C>
Rent expense paid to Brand Electric, Inc............................. $9,200 $9,000 $2,400
Rent expense paid to stockholder..................................... 2,400 2,400 2,400
</TABLE>
In addition, the Company reimbursed an affiliate for payroll payments made
on the Company's behalf.
9. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income (operations) and cash flows for the six
months ended June 30, 1995 and 1996 (interim financial statements) have been
prepared by management and are unaudited. The interim financial statements
include all adjustments, consisting of only normal recurring adjustments
necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-109
<PAGE> 181
REPORT OF INDEPENDENT AUDITORS
The Stockholder
Coastal Air Conditioning Service, Inc.
We have audited the accompanying balance sheets of Coastal Air Conditioning
Service, Inc. as of December 31, 1994 and 1995, and the related statements of
income, stockholder's equity, and cash flows for each of the three years in the
period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Coastal Air Conditioning
Service, Inc. at December 31, 1994 and 1995, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-110
<PAGE> 182
COASTAL AIR CONDITIONING SERVICE, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------- JUNE 30,
1994 1995 1996
--------- ---------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash..................................................... $ 60,846 $ 100,833 $ 73,357
Receivables:
Trade, net of allowance for doubtful accounts of
$5,240 and $19,750 at December 31, 1994 and 1995,
respectively........................................ 291,159 311,055 412,264
Employee.............................................. 4,395 6,559 7,216
Other................................................. 14,443 16,562 12,917
--------- ---------- -----------
370,843 435,009 432,397
Inventories........................................... 206,075 205,944 231,485
Costs and estimated earnings in excess of billings.... 21,178 9,975 8,497
Prepaid expenses and other current assets............. 5,104 3,354 42,798
Deferred income taxes................................. 7,429 20,210 150,975
--------- ---------- -----------
Total current assets............................. 610,629 674,492 939,509
Note receivable from stockholder........................... 150,763 135,944 131,544
Property and equipment:
Machinery and equipment.................................. 152,904 188,261 188,261
Vehicles................................................. 215,644 284,524 277,842
Leasehold improvements................................... 46,024 46,024 46,024
--------- ---------- -----------
414,572 518,809 512,127
Less accumulated depreciation and amortization........... (242,844) (259,072) (279,648)
--------- ---------- -----------
171,728 259,737 232,479
Other assets............................................... 25,097 51,169 61,791
--------- ---------- -----------
Total assets..................................... $ 958,217 $1,121,342 $ 1,365,323
========= ========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Credit agreement......................................... $ 131,138 $ 82,500 $ 127,143
Trade accounts payable and accrued liabilities........... 64,027 86,588 86,613
Accrued compensation..................................... 335,000
Accrued warranties....................................... 17,822 20,875 20,356
Contributions payable to benefit plan.................... 30,000 30,000 40,000
Income taxes payable..................................... 64,009 53,805 56,081
Current portion of amounts due to stockholder............ 15,796 17,107 17,489
Current portion of long-term debt and capital leases..... 45,442 59,186 59,186
--------- ---------- -----------
Total current liabilities........................ 368,234 350,061 741,868
Due to stockholder, net of current portion................. 186,549 169,441 145,677
Long-term debt, net of current portion..................... 45,517 91,751 54,055
Capital lease obligations, net of current portion.......... 19,546 34,409 26,626
Stockholder's equity:
Common stock, par value $5 per share, 20,000 shares
authorized, 980 shares issued and outstanding......... 4,900 4,900 4,900
Additional paid-in capital............................... 54 54 54
Retained earnings........................................ 333,417 470,726 392,143
--------- ---------- -----------
Total stockholders' equity....................... 338,371 475,680 397,097
--------- ---------- -----------
Total liabilities and stockholder's equity....... $ 958,217 $1,121,342 $ 1,365,323
========= ========= =========
</TABLE>
See accompanying notes.
F-111
<PAGE> 183
COASTAL AIR CONDITIONING SERVICE, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues......................... $2,648,484 $3,278,151 $3,824,195 $1,859,731 $2,029,336
Cost of goods sold................... 1,533,732 1,854,194 2,072,274 991,555 1,052,514
---------- ---------- ---------- ---------- ----------
Gross margin......................... 1,114,752 1,423,957 1,751,921 868,176 976,822
Selling, general and administrative
expenses........................... 910,950 1,174,933 1,504,150 684,856 1,104,759
Bad debt expense..................... 19,587 5,240 22,098 5,384 8,962
---------- ---------- ---------- ---------- ----------
Income from operations............... 184,215 243,784 225,673 177,936 (136,899)
Other income (expense):
Interest expense................... (30,314) (28,581) (29,465) (16,394) (17,692)
Other income....................... 8,095 13,828 20,937 17,151 19,638
---------- ---------- ---------- ---------- ----------
Income (loss) before provision for
income taxes....................... 161,996 229,031 217,145 178,693 (134,953)
Provision (benefit) for income taxes:
Current............................ -- 64,009 92,617 68,668 74,395
Deferred........................... 59,743 16,508 (12,781) (6,609) (130,765)
---------- ---------- ---------- ---------- ----------
59,743 80,517 79,836 62,059 (56,370)
---------- ---------- ---------- ---------- ----------
Net income (loss).................... $ 102,253 $ 148,514 $ 137,309 $ 116,634 $ (78,583)
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-112
<PAGE> 184
COASTAL AIR CONDITIONING SERVICE, INC.
STATEMENTS OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
COMMON STOCK $5
PAR VALUE ADDITIONAL
--------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1992..................... 980 $4,900 $ 54 $ 82,650 $ 87,604
Net income..................................... -- -- -- 102,253 102,253
------ ------ --- -------- --------
Balance at December 31, 1993..................... 980 4,900 54 184,903 189,857
Net income..................................... -- -- -- 148,514 148,514
------ ------ --- -------- --------
Balance at December 31, 1994..................... 980 4,900 54 333,417 338,371
Net income..................................... -- -- -- 137,309 137,309
------ ------ --- -------- --------
Balance at December 31, 1995..................... 980 4,900 54 470,726 475,680
Net loss (unaudited)........................... -- -- -- (78,583) (78,583)
------ ------ --- -------- --------
Balance at June 30, 1996 (unaudited)............. 980 $4,900 $ 54 $392,143 $397,097
===== ====== ======= ======== ========
</TABLE>
See accompanying notes.
F-113
<PAGE> 185
COASTAL AIR CONDITIONING SERVICE, INC.
STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
----------------------------------- ---------------------
1993 1994 1995 1995 1996
--------- ----------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)..................... $ 102,253 $ 148,514 $ 137,309 $ 116,634 $ (78,583)
Adjustments to reconcile net income
(loss) to net cash provided by
operating activities:
Depreciation and amortization....... 27,056 46,525 49,537 23,759 25,739
Provisions for loss on accounts
receivable....................... 19,587 5,240 22,098 15,709 --
Loss on asset disposals............. 7,718
Deferred tax asset.................. 59,743 16,508 (12,781) (6,609) (130,765)
Changes in assets and liabilities:
Receivables...................... (20,725) (141,232) (31,458) (136,052) (93,821)
Inventories...................... 30,880 (104,781) 131 9,112 (25,541)
Costs and estimated earnings in
excess of billings............. (6,547) (42,791) 11,203 10,275 1,478
Prepaid expenses and other
assets......................... 6,949 (200) (24,322) (17,036) (50,065)
Contributions payable to benefit
plan........................... -- 30,000 -- -- 10,000
Trade accounts payable and
accrued liabilities............ (63,943) 9,218 22,561 29,680 25
Accrued compensation............. -- 335,000
Accrued warranties............... 509 4,275 3,053 2,102 (519)
Income taxes payable............. 18,949 64,009 (10,204) 39,530 2,276
--------- ----------- --------- --------- ---------
Net cash provided by operating
activities.......................... 174,711 35,285 167,127 87,104 2,942
INVESTING ACTIVITIES
Purchase of property and equipment.... (4,649) (111,592) (100,039) (42,624) (6,200)
--------- ----------- --------- --------- ---------
Net cash used in investing
activities.......................... (4,649) (111,592) (100,039) (42,624) (6,200)
FINANCING ACTIVITIES
Proceeds from debt and credit
agreement........................... 535,733 1,078,874 686,782 318,832 278,337
Payments on debt and credit
agreement........................... (572,386) (1,077,562) (713,883) (312,643) (302,555)
--------- ----------- --------- --------- ---------
Net cash provided by (used in)
financing activities................ (36,653) 1,312 (27,101) 6,189 (24,218)
--------- ----------- --------- --------- ---------
Increase (decrease) in cash........... 133,409 (74,995) 39,987 50,669 (27,476)
Cash at beginning of year............. 2,432 135,841 60,846 60,846 100,833
--------- ----------- --------- --------- ---------
Cash at end of year................... $ 135,841 $ 60,846 $ 100,833 $ 111,515 $ 73,357
========= ========== ========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid......................... $ 30,314 $ 28,581 $ 29,465 $ 16,394 $ 17,692
========= ========== ========= ========= =========
Income tax paid....................... $ -- $ -- $ 102,819 $ $ 48,590
========= ========== ========= ========= =========
Equipment purchase under capital
leases.............................. $ 59,212 $ -- $ 37,507 $ -- $ --
========= ========== ========= ========= =========
</TABLE>
See accompanying notes.
F-114
<PAGE> 186
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Coastal Air Conditioning Service, Inc. ("the Company") is engaged in the
installation and servicing of air conditioning and heating systems primarily for
residential customers in the Savannah, Georgia area.
REVENUE RECOGNITION
Revenues on all of the Company's heating and air conditioning installation
contracts ("Contracts") for customers are recognized on the
percentage-of-completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues related to servicing are recognized upon
completion of those services.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within two months. Nonidentifiable
selling, general and administrative expenses are charged to operations as
incurred and are not allocated to Contract costs.
Trade accounts receivable includes billings on Contracts. The Company
classifies these amounts as current assets because all balances are expected to
be collected in the current year. Concentrations of credit risk with respect to
trade Receivables are limited to the large number of customers comprising the
Company's customer base, and their dispersion across many different industries
and geographies.
The asset, "costs and estimated earnings in excess of billings" represents
revenue recognized in excess of amounts billed on in-progress contracts.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
INVENTORIES
Inventories are stated at the lower of cost or market as determined by the
first-in, first-out (FIFO) method and consist of heating and air conditioning
units ready for installation and related parts and supplies.
F-115
<PAGE> 187
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation and amortization
are provided on the straight-line method over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Machinery and equipment....................................................... 8
Vehicles...................................................................... 6
Leasehold improvements........................................................ 10
</TABLE>
WARRANTIES
The Company provides a one-year warranty on parts and labor for all
construction and a two-year warranty on parts and labor for all replacement
service. This warranty runs concurrent with the manufacturer's warranty on parts
and for the first year on labor. The Company accrues future warranty costs based
upon the relationship of prior year's sales to actual warranty costs. It is the
Company's policy to classify the entire warranty accrual as a current liability.
ADVERTISING
The Company's policy is to expense advertising costs as incurred. Amounts
paid for advertising were approximately $32,300, $24,600 and $59,100 for the
years ended December 31, 1993, 1994 and 1995.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes." Under the liability method, the deferred tax liability or asset
is based on temporary differences between the financial statement and income tax
bases of assets and liabilities, measured at tax rates that will be in effect
when the differences reverse.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results inevitably will differ from those estimates,
and such differences may be material to the financial statements.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $19,587, $5,240 and $22,098, respectively and accounts
written off, net of recoveries were $0, $19,587 and $7,588, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
opinions, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued opinions would have a significant impact on the Company's financial
statements.
F-116
<PAGE> 188
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. CONTRACTS IN PROGRESS
Contracts in process consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------
1994 1995
-------- --------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contracts........................ $136,541 $ 86,585
Estimated earnings........................................... 65,217 53,708
-------- --------
201,758 140,293
Less applicable progress billings.............................. 180,580 130,318
-------- --------
Costs and estimated earnings in excess of billings............. $ 21,178 $ 9,975
======== ========
</TABLE>
As of December 31, 1994 and 1995, there were no contracts with billings in
excess of costs and estimated earnings.
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
3. CREDIT AGREEMENT
The Company purchases substantially all of its inventory from a major
manufacturer of air conditioners under a credit agreement secured by such
inventory. Payment is due in three equal installments over 90 days following the
receipt of such inventory. Amounts payable under this agreement as of December
31, 1994 and 1995 were $131,138 and $82,500, respectively.
F-117
<PAGE> 189
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
3. LONG-TERM DEBT AND CAPITAL LEASES
Long-term debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Secured line of credit with a bank, borrowings of $50,000
available
at 9.5%........................................................ $ -- $ --
Notes payable to a bank, secured by six vehicles bearing interest
at 9.0%. Interest and principal payments of $2,120 are due
through December 1999. ........................................ -- 85,000
Note payable to a bank, secured by two vans, bearing interest at
7.25%. Interest and principal payments of $540 are due monthly
through March 1999. ........................................... 24,469 19,006
Note payable to a bank, secured by a vehicle, software, leasehold
improvements and personal guaranty of stockholder, bearing
interest at 1% above prime (8.5% at December 31, 1995).
Interest and principal payments of $1,241 are due monthly
through November 1997. ........................................ 38,044 26,060
Note payable to a bank, secured by two trucks, bearing interest
at 7.0%. Interest and principal payments of $451 are due
monthly through January 1996. ................................. 5,863 451
Notes payable, secured by two vans, with imputed interest of 10%.
Interest and principal payments of $1,693 were made through
September 1995. ............................................... 9,942 --
Note payable to an employee bearing interest at 10%. Interest and
principal payments of $1,496 were made through April 1996. .... -- 4,854
-------- --------
78,318 135,371
Less current portion............................................. (32,801) (43,620)
-------- --------
$ 45,517 $ 91,751
======== ========
</TABLE>
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1996.............................................................. $ 43,620
1997.............................................................. 39,049
1998.............................................................. 26,501
1999.............................................................. 26,201
--------
$135,371
========
</TABLE>
F-118
<PAGE> 190
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The Company leases certain equipment and vehicles under capital leases.
Future lease payments for the capital lease obligations at December 31, 1995 are
as follows:
<TABLE>
<S> <C>
1996.............................................................. $ 20,395
1997.............................................................. 17,718
1998.............................................................. 8,175
1999.............................................................. 8,175
2000.............................................................. 3,581
--------
Total minimum lease payments...................................... 58,044
Less amount representing interest................................. (8,069)
--------
Present value of net minimum lease payments....................... 49,975
Less current portion.............................................. (15,566)
--------
Long-term capital lease obligations............................... $ 34,409
========
</TABLE>
Equipment with a cost of $59,212 and $96,719 and accumulated amortization
of $19,125 and $31,227 related to these capital leases is included in property
and equipment as of December 31, 1994 and 1995, respectively.
