<PAGE> 1
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON JULY 11, 1997
REGISTRATION NO. 333-12319
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------------
POST-EFFECTIVE AMENDMENT NO. 5
TO
FORM S-4
REGISTRATION STATEMENT UNDER
THE SECURITIES ACT OF 1933
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SERVICE EXPERTS, INC.
(Exact Name of Registrant as Specified in Its Charter)
<TABLE>
<S> <C> <C>
DELAWARE 7623 62-1639453
(State or Other Jurisdiction of (Primary Standard Industrial (I.R.S. Employer
Incorporation or Organization) Classification Code Number) Identification Number)
</TABLE>
111 WESTWOOD PLACE, SUITE 420
BRENTWOOD, TENNESSEE 37027
(615) 371-9990
(Address, Including Zip Code, and Telephone Number, Including Area Code, of
Registrant's Principal Executive Offices)
ALAN R. SIELBECK
CHAIRMAN OF THE BOARD
AND CHIEF EXECUTIVE OFFICER
SERVICE EXPERTS, INC.
111 WESTWOOD PLACE, SUITE 420
BRENTWOOD, TENNESSEE 37027
(615) 371-9990
(Name, Address, Including Zip Code, and Telephone Number, Including Area Code,
of Agent for Service)
---------------------
COPY TO:
J. CHASE COLE, ESQ.
WALLER LANSDEN DORTCH & DAVIS,
A PROFESSIONAL LIMITED LIABILITY COMPANY
2100 NASHVILLE CITY CENTER
511 UNION STREET
NASHVILLE, TENNESSEE 37219
(615) 244-6380
APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO PUBLIC: From time to
time after the effective date of this Registration Statement.
---------------------
If the securities being registered on this form are being offered in
connection with the formation of a holding company and there is compliance with
General Instruction G, check the following box. [ ]
---------------------
THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY
DETERMINE.
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<PAGE> 2
PROSPECTUS
$50,000,000
[SERVICE EXPERTS LOGO]
COMMON STOCK, COMMON STOCK WARRANTS AND DEBT SECURITIES
---------------------
This Prospectus relates to the offer by Service Experts, Inc., a Delaware
corporation (the "Company"), of shares of the Company's Common Stock, $.01 par
value per share ("Common Stock"), warrants to purchase Common Stock ("Common
Stock Warrants") and the shares of 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,
with a collective aggregate offering price of up to $50,000,000 on terms to be
determined at the time of any such offering. The Company may offer Common Stock,
Common Stock Warrants or Debt Securities (collectively, "Securities") from time
to time in connection with the acquisitions of the assets or stock of heating,
ventilating and air conditioning ("HVAC") service and replacement businesses.
The consideration for the acquisition of the assets or stock of such entities
may consist of cash, the assumption of liabilities, Securities, or any
combination thereof, as determined pursuant to arms-length negotiations between
the Company and the sellers of the assets or stock to be acquired.
Common Stock issued pursuant to this Prospectus and any applicable
supplement to this Prospectus (a "Prospectus Supplement") or post-effective
amendment (a "Post-Effective Amendment") to acquire the assets or stock of
individual HVAC service and replacement businesses, as described above, may be
reoffered pursuant hereto by the holders thereof (the "Selling Stockholders")
from time to time in transactions on the open market, in negotiated
transactions, through the writing of options on Securities, or a combination of
such methods of sale, at fixed prices which may be changed, at market prices
prevailing at the time of sale, at prices relating to the prevailing market
prices, or negotiated prices. The Selling Stockholders may effect such
transactions by selling the Common Stock to or through broker-dealers, and such
broker-dealers may receive compensation in the form of discounts, concessions or
commissions from the Selling Stockholders or the purchasers of shares from whom
such broker-dealer may act as agent or to whom they may sell as principal or
both. See "Selling Stockholders."
The Company will not receive any part of the proceeds from the resale by
the Selling Stockholders of any Common Stock thereof pursuant hereto. The
Company will bear all expenses (other than selling discounts and commissions and
fees and expenses of the Selling Stockholders) in connection with the
registration of the Common Stock being reoffered by the Selling Stockholders.
The terms for the issuance of Securities may include provisions for the
indemnification of the Selling Stockholders for certain civil liabilities,
including liabilities under the Securities Act of 1933, as amended (the
"Securities Act").
---------------------
THE SECURITIES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" APPEARING ON PAGES 6 THROUGH 9.
---------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE
SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES
COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS
PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.
---------------------
The date of this Prospectus is July , 1997
<PAGE> 3
AVAILABLE INFORMATION
The Company has filed a Registration Statement on Form S-4, including
amendments thereto, if any, with respect to the Securities (the "Registration
Statement") with the Securities and Exchange Commission (the "Commission"). This
Prospectus and any accompanying Prospectus Supplement do not contain all of the
information set forth in the Registration Statement and the exhibits and
schedules thereto. Statements contained in this Prospectus and any accompanying
Prospectus Supplement concerning the contents of any contract or other document
referred to are not necessarily complete and in each instance reference is made
to the copy of such contract or other document filed as an exhibit to the
Registration Statement or as previously filed with the Commission and
incorporated herein by reference. For further information with respect to the
Company and the Securities, reference is made to the Registration Statement,
exhibits and schedules. A copy of the Registration Statement may be inspected by
anyone without charge at the Commission's principal office at Judiciary Plaza,
450 Fifth Street, N.W., Washington, D.C. 20549, and copies of all or any part
thereof may be obtained from the Commission upon payment of certain fees
prescribed by the Commission.
The Company is subject to the information requirements of the Securities
Exchange Act of 1934, as amended (the "Exchange Act") and, in accordance
therewith, files reports, proxy statements and other information with the
Commission. Such reports, proxy statements and other information may be
inspected and copied at the public reference facilities maintained by the
Commission, Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Judiciary Plaza,
Washington, D.C. 20549, as well as the following Commission Regional Offices:
Northwestern Atrium Center, 500 West Madison Street, Suite 1400, Chicago,
Illinois 60661 and 7 World Trade Center, Suite 1300, New York, New York 10048.
Copies of such material also can be obtained from the Public Reference Section
of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549, at prescribed
rates. The Commission maintains an Internet Web site that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission, and the address of such site is
http://www.sec.gov. The Company's Common Stock is listed on the New York Stock
Exchange (the "NYSE"), and such reports, proxy statements and other information
can also be inspected at the offices of the NYSE, located at 20 Broad Street,
New York, New York 10005, at prescribed rates.
2
<PAGE> 4
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by reference to, and
should be read in conjunction with, the more detailed information and financial
statements, including the notes thereto, appearing elsewhere in this Prospectus.
Unless the context otherwise requires, all references to the "Company" or
"Service Experts" shall mean Service Experts, Inc. The Company completed the
initial public offering of its Common Stock on August 21, 1996 (the "IPO").
Simultaneously with the closing of the IPO, the Company acquired 12 heating,
ventilating and air conditioning ("HVAC") service and replacement businesses and
Contractor Success Group, Inc. ("CSG") (collectively, the "Predecessor
Companies") in exchange for shares of Common Stock and cash (the "Combination").
See "Business -- Acquisitions" for a list of the Predecessor Companies. The term
"Service Centers" refers to HVAC service and replacement businesses operated by
the Company.
THE COMPANY
The Company is one of the leading providers of residential HVAC services
and replacement equipment in the United States, and management believes that the
Company will continue to be a leading consolidator of the fragmented HVAC
service and replacement industry. The Company currently operates 41 Service
Centers in 20 states. The Service Centers install, service and maintain central
air conditioners, furnaces and heat pumps, primarily in existing homes.
Management estimates that over 80% of the Company's pro forma net revenue in
1996, after giving effect to all completed and pending acquisitions, was derived
from replacing, maintaining and servicing HVAC equipment at existing residences.
The Company focuses on the service and replacement segment of the HVAC industry
rather than the new construction segment because management believes that the
service and replacement segment offers higher margins and exposes the Company to
less credit risk. The service and replacement segment offers more attractive
pricing because of customers' demands for immediate, convenient and reliable
service.
CSG was formed in 1991 to offer HVAC companies proprietary products as well
as marketing, management, educational and advisory services not available from
industry trade associations. CSG's products and services are designed to provide
its members with a competitive advantage by utilizing proven marketing and
operational strategies and by enabling members to operate their businesses with
a higher degree of professionalism. All of the Service Centers are members of
CSG and operate in accordance with its recommended methods and procedures. CSG
currently has over 270 members serving distinct market areas of the United
States. Management estimates that the aggregate annual revenues of the CSG
members not owned by the Company are in excess of $500 million.
The HVAC service and replacement industry is large and growing. Management
estimates, based upon industry information, that the market for the service and
replacement of HVAC systems in existing homes is approximately $24 billion
annually. The service and replacement segment of the industry has increased in
size as a result of the aging of the installed base of residential systems, the
introduction of new, energy efficient systems and the upgrading of existing
homes to central air conditioning.
Management believes that the fragmentation of the HVAC industry creates an
opportunity for further acquisitions of HVAC companies. According to Air
Conditioning, Heating and Refrigeration News, over 30,000 independent HVAC
contractors are currently operating in the United States. Management believes
that these businesses are typically closely held, single-center operations that
serve a limited geographic area. The businesses are heavily dependent upon
referrals to generate business. In many cases, these businesses are operated by
service technicians who lack the business and marketing expertise to expand
their businesses, increase their profitability and compete effectively with
larger operators.
