<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15 (D) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
September 4, 1997
SERVICE EXPERTS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Delaware 001-13037 62-1639453
- ---------------- ---------------- -----------------
<S> <C> <C>
(State or Other (Commission File (I.R.S. Employer
Jurisdiction of Number) Identification
Incorporation) Number)
</TABLE>
111 Westwood Place
Suite 420
Brentwood, Tennessee 37027
--------------------------------------------------
(Address of principal executive offices) (Zip Code)
(615) 371-9990
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
-------------------------------------------------------------
(Former name or former address, if changed since last report)
================================================================================
<PAGE> 2
ITEM 5. OTHER EVENTS.
Service Experts, Inc., a Delaware corporation (the "Company"), operates
residential heating, ventilating and air conditioning ("HVAC") service and
replacement businesses. In connection with the acquisition of HVAC businesses,
the Company plans to offer shares of the Company's Common Stock, $.01 par value
per share (the "Common Stock"), warrants to purchase shares of Common Stock and
debt securities convertible into shares of Common Stock pursuant to its
Registration Statement on Form S-4. In order to comply with the disclosure
requirements of the Securities and Exchange Commission regarding the financial
statements of businesses acquired or to be acquired, the Company is filing this
Current Report containing the following audited and pro forma financial
statements:
(a) Financial Statements of Businesses Acquired or to be Acquired
See Pages F-1 through F-71.
(b) Pro Forma Financial Information
See Pages F-72 through F-77.
2
<PAGE> 3
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
----------------------------------
Anthony M. Schofield
Chief Financial Officer, Secretary
and Treasurer
Date: September 4, 1997
3
<PAGE> 4
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
S&W AIR CONDITIONING, INC.
Financial Statements for the Year ended December 31, 1996
and Six Months ended June 30, 1997 (unaudited)
Report of Independent Auditors.............................. F-3
Balance Sheets.............................................. F-4
Statements of Income........................................ F-5
Statements of Stockholders' Equity.......................... F-6
Statements of Cash Flows.................................... F-7
Notes to Financial Statements............................... F-9
J.M. JENKS INCORPORATED DBA J.M. MECHANICAL SYSTEMS
Financial Statements for the Year ended December 31, 1996
and Six Months ended June 30, 1997 (unaudited)
Report of Independent Auditors.............................. F-19
Balance Sheets.............................................. F-20
Statements of Income........................................ F-21
Statements of Stockholders' Equity.......................... F-22
Statements of Cash Flows.................................... F-23
Notes to Financial Statements............................... F-24
</TABLE>
F-1
<PAGE> 5
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
BERKSHIRE AIR CONDITIONING COMPANY
Financial statements for the year ended December 31, 1996
and six months ended June 30, 1997 (unaudited)
Report of Independent Auditors.............................. F-33
Balance Sheets.............................................. F-34
Statements of Income........................................ F-35
Statements of Stockholders' Equity.......................... F-36
Statements of Cash Flows.................................... F-37
Notes to Financial Statements............................... F-38
HOLMES SALES & SERVICES, INC.
Financial statements for the year ended December 31, 1996
and six months ended June 30, 1997 (unaudited)
Report of Independent Auditors.............................. F-47
Balance Sheets.............................................. F-48
Statements of Operations.................................... F-49
Statements of Stockholders' Equity.......................... F-50
Statements of Cash Flows.................................... F-51
Notes to Financial Statements............................... F-52
MID FLA HEATING AND AIR, INC.
Financial statements for the year ended December 31, 1997
and six months ended June 30, 1997 (unaudited)
Report of Independent Auditors.............................. F-60
Balance Sheets.............................................. F-61
Statements of Income........................................ F-62
Statements of Stockholders' Equity.......................... F-63
Statements of Cash Flows.................................... F-64
Notes to Financial Statements............................... F-65
SERVICE EXPERTS, INC. -- UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
Basis of Presentation....................................... F-72
Unaudited Pro Forma Combined Balance Sheet as of June 30,
1997...................................................... F-73
Unaudited Pro Forma Combined Statements of Income for the
Six Months ended June 30, 1997 and for the Twelve
Months ended December 31, 1996............................ F-74
Notes to Unaudited Pro Forma Combined Financial
Statements................................................ F-76
</TABLE>
F-2
<PAGE> 6
Report of Independent Auditors
The Stockholders
S&W Air Conditioning, Inc.
We have audited the accompanying balance sheet of S&W Air Conditioning, Inc. as
of December 31, 1996, and the related statements of income, stockholders'
equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of S&W Air Conditioning, Inc. at
December 31, 1996, and the results of its operations and its cash flows for the
year ended December 31, 1996, in conformity with generally accepted accounting
principles.
/s/ ERNST & YOUNG LLP
Nashville, Tennessee
August 8, 1997
F-3
<PAGE> 7
S&W Air Conditioning, Inc.
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 128,644 $ 184,061
Receivables:
Trade, net of allowance for doubtful accounts
of $16,673 and $20,822 at December 31,
1996 and June 30, 1997 559,874 691,236
Employee 18,582 18,569
Related party 31,596 31,559
Other receivables 12,730 30,820
------------------------------------------
622,782 772,184
Inventories 166,301 216,000
Costs and estimated earnings in excess of billings 13,832 107,042
Note receivable 13,464 -
Prepaid expenses and other current assets 12,337 -
Deferred income taxes 85,342 79,683
------------------------------------------
Total current assets 1,042,702 1,358,970
Property, buildings and equipment:
Buildings 68,391 69,391
Furniture and fixtures 114,725 127,807
Machinery and equipment 73,958 75,718
Vehicles 441,847 530,507
------------------------------------------
698,921 803,423
Less accumulated depreciation and amortization 276,786 321,930
------------------------------------------
422,135 481,493
Goodwill, net of accumulated amortization 14,833 14,017
Other assets 34,200 40,984
------------------------------------------
Total assets $ 1,513,870 $ 1,895,464
==========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $ 466,862 $ 427,588
Accrued compensation 46,597 46,597
Accrued taxes, other than income 15,953 28,606
Accrued warranties 19,651 19,636
Income taxes payable 23,955 64,961
Deferred revenue 21,416 27,819
Billings in excess of costs and estimated earnings 25,085 121,126
Liability to Company's benefit plan 3,912 5,975
Current Portion of long-term debt and capital lease
obligations 91,338 381,200
------------------------------------------
Total current liabilities 714,769 1,123,508
Deferred income taxes 39,729 40,031
Long-term debt and capital lease obligations,
net of current portion 314,529 191,644
------------------------------------------
Total liabilities 1,069,027 1,355,183
Stockholders' equity:
Common stock, $.01 par value, 1,000,000 shares authorized,
950,000 shares issued and outstanding
9,500 9,500
Additional paid-in capital 17,815 17,815
Retained earnings 417,528 512,966
------------------------------------------
Total stockholders' equity 444,843 540,281
==========================================
Total liabilities and stockholders' equity $ 1,513,870 $ 1,895,464
==========================================
</TABLE>
See accompanying notes.
F-4
<PAGE> 8
S&W Air Conditioning, Inc.
Statements of Income
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
------------------------------------------
(Unaudited)
<S> <C> <C>
Net revenues $ 5,059,186 $ 3,006,589
Cost of goods sold 3,919,674 2,397,775
------------------------------------------
Gross margin 1,139,512 608,814
Selling, general and administrative expenses 933,210 416,527
Bad debt expense 54,256 22,546
------------------------------------------
Income from operations 152,046 169,741
Other (income) expense:
Interest expense 45,786 21,919
Other income (18,831) (3,570)
------------------------------------------
26,955 18,349
------------------------------------------
Income before taxes 125,091 150,392
Provision (benefit) for income tax:
Current 68,707 49,993
Deferred (25,476) 5,961
------------------------------------------
Total income taxes 43,231 55,954
------------------------------------------
Net income $ 81,860 $ 95,438
==========================================
</TABLE>
See accompanying notes.
F-5
<PAGE> 9
S&W Air Conditioning, Inc.
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
$.01 PAR VALUE ADDITIONAL
--------------------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
-------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance at
January 1, 1996 950,000 $9,500 $17,815 $335,668 $362,983
Net income -- -- -- 81,860 81,860
-------------------------------------------------------------------------------
Balance at
December 31, 1996 950,000 9,500 17,815 417,528 444,843
Net income
(unaudited) -- -- -- 95,438 95,438
-------------------------------------------------------------------------------
Balance at June 30, 1997
(unaudited) 950,000 $9,500 $17,815 $512,966 $540,281
===============================================================================
</TABLE>
See accompanying notes.
F-6
<PAGE> 10
S&W Air Conditioning, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, JUNE 30,
1996 1997
--------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 81,860 $ 95,438
Adjustments to reconcile net income to net cash
provided by (used in) operating activities:
Depreciation and amortization 108,404 45,961
Provision (benefit) for deferred income taxes (25,476) 5,961
Provision for loss on accounts receivable 11,867 9,082
Gain on asset disposals (2,187) -
Changes in assets and liabilities:
Receivable 84,546 (158,484)
Inventories (68,438) (49,699)
Prepaid expenses and other current assets 19,183 12,337
Trade accounts payable an accrued liabilities 90,466 (37,211)
Accrued compensation 4,740 -
Accrued taxes, other than income (1,095) 12,653
Accrued warranties 6,742 (15)
Deferred revenue 18,350 6,403
Income taxes payable (59,073) 41,006
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings 14,246 2,831
--------------------------------------
Net cash flow provided by (used in) operating activities 284,135 (13,737)
INVESTING ACTIVITIES
Purchase of property, buildings and equipment (210,738) (104,503)
Proceeds from sale of property, buildings and equipment 19,597 -
Increase in (collections on) note receivable (13,464) 13,464
Increase in other assets (30,012) (6,784)
--------------------------------------
Net cash used in investing activities (234,617) (97,823)
FINANCING ACTIVITIES
Payments on debt (252,545) (269,361)
Proceeds from debt 260,734 436,338
--------------------------------------
Net cash provided by financing activities 8,189 166,977
Increase in cash and cash equivalents 57,707 55,417
Cash and cash equivalents at beginning of period 70,937 128,644
--------------------------------------
Cash and cash equivalents at end of period $ 128,644 $ 184,061
======================================
</TABLE>
See accompanying notes
F-7
<PAGE> 11
S&W Air Conditioning, Inc.
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
-------------------------------
(Unaudited)
<S> <C> <C>
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 45,786 $ 21,919
===============================
Income taxes paid $ 126,227 $ 8,986
===============================
Purchase of equipment through capital leases $ 3,816 $ -
===============================
</TABLE>
See accompanying notes.
F-8
<PAGE> 12
S&W Air Conditioning, Inc.
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
S&W Air Conditioning, Inc. (the "Company") operates in one industry segment and
is primarily engaged in the installation and servicing of air conditioning and
heating systems for commercial and residential customers in San Angelo, Texas
and surrounding communities.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balance sheet as of June 30, 1997 and the related statements of income,
stockholders' equity and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments, necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December
31, 1996 audited financial statements appearing herein. The results of the six
months ended June 30, 1997 may not be indicative of operating results for the
full year.