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheet for long-term debt and capital
lease obligations approximate fair value.
4. OPERATING LEASES
Total rental expense for all operating leases was $40,500, $50,502 and
$60,074 for 1993, 1994 and 1995, respectively. The Company leases certain
equipment and vehicles under terms of noncancelable operating lease agreements
which expire at various dates through January 2000 and have an initial
noncancelable term of one year or more. Minimum rental commitments at December
31, 1995 under operating leases are as follows:
<TABLE>
<CAPTION>
OPERATING
LEASES
-------
<S> <C>
1996............................................................... $20,693
1997............................................................... 20,142
1998............................................................... 5,211
-------
$46,046
=======
</TABLE>
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, up to 15% of
total compensation, not to exceed the maximum established annually by the
Internal Revenue Service. Any Company contributions are made at stockholder's
discretion. The Company contributed $30,000 and $40,000 for the years ended
December 31, 1994 and 1995, respectively.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company has guaranteed a $314,266 personal loan of its stockholder with
a bank dated January 1994 and due January 2004.
F-119
<PAGE> 191
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. STOCKHOLDER'S COMPENSATION
Stockholder's compensation, consisting of salary and cash bonuses, is
included in selling, general and administrative expenses and totaled $54,000,
$58,000 and $150,000 for the years ended December 31, 1993, 1994 and 1995,
respectively.
8. INCOME TAXES
Income tax provision (benefit) expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1993 1994 1995
------- ------- --------
<S> <C> <C> <C>
Current:
Federal................................................ $ -- $52,650 $ 77,233
State.................................................. -- 11,359 15,384
------- ------- --------
-- 64,009 92,617
Deferred:
Federal and State...................................... 59,743 16,508 (12,781)
------- ------- --------
$59,743 $80,517 $ 79,836
======= ======= ========
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Capitalized overhead........................................... $(21,594) $(11,859)
Other.......................................................... (3,037) (8,351)
-------- --------
Deferred tax liabilities......................................... (24,631) (20,210)
Deferred tax assets:
Bad debt reserve............................................... 1,989 7,496
Passive activity loss carryforwards............................ 9,490 9,490
Other.......................................................... 20,581 23,434
-------- --------
Deferred tax assets.............................................. 32,060 40,420
-------- --------
Net deferred tax assets.......................................... $ 7,429 $ 20,210
======== ========
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will more likely than not be realized. Accordingly, no valuation allowance has
been recorded for the year ended December 31, 1995.
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before provision
for deferred income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Tax provision at statutory rate........................... $55,079 $77,871 $73,829
State income tax.......................................... -- 11,520 10,892
Other, net................................................ 4,664 (8,874) (4,885)
------- ------- -------
$59,743 $80,517 $79,836
======= ======= =======
</TABLE>
F-120
<PAGE> 192
COASTAL AIR CONDITIONING SERVICE, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. RELATED PARTY TRANSACTIONS
The Company has a note receivable from its stockholder which accrues
interest at 6%. Amounts receivable under this note were $150,763 and $135,944 at
December 31, 1994 and 1995, respectively.
The Company's note payable to its stockholder bears interest at 8% and is
payable through January 2004. Amounts due under this note were $202,345 and
$186,548 at December 31, 1994 and 1995, respectively. The aggregate amounts of
annual principal maturities are $17,107, $18,527, $20,065, $21,730, $23,534 and
$85,585 for 1996, 1997, 1998, 1999, 2000 and thereafter, respectively.
The Company leases its office and warehouse facility from its stockholder.
Rental payments of $40,500, $40,400 and $40,875 related to this lease were made
in the years ended December 31, 1993, 1994 and 1995, respectively. Under the
terms of this lease, the Company paid property taxes related to the lease
facilities of $3,500, $3,800 and $3,600 in the years ended December 31, 1993,
1994 and 1995, respectively.
10. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
11. UNAUDITED INTERIM FINANCIAL INFORMATION
The accompanying balance sheet as of June 30, 1996 and statements of
operations and cash flows for the six months ended June 30, 1995 and 1996 have
been prepared by management and are unaudited. The interim financial statements
include all adjustments, (consisting of normal recurring accruals) considered
necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been omitted from the interim financial statements. The interim financial
statements should be read in conjunction with the audited financial statements
appearing herein. The results of the interim periods may not be indicative of
operating results for the full year.
F-121
<PAGE> 193
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Contractor Success Group, Inc.
We have audited the accompanying balance sheets of Contractor Success
Group, Inc. as of December 31, 1994 and 1995, and the related statements of
income, stockholders' equity, and cash flows for each of the three years in the
period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Contractor Success Group,
Inc. at December 31, 1994 and 1995, and the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-122
<PAGE> 194
CONTRACTOR SUCCESS GROUP, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1994 1995 1996
-------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 83,714 $ 218,228 $ 135,939
Receivables:
Current portion of notes receivable, net of allowance
for doubtful accounts of $79,216 in 1995, $56,387 at
June 30, 1996........................................ 270,795 231,232 224,161
Trade.................................................. 41,688 69,365 240,883
Related party.......................................... 204,456 389,688 47,950
Employee............................................... 18,000 149 149
Other.................................................. -- 10,000 --
-------- ---------- ----------
534,939 700,434 513,143
Prepaid expenses and other current assets................. 7,421 5,573 66,428
-------- ---------- ----------
Total current assets........................................ 626,074 924,235 715,510
Notes receivable, net of current portion.................... 309,725 310,294 300,806
Property and equipment:
Furniture and fixtures.................................... 68,773 86,656 93,402
Equipment................................................. -- 100,000 100,000
-------- ---------- ----------
68,773 186,656 193,402
Less accumulated depreciation............................. (22,932) (45,267) (70,438)
-------- ---------- ----------
45,841 141,389 122,964
Other assets................................................ 13,572 34,773 35,541
-------- ---------- ----------
Total assets...................................... $995,212 $1,410,691 $1,174,821
======== ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................... $ -- $ 251,534 $ --
Trade accounts payable and accrued liabilities............ 150,435 268,613 155,529
Accounts payable to related parties....................... 8,233 111,346 --
Accrued compensation...................................... 31,060 34,672 32,680
Current portion of capital leases......................... 3,619 5,743 --
-------- ---------- ----------
Total current liabilities................................... 193,347 671,908 188,209
Capital lease obligations, less current portion............. 2,216 6,000 --
Other liabilities........................................... 14,677 1,624 --
-------- ---------- ----------
Total liabilities........................................... 210,240 679,532 188,209
Stockholders' equity:
Common stock, $1 par value; authorized, issued and
outstanding -- 5,000 shares............................ 5,000 5,000 5,000
Retained earnings......................................... 779,972 726,159 981,612
-------- ---------- ----------
Total stockholders' equity........................ 784,972 731,159 986,612
-------- ---------- ----------
Total liabilities and stockholders' equity........ $995,212 $1,410,691 $1,174,821
======== ========= =========
</TABLE>
See accompanying notes.
F-123
<PAGE> 195
CONTRACTOR SUCCESS GROUP, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ -----------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenue.......................... $2,414,497 $2,740,976 $3,229,558 $1,570,089 $1,693,636
Cost of goods sold................... 466,196 414,938 615,245 263,124 300,528
---------- ---------- ---------- ---------- ----------
Gross margin......................... 1,948,301 2,326,038 2,614,313 1,306,965 1,393,108
Selling, general and administrative
expenses........................... 1,171,461 1,453,813 1,260,005 514,537 732,524
Bad debt expense..................... 53,358 2,611 79,216 22,829 --
---------- ---------- ---------- ---------- ----------
Income from operations............... 723,482 869,614 1,275,092 769,599 660,584
Other income (expense):
Interest expense................... (1,015) (1,851) (10,196) (1,575) (7,331)
Interest income.................... 119,019 106,388 125,491 50,667 69,200
Other income....................... 56,263 -- 7,800 1,082 13,000
---------- ---------- ---------- ---------- ----------
174,267 104,537 123,095 50,174 74,869
---------- ---------- ---------- ---------- ----------
Net income........................... $ 897,749 $ 974,151 $1,398,187 $ 819,773 $ 735,453
========= ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-124
<PAGE> 196
CONTRACTOR SUCCESS GROUP, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK,
$1 PAR VALUE
--------------- RETAINED
SHARES AMOUNT EARNINGS TOTAL
------ ------ ----------- -----------
<S> <C> <C> <C> <C>
Balance at December 31, 1992.......................... 5,000 $5,000 $ 731,044 $ 736,044
Capital distributions............................... -- -- (972,972) (972,972)
Net income.......................................... -- -- 897,749 897,749
------ ------ ----------- -----------
Balance at December 31, 1993.......................... 5,000 5,000 655,821 660,821
Capital distributions............................... -- -- (850,000) (850,000)
Net income.......................................... -- -- 974,151 974,151
------ ------ ----------- -----------
Balance at December 31, 1994.......................... 5,000 5,000 779,972 784,972
Capital distributions............................... -- -- (1,452,000) (1,452,000)
Net income.......................................... -- -- 1,398,187 1,398,187
------ ------ ----------- -----------
Balance at December 31, 1995.......................... 5,000 5,000 726,159 731,159
Capital distributions (unaudited)................... -- -- (480,000) (480,000)
Net income (unaudited).............................. -- -- 735,453 735,453
------ ------ ----------- -----------
Balance at June 30, 1996 (unaudited).................. 5,000 $5,000 $ 981,612 $ 986,612
===== ====== ========== ==========
</TABLE>
See accompanying notes.
F-125
<PAGE> 197
CONTRACTOR SUCCESS GROUP, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ ---------------------
1993 1994 1995 1995 1996
-------- ----------- ----------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income........................... $897,749 $ 974,151 $ 1,398,187 $ 819,773 $ 735,453
Adjustments to reconcile net income
to net cash provided by operating
activities:
Depreciation and amortization...... 9,115 12,249 22,335 3,153 25,973
Provisions for loss on notes
receivable...................... -- -- 79,216 -- --
Changes in assets and liabilities:
Receivables..................... (10,074) (19,908) (19,826) (95,196) (161,518)
Prepaid expenses and other
current assets................ (3,009) 1,407 1,848 5,983 (60,855)
Notes receivable................ 32,514 20,663 (40,222) 81,736 16,559
Trade accounts payable and
accrued liabilities........... 54,960 78,527 118,178 (13,156) (113,084)
Accrued compensation............ 5,457 (9,115) 3,612 (15,216) (1,992)
Other liabilities............... 8,069 4,810 (11,519) (13,865) (3,158)
-------- ----------- ----------- --------- ---------
Net cash flow provided by operating
activities......................... 994,781 1,062,784 1,551,809 773,212 437,378
INVESTING ACTIVITIES
Purchase of property and equipment... (31,666) (5,975) (105,998) (99,977) (6,746)
Increase in other assets............. (2,341) (4,294) (21,201) (20,010) (1,570)
-------- ----------- ----------- --------- ---------
Net cash used in investing
activities......................... (34,007) (10,269) (127,199) (119,987) (8,316)
FINANCING ACTIVITIES
Proceeds from short-term debt........ -- -- 250,000 50,000 --
Payments on short-term debt.......... -- -- -- -- (250,000)
Payments of capital leases........... (1,431) (3,020) (5,977) (7,242) (11,743)
Accounts receivable and accounts
payable to related parties......... 17,292 (160,679) (82,119) (15,349) 230,392
Distributions to shareholders........ (972,972) (850,000) (1,452,000) (355,000) (480,000)
-------- ----------- ----------- --------- ---------
Net cash used in financing
activities......................... (957,111) (1,013,699) (1,290,096) (327,591) (511,351)
-------- ----------- ----------- --------- ---------
Increase (decrease) in cash and cash
equivalents........................ 3,663 38,816 134,514 325,634 (82,289)
Cash and cash equivalents at
beginning of year.................. 41,235 44,898 83,714 83,714 218,228
-------- ----------- ----------- --------- ---------
Cash and cash equivalents at end of
year............................... $ 44,898 $ 83,714 $ 218,228 $ 409,348 $ 135,939
======== ========== ========== ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid........................ $ 1,015 $ 1,851 $ 8,662 $ 1,575 $ 8,865
======== ========== ========== ========= =========
Income tax paid...................... $ -- $ -- $ -- $ -- $ --
======== ========== ========== ========= =========
Purchase of equipment through capital
leases............................. $ 5,070 $ 3,559 $ 11,885 $ 14,056 $ --
======== ========== ========== ========= =========
</TABLE>
See accompanying notes.
F-126
<PAGE> 198
CONTRACTOR SUCCESS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1993, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Contractor Success Group, Inc. ("the Company") provides management
consulting, marketing services, reporting mechanisms, lead generation tools,
sales techniques, implementation materials and customized training for its
member companies in the heating, ventilation and air conditioning contracting
("HVAC") industry. The Company currently has over 270 members throughout the
United States and Canada.
RECOGNITION OF INCOME
Initial membership fees, less a provision for estimated uncollectible
amounts, are recognized on the date the membership agreement is signed given
that the fees are nonrefundable, and all obligations have been substantially
performed by the Company. Initial membership fees included in net revenue
totaled $1,071,000, $1,120,000 and $900,000 during 1993, 1994 and 1995,
respectively.
Quarterly dues, less a provision for estimated uncollectible amounts, are
recognized in the same period the services and obligations are performed.
Revenue from sales of copyrighted literature is recognized on the date of
sale.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable, Notes Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts
receivable, notes receivable and accounts payable approximate fair value.
Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for capital lease obligations
approximate fair value.
NOTES RECEIVABLE
Notes receivable are accepted from members who desire to finance a portion
of their initial membership fee. The original principal balance generally does
not exceed $15,000 and the notes typically involve a three-year term, accrue
interest at 18% and are payable in equal monthly installments of principal and
interest. The notes are periodically reviewed for collectibility and reserves
are established at the time it appears that collectibility is uncertain.
F-127
<PAGE> 199
CONTRACTOR SUCCESS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $53,358, $2,611 and $79,216, respectively and accounts
written off, net of recoveries were $0, $0 and $79,216, respectively.
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation is
provided on the straight-line method over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................................ 3-7
Equipment..................................................................... 7
</TABLE>
Depreciation expense totaled $9,114, $12,249 and $22,335 during 1993, 1994
and 1995, respectively.
INTANGIBLE AND OTHER ASSETS
Intangible assets, included in other assets, represent the cost of
organization, copyrights, trademarks, and other intangible assets less
accumulated amortization. Amortization is provided on the straight-line method
over five to 15 years. The remaining other assets represent amounts on deposit.