3
<PAGE> 5
ACQUISITION STRATEGY AND RECENT ACQUISITIONS
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. In
addition, management believes that the Company's visibility within the industry
and its operational philosophy of decentralized operations and centralized
administration provide the Company with a competitive advantage, particularly in
enabling the Company to identify and acquire well-managed, profitable HVAC
businesses. By allowing former owners of Service Centers the opportunity to
continue managing their business after acquisition and to increase their focus
on customer service rather than administration, management believes that the
Company offers owners of independent HVAC businesses an attractive alternative.
Management intends to develop a national presence through acquisitions and a
national reputation for superior, high quality service that will enable the
Company to appeal to a large number of customers. The Company has implemented an
aggressive acquisition strategy, acquiring 29 Service Centers (the "Acquired
Companies" and, together with the Predecessor Companies, the "Subsidiaries")
since the IPO with aggregate revenue for the 12 months ended December 31, 1996
of approximately $110.3 million. See "Business -- Acquisitions" for a list of
the Acquired Companies. The Company currently has agreements in principle to
acquire 12 HVAC businesses (the "Pending Acquisitions") with aggregate annual
residential service and replacement revenue of approximately $23.5 million. The
Company expects to complete the Pending Acquisitions during the third quarter of
1997. See "The Pending Acquisitions." The Company's 1996 pro forma net revenue,
giving effect to the acquisition of the Subsidiaries and to one Pending
Acquisition, was approximately $185.3 million. See the Pro Forma Combined
Financial Statements and the Notes thereto for a listing of the companies
included.
Management targets for acquisition as "hubs" CSG members that are
geographically desirable, financially stable and whose management is experienced
in the industry and CSG operating methods. All of the Company's 41 Service
Centers are CSG members. The Company also plans to increase its market presence
through acquisitions of other HVAC businesses that have large customer bases and
that present opportunities for overhead savings or asset sales to improve
profitability. In many cases, the assets of acquired "spoke" companies will be
combined with the operations of existing Service Centers. In addition,
management believes that it will be able to improve the performance of these
acquired companies through the implementation of the methods and procedures
developed by CSG.
The Company's principal executive offices are located at 111 Westwood
Place, Suite 420, Brentwood, Tennessee 37027, and its telephone number is (615)
371-9990.
4
<PAGE> 6
SUMMARY FINANCIAL DATA
(IN THOUSANDS, EXCEPT PER SHARE DATA)
The following table presents summary financial data of the Company. The
Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneously with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. The acquisitions of the Predecessor Companies have
been accounted for using the historical cost basis of the Predecessor Companies
in accordance with Commission Staff Accounting Bulletin No. 48 ("SAB 48"). In
accordance with the provisions of Commission Staff Accounting Bulletin No. 97
("SAB 97"), the historical financial statements of the Company for periods prior
to August 21, 1996 are the combined financial statements of AC Service &
Installation Co., Inc. and Donelson Air Conditioning Company, Inc.
(collectively, the "Acquiring Company"). In addition, the historical financial
statements of the Company for all periods presented include the financial
statements of Custom Air Conditioning, Inc. and Freschi Air Systems, Inc.
(collectively, the "Pooled Companies"), which were acquired effective December
1, 1996 in business combinations accounted for as poolings of interests, and the
operations of all other Subsidiaries are included from their respective
effective dates of acquisition. The following should be read with the historical
financial statements and the Pro Forma Combined Financial Statements and Notes
thereto appearing elsewhere in this Prospectus.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------- ----------------------------
PRO FORMA PRO FORMA
1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- ------- --------- ------ ------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue................................ $22,193 $24,876 $46,856 $185,310 $5,134 $33,355 $42,124
Cost of goods sold......................... 15,999 16,916 30,198 122,555 3,392 20,913 26,909
------- ------- ------- -------- ------ ------- -------
Gross margin............................... 6,194 7,960 16,658 62,755 1,742 12,442 15,215
Selling, general and administrative
expenses................................. 5,723 7,162 12,837 46,567 1,714 9,635 12,222
------- ------- ------- -------- ------ ------- -------
Income from operations..................... 471 798 3,821 16,188 28 2,807 2,993
Other income (expense)..................... (47) (8) 485 783 11 140 236
------- ------- ------- -------- ------ ------- -------
Income before tax.......................... 424 790 4,306 16,971 39 2,947 3,229
Provision for income tax expense........... 41 82 1,196 7,078(2) 6 1,120 1,284
------- ------- ------- -------- ------ ------- -------
Net income................................. $ 383 $ 708 $ 3,110 $ 9,893 $ 33 $ 1,827 $ 1,945
======= ======= ======= ======== ====== ======= =======
Net income per share....................... $ 0.70 $ 0.70(3) $ 0.02 $ 0.15 $ 0.14(4)
Weighted average shares outstanding........ 4,451 14,231(3) 1,561 12,269 14,306(4)
Ratio of earnings to fixed charges......... 3.86 5.82 19.92 15.03
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1997
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ACTUAL PRO FORMA(5)
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(IN THOUSANDS)
<S> <C> <C>
BALANCE SHEET DATA:
Working capital........................................... $ 37,834 $ 26,909
Total assets.............................................. 125,592 138,998
Total debt................................................ 563 --
Stockholders' equity...................................... 104,755 114,675
</TABLE>
- ---------------
(1) Gives effect to the acquisition of the Predecessor Companies, the Acquired
Companies (excluding the Pooled Companies) and to the one Pending
Acquisition as if the transactions were completed on January 1, 1996. In
addition, the pro forma information is based on certain assumptions and
adjustments. Does not give effect to the acquisition of one Acquired Company
and to 11 Pending Acquisitions which have aggregate annual residential
service and replacement revenue of approximately $22.0 million and an
estimated aggregate purchase price of approximately $23.6 million. See the
Pro Forma Combined Financial Statements and the Notes thereto.
(2) Reflects the income tax adjustments for certain of the Acquired Companies
and Predecessor Companies which were Subchapter S corporations prior to
acquisition by the Company and were not subject to federal and some state
income taxes.
(3) The computation of pro forma net income per share is based upon 14,230,793
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO, (iii) 2,587,500 shares sold in the IPO,
(iv) 3,710,762 shares issued to former stockholders of the 28 Acquired
Companies and in the one Pending Acquisition listed on page F-2 hereof, (v)
1,850,000 shares sold in the public offering of the Company's Common Stock
completed on March 21, 1997 (the "Offering") and (vi) 97,795 shares which
reflect the dilutive effect of the options and warrants.
(4) The computation of pro forma net income per share is based upon 14,305,665
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO, (iii) 2,587,500 shares sold in the IPO,
(iv) 3,710,762 shares issued to former stockholders of the 28 Acquired
Companies and in the one Pending Acquisition listed on page F-2 hereof, (v)
1,850,000 shares sold in the Offering, (vi) 162,160 shares which reflect the
dilutive effect of the options and warrants and (vii) 10,507 shares which
reflect the weighted average shares issued pursuant to the Service Experts,
Inc. 1996 Employee Stock Purchase Plan (the "1996 Plan").
(5) Gives effect to the acquisition of seven Acquired Companies closed
subsequent to March 31, 1997 and to one Pending Acquisition as if such
transactions were completed on March 31, 1997. In addition, the pro forma
information is based on certain assumptions and adjustments. Does not give
effect to the acquisition of one Acquired Company and to 11 Pending
Acquisitions which have aggregate annual residential service and replacement
revenue of approximately $22.0 million and an estimated aggregate purchase
price of approximately $23.6 million. See the Pro Forma Combined Financial
Statements and the Notes thereto.
5
<PAGE> 7
RISK FACTORS
In addition to the other information contained in this Prospectus, the
following risk factors should be considered carefully in evaluating an
investment in the shares of Common Stock offered hereby and any accompanying
Prospectus Supplement or Post-Effective Amendment, as applicable.
This discussion also identifies important cautionary factors that could
cause the Company's actual results to differ materially from those expressed in
forward-looking statements made elsewhere herein by, or on behalf of, the
Company. In particular, the Company's forward-looking statements in this
Prospectus, including those regarding the successful integration of the
businesses of the Subsidiaries, the effective implementation of the Company's
strategy, the availability of additional HVAC businesses for acquisition, the
adequacy of the Company's capital resources and other statements regarding
trends relating to the HVAC industry and various revenue and expense items,
could be affected by a number of risks and uncertainties including those
described below.
LIMITED COMBINED OPERATING HISTORY
The Company was incorporated in March 1996 and, simultaneously with the
closing of the IPO, consummated the acquisition of the Predecessor Companies.
Since the IPO, the Company has acquired 29 additional Service Centers. Because
of the limited operating history of the Company as a combined entity, there can
be no assurance that the Company will be able to integrate successfully the
businesses of the Subsidiaries or to operate profitably. There can be no
assurance that the Company's management will be able to effectively manage the
combined entity and effectively implement the Company's operating and
acquisition strategies. Failure to integrate successfully the Subsidiaries and
to implement the Company's operating and acquisition strategies could have a
material adverse effect on the Company's net revenue and earnings. See
"Business -- Acquisitions."
