<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
November 26, 1997
SERVICE EXPERTS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Delaware 001-13037 62-1639453
- ---------------- ---------------- -----------------
<S> <C> <C>
(State or Other (Commission File (I.R.S. Employer
Jurisdiction of Number) Identification
Incorporation) Number)
</TABLE>
111 Westwood Place
Suite 420
Brentwood, Tennessee 37027
--------------------------------------------------
(Address of principal executive offices) (Zip Code)
(615) 371-9990
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
-------------------------------------------------------------
(Former name or former address, if changed since last report)
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<PAGE> 2
ITEM 5. OTHER EVENTS.
Service Experts, Inc., a Delaware corporation (the "Company"), operates
residential heating, ventilating and air conditioning ("HVAC") service and
replacement businesses. In connection with the acquisition of HVAC businesses,
the Company plans to offer shares of the Company's Common Stock, $.01 par value
per share (the "Common Stock"), warrants to purchase shares of Common Stock and
debt securities convertible into shares of Common Stock pursuant to its
Registration Statement on Form S-4. In order to comply with the disclosure
requirements of the Securities and Exchange Commission regarding the financial
statements of businesses acquired or to be acquired, the Company is filing this
Current Report containing the following audited and pro forma financial
statements:
(a) Financial Statements of Businesses Acquired
See Pages F-1 through F-12.
(b) Pro Forma Financial Information
See Pages F-13 through F-19.
2
<PAGE> 3
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
TML, INC. & MT PARTNERSHIP
Combined Financial statements for the year ended December
31, 1996 and nine months ended September 30, 1997
(unaudited)
Report of Independent Auditors.............................. F-2
Combined Balance Sheets..................................... F-3
Combined Statements of Income............................... F-4
Combined Statements of Stockholders' Equity and Partners'
Capital................................................... F-5
Combined Statements of Cash Flows........................... F-6
Notes to Combined Financial Statements...................... F-7
SERVICE EXPERTS, INC. -- UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
Basis of Presentation....................................... F-13
Unaudited Pro Forma Combined Balance Sheet as of September
30, 1997.................................................. F-15
Unaudited Pro Forma Combined Statements of Income for the
Nine Months ended September 30, 1997 and for the Twelve
Months ended December 31, 1996............................ F-16
Notes to Unaudited Pro Forma Combined Financial
Statements................................................ F-18
</TABLE>
F-1
<PAGE> 4
REPORT OF INDEPENDENT AUDITORS
The Stockholders and Partners
TML, Inc. and MT Partnership
We have audited the accompanying combined balance sheet of TML, Inc. and MT
Partnership as of December 31, 1996, and the related combined statements of
income, stockholders' equity and Partners' capital, and cash flows for the year
ended December 31, 1996. These financial statements are the responsibility of
the Companies' 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 combined financial statements referred to above present
fairly, in all material respects, the combined financial position of TML, Inc.
and MT Partnership at December 31, 1996, and the combined results of their
operations and their cash flows for the year ended December 31, 1996, in
conformity with generally accepted accounting principles.
Nashville, Tennessee
October 16, 1997
F-2
<PAGE> 5
TML, INC. AND MT PARTNERSHIP
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ -- $ 517,815
Trade receivables, net of allowance for doubtful accounts
of $31,078 and $26,218 at December 31, 1996 and
September 30, 1997..................................... 1,007,993 824,027
Inventories................................................. 98,917 137,512
Costs and estimated earnings in excess of billings.......... 83,866 121,860
Prepaid expenses and other current assets................... 31,206 --
Deferred income taxes....................................... 25,334 23,425
---------- ----------
Total current assets.............................. 1,247,316 1,624,639
Property, buildings and equipment:
Land...................................................... 118,287 189,482
Buildings and improvements................................ 268,049 547,816
Furniture and fixtures.................................... 303,416 335,751
Machinery and equipment................................... 227,872 239,772
Vehicles.................................................. 471,427 540,641
Construction in progress.................................. 45,231 -0-
---------- ----------
1,434,282 1,853,462