The carrying values of intangible and other assets are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Copyrights......................................................... $10,505 $11,405
Trademarks......................................................... 2,885 6,883
Other intangible assets............................................ 1,500 19,500
Deposits........................................................... 2,000 2,000
------- -------
16,890 39,788
Less accumulated amortization (3,318) (5,015)
------- -------
$13,572 $34,773
======= =======
</TABLE>
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The stockholders of the Company have elected under Subchapter S of the
Internal Revenue Code to include the Company's income in their own income for
federal income tax purposes and state income tax purposes. Accordingly, the
Company is not subjected to income taxes.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-128
<PAGE> 200
CONTRACTOR SUCCESS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SHORT-TERM DEBT
During May 1995, the Company secured a line of credit with a bank that
expired May 1, 1996. Based on its terms, the Company could borrow up to $500,000
at a variable rate of interest. The agreement is secured by the notes and
accounts receivable balances of the Company with the Company's stockholders
acting as personal guarantors.
At December 31, 1995, the Company had borrowings of $250,000 and accrued
interest expense of $1,534 in accordance with this agreement. The Company paid
$6,156 of interest during 1995 at a weighted-average interest rate of 9.25%.
At May 1, 1996, the bank began renewing the line of credit on a monthly
basis.
3. LEASES
Total rental expense for all operating leases was $82,798, $82,798 and
$58,036 during 1993, 1994 and 1995, respectively. Portions of this rental
expense totaling $545, $40,427 and $26,175 during 1993, 1994 and 1995,
respectively, were reimbursed by related parties based on allocations using
percentages of total occupancy. The Company leases office facilities under terms
of a noncancelable operating lease agreement which expires during 1997. Minimum
rental commitments at December 31, 1995 under capital and operating leases
having an initial noncancelable term of one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $ 7,370 $ 58,620
1997.............................................................. 5,192 56,751
1998.............................................................. 1,652 --
------- ---------
14,214 $ 115,371
========
Amounts representing interest..................................... (2,471)
-------
Present value of net minimum rentals (including $5,743 classified
as current)..................................................... $11,743
=======
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Furniture and fixtures............................................. $10,361 $22,246
Less accumulated amortization...................................... 6,234 11,562
------- -------
Net property, plant and equipment under capital leases............. $ 4,127 $10,684
======= =======
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
4. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to various of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position or results of operations of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
F-129
<PAGE> 201
CONTRACTOR SUCCESS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. STOCKHOLDERS' COMPENSATION
Stockholders' compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $579,231,
$400,000 and $300,000 during 1993, 1994 and 1995, respectively.
Capital distributions to stockholders totaled $972,972, $850,000 and
$1,452,000 during 1993, 1994 and 1995, respectively.
6. INCOME TAXES
The Company is an S corporation; accordingly, income tax liabilities are
the responsibility of the respective owners. Under these provisions, the Company
generally does not pay corporate income taxes; rather the income or loss is
allocated to each stockholder for inclusion in their respective income tax
returns. Because of this practice, provisions for income taxes and deferred tax
assets and liabilities of these taxable entities have not been reflected in
these financial statements.
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously in this note, the Company operates under Subchapter
S of the Internal Revenue Code and is not subject to corporate federal income
tax. In connection with the contemplated initial public offering (see Note 8),
the Subchapter S election will be terminated. As a result, the Company will be
subject to corporate income taxes subsequent to the termination of S corporation
status. The Company had net operating income for income tax purposes of
approximately $899,000, $978,000, $1,414,000 and $758,000 for 1993, 1994, 1995
and the six months ended June 30, 1996, respectively. Had the Company filed
federal and state income tax returns as a regular corporation for 1993, 1994,
1995 and the six months ended June 30, 1996, income tax expense under the
provisions of Financial Accounting Standard No. 109 would have been
approximately $342,000, $372,000, $537,000 and $281,000, respectively.
At the date of termination of S corporation status, the Company will be
required to provide for a deferred tax asset for cumulative temporary
differences between financial reporting and tax reporting. Such deferred taxes
will be recognized on the cumulative temporary difference at the date of
termination of S corporation status. The effect of recognizing the deferred
taxes will be included in income from continuing operations. If the termination
of S corporation status had occurred at June 30, 1996, the deferred tax asset
would have been approximately $25,000.
7. RELATED PARTY TRANSACTIONS
During 1995, the Company purchased certain computer equipment for $100,000
from a company owned by one of the stockholders. The Company leases this
equipment to various other companies in which the same stockholder has ownership
interests. The Company received rental fees of $7,500 during 1995 from these
lease agreement.
8. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
F-130
<PAGE> 202
CONTRACTOR SUCCESS GROUP, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
9. UNAUDITED INTERIM FINANCIAL INFORMATION
The statements of income and cash flows for the six months ended June 30,
1995 and 1996 (interim financial statements) have been prepared by management
and are unaudited. The interim financial statements include all adjustments,
consisting of only normal recurring adjustments necessary for a fair
presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-131
<PAGE> 203
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Arrow Heating & Air Conditioning, Inc.
We have audited the accompanying balance sheets of Arrow Heating & Air
Conditioning, Inc. as of December 31, 1994 and 1995, and the related statements
of income, stockholders' equity, and cash flows for the period from January 29,
1993 (date operations commenced) through December 31, 1993, and the years ended
December 31, 1994 and 1995. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Arrow Heating & Air
Conditioning, Inc. at December 31, 1994 and 1995, and the results of its
operations and its cash flows for the period from January 29, 1993 (date
operations commenced) through December 31, 1993 and the years ended December 31,
1994 and 1995 in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-132
<PAGE> 204
ARROW HEATING & AIR CONDITIONING, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------- ----------
1994 1995 1996
-------- -------- ----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................... $126,635 $ 64,080 $ 103,184
Receivables:
Trade.................................................... 174,709 159,862 228,572
Other.................................................... 3,730 49,819 31,435
-------- -------- ----------
178,439 209,681 260,007
Inventories................................................. 143,308 231,246 272,030
Prepaid expenses and other current assets................... 5,214 11,436 48,454
-------- -------- ----------
Total current assets................................ 453,596 516,443 683,675
Property and equipment:
Machinery and equipment..................................... 56,106 158,408 183,732
Vehicles.................................................... 150,712 216,203 279,202
Leasehold improvements...................................... 3,495 14,050 14,050
-------- -------- ----------
210,313 388,661 476,984
Less accumulated depreciation and amortization.............. (23,793) (78,941) (118,293)
-------- -------- ----------
186,520 309,720 358,691
Other assets.................................................. 9,398 4,845 3,800
-------- -------- ----------
Total assets........................................ $649,514 $831,008 $1,046,166
======== ======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and other accrued liabilities........ $127,352 $132,706 $ 187,373
Due to related parties...................................... -- 2,400 180,972
Accrued compensation........................................ 15,454 23,866 61,097
Accrued taxes, other than income............................ 20,568 29,430 17,600
Accrued warranties.......................................... 22,501 16,009 16,009
Deferred revenue............................................ 32,481 26,710 22,469
Related Party Notes......................................... 40,000
Current portion of long-term debt and capital lease
obligations.............................................. 59,943 66,180 140,945
-------- -------- ----------
Total current liabilities........................... 318,299 294,901 626,465
Long-term debt, net of current portion........................ 132,283 104,467 75,149
Capital lease obligations, less current portion............... -- 26,406 21,717
Deferred credit............................................... 12,819 -- --
Stockholders' equity:
Common stock, no par value, 4,500 shares authorized, 100
shares issued and outstanding............................ 10,000 10,000 10,000
Nonvoting common stock, no par value, 4,500 shares
authorized,
100 shares issued and outstanding........................ -- -- --
Retained earnings........................................... 176,113 395,234 312,835
-------- -------- ----------
Total stockholders' equity.......................... 186,113 405,234 322,835
-------- -------- ----------
Total liabilities and stockholders' equity.......... $649,514 $831,008 $1,046,166
======== ======== =========
</TABLE>
See accompanying notes.
F-133
<PAGE> 205
ARROW HEATING & AIR CONDITIONING, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 29,
1993 (DATE
OPERATIONS
COMMENCED) SIX MONTHS ENDED JUNE
THROUGH YEAR ENDED DECEMBER 31, 30,
DECEMBER 31, ----------------------- -----------------------
1993 1994 1995 1995 1996
------------ ---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues........................ $906,693 $1,968,756 $3,228,359 $1,389,869 $1,993,696
Cost of goods sold.................. 503,322 1,324,454 2,127,976 1,006,699 1,235,182
------------ ---------- ---------- ---------- ----------
Gross margin........................ 403,371 644,302 1,100,383 383,170 758,514
Selling, general and administrative
expenses.......................... 315,519 472,722 768,748 361,411 534,443
Bad debt expense.................... 446 252 505 735 1,569
------------ ---------- ---------- ---------- ----------
Income from operations.............. 87,406 171,328 331,130 21,024 222,502
Other income (expense):
Interest expense.................. (11,554) (14,854) (21,419) (10,513) (10,929)
Interest income................... 1,253 1,819 1,811 633 339
Other income (expense)............ 16,226 4,989 (171) 533 1,855
------------ ---------- ---------- ---------- ----------
5,925 (8,046) (19,779) (9,347) (8,735)
------------ ---------- ---------- ---------- ----------
Net income.......................... $ 93,331 $ 163,282 $ 311,351 $ 11,677 $ 213,767
========== ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-134
<PAGE> 206
ARROW HEATING & AIR CONDITIONING, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
NONVOTING
COMMON COMMON
STOCK, STOCK, NO PAR
NO PAR VALUE VALUE
---------------- --------------- RETAINED
SHARES AMOUNT SHARES AMOUNT EARNINGS TOTAL
------ ------- ------ ------ -------- --------
<S> <C> <C> <C> <C> <C> <C>
Issuance of stock for initial capital
contribution.............................. 100 $10,000 -- $ -- $ -- $ 10,000
Capital distributions..................... -- -- -- -- (24,500) (24,500)
Net income................................ -- -- -- -- 93,331 93,331
------ ------- ------ ------ -------- --------
Balance at December 31, 1993................ 100 10,000 -- -- 68,831 78,831
Capital distributions..................... -- -- -- -- (56,000) (56,000)
Net income................................ -- -- -- -- 163,282 163,282
------ ------- ------ ------ -------- --------
Balance at December 31, 1994................ 100 10,000 -- -- 176,113 186,113
Capital distributions..................... -- -- -- -- (92,230) (92,230)
Stock dividend............................ -- -- 100 -- -- --
Net income................................ -- -- -- -- 311,351 311,351
------ ------- ------ ------ -------- --------
Balance at December 31, 1995................ 100 10,000 100 -- 395,234 405,234
Net income (unaudited).................... -- -- -- -- 213,767 213,767
Distributions (unaudited)................. -- -- -- -- (296,166) (296,166)
------ ------- ------ ------ -------- --------
Balance at June 30, 1996 (unaudited)........ 100 $10,000 100 $ -- $312,835 $322,835
===== ======= ===== ====== ======== ========
</TABLE>
See accompanying notes.
F-135
<PAGE> 207
ARROW HEATING & AIR CONDITIONING, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
JANUARY 29,
1993 (DATE
OPERATIONS
COMMENCED) YEAR ENDED SIX MONTHS ENDED
THROUGH DECEMBER 31, JUNE 30,
DECEMBER 31, --------------------- ---------------------
1993 1994 1995 1995 1996
------------ --------- --------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................. $ 93,331 $ 163,282 $ 311,351 $ 11,677 $ 213,767
Adjustments to reconcile net income to net
cash provided by (used in) operating
activities:
Depreciation and amortization............ (2,135) 16,574 49,381 18,865 39,351
Provisions for loss on (recoveries of)
accounts receivable................... 446 252 505 -- --
Gain on asset disposals.................. -- (4,062) -- -- --
Changes in assets and liabilities:
Receivables........................... (6,296) (96,956) (31,747) (78,269) (50,326)
Inventories........................... (9,245) (82,413) (87,938) (34,793) (40,784)
Prepaid expenses and other current
assets.............................. (2,888) 9,467 (6,222) (10,153) (37,018)
Trade accounts payable and other
accrued liabilities................. (59,367) 100,155 5,354 131,599 54,667
Accrued compensation.................. 1,213 7,948 8,412 38,974 37,231
Accrued taxes, other than income...... (1,898) 12,349 8,862 2,940 (11,830)
Accrued warranties.................... 8,346 14,155 (6,492) 7,285 --
Deferred revenue...................... 6,773 25,708 (5,771) (32,481) (4,241)
------------ --------- --------- --------- ---------
Net cash provided by operating
activities............................... 28,280 166,459 245,695 55,644 200,817
INVESTING ACTIVITIES
Purchase of property and
equipment................................ (5,926) (134,869) (140,413) (102,212) (88,323)
Proceeds from sale of property and
equipment................................ -- 5,700 483 -- --
Purchase of business, net of cash acquired
of $63,753............................... (8,247) -- -- -- --
Other deferred credits..................... 65,350 -- -- -- 1,045
Increase in other assets................... -- -- (1,999) -- --
------------ --------- --------- --------- ---------
Net cash provided by (used in) investing
activities............................... 51,177 (129,169) (141,929) (102,212) (87,278)
FINANCING ACTIVITIES
Proceeds of long-term debt................. 61,081 79,621 215,378 78,105 73,617
Payments of long-term debt and capital
lease obligations........................ (13,916) (36,398) (289,469) (30,123) (32,858)
Due to related parties..................... -- -- -- 2,400 180,972
Distributions to shareholders.............. (24,500) (56,000) (92,230) (32,462) (296,166)
------------ --------- --------- --------- ---------
Net cash provided by (used in) financing
activities............................... 22,665 (12,777) (166,321) 17,920 (74,435)
------------ --------- --------- --------- ---------
Increase (decrease) in cash and cash
equivalents.............................. 102,122 24,513 (62,555) (28,648) 39,104
Cash and cash equivalents at beginning of
year..................................... -- 102,122 126,635 126,635 64,080
------------ --------- --------- --------- ---------
Cash and cash equivalents at end of year... $102,122 $ 126,635 $ 64,080 $ 97,987 $ 103,184
========== ========= ========= ========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.............................. $ 11,554 $ 14,854 $ 21,419 $ 10,513 $ 9,928
========== ========= ========= ========= =========
Purchase of equipment through capital
leases and financing arrangements........ $ 15,213 $ 56,625 $ 38,918 $ 17,382 $ --
========== ========= ========= ========= =========
</TABLE>
See accompanying notes.
F-136
<PAGE> 208
ARROW HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. ORGANIZATION AND NATURE OF OPERATIONS
ORGANIZATION
Arrow Heating & Air Conditioning, Inc. (the Company) was incorporated in
December 1992. On January 29, 1993, the Company commenced operations through the
acquisition of a business accounted for as a purchase for $72,000. The fair
value of the assets purchased was $181,221, net of cash acquired of $63,753, and
liabilities of $172,974 were assumed.