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 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.
F-9
<PAGE> 13
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF INCOME (CONTINUED)
Trade accounts receivable includes billings and billed retainage on Contracts.
The Company classifies these amounts as current assets because all balances are
expected to be collected in the current year. 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, "cost and estimated earnings in excess of billings," represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings," represents
billings in excess of revenue recognized on in-progress contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents and certificates of deposit approximate fair value.
Accounts Receivable, Note Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable,
note receivable and accounts payable approximate fair value.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories.
F-10
<PAGE> 14
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost. Depreciation
and amortization are provided on the straight-line method and declining-balance
methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
--------------------
<S> <C>
Leasehold Improvements 15
Furniture and fixtures 7
Machinery and equipment 5 - 7
Vehicles 5
</TABLE>
GOODWILL
Goodwill is being amortized using the straight-line method over 15 years.
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation expenses
payable to various employees.
WARRANTIES
The Company provides the retail customer with a one year warranty on parts and
labor from the date of installation of the heating and air conditioning unit.
This warranty runs concurrent with the manufacturer's warranty on parts. The
Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
F-11
<PAGE> 15
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company uses the liability method of accounting for federal and state income
taxes as provided by SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, the deferred tax liability or asset is based on temporary
differences between the financial statement and income tax bases of assets and
liabilities, measured at tax rates that will be in effect when the differences
reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt expense
totaled $54,256 and recoveries of accounts previously written off was $13,000.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the Company
expensed $101,329.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income."
Statement No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Statement No. 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of FAS No. 130 to have a
material impact on the Company's financial statements.
F-12
<PAGE> 16
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
---------------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts $ 257,192
Estimated earnings 77,914
---------------------
335,106
Less applicable billings 346,359
---------------------
$ (11,253)
=====================
Included in the accompanying balance sheet under the following captions:
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 13,832
Billings in excess of costs and estimated earnings
on uncompleted contracts (25,085)
---------------------
$ (11,253)
=====================
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are not
indicative of the ultimate profit or loss on a contract.
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
--------------------
<S> <C>
Line of credit $ 198,086
Installment and equipment notes 182,284
--------------------
380,370
Less current portion 80,578
--------------------
$ 299,792
====================
</TABLE>
F-13
<PAGE> 17
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
3. DEBT (CONTINUED)
The Company has two lines of credit with a financial institution with a total
borrowing limit of $650,000. The lines of credit bear interest at a fixed rate
of 8.5%.
The Company has various installment and equipment loans to various lenders which
are secured by vehicles and equipment. These loans bear interest at variable
rates ranging from 8.25% to 15.12% at December 31, 1996. These loans require
monthly payments ranging from $291 to $1,199 and are due through May 23, 2000.
As of December 31, 1996, the aggregate amounts of annual principal maturities of
long-term debt are as follows:
<TABLE>
<S> <C>
1997 $ 80,578
1998 265,830
1999 29,044
2000 4,918
Thereafter -
--------------------
$ 380,370
====================
</TABLE>
F-14
<PAGE> 18
S&W Air Conditioning Inc.
Notes to Financial Statements (continued)
4. LEASES
Total rental expense for all operating leases was $37,700 for 1996. The Company
leases certain vehicles, equipment, and office and warehouse facilities under
terms of noncancelable operating and capital lease agreements which expire at
various dates through January 2000. Minimum rental commitments at December 31,
1996 under capital and operating leases having an initial noncancelable term of
one year or more are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
-------------------- --------------------
<S> <C> <C>
1997 $ 13,833 $ 36,000
1998 8,808 36,000
1999 5,032 36,000
2000 3,588 36,000
2001 - 36,000
------------------- --------------------
31,261 $ 180,000
====================
Amounts representing interest (5,764)
-------------------
Present value of net minimum rentals
(including $10,760 classified as current) $ 25,497
===================
</TABLE>
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
--------------------
<S> <C>
Machinery and equipment $ 67,867
Less accumulated amortization (26,183)
--------------------
Net equipment under capital leases $ 41,684
====================
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
F-15
<PAGE> 19
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code. Substantially all
employees of the Company are eligible to participate in the plan. Under the
plan's provisions, a plan member may make contributions, on a tax deferred
basis, not to exceed the maximum established by the Internal Revenue Service.
The Company provides matching contributions of 50% of total contributions by a
plan member, to a maximum of 6% of the employee's total calendar year
compensation. The Company's matching contributions totaled $27,987 for 1996.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the ordinary
course of 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 umbrella policies
to insure itself against any liabilities occurring in the normal course of
business. The Company believes that its insurance coverage is adequate.
7. INCOME TAXES
Income tax expense consists of the following at December 31, 1996:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
--------------------
<S> <C>
Current:
Federal $ 59,495
State 9,212
Deferred (25,476)
--------------------
$ 43,231
====================
</TABLE>
F-16
<PAGE> 20
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
7. INCOME TAXES (CONTINUED)
Significant components of the deferred tax assets and liabilities as of December
31, 1996, are as follows:
<TABLE>
<S> <C>
Deferred tax liabilities:
Depreciation $ 39,729
Deferred tax assets:
Accounts receivable 41,579
Compensation and other reserves 43,763
---------------------
Total gross deferred tax assets 85,342
Valuation allowance -
---------------------
Deferred tax assets 85,342
---------------------
Net deferred tax assets $ 45,613
=====================
</TABLE>
The provision for income taxes differs from the amounts computed by applying the
statutory federal income tax rate of 34% to income before income taxes. The
differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
---------------
<S> <C>
Tax provision at statutory rate $ 42,531
State income tax less applicable federal tax benefit 4,033
Graduated tax rates (3,756)
Other, net 423
---------------
$43,231
===============
</TABLE>
8. RELATED PARTY TRANSACTIONS
The Company leases its office facility from its two primary stockholders. Rental
payments of $36,000 related to this lease were made in the year December 31,
1996.
The Company has various receivables from owners at December 31, 1996 totaling
$31,596.
F-17
<PAGE> 21
S&W Air Conditioning, Inc.
Notes to Financial Statements (continued)
9. MAJOR CUSTOMER
Contract income from one customer accounted for approximately 15% of total
revenue for the year ended December 31, 1996. The Company is one of only three
approved contractors in the state of Texas with whom WalMart contracts for both
new installations at WalMart stores under construction and in retrofit work in
existing stores to repair, replace and upgrade plumbing, heating and
air conditioning systems.
10. SUBSEQUENT EVENT
Subsequent to year end, the Company signed a Combination Agreement with Service
Experts, Inc. to sell all of the Company's stock. In accordance with the
Combination Agreement, the Company will become a wholly-owned subsidiary of
Service Experts, Inc.
F-18
<PAGE> 22
Report of Independent Auditors
The Stockholders
J.M. Jenks Incorporated dba J.M. Mechanical Systems
We have audited the accompanying balance sheet of J.M. Jenks Incorporated dba
J.M. Mechanical Systems as of December 31, 1996, and the related statements of
income, stockholders' equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of J.M. Jenks Incorporated dba
J.M. Mechanical Systems at December 31, 1996, and the results of its operations
and its cash flows for the year ended December 31, 1996, in conformity with
generally accepted accounting principles.
/S/ ERNST & YOUNG LLP
August 1, 1997
Nashville, Tennessee
F-19
<PAGE> 23
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash $ 755 $ 969
Receivables:
Trade, net of allowance for doubtful accounts
of $9,400 at December 31, 1996
and June 30, 1997 666,030 895,144
Related party 13,975 -
38,198
------------------------------------------
680,005 933,342
Inventories 86,277 178,255
Costs and estimated earnings in excess of billings 143,790 -
Other assets 1,500 26,514
------------------------------------------
Total current assets 912,327 1,139,080
Property, buildings and equipment:
Land 30,000 -
Buildings 280,539 112,642
Furniture and fixtures 148,318 186,401
Machinery and equipment 305,026 330,515
Vehicles 270,422 319,797
------------------------------------------
1,034,305 949,355
Less accumulated depreciation and amortization (318,954) (326,171)
------------------------------------------
715,351 623,184
------------------------------------------
Total assets $ 1,627,678 $ 1,762,264
==========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $ 166,256 $ 472,567
Accrued compensation 33,097 30,491
Accrued taxes, other than income 23,971 49,772
Accrued warranties 33,617 33,617
Line of credit 300,000 170,000
Current portion of obligations under capital leases 24,627 10,220
Current maturities of long-term debt 35,854 41,385
Billings in excess of costs and estimated earnings 73,152 41,844
------------------------------------------
Total current liabilities 690,574 849,896
Long-term portion of obligations under capital leases, less
current portion 1,068 -
Long-term debt, less current portion 218,188 86,695
Commitments and contingencies (Note 5)
Stockholders' equity:
Common stock, no par value, 50,000 shares authorized, 10,000
shares issued and outstanding 1,000 1,000
Additional paid-in capital 17,621 17,621
Retained earnings 699,227 807,052
------------------------------------------
Total stockholders' equity 717,848 825,673
==========================================
Total liabilities and stockholders' equity $ 1,627,678 $ 1,762,264
==========================================
</TABLE>
See accompanying notes.
F-20
<PAGE> 24
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Statements of Income
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30
1996 1997
------------------------------------------
(Unaudited)
<S> <C> <C>
Net revenues $ 4,100,593 $ 2,436,895
Cost of goods sold 2,957,134 1,741,451
------------------------------------------
Gross margin 1,143,459 695,444
Selling, general and administrative expenses 694,317 477,466
Bad debt expense 9,400 -
------------------------------------------
Income from operations 439,742 217,978
Other income (expense):
Interest expense (36,232) (14,102)
Interest income 1,653 827
Other expenses (4,692) (265)
------------------------------------------
Net income $ 400,471 $ 204,438
==========================================
</TABLE>
See accompanying notes.
F-21
<PAGE> 25
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
NO PAR VALUE ADDITIONAL
------------------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
-------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at
January 1, 1996 10,000 $1,000 $17,621 $ 399,158 $ 417,779
Cash distributions -- -- (100,402) (100,402)
Net income -- -- 400,471 400,471
-------------------------------------------------------------------------
Balance at
December 31, 1996 10,000 1,000 17,621 699,227 717,848
Property distributions
(unaudited) -- -- (70,760) (70,760)
Cash distributions
(unaudited) -- -- (25,853) (25,853)
Net income
(unaudited) -- -- 204,438 204,438
-------------------------------------------------------------------------
Balance at June 30, 1997
(unaudited) 10,000 $1,000 $17,621 $ 807,052 $ 825,673
=========================================================================
</TABLE>
See accompanying notes.