Less accumulated depreciation and amortization............ 886,335 979,162
---------- ----------
547,947 874,300
Cash surrender value........................................ 23,515 30,711
Deferred income taxes....................................... 28,964 --
Other assets................................................ 22,359 21,359
---------- ----------
Total assets...................................... $1,870,101 $2,551,009
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY AND PARTNERS' CAPITAL
Current liabilities:
Bank overdraft............................................ $ 192,415 $ --
Trade accounts payable and accrued liabilities............ 367,543 369,930
Accrued compensation...................................... 152,962 59,257
Accrued taxes, other than income.......................... 14,382 12,249
Accrued warranties........................................ 62,788 62,788
Income taxes payable...................................... -- 167,604
Deferred revenue.......................................... 12,540 14,260
Billings in excess of costs and estimated earnings........ 2,053 18,250
Note payable to stockholder............................... 2,300 --
Current portion of long-term debt......................... 33,050 38,706
---------- ----------
Total current liabilities......................... 840,033 743,044
Long-term debt, net of current.............................. 57,529 320,991
Deferred income taxes....................................... -- 9,305
Minority interest in partnership............................ 24,499 31,198
Stockholders' equity and partners' capital:
Common stock, $10 par value, 1,250 shares authorized,
1,067 shares issued and outstanding.................... 10,670 10,670
Additional paid-in capital................................ 18,616 18,616
Partners' capital......................................... 331,525 420,057
Retained earnings......................................... 587,229 997,128
---------- ----------
Total stockholders' equity and partners'
capital......................................... 948,040 1,446,471
---------- ----------
Total liabilities stockholders' equity and
partners' capital............................... $1,870,101 $2,551,009
========== ==========
</TABLE>
See accompanying notes.
F-3
<PAGE> 6
TML, INC. AND MT PARTNERSHIP
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
Net revenues................................................ $8,063,898 $8,082,355
Cost of goods sold.......................................... 7,202,851 6,715,983
---------- ----------
Gross margin................................................ 861,047 1,366,372
Selling, general and administrative expenses................ 732,295 452,588
Bad debt expense............................................ 156,565 41,722
---------- ----------
(Loss) income from operations............................... (27,813) 872,062
Other income (expense):
Interest expense.......................................... (18,483) (22,264)
Interest income........................................... 5,286 4,036
Other income.............................................. 9,956 10,331
Minority interest in partnership.......................... 1,501 (2,698)
---------- ----------
(Loss) income before taxes.................................. (29,553) 861,467
---------- ----------
(Benefit) provision for income tax:
Current................................................... -- 224,987
Deferred.................................................. (67,555) 40,178
---------- ----------
Total income taxes................................ (67,555) 265,165
---------- ----------
Net income........................................ $ 38,002 $ 596,302
========== ==========
</TABLE>
See accompanying notes.
F-4
<PAGE> 7
TML, INC. AND MT PARTNERSHIP
COMBINED STATEMENTS OF STOCKHOLDERS' EQUITY AND PARTNERS' CAPITAL
<TABLE>
<CAPTION>
TOTAL
COMMON STOCK STOCKHOLDERS'
$10 PAR VALUE ADDITIONAL EQUITY AND
---------------- PAID-IN RETAINED PARTNERS' PARTNERS'
SHARES AMOUNT CAPITAL EARNINGS CAPITAL CAPITAL
------ ------- ---------- -------- --------- -------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE AT JANUARY 1, 1996.................. 1,067 $10,670 $18,616 $768,782 $ 295,089 $1,093,157
Capital distributions..................... -- -- -- -- (183,119) (183,119)
Net income (loss)......................... -- -- -- (181,553) 219,555 38,002
----- ------- ------- -------- --------- ----------
BALANCE AT DECEMBER 31, 1996................ 1,067 10,670 18,616 587,229 331,525 948,040
Capital distributions (unaudited)......... -- -- -- -- (142,871) (142,871)
Net income (unaudited).................... -- -- -- 409,899 186,403 596,302
Capital contributions (unaudited)......... -- -- -- -- 45,000 45,000
----- ------- ------- -------- --------- ----------
BALANCE AT SEPTEMBER 30, 1997............... 1,067 $10,670 $18,616 $997,128 $ 420,057 $1,446,471
===== ======= ======= ======== ========= ==========
</TABLE>
See accompanying notes.