NATURE OF OPERATIONS
The Company operates in one industry segment and is primarily engaged in
the installation and servicing of air conditioning and heating systems for
residential customers.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
RECOGNITION OF INCOME
Revenues on the Company's heating and air conditioning installation,
service and maintenance are recognized upon completion of the services.
Concentrations of credit risk with respect to trade receivables are limited
due to the large number of customers comprising the Company's customer base.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
F-137
<PAGE> 209
ARROW HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories consist
of:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------- MARCH 31,
1994 1995 1996
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
Supplies and materials................................ $ 61,474 $113,162 $ 144,971
Finished goods (primarily heating and air
conditioning units)................................. 81,834 118,084 160,462
-------- -------- -----------
$143,308 $231,246 $ 305,433
======== ======== =========
</TABLE>
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line method over the following useful
lives:
<TABLE>
<CAPTION>
YEARS
-------
<S> <C>
Machinery and equipment.................................................... 3 to 10
Vehicles................................................................... 3 to 8
Leasehold improvements..................................................... 3 to 10
</TABLE>
WARRANTIES
The Company provides the retail customer with a one-year warranty on parts
and labor from the date of installation of the heating and air conditioning
unit. This warranty runs concurrent with the manufacturer's warranty on parts.
The Company provides an accrual for future warranty costs based upon the
relationship of sales to actual warranty costs.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1993, 1994 and
1995, the Company expensed $18,500, $55,800 and $79,700 in advertising costs.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The stockholders of the Company have elected under Subchapter S of the
Internal Revenue Code to include the Company's income in their own income for
federal income tax purposes and Wisconsin state income tax purposes.
Accordingly, the Company is not subject to federal or state income taxes.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
For the period January 29, 1993 (date operations commenced), through
December 31, 1993, and the years ended December 31, 1994 and December 31, 1995
amounts charged to bad debt expense totaled $446, $252 and $505, respectively
and accounts written off, net of recoveries were $446, $252 and $505,
respectively.
F-138
<PAGE> 210
ARROW HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
STOCK DIVIDEND
On January 1, 1995, the Board of Directors declared a stock dividend of one
share of nonvoting common stock for each outstanding share of common stock. The
number of shares in the accompanying financial statements have been
retroactively adjusted to reflect the stock dividend.
3. LONG-TERM DEBT
Long-term debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Vehicle and equipment loans...................................... $123,476 $155,009
Note payable to the Racine County Economic Development
Corporation, bearing interest at 7%............................ 31,333 --
Mortgage loan with the Small Business Association................ 34,648 --
Subordinated related party note payable.......................... 40,000 --
Other............................................................ 2,769 6,976
-------- --------
232,226 161,985
Less current portion............................................. 59,943 57,518
-------- --------
$172,283 $104,467
======== ========
</TABLE>
The Company has a line of credit with a bank that expires December 19,
1996. Under its terms, the Company can borrow up to $200,000 at the prime rate
(8.5% at December 31, 1995) plus 1%. The agreement is secured by substantially
all of the Company's assets. At December 31, 1994 and 1995, the Company had no
borrowings under this agreement. Payment of any outstanding borrowings is
personally guaranteed by the stockholders of the Company.
The Company has various vehicle and equipment loans from a bank that mature
through December 1999. The loans are secured by the related vehicles and
equipment, and require monthly principal payments of $4,000 plus interest at the
prime rate less 0.5% and monthly payments of $413, including principal and
interest at the prime rate plus 1%.
During the period from January 29, 1993 through September 29, 1995, the
Company had a note payable of $40,000 due to an immediate family member of a
stockholder, bearing interest at 9.5%. The related interest expense recognized
by the Company was $3,500, $3,800 and $3,000 in 1993, 1994 and 1995,
respectively.
It was not practicable to estimate the fair market value of the Company's
long-term debt securities because of a lack of quoted market prices and the
inability to estimate fair value without incurring excessive costs.
F-139
<PAGE> 211
ARROW HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt (excluding capital lease obligations) are as
follows:
<TABLE>
<S> <C>
1996.............................................................. $ 57,518
1997.............................................................. 52,850
1998.............................................................. 46,950
1999.............................................................. 4,667
--------
$161,985
========
</TABLE>
4. LEASES
Total rental expense for all operating leases was $19,217, $22,804 and
$26,600 for 1993, 1994 and 1995, respectively. The Company leases certain office
and warehouse facilities under terms of noncancelable operating lease agreements
which expire at various dates through January 1999. Minimum rental commitments
at December 31, 1995 under capital and operating leases having an initial
noncancelable term of one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $11,723 $26,917
1997.............................................................. 11,723 23,040
1998.............................................................. 11,723 23,040
1999.............................................................. 6,404 1,920
------- ---------
41,573 $74,917
=======
Amounts representing interest..................................... 6,505
-------
Present value of net minimum rentals (including $8,662 classified
as
current)........................................................ $35,068
=======
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1994 1995
------ -------
<S> <C> <C>
Machinery and equipment............................................. $ -- $38,918
Less accumulated amortization....................................... -- 3,084
------ -------
Net equipment under capital leases.................................. $ -- $35,834
====== =======
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, multiples of 1%
to 20% of total compensation, not to exceed the maximum contributions
established annually by the Internal Revenue Service. Matching contributions are
made by the Company equal to 25% of total contributions by a plan member, to a
maximum of 2.5% of the employee's total calendar year compensation. At its
discretion, the Company may make additional contributions. The Company's
contributions totaled $6,500, $9,978 and $13,200 for 1993, 1994 and 1995,
respectively.
F-140
<PAGE> 212
ARROW HEATING & AIR CONDITIONING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
7. STOCKHOLDERS' COMPENSATION
Stockholder's compensation, which consisted of salary and cash bonuses, is
included in selling, general and administrative expenses and totaled $52,239,
$59,900 and $197,321 in 1993, 1994 and 1995, respectively.
8. PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
In connection with the contemplated initial public offering (see Note 9),
the Subchapter S election will be terminated. As a result, the Company will be
subject to corporate income taxes subsequent to the termination of S corporation
status. The Company had net operating income for income tax purposes of $68,000,
$128,300, $244,900 and $143,900 for 1993, 1994, 1995 and the six months ended
June 30, 1996, respectively. Had the Company filed federal and state income tax
returns as a regular corporation for 1993, 1994, 1995 and the six months ended
June 30, 1996, income tax expense under the provisions of Financial Accounting
Standards No. 109 would have been $25,200, $56,700, $122,500 and $75,100,
respectively.
At the date of termination of S corporation status, the Company will be
required to provide deferred taxes for cumulative temporary differences between
financial reporting and income tax reporting bases of assets and liabilities.
Such deferred taxes will be based on the cumulative temporary differences at the
date of termination of S corporation status. The effect of recognizing the
deferred taxes will be included in income from continuing operations. If the
termination of S corporation status had occurred at June 30, 1996, the net
deferred tax liability would have been approximately $62,700.
9. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
10. UNAUDITED INTERIM FINANCIAL INFORMATION
The balance sheet as of June 30, 1996 and the statements of income and cash
flows for the six months ended June 30, 1995 and 1996 (interim financial
statements) have been prepared by management and are unaudited. The interim
financial statements include all adjustments, consisting of only normal
recurring adjustments, necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-141
<PAGE> 213
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Air Experts, a United Services Co., Inc.
We have audited the accompanying balance sheets of Air Experts, a United
Services Co., Inc. as of December 31, 1994 and 1995, and the related statements
of operations, stockholders' equity, and cash flows for each of the two years in
the period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Air Experts, A United
Services Co., Inc. at December 31, 1994 and 1995, and the results of its
operations and its cash flows for each of the two years in the period ended
December 31, 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-142
<PAGE> 214
AIR EXPERTS, A UNITED SERVICES CO., INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------- JUNE 30,
1994 1995 1996
-------- -------- -----------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash.................................................... $ 15,368 $ 76,463 $ 51,121
Receivables:
Trade, net of allowance for doubtful accounts of
$1,534 in 1994, $760 in 1995, and $-0- in 1996..... 37,316 54,708 118,844
Employees............................................ 1,210 521 350
Other................................................ 2,936 10,099 37,180
-------- -------- -----------
41,462 65,328 156,374
Inventories............................................. -- 68,241 103,629
Deferred income taxes................................... 37,051 30,998 43,888
Prepaid expenses and other current assets............... 23,291 37,930 170,355
-------- -------- -----------
Total current assets............................ 117,172 278,960 525,367
Property, buildings and equipment:
Furniture and fixtures.................................. 8,931 8,931 16,567
Machinery and equipment................................. 61,216 71,677 153,648
Vehicles................................................ 17,473 2,394 70,368
Leasehold improvements.................................. 17,893 17,285 26,582
-------- -------- -----------
105,513 100,287 267,165
Less accumulated depreciation and amortization.......... (28,451) (45,648) (68,885)
-------- -------- -----------
77,062 54,639 198,280
Goodwill, net............................................. 467,176 433,806 417,122
Other assets.............................................. 7,938 9,479 14,077
-------- -------- -----------
Total assets.................................... $669,348 $776,884 $ 1,154,846
======== ======== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities.......... $217,070 $111,615 $ 255,518
Accrued compensation.................................... 34,509 63,211 35,492
Accrued taxes, other than income........................ 4,048 5,942 15,244
Accrued warranties...................................... 29,954 31,715 43,870
Income taxes payable.................................... 34,190 96,526 127,221
Deferred revenue........................................ 98,233 78,718 93,205
Current portion of long-term debt and capital leases.... 43,805 19,008 26,782
Due to related parties.................................. 20,000 117,606 --
Liability to Company benefit plan....................... 452 -- --
-------- -------- -----------
Total current liabilities....................... 482,261 524,341 597,332
Long-term debt, net of current portion.................... 6,262 1,965 910
Capital lease obligations, less current portion........... 19,685 14,016 132,828
Deferred income taxes..................................... 1,796 1,383 1,383
Stockholders' equity:
Common stock ($1 per share par value, 30,000 shares
authorized, 4,666 shares issued and outstanding at
December 31, 1995 and 1994 and June 30, 1996)........ 4,666 4,666 4,666
Paid-in capital in excess of par value of common
stock................................................ 176,834 176,834 176,834
Retained earnings....................................... (22,156) 53,679 240,893
-------- -------- -----------
Total stockholders' equity...................... 159,344 235,179 422,393
-------- -------- -----------
Total liabilities and stockholders' equity...... $669,348 $776,884 $ 1,154,846
======== ======== =========
</TABLE>
See accompanying notes.
F-143
<PAGE> 215
AIR EXPERTS, A UNITED SERVICES CO., INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE
YEAR ENDED DECEMBER 31, 30,
----------------------- -----------------------
1994 1995 1995 1996
---------- ---------- ---------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C>
Net revenues.................................... $2,166,990 $2,554,838 $1,123,711 $1,750,233
Cost of goods sold.............................. 1,300,590 1,289,891 547,585 1,015,958
---------- ---------- ---------- ----------
Gross margin.................................... 866,400 1,264,947 576,126 734,275
Selling, general and administrative expenses.... 878,642 1,112,360 490,609 651,165
---------- ---------- ---------- ----------
Income (loss) from operations................... (12,242) 152,587 85,517 83,110
Other income (expense):
Interest expense.............................. (2,848) (17,012) (3,156) (8,255)
Interest income............................... 3 59 56 72
Other income.................................. 31,455 8,176 2,070 36,793
---------- ---------- ---------- ----------
28,610 (8,777) (1,030) 28,610
---------- ---------- ---------- ----------
Income before federal and state income taxes.... 16,368 143,810 84,487 111,720
Provision (benefit) for income taxes:
Current....................................... 34,190 62,335 30,796 30,696
Deferred...................................... 4,334 5,640 (3,907) (12,890)
---------- ---------- ---------- ----------
38,524 67,975 26,889 17,806
---------- ---------- ---------- ----------
Net income (loss)............................... $ (22,156) $ 75,835 $ 57,598 $ 93,914
========= ========= ========= =========
</TABLE>
See accompanying notes.
F-144
<PAGE> 216
AIR EXPERTS, A UNITED SERVICES CO., INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
--------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ -------- -------- --------
<S> <C> <C> <C> <C> <C>
Beginning balance............................... -- $ -- $ -- $ -- $ --
Purchase of company........................... 4,666 4,666 176,834 -- 181,500
Net income.................................... -- -- -- (22,156) (22,156)
------ ------ -------- -------- --------
Balance at December 31, 1994.................... 4,666 4,666 176,834 (22,156) 159,344
Net income.................................... -- -- -- 75,835 75,835
------ ------ -------- -------- --------
Balance at December 31, 1995.................... 4,666 4,666 176,834 53,679 235,179
------ ------ -------- -------- --------
Capital distributions (unaudited)............. -- -- -- 93,300 93,300
Net income (unaudited)........................ -- -- -- 93,914 93,914
------ ------ -------- -------- --------
Balance at June 30, 1996 (unaudited)............ 4,666 $4,666 $176,834 $240,893 $422,393
====== ====== ======== ======== ========
</TABLE>
See accompanying notes.
F-145
<PAGE> 217
AIR EXPERTS, A UNITED SERVICES CO., INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER SIX MONTHS ENDED
31, JUNE 30,
--------------------- -------------------
1994 1995 1995 1996
--------- --------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)................................... $ (22,156) $ 75,835 $ 57,599 $ 93,914
Adjustments to reconcile net income (loss) to net
cash provided by operating activities:
Depreciation and amortization..................... 61,822 59,545 31,808 39,920
Deferred income taxes............................. 4,334 5,640 (3,907) (12,890)
Provisions for loss on (recoveries of) accounts
receivable..................................... 1,534 (774) (774) --
Gain on asset disposals........................... -- (3,216) -- --
Changes in assets and liabilities:
Receivables.................................... 21,962 (23,092) (18,020) (91,047)
Inventories.................................... 4,221 (68,241) (39,177) (35,388)
Prepaid expenses and other current assets...... 5,827 (14,639) (7,447) (132,425)
Trade accounts payable and accrued
liabilities.................................. (74,948) (105,455) (38,455) 143,903
Accrued compensation........................... (5,115) 28,702 19,743 (27,719)
Accrued taxes, other than income............... (7,461) 1,894 1,312 9,302
Accrued warranties............................. (9,728) 1,761 (4,842) 12,155
Deferred revenue............................... (7,111) (19,515) 21,850 14,487
Income taxes payable........................... 34,190 62,335 26,462 30,697
Liability to Company benefit plan.............. 452 (452) -- --
--------- --------- -------- --------
Net cash flow provided by operating activities...... 7,823 328 46,152 44,909
INVESTING ACTIVITIES
Purchase of property, buildings, and equipment...... (45,213) (5,884) (1,015) (9,169)
Proceeds from sale of property, buildings, and
equipment......................................... -- 5,349 -- --
Cash received from acquisition of business.......... 76,906 -- -- --
(Increase) decrease in other assets................. 11,212 (1,541) (13,145) (4,598)
--------- --------- -------- --------
Net cash provided by (used in) investing
activities........................................ 42,905 (2,076) (14,160) (13,767)
FINANCING ACTIVITIES
Proceeds of long-term debt.......................... 117,105 -- -- --
Payments of long-term debt and capital leases....... (112,465) (34,763) (13,829) (32,178)
Due to related parties.............................. (40,000) 97,606 -- (24,306)
--------- --------- -------- --------
Net cash provided by (used in) financing
activities........................................ (35,360) 62,843 (13,829) (56,484)
--------- --------- -------- --------
Increase (decrease) in cash......................... 15,368 61,095 18,163 (25,342)
Cash at beginning of year........................... -- 15,368 15,368 76,463
--------- --------- -------- --------
Cash at end of year................................. $ 15,368 $ 76,463 $ 33,531 $ 51,121
========= ========= ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid....................................... $ 2,848 $ 5,051 $ 3,156 $ 8,255
========= ========= ======== ========
Purchase of equipment through capital leases........ $ 3,068 $ 5,600 $ -- $157,709
========= ========= ======== ========
ACQUISITION OF COMPANY
Common stock issued................................. $ 181,500
Liabilities assumed................................. 613,289
---------
Fair value of assets acquired excluding cash........ (717,883)
---------
Cash received....................................... $ 76,906
=========
</TABLE>
See accompanying notes.
