<PAGE> 1
[FILED PURSUANT TO RULE 424 (B)(1)
REGISTRATION NO. 333-21971]
2,500,000 SHARES
SERVICE EXPERTS LOGO
COMMON STOCK
---------------------
Of the 2,500,000 shares of Common Stock, $.01 par value per share (the
"Common Stock"), of Service Experts, Inc. (the "Company" or "Service Experts")
offered hereby (the "Offering"), 1,850,000 shares are being offered by the
Company and 650,000 shares are being offered by certain selling stockholders of
the Company (the "Selling Stockholders"). The Company will not receive any of
the proceeds from the sale of shares by the Selling Stockholders. See "Principal
and Selling Stockholders." The Common Stock of the Company is traded on the
Nasdaq National Market under the symbol "SERX." On March 17, 1997, the last
reported sale price for the Company's Common Stock was $21.75 per share.
SEE "RISK FACTORS" BEGINNING ON PAGE 6 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 PROCEEDS TO
PUBLIC DISCOUNT(1) COMPANY(2) SELLING STOCKHOLDERS
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share.................... $22.00 $1.10 $20.90 $20.90
- -----------------------------------------------------------------------------------------------------------------
Total(3)..................... $55,000,000 $2,750,000 $38,665,000 $13,585,000
=================================================================================================================
</TABLE>
(1) See "Underwriting" for a description of the indemnification arrangements
with the Underwriters.
(2) Before deducting expenses estimated at $1,000,000 payable by the Company.
(3) The Selling Stockholders have granted to the Underwriters a 30-day option to
purchase up to an additional 375,000 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 Selling Stockholders will be
$63,250,000, $3,162,500 and $21,422,500, 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
March 21, 1997.
EQUITABLE SECURITIES CORPORATION
ALEX. BROWN & SONS
INCORPORATED
A.G. EDWARDS & SONS, INC.
MORGAN KEEGAN & COMPANY, INC.
March 18, 1997
<PAGE> 2
SERVICE EXPERTS LOGO
A MAP OF THE CONTINGUOUS 48 STATES SETTING FORTH THE LOCATION OF EACH
PREDECESSOR COMPANY, ACQUIRED COMPANY, PENDING ACQUISITION AND CSG MEMBER IS
INCLUDED HERE.
---------------------
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 TRANSACTIONS MAY BE EFFECTED ON THE NASDAQ NATIONAL MARKET. SUCH
STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. SEE "UNDERWRITING."
IN CONNECTION WITH THIS OFFERING, CERTAIN UNDERWRITERS (AND SELLING GROUP
MEMBERS) MAY ENGAGE IN PASSIVE MARKET MAKING TRANSACTIONS IN THE COMMON STOCK ON
THE NASDAQ NATIONAL MARKET IN ACCORDANCE WITH RULE 103 OF REGULATION M UNDER THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED (THE "EXCHANGE ACT"). SEE
"UNDERWRITING."
2
<PAGE> 3
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.
Unless the context otherwise requires, all references to the "Company" or
"Service Experts" shall mean Service Experts, Inc. Unless otherwise indicated,
the information in this Prospectus does not give effect to the Underwriters'
over-allotment option. The Company completed the initial public offering of its
Common Stock on August 21, 1996 (the "IPO"). Simultaneously with the closing of
the IPO, the Company acquired 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"). See "Business -- Acquisitions" for a
list of the Predecessor Companies. The term "Service Centers" refers to HVAC
service and replacement businesses operated by the Company.
THE COMPANY
The Company is one of the leading providers of residential HVAC services
and replacement equipment in the United States, and management believes that the
Company will continue to be a leading consolidator of the fragmented HVAC
service and replacement industry. The Company currently operates 32 Service
Centers in 17 states. The Service Centers install, service and maintain central
air conditioners, furnaces and heat pumps, primarily in existing homes.
Management estimates that over 80% of the Company's pro forma net revenue in
1996, after giving effect to all completed and pending acquisitions, was derived
from replacing, maintaining and servicing HVAC equipment at existing residences.
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 offers higher margins and exposes the Company to
less credit risk. The service and replacement segment offers 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's products and services are designed to provide
its members with a competitive advantage by utilizing proven marketing and
operational strategies and by enabling members to operate their businesses with
a higher degree of professionalism. All of the Service Centers are members of
CSG and operate in accordance with its recommended methods and procedures. 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.
The HVAC service and replacement industry is large and growing. Management
estimates, based upon industry information, that the market for the service and
replacement of HVAC systems in existing homes is approximately $24 billion
annually. The service 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.
Management believes that the fragmentation of the HVAC industry creates an
opportunity for further acquisitions of HVAC companies. According to Air
Conditioning, Heating and Refrigeration News, over 30,000 independent HVAC
contractors are currently operating in the United States. Management believes
that these businesses are typically closely held, single-center operations that
serve a limited geographic area. The businesses are heavily dependent upon
referrals to generate business. 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> 4
ACQUISITION STRATEGY AND RECENT ACQUISITIONS
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. In
addition, management believes that the Company's visibility within the industry
and its operational philosophy of decentralized operations and centralized
administration provide the Company with a competitive advantage, particularly in
enabling the Company to identify and acquire well-managed, profitable HVAC
businesses. By allowing former owners of Service Centers the opportunity to
continue managing their business after acquisition and to increase their focus
on customer service rather than administration, management believes that the
Company offers owners of independent HVAC businesses an attractive alternative.
Management intends to develop a national presence through acquisitions and a
national reputation for superior, high quality service that will enable the
Company to appeal to a large number of customers. The Company has implemented an
aggressive acquisition strategy, acquiring 25 HVAC businesses (the "Acquired
Companies" and, together with the Predecessor Companies, the "Subsidiaries")
since the IPO with aggregate revenue for the 12 months ended December 31, 1996
of approximately $79.1 million. The Company currently has agreements in
principle to acquire 11 HVAC businesses (the "Pending Acquisitions") with
aggregate revenue in 1996 of approximately $35.7 million. The Pending
Acquisitions are expected to close during the first six months of 1997. See
"Business -- Acquisitions" for a list of the Acquired Companies and the
companies included in the Pending Acquisitions. The Company's 1996 pro forma net
revenue, reflecting the acquisition of the Subsidiaries and eight Pending
Acquisitions, was approximately $172.3 million. See the Pro Forma Combined
Financial Statements and the Notes thereto for a listing of the companies
included.
Management targets for acquisition as "hubs" CSG members that are
geographically desirable, financially stable and whose management is experienced
in the industry and CSG operating methods. Of the Company's 32 Service Centers
and the 11 companies to be acquired in the Pending Acquisitions, all but four
are CSG members. The Company also plans to increase its market presence through
acquisitions of other HVAC businesses that have large customer bases and that
present opportunities for overhead savings or asset sales to improve
profitability. In many cases, the assets of acquired "spoke" companies will be
combined with the operations of existing Service Centers. In addition,
management believes that it will be able to improve the performance of these
acquired companies through the implementation of the methods and procedures
developed by CSG.
The Company's principal executive offices are located at 111 Westwood
Place, Suite 420, Brentwood, Tennessee 37027, and its telephone number is (615)
371-9990.
THE OFFERING
Common Stock offered by the Company..... 1,850,000 shares
Common Stock offered by the Selling
Stockholders............................ 650,000 shares
Common Stock to be outstanding after the
Offering................................ 13,671,722 shares(1)
Use of Proceeds......................... $15.5 million to fund the cash
portion of the consideration for
the Pending Acquisitions, including
the repayment of certain
indebtedness arising from the
Pending Acquisitions, certain other
indebtedness and capital lease
obligations, and the remainder for
future acquisitions and general
corporate purposes. See "Use of
Proceeds."
Nasdaq National Market Symbol........... SERX
- ---------------
(1) Does not include 758,202 shares of Common Stock issuable upon the exercise
of stock options granted under the Company's stock option plans and
outstanding warrants. See "Management -- Compensation Pursuant to Plans"
and "Description of Capital Stock -- Stock Purchase Warrants." Also does
not include shares of Common Stock to be issued in connection with the
Pending Acquisitions. See "Business -- Acquisitions."
4
<PAGE> 5
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents summary financial data of the Company. The
Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneously with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. The acquisitions of the Predecessor Companies have
been accounted for using the historical cost basis of the Predecessor Companies
in accordance with the Securities and Exchange Commission (the "Commission")
Staff Accounting Bulletin No. 48 ("SAB 48"). In accordance with the provisions
of Commission Staff Accounting Bulletin No. 97 ("SAB 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").
In addition, the historical financial statements of the Company for all periods
presented include the financial statements of Custom Air Conditioning, Inc. and
Freschi Air Systems, Inc. (collectively, the "Pooled Companies"), which were
acquired effective December 1, 1996 in business combinations accounted for as
poolings of interests, and the operations of all other Subsidiaries are included
from their respective effective dates of acquisition. The following should be
read with the historical financial statements and the Pro Forma Combined
Financial Statements and Notes thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
PRO FORMA YEAR ENDED DECEMBER 31, 1996,
GIVING EFFECT TO:
YEAR ENDED DECEMBER 31, ---------------------------------------------
--------------------------- PREDECESSOR ACQUIRED PENDING
1994 1995 1996 COMPANIES(1) COMPANIES(2) ACQUISITIONS(3)
------- ------- ------- ------------ ------------ ---------------
<S> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue..................... $22,193 $24,876 $46,856 $76,984 $140,654 $172,303
Cost of goods sold.............. 15,999 16,916 30,198 49,250 90,656 113,627
Gross margin.................... 6,194 7,960 16,658 27,734 49,998 58,676
Selling, general and
administrative expenses....... 5,723 7,162 12,837 18,999 36,619 42,487
Income from operations.......... 471 798 3,821 8,735 13,379 16,189
Interest (expense) income,
net........................... (64) (56) 271 459 527 610
Pro forma net income(4)......... 281 466 2,794 6,176 8,487 10,166
Pro forma net income per
share(5)...................... $ .63 $ .67 $ .71 $ .76
Pro forma weighted average
shares outstanding(5)......... 4,451 9,220 11,885 13,333
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------------------------------------
PRO FORMA AS
ACTUAL PRO FORMA(3) ADJUSTED(3)(6)
----------- ------------ --------------
<S> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)......................... $12,387 $(1,157) $ 35,644
Total assets...................................... 68,504 100,434 129,756
Total debt........................................ 275 8,344 --
Stockholders' equity.............................. 53,071 72,656 110,322
</TABLE>
- ---------------
(1) Gives effect to the Combination which was accounted for using the historical
cost basis of the Predecessor Companies in accordance with SAB 48. In
addition, the pro forma information is based on certain assumptions and
adjustments. See Notes to the Pro Forma Combined Financial Statements.
(2) Gives effect to the acquisition of the Predecessor Companies and the
Acquired Companies (excluding the Pooled Companies) as if such transactions
were completed as of January 1, 1996. In addition, the pro forma information
is based on certain assumptions and adjustments. Does not include the
results of two Acquired Companies which are immaterial to the pro forma
presentation. See the Pro Forma Combined Financial Statements and the Notes
thereto.
(3) Gives effect to the acquisition of the Predecessor Companies and the
Acquired Companies (excluding the Pooled Companies) and to the Pending
Acquisitions, as if such transactions were completed as of January 1, 1996.
In addition, the pro forma information is based on certain assumptions and
adjustments. Does not give effect to the acquisition of two Acquired
Companies and three Pending Acquisitions which are immaterial to the pro
forma presentation. See the Pro Forma Combined Financial Statements and the
Notes thereto.
(4) Historical net income and income tax expense have been omitted because these
amounts are not meaningful as a result of the different tax status of the
Subsidiaries. Pro forma net income represents the effect of taxing the
entities under Subchapter C of the Internal Revenue Code.
(5) The computation of pro forma net income per share is based upon 13,332,770
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO, (iii) 2,587,500 shares sold in the IPO,
(iv) 3,557,395 shares issued to former stockholders of the 23 Acquired
Companies and in the eight Pending Acquisitions listed on page F-2 hereof,
(v) 1,125,344 shares being issued in this Offering and (vi) 77,795 shares
which reflect the dilutive effect of the options and warrants.
(6) Adjusted to give effect to the application of the net proceeds to the
Company of this Offering.
5
<PAGE> 6
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 expressed in
forward-looking statements made elsewhere herein by, or on behalf of, the
Company. In particular, the Company's forward-looking statements in this
Prospectus, including those regarding the successful integration of the
businesses of the Subsidiaries, the effective implementation of the Company's
strategy, the availability of additional HVAC businesses for acquisition, the
adequacy of the Company's capital resources and other statements regarding
trends relating to the HVAC industry and various revenue and expense items,
could be affected by a number of risks and uncertainties including those
described below.
LIMITED COMBINED OPERATING HISTORY
The Company was incorporated in March 1996 and, simultaneously with the
closing of the IPO, consummated the acquisition of the Predecessor Companies.
Since the IPO, the Company has acquired 25 additional HVAC businesses. Because
of the limited operating history of the Company as a combined entity, there can
be no assurance that the Company will be able to integrate successfully the
businesses of the Subsidiaries or to operate profitably. There can be no
assurance that the Company's 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 Subsidiaries 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 -- Acquisitions."
RISKS ASSOCIATED WITH ACQUISITION STRATEGY AND FINANCING
The success of the Company's acquisition strategy will depend on a number
of factors, including (i) the Company's ability to locate and successfully
negotiate the acquisition of HVAC businesses and to successfully integrate the
operations of acquired Service Centers into the Company's operations and (ii)
the availability of adequate financing to develop or acquire additional HVAC
businesses. In addition, the Company competes with other HVAC and residential
service companies for desirable acquisition candidates. Some of these companies
may have access to capital, personnel and other resources equal to or greater
than those of the Company. The Company expects that its capital needs over the
next several years, primarily for acquisitions, will exceed capital generated
from operations. The Company plans to incur indebtedness and to issue, from time
to time, additional debt or equity securities, including the issuance of Common
Stock in connection with acquisitions of HVAC businesses. To facilitate its
acquisition strategy, the Company has registered $50 million of additional
equity or debt securities under the Securities Act of 1933, as amended (the
"Securities Act"). See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources." In the
event that the Common Stock does not maintain a sufficient market value, or
potential acquisition candidates are unwilling to accept Common Stock as part of
the consideration for the sale of their businesses, the Company may be required
to utilize more of its cash resources, if available, in order to maintain its
acquisition program. In addition, the closing of the Pending Acquisitions is
subject to customary conditions, and there can be no assurance that the Company
will be able to consummate all of the Pending Acquisitions or to successfully
integrate the businesses of its Service Centers. 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 -- Acquisitions."
6
<PAGE> 7
RISKS ASSOCIATED WITH DEVELOPMENT, IMPLEMENTATION, AND INTEGRATION OF OPERATING
SYSTEMS AND POLICIES
As a rapidly growing provider of HVAC services, the Company is faced with
the development, implementation and integration of Company-wide policies and
systems related to its operations. Each of the Subsidiaries and companies to be
acquired may need, to some extent, to modify or adopt certain systems and
policies they have utilized historically in order to implement the Company's
systems and policies, which management is currently formulating. The Company has
implemented a uniform general ledger system and electronic mail system at each
of the Service Centers. The Company plans to implement and integrate certain
other information and operating systems and procedures for the Service Centers
including, but not limited to, employment and human resources policies, uniform
purchasing programs and certain centralized marketing programs. The Company may
experience delays, complications and expenses in implementing, integrating and
operating such systems, any of which could have a material adverse effect on the
Company's operations, net revenue and earnings. See "Business -- Services and
Operations."
COMPETITION
The HVAC service and replacement industry is highly competitive. The
Company's Service Centers 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, 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 is dependent 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 -- Executive
Officers, Directors and Key Employees."
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 is 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 effect on the Company. See "Business -- HVAC
Service and Replacement Industry."
7
<PAGE> 8
CONTROL BY MANAGEMENT AND PRINCIPAL STOCKHOLDERS
Following the completion of this Offering, directors, officers and 5%
stockholders of the Company will beneficially own approximately 23.5% of the
outstanding Common Stock. See "Principal and Selling 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.
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."
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 (the "Clean Air Act"), 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 those
implementing the Clean Air Act, 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
("Restated Certificate") 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 and
Bylaws include certain super-majority voting requirements. The Restated
Certificate also allows the Board to determine the terms of 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 this 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 is to be paid as severance pay such
officer's base
8
<PAGE> 9
salary for the remaining term of the employment agreement. See
"Management -- Employment Agreements."