F-5
<PAGE> 8
TML, INC. AND MT PARTNERSHIP
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------ -------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 38,002 $ 596,302
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Depreciation and amortization............................. 113,911 93,727
(Benefit) provision for deferred income taxes............. (67,555) 40,178
Provision for loss on accounts receivable................. 156,565 41,722
Minority interest......................................... (1,501) 2,698
Changes in assets and liabilities:
Trade receivable....................................... 67,962 142,243
Inventories............................................ 58,407 (38,595)
Prepaid expenses and other current assets.............. (5,715) 4,296
Other assets........................................... 874 (7,196)
Trade accounts payable and accrued liabilities......... (341,791) 2,387
Accrued compensation................................... 83,852 (93,705)
Accrued taxes, other than income....................... 5,035 (2,133)
Accrued warranties..................................... (2,893) --
Deferred revenue....................................... 7,460 1,720
Income taxes payable................................... (77,109) 194,514
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.... (19,451) (21,797)
--------- ---------
Net cash flow provided by operating activities.... 16,053 956,361
INVESTING ACTIVITIES
Purchase of property, buildings and equipment............... (145,550) (419,078)
--------- ---------
Net cash used in investing activities....................... (145,550) (419,078)
FINANCING ACTIVITIES
Distribution to stockholders................................ (183,119) (142,871)
Payments on long-term debt.................................. (73,449) (54,182)
Proceeds from long-term debt................................ 20,000 321,000
Capital contributions....................................... -- 45,000
Capital contributions from minority partners................ 26,000 4,000
--------- ---------
Net cash (used in) provided by financing activities......... (210,568) 172,947
Increase (decrease) in cash and cash equivalents............ (340,065) 710,230
Cash and cash equivalents (bank overdraft) at beginning of
period.................................................... 147,650 (192,415)
--------- ---------
Cash and cash equivalents (bank overdraft) at end of
period.................................................... $(192,415) $ 517,815
========= =========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 18,483 $ 22,264
========= =========
Income taxes paid........................................... $ 26,910 $ 57,893
========= =========
</TABLE>
See accompanying notes.
F-6
<PAGE> 9
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
TML, Inc. and MT Partnership (collectively, "the Company") operates in one
industry segment and is primarily engaged in the installation and servicing of
air conditioning and heating systems for commercial and residential customers in
the Boise, Idaho area.
PRINCIPLES OF COMBINATION AND CONSOLIDATION
The combined financial statements include the accounts of TML, Inc. and the
consolidated financial statements of MT Partnership. The combined entities share
common ownership interests. The consolidated financial statements of MT
Partnership include the accounts of L4 Properties, its majority-owned
partnership. All intercompany transactions have been eliminated in combination
and consolidation.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The combined balance sheet as of September 30, 1997 and the related
combined statements of income, stockholders' equity and partners' capital, and
cash flows for the nine months then ended (interim financial statements) have
been prepared by the Company's management and are unaudited. In the opinion of
management, 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,
1996 audited financial statements appearing herein. The results of the nine
months ended September 30, 1997 may not be indicative of operating results for
the full year.
RECOGNITION OF REVENUE
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 contracts for residential installation and service and maintenance
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. Most Contracts are completed within 6 to 18 months.
Trade accounts receivable includes billings and billed retainage on
Contracts. The Company classifies these amounts as current assets because all
balances are expected to be collected in the current year.
The asset, "cost 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.
F-7
<PAGE> 10
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
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 and Accounts Payable
The carrying amounts reported in the balance sheets for trade receivable
and accounts payable approximate fair value.
CASH EQUIVALENTS
The Company 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 by the first-in, first-out (FIFO) method for all inventories.
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line method and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
------
<S> <C>
Leasehold improvements...................................... 5 - 20
Building.................................................... 31.5
Furniture and fixtures...................................... 7 - 10
Machinery and equipment..................................... 5 - 7
Vehicles.................................................... 5 - 7
</TABLE>
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation
expenses payable to various employees as of year end.
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 prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
DEFERRED REVENUE
The Company pre-sells maintenance contracts in the form of energy service
agreements ("ESA"). ESA revenue is recorded as deferred revenue and recognized
as income when the service is performed.
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.
F-8
<PAGE> 11
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
INCOME TAXES
TML, 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 partners of MT Partnership include the partnership's income in their
own personal income for federal and state income tax purposes. Accordingly, the
partnership is not subject to federal and state income taxes.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt
expense totaled $156,565 and accounts written off net of recoveries were
$166,980.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the
Company expensed $70,740.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive
Income". Statement No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Statement No. 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of Statement No. 130 to
have a material impact on the Company's financial statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts...................... $ 902,867
Estimated earnings........................................ 217,026
----------
1,119,893
Less applicable billings.................................... 1,038,080
----------
$ 81,813
==========
Included in the accompanying balance sheet under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................. $ 83,866
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 2,053
----------
$ 81,813
==========
</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-9
<PAGE> 12
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Line of credit.............................................. $ --
Mortgage note payable....................................... 10,768
Installment notes........................................... 79,811
-------
90,579
Less current portion........................................ 33,050
-------
$57,529
=======
</TABLE>
The Company has a line of credit with a financial institution with a total
borrowing limit of $400,000. The line of credit bears interest at prime plus of
1%.