F-146
<PAGE> 218
AIR EXPERTS, A UNITED SERVICES CO., INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1995
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Air Experts, a United Services Co., Inc. ("the Company"), a wholly-owned
subsidiary of Service Now, Inc. operates in one industry segment and is
primarily engaged in the installation and servicing of air conditioning and
heating systems for residential customers in St. Louis. On January 2, 1994,
(effective January 1, 1994) Service Now purchased all the outstanding shares of
stock of the Company and accounted for the transaction by the purchase method
recording goodwill of $500,546. Prior to the purchase, Air Experts was owned by
an individual who is also a shareholder of Service Now, Inc. The aggregate
purchase price included adjustments for the shareholder's basis in the Company.
Amortization is provided on the straight-line basis over 15 years, which totaled
$33,370 and $33,370 in both 1994 and 1995.
RECOGNITION OF INCOME
Revenue on all of the Company's heating and air conditioning installation
for residential and service and maintenance are recognized upon completion of
the services.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash approximate
fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost.
Depreciation is provided on the straight-line basis over five years, except
leases which are depreciated over five years or the life of the lease, whichever
is shorter.
Depreciation expense was $28,451 and $24,353 and 1995, respectively.
WARRANTIES
The Company provides retail customers with a one-year warranty on labor
from the date of installation of the heating and air conditioning unit. This
warranty runs concurrent with the manufacturer's warranty on parts for the first
year. The Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
F-147
<PAGE> 219
AIR EXPERTS, A UNITED SERVICES CO., INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING COSTS
Advertising costs primarily relate to brochures which are accounted for as
prepaid supplies and expensed as distributed. The Company had no prepaid
advertising at December 31, 1994. The Company had $20,014 of prepaid advertising
at December 31, 1995. Advertising expense was $87,175 and $158,350 in 1994 and
1995, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
During 1994 and 1995, the Company used the liability method of accounting
for income taxes as provided by SFAS No. 109, "Accounting for Income Taxes."
Under the liability method, the deferred tax liability or asset is based on
temporary differences between the financial statement and income tax bases of
assets and liabilities, measured at estimated tax rates that will be in effect
when the differences reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1994 and 1995, amounts charged to bad
debt expense totaled ($614) and $541, respectively, and accounts written off,
net of recoveries, were ($2,148) and $1,315, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
opinions, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued opinions would have a significant impact on the Company's financial
statements.
2. LONG-TERM DEBT
Long-term debt, including capital lease obligations consists of the
following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Note payable to Tokai Financial, monthly payments of $1,000
including principal and interest at 9%, matures July 1996...... $ 21,411 $ 6,262
Term loan with bank, secured by vehicle, monthly payments of $187
including principal and interest at 9.2%, matures November
1997........................................................... -- 3,926
Note payable to Premium Assignment Corporation, monthly payments
of $8,066 including principal and interest at 7%, matured
February 1995.................................................. 16,013 --
Capital lease obligations, payable in monthly installments of
various amounts, maturing February 1996 to March 2001.......... 32,328 19,686
Capital lease obligations -- related party, monthly payments of
$202 including principal and interest at 18%, matures 1998..... -- 5,115
-------- --------
69,752 34,989
Less current portion............................................. (43,805) (19,008)
-------- --------
$ 25,947 $ 15,981
======== ========
</TABLE>
F-148
<PAGE> 220
AIR EXPERTS, A UNITED SERVICES CO., INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt (excluding capital lease obligations) are as
follows:
<TABLE>
<S> <C>
1996............................................................... $ 8,223
1997............................................................... 1,965
-------
$10,188
=======
</TABLE>
Based on market interest rates at December 31, 1995 the fair value of the
long-term debt approximates its carrying value.
3. LEASES
Total rental expense for all operating leases was $78,783 and $61,952 for
1994 and 1995, respectively. The Company leases certain office and warehouse
facilities, vehicles, and equipment under terms of noncancelable operating lease
agreements which expire at various dates through March 1999. Minimum rental
commitments at December 31, 1995 under capital and operating leases having an
initial noncancelable term of one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $13,480 $48,439
1997.............................................................. 8,132 15,689
1998.............................................................. 7,322 8,787
1999.............................................................. 475 1,500
------- ---------
29,409 $74,415
=======
Amounts representing interest..................................... (4,608)
-------
Present value of net minimum rentals (including $10,785 classified
as current)..................................................... $24,801
=======
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Machinery and equipment.......................................... $ 55,087 $ 60,687
Less accumulated amortization.................................... (27,527) (37,772)
-------- --------
Net property, plant and equipment under capital leases........... $ 27,560 $ 22,915
======== ========
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
4. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position or results of operations of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
F-149
<PAGE> 221
AIR EXPERTS, A UNITED SERVICES CO., INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
5. INCOME TAXES
The Company is included in the consolidated return of Service Now, Inc.
Income tax for the Company is calculated as if the Company filed a separate
return.
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Current:
Federal.......................................................... $27,025 $51,212
State............................................................ 7,165 11,123
------- -------
34,190 62,335
Deferred........................................................... 4,334 5,640
------- -------
$38,524 $67,975
======= =======
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization.................................. $ 1,796 $ 1,383
-------- --------
Deferred tax liabilities......................................... 1,796 1,383
Deferred tax assets:
Deferred revenue............................................... 23,533 17,593
Accrued warranty............................................... 11,383 12,052
Contributions.................................................. 33,340 46,097
Other.......................................................... 2,135 1,353
-------- --------
Deferred tax assets.............................................. 70,391 77,095
Valuation allowance.............................................. (33,340) (46,097)
-------- --------
Net deferred tax assets.......................................... 37,051 30,998
-------- --------
Net deferred tax liabilities (assets)............................ $(35,255) $(29,615)
======== ========
</TABLE>
A valuation allowance of $46,097 has been provided against the deferred tax
assets as the Company cannot conclude that it is more likely than not that these
deferred tax assets will be realized. In connection with the acquisition as
described in Note 1 (which was treated as a tax-free exchange for tax purposes),
a valuation allowance of $43,429 was recorded against the deferred tax assets.
During 1994, the Company determined that $39,589 of these assets were realizable
and recorded the related tax benefits as a reduction of goodwill. Of the $46,097
reserve at December 31, 1995, $3,840 relates to assets acquired on January 2,
1994. If these assets are realized in the future, the related tax benefits will
be recorded as a reduction of goodwill. The remaining $42,257 relates to assets
which arose after the acquisition. If these assets are realized in the future,
the related tax benefits will reduce income tax expense.
F-150
<PAGE> 222
AIR EXPERTS, A UNITED SERVICES CO., INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1994 1995
-------- --------
<S> <C> <C>
Tax provision at statutory rate.................................. $ 5,565 $ 48,895
State income tax less applicable federal tax benefit............. 5,030 7,734
Goodwill amortization............................................ 11,346 11,346
Change in valuation allowance.................................... 29,500 12,757
Rate differential................................................ (12,917) (12,757)
-------- --------
$ 38,524 $ 67,975
======== ========
</TABLE>
6. RELATED PARTY TRANSACTIONS
The Company paid rental fees for an office building of $35,414 and $30,000
at December 31, 1994 and 1995, respectively, to STEFCO, whose owner is a
shareholder of the Company's Parent, Service Now, Inc.
The Company has an obligation to its Parent of $20,000 at 12.5% interest at
December 31, 1994 and 1995, respectively, for which there is no fixed repayment
schedule.
The Company also has a capital lease for computer software with its Parent
which has an outstanding obligation of $5,115 at December 31, 1995.
The Company has an obligation to Contractor Success Group (CSG) of $97,606
at 8% interest at December 31, 1995. The Company paid CSG $6,775 and $32,293
during 1994 and 1995, respectively, for monthly membership dues and various
sales materials. The shareholders of CSG also are majority interest shareholders
of the Company's Parent.
7. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
8. UNAUDITED INTERIM FINANCIAL INFORMATION
The statements of income (loss) and cash flows for the six months ended
June 30, 1995 and 1996, (interim financial statements) have been prepared by
management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996, may not be indicative of
operating results for the full respective years.
F-151
<PAGE> 223
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Gilley's Heating & Cooling, Inc.
We have audited the accompanying balance sheets of Gilley's Heating &
Cooling, Inc. as of December 31, 1994 and 1995, and the related statements of
income, stockholder's equity, and cash flows for each of the three years in the
period ended December 31, 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Gilley's Heating & Cooling,
Inc. at December 31, 1994 and 1995, and the results of their operations and
their cash flows for each of the three years in the period ended December 31,
1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-152
<PAGE> 224
GILLEY'S HEATING & COOLING, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
----------------------- ---------
1994 1995 1996
--------- --------- ---------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents............................. $ 321,199 $ 338,032 $ 234,601
Receivables:
Trade, net of allowance for doubtful accounts of
$2,367, $3,232 and $808 in 1994, 1995 and 1996,
respectively..................................... 68,291 104,817 185,763
Related party...................................... -- 12,495 9,494
Other.............................................. -- 2,600 --
--------- --------- ---------
68,291 119,912 195,257
Inventories........................................... 67,014 79,379 104,073
Investments........................................... 36,148 60,595 280,269
Prepaid expenses and other current assets............. 2,839 12,305 69,308
Deferred income taxes................................. 1,222 1,099 549
--------- --------- ---------
Total current assets.......................... 496,713 611,322 884,057
Property and equipment:
Furniture and fixtures................................ 75,263 81,269 81,269
Vehicles.............................................. 226,673 226,673 226,673
Leasehold improvements................................ 18,959 18,959 18,959
--------- --------- ---------
320,895 326,901 326,901
Less accumulated depreciation and amortization........ (209,172) (246,442) (262,574)
--------- --------- ---------
111,723 80,459 64,327
Other assets............................................ 8,566 12,431 12,431
--------- --------- ---------
Total assets.................................. $ 617,002 $ 704,212 $ 960,815
========= ========= =========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities........ $ 45,975 $ 32,812 $ 86,618
Accrued compensation.................................. 6,645 8,889 103,257
Accrued taxes, other than income...................... 4,244 5,747 3,769
Accrued warranties.................................... 7,861 11,374 7,500
Income taxes payable.................................. 78,177 56,398 82,926
Deferred revenue...................................... 10,709 13,473 2,970
--------- --------- ---------
Total current liabilities..................... 153,611 128,693 287,040
Deferred income taxes................................... 8,155 9,176 11,918
Stockholder's equity:
Common stock, no par value, 100 shares authorized and
issued............................................. 4,000 4,000 4,000
Unrealized gains (losses) on available-for-sale
securities......................................... (1,250) 5,244 10,745
Retained earnings..................................... 452,486 557,099 647,112
--------- --------- ---------
Total stockholder's equity.................... 455,236 566,343 661,857
--------- --------- ---------
Total liabilities and stockholder's equity.... $ 617,002 $ 704,212 $ 960,815
========= ========= =========
</TABLE>
See accompanying notes.
F-153
<PAGE> 225
GILLEY'S HEATING & COOLING, INC.
STATEMENTS OF INCOME
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------------ ---------------------
1993 1994 1995 1995 1996
---------- ---------- ---------- -------- ----------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues.......................... $1,758,548 $1,798,733 $1,896,365 $847,595 $1,076,675
Cost of goods sold.................... 1,224,111 1,253,203 1,241,385 580,612 699,348
---------- ---------- ---------- -------- ----------
Gross margin.......................... 534,437 545,530 654,980 266,983 377,327
Selling, general and administrative
expenses............................ 488,396 308,229 510,553 253,016 254,876
Bad debt expense...................... 3,941 2,801 3,232 1,616 1,616
---------- ---------- ---------- -------- ----------
Income from operations................ 42,100 234,500 141,195 12,351 120,835
Other income:
Interest income..................... 4,150 3,952 8,845 4,692 2,371
Other income........................ 447 756 967 483 1,132
---------- ---------- ---------- -------- ----------
4,597 4,708 9,812 5,175 3,503
---------- ---------- ---------- -------- ----------
Income before income taxes............ 46,697 239,208 151,007 17,526 124,338
Provision (benefit) for income taxes:
Current............................. 6,567 82,847 47,417 3,127 32,864
Deferred............................ 2,113 2,857 (1,023) 256 1,461
---------- ---------- ---------- -------- ----------
8,680 85,704 46,394 3,383 34,325
---------- ---------- ---------- -------- ----------
Net income............................ $ 38,017 $ 153,504 $ 104,613 $ 14,143 $ 90,013
========= ========= ========= ======== =========
</TABLE>
See accompanying notes.
F-154
<PAGE> 226
GILLEY'S HEATING & COOLING, INC.