VOLATILITY OF MARKET PRICE
From time to time, 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.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this Offering, the Company will have outstanding
13,671,722 shares of Common Stock, of which 5,087,500 shares (5,462,500 shares
if the Underwriters' over-allotment option is exercised in full) will be freely
tradeable without restriction or further registration under the Securities Act,
except for those held by "affiliates" (as defined in the Securities Act) of the
Company, which will be subject to the resale limitations of Rule 144 under the
Securities Act. Following this Offering, holders of 1,462,100 shares of Common
Stock will be eligible to sell such shares pursuant to Rule 144 (subject to
certain limitations) under the Securities Act beginning April 29, 1997 and an
additional 4,522,546 shares will become eligible for sale pursuant to Rule 144
in August 1997. The Company, its executive officers and directors and the
Selling Stockholders have agreed not to sell or otherwise dispose of shares of
Common Stock for 120 days after the date of this Prospectus without the prior
approval of Equitable Securities Corporation on behalf of the Underwriters. In
connection with acquisitions of Service Centers completed after the IPO,
3,249,486 shares of Common Stock have been issued to stockholders who may be
deemed "affiliates" for purposes of Rule 145 under the Securities Act,
approximately 644,000 of which are eligible for sale in the public market in
accordance with Rule 145. In addition to the resale limitations of Rule 145,
certain stockholders of such acquired companies are subject to lockup agreements
limiting the resale of such shares for a period of two years after the date of
acquisition. Under the terms of these lockup agreements, approximately 343,000
additional shares will become eligible for sale in the public market subject to
Rule 145 between the date of this Prospectus and July 31, 1997. The Company also
plans to issue shares of its Common Stock that have been registered under the
Securities Act in connection with future acquisitions. The Company anticipates
that, upon the issuance thereof, these shares will generally be freely tradeable
unless the resale thereof is contractually restricted. Following this Offering,
sales of substantial amounts of Common Stock in the public market pursuant to
Rule 144, Rule 145 or otherwise, and the potential of such sales, could
adversely affect the prevailing market price of the Common Stock and impair the
Company's ability to raise additional capital through the sale of equity
securities. See "Shares Eligible for Future Sale" and "Underwriting."
9
<PAGE> 10
USE OF PROCEEDS
The net proceeds to the Company from the sale of the shares of Common Stock
offered hereby are estimated to be approximately $37.7 million. The Company will
not receive any of the proceeds from the sale of shares by the Selling
Stockholders.
The Company plans to use approximately $15.5 million of the net proceeds of
the Offering to fund the cash portion of the consideration to be paid in the
Pending Acquisitions, including approximately $7.1 million to repay indebtedness
incurred under the Company's bank credit facilities in connection with the
Pending Acquisitions, and approximately $1.4 million of other indebtedness of
the Company, including debt assumed in connection with the Pending Acquisitions
and capital lease obligations. The credit facilities currently bear interest at
a weighted average interest rate of 6.75%. The remaining $22.2 million of the
net proceeds is expected to be used, together with internally generated funds
and borrowings under its credit facility, to fund the acquisition and
development of additional Service Centers and for general corporate purposes.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
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.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The following table sets forth the reported high and low sales prices of
the Common Stock for the quarters indicated as reported on the Nasdaq National
Market. The Company commenced its IPO on August 16, 1996 at a price per share of
$13.00. The Common Stock is traded on the Nasdaq National Market under the
symbol "SERX."
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1996
Third Quarter (beginning August 16, 1996)................. $20.75 $13.75
Fourth Quarter............................................ 28.50 19.00
1997
First Quarter (through March 17, 1997).................... $28.25 $21.75
</TABLE>
On March 17, 1997, the last reported sale price of the Common Stock was
$21.75 per share. As of March 17, 1997, there were approximately 182 holders of
record of the Company's Common Stock.
The Company has never declared or paid dividends on its Common Stock. The
Company expects that future earnings will be retained to finance the growth and
development of the Company's business and, accordingly, 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. In addition, the Company's credit
facilities impose restrictions on the ability of the Company to pay dividends.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
10
<PAGE> 11
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
December 31, 1996 (i) on an actual basis, (ii) on a pro forma basis to give
effect to the acquisition of eight Acquired Companies completed subsequent to
December 31, 1996 and to the eight Pending Acquisitions listed on page F-2
hereof as if they had been completed as of December 31, 1996 and (iii) on a pro
forma as adjusted basis to give effect to the sale of the 1,850,000 shares of
Common Stock offered by the Company in the Offering and the application of the
net proceeds therefrom. The following table should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the Consolidated Financial Statements of the Company and the
related Notes thereto included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
DECEMBER 31, 1996
---------------------------------
PRO FORMA
ACTUAL PRO FORMA AS ADJUSTED
------- --------- -----------
(IN THOUSANDS)
<S> <C> <C> <C>
Cash........................................................ $10,726 $ 970 $ 30,292
======= ======= ========
Short-term debt, including current portion of long-term
debt, capital lease obligations and notes payable to
related parties........................................... $ 135 $ 7,479 $ --
======= ======= ========
Long-term debt and capital lease obligations, less current
portion................................................... $ 140 $ 734 $ --
Notes payable to related parties............................ -- 131 --
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; 11,050,326 shares outstanding, 11,328,440
shares outstanding pro forma, 13,254,975 shares
outstanding pro forma as adjusted...................... 111 122 141
Additional paid-in capital................................ 48,566 68,140 105,787
Retained earnings......................................... 4,409 4,409 4,409
Equity notes receivable................................... (15) (15) (15)
------- ------- --------
Total stockholders' equity........................ 53,071 72,656 110,322
------- ------- --------
Total capitalization.............................. $53,211 $73,521 $110,322
======= ======= ========
</TABLE>
11
<PAGE> 12
SELECTED CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents selected financial data of the Company. The
Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneously with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. The acquisitions of the Predecessor Companies have
been accounted for using the historical cost basis of the Predecessor Companies
in accordance with SAB 48. In accordance with the provisions of SAB 97, the
historical financial statements of the Company for periods prior to August 21,
1996 are the combined financial statements of the Acquiring Company. In
addition, the historical financial statements of the Company for all periods
presented include the financial statements of the Pooled Companies, which were
acquired effective December 1, 1996 in business combinations accounted for as
poolings of interests, and the operations of all other Subsidiaries are included
from their respective effective dates of acquisition. The following should be
read with the historical financial statements, the Pro Forma Combined Financial
Statements and the Notes thereto appearing elsewhere in this Prospectus.
The selected financial data for the fiscal years ended December 31, 1993,
1994, 1995 and 1996 (except for pro forma amounts) have been derived from the
financial statements of the Acquiring Company and the Pooled Companies. The
selected financial data of the Company for the fiscal year ended December 31,
1992 have been derived from unaudited financial statements 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 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.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue...................................... $14,507 $16,339 $22,193 $24,876 $46,856
Cost of goods sold............................... 10,095 11,716 15,999 16,916 30,198
------- ------- ------- ------- -------
Gross margin..................................... 4,412 4,623 6,194 7,960 16,658
Selling, general and administrative expenses..... 4,241 4,584 5,723 7,162 12,837
------- ------- ------- ------- -------
Income from operations........................... 171 39 471 798 3,821
Other income (expense)........................... 22 24 (47) (8) 485
------- ------- ------- ------- -------
Income before tax................................ 193 63 424 790 4,306
Provision for income taxes....................... 76 18 41 82 1,196
------- ------- ------- ------- -------
Net income....................................... $ 117 $ 45 $ 383 $ 708 $ 3,110
======= ======= ======= ======= =======
Net income per share............................. $ .70
Weighted average shares outstanding.............. 4,451
=======
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------------
1992 1993 1994 1995 1996
------ ------ ------ ------ --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital..................................... $1,231 $1,226 $ 850 $1,336 $ 12,387
Total assets........................................ 3,935 4,605 5,431 6,020 68,504
Total debt.......................................... 1,390 1,374 1,317 1,530 275
Stockholders' equity................................ 1,524 1,452 1,550 2,064 53,071
</TABLE>
12
<PAGE> 13
SELECTED PRO FORMA COMBINED FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following unaudited pro forma statements of operations of the Company
for the year ended December 31, 1996 give effect to (i) the acquisition of the
Predecessor Companies and the 23 Acquired Companies (excluding the Pooled
Companies) and to the eight Pending Acquisitions listed on page F-2 hereof as if
all of these transactions had been consummated as of January 1, 1996, (ii) the
sale of 1,066,170 shares of Common Stock in this Offering and the application of
the net proceeds therefrom to repay all assumed indebtedness and (iii) the
issuance of shares of the Company's Common Stock and cash proceeds to complete
the eight Pending Acquisitions listed on page F-2 hereof. See the Pro Forma
Combined Financial Statements and the Notes thereto. The unaudited pro forma
financial information set forth below is qualified by reference to and should be
read in conjunction with the historical financial statements of the Company and
the Pro Forma Combined Financial Statements and the Notes thereto included
elsewhere in this Prospectus. The unaudited pro forma financial information set
forth below is not necessarily indicative of the results of operations that
might have occurred if the transactions had taken place on such date or of the
Company's results of operations for any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------------------------------------------
PREDECESSOR PRO FORMA ACQUIRED PRO FORMA PENDING
COMPANIES PREDECESSOR COMPANIES ACQUIRED ACQUISITIONS
COMPANY(1) AS ADJUSTED(2) COMPANIES AS ADJUSTED(3) COMPANIES AS ADJUSTED(4)
---------- -------------- ----------- -------------- ------------ --------------
<S> <C> <C> <C> <C> <C> <C>
Net revenues................ $46,856 $30,128 $76,984 $63,670 $140,654 $ 31,649
Cost of goods sold.......... 30,198 19,052 49,250 41,406 90,656 22,971
------- ------- ------- ------- -------- --------
Gross margin................ 16,658 11,076 27,734 22,264 49,998 8,678
Selling, general and
administrative expenses... 12,837 6,162 18,999 17,620 36,619 5,868
------- ------- ------- ------- -------- --------
Income from operations...... 3,821 4,914 8,735 4,644 13,379 2,810
Other income (expense):
Interest expense.......... (63) (4) (67) 1 (66) (649)
Interest income........... 334 192 526 67 593 17
Other income (expense).... 214 43 257 (165) 92 73
------- ------- ------- ------- -------- --------
Income before tax........... 4,306 5,145 9,451 4,547 13,998 2,251
Pro forma income tax
expense................... 1,512 1,763 3,275 2,236 5,511 1,015
------- ------- ------- ------- -------- --------
Pro forma net income........ $ 2,794 $ 3,382 $ 6,176 $ 2,311 $ 8,487 $ 1,236
======= ======= ======= ======= ======== ========
Pro forma net income per
share..................... $ 0.63 $ 0.67 $ 0.71
Pro forma weighted average
shares outstanding........ 4,451 9,220 11,885
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------
PRO FORMA
OFFERING PRO FORMA
ADJUSTMENTS ALL ACQUISITIONS
----------- ----------------
<S> <C> <C>
Net revenues................ -- $172,303
Cost of goods sold.......... -- 113,627
---- --------
Gross margin................ -- 58,676
Selling, general and
administrative expenses... -- 42,487
---- --------
Income from operations...... -- 16,189
Other income (expense):
Interest expense.......... 715(5) --
Interest income........... -- 610
Other income (expense).... -- 165
---- --------
Income before tax........... 715 16,964
Pro forma income tax
expense................... 272(6) 6,798
---- --------
Pro forma net income........ $443 $ 10,166
==== ========
Pro forma net income per
share..................... $ 0.76
Pro forma weighted average
shares outstanding........ 13,333(7)
</TABLE>
- ---------------
(1) See "Summary Financial Data" for a description of the Company's historical
financial statements.
(2) Gives effect to the Predecessor Companies for the period January 1, 1996 to
August 21, 1996.
(3) Gives effect to the 23 Acquired Companies (excluding the Pooled Companies)
listed on page F-2 hereof. Reflects adjustments to expense items in
connection with the acquisitions. See Pro Forma Combined Financial
Statements and the Notes thereto for information regarding these
adjustments.
(4) Gives effect to the eight Pending Acquisitions listed on page F-2 hereof.
Reflects adjustments to expense items in connection with the acquisitions.
See Pro Forma Combined Financial Statements and the Notes thereto for
information regarding these adjustments.
(5) Reflects adjustments to interest expense for the elimination of debt.
(6) Reflects the adjustment to income taxes.
(7) The computation of pro forma net income per share is based upon 13,332,770
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO (iii) 2,587,500 shares sold in the IPO,
(iv) 3,557,395 shares issued to former stockholders of the 23 Acquired
Companies and in the eight Pending Acquisitions listed on page F-2 hereof,
(v) 1,125,344 shares being issued in this Offering and (vi) 77,795 shares
which reflect the dilutive effect of the options and warrants.
13
<PAGE> 14
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 Company's Consolidated Financial Statements and Pro Forma
Combined Financial Statements, including the Notes thereto, and the other
financial information appearing elsewhere in this Prospectus.
OVERVIEW
Simultaneous with the IPO in August 1996, the Company acquired the
Predecessor Companies in the Combination. Prior to the Combination, the Company
had no operations. The consideration paid by the Company for the Predecessor
Companies was approximately $77.5 million, consisting of 4.5 million shares of
Common Stock and $18.7 million in cash. No intangible assets were recorded as a
result of the Combination due to the accounting treatment in accordance with SAB
48. On a pro forma basis, these companies, together with the Pooled Companies,
generated revenue in 1996 of approximately $77.0 million and contributed
operating income of approximately $8.7 million.
Since the IPO, the Company has acquired 25 HVAC businesses. The
consideration paid by the Company for the Acquired Companies was approximately
$59.6 million, consisting of 3.2 million shares of Common Stock and $6.2 million
in cash. Two of the transactions were accounted for using the pooling of
interests method of accounting, and the remainder were accounted for using the
purchase method. Of the purchase price, $45.6 million was allocated to
intangible assets which are to be amortized over a 40-year period. The Acquired
Companies' aggregate revenue and operating income for the 12 months ended 1996
were approximately $79.1 million and $3.8 million, respectively.
The Company currently has entered into agreements in principle to acquire
11 HVAC businesses. The Pending Acquisitions are expected to close during the
first six months of 1997. The consideration to be paid by the Company for these
businesses is approximately $24.0 million, consisting of 376,492 shares of
Common Stock and $15.5 million in cash. All of the Pending Acquisitions are
expected to be accounted for using the purchase method. Of the purchase price,
$18.6 million is expected to be allocated to intangible assets which are to be
amortized over a 40-year period. On a pro forma basis, the eight companies
listed as Pending Acquisitions on page F-2 hereof generated revenue in 1996 of
approximately $31.6 million and contributed operating income of approximately
$2.8 million. The Pending Acquisitions are subject to customary conditions, and
there can be no assurance that the Company will be able to consummate all of the
acquisitions or to successfully integrate the businesses of the acquired
companies.
FINANCIAL STATEMENT PRESENTATION
Since the IPO, the financial presentation of the Company has changed. The
Combination was accounted for using the historical cost basis of the Predecessor
Companies in accordance with SAB 48. On July 31, 1996, SAB 97 was adopted to
replace SAB 48 for certain combination transactions. In accordance with the
provisions of SAB 97, the presentation of financial information for the Company
reflects the Acquiring Company as the acquiror of the other Predecessor
Companies. Prior financial statements of the combined Predecessor Companies are
not included in the Company's historical financial presentation. The operation
of the Predecessor Companies and other acquired companies (except for those
companies acquired under the pooling of interests method) have been included in
the Company's financial statements from their respective effective dates of
acquisition.
The Pro Forma Combined Financial Statements and "Selected Pro Forma
Combined Financial Data" give effect to the acquisition of the Predecessor
Companies and the Acquired Companies (excluding the Pooled Companies) and to
eight Pending Acquisitions as if they had occurred on January 1, 1996. The pro
forma presentation does not give effect to the acquisition of two Acquired
Companies and to three Pending Acquisitions which are immaterial to such
presentation. The pro forma analysis adjusts the combined financial statements
to give effect to the accounting treatment of the respective transactions,
including the use of cash or issuance of shares of Common Stock and the
elimination or adjustment of certain expenses which
14
<PAGE> 15
management expects will result from the acquisition. The pro forma statements
contain estimates and may not be indicative of actual results of the Company in
the future.
The Subsidiaries historically have been managed as independent private
companies and, as such, their results of operations reflect different tax
structures which have influenced, among other things, their historical levels of
owner's compensation. Owners and certain key employees of the Subsidiaries have
agreed to certain reductions in their compensation in connection with the
acquisitions. These reductions equaled approximately $8.1 million based upon
1996 actual compensation expense. The pro forma financial data have been
adjusted to reflect this expense reduction. The pro forma financial statements
have also been adjusted to reflect the addition of a corporate headquarters and
management team. These additional costs equaled approximately $1.3 million.