The Company has a mortgage note payable which is secured by the related
office building and land. This loan requires monthly installments of $387,
including principal interest (8% at December 31, 1996) through November 2002.
The Company has various installment loans which are secured by vehicles.
These loans bear interest at various fixed rates ranging from 8% to 9.5% per
annum or at variable rates ranging from 7.5% to 9.75% at December 31, 1996.
These loans require monthly payments ranging from $387 to $881 and are due
through June 2001.
As of December 31, 1996, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1997........................................................ $33,050
1998........................................................ 23,521
1999........................................................ 18,452
2000........................................................ 14,090
2001........................................................ 1,466
-------
$90,579
=======
</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 ("the Code").
Substantially all employees of the Company are eligible to participate in the
plan. Under the plan's provisions, a plan member may make contributions, on a
tax deferred basis, not to exceed the maximum established by the Internal
Revenue Service. The Company provides matching contributions of 50% of total
contributions by a plan member, to a maximum of 6% of the employee's total
calendar year compensation. The Company's matching contributions totaled $37,587
for 1996.
5. SELF INSURANCE
The Company is self-insured for certain health benefits up to $20,000 per
occurrence per individual. The cost of such benefits is recognized as expense in
the period the incident occurred. This cost was $120,474 in 1996.
F-10
<PAGE> 13
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and umbrella
policies to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
7. INCOME TAXES
Income tax benefit consists of the following at December 31, 1996:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
------------
<S> <C>
Current:
Federal................................................... $ --
State..................................................... --
Deferred.................................................... (67,555)
--------
$(67,555)
========
</TABLE>
Significant components of the deferred tax assets and liabilities as of
December 31, 1996, are as follows:
<TABLE>
<S> <C>
Deferred tax liabilities:
Contract billings......................................... $ 31,907
Depreciation and amortization............................. 14,864
Other..................................................... 8,581
----------
Deferred tax liabilities.................................. 55,352
Deferred tax assets:
Accounts receivable....................................... 12,120
Accounts payable.......................................... 9,372
Warranty reserves......................................... 24,487
Prepaid insurance......................................... 11,038
Net carryforward.......................................... 43,621
Other..................................................... 9,012
----------
Total gross deferred tax assets................... 109,650
Valuation allowance......................................... --
----------
Deferred tax assets......................................... 109,650
----------
Net deferred tax assets........................... $ 54,298
==========
</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,
1996
------------
<S> <C>
Tax provision at statutory rate............................. $ 15,281
State income tax less applicable federal tax benefit........ (8,990)
Partnership income not subject to tax....................... (74,648)
Other, net.................................................. 802
--------
$ 67,555
========
</TABLE>
F-11
<PAGE> 14
TML, INC. AND MT PARTNERSHIP
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
MT Partnership operates under Subchapter K of the Internal Revenue Code and
is not subject to federal and state income tax since income and expenses are
passed through to the partners. In connection with the proposed combination, the
partnership will terminate. As a result, MT Partnership will be subject to
corporate income taxes subsequent to the termination of the partnership. MT
Partnership had net operating income for income tax purposes of $230,833 for
1996.
Had the Company filed federal and state income tax returns as a regular
corporation for 1996, income tax expense under the provisions of SFAS No. 109
would have been $90,671.
At the date of termination of the partnership 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 based on the cumulative temporary differences at the date
of termination of the partnership. The effect of recognizing the deferred taxes
will be recorded as an adjustment to goodwill in purchase accounting. If the
termination of the partnership status had occurred at September 30, 1997, the
deferred tax liability would have been approximately $25,217.
8. SUBSEQUENT EVENT
Subsequent to year end the shareholders of TML, Inc., and the partners of
MT Partnership and L4 Properties, signed a Stock Purchase Agreement and
Partnership Purchase Agreements, respectively, with Service Experts, Inc. and a
wholly-owned subsidiary of Service Experts, Inc. to sell all of the stock of
TML, Inc. and partnership interests of MT Partnership and L4 Properties. In
accordance with these agreements, TML, Inc. became a wholly-owned subsidiary of
Service Experts, Inc. and MT Partnership and L4 Properties were acquired by a
wholly-owned subsidiary of Service Experts, Inc. on September 30, 1997.