F-22
<PAGE> 26
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 400,471 $ 204,438
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 91,587 49,746
Provision for loss on accounts receivable 9,400 --
Changes in assets and liabilities:
Receivables 81,394 (253,337)
Inventories (13,965) (91,978)
Other current assets (1,176) (25,014)
Trade acounts payable and accrued liabilities (421,304) 306,311
Accrued compensation 33,097 (2,606)
Accrued taxes, other than income 12,794 25,801
Costs and estimated earnings in excess of
billings and billings in excess of costs and
estimated earnings (23,653) 112,482
------------------------------
Net cash flow provided by operating activities 168,645 325,843
INVESTING ACTIVITIES
Purchase of property, buildings and equipment (219,007) (28,339)
------------------------------
Net cash used in investing activities (219,007) (28,339)
FINANCING ACTIVITIES
Distributions to stockholders (100,402) (25,853)
Proceeds from debt 277,346 11,700
Payments on debt and capital leases (126,112) (283,137)
------------------------------
Net cash provided by (used in) financing activities 50,832 (297,290)
Increase in cash 470 214
Cash and at beginning of period 285 755
------------------------------
Cash and at end of period $ 755 $ 969
==============================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 36,232 $ 14,102
==============================
</TABLE>
See accompanying notes.
F-23
<PAGE> 27
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
J.M. Jenks Incorporated dba J.M. Mechanical Systems (the "Company") operates in
one industry segment and is primarily engaged in the installation and servicing
of air conditioning and heating systems for commercial and residential customers
in the Northern Utah area.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balance sheet as of June 30, 1997 and the related statements of income,
stockholders' equity, and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments, necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted from the interim financial
statements. The interim financial statements should be read in conjunction with
the December 31, 1996 audited financial statements appearing herein. The
results of the six months ended June 30, 1997 may not be indicative of
operating results for the full year.
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
F-24
<PAGE> 28
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF INCOME (CONTINUED)
of the Company's residential heating and air conditioning installation, service
and maintenance are recognized upon completion of the services, which
is usually within one to two days.
Earnings and estimated costs on Contracts are reviewed throughout the terms of
the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
Contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within six to 18 months.
Trade accounts receivable includes billings and billed retainage on Contracts.
The Company classifies these amounts as current assets because all balances are
expected to be collected in the current year. 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, "cost and estimated earnings in excess of billings," represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings," represents
billings in excess of revenue recognized on in-progress contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable and
accounts payable approximate fair value.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories.
F-25
<PAGE> 29
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost. Depreciation
and amortization are provided on the straight-line method over the following
useful lives:
YEARS
----------------
Buildings 40
Furniture and fixtures 7
Machinery and equipment 10
Vehicles 5
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation expenses
payable to various employees.
WARRANTIES
The Company provides the retail customer with a one year warranty on parts and
labor from the date of installation of the heating and air conditioning unit.
This warranty runs concurrent with the manufacturer's warranty on parts. The
Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
INCOME TAXES
The stockholders of the Company have elected under Subchapter S of the Internal
Revenue Code to include their respective share of the Company's income in their
individual income for federal income tax purposes. Accordingly, the Company is
not subject to federal income taxes.
F-26
<PAGE> 30
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt expense was
$9,400.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the Company
expensed approximately $48,000.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income."
Statement No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Statement No. 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of FAS No. 130 to have a
material impact on the Company's financial statements.
F-27
<PAGE> 31
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-------------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contracts $ 913,824
Estimated earnings 202,356
-------------------
1,116,180
Less applicable billings 1,045,542
-------------------
$ 70,638
===================
Included in the accompanying balance sheet under the following captions:
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 143,790
Billings in excess of costs and estimated earnings
on uncompleted contracts 73,152
-------------------
$ 70,638
===================
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are not
indicative of the ultimate profit or loss on a contract.
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------
<S> <C>
Line of credit $300,000
Mortgage note payable 123,044
Installment and equipment notes 130,998
--------------------
554,042
Less current portion 335,854
--------------------
$218,188
====================
</TABLE>
F-28
<PAGE> 32
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
3. DEBT (CONTINUED)
The Company has a line of credit with a financial institution with a total
borrowing limit of $300,000. The line of credit bears interest at a fixed rate
of prime plus 1.5% (9.75% at December 31, 1996).
The Company has a mortgage note payable which is secured by the related office
building and land. This loan requires monthly principal and interest payments of
approximately $1,400. The loan bears interest at 8.5% through May 2008.
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 8.125% to 10.5% per annum. These loans require monthly
payments ranging from approximately $300 to $600 and are due through 2001.
As of December 31, 1996, the aggregate amounts of annual principal maturities of
long-term debt are as follows:
<TABLE>
<S> <C>
1997 $335,854
1998 40,682
1999 42,782
2000 31,790
2001 18,854
Thereafter 84,080
--------------------
$554,042
====================
</TABLE>
4. LEASES
The Company leases certain machinery and equipment under terms of capital lease
agreements which expire at various dates through January 1998. Minimum rental
commitments at December 31, 1996 under capital and operating leases having an
initial noncancelable term of one year or more, are as follows:
<TABLE>
<CAPTION>
CAPITAL
LEASES
--------------------
<S> <C>
1997 $30,699
1998 1,596
--------------------
32,295
Amounts representing interest 6,600
--------------------
Present value of net minimum rentals
(including $24,627 classified as current) $25,695
====================
</TABLE>
F-29
<PAGE> 33
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
4. LEASES (CONTINUED)
The carrying values of assets under capital leases, which are included with
owned assets in the accompanying balance sheets, are as follows:
DECEMBER 31, 1996
--------------------
Machinery and equipment $ 133,443
Less accumulated amortization (68,189)
--------------------
Net equipment under capital leases $ 65,254
====================
Amortization of the assets under capital leases is included in depreciation
expense.
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is subject to legal proceedings arising from the normal conduct 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 umbrella policies
to insure itself against any liabilities occurring in the normal course of
business. The Company believes that its insurance coverage is adequate.
6. INCOME TAXES
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
The Company operates under Subchapter S of the Internal Revenue Code and is not
subject to corporate federal income tax. In connection with the proposed
combination discussed in Note 8, the Subchapter S election will be terminated.
As a result, the Company will be subject to corporate income taxes subsequent
to the termination of S corporation status. The Company had net operating
income for income tax purposes of approximately $65,000 for 1996. Had the
Company filed federal and state income tax returns as a regular C corporation
for 1996, income tax expense under the provisions of SFAS No. 109 would have
been approximately $14,000.
F-30
<PAGE> 34
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
PRO FORMA INCOME TAX INFORMATION (UNAUDITED) (CONTINUED)
At the date of termination of S corporation status, the Company will be required
to provide deferred taxes for cumulative temporary differences between financial
reporting and tax reporting basis of assets and liabilities. Such deferred taxes
will be based on the cumulative temporary differences at the date of termination
of S corporation status. The effect of recognizing the deferred taxes will be
recorded as an adjustment to goodwill in purchase accounting. If the termination
of S corporation status had occurred at June 30, 1997, the deferred tax
liability would have been approximately $146,000.
7. RELATED PARTY TRANSACTIONS
The two major stockholders of the Company jointly own Jenks Properties, which
develops and manages a community of townhouses. During 1996, the Company
installed and serviced heating and air conditioning equipment on property owned
by Jenks Properties. The related party receivable from Jenks Properties of
$13,975 is included in the accompanying financial statements at December 31,
1996 as a receivable from related party. Total revenue during 1996 from Jenks
Properties was approximately $13,975 and has been included in net revenues in
the Statement of Income for the year ended December 31, 1996.
8. SUBSEQUENT EVENTS
COMBINATION AGREEMENT
Subsequent to year end, the Company signed a Combination Agreement with Service
Experts, Inc. to sell all of the Company's stock. In accordance with the
Combination Agreement, the Company will become a wholly-owned subsidiary of
Service Experts, Inc.
EMPLOYEE BENEFIT PLANS
Beginning on June 1, 1997, the Company began sponsoring a 401(K) plan for
substantially all employees of the Company. Under the plan's provisions, a plan
member may make contributions, on a tax deferred basis, not to exceed the
maximum established by the Internal Revenue Service. The Company provides
matching contributions of 25% of total contributions by a plan member, to a
maximum of 4% of the employee's total calendar year compensation.
F-31
<PAGE> 35
J.M. Jenks Incorporated dba J.M. Mechanical Systems
Notes to Financial Statements (continued)
8. SUBSEQUENT EVENTS (CONTINUED)
EMPLOYEE BENEFIT PLANS (CONTINUED)
On July 1, 1997, the stockholders approved an internal stock purchase plan for
key employees authorized by the Company's stockholders. On July 3, 1997, 990
shares of the Company's common stock were issued to key employees in accordance
with this agreement. The stock was issued at a fair value of $120 per share
based on a stock valuation. This agreement states that no more than 15% of the
total shares outstanding may be sold by stockholders or issued under the plan
during any one calendar year.
DISTRIBUTION TO STOCKHOLDERS
Subsequent to December 31, 1996, the Company distributed a building and
equipment with a net book value of $163,804 and the associated debt totaling
$123,044.
F-32
<PAGE> 36
Report of Independent Auditors
The Stockholders
Berkshire Air Conditioning Company
We have audited the accompanying balance sheet of Berkshire Air Conditioning
Company as of December 31, 1996, and the related statements of income,
stockholders' equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Berkshire Air Conditioning
Company at December 31, 1996, and the results of its operations and its cash
flows for the year ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
August 7, 1997
F-33
<PAGE> 37
Berkshire Air Conditioning Company
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
------------------------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 159,289 $ 136,391
Trade receivables, net of allowance for doubtful
accounts of $160,778 and $227,036 at
December 31, 1996 and June 30, 1997 598,144 651,167
Inventories 122,985 155,677
Costs and estimated earnings in excess of billings 23,376 16,609
Prepaid expenses and other current assets 15,048 1,405
------------------------------------------
Total current assets 918,842 961,249
Property, buildings and equipment:
Furniture and fixtures 139,475 148,132
Machinery and equipment 193,580 203,592
Vehicles 294,421 314,671
Buildings and improvements 568,188 568,188
------------------------------------------
1,195,664 1,234,583
Less accumulated depreciation and amortization (546,005) (589,446)
------------------------------------------
649,659 645,137
Deferred income taxess 49,641 78,549
------------------------------------------
Total assets $ 1,618,142 $ 1,684,935
==========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $ 97,859 $ 106,366
Accrued compensation 18,259 13,143
Accrued warranties 24,727 24,727
Deferred revenue 18,000 18,000
Billings in excess of costs and estimated earnings 50,362 83,195
Income taxes payable 4,546 4,546
Deferred income taxes 290,285 332,785
Current portion related party note payable
and capital lease obligation 75,829 77,773
Current portion of long-term debt 32,936 32,129
------------------------------------------
Total current liabilities 612,803 692,664
Related party note payable and capital lease obligation
net of current portion 583,262 543,877
Long-term debt, net of current portion 60,383 58,904
Stockholders' equity:
Common class A voting stock, no par value,
1,000 shares authorized, 1,000 shares issued
and outstanding 500 500
Common class B non-voting stock, no par value,
1,000 shares authorized, 1,000 shares issued
and outstanding 500 500
Retained earnings 360,694 388,490
------------------------------------------
Total stockholders' equity 361,694 389,490
------------------------------------------
Total liabilities and stockholders' equity $ 1,618,142 $ 1,684,935
==========================================
</TABLE>
See accompanying notes.