Other adjustments, in the aggregate, increased the Company's expenses associated
with these companies by approximately $1.3 million.
COMPONENTS OF INCOME
Net revenue of the Subsidiaries has been derived primarily from the
following sources (i) the installation of central air conditioners, furnaces and
heat pumps primarily in existing homes and (ii) the service and maintenance of
central air conditioners, furnaces and heat pumps primarily in existing homes.
Net revenue and associated income from operations are subject to seasonal
fluctuations resulting from increased demand for the Company's services during
warmer weather in the summer months and during colder weather in winter months,
particularly in the beginning of each season. Cost of goods sold primarily
consists of purchased materials such as replacement air conditioning units and
heat pumps and the labor associated with both installations and repair orders.
The main components of selling, general and administrative expenses include
administrative salaries, insurance expense and promotion and advertising
expenses.
RESULTS OF OPERATIONS
Because of the significant effect of the Combination, the acquisitions of
the Acquired Companies and the anticipated effect of the Pending Acquisitions on
the Company's results of operations, the Company's historical results of
operations and period-to-period comparisons will not be indicative of future
results and may not be meaningful. The Company plans to continue acquiring
Service Centers in the future. The integration of acquired Service Centers and
the addition of management personnel to support existing and future acquisitions
may positively or negatively affect the Company's results of operations during
the period immediately following acquisition.
The following table sets forth certain selected financial data as a
percentage of net revenue for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
Net revenue................................................. 100.0% 100.0% 100.0%
Cost of goods sold.......................................... 72.1 68.0 64.4
----- ----- -----
Gross margin................................................ 27.9 32.0 35.6
Selling, general and administrative expenses................ 25.8 28.8 27.4
----- ----- -----
Income from operations...................................... 2.1% 3.2% 8.2%
===== ===== =====
</TABLE>
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net Revenue. Net revenue increased $22.0 million, or 88.4%, from $24.9
million for the year ended December 31, 1995 to $46.9 million for the year ended
December 31, 1996. This increase is primarily attributable to the acquisitions
completed during 1996.
Cost of Goods Sold. Cost of goods sold increased $13.3 million, or 78.5%,
from $16.9 million for the year ended December 31, 1995 to $30.2 million for the
year ended December 31, 1996. As a percentage of net revenue, cost of goods sold
decreased from 68.0% for the year ended December 31, 1995 to 64.4% for the year
ended December 31, 1996.
15
<PAGE> 16
Gross Margin. Gross margin increased $8.7 million, or 109.3%, from $8.0
million for the year ended December 31, 1995 to $16.7 million for the year ended
December 31, 1996. As a percentage of net revenue, gross margin increased from
32.0% for the year ended December 31, 1995 to 35.6% for the year ended December
31, 1996. The increase in gross margin as a percentage of net revenue is
attributable to the inclusion of Acquired Companies that operated at a higher
margin.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $5.7 million, or 79.2%, from $7.2 million for
the year ended December 31, 1995 to $12.8 million for the year ended December
31, 1996. This increase is attributable to the inclusion of the Acquired
Companies and an increase in management personnel since the IPO. As a percentage
of net revenue, general and administrative expenses decreased from 28.8% for the
year ended December 31, 1995 to 27.4% for the year ended December 31, 1996.
Income from Operations. Income from operations increased $3.0 million, or
378.8%, from $798,000 for the year ended December 31, 1995 to $3.8 million for
the year ended December 31, 1996. Income from operations as a percent of net
revenue increased from 3.2% in the 1995 period to 8.2% in the 1996 period.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Net Revenue. Net revenue increased $2.7 million, or 12.1%, from $22.2
million in 1994 to $24.9 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 $917,000, or 5.7%, from
$16.0 million in 1994 to $16.9 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 72.1% in 1994 to 68.0% 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. Gross margin increased $1.8 million, or 28.5%, from $6.2
million for the twelve months ended December 31, 1994 to $8.0 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 4.1% from 27.9% for the twelve months ended December 31, 1994
to 32.0% 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 $1.4 million, or 25.1%, from $5.7 million in
1994 to $7.2 million in 1995. As a percentage of net revenue, selling, general
and administrative expenses increased from 25.8% in 1994 to 28.8% 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 $327,000, or
69.4%, from $471,000 in 1994 to $798,000 in 1995. As a percentage of net
revenue, income from operations increased from 2.1% in 1994 to 3.2% in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital needs arise from the acquisition of new
HVAC businesses and the costs associated with such expansion. Cash used in
investing activities was primarily attributable to the acquisition of HVAC
businesses. Cash provided by financing activities consisted primarily of
proceeds from the IPO.
On August 21, 1996, the Company completed the IPO at $13.00 per share. The
proceeds to the Company, net of expenses and underwriting discounts and
commissions, were approximately $28.1 million. Of the net proceeds, $18.7
million was used to pay the cash portion of the consideration for the
Predecessor Companies, including $1.2 million which was used to repay certain
indebtedness arising from the Combination. The Company is using the remaining
proceeds for working capital and capital expenditures, including the acquisition
of additional Service Centers.
16
<PAGE> 17
The Company's ability to acquire new HVAC businesses will depend on a
number of factors, including the ability of management of the Company to
identify target businesses and to negotiate acceptable acquisition terms, the
availability of adequate financing and other factors, many of which are beyond
the control of the Company. Since the IPO, the Company has acquired 25 HVAC
businesses for an aggregate of approximately $6.2 million cash and approximately
3.2 million shares of Common Stock. In addition, the Company currently has
agreements in principle to acquire 11 HVAC businesses for an aggregate of
approximately $15.5 million cash and approximately 376,492 shares of Common
Stock. There can be no assurance that the Company will be successful in
identifying and acquiring new HVAC businesses, that the Company can integrate
such new Service Centers into the Company's operations or that the Company's new
Service Centers will generate sales revenue or profit margins consistent with
those of the Company's existing Service Centers.
The Company has a $10 million unsecured revolving credit facility and an
additional $10 million unsecured discretionary revolving credit facility with
SunTrust Bank, Nashville, N.A. ("SunTrust") available through September 10, 1998
(together, the "Credit Facilities"). Borrowings under the Credit Facilities bear
interest at a variable rate equal to the 30-day LIBOR, as such rate changes from
time to time, plus a variable margin of from 125 to 250 basis points depending
on the Company's funded debt to EBITDA ratio determined on a quarterly basis.
Certain of the Subsidiaries have guaranteed the repayment of indebtedness under
the Credit Facilities. At December 31, 1996, there were no amounts outstanding
on the above lines of credit. The Credit Facilities contain covenants with
respect to the maintenance of certain financial ratios and specified net worth
and limiting the incurrence of additional indebtedness, the sale of substantial
assets, consolidations or mergers by the Company and the payments of dividends.
The Company currently is negotiating with SunTrust to increase the amount
available under the Credit Facilities, but there can be no assurance that such
negotiations will be successful.
The Company currently has on file with the Commission a registration
statement on Form S-4 (the "Shelf Registration Statement") covering securities
with a collective aggregate offering price of $50.0 million for use in future
acquisitions of HVAC businesses. Under the Shelf Registration Statement, as
proposed to be amended by the Company, the Company may issue shares of Common
Stock, warrants to purchase Common Stock and debt securities in connection with
acquisitions.
Management believes that the proceeds of this Offering, the Company's
existing cash balances, cash generated from operations and additional borrowings
will be sufficient to fund the Company's operating needs, planned capital
expenditures and debt service requirements for the next 12 months. Management
continually evaluates potential strategic acquisitions as part of the Company's
growth strategy. To date, such acquisitions have been predominantly funded by
issuing shares of Common Stock, although future acquisitions could be effected
using greater amounts of cash. Although the Company believes that its financial
resources will enable it to consider potential acquisitions, should the
Company's actual results of operations fall short of, or its rate of expansion
significantly exceed, its plans, or should its costs or capital expenditures
exceed expectations, the Company may need to seek additional financing in the
future. In negotiating such financing, there can be no assurance that the
Company will be able to raise additional capital on terms satisfactory to the
Company. Failure to obtain additional financing on reasonable terms could have a
negative effect on the Company's plans to acquire additional HVAC businesses.
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 or any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
The Company has elected to adopt the pro forma provisions of the Statement
of Financial Accounting Standard No. 123 "Accounting for Stock-Based
Compensation."
17
<PAGE> 18
BUSINESS
GENERAL
The Company is one of the leading providers of residential HVAC services
and replacement equipment in the United States, and management believes that the
Company will continue to be a leading consolidator of the fragmented HVAC
service and replacement industry. The Company currently operates 32 Service
Centers in 17 states. The Service Centers install, service and maintain central
air conditioners, furnaces and heat pumps, primarily in existing homes.
Management estimates that over 80% of the Company's pro forma net revenue in
1996, after giving effect to all completed and Pending Acquisitions, was derived
from replacing, maintaining and servicing HVAC equipment at existing residences.
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 offers higher margins and exposes the Company to
less credit risk. The service and replacement segment offers more attractive
pricing because of customers' demands for immediate, convenient and reliable
service.
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. In
addition, management believes that the Company's visibility within the industry
and its operational philosophy of decentralized operations and centralized
administration provide the Company with a competitive advantage, particularly in
enabling the Company to identify and acquire well-managed, profitable HVAC
businesses. By allowing former owners of Service Centers the opportunity to
continue managing their business after acquisition and to increase their focus
on customer service rather than administration, management believes that the
Company offers owners of independent HVAC businesses an attractive alternative.
Management intends to develop a national presence through acquisitions and a
national reputation for superior, high quality service which will enable the
Company to appeal to a large number of customers. The Company has implemented an
aggressive acquisition strategy, acquiring 25 HVAC businesses since the IPO with
aggregate revenue for the year ended December 31, 1996 of approximately $79.1
million. The Company currently has agreements in principle to acquire 11 HVAC
businesses with aggregate revenue in 1996 of approximately $35.7 million. The
Pending Acquisitions are expected to close during the first six months of 1997.
The Company's 1996 pro forma net revenue, reflecting the acquisition of the
Subsidiaries and eight Pending Acquisitions, was approximately $172.3 million.
See Pro Forma Combined Financial Statements and the Notes thereto for a listing
of the companies included.
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 nine
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."
According to Air Conditioning, Heating, and Refrigeration News, over 30,000
HVAC contractors are currently operating in the United States. 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
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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. Management believes that 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.
ACQUISITIONS
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 businesses and the
continued revenue and profit growth of its Service Centers.
Strategy
The Company has implemented 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."
Expanding Geographic Presence through Hub Acquisitions. The Company plans
to continue to make "hub" acquisitions of existing HVAC businesses in new
markets that are not being served by the Company. Management targets 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 of this
Prospectus 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 considers candidates that
are in attractive markets, financially stable, experienced in the industry and
characterized by strong management.
Expanding Market Penetration of Hubs through the Acquisition of Other HVAC
Businesses. The Company expects to increase market share through "spoke"
acquisitions of other HVAC businesses that have large customer bases 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.
Recent and Pending Acquisitions
Since the IPO, the Company has acquired 25 HVAC businesses. The
consideration paid by the Company for these businesses was approximately $59.5
million, consisting of 3.2 million shares of Common Stock and $6.2 million in
cash. Two of the transactions were accounted for using the pooling of interests
method of accounting, and the remainder were accounted for using the purchase
method. Of the purchase price, $45.6 million was allocated to intangible assets
which are to be amortized over a 40-year period. The Acquired Companies'
aggregate revenue and operating income for the 12 months ended December 31, 1996
were $79.1 million and $3.8 million, respectively.
The Company currently has agreements in principle to acquire 11 HVAC
businesses. The transactions are expected to close during the first six months
of 1997. The consideration to be paid by the Company for these businesses is
approximately $24.0 million, consisting of 376,492 shares of Common Stock and
$15.5
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million cash. All of these transactions are expected to be accounted for using
the purchase method. Of the purchase price, $18.6 million is expected to be
allocated to intangible assets which are to be amortized over a 40-year period.
On a pro forma basis, the eight companies listed as Pending Acquisitions in the
Pro Forma Combined Financial Statements generated revenue in 1996 of
approximately $31.6 million and contributed operating income of approximately
$2.8 million. The acquisitions are subject to customary conditions, and there
can be no assurance that the Company will be able to consummate all of the
acquisitions or to successfully integrate the businesses of the acquired
companies.
The Company's acquisitions since the IPO expanded the geographic coverage
of the Company by providing entry to the Florida, Illinois, Maryland,
Mississippi, New York, Oklahoma, South Carolina and Texas markets and increasing
the Company's market presence in Arkansas, California, Indiana, Louisiana and
Tennessee. The Company now operates 32 Service Centers (the operations of five
HVAC businesses included among the Acquired Companies were consolidated
following acquisition) in 31 market areas in 17 states.
The following table sets forth certain information with respect to the
Company's existing Service Centers and the Pending Acquisitions:
<TABLE>
<CAPTION>
COMPANY MARKET EFFECTIVE DATE
- ------- ------ --------------
<S> <C> <C>
PREDECESSOR COMPANIES
Norrell Heating and Air Conditioning
Company, Inc.............................. Birmingham, AL August 21, 1996
Hardwick Air Masters, Inc................... Little Rock, AR August 21, 1996
Service Experts of Palm Springs, Inc........ Palm Springs, CA August 21, 1996
Comerford's Heating and Air Conditioning,
Inc....................................... Pleasanton, CA August 21, 1996
Coastal Air Conditioning Service, Inc....... Savannah, GA August 21, 1996
Rolf Coal and Fuel Corp..................... Fort Wayne, IN August 21, 1996
Brand Heating & Air Conditioning, Inc....... Lafayette, IN August 21, 1996
Gilley's Heating & Cooling, Inc............. Monroe, LA August 21, 1996
Vision Holding Company, Inc................. Kansas City, MO August 21, 1996
Air Experts, a United Services Co., Inc..... St. Louis, MO August 21, 1996
AC Service & Installation Co., Inc./
Donelson Air Conditioning Company, Inc.... Nashville, TN August 21, 1996
Arrow Heating & Air Conditioning, Inc....... Racine, WI August 21, 1996
ACQUIRED COMPANIES
AirCon Air Conditioning, Inc. .............. Little Rock, AR January 2, 1997
Mark's Air Conditioning, Inc................ Little Rock, AR February 1, 1997
Freschi Air Systems, Inc.................... Antioch, CA December 1, 1996
Dial One Raymond's Plumbing, Heating &
Cooling, Inc. ............................ Auburn, CA January 2, 1997
Gaddis Co................................... El Centro, CA January 2, 1997
Custom Air Conditioning, Inc................ Jupiter, FL December 1, 1996
Automated Air, Inc. ........................ Champaign, IL January 2, 1997
Bauer Heating & Air Conditioning, Inc....... Decatur, IL January 2, 1997
Sylvester's Corp............................ Anderson, IN January 2, 1997
Bryant-Allen, Inc........................... Indianapolis, IN January 2, 1997
Paul E. Smith Co., Inc...................... Indianapolis, IN December 1, 1996
B. W. Heating & Cooling, Inc................ Mishawaka, IN January 2, 1997
Quality Air Conditioning & Heating of West
Monroe, Inc............................... Monroe, LA December 1, 1996
Frees Service Experts, Inc.................. Shreveport, LA December 1, 1996
Parker Heating & Air Conditioning,
Incorporated.............................. Gaithersburg, MD January 2, 1997
Comfortech, Inc............................. Jackson, MS December 1, 1996
Sunbeam Service Experts, Inc................ Buffalo, NY December 1, 1996
Falso Service Experts, Inc.................. East Syracuse, NY December 17, 1996
</TABLE>
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<TABLE>
<CAPTION>
COMPANY MARKET EFFECTIVE DATE
- ------- ------ --------------
<S> <C> <C>
ACQUIRED COMPANIES (CONT'D)
Gordon's Specialty Company.................. Norman, OK December 1, 1996
Pardee Refrigeration Company Incorporated... Charleston, SC December 1, 1996
Sanders Indoor Comfort, Inc................. Greeneville, SC December 1, 1996
Island Air Conditioning, Inc................ Isle of Palms, SC December 1, 1996
Air-Conditioning and Heating Unlimited,
Inc....................................... Memphis, TN December 1, 1996
B & B Air Conditioning, Inc................. Dallas, TX December 1, 1996
Eisenbach Enterprises, Inc.................. Tyler, TX December 1, 1996
PENDING ACQUISITIONS
C. Iapaluccio Co., Inc...................... Danbury, CT
Griffin Heating & Air Conditioning, Inc..... Ft. Wayne, IN
The Air Comfort Center, Inc................. Shreveport, LA
Piedmont Air Conditioning, Inc.............. Raleigh, NC
Roland J. Down, Inc......................... Albany, NY
Stark Services Company, Inc................. Dallas, TX
Superior Air Conditioning Co., Inc.......... Duncanville, TX
Claire's Air Conditioning and Refrigeration,
Inc....................................... Midland, TX
Claire & Sanders, Inc....................... Midland, TX
Lewis & Guymon, Inc. ....................... Orem, UT
Royden, Inc................................. Provo, UT
</TABLE>
OPERATING STRATEGY
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, national company. The Company's operating strategy
incorporates the successful methods developed by CSG and capitalizes on the
operating efficiencies resulting from the integration of the operations of the
Subsidiaries. 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 high quality service at a competitive price and in a
friendly, professional manner. In order to provide such service, service
technicians, maintenance technicians and installers employed by the Company
complete comprehensive training programs designed to teach employees the
Company's operating procedures. These 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 standardized 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 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 plans to
establish a toll-free "Customer Can't Lose" phone line during the second quarter
of 1997 to address customer complaints and questions.