F-12
<PAGE> 15
PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
Service Experts, Inc. (the "Company") was incorporated on March 27, 1996.
On August 21, 1996, and simultaneous with the closing of its initial public
offering of Common Stock, the Company acquired the Predecessor Companies (as
defined below). In accordance with the provisions of Securities and Exchange
Commission (the "Commission") Staff Accounting Bulletin No. 97, the historical
financial statements of the Company for periods prior to August 21, 1996 are the
combined financial statements of AC Service & Installation Co., Inc. and
Donelson Air Conditioning Company, Inc. (collectively, the "Acquiring Company").
Such historical financial statements have been restated for the Pooled Companies
(as defined below), which were acquired in December 1996, May 1997 and September
1997 in business combinations accounted for as poolings of interests. The
operations of the Company's subsidiaries other than the Pooled Companies have
been included in the Company's financial statements from their respective
effective dates of acquisition. The acquisitions of the Predecessor Companies
have been accounted for using the historical cost basis of the Predecessor
Companies in accordance with Commission Staff Accounting Bulletin No. 48. The
Predecessor Companies are the Acquiring Company; Hardwick Air Masters, Inc.
d/b/a Airmasters, Inc.; Norrell Heating and Air Conditioning Company, Inc.;
Vision Holding Company, Inc.; Comerford's Heating and Air Conditioning, Inc.;
Rolf Coal and Fuel Corp.; Brand Heating and Air Conditioning, Inc.; Coastal Air
Conditioning Service, Inc.; Contractor Success Group, Inc.; and Service Experts
of Palm Springs, Inc. The Pooled Companies are Custom Air Conditioning, Inc.,
Freschi Air Systems, Inc., C. Iapaluccio Company, Inc., Hawk Heating & Air
Conditioning, Inc., TML, Inc. and MT Partnership, Parrott Mechanical, Inc. and
McAlister Heat & Air, Inc.
The following unaudited pro forma combined financial statements give effect
to the acquisition by the Company of 36 Acquired Companies (as defined below)
and to one HVAC business with which the Company has entered into an agreement in
principle (the "Pending Acquisition") in exchange for shares of the Company's
Common Stock, cash, warrants to purchase shares of Common Stock and the
assumption of certain debt. The pro forma combined financial statements do not
give effect to the acquisition of 15 HVAC businesses with which the Company has
entered into agreements in principle and which management of the Company
believes will close within the next three months. These businesses had aggregate
revenues in 1996 of approximately $19.5 million and an estimated aggregate
purchase price of $19.9 million.
The unaudited pro forma combined balance sheet as of September 30, 1997
gives effect to the acquisition of four Acquired Companies closed effective
after September 30, 1997 and one Pending Acquisition. The four Acquired
Companies which were closed effective after September 30, 1997 are Teays Valley
Heating and Cooling, Inc., J.M. Jenks Incorporated d/b/a J.M. Mechanical
Systems, Holmes Sales & Service, Inc. and Getzschman Heating & Sheet Metal
Contractors, Inc. The Pending Acquisition is PTM Enterprises, Inc. (formerly the
residential division of Martin Mechanical Contractors, Inc.). The unaudited pro
forma combined statement of income for the nine months ended September 30, 1997
gives effect to the acquisition of 21 Acquired Companies closed during the nine
month period ended September 30, 1997, four Acquired Companies which were closed
effective after September 30, 1997 and one Pending Acquisition as if such
transactions had occurred as of January 1, 1996. The 21 Acquired Companies
closed during the nine month period ended September 30, 1997 are Dial One
Raymond's Plumbing, Heating & Cooling, Inc., Gaddis Co., Automated Air, Inc.,
Bauer Heating & Air Conditioning, Incorporated, Sylvester's Corp., B. W. Heating
& Air Conditioning, Inc., Parker Heating & Air Conditioning, Incorporated,
Roland J. Down, Inc., Claire's Air Conditioning and Refrigeration, Inc., Claire
& Sanders, Inc., Royden Inc., Service Experts of Raleigh, Inc., Stark Services
Company, Inc., ProAir Services, L.P., Superior Air Conditioning Co., Inc., Artic
Aire of Chico, Inc., All American Air Conditioning & Heating, Inc., A-1 Air
Conditioning, Inc., Mid Fla Heating and Air, Inc., S&W Air Conditioning, Inc.