F-34
<PAGE> 38
Berkshire Air Conditioning Company
Statements of Income
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
--------------------------------
(Unaudited)
<S> <C> <C>
Net revenues $ 3,301,707 $ 1,520,559
Cost of goods sold 2,402,850 1,153,910
-----------------------------
Gross margin 898,857 366,649
Selling, general and administrative expenses 555,761 219,279
Bad debt expense 94,224 75,678
-----------------------------
Income from operations 248,272 71,692
Other income (expense):
Interest expense (63,587) (34,321)
Other income 4,624 4,017
-----------------------------
(58,963) (30,304)
-----------------------------
Income before taxes 189,909 41,388
Provision for income tax:
Current 4,546 --
Deferred 58,794 13,592
-----------------------------
Total income taxes 63,340 13,592
-----------------------------
Net income $ 126,569 $ 27,796
=============================
</TABLE>
See accompanying notes
F-35
<PAGE> 39
Berkshire Air Conditioning Company
Statement of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK COMMON CLASS A VOTING COMMON CLASS B NON-VOTING
NO PAR VALUE STOCK, NO PAR VALUE STOCK, NO PAR VALUE
------------------------------------------------------------------------ RETAINED
SHARES AMOUNT SHARES AMOUNT SHARES AMOUNT EARNINGS TOTAL
------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996 20 $ 1,000 -- $ -- -- $ -- $234,125 $235,125
Exchange common stock (20) (1,000) 1,000 500 1,000 500 -- --
Net income -- -- -- -- -- -- 126,569 126,569
------------------------------------------------------------------------------------------------
Balance at December 31, 1996 -- -- 1,000 500 1,000 500 360,694 361,694
Net income (unaudited) -- -- -- -- -- -- 27,796 27,796
------------------------------------------------------------------------------------------------
Balance at June 30, 1997
(unaudited) -- $ -- 1,000 $ 500 1,000 $ 500 $388,490 389,490
================================================================================================
</TABLE>
See accompanying notes.
F-36
<PAGE> 40
Berkshire Air Conditioning Company
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1997
--------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 126,569 $ 27,796
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 65,413 43,441
Provision for deferred income taxes 58,794 13,592
Provision for loss on accounts receivable 94,224 75,678
Gain on asset disposals 2,246 -
Changes in assets and liabilities:
Accounts Receivable (13,052) (128,701)
Inventories (4,726) (32,692)
Prepaid expenses and other current assets (6,674) 13,643
Trade accounts payable and accrued liabilities (20,825) 8,507
Accrued compensation 9,419 5,116
Accrued warranties 3,135 -
Deferred revenue 3,000 -
Income taxes payable 4,546 -
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings (135,217) 39,600
--------------------------------------
Net cash flow provided by operating activities 186,852 55,748
INVESTING ACTIVITIES
Purchase of property and equipment (130,610) (38,919)
Proceeds from sale of property and equipment 2,696 -
--------------------------------------
Net cash used in investing activities (127,914) (38,919)
FINANCING ACTIVITIES
Proceeds from related party note payable 163,763 -
Payments on related party note payable and capital lease obligation (65,359) (37,441)
Proceeds from long-term debt 93,924 -
Payments on long-term debt (185,493) (2,286)
--------------------------------------
Net cash provided by (used in) financing activities 6,835 (22,086)
Increase (decrease) in cash and cash equivalents 65,773 (22,898)
Cash and cash equivalents at beginning of period 93,516 159,289
--------------------------------------
Cash and cash equivalents at end of period $ 159,289 $ 136,391
======================================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid $ 16,255 $ 7,118
======================================
Income taxes paid $ - $ -
======================================
Purchase of building through capital lease $ 560,687 $ -
======================================
</TABLE>
See accompanying notes.
F-37
<PAGE> 41
Berkshire Air Conditioning Company
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Berkshire Air Conditioning Company (the "Company") operates in one industry
segment and is primarily engaged in the installation and servicing of air
conditioning and heating systems for commercial and residential customers in the
metropolitan Springfield, Massachusetts area.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balance sheet as of June 30, 1997 and the related statements of income,
stockholders' equity and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments, necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles have been condensed or omitted from the interim financial
statements. The interim financial statements should be read in conjunction with
the December 31, 1996 audited financial statements appearing herein. The
results of the six months ended June 30, 1997 may not be indicative of
operating results for the full year.
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 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.
F-38
<PAGE> 42
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF INCOME (CONTINUED)
At December 31, 1996, the Company had a long-term contract outstanding with a
single customer with a total contract price of $609,365. As of December 31,
1996, total costs incurred on this single contract were approximately 3% of the
total estimated costs for this contract and billings to date were approximately
5% of the total contract price.
Trade accounts receivable includes billings and billed retainage on Contracts.
Also included in trade accounts receivable are unbilled retainage amounts of
$19,850 at December 31, 1996. The Company classifies these amounts as current
assets because all balances are expected to be collected in the current year.
Except as discussed in Note 5, 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, "cost and estimated earnings in excess of billings," represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings," represents
billings in excess of revenue recognized on in-progress contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents and certificates of deposit approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable and
accounts payable approximate fair value.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
F-39
<PAGE> 43
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost. Depreciation
and amortization are provided on the straight-line method over the following
useful lives:
YEARS
--------------------
Furniture and fixtures 7
Machinery and equipment 7
Vehicles 5
Building and improvements 10
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation expenses
payable to various employees.
WARRANTIES
The Company provides its residential customers with a one year warranty on parts
and labor from the date of installation of the heating and air conditioning
unit. This warranty runs concurrent with the manufacturer's warranty on parts.
The Company also offers five and ten year warranties on residential parts. The
Company provides the commercial customer with a one year warranty on parts and
labor. The Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the
Company's practice to classify the entire warranty accrual as a current
liability.
F-40
<PAGE> 44
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for 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.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt expense
totaled $94,224.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the Company
expensed $7,602.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income."
Statement No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Statement No. 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of FAS No. 130 to have a
material impact on the Company's financial statements.
F-41
<PAGE> 45
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts $ 337,789
Estimated earnings 122,349
--------------
460,138
Less applicable billings (487,124)
--------------
$ (26,986)
==============
Included in the accompanying balance sheet under
the following captions:
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 23,376
Billings in excess of costs and estimated earnings
on uncompleted contracts (50,362)
--------------
$ (26,986)
==============
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are not
indicative of the ultimate profit or loss on a contract.
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
-----------------
<S> <C>
Officer loan $ 130,696
Installment and equipment notes 93,319
-----------------
224,015
Less current portion 72,536
-----------------
$ 151,479
=================
</TABLE>
F-42
<PAGE> 46
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
3. DEBT (CONTINUED)
The Company has an outstanding note payable to an officer of the Company with
$130,696 outstanding at December 31, 1996. The note payable requires monthly
principal payments of $3,633 plus interest at 6% per year through February 2000.
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 8.99% to 11.99%. These loans require monthly payments
ranging from $356 to $1,333 and are due through August 2000.
As of December 31, 1996, the aggregate amounts of annual principal maturities of
long-term debt are as follows:
1997 $ 72,536
1998 76,536
1999 65,114
2000 9,829
--------------------
$ 224,015
====================
The Company has an outstanding commercial guaranty on a loan from a bank to an
officer of the Company. At December 31, 1996, $406,933 was outstanding on the
loan which is secured by the building leased to the Company. The loan matures in
April 2001. The commercial guaranty requires the Company to maintain a minimum
cash flow to debt service payments ratio. The Company was in compliance with the
ratio at December 31, 1996.
F-43
<PAGE> 47
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
4. LEASES
Total rental expense for all operating leases was $35,281 for 1996. The Company
leases office and warehouse space from a stockholder of the Company under a
noncancelable capital lease which expires in February 2006. Total payments
under this lease were $75,000 in 1996. The Company leases certain equipment
under terms of noncancelable operating lease agreements which expire at various
dates through November 1999. Minimum rental commitments at December 31, 1996
under operating leases having an initial noncancelable term of one year or more
are as follows:
<TABLE>
<CAPTION>
RELATED PARTY
CAPITAL LEASE OPERATING LEASES
-------------------- ----------------
<S> <C> <C>
1997 $ 90,000 $ 7,406
1998 90,000 3,539
1999 90,000 3,244
2000 90,000 -
2001 90,000 -
Thereafter 375,000 -
-------------------- ---------------
825,000 $ 14,189
===============
Amounts representing interest (296,605)
--------------------
Present value of net minimum rentals
(including $36,229 classified as current) $ 528,395
====================
</TABLE>
The carrying value of assets under the capital lease, which is included with
owned assets in the accompanying balance sheets, is $513,963 at December 31,
1996. Amortization of the assets under the capital lease is included in
depreciation expense.
5. MAJOR CUSTOMERS
Approximately 12% of the Company's 1996 net revenue and approximately 44% of the
accounts receivable at December 31, 1996 was from one major customer.
F-44
<PAGE> 48
Berkshire Air Conditioning Company
Notes to Financial Statements (continued)
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the ordinary
course of 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 umbrella policies
to insure itself against any liabilities occurring in the normal course of
business. The Company believes that its insurance coverage is adequate.
7. AMENDMENT OF CERTIFICATE OF INCORPORATION
In January 1996, the Company amended its Certificate of Incorporation to
authorize 1,000 shares each of no par value Class A voting common stock and
Class B non-voting common stock. The stockholders exchanged all of the then
outstanding common stock for 1,000 shares of each class.
8. INCOME TAXES
Income tax expense consists of the following at December 31, 1996:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------
<S> <C>
Current:
Federal $ -
State 4,546
Deferred 58,794
====================
$ 63,340
====================
</TABLE>
F-45
<PAGE> 49
8. INCOME TAXES (CONTINUED)
Significant components of the deferred tax assets and liabilities as of December
31, 1996, are as follows:
<TABLE>
<CAPTION>
<S> <C>
Deferred tax liabilities:
Deferred revenue $ 347,640
Deferred tax assets:
Net operating loss carryforwards 30,764
Compensation and other reserves 57,355
Depreciation and amortization 18,877
---------------------
Total gross deferred tax assets 106,996
Valuation allowance -
---------------------
Deferred tax assets 106,996
=====================
Net deferred tax liabilities $ 240,644
=====================
</TABLE>
The provision for income taxes differs from the amount computed by applying
the statutory federal income tax rate of 34% to income before income taxes.