Increasing Revenue at Service Centers. The Company actively promotes 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
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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. Certain Service Centers also offer their customers a Professional
Courtesy(TM) credit card solely for use in purchasing equipment and services
from the Company. This 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 a variety of 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 these marketing efforts will result in increased business for its Service
Centers. In 1996, advertising and marketing expenditures (net of marketing
expenditures by manufacturers) were 3.4% as a percentage of the Company's net
revenue.
The Company's Service Centers offer 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 offers and actively
promotes a variety of IAQ services designed to detect and correct unhealthy air
quality. 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 is currently discussing purchase terms for HVAC equipment
with certain manufacturers on a national basis. Management believes that the
Company will be able to increase the discounts and rebates previously available
to the individual Service Centers. Since the IPO, the Company has achieved
increased operating efficiencies by consolidating certain functions at the
corporate level, including the purchase of insurance, the provision of legal
support and the utilization of corporate trainers in the areas of marketing and
IAQ. The Company intends to review the desirability of consolidating other
functions at the corporate level, including the purchasing and leasing of
service vehicles and national marketing. A portion of any operating efficiencies
will be offset by increased general and administrative expenses at the Company's
corporate headquarters.
Since the IPO, the Company has implemented a uniform system of budgets,
forecasts, reports and financial controls, including a uniform general ledger
system and electronic mail system, 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 uses this information to prepare and provide to each Service
Center monthly and quarterly comparative financial data, which 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 intends to
establish 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 generally 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.
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Potential employees of most Service Centers must pass extensive interviews
and background checks, where permitted, as well as technical tests prior to
being hired. Service technicians, maintenance technicians and installers
employed by the Company are required to complete training programs designed to
teach employees the Company's operating procedures. These training programs are
conducted both at the Service Centers and at CSG sponsored seminars. Since the
IPO, the Company has implemented training programs relating to marketing and IAQ
products that are conducted at Service Centers by the Company's corporate
trainers. Management believes that these policies have resulted in a low rate of
employee turnover. See "Contractor Success Group."
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 1996, CSG collected fees totaling approximately $3.4 million. CSG
members are granted exclusive rights to the territory in which they operate.
Although the Company has acquired 32 CSG members since its formation, other HVAC
companies have joined CSG. 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 the aspects 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 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 acquisition of its Service Centers, the Company has
acquired approximately 37% of the issued and outstanding Common Stock of Future
University, Inc. ("Future University(R)"). The remaining shares of Future
University's Common Stock are held by a number of CSG members and their
shareholders. Future University is a corporation formed in 1991 that offers to
CSG members for an additional enrollment fee technical and operational
educational programs designed to improve the profitability of the
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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 Company's Subsidiaries. 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 1994, over 1,000 students per year have
completed Future University's technical and operational training programs.
SERVICE CENTERS
General
Management estimates that during 1996 the Service Centers' service and
maintenance technicians responded to over 350,000 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 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 1996 the installation and
servicing of plumbing systems represented less than 1% of the Company's pro
forma net revenue. The Company anticipates that these Service Centers will
continue to offer, and that Service Centers acquired in the future may offer,
plumbing services, but currently does not intend to expand this business.
All of the Service Centers' technicians are trained to promote the
Company's preventive maintenance agreements, and many technicians are trained 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 for the particular job before work
begins and charges the quoted price regardless of the time necessary to repair
the system. While this may result in parts, labor and other costs incurred in
repairing a customer's system exceeding the quoted price from time to time, the
Company is able to alter its pricing on a per job basis. 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.
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Sale of Replacement Units
The replacement market for residential HVAC equipment is dependent upon the
base of installed units, the mechanical life and usage of the equipment and
technological advances in the efficiency of newer units. Management 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 maintains 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
Management estimates that the Company currently has approximately 64,000
maintenance agreements with customers. These agreements are for a term of one to
three years and generally 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 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 these 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 the 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, certain 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
will insure its service agreements through licensed insurers or otherwise comply
with applicable laws and regulations. Management believes that the Company has
made adequate provision for potential claims under these agreements. See
"Regulation."
Commercial Service and Replacement
Some of the Service Centers offer HVAC services to small and medium-sized
businesses. In 1996, 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
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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 commercial HVAC business beyond existing
operations given the potential for growth in the residential service and
replacement market, the Company intends to continue to provide, and may acquire
Service Centers that provide, commercial HVAC services.
SERVICES AND OPERATIONS
The Company provides management, financial and accounting services for all
of the Service Centers' operations, as well as insurance and certain marketing
and legal support. Management provides 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.
Since the IPO, the Company has added various corporate management and staff
personnel including three regional vice presidents, a controller, a human
resources manager, a management information systems director, a general counsel,
a regional accountant, a staff accountant and two corporate trainers.
In order to better organize its corporate support structure, the Company
has divided its Service Centers into three regions. Each Service Center in a
region reports directly to a regional vice president. In addition, the Company
intends to appoint area presidents who will coordinate various functions among
groups of Service Centers located in the same geographic area while continuing
to operate as president of a Service Center. These individuals will report to
their respective regional vice presidents.
The Company provides the following services:
Purchasing
Each Service Center generally purchases the HVAC units, parts and supplies
it uses from distributors. Because of the number of Service Centers operated by
the Company, management believes that it will be able to negotiate at a lower
cost the purchase of these items. 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. 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 12 months. The
Company has recently implemented a general ledger system utilizing SuccessWare
software at each of its Service Centers. See "Certain Transactions." The
implementation of an integrated system will allow the Company to maintain
greater control over the operations of its Service Centers. The Company tracks
important data related to the Service Centers' operations and financial
performance and monitors all advertising expenditures. In addition, the Service
Centers generate and provide to the Company a daily management report of revenue
and expense information and certain billing and collection data. The Company
uses such information to prepare and provide to each Service Center monthly and
quarterly comparative financial data, which 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 are tested to
determine their technical expertise. In addition, as permitted by local law,
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 generally complete
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<PAGE> 27
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." The Company has
recently established training programs relating to marketing and IAQ products
that are conducted at the Company's Service Centers by two corporate trainers.
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 various means, including local
print advertising, yellow page advertising and direct mail campaigns followed up
by telemarketing. In 1996, advertising and marketing expenditures (net of
marketing expenditures by manufacturers) were 3.4% as a percentage of the
Company's net revenue. The Company intends, over time, to develop the Service
Experts name as a key element of its marketing strategy. As a part of this
strategy, management intends gradually to integrate the Company's name and logo
in advertising while continuing to utilize established local brand names.
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, 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, compliance with existing 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, 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 37% 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 compete
with utility companies and other full-service HVAC businesses primarily on the
basis of quality, reliability, customer service and price. Some of these
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<PAGE> 28
companies 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. Certain of these companies
are pursuing a consolidation strategy in the industry and compete with the
Company for potential acquisitions as well as for customers.
EMPLOYEES
Management estimates that the Company has approximately 1,300 employees,
all but approximately 20 of which are employed at Service Centers. None of the
Company's employees is represented by a collective bargaining agreement.
PROPERTIES
The Company currently occupies the building and underlying real estate on
which all of its 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,
including certain leased vehicles and equipment, in 1996 was approximately
$490,000 and is expected to be approximately $2.0 million in 1997. The Company
generally plans to continue to lease rather than purchase space for the Service
Centers to maximize the Company's available capital.
The Company's corporate headquarters are located in approximately 6,580
square feet of space in Brentwood, Tennessee. The remaining term of the lease on
this office space is approximately five years, and the Company pays annual rent
of $115,200. 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 eight months, and the Company pays
annual rent of approximately $60,000.
INSURANCE
The Company maintains general liability, workers compensation and property
insurance. The costs of insurance coverage varies, and the availability of
certain coverage has fluctuated in recent years. As of February 1, 1997, the
Company consolidated the purchase of insurance for its operations under a single
policy, excluding major medical insurance which will continue to be provided by
existing plans until a consolidated plan can be negotiated. This coverage will
result in savings from the amounts previously paid by the Subsidiaries. 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 Subsidiaries may, from time to time, be parties to
litigation or administrative proceedings which arise in the normal course of
their businesses.
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<PAGE> 29
MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The table below sets forth certain information concerning each of the
executive officers, directors and other key employees of the Company.
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS AND DIRECTORS AGE POSITION
- -------------------------------- --- --------
<S> <C> <C>
Alan R. Sielbeck.......................... 44 Chairman of the Board and Chief Executive Officer
James D. Abrams........................... 49 President, Chief Operating Officer and Director
Anthony M. Schofield...................... 42 Chief Financial Officer, Secretary and Treasurer
Raymond J. De Riggi(1).................... 49 Director
Timothy G. Wallace(1)(2).................. 38 Director
William G. Roth(2)........................ 58 Director
Norman T. Rolf, Jr........................ 50 Director
<CAPTION>
OTHER KEY EMPLOYEES
- ------------------------------------------
<S> <C> <C>
Louis N. Laderman......................... 45 Vice President and General Counsel
Robert E. Reece........................... 41 Regional Vice President
Michael S. Robinson....................... 37 Regional Vice President
Peter J. Zabaski.......................... 48 Regional Vice President
</TABLE>
- ---------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
The Company's Board of Directors is divided into three classes, each
consisting of two members. At each annual stockholders meeting, directors of one
class are elected to three year terms. The terms of Messrs. De Riggi and Rolf
expire in 1997, Messrs. Abrams and Roth in 1998 and Messrs. Sielbeck and Wallace
in 1999. See "Description of Capital Stock -- Anti-Takeover Provisions."
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 a Subsidiary, 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. From 1990 to 1996,
Mr. Abrams served as Chief Executive Officer and a director of CSG. Mr. Abrams
has served as President of Air Experts and Service Experts of Palm Springs,
Inc., each a Subsidiary, 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 served, from 1992 to 1996,
as Chairman and President of Service Now, Inc. ("Service Now"), a holding
company that owns several HVAC businesses, and prior to the Combination owned
Air Experts and Service Experts of Palm Springs, Inc. He resigned from his
positions with Service Now prior to the closing of the Combination and the IPO.
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, Secretary and
Treasurer of the Company 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
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<PAGE> 30
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 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 served as Chairman of the Board of Directors of Dravo Corporation, a
natural resources company that is the largest producer of lime in the United
States, from 1989 to 1994. 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. Mr. Roth currently serves as a director of Amcast
Industrial Corporation and Teknowledge Corporation.
Norman T. Rolf, Jr. has served as a director of the Company since July
1996. Since 1988, Mr. Rolf has served as President of Rolf Coal and Fuel Corp.,
a Subsidiary, where he also has previously served as a director and has been
employed in various positions since 1966.
Louis N. Laderman has served as Vice President and General Counsel of the
Company since January 1997. Since 1996, Mr. Laderman has served as general
counsel of CSG, Service Now, Future University and SuccessWare. From 1986 to
1996, Mr. Laderman practiced law as a member of McCarthy, Leonard, Kaemmerer,
Owen, Laderman & Lamkin, LLC in St. Louis, Missouri.
Robert E. Reece has served as a Regional Vice President of the Company
since January 1997. From 1991 to 1997, Mr. Reece served as Vice President and a
director of Pardee Refrigeration Company Incorporated and Island Air
Conditioning, Inc., each a Subsidiary, and as Secretary and a director of
Sanders Indoor Comfort, Inc., a Subsidiary.
Michael S. Robinson has served as a Regional Vice President of the Company
since January 1997. From 1993 to 1996, Mr. Robinson served as Vice President and
a director of Arrow Heating & Air Conditioning, Inc., a Subsidiary. From 1992 to
1993, Mr. Robinson served as a marketing and sales representative for J. D.
Edwards, Inc., a worldwide provider of financial, distribution and manufacturing
software. Prior to that time, Mr. Robinson served as a marketing and sales
representative for IBM from 1988 to 1992. Mr. Robinson is a certified public
accountant in Illinois.
Peter J. Zabaski has served as a Regional Vice President of the Company
since February 1997. From 1994 to 1997, Mr. Zabaski served as Regional Vice
President of Hughes Supply, Inc., a distributor of industrial products and
supplies. From 1990 to 1994, Mr. Zabaski served as President of One Stop Supply
Inc., a HVAC wholesale supplier and subsidiary of Hughes Supply, Inc.
The Compensation Committee of the Board of Directors is 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 is responsible for the annual
appointment of the Company's auditors and reviewing the scope of audit and
non-audit assignments and related fees,
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<PAGE> 31
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 AND OTHER INFORMATION
Summary of Compensation Table. The following table sets forth the total
compensation paid or accrued by the Company for the Company's last completed
fiscal year on behalf of the (i) Company's Chief Executive Officer and (ii) the
two other executive officers of the Company as of the end of 1996:
SUMMARY COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
ANNUAL COMPENSATION ----------------------
NAME AND -------------------- SECURITIES
PRINCIPAL POSITION YEAR SALARY($) BONUS($) UNDERLYING OPTIONS(#)
- -------------------------------------------------- ---- --------- -------- ----------------------
<S> <C> <C> <C> <C>
Alan R. Sielbeck.................................. 1996 $86,538 -- 40,000
Chairman of the Board and Chief Executive
Officer
James D. Abrams................................... 1996 86,538 -- 40,000
President and Chief Operating Officer
Anthony M. Schofield.............................. 1996 58,385 -- 40,000
Chief Financial Officer
</TABLE>
- ---------------
(1) Does not include amounts paid by the Company's Subsidiaries prior to the
Combination in August 1996.
Options Granted in Last Fiscal Year
The following table summarizes certain information regarding stock options
issued to the Company's executive officers during 1996. No stock appreciation
rights ("SARs") have been granted by the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
----------------------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF TOTAL STOCK APPRECIATION FOR
SECURITIES OPTIONS GRANTED EXERCISE OPTION TERM
UNDERLYING TO EMPLOYEES IN PRICE EXPIRATION -----------------------
NAME OPTIONS GRANTED FISCAL 1996 ($/SHARE) DATE 5%($) 10%($)
---- --------------- ---------------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Alan R. Sielbeck(1)....... 40,000 7.72% $17.25 9/26/06 $433,937 $1,099,682
James D. Abrams(1)........ 40,000 7.72 17.25 9/26/06 433,937 1,099,682
Anthony M. Schofield(2)... 40,000 7.72 13.00 8/15/06 327,025 828,746
</TABLE>
- ---------------
(1) All options were granted pursuant to the 1996 Incentive Stock Plan (the
"Incentive Plan") and vest in one-third increments annually beginning
September 26, 1998. Potential realizable value is calculated from a base
stock price of $17.25, the exercise price of the options granted.
(2) All options were granted pursuant to the Incentive Plan and vest in
one-third increments annually beginning August 15, 1998. Potential
realizable value is calculated from a base stock price of $13.00, the
exercise price of the options granted.
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<PAGE> 32
Options Exercised in Last Fiscal Year, Fiscal Year End Option Values
No options were exercised in the year ended December 31, 1996. The
following table summarizes certain information regarding year end option values
of the Company's executive officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS HELD AT OPTIONS HELD AT
DECEMBER 31, 1996 DECEMBER 31, 1996($)(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Alan R. Sielbeck................................ -- 40,000 -- $350,000
James D. Abrams................................. -- 40,000 -- 350,000
Anthony M. Schofield............................ -- 40,000 -- 520,000
</TABLE>
- ---------------
(1) Reflects the market value of the underlying securities at the closing sales
price reported on the Nasdaq National Market on December 31, 1996 ($26.00),
less the exercise price.