STATEMENTS OF STOCKHOLDER'S EQUITY
<TABLE>
<CAPTION>
UNREALIZED
COMMON STOCK, GAINS (LOSSES)
NO PAR VALUE ON AVAILABLE-
--------------- FOR-SALE RETAINED
SHARES AMOUNT SECURITIES EARNINGS TOTAL
------ ------ -------------- -------- --------
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1992.................. 100 $4,000 $ -- $260,965 $264,965
Net income.................................. -- -- -- 38,017 38,017
------ ------ -------------- -------- --------
Balance at December 31, 1993.................. 100 4,000 -- 298,982 302,982
Net income.................................. -- -- -- 153,504 153,504
Adjustment to unrealized losses on
available-for-sale securities, net of
tax...................................... -- -- (1,250) -- (1,250)
------ ------ -------------- -------- --------
Balance at December 31, 1994.................. 100 4,000 (1,250) 452,486 455,236
Net income.................................. -- -- -- 104,613 104,613
Adjustment to unrealized gains on
available-for-sale securities, net of
tax...................................... -- -- 6,494 -- 6,494
------ ------ -------------- -------- --------
Balance at December 31, 1995.................. 100 4,000 5,244 557,099 566,343
Net income (unaudited)...................... -- -- -- 90,013 90,013
Adjustment to unrealized gains on
available-for-sale securities, net of tax
(unaudited).............................. -- -- 5,501 -- 5,501
------ ------ -------------- -------- --------
Balance at June 30, 1996 (unaudited).......... 100 $4,000 $ 10,745 $647,112 $661,857
===== ====== =========== ======== ========
</TABLE>
See accompanying notes.
F-155
<PAGE> 227
GILLEY'S HEATING & COOLING, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
SIX MONTHS ENDED
YEAR ENDED DECEMBER 31, JUNE 30,
------------------------------ --------------------
1993 1994 1995 1995 1996
-------- -------- -------- -------- ---------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income................................. $ 38,017 $153,504 $104,613 $ 14,143 $ 90,013
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization............ 31,478 38,256 37,270 18,135 16,132
Current deferred income taxes............ 2,113 2,857 (1,023) 256 1,461
Provisions for loss on accounts
receivable............................ 3,941 2,801 3,232 1,616 1,616
Loss on asset disposals.................. 1,529 -- -- -- --
Changes in assets and liabilities:
Receivables........................... 1,568 (3,363) (54,853) (87,071) (76,961)
Inventories........................... 38,576 (357) (12,365) (25,662) (24,694)
Prepaid expenses and other current
assets.............................. 1,242 (170) (9,466) 1,313 (57,003)
Trade accounts payable and accrued
liabilities......................... (14,520) 2,904 (13,163) 64,698 53,806
Accrued compensation.................. 54,394 (59,896) 2,244 93,355 94,368
Accrued taxes, other than income...... 28,489 (33,607) 1,503 (4,357) (1,978)
Accrued warranties.................... (2,086) 6,187 3,513 1,171 (3,874)
Deferred revenue...................... (2,314) 1,039 2,764 1,337 (10,503)
Income taxes payable.................. 714 75,026 (21,779) (64,384) 24,777
-------- -------- -------- -------- ---------
Net cash flow provided by operating
activities............................... 183,141 185,181 42,490 14,550 107,160
INVESTING ACTIVITIES
Purchase of property and equipment......... $(10,760) $(64,347) $ (6,006) $ -- $ --
Purchase of investments.................... (16,960) (13,605) (15,786) (7,918) (210,591)
Increase in other assets................... (3,174) (3,654) (3,865) (1,932) --
-------- -------- -------- -------- ---------
Net cash used in investing activities...... (30,894) (81,606) (25,657) (9,850) (210,591)
-------- -------- -------- -------- ---------
Increase (decrease) in cash and cash
equivalents.............................. 152,247 103,575 16,833 4,700 (103,431)
Cash and cash equivalents at beginning of
year..................................... 65,377 217,624 321,199 321,199 338,032
-------- -------- -------- -------- ---------
Cash and cash equivalents at end of year... $217,624 $321,199 $338,032 $325,899 $ 234,601
======== ======== ======== ======== =========
SUPPLEMENTAL CASH FLOW INFORMATION
Income tax paid............................ $ 5,853 $ 7,821 $ 69,196 $ 70,037 $ 12,703
======== ======== ======== ======== =========
</TABLE>
See accompanying notes.
F-156
<PAGE> 228
GILLEY'S HEATING & COOLING, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Gilley's Heating & Cooling, Inc. ("the Company") is a "C" corporation and
operates in one industry segment and is primarily engaged in the installation
and servicing of air conditioning and heating systems for residential customers.
Concentrations of credit risk with respect to trade receivables are limited due
to the large number of customers comprising the Company's customer base.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
for residential installation and service and maintenance revenue are recognized
upon completion of the services.
CASH EQUIVALENTS
The Company considers all highly liquid inventory investments with an
original maturity of three months or less to be cash equivalents.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt approximate
fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
SHORT-TERM INVESTMENTS
Short-term investments include investments in mutual funds. These
investments are accounted for in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 115, "Accounting for Certain Investments in
Debt and Equity Securities." It is the Company's intent not to hold these
investments to maturity.
F-157
<PAGE> 229
GILLEY'S HEATING & COOLING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line and declining-balance methods
over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures...................................................... 5
Machinery and equipment..................................................... 5
Vehicles.................................................................... 5
Leasehold improvements...................................................... 10
</TABLE>
WARRANTIES
The Company provides the retail customer with a two-year warranty on parts
and labor from the date of installation of the heating and air conditioning
unit. This warranty runs concurrent with the manufacturer's warranty on parts
and for the first year on labor. The Company provides an accrual for future
warranty costs based upon the relationship of prior years' sales to actual
warranty costs. It is the Company's practice to classify the entire warranty
accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes." Under the liability method, the deferred tax liability or asset
is based on temporary differences between the financial statement and income tax
bases of assets and liabilities, measured at tax rates that will be in effect
when the differences reverse.
ADVERTISING
The cost of advertising is expensed as incurred. The Company incurred
$47,788, $48,373 and $57,581 is such costs during 1993, 1994 and 1995,
respectively.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1993, 1994 and 1995 amounts charged to
bad debt expense totaled $3,941, $2,801 and $3,232, respectively and accounts
written off, net of recoveries were $2,016, $2,359 and $2,367, respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-158
<PAGE> 230
GILLEY'S HEATING & COOLING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. SHORT-TERM INVESTMENTS
Effective January 1, 1994, the Company adopted SFAS No. 115. The Company's
investment securities are classified as available for sale under SFAS No. 115
and, as a result, the carrying amount is a reasonable estimate of fair value.
The cost of available-for-sale securities was $37,815 and $53,601 at December
31, 1994 and 1995, respectively. The adoption of SFAS No. 115 did not have a
significant impact on the Company's 1994 financial statements.
All investments are classified as current because the Company views its
portfolio as available for use in its current operations.
3. LINE OF CREDIT
The Company has an unsecured line of credit with a bank that expires in
October 1996. Under its terms, the Company can borrow up to $50,000 at prime
plus 1.25%. At December 31, 1994 and 1995, the Company had no borrowings
outstanding under this agreement.
4. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
5. STOCKHOLDER'S COMPENSATION
Stockholder's compensation which consisted of salary and cash bonuses is
included in selling, general and administrative expenses and totaled $300,000,
$104,000 and $296,000 in 1993, 1994 and 1995, respectively.
6. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------
1993 1994 1995
------ ------- -------
<S> <C> <C> <C>
Current:
Federal.................................................. $5,261 $72,912 $41,214
State.................................................... 1,306 9,935 6,203
Deferred................................................... 2,113 2,857 (1,023)
------ ------- -------
$8,680 $85,704 $46,394
====== ======= =======
</TABLE>
F-159
<PAGE> 231
GILLEY'S HEATING & COOLING, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------
1994 1995
------ ------
<S> <C> <C>
Deferred tax liabilities:
Unrealized gain on available-for-sale securities................... $ -- $1,752
Depreciation and amortization...................................... 8,155 7,424
------ ------
8,155 9,176
Deferred tax assets:
Accounts receivable................................................ 805 1,099
Unrealized loss on available-for-sale securities................... 417 --
------ ------
Deferred tax assets.................................................. 1,222 1,099
Valuation allowance.................................................. -- --
------ ------
Net deferred tax assets.............................................. 1,222 1,099
------ ------
Net deferred tax liabilities......................................... $6,933 $8,077
====== ======
</TABLE>
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before income
taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1993 1994 1995
------- ------- -------
<S> <C> <C> <C>
Tax provision at statutory rate........................... $15,877 $81,331 $51,342
State income tax less applicable federal tax benefit...... 862 6,557 4,094
Other, net -- principally effects of graduated rates...... (8,059) (2,184) (9,042)
------- ------- -------
$ 8,680 $85,704 $46,394
======= ======= =======
</TABLE>
7. RELATED PARTY TRANSACTIONS
The Company paid annual rental fees of $18,000 in 1993, 1994 and 1995 to
the president and sole stockholder of the Company.
8. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
9. UNAUDITED INTERIM FINANCIAL INFORMATION
The combined statements of income and cash flows for the six months ended
June 30, 1995 and 1996 (interim financial statements) have been prepared by
management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-160
<PAGE> 232
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Service Experts of Palm Springs, Inc.
We have audited the accompanying balance sheets of Service Experts of Palm
Springs, Inc. as of December 31, 1994 and 1995, and the related statements of
operations, stockholders' equity (deficit), and cash flows for the period from
October 15, 1993 (date operations commenced) through December 31, 1993, and the
years ended December 31, 1994 and 1995. These financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Service Experts of Palm
Springs, Inc. at December 31, 1994 and 1995, and the results of their operations
and their cash flows for the period from October 15, 1993 (date operations
commenced) through December 31, 1993, and for the years ended December 31, 1994
and 1995, in conformity with generally accepted accounting principles.
/s/ ERNST & YOUNG LLP
--------------------------------------
Ernst & Young LLP
Nashville, Tennessee
May 10, 1996
F-161
<PAGE> 233
SERVICE EXPERTS OF PALM SPRINGS, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
------------------- --------
1994 1995 1996
-------- -------- --------
(UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents.................................... $ 2,933 $ 82,008 $ 64,916
Receivables:
Trade, net of allowance for doubtful accounts of $2,400 in
1994, $9,000 in 1995, and $-0- in 1996.................. 15,563 33,989 17,915
Employee.................................................. -- 881 --
-------- -------- --------
15,563 34,870 17,915
Inventories.................................................. 21,550 18,775 20,924
Prepaid expenses and other current assets.................... 26,320 29,460 76,123
Deferred income taxes........................................ -- 25,000 20,737
-------- -------- --------
Total current assets................................. 66,366 190,113 200,615
Property and equipment:
Furniture and fixtures....................................... 7,036 8,362 8,362
Machinery and equipment...................................... 34,487 76,653 78,054
Vehicles..................................................... 2,500 2,500 2,500
-------- -------- --------
44,023 87,515 88,916
Less accumulated depreciation and amortization............... 5,385 17,859 22,394
-------- -------- --------
38,638 69,656 66,522
Intangible assets, net of accumulated amortization of $2,589 in
1994 and $5,666 in 1995 and 1996............................. 44,811 41,734 40,936
-------- -------- --------
Total assets......................................... $149,815 $301,503 $308,073
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Trade accounts payable and accrued liabilities............... $ 47,234 $ 2,805 $ 33,212
Accrued compensation......................................... 17,466 30,760 24,599
Accrued warranties........................................... 7,058 9,595 10,886
Income taxes payable......................................... -- 41,000 57,050
Deferred revenue............................................. 34,511 42,032 39,692
Current portion of long-term debt and capital lease
obligations............................................... 46,069 40,775 --
-------- -------- --------
Total current liabilities............................ 152,338 166,967 165,439
Long-term debt and capital lease obligations, net of current
portion...................................................... 69,362 47,686 --
Deferred income taxes.......................................... -- 5,500 5,426
Stockholders' equity (deficit):
Common stock, $1 par value; 1,000 shares authorized, 100
shares issued and outstanding............................. 100 100 100
Additional paid-in capital................................... 59,900 59,900 59,900
(Accumulated deficit) retained earnings...................... (131,885) 21,350 77,208
-------- -------- --------
Total shareholders' (deficit) equity................. (71,885) 81,350 137,208
-------- -------- --------
Total liabilities and stockholders' equity
(deficit).......................................... $149,815 $301,503 $308,073
======== ======== ========
</TABLE>
See accompanying notes.
F-162
<PAGE> 234
SERVICE EXPERTS OF PALM SPRINGS, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 15, YEAR ENDED DECEMBER SIX MONTHS ENDED
1993 THROUGH 31, JUNE 30,
DECEMBER 31, --------------------- -------------------
1993 1994 1995 1995 1996
------------ -------- ---------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues.......................... $ 54,175 $999,164 $1,361,727 $674,098 $594,058
Cost of goods sold.................... 43,092 632,425 707,598 325,147 280,188
------------ -------- ---------- -------- --------
Gross margin.......................... 11,083 366,739 654,129 348,951 313,870
Selling, general and administrative
expenses............................ 50,186 449,052 454,847 235,110 234,633
Bad debt expense...................... -- 2,400 9,323 -- --
------------ -------- ---------- -------- --------
Income (loss) from operations......... (39,103) (84,713) 189,959 113,841 79,237
Other income (expense):
Interest expense.................... (105) (8,438) (15,253) (820) (3,140)
Other income........................ -- 474 29 1,315 --
------------ -------- ---------- -------- --------
(105) (7,964) (15,224) 495 (3,140)
------------ -------- ---------- -------- --------
Income (loss) before federal and state
income taxes........................ (39,208) (92,677) 174,735 114,336 76,097
Provision (benefit) for income taxes:
Current............................. -- -- 41,000 39,527 16,119
Deferred............................ -- -- (19,500) (4,772) 4,120
------------ -------- ---------- -------- --------
-- -- 21,500 34,755 20,239
------------ -------- ---------- -------- --------
Net income (loss)..................... $(39,208) $(92,677) $ 153,235 $ 79,581 $ 55,858
============ ======== ========= ======== ========
</TABLE>
See accompanying notes.
F-163
<PAGE> 235
SERVICE EXPERTS OF PALM SPRINGS, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK, (ACCUMULATED
$1 PAR VALUE ADDITIONAL DEFICIT)
--------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- ------------ ---------
<S> <C> <C> <C> <C> <C>
Beginning balance............................. -- $ -- $ -- $ -- $ --
Issuance of stock........................... 100 100 59,900 -- 60,000
Net loss.................................... -- -- -- (39,208) (39,208)
------ ------ ---------- ------------ ---------
Balance at December 31, 1993.................. 100 100 59,900 (39,208) 20,792
Net loss.................................... -- -- -- (92,677) (92,677)
------ ------ ---------- ------------ ---------
Balance at December 31, 1994.................. 100 100 59,900 (131,885) (71,885)
Net income.................................. -- -- -- 153,235 153,235
------ ------ ---------- ------------ ---------
Balance at December 31, 1995.................. 100 100 59,900 21,350 81,350
Net income (unaudited)...................... -- -- -- 55,858 55,858
------ ------ ---------- ------------ ---------
Balance at June 30, 1996 (unaudited).......... 100 $100 $ 59,900 $ 77,208 $ 137,208
===== ====== ======= ========== =========
</TABLE>
See accompanying notes.