RISKS ASSOCIATED WITH ACQUISITION STRATEGY AND FINANCING
The success of the Company's acquisition strategy will depend on a number
of factors, including (i) the Company's ability to locate and successfully
negotiate the acquisition of HVAC businesses and to successfully integrate the
operations of acquired Service Centers into the Company's operations and (ii)
the availability of adequate financing to develop or acquire additional HVAC
businesses. In addition, the Company competes with other HVAC and residential
service companies for desirable acquisition candidates. Some of these companies
may have access to capital, personnel and other resources equal to or greater
than those of the Company. The Company expects that its capital needs over the
next several years, primarily for acquisitions, will exceed capital generated
from operations. The Company plans to incur indebtedness and to issue, from time
to time, additional debt or equity securities, including the issuance of
Securities in connection with the types of transactions identified on the cover
page of this Prospectus. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources." In the
event that the Common Stock does not maintain a sufficient market value, or
potential acquisition candidates are unwilling to accept Common Stock as part of
the consideration for the sale of their businesses, the Company may be required
to utilize more of its cash resources, if available, in order to maintain its
acquisition program. In addition, the closing of the Pending Acquisitions is
subject to customary conditions, and there can be no assurance that the Company
will be able to consummate the Pending Acquisitions or to successfully integrate
the businesses of its Service Centers. There can be no assurance that the
Company's acquisition strategy will be successful, that modifications to the
Company's strategy will not be required, that the Company will be able to
effectively manage and enhance the profitability of additional Service Centers
or that the Company will be able to obtain adequate financing on reasonable
terms to develop or acquire additional HVAC service businesses. See
"Business -- Acquisitions."
RISKS ASSOCIATED WITH DEVELOPMENT, IMPLEMENTATION, AND INTEGRATION OF OPERATING
SYSTEMS AND POLICIES
As a rapidly growing provider of HVAC services, the Company is faced with
the development, implementation and integration of Company-wide policies and
systems related to its operations. Each of the Subsidiaries and companies to be
acquired may need, to some extent, to modify or adopt certain systems and
policies they have
6
<PAGE> 8
utilized historically in order to implement the Company's systems and policies,
which management is currently formulating. The Company has implemented a uniform
general ledger system and electronic mail system at each of the Service Centers.
The Company plans to implement and integrate certain other information and
operating systems and procedures for the Service Centers including, but not
limited to, employment and human resources policies, uniform purchasing programs
and certain centralized marketing programs. The Company may experience delays,
complications and expenses in implementing, integrating and operating such
systems, any of which could have a material adverse effect on the Company's
operations, net revenue and earnings. See "Business -- Services and Operations."
COMPETITION
The HVAC service and replacement industry is highly competitive. The
Company's Service Centers compete with other full-service HVAC businesses
primarily on the basis of quality, reliability, customer service and price.
Several companies have been organized to pursue the acquisition of businesses
that offer HVAC services. Some of these competitors have access to capital,
personnel, marketing and technological resources that are equal to or greater
than those of the Company. In certain markets, the Company competes with utility
companies which have access to capital, personnel, marketing and technological
resources that are equal to or greater than those of the Company. Because of the
fragmented nature of the industry and relatively low barriers to entry,
additional competitors, including companies that offer other home improvement
services in addition to HVAC services, may emerge that have greater access than
the Company to capital, personnel and technological resources. There can be no
assurance that the Company will be able to compete successfully or that such
competition will not make it more difficult to acquire HVAC businesses on terms
beneficial to the Company.
DEPENDENCE ON KEY PERSONNEL
The success of the Company is dependent upon the continued services of the
Company's senior management, particularly upon its Chairman of the Board and
Chief Executive Officer, Alan R. Sielbeck, and its President and Chief Operating
Officer, James D. Abrams. The loss of the services of Messrs. Sielbeck, Abrams
or any of the Company's senior management would have a material adverse effect
upon the Company's business and prospects. See "Management -- Executive
Officers, Directors and Key Employees."
LABOR AVAILABILITY
The timely provision of high-quality service by the Service Centers
requires an adequate supply of skilled labor. In addition, the operating costs
of each Service Center may be adversely affected by high turnover in skilled
positions. Accordingly, the Company's ability to increase productivity and net
earnings is limited to a degree by its ability to employ the skilled laborers
necessary to meet the Company's service requirements. There can be no assurance
that the Company will be able to maintain an adequate skilled labor force
necessary to efficiently operate its Services Centers or that the Company's
labor expenses will not increase as a result of a shortage in the supply of
skilled workers.
SEASONAL AND CYCLICAL NATURE OF THE INDUSTRY
The HVAC service industry generally experiences increased demand during the
summer and winter months. The Company may, in certain periods, be affected by
these seasonal trends. The residential HVAC service and replacement industry
historically has been highly cyclical and is influenced by many of the same
national and regional economic and demographic factors which affect demand for
durable consumer goods, including consumer confidence, interest rates,
availability of financing, regional population and employment trends, and
general economic conditions. There can be no assurance that the HVAC service and
replacement industry will not experience future declines or that such declines
will not have a material adverse effect on the Company. See "Business -- HVAC
Service and Replacement Industry."
7
<PAGE> 9
CONTROL BY MANAGEMENT AND PRINCIPAL STOCKHOLDERS
As of the date of this Prospectus, directors, officers and 5% stockholders
of the Company beneficially own approximately 16.6% of the outstanding Common
Stock. See "Principal Stockholders." Accordingly, these persons will have
substantial influence over the affairs of the Company, including the ability to
influence the election of directors and other matters requiring stockholder
approval.
CONFLICTS OF INTEREST
Certain executive officers of the Company are owners of HVAC companies that
are not affiliated with the Company. While such executive officers have agreed
to devote their full time efforts to the operations of the Company, there can be
no assurance that they will not periodically devote time and attention to the
operations of HVAC companies that are not affiliated with the Company. Currently
none of the unaffiliated companies owned by such executive officers are located
in geographic areas served by the Company. There can be no assurance that the
Company will not enter the markets served by these companies in the future. See
"Management" and "Certain Transactions."
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, as amended (the "Clean Air Act"), relating to minimum energy efficiency
standards of HVAC systems and the production, servicing and disposal of certain
ozone depleting refrigerants used in such systems. In connection with the entry
into new markets, the Company may become subject to compliance with additional
regulations, and there can be no assurance that the regulatory environment in
which the Company operates will not change significantly in the future.
Various local, state and federal laws and regulations, including those
implementing the Clean Air Act, impose licensing standards on technicians who
service heating and air conditioning units. While the installers and technicians
employed by the Service Centers are duly certified by applicable local, state
and federal agencies and have been able to meet or exceed such standards to
date, there can be no assurance that they will be able to meet future standards.
In some states, warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies thereby subjecting the Company and the service agreements to the
insurance laws and regulations of such state.
CERTAIN ANTI-TAKEOVER PROVISIONS
Certain provisions of the Company's Restated Certificate of Incorporation
("Restated Certificate") and Bylaws and Delaware law may make a change in the
control of the Company more difficult to effect, even if a change in control
were in the stockholders' interest. Section 203 of the Delaware General
Corporation Law would prevent an "interested stockholder" (defined in Section
203, generally, as a person owning 15% or more of the Company's outstanding
voting stock) from engaging in a "business combination" (as defined in Section
203) with the Company for three years following the date such person became an
interested stockholder unless certain conditions, including approval by the
Company's Board of Directors, are met. The Company's Restated Certificate and
Bylaws include certain super-majority voting requirements. The Restated
Certificate also allows the Board to determine the terms of preferred stock
which may be issued by the Company without approval of the holders of the Common
Stock. The ability of the Company to issue preferred stock in this manner could
enable the Board to prevent changes in management and control of the Company.
The Board of the Company is divided into three classes of directors, with
directors being elected for staggered three-year terms. Such staggered terms may
affect the ability of the holders of the Common Stock to change control of the
Company. See "Description of Capital Stock -- Anti-Takeover Provisions." In
addition, certain provisions of the employment agreements between the Company
and the executive officers of the Company may make a change of control more
difficult. Pursuant to these employment agreements, upon a change in control of
the Company, each executive officer is to be paid as severance pay such
officer's base salary for the remaining term of the employment agreement. See
"Management -- Employment Agreements."
8
<PAGE> 10
VOLATILITY OF MARKET PRICE
From time to time, there may be significant volatility in the market price
of the Common Stock. Quarterly operating results of the Company, changes in
earnings estimated by analysts, changes in general conditions in the economy or
the financial markets or other developments affecting the Company could cause
the market price of the Common Stock to fluctuate substantially. In addition, in
recent years the stock market has experienced extreme price and volume
fluctuations. This volatility has had a significant effect on the market prices
of securities issued by many companies for reasons unrelated to their operating
performance.
SHARES ELIGIBLE FOR FUTURE SALE
As of the date of this Prospectus, the Company has outstanding 14,165,092
shares of Common Stock, of which approximately 5,728,755 shares are freely
tradeable without restriction or further registration under the Securities Act,
except for those held by "affiliates" (as defined in the Securities Act) of the
Company, which are subject to the resale limitations of Rule 144 under the
Securities Act ("Rule 144"). Holders of 1,462,100 shares of Common Stock are
eligible to sell such shares pursuant to Rule 144 (subject to certain
limitations) under the Securities Act, and an additional 4,522,636 shares will
become eligible for sale pursuant to Rule 144 in August 1997. In connection with
acquisitions of Service Centers completed after the IPO, approximately 3,681,237
shares of Common Stock have been issued to stockholders who may be deemed
"affiliates" for purposes of Rule 145 under the Securities Act ("Rule 145") and
are eligible for sale in the public market in accordance with Rule 145. In
addition to the resale limitations of Rule 145, certain stockholders of such
acquired companies are subject to lockup agreements limiting the resale of such
shares for a period of two years after the date of acquisition. The Company also
plans to issue shares of its Common Stock that have been registered under the
Securities Act in connection with future acquisitions. The Company anticipates
that, upon the issuance thereof, these shares will generally be eligible for
sale in accordance with Rule 145 unless the resale thereof is contractually
restricted. Sales of substantial amounts of Common Stock in the public market
pursuant to Rule 144, Rule 145 or otherwise, and the potential of such sales,
could adversely affect the prevailing market price of the Common Stock and
impair the Company's ability to raise additional capital through the sale of
equity securities. See "Shares Eligible for Future Sale."