EMPLOYMENT AGREEMENTS
Pursuant to employment agreements, effective as of August 21, 1996, Messrs.
Sielbeck, Abrams and Schofield (the "executive officers") are employed as
executive officers of the Company. The employment 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 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
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<PAGE> 33
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 Incentive
Plan. The Company has reserved 700,000 of the authorized shares of Common Stock
for issuance pursuant to stock options and 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 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 657,811 shares of Common Stock under the Incentive Plan.
These options are exercisable at prices ranging from $13.00 to $27.88 per share
and vest one-third per year commencing on the second anniversary of the date of
grant.
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.
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<PAGE> 34
Pursuant to the Director Plan, each Non-Employee Director is granted
options to purchase 5,000 shares of Common Stock 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 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. The Company has
granted options to purchase 18,000 shares of Common Stock under the Director
Plan, of which 15,000 options have an exercise price of $13.00 and 3,000 options
have an exercise price of $26.00.
Employee Stock Purchase Plan. The Service Experts, Inc. 1996 Employee
Stock Purchase Plan (the "Purchase Plan") was adopted in June 1996 and became
effective simultaneously with the IPO. 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.
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.
In September 1996, the Company filed a registration statement on Form S-8
with respect to 900,000 shares of Common Stock covered by the Incentive Plan,
the Director Plan and the Purchase 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 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."
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<PAGE> 35
CERTAIN TRANSACTIONS
Prior to the IPO, Mr. Abrams, Mr. Sielbeck, John R. Young, a principal
stockholder of CSG, and R. Edward Hutton, Jr., a principal stockholder of the
Acquiring Company, 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 received in exchange for their interests in certain of the
Predecessor Companies. Following the issuance of such shares, Messrs. Abrams and
Young transferred 103,407 and 97,891 shares, respectively, to the other
stockholders of Service Now.
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 received cash and shares of Common Stock as
follows: Mr. Sielbeck -- $2,513,959 and 576,549 shares; Mr. Abrams -- $2,000,505
and 390,612 shares; Mr. Young -- $2,000,505 and 390,612 shares; Mr.
Hutton -- $2,513,959 and 576,549 shares; and Norman T. Rolf, Jr. -- $636,217 and
133,661 shares. Such amounts were determined on the basis of the evaluation by
the Company and the representatives of the underwriters of the IPO of the
following factors: the financial and operational history and trends of the
Predecessor Companies, 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, market conditions for new offerings of
securities and the prices of similar securities of comparable companies.
In connection with the Combination, the Company acquired approximately 36%
of the issued and outstanding common stock of Future University in exchange for
$2,000 per share in cash, an aggregate of $590,000. The consideration paid was
determined by arms length negotiations between the Company and the stockholders
of Future University who agreed to sell their shares to the Company. Mr. Abrams
and Mr. Young, who were 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. See "Business -- Contractor
Success Group."
Service Now, of which Mr. Abrams and Mr. Young are principal stockholders,
is a 48% stockholder of SuccessWare, a corporation that provides management and
financial information systems software to the Company. The Company has
implemented a general ledger system utilizing SuccessWare software in all of its
Service Centers and plans to expand its use of other SuccessWare products. In
1996, the Company and its Subsidiaries made aggregate payments to SuccessWare of
approximately $50,000. The Company has entered into a letter of intent with
SuccessWare to license its software and expects to make payments to SuccessWare
in 1997 of approximately $220,000. 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. Service Now continues 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 stockholders of Fusion Filters, Inc.
("Fusion"), which licenses air filters and other products from manufacturers and
sublicenses them to HVAC contractors, including certain of the Subsidiaries. The
Company has not entered into any definitive agreements with Fusion, but certain
Service Centers purchase filters from Fusion from time to time. In 1996, the
Company's Service Centers made aggregate payments to Fusion of approximately
$450,000. The Company and many of the Subsidiaries also utilize, from time to
time, the services of Travel Now, Inc., a travel agency, of which Mr. Abrams and
Mr. Young are principal stockholders.
At March 31, 1996, Mr. Sielbeck had outstanding indebtedness payable to the
Acquiring Company 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 the Acquiring Company in the amount of
$133,800, consisting of a note
35
<PAGE> 36
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 this
indebtedness was repaid during 1996.
Prior to the Combination, Messrs. Sielbeck and Hutton purchased from the
Acquiring Company the building and underlying real estate on which the Acquiring
Company is located and certain residential property for approximately $826,000
and $61,000, respectively. The Acquiring Company purchased the building and real
estate for its main facility in 1992 for approximately $729,000 and made certain
improvements to such property costing approximately $78,000. The Acquiring
Company purchased the residential property in 1994 for approximately $61,000.
The sale price for such properties was determined by the board of directors of
the Acquiring Company. The Acquiring Company has entered into a lease with
Messrs. Sielbeck and Hutton whereby the Acquiring Company will make annual
rental payments of approximately $140,000 to Messrs. Sielbeck and Hutton.
Management of the Company believes such transactions are on terms that are
commercially reasonable and no less favorable to the Acquiring Company than
those which could be obtained from unaffiliated third parties.
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 is responsible for reviewing all related
party transactions on a continuing basis and potential conflict of interest
situations where appropriate.
36
<PAGE> 37
PRINCIPAL AND SELLING 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 Offering, 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, (iii) all directors and executive officers of the
Company as a group and (iv) the Selling Stockholders. 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 TO BE BENEFICIALLY
SHARES BENEFICIALLY OWNED SHARES TO OWNED AFTER THE
PRIOR TO THE OFFERING(1) BE SOLD OFFERING(1)(3)
---------------------------- IN THE -------------------------
DIRECTORS, OFFICERS AND 5% STOCKHOLDERS NUMBER PERCENT OFFERING(2) NUMBER PERCENT
- --------------------------------------- ------------ ------- ----------- ------------ -------
<S> <C> <C> <C> <C> <C>
Alan R. Sielbeck(4).................... 820,255 6.9% -- 820,255 6.0%
James D. Abrams(4)..................... 991,914(5) 8.4 93,497(6) 803,044(7) 5.9
John R. Young(8)....................... 970,627(5) 8.2 37,399(6) 837,855(7) 6.1
R. Edward Hutton, Jr.(4)............... 820,256 6.9 124,493 695,763 5.1
Anthony M. Schofield................... 3,000 * -- 3,000 *
Raymond J. De Riggi(9)................. 6,000 * -- 6,000 *
Timothy G. Wallace(9).................. 6,000 * -- 6,000 *
William G. Roth(9)..................... 11,000 * -- 11,000 *
Norman T. Rolf, Jr..................... 138,958 1.1 6,311 132,647 *
All executive officers and directors as
a group (seven persons).............. 1,977,127(5)(10) 16.7% 99,808 1,781,946(7)(10) 13.0%
OTHER SELLING STOCKHOLDERS
Jerry Brand............................ 92,581 * 5,610 86,971 *
Rachelle Brand......................... 92,581 * 5,610 86,971 *
Steve Burbridge........................ 250,616 2.1 29,290 221,326 1.6
Lonald Cassel.......................... 36,418 * 4,675 31,743 *
Clinton Davenport...................... 77,080 * 7,985 69,095 *
William C. Efird, Jr................... 243,988 2.0 20,564 223,424 1.6
Peter G.B. Franck...................... 326,419 2.8 37,399 289,020 2.1
Mark Randall Gilley.................... 164,524 1.4 18,699 145,825 1.1
David E. Gregg......................... 81,298 * 9,350 71,948 *
Richard Iorio.......................... 260,527 2.2 39,736 220,791 1.6
A. Bruce Morain, Jr.................... 129,885 1.1 6,958 122,927 *
Richard Osgood......................... 77,080 * 9,350 67,730 *
Virginia Phillips...................... 80,517 * 7,480 73,037 *
Glenn T. Ratliff....................... 91,206 * 4,675 86,531 *
Michael S. Robinson.................... 111,888 * 9,347 102,541 *
Randall V. Rolf........................ 134,316 1.1 18,699 115,617 *
Louis E. Selman........................ 141,481 1.2 13,557 127,924 *
Service Now, Inc....................... 204,014 1.7 95,373 108,641 *
Alton B. Smith......................... 36,482 * 1,870 34,612 *
Gene Sylvester......................... 77,967 * 8,882 69,085 *
Don Wright............................. 190,946 1.6 33,191 157,755 1.2
---------
Total........................ 650,000
</TABLE>
- ---------------
* Represents less than 1%.
Footnotes on following page.
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<PAGE> 38
(1) The table above includes shares of the Company's Common Stock which an
individual has a right to acquire, whether upon conversion of convertible
securities or upon exercise of options and warrants, within 60 days of the
date of this Prospectus. Such shares are deemed to be outstanding for the
purposes of calculating the percentage ownership of the individual holding
such shares, but are not deemed outstanding for purposes of computing the
percentage of any other person shown on the table.
(2) An additional 375,000 shares of Common Stock may be sold by the Selling
Stockholders if the over-allotment option is exercised in full as follows:
Mr. Sielbeck, 39,003 shares, and the remaining Selling Stockholders, the
same percentage of 349,288 that the numbers of shares to be sold by each of
them as shown in the above table bears to the 650,000 shares of Common
Stock offered by the Selling Stockholders.
(3) Assumes no exercise of the Underwriters' over-allotment option.
(4) The indicated person's address is c/o Service Experts, Inc., 111 Westwood
Place, Suite 420, Brentwood, Tennessee 37027.
(5) Includes 204,014 shares issued to Service Now, the sole stockholder of two
of the Predecessor Companies, in connection with the Combination. Messrs.
Abrams and Young are principal stockholders of Service Now.
(6) Does not include shares to be sold by Service Now.
(7) Includes 108,641 shares owned by Service Now, of which Messrs. Abrams and
Young are principal stockholders.
(8) Mr. Young's address is c/o John Young & Associates, 13950 Switzer, Overland
Park, Kansas 66221.
(9) Includes 6,000 shares subject to outstanding options held by such
individuals.
(10) Includes 18,000 shares subject to outstanding options held by such
individuals.
38
<PAGE> 39
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, the Company
will have 13,671,722 shares of Common Stock 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, a
copy of which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part. An additional 800,000 shares of Common Stock are
reserved for issuance upon exercise of employee and director stock options, of
which options to purchase 675,811 shares have been granted as of the date
hereof, and 100,000 shares have been reserved under the Purchase Plan. See
"Management -- Compensation Pursuant to Plans." As of March 17, 1997, there were
approximately 182 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 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.
STOCK PURCHASE WARRANTS
Equitable Securities Corporation was engaged to provide financial advisory
and investment banking services in the formation of the Company and the
structuring of the Combination. In connection with this engagement, Equitable
Securities Corporation received warrants (the "ESC Warrants") to purchase 82,391
shares of the Common Stock. The ESC Warrants are exercisable until August 16,
2001, in whole or in part, are subject to anti-dilution adjustments, and the
holder is entitled to one demand registration right for the underlying Common
Stock exercisable until August 16, 2001 and incidental registration rights
exercisable until August 16, 2003.
LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS
The Company's Restated Certificate 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 contains provisions
39
<PAGE> 40
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.
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 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 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, Directors and Key Employees." The Company's
Restated Certificate eliminates the right of stockholders to take action by
written consent. In addition, the Company's Restated Certificate 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
Boatmen's Trust Company.
40
<PAGE> 41
SHARES ELIGIBLE FOR FUTURE SALE
No prediction 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
13,671,722 shares of Common Stock of which 5,087,500 shares (5,462,500 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").
On March 27, 1996, the Company issued 1,462,100 shares of Common Stock to
Messrs. Sielbeck, Abrams, Young and Hutton as founders of the Company. These
shares and 4,522,636 shares issued in connection with the Combination 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 effective April 29, 1997, a person who has beneficially owned these
shares for at least one year, 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 two years, would
be 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.
In connection with acquisitions completed after the Combination, the
Company issued 3,249,486 shares of Common Stock pursuant to the Shelf
Registration Statement, approximately 644,000 of which are eligible for sale in
the public market in accordance with Rule 145. Certain stockholders of such
acquired companies may be deemed "affiliates" for purposes of Rule 145 under the
Securities Act. In general, under Rule 145 as currently in effect, a shareholder
who is an "affiliate" may sell shares in broker's transactions subject to the
volume limitations and requirements as to the manner and notice of sale and the
availability of public information described above. In addition to the
requirements of Rule 145, certain stockholders of such acquired companies are
subject to lockup agreements that generally prohibit a shareholder from selling,
offering to sell, granting any option for the sale of, or otherwise disposing of
any shares of Common Stock, any options, rights or warrants to purchase any
shares of Common Stock, or any other securities convertible into or exchangeable
for shares of Common Stock owned directly by such stockholder or with respect to
which he has the power of disposition, for a period of six months following the
effective time of the acquisition, without the prior written consent of the
Company. Beginning six months after the closing of the acquisition, such
stockholders will be entitled to sell or otherwise dispose of up to 25% of the
shares of Common Stock held by such stockholder, and an additional 25% of the
shares of Common Stock held by such stockholder during each of the three
successive six month periods until the twenty-fourth month following the closing
of the acquisition, at which time such stockholder will be entitled to sell all
shares of Common Stock held by such stockholder. Under the terms of these lockup
agreements, approximately 343,000 additional shares will become eligible for
sale in the public market subject to Rule 145 between the date of this
Prospectus and July 31, 1997. The Company also plans to issue shares of its
Common Stock that have been registered under the Securities Act in connection
with future acquisitions. The Company anticipates that, upon the issuance
thereof, these shares will generally be freely tradeable unless the resale
thereof is contractually restricted.
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<PAGE> 42
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 120
days after the date of this Prospectus without the prior written consent of
Equitable Securities Corporation on behalf of the Underwriters. See
"Underwriting."
42
<PAGE> 43
UNDERWRITING
The Underwriters named below (the "Underwriters") 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............................ 625,000
Alex. Brown & Sons Incorporated............................. 625,000
A.G. Edwards & Sons, Inc.................................... 625,000
Morgan Keegan & Company, Inc................................ 625,000
---------
Total............................................. 2,500,000
=========
</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 $0.65 per share. The Underwriters may allow, and
such dealers may reallow, a concession not in excess of $0.10 per share to
certain other dealers. After the Offering, the offering price and other selling
terms may be changed.
The Selling Stockholders have granted the Underwriters a 30-day option to
purchase up to an additional 375,000 shares of Common Stock at the 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 375,000 additional shares of Common
Stock from the Selling Stockholders, 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 2,500,000 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.
The Company, its directors and executive officers and the Selling
Stockholders 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 120 days after the date of this
Prospectus without the prior written consent of Equitable Securities Corporation
on behalf of the Underwriters; provided, however, the Company may (i) grant
stock options under, and issue shares of Common Stock upon the exercise of
outstanding stock options granted under, the Company's Incentive Stock Plan, and
(ii) issue securities in connection with acquisitions of Service Centers.
The Company and the Selling Stockholders have 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.
The rules of the Commission generally prohibit the Underwriters from making
a market in the Common Stock during the business day prior to commencement of
sales in a public offering (the "Cooling-Off Period"). The Commission has,
however, adopted Rule 103 of Regulation M ("Rule 103") which provides an
exemption from such prohibition for certain passive market making transactions.
Such passive market making transactions must comply with applicable price and
volume limits and must be identified as passive market making transactions. In
general, pursuant to Rule 103, a passive market maker may display its bid for a
security at a price not in excess of the highest independent bid for the
security. If independent bids are lowered below the passive market maker's bid,
however, the bid must then be lowered when certain purchase limits are
43
<PAGE> 44
exceeded. Further, net purchases by a passive market maker on each day are
generally limited to a specified percentage of the passive market maker's
average daily trading volume in a security during a specified prior period and
must be discontinued when this limit is reached. Pursuant to the exemption
provided by Rule 103, certain of the Underwriters and selling group members may
engage in passive market making in the Common Stock during the Cooling-Off
Period. Passive market making may stabilize the market price of the Common Stock
at a level above that which might otherwise prevail and if commenced, may be
discontinued at any time. Following the commencement of the Offering, the
Underwriters may engage in certain activities which may constitute stabilization
of the Common Stock, including covering short sales and over-allotments. Such
activities may stabilize the market price of the Common Stock at a level above
that which might otherwise prevail, and if commenced, may be discontinued at any
time.
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.