The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31, 1996
--------------------
<S> <C>
Tax provision at statutory rate $ 64,569
State income tax less applicable federal tax benefit 12,361
Effect of graduated tax rates (17,025)
Other, net 3,485
====================
$ 63,340
====================
</TABLE>
9. SUBSEQUENT EVENT
Subsequent to year end, the Company signed a Letter of Intent with Service
Experts, Inc. to sell all of the Company's stock. In accordance with the
proposed Combination Agreement, the Company would become a wholly-owned
subsidiary of Service Experts, Inc.
F-46
<PAGE> 50
Report of Independent Auditors
The Stockholders
Holmes Sales & Service, Inc.
We have audited the accompanying balance sheet of Holmes Sales & Service, Inc.
as of December 31, 1996, and the related statements of operations,
stockholders' equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining statements, on a test
basis evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Holmes Sales & Service, Inc.
at December 31, 1996, and the results of its operations and its cash flows
for the year ended December 31, 1996, in conformity with generally accepted
accounting principles.
Nashville, Tennessee
August 15,1997
F-47
<PAGE> 51
Holmes Sales & Service, Inc.
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1996 1997
-----------------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 42,063 $ 78,009
Receivables:
Trade, net of allowance for doubtful accounts
of $10,206 and $9,466 at December 31,
1996 and June 30, 1997 186,805 197,813
Employee 13,547 6,440
Related Party 4,917 3,734
Other receivables 3,851 2,188
----------------------------
209,120 210,175
Inventories 145,817 172,132
Income tax receivable 12,558 12,558
Prepaid expenses and other current assets 6,483 1,320
Deferred income taxes 15,045 10,080
----------------------------
Total current assets 431,086 484,274
Property and equipment:
Leasehold improvements 39,914 39,914
Furniture and fixtures 908 908
Machinery and equipment 277,372 314,029
Vehicles 180,176 214,371
----------------------------
498,370 569,222
Less accumulated depreciation and amortization 304,188 335,063
----------------------------
194,182 234,159
Other non current assets 10,531 11,732
Intangibles net of accumulated amortization of
$21,429 and $31,268 December 31, 1996 and
June 30, 1997 76,786 91,014
----------------------------
Total assets $712,585 $821,179
============================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities $148,259 $116,405
Accrued compensation 71,085 90,039
Accrued taxes, other than income 14,423 16,001
Accrued warranties 14,936 14,528
Deferred revenue 32,476 27,746
Current portion of long-term debt and capital
lease obligations 24,252 59,764
Current portion of long-term debt-related party 36,002 36,002
----------------------------
Total current liabilities 341,433 360,485
Long-term debt and capital lease obligations, net of
current portion 106,326 207,843
Long-term debt-related party, net of current portion 110,089 98,007
Deferred income taxes 9,844 6,341
Stockholders' equity:
Common stock, no par value, 500 share authorized,
100 shares issued and outstanding 10,000 10,000
Retained earnings 134,893 138,503
----------------------------
Total stockholders' equity 144,893 148,503
----------------------------
Total liabilities and stockholders' equity $712,585 $821,179
============================
</TABLE>
See accompanying notes.
F-48
<PAGE> 52
Holmes Sales & Service, Inc.
Statements of Operations
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
------------------------------------
(Unaudited)
<S> <C> <C>
Net revenues $3,088,460 $1,523,220
Cost of goods sold 2,209,598 1,108,115
----------------------------------
Gross margin 878,862 415,105
Selling, general and administrative expenses 862,627 397,565
Bad debt expense 4,618 626
----------------------------------
Income from operations 11,617 16,914
Other income (expense):
Interest expense (32,829) (16,142)
Interest income 3,692 1,460
Other income 9,841 2,840
----------------------------------
(19,296) (11,842)
----------------------------------
Income (loss) before taxes (7,679) 5,072
Benefit (provision) for income tax:
Current 2,918 -
Deferred (3,848) 1,462
----------------------------------
Total income taxes (930) 1,462
----------------------------------
Net income (loss) $ (6,749) $ 3,610
==================================
</TABLE>
See accompanying notes.
F-49
<PAGE> 53
Holmes Sales & Service, Inc.
Statements of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
NO PAR VALUE
------------ RETAINED
SHARES AMOUNT EARNINGS TOTAL
---------------------------------------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1996 100 $10,000 $141,642 $151,642
Net loss (6,749) (6,749)
---------------------------------------------------
Balance at December 31, 1996 100 10,000 134,893 144,893
Net income (Unaudited) 3,610 3,610
---------------------------------------------------
Balance at June 30, 1997
(unaudited) 100 $10,000 $138,503 $148,503
===================================================
</TABLE>
See accompanying notes.
F-50
<PAGE> 54
Holmes Sales & Service, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS
DECEMBER 31, ENDED JUNE 30,
1996 1997
------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net (loss) income $ (6,749) $ 3,610
Adjustments to reconcile net (loss) income to net cash
provided by operating activities:
Depreciation and amortization 83,716 46,510
(Benefit) Provision for deferred income taxes (3,848) 1,462
Provision for loss on accounts receivable 4,618 626
Gain on asset disposals 4,965 7,534
Changes in assets and liabilities:
Accounts receivable 23,803 (1,681)
Inventories (3,628) (11,364)
Income tax receivable (3,847) -
Prepaid expenses and other assets (8,583) 3,962
Trade accounts payable and accrued liabilities 2,982 (31,854)
Accrued compensation 15,021 18,954
Accrued taxes, other than income (136) 1,578
Deferred revenue 1,635 (4,730)
Accrued warranty 74 (408)
------------------------------------
Net cash flow provided by operating activities 110,023 34,199
INVESTING ACTIVITIES
Purchase of property and equipment (45,417) (47,859)
Purchase of acquired company - (12,500)
Proceeds from sale of property and equipment 2,231 -
------------------------------------
Net cash used in investing activities (43,186) (60,359)
FINANCING ACTIVITIES
Proceeds from long-term debt 174,279 90,130
Payments on long-term debt and capital lease obligations (248,158) (28,024)
------------------------------------
Net cash provided by (used in) financing activities (73,879) 62,106
(Decrease) increase in cash and cash equivalents (7,042) 35,946
Cash and cash equivalents at beginning of period 49,105 42,063
------------------------------------
Cash and cash equivalents at end of period $ 42,063 $ 78,009
====================================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 32,829 $ 16,142
====================================
Purchase of equipment through capital lease obligation $ - $ 22,841
====================================
Income taxes paid $ 13,802 $ -
====================================
ACQUISITION OF COMPANY
Fair value of assets acquired $ - $ 52,500
Cash paid $ - $ (12,500)
------------------------------------
Liabilities assumed $ - $ 40,000
====================================
</TABLE>
See accompanying notes.
F-51
<PAGE> 55
Holmes Sales & Service, Inc.
Notes to Financial Statements
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Holmes Sales & Service, Inc. (the "Company") operates in one industry segment
and is primarily engaged in the installation and servicing of air condition and
heating systems for commercial and residential customers in the metropolitan
Davenport, Iowa area.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balances sheet as of June 30, 1997 and the related statements of operations,
stockholders' equity and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments,
consisting of only normal recurring adjustments, necessary for a fair
presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December
31, 1996 audited financial statements appearing herein. The results of the six
months ended June 30, 1997 may not be indicative of operating results for the
full year.
RECOGNITION OF INCOME
Revenues on all of the Company's residential heating and air conditioning
installation, service and maintenance are recognized upon completion of the
services, which is usually within one to two days.
Rental income on leased equipment and maintenance contracts are recognized as
earned over the life of the such contracts.
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.
F-52
<PAGE> 56
Holmes Sales & Service, Inc.
Notes to Financial Statements (Continued)
December 31, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents and certificates of deposit approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable and
accounts payable approximate fair value.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original mauturity
of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories.
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line method and declining-balance
methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
--------
<S> <C>
Leasehold improvements 5 - 7
Furniture and fixtures 7
Computers 5
Machinery and equipment 5
Vehicles 5 - 7
--------
</TABLE>
F-53
<PAGE> 57
Holmes Sales & Service, Inc.
Notes to Financial Statements (Continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INTANGIBLES
Intangibles consist of a covenant not-to-compete that is being amortized on a
straight-line basis over seven years.
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation
expenses payable to various employees as of year end.
WARRANTIES
The Company provides the retail customer with a one year warranty on parts and
labor from the date of installation of the heating and air conditioning unit.
This warranty runs concurrent with the manufacturer's warranty on parts. The
Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the
Company's practice to classify the entire warranty accrual as a current
liability.
EXTENDED SERVICE AGREEMENTS
The Company provides the customer with one to five year extended service
agreements. The Company recognizes the revenue associted with these contracts
over the period of the agreement.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the amounts reported in the financial statements and accompanying
notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for 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
F-54
<PAGE> 58
Holmes Sales & Service, Inc.
Noted to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
financial statement and income tax bases of assets and liabilities, measured at
tax rates that will be in effect when the differences reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt expense
totaled $8,691 and recoveries of accounts previously written off were $4,073.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the Company
expensed $62,683.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued FAS No. 130, "Reporting Comprehensive Income."
Statement No. 130 establishes standards for reporting and displaying
comprehensive income and its components in a full set of general purpose
financial statements. Statement No. 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of FAS No. 130 to have a
material impact on the Company's financial statements.
F-55
<PAGE> 59
Holmes Sales & Service, Inc.
Notes to Financial Statements (continued)
2. DEBT
Debt consists of:
<TABLE>
<CAPTION> DECEMBER 31,
1996
------------
<S> <C>
Installment and equipment notes $ 30,807
Term note with the bank 99,771
Promissory notes with a related party 146,091
--------
276,669
Less current portion 60,254
--------
$216,415
========
</TABLE>
The Company has a unused line of credit with a financial institution with a
total borrowing limit of $50,000. The line of credit bears interest at a
variable rate of prime plus 1% (9.25% at December 31, 1996).
The Company has various installment and equipment loans to various lenders
which are secured by vehicles and equipment. These loans bear interest at
various variable rates ranging from 8.75% to 9.25% at December 31, 1996.
These loans require monthly payments ranging from $265 to $455 and are due
through July 1, 2001.
The Company has a term note with the bank which is secured by substantially all
the assets of the Company. The loan bears interest at a fixed rate of 9.25%.
This loan requires monthly payments of $2,919 that are due through
December 6, 1999.
The Company has various promissory notes with Edward Holmes, a related party.
These loans bear interest at various rates ranging from 8% to 10% at December
31, 1996. These loans require monthly payments ranging from $1,269 to $2,692
and are due through June 2003.
F-56
<PAGE> 60
Holmes Sales & Service, Inc.