and Berkshire Air Conditioning Company. The unaudited pro forma combined
statement of income for the 12 months ended December 31, 1996 gives effect to
the acquisition of the Predecessor Companies as described above, 11 Acquired
Companies closed during 1996, 21 Acquired Companies closed during the nine month
period ended September 30, 1997, four Acquired Companies closed effective after
September 30, 1997 and one Pending Acquisition as if such transactions had
occurred on January 1, 1996. The 11 Acquired Companies closed during 1996 are
Service Experts of Indianapolis, Inc.,
F-13
<PAGE> 16
Frees Service Experts, Inc., Comfortech, Inc., Sunbeam Service Experts, Inc.,
Falso Service Experts, Inc., Gordon's Specialty Company, Pardee Refrigeration
Company Incorporated, Sanders Indoor Comfort, Inc., Island Air Conditioning,
Inc., Air-Conditioning and Heating Unlimited, Inc. and B&B Air Conditioning,
Inc.
The unaudited pro forma combined financial statements have been prepared by
the Company based on the historical financial statements of the Company and the
companies referred to above and certain preliminary estimates and assumptions
deemed appropriate by management of the Company. These pro forma combined
financial statements may not be indicative of results that would have been
achieved had these acquisitions occurred on the dates indicated or of results
which may be realized in the future. Neither expected benefits nor cost
reductions anticipated by the Company following consummation of these
acquisitions have been reflected in the pro forma combined financial statements.
The pro forma combined financial statements should be read in conjunction
with the historical financial statements of the Company.
F-14
<PAGE> 17
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
-------- --------- ----------- ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents............................ $ 14,537 $ 23 $ 623 $(3,043)(a) $ 10,946
(1,194)(b)
Receivables:
Trade receivables, net............................... 25,800 1,973 339 28,112
Related party........................................ 5 43 -- 48
Employee............................................. 267 13 -- 280
Other................................................ 1,649 -- 6 1,655
-------- ------ ------ ------- --------
27,721 2,029 345 30,095
Inventories............................................ 9,463 739 126 10,328
Cost and estimated earnings in excess of billings...... 1,203 72 -- 1,275
Prepaid expenses and other current assets.............. 2,493 31 -- 2,524
Current portion of notes receivable -- related
parties.............................................. 14 9 -- 23
Current portion of notes receivable.................... 251 -- -- 251
Deferred income taxes.................................. 3,548 4 -- 3,552
-------- ------ ------ ------- --------
Total current assets........................... 59,230 2,907 1,094 (4,237) 58,994
Property, buildings and equipment, net................. 20,963 1,231 402 22,596
Notes receivable -- related parties.................... 343 -- -- 343
Notes receivable -- other.............................. 668 -- -- 668
Investment in affiliate................................ 574 -- -- 574
Deferred income taxes.................................. 434 -- -- 434
Goodwill............................................... 83,439 -- 17 11,311(a) 94,767
Other assets........................................... 839 142 -- 981
-------- ------ ------ ------- --------
Total assets................................... $166,490 $4,280 $1,513 $ 7,074 $179,357
======== ====== ====== ======= ========
Current liabilities:
Short-term debt...................................... $ 665 $ 259 $ -- $ (259)(b) $ 665
Trade accounts payable and accrued liabilities....... 11,158 1,188 331 12,677
Accrued compensation................................. 5,371 223 8 5,602
Accrued warranties................................... 2,106 78 -- 2,184
Income taxes payable................................. 1,965 (21) -- 1,944
Deferred revenue..................................... 7,226 151 172 7,549
Billings in excess of costs and estimated earnings... 971 284 -- 1,255
Current portion of long-term debt and capital lease
obligations........................................ 439 301 -- (301)(b) 439
-------- ------ ------ ------- --------
Total current liabilities...................... 29,901 2,463 511 (560) 32,315
Long-term debt and capital lease obligations, net of
current.............................................. 10,725 626 -- (626)(b) 10,725
Related parties notes.................................. 8 (8)(b) --
Deferred income taxes.................................. 1,017 -- -- -- 1,017
Other long term liabilities............................