AVAILABLE INFORMATION
The Company has filed a Registration Statement on Form S-1, including
amendments thereto, relating to the Common Stock offered hereby (the
"Registration Statement") with the Commission. This Prospectus does not contain
all of the information set forth in the Registration Statement and the exhibits
and schedules thereto. Statements contained in this Prospectus as to the
contents of any contract or other document referred to are not necessarily
complete and in each instance reference is made to the copy of such contract or
other document filed as an exhibit to the Registration Statement or as
previously filed with the Commission and incorporated herein by reference. For
further information with respect to the Company and the Common Stock offered
hereby, reference is made to such Registration Statement, exhibits and
schedules.
The Company is subject to the information requirements of the Exchange Act
and, in accordance therewith, files reports, proxy statements and other
information with the Commission. The Registration Statement, as well as such
reports, proxy statements and other information, may be inspected and copied at
prescribed rates at the public reference facilities maintained by the Commission
at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549,
and at the Commission's regional offices located at 500 West Madison Street,
Suite 1400, Chicago, Illinois 60661 and Seven World Trade Center, Suite 1300,
New York, New York 10048. In addition, the Commission maintains a web site that
contains reports, proxy and information statements and other information
regarding registrants that file electronically with the Commission at
http://www.sec.gov. The Company's Common Stock is quoted on the Nasdaq National
Market, and such reports, proxy statements and other information may be
inspected at the offices of Nasdaq Operations, 1735 K Street, N.W., Washington,
D.C. 20006.
44
<PAGE> 45
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SERVICE EXPERTS, INC. -- UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
Basis of Presentation....................................... F-2
Unaudited Pro Forma Combined Balance Sheet as of December
31, 1996.................................................. F-3
Unaudited Pro Forma Combined Statement of Income for the
Twelve Months ended December 31, 1996..................... F-4
Notes to Unaudited Pro Forma Combined Financial
Statements................................................ F-5
SERVICE EXPERTS, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
Report of Independent Auditors.............................. F-9
Consolidated Balance Sheets................................. F-10
Consolidated Statements of Income........................... F-12
Consolidated Statements of Stockholders' Equity............. F-13
Consolidated Statements of Cash Flows....................... F-14
Notes to Consolidated Financial Statements.................. F-15
</TABLE>
F-1
<PAGE> 46
PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
The Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneous with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. In accordance with the provisions of SAB 97, the
historical financial statements of the Company for periods prior to August 21,
1996 are the combined financial statements of the Acquiring Company. Such
historical financial statements have been restated for Custom Air Conditioning,
Inc. and Freschi Air Systems, Inc. (collectively "Pooled Companies"), which were
acquired in December 1996 in business combinations accounted for as poolings of
interests. The operations of the 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 SAB 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 &
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.; and Service Experts
of Palm Springs, Inc.
The following unaudited pro forma combined financial statements give effect
to the acquisition by the Company of certain Acquired Companies and certain
Pending Acquisitions in exchange for shares of the Company's Common Stock, cash,
and the assumption of certain debt.
Since the acquisition of the Predecessor Companies, the Company has
completed 25 additional acquisitions (the "Acquired Companies"), of which two
have been accounted for as poolings of interests. The pro forma combined
financial statements give effect to the acquisition of the following Acquired
Companies: Dial One Raymond's Plumbing, Heating & Cooling, Inc., Gaddis Co.,
Automated Air, Inc., Bauer Heating & Air Conditioning, Inc., Sylvester's Corp.,
Bryant-Allen, Inc., Paul E. Smith Co., Inc., Quality Air Conditioning & Heating
of West Monroe, Inc., Frees Service Experts, Inc., Parker Heating & Air
Conditioning, Incorporated, Comfortech, Inc., Sunbeam Service Experts, Inc.,
Falso Service Experts, Inc., Gordon's Specialty Company, Inc., Pardee
Refrigeration Company Incorporated, Sanders Indoor Comfort, Inc., Island Air
Conditioning, Inc., Air-Conditioning and Heating Unlimited, Inc., B&B Air
Conditioning, Inc. and Eisenbach Enterprises, Inc. The pro forma combined
financial statements give effect to the following eight Pending Acquisitions: C.
Iapaluccio Co., Inc., Claire's Air Conditioning and Refrigeration, Inc., Claire
& Sanders, Inc., Royden, Inc., Piedmont Air Conditioning, Inc., Roland J. Down,
Inc., Stark Services Company, Inc. and Lewis & Guymon, Inc. The pro forma
combined financial statements do not give effect to the acquisition of two
Acquired Companies or to three Pending Acquisitions which are immaterial to the
pro forma presentation.
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 combining financial
statements. The pro forma combining balance sheet as of December 31, 1996, gives
effect to the eight Pending Acquisitions listed above as if such transactions
had occurred on December 31, 1996. The pro forma combined statements of income
for the year ended December 31, 1996 assume the acquisitions of the Subsidiaries
and the eight Pending Acquisitions were completed on January 1, 1996.
The pro forma combined financial statements should be read in conjunction
with the historical financial statements of the Company, 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-2
<PAGE> 47
PRO FORMA COMBINED BALANCE SHEET OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
DECEMBER 31, 1996
<TABLE>
<CAPTION>
ACQUIRED
COMPANIES PENDING PRO FORMA
EFFECTIVE AFTER ACQUISITIONS PRO FORMA OFFERING PRO FORMA
COMPANY DECEMBER 31, 1996 AS ADJUSTED ADJUSTMENTS PRO FORMA ADJUSTMENTS AS ADJUSTED
------- ----------------- ------------ ----------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Current assets:
Cash and cash
equivalents............. $ 10,726 $ 1,257 $ 663 $(14,568)(c) $ 970 $37,666(d) $ 30,292
(673)(a) (8,344)(e) --
(3,535)(b) -- --
7,100(c) -- --
-------- ------- ------- ----------- -------- ------- --------
Receivables:
Trade receivables, net.... 9,048 1,044 2,625 -- 12,717 -- 12,717
Related party............. 129 23 12 -- 164 -- 164
Employee.................. 113 25 19 -- 157 -- 157
Other..................... 208 (8) 67 -- 267 -- 267
-------- ------- ------- ---------- -------- ------- --------
9,498 1,084 2,723 -- 13,305 -- 13,305
Inventories................. 3,923 870 1,502 -- 6,295 -- 6,295
Cost and estimated earnings
in excess of billings..... 283 -- 610 -- 893 -- 893
Prepaid expenses and other
current assets............ 697 137 526 -- 1,360 -- 1,360
Current portion of notes
receivable -- related
parties................... 14 -- -- -- 14 -- 14
Current portion of notes
receivable -- other....... 286 -- 131 -- 417 -- 417
Deferred income taxes....... 1,893 222 1 -- 2,116 -- 2,116
-------- ------- ------- ---------- -------- ------- --------
Total current
assets............ 27,320 3,570 6,156 (11,676) 25,370 29,322 54,692
Property, buildings and
equipment, net............ 6,329 1,289 1,603 1,000(c) 10,221 -- 10,221
Notes receivable -- related
parties................... 352 -- 15 -- 367 -- 367
Notes receivable -- other... 500 -- -- -- 500 -- 500
Investment in affiliate..... 674 5 1 -- 680 -- 680
Long-term deferred income
taxes..................... -- 3 -- -- 3 -- 3
Goodwill.................... 33,032 85 1 12,817(b) 62,825 -- 62,825
16,890(c)
Other assets................ 297 46 125 -- 468 -- 468
-------- ------- ------- -------- -------- ------- --------
Total assets........ $ 68,504 $ 4,998 $ 7,901 $ 19,031 $ 100,434 $29,322 $129,756
======== ======= ======= ======== ========= ======= ========
Current liabilities:
Short-term debt........... $ -- $ 148 $ 22 $ 7,100(c) $ 7,270 $(7,270)(e) $ --
Trade accounts payable and
accrued liabilities..... 5,174 1,055 1,298 -- 7,527 -- 7,527
Cash consideration
payable................. 1,495 -- -- (1,495)(b) -- -- --
Accrued compensation...... 1,601 756 1,100 (673)(a) 2,784 -- 2,784
Accrued warranties........ 963 121 213 -- 1,297 -- 1,297
Income taxes payable...... 1,723 57 26 -- 1,806 -- 1,806
Deferred revenue.......... 3,502 909 617 -- 5,028 -- 5,028
Billings in excess of
costs and estimated
earnings................ 340 5 261 -- 606 -- 606
Current portion of
long-term debt and
capital lease
obligations............. 135 59 15 -- 209 (209)(e) --
-------- ------- ------- -------- --------- ------- --------
Total current
liabilities....... 14,933 3,110 3,552 4,932 26,527 (7,479) 19,048
Long-term debt and capital
lease obligations, net of
current................... 140 108 486 -- 734 (734)(e) --
Related parties notes....... -- 50 81 -- 131 (131)(e) --
Deferred income taxes....... 360 26 -- -- 386 -- 386
Common stock................ 111 -- -- 8(b) 122 19(d) 141
3(c)
Additional
paid-in-capital........... 48,566 -- -- 12,473(b) 68,140 37,647(d) 105,787
7,101(c) --
Retained earnings........... 4,409 1,704 3,782 (3,782)(c) 4,409 -- 4,409
(1,704)(b) --
Equity notes receivable..... (15) -- -- -- (15) -- (15)
------- ------- ------- --------- -------- ------- -------
$68,504 $ 4,998 $ 7,901 $ 19,031 $100,434 $29,322 $129,756
======= ======= ======= ========= ======== ======= ========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-3
<PAGE> 48
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>
PRO FORMA PRO FORMA
PREDECESSOR PRO FORMA ACQUIRED PRO FORMA
COMPANIES PREDECESSOR ACQUIRED COMPANIES ACQUIRED PENDING
COMPANY PREDECESSOR ADJUSTMENTS COMPANIES COMPANIES ADJUSTMENTS COMPANIES ACQUISITIONS
------- ----------- ----------- ----------- ----------- ----------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues......... $46,856 $30,128 $ -- $ 76,984 $63,670 $ -- $140,654 $31,649
Cost of goods sold... 30,198 19,052 -- 49,250 41,547 (141)(j) 90,656 22,954
------- ------- ------- -------- ------- ------ -------- -------
Gross margin......... 16,658 11,076 -- 27,734 22,123 141 49,998 8,695
Selling, general and
administrative
expenses........... 12,837 8,670 (2,508)(f) 18,999 20,613 (2,993)(k) 36,619 6,421
------- ------- ------- -------- ------- ------ -------- -------
Income from
operations......... 3,821 2,406 2,508 8,735 1,510 3,134 13,379 2,274
Other income
(expense):
Interest expense... (63) (216) 212 (g) (67) (237) 238 (l) (66) (45)
Interest income.... 334 192 -- 526 67 -- 593 17
Other income
(expense)........ 214 3 40 (h) 257 (165) -- 92 73
------- ------- ------- ------- ------- ------ -------- -------
485 (21) 252 716 (335) 238 619 45
------- ------- ------- ------- ------- ------ -------- -------
Income before tax.... 4,306 2,385 2,760 9,451 1,175 3,372 13,998 2,319
Provision for income
taxes.............. 1,196 324 1,755 (i) 3,275 40 2,196 (m) 5,511 32
------- ------- ------- ------- ------- ------ -------- -------
Net income $3,110 $ 2,061 $ 1,005 $ 6,176 $1,135 $1,176 $ 8,487 $ 2,287
======= ======= ======= ======= ======= ====== ======== =======
Pro forma net income
per share.......... $ 0.67 $ 0.71
Pro forma weighted
average shares
outstanding........ 9,220 11,885
<CAPTION>
PRO FORMA
PENDING PRO FORMA PRO FORMA
ACQUISITIONS PENDING OFFERING PRO FORMA
ADJUSTMENTS ACQUISITIONS ADJUSTMENTS ALL ACQUISITIONS
------------ ------------ ----------- ----------------
<S> <C> <C> <C> <C>
Net revenues......... $ -- $172,303 $ -- $172,303
Cost of goods sold... 17(n) 113,627 -- 113,627
------- -------- ---- --------
Gross margin......... (17) 58,676 -- 58,676
Selling, general and
administrative
expenses........... (553)(o) 42,487 -- 42,487
------- -------- ---- --------
Income from
operations......... 536 16,189 -- 16,189
Other income
(expense):
Interest expense... (604)(p) (715) 715(r) --
Interest income.... -- 610 -- 610
Other income
(expense)........ -- 165 -- 165
------- -------- ---- --------
(604) 60 715 775
------- -------- ---- --------
Income before tax.... (68) 16,249 715 16,964
Provision for income
taxes.............. 983(q) 6,526 272(s) 6,798
------- -------- ---- --------
Net income $(1,051) $ 9,723 $443 $ 10,166
======= ======== ==== ========
Pro forma net income
per share.......... $ 0.76
Pro forma weighted
average shares
outstanding........ 13,333
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements
F-4
<PAGE> 49
SERVICE EXPERTS, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
PRO FORMA BALANCE SHEET ADJUSTMENTS
(a) Reflects the distribution of equity in excess of minimum required per merger
agreements
(b) Reflects the payments to owners of the Subsidiaries of $3,535,000 in cash
and 756,396 shares of Common Stock
(c) Reflects the payments to owners of the Predecessor Companies of $14,568,000
in cash and 322,909 shares of common stock for the Pending Acquisitions and
debt incurred associated with the transaction.
(d) Reflects the proceeds of the Offering, net of estimated expenses of
$1,000,000 and underwriting commissions of $2,035,000. The net proceeds are
reflected as: (i) $39,755,000 of cash, (ii) $18,500 of par value of
1,850,000 shares of common stock, (iii) $37,647,000 of additional paid-in
capital.
(e) Reflects the elimination of all outstanding debt
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS -- SERVICE EXPERTS
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
--------------
(IN THOUSANDS)
<C> <C> <S> <C>
(f) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $(4,416)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 1,322
(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)
-------
$(2,508)
=======
(g) 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 shareholders
of AC Service & Installation Co., Inc. and Custom Air
Conditioning, Inc. ......................................... 15
(iii) Elimination of all other debt assumed in the transaction to
be paid at closing.......................................... 152
-------
$ 212
=======
(h) REFLECTS THE FOLLOWING ADJUSTMENT TO OTHER INCOME:
(i) The addition of income from its 37% investment in Future
University.................................................. $ 40
=======
</TABLE>
F-5
<PAGE> 50
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
--------------
<C> <C> <S> <C>
(i) 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 Predecessor
Companies previously were taxed as Subchapter S
corporations................................................ $ 706
(ii) Additional income taxes on adjustments (f) thru (h)......... 1,049
-------
$ 1,755
=======
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS -- ACQUIRED COMPANIES
(j) REFLECTS THE FOLLOWING ADJUSTMENTS TO COST OF GOODS SOLD:
(i) Adjust rent expense per new leases.......................... $ (122)
(ii) Elimination of real estate depreciation..................... (19)
-------
$ (141)
=======
(k) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $(6,739)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 1,752
(iii) Three regional vice presidents and one MIS director......... 700
(iv) Goodwill amortization....................................... 1,294
-------
$(2,993)
=======
(l) REFLECTS THE FOLLOWING ADJUSTMENT TO INTEREST EXPENSE:
(i) Elimination of interest expense on debt retired............. $ 238
=======
(m) 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 previously were taxed as Subchapter S
corporations................................................ $ 480
(ii) Additional income taxes on adjustments (j) thru (l)......... $ 1,281
(iii) Additional income tax provision for state and federal taxes
due to the non-deductibility of goodwill.................... $ 435
-------
$ 2,196
=======
</TABLE>
F-6
<PAGE> 51
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS -- PENDING ACQUISITIONS
<TABLE>
<CAPTION>
TWELVE MONTHS
ENDED
DECEMBER 31,
1996
-------------
(IN
THOUSANDS)
<C> <C> <S> <C>
(n) REFLECTS THE FOLLOWING ADJUSTMENT TO COST OF GOODS SOLD:
(i) Adjust rent expense per new leases.......................... $ 17
=======
(o) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $ (925)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 506
(iii) Elimination of general and administrative expenses.......... (556)
(iv) Goodwill amortization....................................... 422
-------
$ (553)
=======
(p) REFLECTS THE FOLLOWING ADJUSTMENT TO INTEREST EXPENSE:
(i) Additional interest on debt incurred associated with the
transactions................................................ $ 604
=======
(q) 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 Acquisition
Companies previously were taxed as Subchapter S
corporations................................................ $ 849
(ii) Additional income taxes on adjustments (n) thru (p)......... (26)
(iii) Additional tax provision for state and federal taxes due to
the non-deductibility of goodwill........................... 160
-------
$ 983
=======
PRO FORMA STATEMENT OF INCOME ADJUSTMENTS -- OFFERING ADJUSTMENTS
(r) REFLECTS THE FOLLOWING ADJUSTMENT TO INTEREST EXPENSE:
(i) Elimination of interest expense on debt retired............. $ 715
=======
(s) REFLECTS THE FOLLOWING ADJUSTMENT TO INCOME TAXES:
(i) Additional income taxes on adjustment (r)................... $ 272
=======
</TABLE>
F-7
<PAGE> 52
(This page intentionally left blank)
F-8
<PAGE> 53
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Service Experts, Inc.