Notes to Financial Statements (continued)
2. DEBT (CONTINUED)
As of December 31, 1996, the aggregate amounts of annual principal maturities
of long-term debt are as follows:
1997 $ 60,254
1998 75,909
1999 61,515
2000 42,239
2001 15,294
Thereafter 21,458
--------------
$276,669
==============
3. LEASES
The Company leases certain vehicles, equipment, and office and warehouse
facilities under terms of noncancelable operating lease agreements which expire
at various dates through October 1999. Total rental expense for operating
leases for the year ended December 31, 1996 was $60,456. Minimum rental
commitments at December 31, 1996 under operating leases having an initial
noncancelable term of one year or more are as follows:
OPERATING
LEASES
----------------
1997 $ 54,467
1998 34,828
1999 21,451
Thereafter ---
----------------
$110,746
================
4. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code. Substantially all
employees of the Company are eligible to participate in the plan. Under the
plan's provisions, a plan member may make contributions, on a tax deferred
basis, not to exceed the maximum established by the Internal Revenue Service.
The Company provides matching contributions of 100% of total contributions by a
plan member, to a maximum of 2% of the employee's total calendar year
compensation. The Company's matching contributions totaled $16,706 for 1996.
F-57
<PAGE> 61
Holmes Sales & Service, Inc.
Notes to Financial Statements (continued)
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the ordinary
course of 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 to insure itself
against any liabilities occurring in the normal course of business. The Company
believes that its insurance coverage is adequate.
6. INCOME TAXES
Income tax (benefit) consists of the following at December 31, 1996:
DECEMBER 31,
1996
------------
Current:
Federal $ 2,047
State 871
Deferred (3,848)
------------
$ (930)
============
Significant components of the deferred tax assets and liabilities as of
December 31, 1996, are as follows:
Deferred tax liabilities:
Depreciation $9,844
Deferred tax assets:
Deferred revenue 6,495
Accounts receivable 2,051
Warranty and other 6,499
------------
Total gross deferred tax assets 15,045
Valuation allowance -
------------
Net deferred tax assets $5,201
============
F-58
<PAGE> 62
Holmes Sales & Service, Inc.
Notes to Financial Statements (continued)
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before
income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
-------------
<S> <C>
Tax provision at statutory rate $ (2,611)
State income tax less applicable federal tax benefit (187)
Effect of graduated tax rates 863
Other, net 1,005
--------------
$ (930)
===============
</TABLE>
7. RELATED PARTY TRANSACTIONS
The Company has an informal agreement with Management Services Group ("MSG"), a
related party, whereby the Company pays MSG a fee for assisting with warranty
claims. During 1996, the Company paid MSG $75,000.
8. SUBSEQUENT EVENTS
On May 30, 1997, the Company acquired Lester J. Smith d/b/a Smitty's
Refrigeration Sales and Service, a heating and air conditioning service
company. The purchase price was $12,500 cash plus the assumption of a note
totaling $40,000. The purchase agreement also contains an earn out provision
for an amount not greater than $20,000 contingent upon certain performance
objectives. The results of operations for the period ended June 30, 1997
includes the results of the acquired company's operations from the date of
acquisition.
Subsequent to year end, the Company incurred additional debt and capital lease
obligations totaling $113,130 for certain equipment. The obligations bear
interest at 8.5% to 1.5% over prime and require monthly payments ranging from
$206 to $1,346 and are due through May 23, 2002.
Subsequent to year end, the Company signed a Combination Agreement with Service
Experts, Inc. to sell all of the Company's stock. In accordance with the
Combination Agreement, the Company will become a wholly-owned subsidiary of
Service Experts, Inc.
F-59
<PAGE> 63
Report of Independent Auditors
The Stockholders
Mid Fla Heating and Air, Inc.
We have audited the accompanying balance sheet of Mid Fla Heating and Air, Inc.
as of December 31, 1996, and the related statements of income, stockholders'
equity, and cash flows for the year 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 audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Mid Fla Heating and Air, Inc.
at December 31, 1996, and the results of its operations and its cash flows for
the year ended December 31, 1996, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
July 11, 1997
F-60
<PAGE> 64
Mid Fla Heating and Air, Inc.
Balance Sheet
<TABLE>
<CAPTION>
December 31, June 30,
1996 1997
--------------------- ---------------------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 42,994 $ 123,215
Receivables:
Trade, net of allowance for doubtful accounts of $14,335 89,828 232,409
and $17,493 at December 31, 1996 and June 30, 1997
Employee 433 2,562
--------------------- ---------------------
90,261 234,971
Inventories 86,769 86,769
Deferred income taxes 25,136 16,540
--------------------- ---------------------
Total current assets 245,160 461,495
Property, buildings and equipment:
Land 17,539 17,539
Buildings 71,880 71,105
Furniture and fixtures 87,708 103,170
Machinery and equipment 95,779 113,098
Vehicles 200,266 200,266
--------------------- ---------------------
473,172 505,178
Less accumulated depreciation and amortization (225,888) (247,910)
--------------------- ---------------------
247,284 257,268
--------------------- ---------------------
Other assets:
Customer list, net of accumulated amortization of $133 3,867 3,734
and $266 at December 31, 1996 and June 30, 1997 --------------------- ---------------------
Total assets $ 496,311 $ 722,497
===================== =====================
LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities:
Line of credit $ 53,998 $ 63,998
Trade accounts payable and accrued liabilities 156,398 242,242
Accrued compensation 21,864 26,756
Accrued taxes, other than income 847 1,331
Accrued warranties 20,715 30,974
Income taxes payable 5,817 29,033
Deferred revenue 53,952 73,778
Current portion of long-term debt 21,249 19,871
--------------------- ---------------------
Total current liabilities 334,840 487,983
Long-term debt, net of current portion 139,793 130,727
Deferred income taxes 23,471 21,351
Stockholders' equity:
Common stock, $1 par value, 500 shares authorized,
issued and outstanding 500 500
Additional paid-in-capital 872 872
Retained earnings--deficit (3,165) 81,064
--------------------- ---------------------
Total stockholders' equity (1,793) 82,436
--------------------- ---------------------
Total liabilities and stockholders' equity $ 496,311 $ 722,497
===================== =====================
</TABLE>
See accompanying notes.
F-61
<PAGE> 65
Mid Fla Heating and Air, Inc.
Statements of Income
<TABLE>
<CAPTION>
Year Ended Six Months
December 31, ended June 30,
1996 1997
--------------------- ---------------------
(UNAUDITED)
<S> <C> <C>
Net revenues $ 2,923,707 $ 1,782,096
Cost of goods sold 2,049,592 1,178,973
--------------------- ---------------------
Gross margin 874,115 603,123
Selling, general and administrative expenses 845,141 480,832
Bad debt expense 4,565 4,396
--------------------- ---------------------
Income from operations 24,409 Other income (expense): 24,409 117,895
Interest expense (16,748) (11,002)
Interest income 2,048 95
Other income 2,340 6,933
--------------------- ---------------------
(12,360) (3,974)
--------------------- ---------------------
Income before taxes 12,049 113,921
Provision (benefit) for income tax:
Current 4,868 23,216
Deferred (3,080) 6,476
--------------------- ---------------------
Total income taxes 1,788 29,692
--------------------- ---------------------
Net income $ 10,261 $ 84,229
===================== =====================
</TABLE>
See accompanying notes.
F-62
<PAGE> 66
Mid Fla Heating and Air, Inc.
Statement of Stockholders' Equity
<TABLE>
<CAPTION>
COMMON STOCK
NO PAR VALUE ADDITIONAL RETAINED
---------------------------- PAID-IN EARNINGS--
SHARES AMOUNT CAPITAL DEFICIT TOTAL
-----------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996 500 $500 $ 6,638 $(13,426) $ (6,288)
Distribution to stockholders - - (5,766) - (5,766)
Net income - - - 10,261 10,261
-----------------------------------------------------------------------
Balance at December 31, 1996 500 $500 872 (3,165) (1,793)
Net income (unaudited) - - - 84,229 84,229
-----------------------------------------------------------------------
Balance at June 30, 1997 500 $500 $ 872 $ 81,064 $ 82,436
(unaudited) =======================================================================
</TABLE>
See accompanying notes.
F-63
<PAGE> 67
MID FLA HEATING AND AIR, INC.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1996 JUNE 30, 1997
----------------- ----------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 10,261 $ 84,229
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 51,929 22,155
(Benefit) provision for deferred income taxes (3,080) 6,476
Provision for loss on accounts receivable 4,565 4,396
Changes in assets and liabilities:
Receivable 57,677 (149,106)
Inventories (34,469) -
Prepaid expenses and current assets 8,428 -
Trade accounts payable an accrued liabilities (78,031) 85,845
Accrued compensation 6,090 4,892
Accrued taxes other than income 400 484
Accrued warranties 9,762 10,259
Deferred revenue 11,893 19,826
Income taxes payable 2,684 23,215
----------------- ----------------
Net cash flow provided by operating activities 48,109 112,671
INVESTING ACTIVITIES
Purchase of property, buildings and equipment (23,626) (32,006)
Proceeds from sale of properties, building and equipment 22,000 -
Payment of cash for acquired company (20,000) -
------------------ -----------------
Net cash used in investing activities (21,626) (32,006)
FINANCING ACTIVITIES
Proceeds from short-term debt - 10,000
Payments on short-term debt (13,789) -
Payments on long-term debt (21,921) (10,444)
Distribution to stockholders (5,766) -
------------------ -----------------
Net cash used in financing activities (41,476) (444)
(Decrease) increase in cash and cash equivalents (14,993) 80,221
Cash and cash equivalents at beginning of period 57,987 42,994
----------------- ------------------
Cash and cash equivalents at end of period $ 42,994 $123,215
================= ==================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest Paid $ 16,748 $ 11,002
================= ==================
Income tax paid $ - $ -
================= ==================
</TABLE>
See accompanying notes.
F-64
<PAGE> 68
Mid Fla Heating and Air, Inc.
Notes to Financial Statements
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Mid Fla Heating and Air, Inc. (the "Company") operates in one industry segment
and is primarily engaged in the installation and servicing of air conditioning
and heating systems for commercial and residential customers in the metropolitan
Gainesville, Florida area.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balance sheet as of June 30, 1997 and the related statements of income,
stockholders' equity and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments, necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting
principles, have been condensed or omitted from the interim financial
statements. The interim financial statements should be read in conjunction with
the December 31, 1996 audited financial statements appearing herein. The
results of the six months ended June 30, 1997 may not be indicative of
operating results for the full year.
RECOGNITION OF INCOME
Revenues on all of the Company's residential heating and air conditioning
installation, service and maintenance are recognized upon completion of the
services, which is usually within one to two days.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheet for cash approximate fair
value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable and
accounts payable approximate fair value.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original maturity of
three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories.
F-65
<PAGE> 69
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost. Depreciation
and amortization are provided on the straight-line method over the following
useful lives:
<TABLE>
<CAPTION>
YEARS
---------
<S> <C>
Buildings 31 - 39
Furniture and fixtures 5 - 7
Machinery and equipment 3 - 7
Vehicles 5
</TABLE>
CUSTOMER LIST
Customer list is amortized using the straight-line method over 5 years.
ACCRUED COMPENSATION
Accrued compensation consists of salary, commission and vacation expenses
payable to various employees.