9
<PAGE> 11
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
March 31, 1997 (i) on an actual basis and (ii) on a pro forma basis to give
effect to the seven Acquired Companies closed subsequent to March 31, 1997 and
to one Pending Acquisition as if they had been completed on March 31, 1997. The
following table should be read in conjunction with "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and the Consolidated
Financial Statements of the Company and the related Notes thereto included
elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1997
--------------------
ACTUAL PRO FORMA
-------- ---------
(IN THOUSANDS)
<S> <C> <C>
Cash........................................................ $ 33,155 $ 21,924
======== ========
Short-term debt, including current portion of long-term
debt, capital lease obligations and notes payable to
related parties........................................... $ 426 $ --
======== ========
Long-term debt and capital lease obligations, less current
portion................................................... $ 137 $ --
Stockholders' equity:
Preferred Stock, $.01 par value per share; 10,000,000
shares authorized, no shares outstanding............... -- --
Common Stock, $.01 par value per share; 30,000,000 shares
authorized; 13,694,377 shares outstanding, 14,155,653
shares outstanding pro forma........................... 137 142
Additional paid-in capital................................ 98,382 108,297
Retained earnings......................................... 6,236 6,236
-------- --------
Total stockholders' equity........................ 104,755 114,675
-------- --------
Total capitalization.............................. $104,892 $114,675
======== ========
</TABLE>
10
<PAGE> 12
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected financial data of the Company. The
Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneously with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. The acquisitions of the Predecessor Companies have
been accounted for using the historical cost basis of the Predecessor Companies
in accordance with SAB 48. In accordance with the provisions of SAB 97, the
historical financial statements of the Company for periods prior to August 21,
1996 are the combined financial statements of the Acquiring Company. In
addition, the historical financial statements of the Company for all periods
presented include the financial statements of the Pooled Companies, which were
acquired effective December 1, 1996 in business combinations accounted for as
poolings of interests, and the operations of all other Subsidiaries are included
from their respective effective dates of acquisition. The following should be
read with the historical financial statements, the Pro Forma Combined Financial
Statements and the Notes thereto appearing elsewhere in this Prospectus.
The selected financial data for the fiscal years ended December 31, 1993,
1994, 1995 and 1996 (except for pro forma amounts) have been derived from the
financial statements of the Acquiring Company and the Pooled Companies. The
selected financial data of the Company for the fiscal year ended December 31,
1992 have been derived from unaudited financial statements not included
elsewhere in this Prospectus. The Selected Consolidated Financial Data of the
Company for the three months ended March 31, 1996 and March 31, 1997 have been
derived from the unaudited financial statements that appear elsewhere in this
Prospectus. The unaudited financial statements have been prepared on the same
basis as the audited financial statements and, in the opinion of management,
contain all adjustments, consisting only of normal recurring accruals, necessary
for a fair presentation of the combined financial position and combined results
of operations for the periods presented.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, THREE MONTHS ENDED MARCH 31,
------------------------------------------------------------- ------------------------------
PRO FORMA PRO FORMA
1992 1993 1994 1995 1996 1996(1) 1996 1997 1997(1)
------- ------- ------- ------- ------- ----------- ------ ------- -----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
INCOME STATEMENT DATA:
Net revenue...................... $14,507 $16,339 $22,193 $24,876 $46,856 $185,310 $5,134 $33,355 $42,124
Cost of goods sold............... 10,095 11,716 15,999 16,916 30,198 122,555 3,392 20,913 26,909
------- ------- ------- ------- ------- -------- ------ ------- -------
Gross margin..................... 4,412 4,623 6,194 7,960 16,658 62,755 1,742 12,442 15,215
Selling, general and
administrative expenses........ 4,241 4,584 5,723 7,162 12,837 46,567 1,714 9,635 12,222
------- ------- ------- ------- ------- -------- ------ ------- -------
Income from operations........... 171 39 471 798 3,821 16,188 28 2,807 2,993
Other income (expense)........... 22 24 (47) (8) 485 783 11 140 236
------- ------- ------- ------- ------- -------- ------ ------- -------
Income before tax................ 193 63 424 790 4,306 16,971 39 2,947 3,229
Provision for income tax
expense........................ 76 18 41 82 1,196 7,078(2) 6 1,120 1,284
------- ------- ------- ------- ------- -------- ------ ------- -------
Net income....................... $ 117 $ 45 $ 383 $ 708 $ 3,110 $ 9,893 $ 33 $ 1,827 $ 1,945
======= ======= ======= ======= ======= ======== ====== ======= =======
Net income per share............. $ 0.70 $ 0.70(3) $ 0.02 $ 0.15 $ 0.14(4)
Weighted average shares
outstanding.................... 4,451 14,231(3) 1,561 12,269 14,306(4)
Ratio of earnings to fixed
charges........................ 2.28 1.45 3.86 5.82 19.92 15.03
</TABLE>
11
<PAGE> 13
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, 1997
-------------------------------------------- -----------------------
1992 1993 1994 1995 1996 ACTUAL PRO FORMA(5)
------ ------ ------ ------ -------- -------- ------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital..................................... $1,231 $1,226 $ 850 $1,336 $ 12,387 $ 37,834 $ 26,909
Total assets........................................ 3,935 4,605 5,431 6,020 68,504 125,592 138,998
Total debt.......................................... 1,390 1,374 1,317 1,530 275 563 --
Stockholders' equity................................ 1,524 1,452 1,550 2,064 53,071 104,755 114,675
</TABLE>
- ---------------
(1) Gives effect to the acquisition of the Predecessor Companies, the Acquired
Companies (excluding the Pooled Companies) and to one Pending Acquisition as
if such transactions were completed on January 1, 1996. In addition, the pro
forma information is based on certain assumptions and adjustments. Does not
give effect to the acquisition of one Acquired Company and to 11 Pending
Acquisitions which have aggregate annual residential service and replacement
revenue of approximately $22.0 million and an estimated aggregate purchase
price of approximately $23.6 million. See the Pro Forma Combined Financial
Statements and the Notes thereto.
(2) Reflects the income tax adjustments for certain of the Acquired Companies
and Predecessor Companies which were Subchapter S corporations prior to
acquisition by the Company and were not subject to federal and some state
income taxes.
(3) The computation of pro forma net income per share is based upon 14,230,793
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO, (iii) 2,587,500 shares sold in the IPO,
(iv) 3,710,762 shares issued to former stockholders of the 28 Acquired
Companies and in the one Pending Acquisition listed on Page F-2, (v)
1,850,000 shares sold in the Offering and (vi) 97,795 shares which reflect
the dilutive effect of the options and warrants.
(4) The computation of pro forma net income per share is based upon 14,305,665
weighted average shares of Common Stock outstanding, which includes (i)
4,522,636 shares distributed to the former stockholders of the Predecessor
Companies, (ii) 1,462,100 shares outstanding held by existing stockholders
of the Company prior to the IPO, (iii) 2,587,500 shares sold in the IPO,
(iv) 3,710,762 shares issued to former stockholders of the 28 Acquired
Companies and in the one Pending Acquisition listed on Page F-2 hereof, (v)
1,850,000 shares sold in the Offering, (vi) 162,160 shares which reflect the
dilutive effect of the options and warrants and (vii) 10,507 shares which
reflect the weighted average shares issued pursuant to the 1996 Plan.
(5) Gives effect to the acquisition of seven Acquired Companies closed
subsequent to March 31, 1997 and to one Pending Acquisition as if such
transactions were completed on March 31, 1997. In addition, the pro forma
information is based on certain assumptions and adjustments. Does not give
effect to the acquisition of one Acquired Company and to 11 Pending
Acquisitions which have aggregate annual residential service and replacement
revenue of approximately $22.0 million and an estimated aggregate purchase
price of approximately $23.6 million. See the Pro Forma Combined Financial
Statements and the Notes thereto.
12
<PAGE> 14
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the information
contained in the Company's Consolidated Financial Statements and Pro Forma
Combined Financial Statements, including the Notes thereto, and the other
financial information appearing elsewhere in this Prospectus.
OVERVIEW
Simultaneous with the IPO in August 1996, the Company acquired the
Predecessor Companies in the Combination. Prior to the Combination, the Company
had no operations. The consideration paid by the Company for the Predecessor
Companies was approximately $77.5 million, consisting of 4.5 million shares of
Common Stock and $18.7 million in cash. No intangible assets were recorded as a
result of the Combination due to the accounting treatment in accordance with SAB
48. On a pro forma basis, these companies, together with the Pooled Companies,
generated revenue in 1996 of approximately $77.0 million and contributed
operating income of approximately $8.7 million.