We have audited the accompanying consolidated balance sheets of Service
Experts, Inc. (formerly AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company -- see Note 1) as of December 31, 1995 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 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 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 from
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 consolidated financial position of
Service Experts, Inc. (formerly AC Service & Installation Co., Inc. and Donelson
Air Conditioning Company -- see Note 1) at December 31, 1995 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 12, 1997
F-9
<PAGE> 54
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 445 $10,726
Accounts Receivable:
Trade, net of allowance for doubtful accounts of
$135,000 in 1995 and $620,000 in 1996................. 2,334 9,048
Related party.......................................... 298 129
Employee............................................... 66 113
Other.................................................. 77 208
------- -------
2,775 9,498
Inventories............................................... 472 3,923
Costs and estimated earnings in excess of billings........ 31 283
Prepaid expenses and other current assets................. 265 697
Current portion of notes receivable -- related parties.... -- 14
Current portion of notes receivable -- other.............. -- 286
Deferred income taxes..................................... 17 1,893
------- -------
Total current assets.............................. 4,005 27,320
Property, buildings and equipment:
Land...................................................... 105 10
Buildings................................................. 767 67
Furniture and fixtures.................................... 472 841
Machinery and equipment................................... 364 1,913
Vehicles.................................................. 2,149 5,339
Leasehold improvements.................................... 80 620
------- -------
3,937 8,790
Less accumulated depreciation and amortization.............. (2,002) (2,461)
------- -------
1,935 6,329
Notes receivable -- related parties, net of current
portion................................................... -- 352
Notes receivable -- other, net of current portion........... -- 500
Investment in affiliate..................................... -- 674
Goodwill.................................................... -- 33,032
Other assets................................................ 80 297
------- -------
Total assets...................................... $ 6,020 $68,504
======= =======
See accompanying notes.
</TABLE>
F-10
<PAGE> 55
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
------------------
1995 1996
------- -------
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities............ $ 740 $ 5,174
Cash consideration payable................................ -- 1,495
Accrued compensation...................................... 743 1,601
Accrued warranties........................................ 169 963
Income taxes payable...................................... 67 1,723
Deferred revenue.......................................... 471 3,502
Billings in excess of costs and estimated earnings........ 228 340
Current portion related party notes....................... 7 --
Current portion of long-term debt and capital lease
obligations............................................ 244 135
------- -------
Total current liabilities......................... 2,669 14,933
Long-term debt and capital lease obligations, net of current
portion................................................... 610 140
Related party notes, net of current portion................. 669 --
Deferred income taxes....................................... 8 360
Commitments (Note 10).......................................
Stockholders' equity:
Common stock $.01 par value; 30,000,000 shares authorized;
1,560,912 and 11,050,326 shares issued and outstanding
at December 31, 1995 and 1996, respectively............ 16 111
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares issued and outstanding........... -- --
Additional paid-in capital................................ 241 48,566
Retained earnings......................................... 1,807 4,409
Equity notes receivable................................... -- (15)
------- -------
Total stockholders' equity........................ 2,064 53,071
------- -------
Total liabilities and stockholders' equity........ $ 6,020 $68,504
======= =======
</TABLE>
See accompanying notes.
F-11
<PAGE> 56
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------
1994 1995 1996
------- ------- -------
(IN THOUSANDS, EXCEPT PER
SHARE DATA)
<S> <C> <C> <C>
Net revenues................................................ $22,193 $24,876 $46,856
Cost of goods sold.......................................... 15,999 16,916 30,198
------- ------- -------
Gross margin................................................ 6,194 7,960 16,658
Selling, general and administrative expenses................ 5,723 7,162 12,837
------- ------- -------
Income from operations...................................... 471 798 3,821
Other income (expense):
Interest expense.......................................... (90) (100) (63)
Interest income........................................... 26 44 334
Other income.............................................. 17 48 214
------- ------- -------
(47) (8) 485
Income before federal and state income taxes................ 424 790 4,306
Provision (benefit) for income taxes:
Current................................................... 48 105 2,675
Deferred.................................................. (7) (23) (1,479)
------- ------- -------
41 82 1,196
------- ------- -------
Net income................................................ $ 383 $ 708 $ 3,110
======= ======= =======
Net income per common share................................. $ .25 $ .45 $ .70
======= ======= =======
Weighted average shares used in earnings per share
computation............................................... 1,561 1,561 4,451
======= ======= =======
</TABLE>
See accompanying notes.
F-12
<PAGE> 57
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL EQUITY
--------------- PAID-IN RETAINED NOTES
SHARES AMOUNT CAPITAL EARNINGS RECEIVABLE TOTAL
------ ------ ---------- --------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994................... 1,561 $ 16 $ 241 $ 1,193 -- $ 1,450
Capital distributions...................... -- -- -- (284) -- (284)
Net income................................. -- -- -- 383 -- 383
------ ---- ------- --------- --------- ---------
Balance at December 31, 1994................. 1,561 16 241 1,292 -- 1,549
Capital distributions...................... -- -- -- (193) -- (193)
Net income................................. -- -- -- 708 -- 708
------ ---- ------- --------- --------- ---------
Balance at December 31, 1995................. 1,561 16 241 1,807 -- 2,064
Issuance of stock at initial public
offering................................. 2,588 26 28,087 -- -- 28,113
Predecessor Companies (see Note 3)
Issuance of stock........................ 4,832 48 6,462 -- (15) 6,495
Cash distributions......................... -- -- (18,699) -- -- (18,699)
Issuance of stock for Acquired Companies
(see Note 4)........................... 2,069 21 32,475 -- -- 32,496
Capital distributions...................... -- -- -- (508) -- (508)
Net income................................. -- -- -- 3,110 -- 3,110
------ ---- ------- --------- --------- ---------
Balance at December 31, 1996................. 11,050 $111 $48,566 $ 4,409 $ (15) $ 53,071
====== ==== ======= ========= ========= =========
</TABLE>
See accompanying notes.
F-13
<PAGE> 58
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1994 1995 1996
------ ------ --------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 383 $ 708 $ 3,110
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 449 572 650
Equity in affiliate earnings.............................. -- -- (30)
Benefit for deferred income taxes......................... (7) (23) (1,479)
(Loss) gain on asset disposals............................ 8 (13) (40)
Changes in assets and liabilities:
Receivables............................................. (752) (232) 115
Inventories............................................. (76) (2) (203)
Prepaid expenses and other current assets............... 28 (7) (336)
Trade accounts payable and accrued liabilities.......... 227 (227) (1,745)
Accrued compensation.................................... 156 50 (910)
Accrued warranties...................................... 15 56 148
Deferred revenue........................................ 225 (44) 404
Income taxes payable.................................... 4 41 363
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.... 59 18 (128)
------ ------ --------
Net cash flow provided by (used in) operating
activities....................................... 719 897 (81)
INVESTING ACTIVITIES
Advances on notes receivable................................ -- -- (250)
Purchase of property, buildings, and equipment.............. (630) (766) (638)
Proceeds from sale of property, buildings, and equipment.... 9 30 225
Cash acquired through acquisitions.......................... -- -- 3,961
Payment of cash portion of consideration to Predecessor
Companies................................................. -- -- (18,699)
(Increase) decrease in other assets......................... (96) (96) (304)
------ ------ --------
Net cash used in investing activities.............. (717) (832) (15,705)
FINANCING ACTIVITIES
Proceeds from notes payable to shareholders and related
parties................................................... -- -- 59
Payments on notes payable to shareholders and related
parties................................................... -- -- (886)
Issuance of stock, net of issuance costs.................... -- -- 28,113
Proceeds of long-term debt and capital leases............... 423 648 104
Payments of long-term debt and capital leases............... (365) (437) (815)
Distributions paid.......................................... (284) (193) (508)
------ ------ --------
Net cash (used in) provided by financing activities......... (226) 18 26,067
------ ------ --------
Increase (decrease) in cash and cash equivalents............ (224) 83 10,281
Cash and cash equivalents at beginning of period............ 586 362 445
------ ------ --------
Cash and cash equivalents at end of period.................. $ 362 $ 445 $ 10,726
====== ====== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 103 $ 100 $ 63
====== ====== ========
Income tax paid............................................. $ 49 $ 67 $ 1,880
====== ====== ========
ACQUISITION OF COMPANIES:
Fair value of assets acquired............................. $ -- $ -- $ 42,333
Cash paid................................................. 1,478
Common stock issued....................................... 34,068
------ ------ --------
Liabilities assumed....................................... $ -- $ -- $ 6,787
====== ====== ========
DISTRIBUTION OF ASSETS TO STOCKHOLDERS
Book value of assets distributed............................ $ -- $ -- $ 1,324
====== ====== ========
Long-term debt assumed by stockholders...................... $ -- $ -- $ 488
====== ====== ========
Notes payable to stockholders retired....................... $ -- $ -- $ 343
====== ====== ========
</TABLE>
See accompanying notes.
F-14
<PAGE> 59
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Service Experts, Inc. was incorporated on March 27, 1996. As a result of
the adoption of Securities and Exchange Commission Staff Accounting Bulletin No.
97 ("SAB 97") on July 31, 1996, the historical financial statements of Service
Experts, Inc. ("the Company") for periods prior to August 21, 1996 are the
combined financial statements of AC Service & Installation Co., Inc. and
Donelson Air Conditioning, Inc. ("the Acquiring Company") and subsequent
acquisitions accounted for under pooling of interests. (See Note 2). AC Service
& Installation Co., Inc. and Donelson Air Conditioning, Inc. were under common
control. On August 21, 1996 and simultaneous with the closing of its initial
public offering, the Company acquired in separate transactions, 12 heating,
ventilating and air conditioning ("HVAC") replacement and service businesses and
Contractor Success Group, Inc. (collectively, the "Predecessor Companies") in
exchange for shares of the Company's Common Stock and cash (the "Combination").
The Acquiring Company was treated as the acquiror entity in this transaction in
accordance with SAB 97. The operations of the acquired companies have been
included in the Company's financial statements from the date of acquisition. The
above-mentioned acquisitions have been accounted for using the historical cost
basis of the acquired companies in accordance with Securities and Exchange
Commission Staff Accounting Bulletin No. 48 ("SAB 48"). The Company operates in
one industry segment and is primarily engaged in the replacement and servicing
of HVAC for residential and commercial customers. The Company has Service
Centers located in cities across the United States.
PRINCIPALS OF CONSOLIDATION
The consolidated financial statements of Service Experts, Inc. include the
accounts of the Company and its subsidiaries. All intercompany transactions have
been eliminated in consolidation. Investments in affiliates less than 50 percent
owned are generally recorded on the equity method.
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 residential heating and
air conditioning installation, service and maintenance jobs 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 six 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 $76,000 and $359,000 at December 31, 1995 and 1996, 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, 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," represents
billings in excess of revenue recognized on in-progress contracts.
F-15
<PAGE> 60
SERVICE EXPERTS, 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. Accounts receivable are usually
unsecured.
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.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1994, 1995 and 1996 amounts charged to
bad debts expense totaled $95,000, $42,000 and $98,000, respectively and
accounts written off, net of recoveries, were $11,000, $13,000 and $3,000,
respectively.
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...................................... 5-10
Machinery and equipment..................................... 5-10
Vehicles.................................................... 5-10
Leasehold improvements...................................... 7-30
</TABLE>
DEFERRED REVENUE
The Company pre-sells maintenance contracts in the form of extended service
agreements ("ESA"). ESA revenue is recorded as deferred revenue and recognized
as income when service is performed.
WARRANTIES
The Company provides the retail customer with a warranty ranging from one
to ten years on parts and labor from the date of installation of the heating and
air conditioning unit. This warranty generally runs concurrent with the
manufacturer's warranty on parts and for the first year on labor. The Company
provides an
F-16
<PAGE> 61
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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
Donelson Air Conditioning Company, Inc. used 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 former stockholders of AC Service & Installation Co., Inc., Custom Air
Conditioning, Inc. and Freschi Air Systems, Inc. (see Note 2) 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., Custom Air Conditioning, Inc. and Freschi Air Systems,
Inc. are not subject to federal income taxes. This election is not available for
Tennessee state income tax reporting; accordingly, AC Service & Installation
Co., Inc. used the liability method of accounting for Tennessee state income
taxes.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1994, 1995 and
1996, the Company expensed $530,000, $524,000, and $1,584,000, respectively.
GOODWILL
Goodwill consists of the excess of purchase price over the fair value of
acquired tangible and identifiable intangible assets. Excess cost over the fair
value of net assets acquired (or goodwill) is amortized on a straight-line basis
over 40 years. The carrying value of goodwill is reviewed if the facts and
circumstances suggest that it may be impaired. If this review indicates that
goodwill will not be recoverable, as determined based on the undiscounted cash
flows of the entity acquired over the remaining amortization period, the
Company's carrying value of the goodwill will be reduced by the estimated
shortfall of cash flow. Accumulated amortization of goodwill was $87,000 at
December 31, 1996.
INCOME PER COMMON SHARE
Income per common share is based on the weighted average number of shares
of common stock outstanding and common stock equivalents consisting of dilutive
stock options and warrants. Fully diluted earnings per share for 1994, 1995 and
1996 are not materially different from primary earnings per share and,
therefore, are not presented.
RECLASSIFICATIONS
Certain reclassifications have been made in 1994 and 1995 financial
statements to conform to the 1996 presentation. These reclassifications had no
effect on the results of operations previously reported.
F-17
<PAGE> 62
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
2. MERGERS
In December 1996, the Company completed mergers with Custom Air
Conditioning, Inc. ("Custom") and Freschi Air Systems, Inc. ("Freschi") through
the exchange of 230,049 and 177,765 shares, respectively, of the Company's
Common Stock.
These mergers have been accounted for as poolings of interests and,
accordingly, the consolidated financial statements for the periods presented
have been restated to include the accounts of Custom and Freschi. The following
is a summary of results of operations of the separate entities for periods prior
to the mergers.
<TABLE>
<CAPTION>
YEAR ENDED ELEVEN MONTHS
DECEMBER 31, ENDED
------------------ NOVEMBER 30,
1994 1995 1996
------- ------- --------------
(IN THOUSANDS) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Net Revenues
Service Experts......................................... $14,299 $16,453 $29,167
Custom.................................................. 4,638 5,169 5,068
Freschi................................................. 3,256 3,254 4,116
------- ------- -------
Combined................................................ $22,193 $24,876 $38,351
======= ======= =======
Net Income (loss)
Service Experts......................................... $ 179 $ 629 $ 1,751
Custom.................................................. 245 173 213
Freschi................................................. (41) (94) 406
------- ------- -------
Combined................................................ $ 383 $ 708 $ 2,370
======= ======= =======
</TABLE>
3. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
On August 21, 1996, the Company completed an initial public offering
("IPO") of 2,587,500 shares of Common Stock at $13.00 per share. Simultaneously
with the closing of the IPO, the Company issued 3,369,538 shares of Common Stock
and distributed $18,699,000 in cash (exclusive of 1,153,098 shares issued and
$5,027,947 cash distributed to the former stockholders of the Acquiring Company)
in exchange for the stock of Hardwick Air Masters, Inc., Air Experts, a United
Services Co., Inc., Arrow Heating & Air Conditioning, Inc., Brand Heating and
Air Conditioning, Inc., Coastal Air Conditioning Service, Inc., Contractor
Success Group, Inc., Comerford's Heating and Air Conditioning, Inc., Gilley's
Heating & Cooling, Inc., Norrell Heating and Air Conditioning Company, Inc.,
Rolf Coal and Fuel Corp., Service Experts of Palm Springs, Inc. and Vision
Holding Company, Inc. The exchange is being accounted for utilizing the
historical cost basis in accordance with SAB 48 with the stock being valued at
the historical cost of the net assets exchanged. Cash consideration given in
these acquisitions is treated for accounting purposes as a dividend from the
Company.
The Company's stock is currently traded on the Nasdaq Stock Market's
National Market under the symbol SERX.