WARRANTIES
The Company provides the retail customer with a one to two year warranty on
labor from the date of installation of the heating and air conditioning unit.
This warranty runs concurrent with the manufacturer's warranty on parts. The
Company provides an accrual for future warranty costs based upon the
relationship of prior years' sales to actual warranty costs. It is the Company's
practice to classify the entire warranty accrual as a current liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates.
F-66
<PAGE> 70
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
The Company uses the liability method of accounting for federal and state income
taxes as provided by Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes." Under the liability method, the deferred tax
liability or asset is based on temporary differences between the financial
statement and income tax bases of assets and liabilities, measured at tax rates
that will be in effect when the differences reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1996, amounts charged to bad debt expense
totaled $4,585 and recoveries of accounts previously written off was $20.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, the Company
expensed $142,515.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement of Financial Accounting Standards (FAS)
No. 130, "Reporting Comprehensive Income." FAS No. 130 establishes standards
for reporting and displaying comprehensive income and its components in a full
set of general purpose financial statements. Statement 130 is effective for
interim and annual periods beginning after December 15, 1997. Comprehensive
income encompasses all changes in shareholders' equity (except those arising
from transactions from owners) and includes net income, net unrealized capital
gains or losses on available for sale securities and foreign currency
translation adjustments. Management of the Company does not expect the adoption
of FAS No. 130 to have a material impact on the Company's financial statements.
F-67
<PAGE> 71
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
2. ACQUISITION
Effective October 31, 1996, the Company acquired certain tangible and intangible
personal property of a residential and commercial air conditioning facility
located in Ocala, Florida for a total purchase price of $75,000. This
transaction was accounted for using the purchase method. The results of
operations of the facility have been included in the accompanying statement of
income since the date of acquisition.
3. LINE OF CREDIT
The Company has a line of credit with a maximum principal borrowing of $150,000
and bearing interest at prime plus 2%, (10.25% at December 31, 1996). Interest
is payable monthly and the note is due on demand. The Company had outstanding
principal borrowings of $53,998 at December 31, 1996 under this line. The note
is secured by all inventory, accounts receivable, and equipment.
4. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
----------------------
<S> <C>
Note payable bearing interest at 10%, payable in equal installments
of $570, principal and interest, through November 2001 $ 52,880
Note payable bearing interest at 10%, payable in equal installments
of principal and interest of $931 plus balloon payment due
January 2002 82,157
Other notes payable - vehicles 25,965
----------------------
161,042
Less current portion 21,249
======================
Long-term debt $ 139,793
======================
</TABLE>
The note payables are secured by substantially all of the Company's assets.
F-68
<PAGE> 72
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
4. LONG-TERM DEBT (CONTINUED)
As of December 31, 1996, the aggregate amounts of annual principal maturities of
long-term debt are as follows:
<TABLE>
<S> <C>
Year ending December 31:
1997 $ 21,249
1998 14,104
1999 5,693
2000 6,254
2001 6,945
Thereafter 106,797
-------------
$ 161,042
=============
</TABLE>
5. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the ordinary
course of 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 umbrella policies
to insure itself against any liabilities occurring in the normal course of
business. The Company believes that its insurance coverage is adequate.
6. INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
1996
------------
<S> <C>
Current:
Federal $ 3,507
State 1,361
Deferred (3,080)
------------
$ (1,788)
============
</TABLE>
F-69
<PAGE> 73
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
6. INCOME TAXES (CONTINUED)
Significant components of the deferred tax assets and liabilities as of December
31, 1996, are as follows:
<TABLE>
<S> <C>
Deferred tax liabilities:
Depreciation and amortization $ 23,471
Deferred tax assets:
Accounts receivable 5,394
Compensation and warranty reserves 19,742
Capital loss carryforward 24,776
-----------
Total gross deferred tax assets 49,912
Valuation allowance (24,776)
-----------
Deferred tax assets 25,136
===========
Net deferred tax assets $ 1,665
===========
</TABLE>
There was no change in the valuation allowance during 1996.
The provision for income taxes differs from the amounts computed by
applying the statutory federal income tax rate of 34% to income before
income taxes. The differences are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1996
-------------
<S> <C>
Tax provision at statutory rate $ (4,097)
State income tax less applicable federal tax benefit 601
Effect of graduated tax rates (4,841)
Other, net 1,931
--------------
$ 1,788
===============
</TABLE>
7. RELATED PARTY TRANSACTIONS
The Company rents office and warehouse facilities at its location in Ocala,
Florida from the stockholders under a verbal month-to-month operating lease
agreement. The Company paid rental fees of approximately $1,500 during 1996 for
this location.
F-70
<PAGE> 74
Mid Fla Heating and Air, Inc.
Notes to Financial Statements (continued)
8. SUBSEQUENT EVENT
Subsequent to year end, the Company signed a Combination Agreement with Service
Experts, Inc. to sell all of the Company's stock. In accordance with the
Combination Agreement, the Company will become a wholly-owned subsidiary of
Service Experts, Inc.
F-71
<PAGE> 75
PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
Service Experts Inc. (the "Company") was incorporated on March 27,
1996. On August 21, 1996, and simultaneous with the closing of its initial
public offering of Common Stock, the Company acquired the Predecessor Companies
(as defined below). In accordance with the provisions of Securities and
Exchange Commission (the "Commission") Staff Accounting Bulletin No. 97, the
historical financial statements of the Company for periods prior to August 21,
1996 are the combined financial statements of AC Service & Installation Co.,
Inc. and Donelson Air Conditioning Company, Inc. (collectively, the "Acquiring
Company"). Such historical financial statements have been restated for the
Pooled Companies (as defined below), which were acquired in December 1996 and
May 1997 in business combinations accounted for as poolings of interests. The
operations of the Company's subsidiaries other than the Pooled Companies have
been included in the Company's financial statements from their respective
effective dates of acquisition. The acquisitions of the Predecessor Companies
have been accounted for using the historical cost basis of the Predecessor
Companies in accordance with Commission Staff Accounting Bulletin No. 48. The
Predecessor Companies are the Acquiring Company; Hardwick Air Masters, Inc.
d/b/a Airmasters, Inc.; Norrell Heating and Air Conditioning Company, Inc.;
Vision Holding Company, Inc.; Comerford's Heating and Air Conditioning, Inc.;
Rolf Coal and Fuel Corp.; Brand Heating and Air Conditioning, Inc.; Coastal Air
Conditioning Service, Inc.; Contractor Success Group, Inc.; and Service Experts
of Palm Springs, Inc. The Pooled Companies are Custom Air Conditioning, Inc.,
Freschi Air Systems, Inc. and C. Iapaluccio Company, Inc.
The following unaudited pro forma combined financial statements give
effect to the acquisition by the Company of 30 Acquired Companies (as defined
below) and to four HVAC businesses with which the Company has entered into
agreements in principle (the "Pending Acquisitions") in exchange for shares of
the Company's Common Stock, cash, warrants to purchase shares of Common Stock
and the assumption of certain debt. The pro forma combined financial
statements do not give effect to the acquisition of 12 HVAC businesses with
which the Company has entered into agreements in principle which had aggregate
residential service and replacement revenue in 1996 of approximately $27.8
million and an estimated aggregate purchase price of $23.0 million.
The unaudited pro forma combined balance sheet as of June 30, 1997
gives effect to the acquisition of four Acquired Companies closed subsequent to
June 30, 1997 and the four Pending Acquisitions. The four Acquired Companies
which were closed subsequent to June 30, 1997 are Artic Aire of Chico, Inc.,
All American Air Conditioning & Heating, Inc., A-1 Air Conditioning, Inc. and
Mid Fla Heating and Air, Inc. The four Pending Acquisitions are S&W Air
Conditioning, Inc., J.M. Jenks Incorporated dba J.M. Mechanical Systems,
Berkshire Air Conditioning Company, and Holmes Sales & Service, Inc. The
unaudited pro forma combined statement of income for the six months ended June
30, 1997 gives effect to the acquisition of 15 Acquired Companies closed during
the six month period ended June 30, 1997, four Acquired Companies which were
closed subsequent to June 30, 1997 and four Pending Acquisitions as if such
transactions had occurred as of January 1, 1996. The 15 Acquired Companies
closed during the six month period ended June 30, 1997 are Dial One Raymond's
Plumbing, Heating & Cooling, Inc., Gaddis Co., Automated Air, Inc., Bauer
Heating & Air Conditioning, Incorporated, Sylvester's Corp., B. W. Heating &
Air Conditioning, Inc., Parker Heating & Air Conditioning, Incorporated,
Roland J. Down, Inc., Claire's Air Conditioning and Refrigeration, Inc., Claire
& Sanders, Inc., Royden Inc., Service Experts of Raleigh, Inc., Stark Services
Company, Inc., ProAir Services, L.P. and Superior Air Conditioning Co., Inc.
The unaudited pro forma combined statement of income for the 12 months ended
December 31, 1996 gives effect to the acquisition of the Predecessor Companies
as described above, 11 Acquired Companies closed during 1996, 15 Acquired
Companies closed during the six month period ended June 30, 1997, four Acquired
Companies closed subsequent to June 30, 1997 and four Pending Acquisitions as
if such transactions had occurred on January 1, 1996. The 11 Acquired
Companies closed during 1996 are Service Experts of Indianapolis, Inc., Frees
Service Experts, Inc., Comfortech, Inc., Sunbeam Service Experts, Inc., Falso
Service Experts, Inc., Gordon's Specialty Company, Pardee Refrigeration Company
Incorporated, Sanders Indoor Comfort, Inc., Island Air Conditioning, Inc.,
Air-Conditioning and Heating Unlimited, Inc. and B&B Air Conditioning, Inc.
The unaudited pro forma combined financial statements have been
prepared by the Company based on the historical financial statements of the
Company and the companies referred to above and certain preliminary estimates
and assumptions deemed appropriate by management of the Company. These pro
forma combined financial statements may not be indicative of results that
would have been achieved had these acquisitions occurred on the dates indicated
or of results which may be realized in the future. Neither expected benefits
nor cost reductions anticipated by the Company following consummation of
these acquisitions have been reflected in the pro forma combined financial
statements.
The pro forma combined financial statements should be read in
conjuction with the historical financial statements of the Company.