Since the IPO, the Company has acquired 29 Service Centers. The
consideration paid by the Company for the Acquired Companies was approximately
$85.9 million, consisting of approximately 3.6 million shares of Common Stock
and $23.4 million in cash. Two of the transactions were accounted for using the
pooling of interests method of accounting, and the remainder were accounted for
using the purchase method. Of the purchase price, approximately $69.7 million
was allocated to intangible assets which are to be amortized over a 40-year
period.
FINANCIAL STATEMENT PRESENTATION
Since the IPO, the financial presentation of the Company has changed. The
Combination was accounted for using the historical cost basis of the Predecessor
Companies in accordance with SAB 48. On July 31, 1996, SAB 97 was adopted to
replace SAB 48 for certain combination transactions. In accordance with the
provisions of SAB 97, the presentation of financial information for the Company
reflects the Acquiring Company as the acquiror of the other Predecessor
Companies. Prior financial statements of the combined Predecessor Companies are
not included in the Company's historical financial presentation. The operation
of the Predecessor Companies and other acquired companies (except for those
companies acquired under the pooling of interests method) have been included in
the Company's financial statements from their respective effective dates of
acquisition.
The Subsidiaries historically have been managed as independent private
companies and, as such, their results of operations reflect different tax
structures which have influenced, among other things, their historical levels of
owner's compensation. Owners and certain key employees of the Subsidiaries have
agreed to certain reductions in their compensation in connection with the
acquisitions. The pro forma financial data have been adjusted to reflect this
expense reduction.
COMPONENTS OF INCOME
Net revenue of the Subsidiaries has been derived primarily from the
following sources (i) the installation of central air conditioners, furnaces and
heat pumps primarily in existing homes and (ii) the service and maintenance of
central air conditioners, furnaces and heat pumps primarily in existing homes.
Net revenue and associated income from operations are subject to seasonal
fluctuations resulting from increased demand for the Company's services during
warmer weather in the summer months and during colder weather in winter months,
particularly in the beginning of each season. Cost of goods sold primarily
consists of purchased materials such as replacement air conditioning units and
heat pumps and the labor associated with both installations and repair orders.
The main components of selling, general and administrative expenses include
administrative salaries, insurance expense and promotion and advertising
expenses.
RESULTS OF OPERATIONS
Because of the significant effect of the Combination, the acquisitions of
the Acquired Companies and the anticipated effect of the Pending Acquisitions on
the Company's results of operations, the Company's historical
13
<PAGE> 15
results of operations and period-to-period comparisons will not be indicative of
future results and may not be meaningful. The Company plans to continue
acquiring Service Centers in the future. The integration of acquired Service
Centers and the addition of management personnel to support existing and future
acquisitions may positively or negatively affect the Company's results of
operations during the period immediately following acquisition.
The following table sets forth certain selected financial data as a
percentage of net revenue for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
----------------------- ----------------
1994 1995 1996 1996 1997
----- ----- ----- ------ ------
<S> <C> <C> <C> <C> <C>
Net revenue................................ 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of goods sold......................... 72.1 68.0 64.4 66.1 62.7
----- ----- ----- ----- -----
Gross margin............................... 27.9 32.0 35.6 33.9 37.3
Selling, general and administrative
expenses................................. 25.8 28.8 27.4 33.4 28.9
----- ----- ----- ----- -----
Income from operations..................... 2.1% 3.2% 8.2% 0.5% 8.4%
===== ===== ===== ===== =====
</TABLE>
Three Months Ended March 31, 1997 Compared to Three Months Ended March 31,
1996
Net Revenue. Net revenue increased $28.2 million from $5.1 million for the
three months ended March 31, 1996 to $33.4 million for the three months ended
March 31, 1997. Management believes that the significant increase in net
revenues and related expenses was primarily the result of the acquisition of 33
heating, ventilating and air conditioning businesses between August 1996 and
April 1997.
Cost of Goods Sold. Cost of goods sold increased $17.5 million from $3.4
million for the three months ended March 31, 1996 to $20.9 million for the three
months ended March 31, 1997. Management believes that the significant increase
in cost of goods sold from 1996 to 1997 was primarily the result of the
acquisition of 33 heating, ventilating and air conditioning businesses between
August 1996 and April 1997. As a percentage of net revenue, cost of goods sold
decreased 3.4% from 66.1% for the three months ended March 31, 1996 to 62.7% for
the three months ended March 31, 1997.
Gross Margin. Gross margin increased from $1.7 million for the three
months ended March 31, 1996 to $12.4 million for the three months ended March
31, 1997, an increase of $10.7 million. As a percentage of net revenue, gross
margin increased from 33.9% for the three months ended March 31, 1996 to 37.3%
for the three months ended March 31, 1997. The primary factor for this increase
in percent of revenue is a more favorable product mix with a higher percentage
content of residential business for the three months ended March 31, 1997
compared to the three months ended March 31, 1996.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $7.9 million from $1.7 million for the three
months ended March 31, 1996 to $9.6 million for the three months ended March 31,
1997. As a percentage of net revenue, selling, general and administrative
expenses decreased from 33.4% for the three months ended March 31, 1996 to 28.9%
for the three months ended March 31, 1997. Management believes this decrease in
percent of revenue is primarily attributed to a leverage of administrative cost
due to consolidation along with a reduction in former owners' compensation
expense following the acquisitions.
Income from Operations. Income from operations increased from $28,000 for
the three months ended March 31, 1996 to $2.8 million for the three months ended
March 31, 1997. Income from operations as a percent of net revenue increased
from 0.5% for the three months ended March 31, 1996 to 8.4% for the three months
ended March 31, 1997.
Other Income and Expense. Other income and expense increased from $11,000
for the three months ended March 31, 1996 to $140,000 for the three months ended
March 31, 1997, an increase of $129,000. Other income and expense as a percent
of net revenue increased from 0.2% for the three months ended March 31, 1996 to
0.4% for the three months ended March 31, 1997.
14
<PAGE> 16
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net Revenue. Net revenue increased $22.0 million, or 88.4%, from $24.9
million for the year ended December 31, 1995 to $46.9 million for the year ended
December 31, 1996. This increase is primarily attributable to the acquisitions
completed during 1996.
Cost of Goods Sold. Cost of goods sold increased $13.3 million, or 78.5%,
from $16.9 million for the year ended December 31, 1995 to $30.2 million for the
year ended December 31, 1996. As a percentage of net revenue, cost of goods sold
decreased from 68.0% for the year ended December 31, 1995 to 64.4% for the year
ended December 31, 1996.
Gross Margin. Gross margin increased $8.7 million, or 109.3%, from $8.0
million for the year ended December 31, 1995 to $16.7 million for the year ended
December 31, 1996. As a percentage of net revenue, gross margin increased from
32.0% for the year ended December 31, 1995 to 35.6% for the year ended December
31, 1996. The increase in gross margin as a percentage of net revenue is
attributable to the inclusion of Acquired Companies that operated at a higher
margin.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $5.7 million, or 79.2%, from $7.2 million for
the year ended December 31, 1995 to $12.8 million for the year ended December
31, 1996. This increase is attributable to the inclusion of the Acquired
Companies and an increase in management personnel since the IPO. As a percentage
of net revenue, general and administrative expenses decreased from 28.8% for the
year ended December 31, 1995 to 27.4% for the year ended December 31, 1996.
Income from Operations. Income from operations increased $3.0 million, or
378.8%, from $798,000 for the year ended December 31, 1995 to $3.8 million for
the year ended December 31, 1996. Income from operations as a percent of net
revenue increased from 3.2% in the 1995 period to 8.2% in the 1996 period.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Net Revenue. Net revenue increased $2.7 million, or 12.1%, from $22.2
million in 1994 to $24.9 million in 1995. The increase in net revenue was
primarily attributable to promotion of service contracts and increased
advertising.
Cost of Goods Sold. Cost of goods sold increased $917,000, or 5.7%, from
$16.0 million in 1994 to $16.9 million in 1995. As a percentage of net revenue,
cost of goods sold decreased from 72.1% in 1994 to 68.0% in 1995. The decrease
as a percentage of net revenue was primarily attributable to an emphasis on more
profitable products, improved employee training and volume purchasing discounts.
Gross Margin. Gross margin increased $1.8 million, or 28.5%, from $6.2
million for the twelve months ended December 31, 1994 to $8.0 million for the
twelve months ended December 31, 1995. As a percentage of net revenue, gross
margin increased 4.1% from 27.9% for the twelve months ended December 31, 1994
to 32.0% for the twelve months ended December 31, 1995. The increase as a
percentage of net revenue was primarily attributable to the emphasis on more
profitable products, improved employee training and volume purchasing discounts.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $1.4 million, or 25.1%, from $5.7 million in
1994 to $7.2 million in 1995. As a percentage of net revenue, selling, general
and administrative expenses increased from 25.8% in 1994 to 28.8% in 1995. The
increase as a percentage of net revenue was primarily attributable to increased
management personnel added to support recent growth.
Income from Operations. Income from operations increased $327,000, or
69.4%, from $471,000 in 1994 to $798,000 in 1995. As a percentage of net
revenue, income from operations increased from 2.1% in 1994 to 3.2% in 1995.
15
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital needs arise from the acquisition of new
HVAC businesses and the costs associated with such expansion. Cash used in
investing activities was primarily attributable to the acquisition of HVAC
businesses. Cash provided by financing activities consisted primarily of
proceeds from the IPO and the Offering.