4. ACQUISITIONS
On November 18, 1996, the Company filed a Registration Statement on Form
S-4 (the "Shelf Registration Statement") covering securities with a collective
aggregate offering price of $50.0 million for use in acquisitions, including the
acquisition of 23 unrelated HVAC replacement and service businesses. Of the 23
companies to be acquired, the Company had completed the acquisition of 15 of
these companies as of December 31, 1996. Two of these acquisitions completed by
December 31, 1996 were accounted for as poolings of interests as discussed in
Note 2. In connection with the 13 acquisitions accounted for using the
F-18
<PAGE> 63
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
purchase method of accounting, the Company issued 2,069,000 shares at a fair
market value of $34,068,000, excluding stock issuance costs of $1,572,000, and
cash of $1,499,000. The Company established an escrow account equal to 10% of
the purchase price for each acquisition subject to final closing adjustments.
The purchase price was allocated to the acquired assets based on the fair values
of those assets as determined by the Company as set forth below (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Current Assets.............................................. $ 7,032
Property, Buildings and Equipment........................... 2,593
Other Assets................................................ 392
Goodwill.................................................... 32,337
Liabilities Assumed......................................... (6,787)
-------
Purchase Price............................... $35,567
=======
</TABLE>
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase
method of accounting except as indicated in Note 3. The allocation of the
purchase price associated with the acquisitions has been determined by the
Company based upon available information and is subject to further refinement.
The operating results of the acquired companies have been included in the
accompanying consolidated statements of income from the respective dates of
acquisition. The following unaudited pro forma results of operations give effect
to the operations of the entities acquired as if the respective transactions had
occurred as of the first day of the fiscal year immediately preceding the year
of the transactions. The pro forma results of operations do not purport to
represent what the Company's results of operations would have been had such
transactions in fact occurred at the beginning of the years presented or to
project the Company's results of operations in any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
--------- ---------
(IN THOUSANDS)
<S> <C> <C>
Net revenues................................................ $112,056 $120,083
Net income.................................................. 5,227 6,043
Income per common share..................................... $ .47 $ .55
</TABLE>
.
Subsequent to December 31, 1996, the Company completed the acquisition of
the remaining eight companies included in the previously mentioned Shelf
Registration Statement by issuing 680,758 shares of stock and paying cash
consideration of $2.0 million. The following unaudited pro forma results of
operations give effect to the operations of the entities acquired during 1996
and subsequent to December 31, 1996 as if the respective transactions had
occurred as of the first day of the fiscal year immediately preceding the year
of the transactions. The pro forma results of operations do not purport to
represent what the Company's results of operations would have been had such
transactions in fact occurred at the beginning of the years presented or to
project the Company's results of operations in any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
---------- ----------
(IN THOUSANDS)
<S> <C> <C>
Net revenues........................................... $131,788 $140,654
Net income............................................. 5,727 8,490
Income per common share................................ $ .52 $ .71
</TABLE>
F-19
<PAGE> 64
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------ ------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts..................... $ 911 $2,903
Estimated earnings....................................... 487 1,147
------ ------
$1,398 $4,050
Less applicable billings................................... $1,595 $4,107
------ ------
$ (197) $ (57)
====== ======
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. $ 31 $ 283
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (228) (340)
------ ------
$ (197) $ (57)
====== ======
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
6. LEASES
Total rental expense for all operating leases was $174,000, $191,000 and
$490,000 for 1994, 1995 and 1996, respectively. The Company leases office and
warehouse space from various stockholders of the Company. These lease agreements
expire at various dates through 2000. Related party rental expense for 1994,
1995 and 1996 was $151,000, $161,000, and $295,000, respectively. The Company
leases certain vehicles and office and warehouse facilities under terms of
noncancelable operating lease agreements which expire at various dates through
2006. Minimum rental commitments at December 31, 1996 under operating leases
having an initial noncancelable term of one year or more are as follows (in
thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING RELATED
LEASES LEASES PARTY TOTAL
------- --------- ------- ------
<S> <C> <C> <C> <C>
1997...................................... $ 60 $ 421 $1,485 $1,966
1998...................................... 55 308 1,483 1,846
1999...................................... 47 239 1,432 1,718
2000...................................... 23 151 1,432 1,606
2001...................................... -- 105 1,112 1,217
Thereafter................................ -- -- 1,171 1,171
---- ------ ------ ------
185 $1,224 $8,115 $9,524
====== ====== ======
Amounts representing interest............. 32
----
Present value of net minimum
rentals (including $45 classified as
current)................................ $153
====
</TABLE>
The carrying value of assets under capital leases, which are included with
owned assets in the accompanying balance sheets is $154,000.
Amortization of the assets under capital leases is included in depreciation
expense.
F-20
<PAGE> 65
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1995 1996
---- ----
<S> <C> <C>
Mortgage note payable....................................... $516 $ --
Installment and equipment notes............................. 314 94
Other....................................................... 24 28
---- ----
854 122
Less current portion........................................ 244 90
---- ----
$610 $ 32
==== ====
</TABLE>
On September 10, 1996, the Company entered into a Revolving Line of Credit
agreement with a Nashville, Tennessee bank for up to $10,000,000 to be used for
working capital purposes and acquisitions. On the same date, the Company also
entered into a Discretionary Line of Credit agreement with a Nashville,
Tennessee bank for up to $10,000,000 to be used for acquisitions or such other
purposes as may be approved by the bank. Any principal amounts outstanding on
the Line of Credit are due on September 10, 1998. On December 31, 1996, there
were no amounts outstanding under the above lines of credit.
Interest on any outstanding portion of the lines of credit is the LIBOR
rate plus applicable rate margin ranging from 125 basis points per annum to 250
basis points per annum (8.5% at December 31, 1996) dependent upon the funded
debt to EBITDA ratio. The Company pays an annual fee of 0.25% of the unused
portion of the available borrowings.
As long as any indebtedness is outstanding, the Lines of Credit require,
among other things, that the Company maintain various financial ratios at
specified levels including minimum levels for stockholders' equity. The Lines of
Credit also limit consolidations and mergers, and incurrence of indebtedness or
liens and prohibit dividends and distributions. At December 31, 1996, the
Company was in compliance with all covenants.
The Company had a mortgage note payable to Free Will Baptist, Inc. that was
secured by the Company's office building and related land. The loan required
monthly installments of $8,400, including fixed principal and imputed interest
(6.1% at December 31, 1995). The mortgage was transferred to the former
shareholders of AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. on June 30, 1996 (see Note 12).
The Company has 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 4.8% to 13% per annum with maturity dates
through 1999.
As of December 31, 1996, the aggregate amounts of annual principal
maturities of long-term debt are as follows (in thousands):
<TABLE>
<S> <C>
1997........................................................ $ 90
1998........................................................ 29
1999........................................................ 3
----
$122
====
</TABLE>
F-21
<PAGE> 66
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCK PLANS
INCENTIVE STOCK OPTION PLAN
The Company has reserved 700,000 shares of common stock under an incentive
stock option plan. A summary of the status of the plan follows:
<TABLE>
<CAPTION>
YEAR ENDED WEIGHTED
DECEMBER 31, AVERAGE
1996 EXERCISE PRICE
-------------- --------------
<S> <C> <C>
Granted........................................ 517,811 $16.92
Exercised...................................... -- --
Canceled....................................... -- --
-------------- ------
Outstanding at end of year..................... 517,811 $16.92
============== ======
Option price range per share at end of year.... $13.00 - $17.25 $16.92
============== ======
Options exercisable at end of year............. --
==============
</TABLE>
Stock options are exercisable over a period determined by the Board of
Directors, but no longer than ten years after the date of the grant. At December
31, 1996, options to purchase 182,189 shares were available for grant.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123), requires
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Pro Forma information regarding net income and earnings per share is
required by FAS 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996, respectively; risk-free interest rates of 5.97% to 6.34%;
dividends yields of 0.0%; volatility factors of the expected market price of the
Company's common stock of .55 and .25; and a weighted-average expected life of
the options of three years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
For purposes of pro forma disclosures, the estimated fair value of options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
<TABLE>
<CAPTION>
1996
--------
<S> <C>
Net income.................................................. $ 3,110
Pro forma compensation expense from stock options, net of
taxes..................................................... (121)
--------
Pro forma net income........................................ $ 2,989
========
Pro forma earnings per common and common equivalent share... $ .67
========
</TABLE>
F-22
<PAGE> 67
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Under FAS 123, disclosure of exercise prices is required for the year ended
December 31, 1996 only. The weighted-average fair value of options granted
during 1996 was $4.27. The weighted-average remaining contractual life of those
options is 9.7 years.
NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
The Company has a Director Stock Option Plan that provides for a maximum of
issuance 100,000 shares of Common Stock for grant to non-management members of
the Board of Directors.
Options to purchase a total of 15,000 shares of Common Stock with exercise
price of $13.00 per share were outstanding at December 31, 1996. Each option is
exercisable in full upon receipt and shall expire ten years after the Grant
Date.
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan under which the sale of
100,000 shares of Common Stock have been authorized. Employees may designate up
to 10% of their base compensation, at a price equal to 85% of the lessor fair
market value of the Common Stock January 1 or December 31. 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 date of hire. At December 31, 1996 no shares had been issued under this
plan.
WARRANTS
In connection with the Company's IPO, Equitable Securities Corporation
received warrants to purchase 82,391 shares of the Company's Common Stock at an
exercise price of $13.00 per share. The warrants are exercisable for a period of
five years.
9. EMPLOYEE BENEFIT PLANS
The Company has defined-contribution employee benefit plans incorporating
provisions of section 401(k) of the Internal Revenue Code. Generally, employees
of the Company must have one year of service and work 500 hours during the plan
year to be eligible. Under the plans' provisions, a plan member may make
contributions, on a tax-deferred basis, from 1% to 20% of total compensation not
to exceed the maximum established annually by the Internal Revenue Service.
Under the plans matching contributions are made by the Company in amounts
ranging from 1% to 50% of total contributions by a plan member, to a maximum of
between 2% and 6% of the employee's total calendar year compensation. The
Company's matching contributions totaled $126,000, $201,000 and $206,000 as of
December 31, 1994, 1995 and 1996, respectively.
10. 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-23
<PAGE> 68
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1994 1995 1996
----- ----- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................................... $40 $ 65 $2,214
State..................................................... 8 40 461
Deferred.................................................... (7) (23) (1,479)
--- ---- ------
$41 $ 82 $1,196
=== ==== ======
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------ ------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Contract billings......................................... $ 22 $ 136
Depreciation and amortization............................. -- 360
Other-net................................................. -- 63
------ ------
Deferred tax liabilities.................................... 22 559
Deferred tax assets:
Depreciation and amortization............................. 2 --
Bad debts................................................. 18 256
Warranty reserves......................................... 11 330
Deferred revenue.......................................... -- 1,045
Accrued expenses.......................................... -- 365
Other-net................................................. -- 96
------ ------
Total gross deferred tax assets............................. 31 2,092
------ ------
Net deferred tax assets..................................... $ 9 $1,533
====== ======
</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. Accordingly, no valuation allowance has
been recognized.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1994 1995 1996
---- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax provision at statutory rate.................... $ 75 $ 241 $1,464
State income tax less applicable federal tax
benefit.......................................... 5 27 147
Less benefit of graduated tax rates and adjustments
to eliminate S corporation....................... (39) (186) (218)
Less benefit recognized upon termination of
Subchapter S election for AC Service &
Installation Co., Inc............................ -- -- (236)
Other-net.......................................... -- -- 39
---- ------ ------
$ 41 $ 82 $1,196
==== ====== ======
</TABLE>
F-24
<PAGE> 69
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously, AC Service & Installation Co., Inc.; Custom Air
Conditioning, Inc.; and Freschi Air Systems, Inc. operated under Subchapter S of
the Internal Revenue Code and were not subject to corporate federal income tax.
The Subchapter S elections were terminated upon acquisition by the Company. As a
result, these companies are subject to corporate income taxes subsequent to the
termination of S corporation status. AC Service & Installation Co., Inc.; Custom
Air Conditioning, Inc. and Freschi Air Systems, Inc. had net operating income
for income tax purposes of $133,000, $682,000 and $1,760,000 for 1994, 1995 and
1996, respectively. Had AC Service & Installation Co., Inc.; Custom Air
Conditioning, Inc. and Freschi Air Systems, Inc. filed federal and state income
tax returns as regular C corporations for 1994, 1995, and periods ended during
1996, income tax expense under the provisions of Financial Accounting Standard
No. 109 would have been, $102,000, $242,000 and $316,000, respectively.
At the date of termination of S corporation status, AC Service &
Installation Co., Inc.; Custom Air Conditioning, Inc. and Freschi Air Systems,
Inc. were required to provide deferred taxes for cumulative temporary
differences between financial reporting and tax reporting basis of assets and
liabilities. Such deferred taxes were based on the cumulative temporary
differences at the date of termination of S corporation status.
The termination of S corporation status occurred on August 21, 1996 for AC
Service & Installation Co., Inc., and a deferred tax asset of $236,000 was
recorded. The effect of recognizing the deferred tax asset was included in the
provision for income taxes.
12. RELATED PARTY TRANSACTIONS
Notes Receivable from Related Parties
The Company has one outstanding note receivable of $366,000 from a
stockholder of the Company as of December 31, 1996. The note is payable in 180
monthly installments of $3,905 and bears annual interest of 9%.
Other Related Party Transactions
On June 30, 1996, the Company distributed land, buildings, accounts
receivable and other assets with a net book value of $1,096,000 in satisfaction
of mortgage notes payable of $488,000, shareholder notes payable of $343,000,
and accrued compensation of $365,000 to the former shareholders of AC Service &
Installation Co., Inc. and Donelson Air Conditioning, Inc.
Notes Payable to Related Parties
At December 31, 1995 the Company had notes payable to related parties,
including current and former shareholders, which bear interest ranging from 0.0%
to 12.5% and were due through 2009. These notes were repaid during 1996.
F-25
<PAGE> 70
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the year ended December 31, 1996 is
summarized below:
<TABLE>
<CAPTION>
QUARTER
--------------------------------------
1ST 2ND 3RD 4TH
------ ------ ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues.................................. $5,134 $7,693 $13,130 $20,899
Income before income taxes.................... 39 59 1,527 2,681
Net income.................................... 33 152 1,239 1,686
Income per common share....................... $ .02 $ .10 $ .25 $ .17
</TABLE>
14. SUBSEQUENT EVENT
Subsequent to December 31, 1996, the Company entered into agreements in
principle to acquire eight HVAC businesses. Pursuant to these agreements in
principle, the Company will merge with or acquire the stock of the eight
companies for an aggregate of approximately $15.4 million cash and approximately
225,400 shares of Common Stock. Closing of the transactions is subject to
customary conditions and is expected to take place prior to June 30, 1997.
F-26
<PAGE> 71
======================================================
NO DEALER, SALESMAN OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS IN CONNECTION WITH THIS OFFERING
OTHER THAN THOSE CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH
INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED
BY THE COMPANY, THE SELLING STOCKHOLDERS OR ANY UNDERWRITER. NEITHER THE
DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL UNDER ANY
CIRCUMSTANCES CREATE ANY IMPLICATION THAT THERE HAS BEEN NO CHANGE IN THE
AFFAIRS OF THE COMPANY SINCE THE DATE HEREOF OR THAT THE INFORMATION CONTAINED
HEREIN IS CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF. THIS PROSPECTUS
DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY TO ANY
PERSON IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION WOULD BE UNLAWFUL
OR TO ANY PERSON TO WHOM IT IS UNLAWFUL.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Prospectus Summary.................... 3
Risk Factors.......................... 6
Use of Proceeds....................... 10
Price Range of Common Stock and
Dividend Policy..................... 10
Capitalization........................ 11
Selected Consolidated Financial
Data................................ 12
Selected Pro Forma Combined Financial
Data................................ 13
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 14
Business.............................. 18
Management............................ 29
Certain Transactions.................. 35
Principal and Selling Stockholders.... 37
Description of Capital Stock.......... 39
Shares Eligible for Future Sale....... 41
Underwriting.......................... 43
Legal Matters......................... 44
Experts............................... 44
Available Information................. 44
Index to Financial Statements......... F-1
</TABLE>
======================================================
======================================================
2,500,000 SHARES
SERVICE EXPERTS LOGO
COMMON STOCK
--------------------
PROSPECTUS
--------------------
EQUITABLE SECURITIES
CORPORATION
ALEX. BROWN & SONS
INCORPORATED
A.G. EDWARDS & SONS, INC.
MORGAN KEEGAN &
COMPANY, INC.
March 18, 1997
======================================================