Common stock........................................... 149 -- -- 5(a) 154
Additional paid-in-capital............................. 106,355 79 580 9,789(a) 116,803
Retained earnings...................................... 18,343 1,112 414 (1,526)(a) 18,343
-------- ------ ------ ------- --------
$166,490 $4,280 $1,513 $ 7,074 $179,357
======== ====== ====== ======= ========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-15
<PAGE> 18
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
-------- --------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net revenues............................. $167,647 $33,655 $3,317 -- $204,619
Cost of goods sold....................... 107,400 24,008 2,211 4(d) 133,623
-------- ------- ------ ------ --------
Gross margin............................. 60,247 9,647 1,106 (4) 70,996
Selling, general and administrative
expenses............................... 42,967 9,325 944 (937)(e) 52,299
-------- ------- ------ ------ --------
Income from operations................... 17,280 322 162 933 18,697
Other income (expense):
Interest expense....................... (160) (250) -- 250(f) (160)
Interest income........................ 608 42 1 -- 651
Other income (expense)................. 382 (115) -- 147(g) 414
-------- ------- ------ ------ --------
830 (323) 1 397 905
-------- ------- ------ ------ --------
Income (loss) before tax................. 18,110 (1) 163 1,330 19,602
Provision for income taxes............... 6,595 137 64 1,007(h) 7,803
-------- ------- ------ ------ --------
Net income (loss)........................ $ 11,515 $ (138) $ 99 $ 323 $ 11,799
======== ======= ====== ====== ========
Pro forma net income per share........... $ 0.81 $ 0.77
Pro forma weighted average shares
outstanding............................ 14,152 1,229(i) 15,381
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-16
<PAGE> 19
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
------- --------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net revenues.............................. $73,683 $166,614 $14,783 $(10,949)(c) $244,131
Cost of goods sold........................ 49,706 111,580 12,580 (9,785)(d) 164,081
------- -------- ------- -------- --------
Gross margin.............................. 23,977 55,034 2,203 (1,164) 80,050
Selling, general and administrative
expenses................................ 19,013 47,662 1,465 (7,134)(e) 61,006
------- -------- ------- -------- --------
Income from operations.................... 4,964 7,372 738 5,970 19,044
Other income (expense):
Interest expense........................ (460) (762) -- 762(f) (460)
Interest income......................... 378 298 32 -- 708
Other income (expense).................. 89 (150) -- 40(g) (21)
------- -------- ------- -------- --------
7 (614) 32 802 227
------- -------- ------- -------- --------
Income before tax......................... 4,971 6,758 770 6,772 19,271
Provision for income taxes................ 1,137 762 297 5,724(h) 7,920
------- -------- ------- -------- --------
Net income................................ $ 3,834 $ 5,996 $ 473 $ 1,048 $ 11,351
======= ======== ======= ======== ========
Pro forma net income per share............ $ 0.76 $ 0.74
Pro forma weighted average shares
outstanding............................. 5,023 10,251(j) 15,274
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-17
<PAGE> 20
SERVICE EXPERTS, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
PRO FORMA BALANCE SHEET ADJUSTMENTS
(a) Reflects the payments to owners of four Acquired Companies and one
Pending Acquisition of $3,043,000 in cash and 391,000 shares of common stock
resulting in an increase in Goodwill of $11,311,000 which is amortized over 40
years. The allocation of the purchase price associated with the acquisitions has
been determined by the Company based on available information and is subject to
further refinement.
(b) Reflects the assumed payment of all outstanding debt.
<TABLE>
<CAPTION>
TWELVE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------- -------------
(IN THOUSANDS)
<C> <S> <C> <C>
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS
(c) REFLECTS THE FOLLOWING ADJUSTMENTS TO REVENUES:
(i) Elimination of division not acquired........................ $(10,949) $ --
======== ========
(d) REFLECTS THE FOLLOWING ADJUSTMENTS TO COST OF GOODS SOLD:
(i) Adjust rent expense per new leases.......................... $ (105) $ --
(ii) (Elimination) addition of real estate depreciation.......... (19) 4
(iii) Elimination of division not acquired........................ (9,661) --
-------- --------
$ (9,785) $ 4
======== ========
(e) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $(13,734) $ (1,777)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 4,642 800
(iii) Additional lease expense on real estate sold by AC Service &
Installation Co., Inc. and Vision Holding Company, Inc...... 53 --
(iv) Elimination of depreciation expense on real estate sold by
AC Service & Installation Co., Inc. and Vision Holding
Company, Inc................................................ (24) --
(v) Elimination of non-competition fees resulting from buyout of
non-compensation agreements................................. (43) --
(vi) Corporate office overhead expenses.......................... 270 --
(vii) Corporate office compensation............................... 366 --
(viii) Elimination of management fees paid by Air Experts, a United
Services Co., Inc. and Service Experts of Palm Springs, Inc.