On August 21, 1996, the Company completed the IPO at $13.00 per share. The
proceeds to the Company, net of expenses and underwriting discounts and
commissions, were approximately $28.1 million. Of the net proceeds, $18.7
million was used to pay the cash portion of the consideration for the
Predecessor Companies, including $1.2 million which was used to repay certain
indebtedness arising from the Combination. The Company used the remaining
proceeds for working capital and capital expenditures, including the acquisition
of additional HVAC businesses.
The Company's ability to acquire new HVAC businesses will depend on a
number of factors, including the ability of management of the Company to
identify target businesses and to negotiate acceptable acquisition terms, the
availability of adequate financing and other factors, many of which are beyond
the control of the Company. Since the IPO, the Company has acquired 29 Service
Centers for an aggregate of approximately $23.4 million cash, approximately 3.6
million shares of Common Stock and warrants to purchase 200,000 shares of Common
Stock. The Company estimates that it will pay aggregate consideration of
approximately $25.2 million, consisting of shares of Common Stock and cash, in
connection with the 12 Pending Acquisitions. In addition, the Company is
currently engaged in preliminary discussions to acquire a number of HVAC
businesses and anticipates completing by the end of 1997 the acquisition of 18
to 25 HVAC businesses for an aggregate purchase price, consisting of shares of
Common Stock and cash, of $25 million to $40 million, with aggregate annualized
service and replacement revenue of $35 million to $50 million. There can be no
assurance that any such discussions will result in a completed transaction or
that the terms of such transactions would be favorable to the Company, that the
Company will be successful in identifying and acquiring new HVAC businesses,
that the Company can integrate such new Service Centers into the Company's
operations or that the Company's new Service Centers will generate sales revenue
or profit margins consistent with those of the Company's existing Service
Centers.
On March 18, 1997, the Company completed a secondary offering of 1,850,000
shares of its Common Stock at $22.00 per share. The proceeds to the Company, net
of expenses and underwriters discounts and commissions, were approximately $37.7
million. The Company is using the proceeds for planned capital expenditures,
future acquisitions and general corporate purposes.
Working capital at March 31, 1997 was $37.8 million and cash, cash
equivalents and short-term investments were $33.2 million. Net cash generated
from operations during the first quarter was $1.2 million.
The Company's principal capital needs arise from the acquisition of new
HVAC businesses and the costs associated with such expansion. During the first
three months of 1997, the Company's capital expenditures were $2.6 million. At
March 31, 1997 the Company had $563,000 of notes payable and long-term debt
outstanding.
The Company has a $10 million unsecured revolving credit facility and an
additional $10 million unsecured discretionary revolving credit facility with
SunTrust Bank, Nashville, N.A. ("SunTrust") available through September 10, 1998
(together, the "Credit Facilities"). Borrowings under the Credit Facilities bear
interest at a variable rate equal to the 30-day LIBOR, as such rate changes from
time to time, plus a variable margin of from 125 to 250 basis points depending
on the Company's funded debt to EBITDA ratio determined on a quarterly basis.
Certain of the Company's subsidiaries have guaranteed the repayment of
indebtedness under the Credit Facilities. As of the date of this Prospectus,
there are no amounts outstanding on the above lines of credit. The Credit
Facilities contain covenants with respect to the maintenance of certain
financial ratios and specified net worth and limiting the incurrence of
additional indebtedness, the sale of substantial assets, consolidations or
mergers by the Company and the payments of dividends. The Company currently is
negotiating with SunTrust to increase the amount available under the Credit
Facilities, but there can be no assurance that such negotiations will be
successful.
16
<PAGE> 18
Management believes that the Company's existing cash balances, cash
generated from operations and additional borrowings will be sufficient to fund
the Company's operating needs, planned capital expenditures and debt service
requirements for the next 12 months. Management continually evaluates potential
strategic acquisitions as part of the Company's growth strategy. To date, such
acquisitions have been predominantly funded by issuing shares of Common Stock,
although future acquisitions could be effected using greater amounts of cash.
Although the Company believes that its financial resources will enable it to
consider potential acquisitions, should the Company's actual results of
operations fall short of, or its rate of expansion significantly exceed, its
plans, or should its costs or capital expenditures exceed expectations, the
Company may need to seek additional financing in the future. In negotiating such
financing, there can be no assurance that the Company will be able to raise
additional capital on terms satisfactory to the Company. Failure to obtain
additional financing on reasonable terms could have a negative effect on the
Company's plans to acquire additional HVAC businesses.
Newly Issued Accounting Standards
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this or any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share ("Statement 128"), which is required to be adopted
on December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. This change will not have
a material effect on primary earnings per share as previously reported.
Statement 128 is not expected to have a material effect on the calculation of
fully diluted earnings per share.
17
<PAGE> 19
BUSINESS
GENERAL
The Company is one of the leading providers of residential HVAC services
and replacement equipment in the United States, and management believes that the
Company will continue to be a leading consolidator of the fragmented HVAC
service and replacement industry. The Company currently operates 41 Service
Centers in 20 states. The Service Centers install, service and maintain central
air conditioners, furnaces and heat pumps, primarily in existing homes.
Management estimates that over 80% of the Company's pro forma net revenue in
1996, after giving effect to all completed and Pending Acquisitions, was derived
from replacing, maintaining and servicing HVAC equipment at existing residences.
The Company focuses on the service and replacement segment of the HVAC industry
rather than the new construction segment because management believes that the
service and replacement segment offers higher margins and exposes the Company to
less credit risk. The service and replacement segment offers more attractive
pricing because of customers' demands for immediate, convenient and reliable
service.
Management believes that the Company is positioned to capitalize on the
fragmentation and growth of the HVAC service and replacement industry. In
addition, management believes that the Company's visibility within the industry
and its operational philosophy of decentralized operations and centralized
administration provide the Company with a competitive advantage, particularly in
enabling the Company to identify and acquire well-managed, profitable HVAC
businesses. By allowing former owners of Service Centers the opportunity to
continue managing their business after acquisition and to increase their focus
on customer service rather than administration, management believes that the
Company offers owners of independent HVAC businesses an attractive alternative.
Management intends to develop a national presence through acquisitions and a
national reputation for superior, high quality service which will enable the
Company to appeal to a large number of customers. The Company has implemented an
aggressive acquisition strategy, acquiring 29 Service Centers since the IPO with
aggregate revenue for the year ended December 31, 1996 of approximately $110.3
million. The Company's 1996 pro forma net revenue, giving effect to the
acquisition of the Subsidiaries and to one Pending Acquisition, was
approximately $185.3 million. See Pro Forma Combined Financial Statements and
the Notes thereto for a listing of the companies included.
HVAC SERVICE AND REPLACEMENT INDUSTRY
The HVAC industry consists of (i) the installation, replacement,
maintenance, service and repair of HVAC systems at existing residences and
commercial businesses and (ii) the installation of HVAC systems at newly
constructed homes and businesses. The Company primarily provides installation
and replacement services to existing homes and small to medium-sized businesses.
According to Air Conditioning, Heating and Refrigeration News, there are
approximately 43 million central air conditioners, 54 million furnaces and nine
million heat pumps in operation in homes in the United States. Management
estimates, based on industry information, that the market for the service and
replacement of HVAC systems in existing homes is approximately $24 billion
annually. The installation and replacement segment of the industry has increased
in size as a result of the aging of the installed base of residential systems,
the introduction of new, energy efficient systems and the upgrading of existing
homes to central air conditioning. According to the Air Conditioning and
Refrigeration Institute, over 61 million central air conditioners have been
installed in the United States since 1975. Many of the units installed from the
mid-1970s to the mid-1980s are reaching the end of their useful lives, thus
providing a growing replacement market. In addition, in recent years, increased
governmental regulation restricting the use of ozone depleting refrigerants in
HVAC systems has contributed to the growing replacement market. See
"Regulation."
According to Air Conditioning, Heating, and Refrigeration News, over 30,000
HVAC contractors are currently operating in the United States. Management
believes that HVAC businesses are typically closely held, single-center
operations that serve a limited geographic area and are heavily dependent upon
referrals to generate business. Management believes that, in many cases, these
businesses are operated by former service technicians who lack the business and
marketing expertise to expand their businesses, increase their profitability and
compete
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<PAGE> 20
effectively with larger operators. Management believes that larger companies are
able to operate more efficiently, offer customers a broader array of products
and services and provide a higher level of customer service than smaller
operators. Management believes that these competitive advantages are the result
of greater managerial and financial resources as well as economies of scale in
purchasing and marketing expenses. Management believes that these factors will
continue to promote a trend toward consolidation in the industry and present an
opportunity for well-capitalized operators to acquire additional businesses on
favorable terms.
ACQUISITIONS
The Company's goal is to become the leading provider of residential HVAC
services and replacement equipment in the United States through the acquisition
of CSG members in new markets, the integration of other HVAC businesses and the
continued revenue and profit growth of its Service Centers.
Strategy
The Company has implemented an aggressive acquisition program utilizing a
"hub and spoke" strategy for expansion into new geographic areas and further
penetration into existing markets. The U.S. residential HVAC service industry is
currently highly fragmented. Management believes that many HVAC businesses,
which lack the capital necessary to expand operations and the ability to exit
their business profitably, will desire to affiliate with the Company because the
Company will provide (i) business and marketing systems that enable a company to
operate more profitably, (ii) the opportunity to increase the operator's focus
on customer service rather than administration, (iii) the potential for national
name recognition and (iv) the opportunity for the owner to gain liquidity while,
in some cases, continuing to manage the operations of the business. By expanding
geographically, management believes the Company will be able to offset certain
seasonal and economic trends that affect different regions of the country
periodically. See "Risk Factors -- Seasonal and Cyclical Nature of the
Industry."