F-164
<PAGE> 236
SERVICE EXPERTS OF PALM SPRINGS, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
PERIOD FROM
OCTOBER 15, YEAR ENDED DECEMBER SIX MONTHS ENDED JUNE
1993 THROUGH 31, 30,
DECEMBER 31, ---------------------- ---------------------
1993 1994 1995 1995 1996
------------ --------- -------- -------- --------
(UNAUDITED)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss).................. $(39,208) $ (92,677) $153,235 $ 79,581 $ 55,858
Adjustments to reconcile net income
(loss) to net cash provided by
(used in) operating activities:
Depreciation and amortization.... 197 7,775 15,551 4,200 4,535
Deferred income taxes............ -- -- (19,500) (4,772) 4,120
Provisions for loss on accounts
receivable.................... -- 2,400 6,600 -- --
Changes in assets and
liabilities:
Receivables................... (9,262) (8,701) (25,907) (16,041) 16,955
Inventories................... (525) (21,025) 2,775 (10,485) (46,032)
Prepaid expenses and other
current assets.............. (19,405) (6,915) (3,140) 9,918 (2,780)
Trade accounts payable and
accrued liabilities......... 2,903 44,331 (44,429) (37,292) 30,407
Accrued compensation.......... 6,721 10,745 13,294 (11,160) (6,161)
Accrued warranties............ 406 6,652 2,537 (4,192) 1,291
Deferred revenue.............. -- 34,511 7,521 5,024 (2,340)
Income taxes payable.......... -- -- 41,000 48,992 16,119
------------ --------- -------- -------- --------
Net cash flows provided by (used
in) operating activities......... (58,173) (22,904) 149,537 63,773 71,972
INVESTING ACTIVITIES
Purchase of property and
equipment........................ (7,860) (36,163) (43,492) (6,351) (1,401)
Purchase of customer lists......... (2,400) (45,000) -- (2,455) 798
------------ --------- -------- -------- --------
Net cash used in investing
activities....................... (10,260) (81,163) (43,492) (8,806) (603)
FINANCING ACTIVITIES
Issuance of common stock, including
additional paid-in-capital....... 60,000 -- -- -- --
Proceeds of long-term debt......... 14,891 125,009 38,384 -- --
Payments on long-term debt and
capital leases................... (1,609) (22,858) (65,354) (25,137) (88,461)
------------ --------- -------- -------- --------
Net cash provided by (used in)
financing activities............. 73,282 102,151 (26,970) (25,137) (88,461)
------------ --------- -------- -------- --------
Increase (decrease) in cash........ 4,849 (1,916) 79,075 29,830 (17,092)
Cash at beginning of year.......... -- 4,849 2,933 2,933 82,008
------------ --------- -------- -------- --------
Cash at end of year................ $ 4,849 $ 2,933 $ 82,008 $ 32,763 $ 64,916
============ ========= ======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid...................... $ 105 $ 6,952 $ 16,739 $ 4,240 $ 2,270
============ ========= ======== ======== ========
Income tax paid.................... $ -- $ 800 $ 800 $ 800 $ 12,000
============ ========= ======== ======== ========
</TABLE>
See accompanying notes.
F-165
<PAGE> 237
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 31, 1994 AND 1995 AND MARCH 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION
The Company was incorporated in the state of California during October of
1993. At that time, 1,000 shares of capital stock were authorized with a par
value of $1 per share. Capital of $60,000 was received in exchange for 100
shares of the Company's stock during 1993, resulting in additional paid-in
capital of $59,900.
REPORTING ENTITY
Service Experts of Palm Springs, Inc. ("the Company") is primarily engaged
in the installation and servicing of air conditioning and heating systems for
residential customers in and around Palm Springs, California. The Company
commenced operations in October of 1993. Accordingly, 1993 includes
approximately three months of operations, compared to twelve months during 1994
and 1995.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
and other services are recognized upon completion of the services.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value.
Long-Term Debt and Capital Lease Obligations
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and capital
lease obligations approximate fair value.
INVENTORIES
Inventories are stated at the lower of cost or market. Cost is determined
principally by the first-in, first-out (FIFO) method for all inventories.
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization, including that associated with equipment acquired under capital
leases, are provided on the straight-line method over the following useful
lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................................ 5
Machinery and equipment....................................................... 5
Vehicles...................................................................... 5
</TABLE>
F-166
<PAGE> 238
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
INTANGIBLE ASSETS
Intangible assets include customer lists purchased from outside parties and
are recorded at cost, net of accumulated amortization. Such assets are amortized
on a straight-line basis over a period of 15 years.
WARRANTIES
The Company provides customers with a one-year warranty on parts and labor
from the date of installation of the heating and air conditioning unit. This
warranty runs concurrent with the manufacturer's warranty on parts. The Company
provides an accrual for future warranty costs based upon the relationship of
prior years' sales to actual warranty costs. It is the Company's practice to
classify the entire warranty accrual as a current liability.
ADVERTISING COSTS
Costs associated with advertising are expensed at the time of the
advertisement's first showing. Advertising expenses totaled approximately $200,
$54,000 and $92,000 for the period from October 15, 1993 through December 31,
1993 and years ended December 31, 1994 and 1995, respectively.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided in Statement of Financial Accounting Standards No. 109 "Accounting for
Income Taxes." Under the liability method, the deferred tax liability or asset
is based on temporary differences between the financial statement and income tax
bases of assets and liabilities, measured at tax rates that will be in effect
when the differences reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
For the period October 15, 1993 (date operations commenced), through
December 31, 1993, and the years ended December 31, 1994 and December 31, 1995
amounts charged to bad debt expense totaled $0, $2,400 and $9,323, respectively
and accounts written off, net of recoveries were $0, $0 and $2,723,
respectively.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-167
<PAGE> 239
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. LONG-TERM DEBT
Long-term debt consist of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
-------- -------
<S> <C> <C>
Notes payable to related party.................................. $ 69,842 $33,254
Note payable for insurance coverage............................. 24,838 17,859
Loan payable to a bank.......................................... 20,751 14,410
Capital leases.................................................. -- 22,938
-------- -------
115,431 88,461
Less current portion............................................ 46,069 40,775
-------- -------
$ 69,362 $47,686
======== =======
</TABLE>
The Company has notes payable to a party related through similar ownership.
These notes are due through 1999 and were given in exchange for cash to fund
operations and finance capital purchases. The notes require monthly payments of
$1,500 including principal and interest at 8%. Subsequent to December 31, 1995,
the Company used available funds to pay down a significant portion of these
notes, leaving approximately $1,300 due as of March 31, 1996.
Insurance coverage is financed annually through an outside lending
institution. The Company has a note payable to this institution that requires
monthly payments of $2,575 including principal and interest at 8%.
The Company has a term loan with a bank that expires in 1997. The loan is
secured by equipment and requires monthly payments of approximately $630
including principal and interest at 9.4%.
Certain computer software is leased under capital lease agreements with
parties related to the Company through similar ownership. The leases continue
through 1999. Ownership of this software will transfer to the Company at the end
of the lease term. The leases are payable in monthly installments of
approximately $700 including implicit interest at 8%.
As of December 31, 1995, the aggregate amounts of annual principal
maturities of long-term debt (excluding capital lease obligations) are as
follows:
<TABLE>
<S> <C>
1996............................................................ $33,933
1997............................................................ 16,159
1998............................................................ 10,079
1999............................................................ 5,352
-------
$65,523
=======
</TABLE>
3. LEASES
Total rental expense for all operating leases was approximately $7,500,
$53,000 and $49,000 for the years ended December 31, 1993, 1994 and 1995,
respectively. The Company leases certain office and warehouse facilities and
equipment, as well as vehicles under terms of noncancellable operating lease
agreements which
F-168
<PAGE> 240
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
expire at various dates through 1998. Minimum rental commitments at December 31,
1995 under capital and operating leases having an initial noncancellable term of
one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1996.............................................................. $ 8,430 $41,000
1997.............................................................. 8,430 27,500
1998.............................................................. 7,620 1,300
1999.............................................................. 1,500 --
------- ---------
25,980 $69,800
=======
Amounts representing interest..................................... 3,042
-------
Present value of net minimum rentals, including $1,588 classified
as
current......................................................... $22,938
=======
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1994 1995
------- -------
<S> <C> <C>
Machinery and equipment............................................ $ -- $24,885
Less accumulated amortization...................................... -- 1,786
------- -------
Net property and equipment under capital leases.................... $ -- $23,099
======= =======
</TABLE>
4. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code. Substantially all
employees are eligible to participate in the plan. Under the plan's provisions,
a plan member may annually contribute, on a tax-deferred basis, 2% to 12% of
total compensation, not to exceed the maximum established annually by the
Internal Revenue Service. Matching contributions are made by the Company in an
amount determined at the discretion of management. The Company's matching
contributions for 1995 totaled approximately $3,000. No contributions were made
during 1994 or 1993.
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage to insure itself
against liabilities occurring in the normal course of business. The Company
believes that its insurance coverage is adequate.
F-169
<PAGE> 241
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
6. INCOME TAXES
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1994 1995
-------- -------
<S> <C> <C>
Deferred tax liabilities:
Depreciation and amortization................................. $ 1,800 $ 5,500
-------- -------
Total deferred tax liabilities........................ 1,800 5,500
Deferred tax assets:
Net operating loss carryforwards.............................. 39,500 --
Deferred revenue.............................................. 8,800 17,200
Other......................................................... 4,000 7,800
-------- -------
Total deferred tax assets............................. 52,300 25,000
Valuation allowance for deferred tax assets..................... (50,500) --
-------- -------
Net deferred tax assets......................................... 1,800 25,000
-------- -------
Net deferred tax assets......................................... $ -- $19,500
======== =======
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will be more likely than not realized during the carryforward period.
Accordingly, no valuation allowance has been recorded for the year ended
December 31, 1995. The valuation allowance was decreased by $50,500 during the
year ended December 31, 1995.
Significant components of the (benefit) provision for income taxes
attributable to continuing operations are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Current:
Federal.............................................. $ -- $ -- $ 31,000
State................................................ -- -- 10,000
-------- -------- --------
-- -- 41,000
Deferred:
Federal.............................................. -- -- (16,100)
State................................................ -- -- (3,400)
-------- -------- --------
-- ..... -- (19,500)
-------- -------- --------
Provision for income taxes $ -- $ -- $ 21,500
======== ======== ========
</TABLE>
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income (loss) before
income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------------
1993 1994 1995
-------- -------- --------
<S> <C> <C> <C>
Tax (benefit) provision at federal statutory rate...... $(13,300) $(22,500) $ 59,500
State income tax less applicable federal tax benefit... (1,400) (2,300) 12,500
Change in valuation allowance.......................... -- -- (50,500)
Net operating losses for which no benefit was
recognized........................................... 14,700 24,800 --
-------- -------- --------
$ -- $ -- $ 21,500
======== ======== ========
</TABLE>
F-170
<PAGE> 242
SERVICE EXPERTS OF PALM SPRINGS, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
7. RELATED PARTY TRANSACTIONS
The Company paid management and other service fees of approximately $2,000,
$28,500 and $34,500 during the period from October 15, 1993 through December 31,
1993 and for years ended December 31, 1994 and 1995, respectively, to parties
with similar ownership to that of the Company.
8. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
The Company plans to exchange shares of its common stock in exchange for
shares of common stock and cash of Service Experts, Inc. simultaneously with
Service Experts, Inc. closing the initial public offering of its common stock.
Service Experts, Inc. was formed primarily for the purpose of acquiring air
conditioning and heating companies, similar to the Company, in exchange for
shares of its common stock and cash. The combination is to be effected in
accordance with executed combination agreements with air conditioning and
heating companies and Service Experts, Inc.
9. UNAUDITED INTERIM FINANCIAL INFORMATION
The statements of operations and cash flows for the six months ended June
30, 1995 and 1996 (interim financial statements) have been prepared by
management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1993, 1994 and 1995 audited financial statements appearing herein. The results
of the six months ended June 30, 1995 and 1996 may not be indicative of
operating results for the full respective years.
F-171
<PAGE> 243
- ------------------------------------------------------
- ------------------------------------------------------
NO PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY
REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS IN CONNECTION WITH
THE OFFER MADE BY THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR
REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY
OR ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF ANY OFFER TO BUY ANY OF THE SECURITIES OFFERED HEREBY BY ANYONE
IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED, OR IN
WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO, OR
TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER
THE DELIVERY OF THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY
CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 8
Use of Proceeds....................... 12
S Corporation Distributions........... 12
Dividend Policy....................... 13
Capitalization........................ 13
Dilution.............................. 14
Selected Combined Financial Data...... 15
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 22
Business.............................. 43
The Combination....................... 53
Management............................ 57
Certain Transactions.................. 61
Principal Stockholders................ 63
Description of Capital Stock.......... 64
Shares Eligible for Future Sale....... 66
Underwriting.......................... 67
Legal Matters......................... 68
Experts............................... 68
Available Information................. 69
Index to Combined Financial
Statements.......................... F-1
</TABLE>
---------------------
UNTIL SEPTEMBER , 1996, (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL
DEALERS EFFECTING TRANSACTIONS IN THE REGISTERED SECURITIES, WHETHER OR NOT
PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS.
THIS IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN
ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR
SUBSCRIPTIONS.
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
- ------------------------------------------------------
2,250,000 SHARES
[LOGO] SERVICE EXPERTS(R)
COMMON STOCK
--------------------
PROSPECTUS
--------------------
EQUITABLE SECURITIES
CORPORATION
MORGAN KEEGAN &
COMPANY, INC.
August , 1996
- ------------------------------------------------------
- ------------------------------------------------------
<PAGE> 244
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 13 OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION.
<TABLE>
<S> <C>
Commission Registration Fee...................................................... $ 12,492
National Association of Securities Dealers, Inc. Fee............................. 4,123
Nasdaq National Market Fee....................................................... 38,125
State Qualification Expenses (including legal fees).............................. 15,000
Printing Expenses................................................................ 275,000
Legal Fees and Expenses.......................................................... 325,000
Auditors' Fees and Expenses...................................................... 1,600,000
Transfer Agent and Registrar Fees................................................ 15,000
Miscellaneous Expenses........................................................... 165,260
----------
Total.................................................................. $2,450,000(1)
=========
</TABLE>
- ---------------
(1) Of this amount, $1,300,000 in expenses have been prepaid by the Company.
ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
(a) The Delaware General Corporation Law ("DGCL") provides that a
corporation may indemnify any person made party to an action by reason of such
person's status as a director, officer, employee or agent of the corporation
against expenses, judgments, fines and settlements provided such person acted
(i) in good faith, (ii) in a manner reasonably believed to be in or not opposed
to the best interests of the Corporation and (iii) with respect to a criminal
action, had no reasonable cause to believe such person's conduct was unlawful.