F-72
<PAGE> 76
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
JUNE 30, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITIONS ADJUSTMENTS PRO FORMA
--------- --------- ------------ ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 18,795 $ 90 $ 522 $(16,119)(a) $ 142
(3,146)(b)
Receivables
Trade receivables, net................................... 20,815 685 2,668 24,168
Related party............................................ 38 54 74 166
Employee................................................. 268 12 28 308
Other ................................................... 1,749 -- 33 1,782
--------- ------ ------ -------- --------
22,870 751 2,803 26,424
Inventories................................................ 7,413 699 809 8,921
Cost and estimated earnings in excess of billings.......... 723 30 124 877
Prepaid expenses and other current assets.................. 1,797 63 42 1,902
Current portion of notes receivable - related parties...... 14 -- -- 14
Current portion of notes receivable........................ 260 -- -- 260
Deferred income taxes...................................... 2,461 5 107 2,573
--------- ------ ------ -------- --------
Total current assets............................... 54,333 1,638 4,407 (19,265) 41,113
Property, buildings and equipment, net..................... 13,504 344 2,239 16,087
Notes receivable - related parties......................... 330 23 -- 353
Notes receivable - other................................... 509 -- -- 509
Investment in affiliate.................................... 573 -- -- 573
Deferred income taxes...................................... -- -- 79 79
Goodwill................................................... 68,981 -- 14 14,123(a) 83,118
Unallocated purchase price................................. -- -- -- --
Other assets............................................... 785 40 148 973
--------- ------ ------ -------- --------
Total assets $ 139,015 $2,045 $6,887 $ (5,142) $142,805
========= ====== ====== ======== ========
Current liabilities:
Short-term debt.......................................... $ 27 $ -- $ 234 $ (261)(b) $ --
Trade accounts payable and accrued liabilities........... 9,939 462 1,457 11,858
Cash consideration payable............................... -- -- -- --
Accrued compensation..................................... 4,586 68 213 4,867
Accrued warranties....................................... 1,646 52 125 1,823
Income taxes payable..................................... 1,295 120 99 1,514
Deferred revenue......................................... 6,849 46 148 7,043
Billings in excess of costs and estimated earnings....... 1,100 37 246 1,383
Current portion of long-term debt and capital lease
obligations............................................ 460 50 658 (1,168)(b) --
--------- ------ ------ -------- --------
Total current liabilities.......................... 25,902 835 3,180 (1,429) 28,488
Long-term debt and capital lease obligations,
net of current......................................... 252 146 677 (1,075)(b) --
Related parties notes...................................... -- -- 642 (642)(b) --
Deferred income taxes...................................... 583 12 400 995
Common stock............................................... 142 -- -- 4 (a) 146
Additional paid-in-capital................................. 101,658 -- -- 1,040 (a) 102,698
Retained earnings.......................................... 10,478 1,052 1,988 (3,040)(a) 10,478
--------- ------ ------ -------- --------
$ 139,015 $2,045 $6,887 $ (5,142) $142,805
========= ======= ====== ======== ========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-73
<PAGE> 77
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE SIX MONTHS ENDED JUNE 30, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITIONS ADJUSTMENTS PRO FORMA
--------- --------- ------------ ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net revenues.............................................. $86,235 11,761 8,488 -- 106,484
Cost of goods sold........................................ 54,606 7,890 6,401 4 (c) 68,901
------- ----- ------ ----- --------
Gross margin.............................................. 31,629 3,871 2,087 (4) 37,583
Selling, general and administrative expenses.............. 22,310 4,047 1,596 (621)(d) 27,332
------- ----- ------ ----- --------
Income from operations.................................... 9,319 (176) 491 617 10,251
Other income (expense):
Interest expense....................................... (109) (111) (86) 306 (e) --
Interest income........................................ 441 26 2 -- 469
Other income (expense)................................. 190 (132) 11 -- 69
------- ----- ------ ----- --------
522 (217) (73) 306 538
------- ----- ------ ----- --------
Income (loss) before tax................................. 9,841 (393) 418 927 10,789
Provision for income taxes............................... 3,755 20 71 288 (g) 4,134
------- ----- ------ ----- --------
Net income (loss) $ 6,086 (413) 347 635 6,655
======= ===== ====== ===== ========
Pro forma net income per share........................... $ 0.46 $ 0.45
Pro forma weighted average shares outstanding............ 13,237 1,450 (h) 14,687
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-74
<PAGE> 78
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1996
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
--------- --------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net revenues.............................................. $49,446 143,386 15,550 -- 208,382
Cost of goods sold........................................ 32,004 94,253 11,490 (124)(c) 137,623
------ ------- ------ ------ -------
Gross margin.............................................. 17,442 49,133 4,060 124 70,759
Selling, general and administrative expenses.............. 13,504 42,669 3,222 (6,413)(d) 52,982
------ ------- ------ ------ -------
Income from operations.................................... 3,938 6,464 838 6,537 17,777
Other income (expense):
Interest expense....................................... (66) (512) (179) 757 (e) --
Interest income........................................ 336 289 6 -- 631
Other income (expense)................................. 189 (170) 29 40 (f) 88
------ ------- ------ ------ -------
459 (393) (144) 797 719
------ ------- ------ ------ -------
Income before tax........................................ 4,397 6,071 694 7,334 18,496
Provision for income taxes............................... 1,204 657 105 5,617 (g) 7,583
------ ------- ------ ------ -------
Net income 3,193 5,414 589 1,717 10,913
====== ======= ====== ====== =======
Pro forma net income per share........................... $ 0.70 $ 0.75
Pro forma weighted average shares outstanding............ 4,544 10,035 (i) 14,579
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-75
<PAGE> 79
SERVICE EXPERTS, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS
PRO FORMA BALANCE SHEET ADJUSTMENTS
(a) Reflects the payments to owners of four Acquired Companies and four
Pending Acquisitions of $16,119,000 in cash and 417,000 shares of common
stock resulting in an increase in Goodwill of $14,123,000 which
is amortized over 40 years. The allocation of the purchase price
associated with the acquisitions has been determined by the Company
based on available information and is subject to further refinement.
(b) Reflects the assumed payment of all outstanding debt.
<TABLE>
<CAPTION> TWELVE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31, JUNE 30,
1996 1997
------------ ----------
(IN THOUSANDS)
<S> <C> <C>
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS
(c) REFLECTS THE FOLLOWING ADJUSTMENTS TO COST OF GOODS SOLD:
(i) Adjust rent expense per new leases............................................... $ (105) $ --
(ii) (Elimination) additional real estate depreciation................................ (19) 4
--------- -------
$ (124) $ 4
========= =======
(d) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation................................... $(13,062) $(1,028)
(ii) Additional compensation relating to new agreements with previous
owners........................................................................... 4,192 432
(iii) Additional lease expense on real estate sold by AC Service &
Installation Co., Inc. and Vision Holding Company, Inc........................... 53 --
(iv) Elimination of depreciation expense on real estate sold by AC Service
& Installation Co., inc. and Vision Holding Company, Inc......................... (24) --
(v) Elimination of non-competition fees resulting from buyout of non-
compensation agreements.......................................................... (43) --
(vi) Corporate office overhead expenses............................................... 270 --
(vii) Corporate office compensation.................................................... 366 --
(viii) Elimination of management fees paid by Air Experts, a United Services
Co., Inc. and Service Experts of Palm Springs, Inc. to parent companies
or affiliates which are part of the corporate office adjustments................. (36) --
(ix) Goodwill amortization............................................................ 2,292 322
(x) Elimination of general and administrative expenses............................... (1,121) (347)
(xi) Three regional vice presidents and one MIS director.............................. 700 --
-------- -----
$ (6,413) $ (621)
======== =======
(e) REFLECTS THE FOLLOWING ADJUSTMENTS TO INTEREST EXPENSE RELATED TO:
(i) Elimination of debt distributed to shareholder of Vision Holding
Company, Inc..................................................................... $ 45 $ --
(ii) Elimination of interest on debt distributed to shares of AC
Service & Installation Co., Inc. and Custom Air Conditioning, Inc................ 15 --
(iii) Elimination of all other debt assumed in the transaction to be paid at
closing.......................................................................... 1,301 306
(iv) Additional interest on debt incurred associated with the transaction............. (604) --
-------- ------
$ 757 $ 306
======== ======
</TABLE>
F-76
<PAGE> 80
<TABLE>
<CAPTION>
TWELVE MONTHS SIX MONTHS
ENDED ENDED
DECEMBER 31, JUNE 30,
1996 1997
------------ ----------
(IN THOUSANDS)
<S> <C> <C>
(f) REFLECTS THE FOLLOWING ADJUSTMENT TO OTHER INCOME:
(i) The addition of income from its 37% investment in Future University.. $ 40 $ --
====== =====
(g) REFLECTS THE FOLLOWING ADJUSTMENTS TO INCOME TAXES:
(i) Additional income tax provision for state and federal taxes at a
combined effective rate of 38% as certain Acquired Companies and the
Pending Acquisition previously which were taxed as Subchapter S
corporations......................................................... $2,335 $ 157
(ii) Additional income taxes on adjustments (c) thru (f).................. 2,506 87
(iii) Additional income tax provision for state and federal taxes due to the
non-deductibility of goodwill......................................... 776 44
------ -----
$5,617 $ 288
====== =====
(h) Reflects adjustments to weighted average shares outstanding as follows:
(i) 363,000 shares and the dilutive effect of warrants issued to the
owners of the Acquired Companies, (ii) 306,000 shares issued to the
owners of one Pending Acquisition, (iii) 781,000 additional shares to
reflect the shares issued in the Secondary Offering as outstanding for the
entire period.
(i) Reflects adjustments to weighted average shares outstanding as follows:
(i) 1,217,000 shares and the dilutive effect of warrants issued to the
owners of the Acquired Companies, (ii) 306,000 shares issued to the
owners of one Pending Acquisition, (iii) 1,850,000 shares issued in
the Secondary Offering, (iv) 6,662,000 additional shares to reflect the
shares issued in the Initial Public Offering to the Predecessor Companies
and shares issued to the 11 Acquired Companies closed in 1996 as
outstanding for the entire period.
</TABLE>
F-77
<PAGE> 81
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C>
23 Consent of Ernst & Young LLP
</TABLE>
<PAGE> 1
Exhibit 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Post-Effective Amendment No.
6 to the Registration Statement (Form S-4 No. 333-12319) and related Prospectus
of Service Experts, Inc. related to $50,000,000 aggregate amount of shares of
its $.01 par value common stock, warrants to purchase its common stock ("Common
Stock Warrants") and the shares of its common stock issued thereunder upon the
exercise of such Common Stock Warrants or debt securities ("Debt Securities"),
and the shares of common stock issued thereunder upon the conversion thereof;
and in the Registration Statement (Form S-8 No. 333-11791) pertaining to the
Service Experts, Inc. 1996 Incentive Stock Plan, Service Experts, Inc. 1996
Non-Employee Director Stock Option Plan and Service Experts, Inc. 1996 Employee
Stock Purchase Plan, of our report dated August 8, 1997, with respect to the
financial statements of S&W Air Conditioning, Inc., of our report dated August
1, 1997 with respect to the financial statements of J.M. Jenks Incorporated
dba J.M. Mechanical Systems, of our report dated August 7, 1997 with respect
to the financial statements of Berkshire Air Conditioning Company, of our
report dated August 15, 1997 with respect to the financial statements of Holmes
Sales & Service, Inc. and of our report dated July 11, 1997 with respect to the
financial statements of Mid Fla Heating and Air, Inc. included in this Current
Report on Form 8-K dated September 4, 1997, filed with the Securities and
Exchange Commission.
/s/ Ernst & Young LLP
Nashville, Tennessee
September 3, 1997