Expanding Geographic Presence through Hub Acquisitions. The Company plans
to continue to make "hub" acquisitions of existing HVAC businesses in new
markets that are not being served by the Company. Management targets for
acquisition HVAC businesses that are members of CSG and familiar with the
Company's policies and procedures. Typically, these businesses have annual net
revenue ranging from $2.0 million to $5.0 million. In evaluating such
acquisitions, the Company considers candidates that are in attractive markets,
financially stable, experienced in the industry and characterized by strong
management.
Expanding Market Penetration of Hubs through the Acquisition of Other HVAC
Businesses. The Company expects to increase market share through "spoke"
acquisitions of other HVAC businesses that have large customer bases and that
present opportunities to reduce overhead or dispose of fixed assets to improve
profitability. When acquired, the operations of such businesses will be
integrated into the operations of existing hubs, enabling the Company to reduce
overhead costs, sell redundant assets and consolidate operations within existing
areas served by the Company.
Recent Acquisitions
Since the IPO, the Company has acquired 29 Service Centers. The
consideration paid by the Company for these businesses was approximately $85.9
million, consisting of approximately 3.6 million shares of Common Stock, $23.4
million in cash and warrants to purchase 200,000 shares of Common Stock. Two of
the transactions were accounted for using the pooling of interests method of
accounting, and the remainder were accounted for using the purchase method. Of
the purchase price, approximately $69.7 million was allocated to intangible
assets which are to be amortized over a 40-year period.
The Company's acquisitions since the IPO expanded the geographic coverage
of the Company by providing entry to the Connecticut, Florida, Illinois,
Maryland, Mississippi, New York, North Carolina, Oklahoma, South Carolina, Texas
and Utah markets and increasing the Company's market presence in Arkansas,
California, Georgia, Indiana, Louisiana, New York and Tennessee. The Company now
operates 41 Service Centers in 20 states.
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The following table sets forth certain information with respect to the
Company's existing Service Centers:
<TABLE>
<CAPTION>
COMPANY MARKET EFFECTIVE DATE
- ------- ------ --------------
<S> <C> <C>
PREDECESSOR COMPANIES
Norrell Heating and Air Conditioning
Company, Inc.............................. Birmingham, AL August 21, 1996
Hardwick Air Masters, Inc................... Little Rock, AR August 21, 1996
Service Experts of Palm Springs, Inc........ Palm Springs, CA August 21, 1996
Comerford's Heating and Air Conditioning,
Inc....................................... Pleasanton, CA August 21, 1996
Coastal Air Conditioning Service, Inc....... Savannah, GA August 21, 1996
Rolf Coal and Fuel Corp..................... Fort Wayne, IN August 21, 1996
Brand Heating & Air Conditioning, Inc....... Lafayette, IN August 21, 1996
Gilley's Quality Heating & Cooling, Inc..... Monroe, LA August 21, 1996
Vision Holding Company, Inc................. Kansas City, MO August 21, 1996
Air Experts, a United Services Co., Inc..... St. Louis, MO August 21, 1996
AC Service & Installation Co., Inc./
Donelson Air Conditioning Company, Inc.... Nashville, TN August 21, 1996
Arrow Heating & Air Conditioning, Inc....... Racine, WI August 21, 1996
ACQUIRED COMPANIES
Freschi Air Systems, Inc.................... Antioch, CA December 1, 1996
Dial One Raymond's Plumbing, Heating
& Cooling, Inc. .......................... Auburn, CA January 2, 1997
Gaddis Co................................... El Centro, CA January 2, 1997
C. Iapaluccio Company, Inc.................. Danbury, CT May 28, 1997
Custom Air Conditioning, Inc................ Jupiter, FL December 1, 1996
ProAir Services, L.P........................ Atlanta, GA June 15, 1997
Automated Air, Inc. ........................ Champaign, IL January 2, 1997
Sylvester's Corp............................ Anderson, IN January 2, 1997
Service Experts of Indianapolis, Inc........ Indianapolis, IN December 1, 1996
B. W. Heating & Cooling, Inc................ Mishawaka, IN January 2, 1997
Frees Service Experts, Inc.................. Shreveport, LA December 1, 1996
Parker Heating & Air Conditioning,
Incorporated.............................. Gaithersburg, MD January 2, 1997
Comfortech, Inc............................. Jackson, MS December 1, 1996
Roland J. Down, Inc......................... Albany, NY March 1, 1997
Sunbeam Service Experts, Inc................ Buffalo, NY December 1, 1996
Falso Service Experts, Inc.................. East Syracuse, NY December 17, 1996
Service Experts of Raleigh, Inc............. Raleigh, NC April 1, 1997
Gordon's Specialty Company.................. Norman, OK December 1, 1996
Pardee Refrigeration Company Incorporated... Charleston, SC December 1, 1996
Sanders Indoor Comfort, Inc................. Greeneville, SC December 1, 1996
Island Air Conditioning, Inc................ Isle of Palms, SC December 1, 1996
Air-Conditioning and Heating Unlimited,
Inc....................................... Memphis, TN December 1, 1996
B & B Air Conditioning, Inc................. Dallas, TX December 1, 1996
ProAir Services, L.P........................ Dallas, TX June 15, 1997
Superior Air Conditioning Co., Inc.......... Duncanville, TX May 1, 1997
Stark Services Company, Inc................. Grand Prairie, TX April 1, 1997
Claire's Air Conditioning and Refrigeration,
Inc....................................... Midland, TX April 1, 1997
Claire & Sanders, Inc....................... Wichita Falls, TX April 1, 1997
Royden, Inc................................. Provo, UT April 1, 1997
</TABLE>
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<PAGE> 22
OPERATING STRATEGY
Management believes that successful implementation of the Company's
operating strategy will enable it to establish a national reputation for
superior, high quality service. By developing a national reputation, management
believes the Company will appeal to a large number of customers who are familiar
with and rely upon a large, national company. The Company's operating strategy
incorporates the successful methods developed by CSG and capitalizes on the
operating efficiencies resulting from the integration of the operations of the
Subsidiaries. The key elements of the Company's operating strategy are as
follows:
Providing Superior, High Quality Service in a Professional Manner. The
Service Centers provide high quality service at a competitive price and in a
friendly, professional manner. In order to provide such service, service
technicians, maintenance technicians and installers employed by the Company
complete comprehensive training programs designed to teach employees the
Company's operating procedures. These procedures are described in CSG's training
manuals which provide detailed instructions in areas such as residential
replacement sales, residential installation, preventive maintenance agreements,
service and routine maintenance. The Company has standardized policies and
operating procedures intended to result in a uniform level of professional, high
quality service, including installation and maintenance procedures, drug-testing
of employees, the technician's appearance and the use of "Carpet Saver" shoe
coverings when inside a customer's home. The Service Centers utilize a flat rate
billing system that advises the customer of the cost of service before work
begins and charges the quoted price regardless of the actual time necessary to
repair the system. The Service Centers are generally open for business from 8:00
a.m. to 8:00 p.m. on weekdays, and most are open on Saturday from 8:00 a.m. to
4:00 p.m. Management believes that by providing evening and Saturday service, in
addition to 24 hour emergency service, the Service Centers are able to better
accommodate customers than most of its competitors.
Increasing Revenue at Service Centers. The Company actively promotes its
maintenance agreements to both new and existing customers. See "Service
Centers -- Maintenance and Service Agreements." The sale of maintenance
agreements not only generates recurring revenue through the payment of fees, but
also helps the Company develop a committed, loyal customer base and provides the
opportunity for cross-marketing of the Company's other services and products.
The Company offers a wide assortment of financing packages designed to enable
customers to purchase equipment and services from the Company in the most
convenient and cost-effective manner possible. Certain Service Centers also
offer their customers a Professional Courtesy(TM) credit card solely for use in
purchasing equipment and services from the Company. This financing, including
the Professional Courtesy credit card, is offered through a number of third
party lenders. Pursuant to its arrangements with such financing companies, the
Company receives an origination fee based on the amount financed, but does not
bear any credit risk from such financing.
The Service Centers utilize a variety of local print advertising and
targeted marketing promotions designed by CSG, including maintenance technician
referrals, service technician referrals, yellow page advertising and direct mail
campaigns followed up by telemarketing. During the off-peak spring and fall
months, the Service Centers aggressively market products and services which
generate revenue during such months and help to offset increased demand
historically experienced in the summer and winter months. Management believes
that these marketing efforts will result in increased business for its Service
Centers. In 1996, advertising and marketing expenditures (net of marketing
expenditures by manufacturers) were 3.4% as a percentage of the Company's net
revenue.
The Company's Service Centers offer a number of services and products that
are not available from most HVAC contractors. Indoor air quality ("IAQ") has
become an increasingly popular and profitable segment of the industry. According
to industry sources, the market for IAQ products and services in the United
States was estimated to be $1.8 billion in 1994 and is expected to double by the
year 2000 as public awareness of indoor air pollution, which the U.S.
Environmental Protection Agency now ranks as one of the top five environmental
health threats, continues to grow. As technology has improved, HVAC businesses
have begun to utilize equipment that monitors the levels of certain harmful
substances in the air of a customer's home. The Company offers and actively
promotes a variety of IAQ services designed to detect and correct unhealthy air
quality. Among these services are duct cleaning, fresh air ventilation and heat
recovery systems, ultraviolet light processes and the sale and installation of
ozonators.