to parent companies or affiliates which are part of the
corporate office adjustments................................ (36) --
(ix) Goodwill amortization....................................... 2,472 457
(x) Elimination of general and administrative expenses including
elimination of division not acquired........................ (1,800) (417)
(xi) Three regional vice presidents and one MIS director......... 700 --
-------- --------
$ (7,134) $ (937)
======== ========
</TABLE>
F-18
<PAGE> 21
SERVICE EXPERTS, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
TWELVE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1996 1997
------------- -------------
(IN THOUSANDS)
<C> <S> <C> <C>
(f) REFLECTS THE FOLLOWING ADJUSTMENTS TO INTEREST EXPENSE RELATED TO:
(i) Elimination of debt distributed to shareholder of Vision
Holding Company, Inc........................................ $ 45 $ --
(ii) Elimination of interest on debt distributed to shares of AC
Service & Installation Co., Inc. and Custom Air
Conditioning, Inc........................................... 15 197
(iii) Elimination of all other debt assumed in the transaction to
be paid at closing.......................................... 1,306 53
(iv) Additional interest on debt incurred associated with the
transaction................................................. (604) --
-------- --------
$ 762 $ 250
======== ========
(g) REFLECTS THE FOLLOWING ADJUSTMENT TO OTHER INCOME:
(i) The addition of income from its 37% investment in Future
University.................................................. $ 40 $ --
(ii) Elimination of debt retirement expenses..................... -- 147
-------- --------
$ 40 147
======== ========
(h) REFLECTS THE FOLLOWING ADJUSTMENTS TO INCOME TAXES:
(i) Additional income tax provision for state and federal taxes
at a combined effective rate of 38% as certain Acquired
Companies and the Pending Acquisition previously which were
taxed as Subchapter S corporations.......................... $ 2,335 $ 689
(ii) Additional income taxes on adjustments (c) thru (g)......... 2,264 133
(iii) Additional income tax provision for state and federal taxes
due to the non-deductibility of goodwill.................... 1,125 98
(iv) Estimated state and federal tax on acquired companies and
the pending acquisition..................................... -- 87
-------- --------
$ 5,724 $ 1,007
======== ========
(i) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 650,000 shares and the dilutive effect of warrants
issued to the owners of the Acquired Companies, (ii) 58,000
shares issued to the owners of the Pending Acquisition,
(iii) 521,000 additional shares to reflect the shares issued
in the Secondary Offering as outstanding for the entire
period.
(j) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 1,666,000 shares and the dilutive effect of warrants
issued to the owners of the Acquired Companies, (ii) 58,000
shares issued to the owners of the Pending Acquisition,
(iii) 1,850,000 shares issued in the Secondary Offering,
(iv) 6,677,000 additional shares to reflect the shares
issued in the Initial Public Offering to the Predecessor
Companies and shares issued to the 11 Acquired Companies
closed in 1996 as outstanding for the entire period.
</TABLE>
F-19
<PAGE> 22
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
----------------------------------
Anthony M. Schofield
Chief Financial Officer, Secretary
and Treasurer
Date: November 26, 1997
3
<PAGE> 23
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C>
23 Consent of Ernst & Young LLP
</TABLE>
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Post-Effective Amendment No.
6 to the Registration Statement (Form S-4 No. 333-12319) and related Prospectus
of Service Experts, Inc. related to $50,000,000 aggregate amount of shares of
its $.01 par value common stock, warrants to purchase its common stock ("Common
Stock Warrants") and the shares of its common stock issued thereunder upon the
exercise of such Common Stock Warrants or debt securities ("Debt Securities"),
and the shares of common stock issued thereunder upon the conversion thereof;
and in the Registration Statement (Form S-8 No. 333-11791) pertaining to the
Service Experts, Inc. 1996 Incentive Stock Plan, Service Experts, Inc. 1996
Non-Employee Director Stock Option Plan and Service Experts, Inc. 1996 Employee
Stock Purchase Plan, of our report dated October 16, 1997, with respect to the
combined financial statements of TML, Inc. and MT Partnership included in this
Current Report on Form 8-K dated November 26, 1997, filed with the Securities
and Exchange Commission.
/s/ Ernst & Young LLP
Nashville, Tennessee
November 26, 1997