The termination of an action by a judgment, order, settlement, conviction or
plea of nolo contendere shall not create a presumption that a person did not
meet the standard of conduct set forth above. In actions brought by or in the
right of the corporation, however, the DGCL provides that no indemnification may
be made if the person was adjudged to be liable to the corporation unless and
only to the extent that the Court of Chancery or the court in which such action
was brought shall determine upon application that, despite the adjudication of
liability but in view of all circumstances of the case, such person is fairly
and reasonably entitled to indemnity for such expenses which the court shall
deem proper. To the extent that a person is successful, on the merits or
otherwise, in the defense of any proceeding instigated because of his or her
status as a director, officer, employee or agent of a corporation, the DGCL
mandates that the corporation indemnify such person against reasonable expenses
incurred in the proceeding. A corporation may advance litigation expenses,
including attorneys' fees, to a person who is a party to a proceeding upon such
person undertaking to repay such amount if it shall ultimately be determined
that such person is not entitled to indemnification. The indemnification and
advancement of expenses under the DGCL are not deemed exclusive of any other
rights to which a person may be entitled under any bylaw, agreement, vote of
shareholders or disinterested directors or otherwise.
(b) Article VII of the Registrant's Restated Certificate of Incorporation
provides as follows:
(i) The Corporation shall indemnify, and upon request shall advance
expenses (including attorneys' fees) to, in the manner and to the fullest
extent permitted by law, any officer or director (or the estate of any such
person) who was or is a party to, or is threatened to be made a party to,
any threatened, pending or completed action, suit or proceeding, whether
civil, criminal, administrative, investigative or otherwise, by reason of
the fact that such person is or was a director or officer of the
Corporation, or is or was serving at the request of the Corporation as a
director, officer, partner, trustee, employee or agent of another
corporation, partnership, joint venture, trust, other enterprise or
employee benefit plan (an "indemnitee"). The Corporation may, to the
fullest extent permitted by law, purchase and maintain insurance on behalf
of any person who is or was a director, officer, employee or agent of the
Corporation, or is or was serving at the request of the Corporation as a
director, officer, partner, trustee, employee or agent of another
corporation, partnership, joint venture, trust, other enterprise or
employee benefit plan against
II-1
<PAGE> 245
any liability which may be asserted against such person. To the fullest
extent permitted by law, the indemnification and advances provided for
herein shall include expenses (including attorneys' fees), judgments,
penalties, fines and amounts paid in settlement. The indemnification
provided herein shall not be deemed to limit the right of the Corporation
to indemnify any other person for any such expenses (including attorneys'
fees), judgments, fines and amounts paid in settlement to the fullest
extent permitted by law, both as to action in his official capacity and as
to action in another capacity while holding such office.
(ii) Notwithstanding the foregoing, the Corporation shall not
indemnify any such indemnitee who was or is a party or is threatened to be
made a party to any threatened, pending or completed action or suit by or
in the right of the Corporation to secure a judgment in its favor against
such indemnitee with respect to any claim, issue or matter as to which the
indemnitee shall have been adjudged to be liable to the Corporation, unless
and only to the extent that, the Court of Chancery or the court in which
such action or suit was brought shall determine upon application that,
despite the adjudication of liability but in view of all the circumstances
of the case, such indemnitee is fairly and reasonably entitled to indemnity
for such expenses which the Court of Chancery or such other court shall
deem proper.
(iii) The rights to indemnification and advancement of expenses set
forth in this Article VII are intended to be greater than those which are
otherwise provided for in the General Corporation Law of the State of
Delaware, are contractual between the Corporation and the person being
indemnified, his heirs, executors and administrators, and, with respect to
this Article VII are mandatory, notwithstanding a person's failure to meet
the standard of conduct required for permissive indemnification under the
General Corporation Law of the State of Delaware, as amended from time to
time. The rights to indemnification and advancement of expenses set forth
in this Article VII are nonexclusive of other similar rights which may be
granted by law, this Certificate, the Bylaws, a resolution of the Board of
Directors or stockholders or an agreement with the Corporation, which means
of indemnification and advancement of expenses are hereby specifically
authorized.
(iv) Any repeal or modification of the provisions of this Article VII,
either directly or by the adoption of an inconsistent provision of this
Certificate, shall be prospective only and shall not adversely affect any
right or protection set forth herein existing in favor of a particular
individual at the time of such repeal or modification. In addition, if an
amendment to the General Corporation Law of the State of Delaware limits or
restricts in any way the indemnification rights permitted by law as of the
date hereof, such amendment shall apply only to the extent mandated by law
and only to activities of persons subject to indemnification under this
Article VII which occur subsequent to the effective date of such amendment.
(c) The Underwriting Agreement (set forth in Exhibit 1 hereto) provides for
the indemnification by the Underwriters of the Company, each of the Company's
directors, each of the Company's officers who signs this Registration Statement
and each person who controls the Company within the meaning of the Securities
Act, solely with respect to information provided by the Underwriters for
inclusion in this Registration Statement.
(d) The Company intends to obtain insurance which provides general coverage
for its directors and executive officers in amounts to be determined. In
addition, the Company intends to obtain insurance coverage for its directors and
executive officers in amounts to be determined with respect to the Offering.
ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES.
Except as described in this section, no securities of the Company have been
sold by the Company within the past three years without registration under the
Securities Act.
On March 27, 1996, the Company issued an aggregate of 1,000,000 shares of
Common Stock to Alan R. Sielbeck, James D. Abrams, John R. Young and R. Edward
Hutton, Jr. for their services in forming the Company, developing its business
plans and procedures and in acquiring the Predecessor Companies. The private
placement transaction did not involve a public offering and was, therefore,
exempt from the registration requirements of the Securities Act in reliance upon
Section 4(2).
II-2
<PAGE> 246
In June 1996, the Company entered into the Combination Agreements in a
private placement transaction exempt from the registration requirements of the
Securities Act in reliance upon Section 4(2) and Regulation D promulgated
thereunder. The private placement of securities in connection with the
Combination is exempt under Section 4(2) because the transaction did not involve
any public offering. No general solicitation or advertising was utilized in
connection with the private placement. The shares were issued in exchange for
ownership interests in the Predecessor Companies.
ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------ ------------------------------------------------------------------------------------
<C> <C> <S>
1.1* -- Form of Underwriting Agreement
2.1* -- Form of Combination Agreement by and among each of the Predecessor Companies, each
of its respective stockholders and the Registrant
3.1* -- Restated Certificate of Incorporation of the Registrant
3.2* -- Bylaws of the Registrant
4.1** -- Specimen of Common Stock certificate
5.1** -- Opinion of Waller Lansden Dortch & Davis, PLLC
10.1* -- Registrant's 1996 Incentive Stock Plan
10.2* -- Registrant's 1996 Non-Employee Director Stock Option Plan
10.3* -- Registrant's 1996 Employee Stock Purchase Plan
10.4 -- [Intentionally left blank].
10.5* -- Employment Agreement, dated June 26, 1996, between the Registrant and Alan R.
Sielbeck
10.6* -- Employment Agreement, dated June 26, 1996, between the Registrant and James D.
Abrams
10.7* -- Employment Agreement, dated June 26, 1996, between the Registrant and Anthony M.
Schofield
10.8* -- Form of Employment Agreement between the Registrant and certain of its employees
10.9* -- Form of Escrow Agreement between the Registrant, each of the stockholders of the
Predecessor Companies and the escrow agent
10.10** -- Form of Equitable Securities Corporation Stock Purchase Warrant
23.1 -- Consent of Ernst & Young LLP
23.2** -- Consent of Waller Lansden Dortch & Davis, PLLC (included in Exhibit 5)
24.1* -- Power of Attorney
27.1 -- Financial Data Schedule
</TABLE>
- ---------------
* Previously filed.
** To be filed by amendment.
(b) Financial Statement Schedules
All other schedules for which provision is made in the applicable
accounting regulations of the Commission are not required under the related
instructions or are inapplicable, and therefore have been omitted.
ITEM 17. UNDERTAKINGS.
The undersigned Registrant hereby undertakes to provide to the Underwriters
at the closing specified in the Underwriting Agreement certificates in such
denominations and registered in such names as required by the Underwriters to
permit prompt delivery to each purchaser.
II-3
<PAGE> 247
Insofar as indemnification for liabilities arising under the Securities Act
may be permitted to directors, officers and controlling persons of the
Registrant, pursuant to the foregoing provisions or otherwise, the Registrant
has been advised that in the opinion of the Commission such indemnification is
against public policy as expressed in the Securities Act and is, therefore,
unenforceable. In the event that a claim for indemnification against such
liabilities (other than the payment by the Registrant of expenses incurred or
paid by a director, officer or controlling person of the Registrant in the
successful defense of any action, suit or proceeding) is asserted against the
Registrant by such director, officer or controlling person in connection with
the securities being registered, the Registrant will, unless in the opinion of
its counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the Securities Act and will be
governed by the final adjudication of such issue.
The undersigned Registrant hereby undertakes that:
(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by the Registrant pursuant to Rule 424(b)(1) or
(4) or 497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.
(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new Registration Statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.
II-4
<PAGE> 248
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Amendment to the Registration Statement to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Nashville,
State of Tennessee, on July 31, 1996.
SERVICE EXPERTS, INC.
By: /s/ ALAN R. SIELBECK
------------------------------------
Alan R. Sielbeck
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE(S) DATE
- --------------------------------------------- -------------------------------- --------------
<C> <S> <C>
/s/ ALAN R. SIELBECK Chairman of the Board and Chief July 31, 1996
- --------------------------------------------- Executive Officer (principal
Alan R. Sielbeck executive officer)
* President, Chief Operating July 31, 1996
- --------------------------------------------- Officer and Director
James D. Abrams
* Chief Financial Officer July 31, 1996
- --------------------------------------------- (principal financial and
Anthony M. Schofield accounting officer)
* Director July 31, 1996
- ---------------------------------------------
Raymond J. De Riggi
* Director July 31, 1996
- ---------------------------------------------
Timothy G. Wallace
*By: /s/ ALAN R. SIELBECK Director July 31, 1996
- ---------------------------------------------
Alan R. Sielbeck
As Attorney-in-fact
</TABLE>
II-5
<PAGE> 249
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT PAGE
NUMBER DESCRIPTION OF EXHIBITS NUMBER
- ------- ------------------------------------------------------------------------- -------
<C> <S> <C> <C>
1.1* -- Form of Underwriting Agreement
2.1* -- Form of Combination Agreement by and among each of the Predecessor
Companies, each of its respective stockholders and the Registrant
3.1* -- Restated Certificate of Incorporation of the Registrant
3.2* -- Bylaws of the Registrant
4.1** -- Specimen of Common Stock certificate
5.1** -- Opinion of Waller Lansden Dortch & Davis, PLLC
10.1* -- Registrant's 1996 Incentive Stock Plan
10.2* -- Registrant's 1996 Non-Employee Director Stock Option Plan
10.3* -- Registrant's 1996 Employee Stock Purchase Plan
10.4 -- [Intentionally left blank]
10.5* -- Employment Agreement, dated June 26, 1996, between the Registrant and
Alan R. Sielbeck
10.6* -- Employment Agreement, dated June 26, 1996, between the Registrant and
James D. Abrams
10.7* -- Employment Agreement, dated June 26, 1996, between the Registrant and
Anthony M. Schofield
10.8* -- Form of Employment Agreement between the Registrant and certain of its
employees
10.9* -- Form of Escrow Agreement between the Registrant, each of the stockholders
of the Predecessor Companies and the escrow agent
10.10** -- Form of Equitable Securities Corporation Stock Purchase Warrant
23.1 -- Consent of Ernst & Young LLP
23.2** -- Consent of Waller Lansden Dortch & Davis, PLLC (included in Exhibit 5)
24.1* -- Power of Attorney (included on page II-5)
27.1 -- Financial Data Schedule (for SEC use only)
</TABLE>
- ---------------
* Previously filed.
** To be filed by amendment.
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the captions "Selected
Combined Financial Data" and "Experts" and the use of our report dated June 7,
1996 with respect to the financial statements of Service Experts, Inc., the use
of our report dated June 7, 1996 with respect to the financial statements of the
Combined Predecessor Companies, the use of our report dated May 5, 1996, with
respect to the financial statements of the Combined AC Service & Installation
Co., Inc. and Donelson Air Conditioning Company, Inc., the use of our report
dated May 10, 1996 with respect to the financial statements of Hardwick Air
Masters, Inc., the use of our report dated May 6, 1996 with respect to the
financial statements of Norrell Heating & Air Conditioning, Inc., the use of our
report dated May 24, 1996 with respect to the financial statements of Vision
Holding Company, Inc., the use of our report date May 15, 1996 with respect to
the financial statements of Comerford's Heating and Air Conditioning, Inc., the
use of our report date May 17, 1996 with respect to the financial statements of
Rolf Coal and Fuel Corp., the use of our report dated May 14, 1996 with respect
to the financial statements of Brand Heating & Air Conditioning, Inc., the use
of our report date May 10, 1996 with respect to the financial statements of
Coastal Air Conditioning Service, Inc., the use of our report dated May 10, 1996
with respect to the financial statements of Contractor Success Group, Inc., the
use of our report dated May 10, 1996 with respect to the financial statements of
Arrow Heating & Air Conditioning, Inc., the use of our report dated May 10, 1996
with respect to the financial statements of Air Experts, a United Services Co.,
Inc., the use of our report dated May 10, 1996 with respect to the financial
statements of Gilley's Heating & Cooling, Inc. and the use of our report dated
May 10, 1996 with respect to the financial statements of Service Experts of Palm
Springs, Inc., in Amendment No. 1 to the Registration Statement (Form S-1 No.
333-07037) and related Prospectus of Service Experts, Inc. and for the
Registration of 2,250,000 shares of its common stock.
ERNST & YOUNG LLP
Nashville, Tennessee
July 30, 1996
<TABLE> <S> <C>
<ARTICLE> 5
<RESTATED>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> MAR-27-1996
<PERIOD-END> JUN-30-1996
<CASH> 13,386
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 473,385
<PP&E> 0
<DEPRECIATION> 0
<TOTAL-ASSETS> 473,385
<CURRENT-LIABILITIES> 486,771
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 486,771
<SALES> 0
<TOTAL-REVENUES> 0
<CGS> 0
<TOTAL-COSTS> 0
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 0
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 0
<EPS-PRIMARY> 0
<EPS-DILUTED> 0<F1>
<FN>
<F1>SERVICE EXPERTS, INC. WAS FORMED ON MARCH 27, 1996 FOR THE PURPOSE OF
ACQUIRING UNRELATED HEATING AND AIR CONDITIONING COMPANIES IN EXCHANGE
FOR SHARES OF ITS COMMON STOCK. THE COMPANY DID NOT HAVE ANY OPERATIONS
AS OF JUNE 30, 1996 (LATEST BALANCE SHEET DATE).
</FN>
</TABLE>