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<PAGE> 23
Achieving Operating Efficiencies. Manufacturers of HVAC equipment have
historically offered more favorable prices and rebates to high volume
purchasers. Management is currently discussing purchase terms for HVAC equipment
with certain manufacturers on a national basis. Management believes that the
Company will be able to increase the discounts and rebates previously available
to the individual Service Centers. Since the IPO, the Company has achieved
increased operating efficiencies by consolidating certain functions at the
corporate level, including the purchase of insurance, the provision of legal
support and the utilization of corporate trainers in the areas of marketing and
IAQ. The Company intends to review the desirability of consolidating other
functions at the corporate level, including the purchasing and leasing of
service vehicles and national marketing. A portion of any operating efficiencies
will be offset by increased general and administrative expenses at the Company's
corporate headquarters.
Since the IPO, the Company has implemented a uniform system of budgets,
forecasts, reports and financial controls, including a uniform general ledger
system and electronic mail system, for its Service Centers. In addition, each of
the Service Centers generates and provides to the Company a daily management
report of revenue and expense information and certain billing and collection
data. The Company uses this information to prepare and provide to each Service
Center monthly and quarterly comparative financial data, which enable each
Service Center to track and compare its performance with the other Service
Centers.
Attracting and Retaining Quality Employees. Management believes the
Service Centers attract and retain quality employees by providing (i) an
environment that emphasizes professionalism and customer satisfaction, (ii)
extensive training that allows employees to advance to higher-earning positions
and (iii) stability of income because the Service Centers do not experience the
cyclical lay-offs typically found in the HVAC industry. The Company has
established a cash bonus program for each Service Center pursuant to which
managers may earn bonuses based on the performance of the Service Center and the
Company relative to established goals set by the Service Center's president and
the Company. The Service Centers generally are operated by managers who are
trained in the CSG operating methods and procedures and who management believes
are better educated than a typical HVAC service business operator.
Potential employees of most Service Centers must pass extensive interviews
and background checks, where permitted, as well as technical tests prior to
being hired. Service technicians, maintenance technicians and installers
employed by the Company are required to complete training programs designed to
teach employees the Company's operating procedures. These training programs are
conducted both at the Service Centers and at CSG sponsored seminars. Since the
IPO, the Company has implemented training programs relating to marketing and IAQ
products that are conducted at Service Centers by the Company's corporate
trainers. Management believes that these policies have resulted in a low rate of
employee turnover. See "Contractor Success Group."
CONTRACTOR SUCCESS GROUP
CSG, a wholly-owned subsidiary of the Company, was formed in 1991 to offer
HVAC companies proprietary products and marketing, management, educational and
advisory services not available from industry trade associations. Currently,
there are approximately 270 members of CSG serving distinct market areas in the
United States and Canada defined primarily by zip codes. CSG offers its members
a competitive edge over other contractors in the market by providing useful
management and technical skills, training programs and proprietary products. In
exchange, CSG members pay an initial fee upon joining CSG and a quarterly fee
thereafter. In 1996, CSG collected fees totaling approximately $3.4 million. CSG
members are granted exclusive rights to the territory in which they operate. The
Company intends to continue to build and expand the membership of CSG.
CSG licenses to its members copyrighted training manuals that cover in
specific detail the aspects of owning and operating an HVAC service and
replacement company, including residential replacement sales, residential
maintenance, service contracts, residential installation, business planning and
service dispatch. In addition, CSG members receive materials containing, and
attend conferences discussing, methods and procedures to operate an efficient,
profitable company, including (i) daily report forms designed to provide
accurate and timely sales and cost information essential to determining the
performance of an HVAC business, (ii) "Scorecard," a monthly report distributed
to CSG members comparing top producers among members, (iii) contracts and forms,
including non-competition agreements for employees, sales and service contracts,
(iv) marketing promotions that are tested
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<PAGE> 24
and proven with specific instructions on how to tailor advertising for the
member's market and (v) quarterly projects introducing to CSG members new
products and services designed to increase productivity.
Seminars and Services
Potential CSG subscribers are invited to attend an informational seminar at
CSG's facility in St. Louis, Missouri where they are introduced to the CSG
concept and are invited to join the organization. Upon paying the initial fee,
CSG subscribers attend "Boot Camp" which is an intensive four-day workshop
conducted by CSG three times each year. At Boot Camp, HVAC contractors are
educated on all aspects of operating an HVAC service and replacement business.
Attendees receive presentations and materials that explain in specific detail
the methods and procedures successfully utilized by CSG members. Topics covered
include administration, sales, service, advertising, direct marketing,
maintenance, service contracts, acquisitions and accounting. CSG members may
also attend "Success Convention," which is a quarterly two-day convention of CSG
members designed to allow the members to compare ideas and projects and at which
quarterly projects are presented, and "Sales Extravaganza," which is an annual
convention designed to encourage and motivate a member's salespeople, selling
technicians and telemarketers.
Future University
In connection with the acquisition of its Service Centers, the Company has
acquired approximately 37% of the issued and outstanding Common Stock of Future
University, Inc. ("Future University(R)"). The remaining shares of Future
University's Common Stock are held by a number of CSG members and their
shareholders. Future University is a corporation formed in 1991 that offers to
CSG members for an additional enrollment fee technical and operational
educational programs designed to improve the profitability of the CSG member's
business. The technical programs offer installers and technicians a combination
of classroom and on-the-job-training during one and two week sessions.
Technicians receive skills training that will enable them to effectively analyze
customer problems and offer efficient solutions. In the maintenance training
classes, for example, technicians are trained to maximize the operating
efficiency of HVAC systems, assure safe operation of systems and reduce the
chances of future breakdowns. In the sales training classes, technicians are
trained to deal with customer expectations, use and promote various products and
services, develop leads, explain financing programs and improve on various
customer relations skills. In sending technicians to the Future University
program, CSG members are able to develop a high level of commitment in their
employees. The technical programs are held in Little Rock, Arkansas under an
exclusive licensing arrangement with Hardwick Air Masters, Inc., one of the
Company's Subsidiaries. Pursuant to the current licensing arrangement, Hardwick
Air Masters, Inc. receives 70% of the revenue from the technical programs and
Future University receives 30% of such revenue. The operational programs offer
to general managers and salespeople a variety of classes covering residential
sales training, replacement sales, marketing and promotions, telemarketing and
general operations. These programs are held in Houston, Texas.
Management believes that Future University is the only comprehensive
training school for management, salespeople, installers and technicians in the
residential HVAC industry. Since 1994, over 1,000 students per year have
completed Future University's technical and operational training programs.
SERVICE CENTERS
General
Management estimates that during 1996 the Service Centers' service and
maintenance technicians responded to over 350,000 maintenance, repair and
service calls. The services offered by each Service Center include (i) the sale
of replacement central air conditioners, furnaces and heat pumps, (ii) the
maintenance and repair of HVAC units, (iii) diagnostic analysis of the condition
of existing unit and (iv) the sale of ancillary products such as IAQ devices and
monitors. Most of the Service Centers employ an in-house sales force that sells
replacement units, installation technicians who install replacement equipment in
existing homes, service technicians who service and maintain the equipment, and
an administrative staff to perform dispatching, purchasing and other
administrative functions. In addition, some of the Service Centers offer
plumbing services. Management believes that in 1996 the installation and
servicing of plumbing systems represented less than 1% of
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<PAGE> 25
the Company's pro forma net revenue. The Company anticipates that these Service
Centers will continue to offer, and that Service Centers acquired in the future
may offer, plumbing services, but currently does not intend to expand this
business.
All of the Service Centers' technicians are trained to promote the
Company's preventive maintenance agreements, and many technicians are trained to
cross-market IAQ equipment and other ancillary services and products offered by
the Company. Service technicians are trained to perform service and maintenance
in a professional manner, to identify problems with existing HVAC systems and to
offer customers the most practical, cost-effective solution to their problem,
whether that involves repairing the existing system or suggesting a replacement
system or part. Often this involves providing customers with information on
products to upgrade their system and improve efficiency as well as informing
them about the advantages and disadvantages of a particular product or service.
Maintenance technicians perform routine maintenance examinations of HVAC systems
in an effort to keep the systems in working order and to identify potential
problems before they become too costly to correct.
Management believes that most HVAC contractors charge the cost of the
materials and the hourly rate for the actual time it takes to install or repair
the system. In contrast, the Company utilizes a flat rate pricing system that
advises the customer of the cost of service for the particular job before work
begins and charges the quoted price regardless of the time necessary to repair
the system. While this may result in parts, labor and other costs incurred in
repairing a customer's system exceeding the quoted price from time to time, the
Company is able to alter its pricing on a per job basis. The Company's
experience is that customers generally prefer this pricing method because it
eliminates surprise or hidden costs. This pricing method also creates an
incentive for the Company to hire quality technicians and to provide them with
the training necessary to service customer needs efficiently.
Sale of Replacement Units
The replacement market for residential HVAC equipment is dependent upon the
base of installed units, the mechanical life and usage of the equipment and
technological advances in the efficiency of newer units. Management believes the
replacement market for HVAC units offers the potential for high growth and
profitability in the future given the potential number of HVAC systems that will
need replacement in the coming years and the Company's ability to effectively
service that need. The market for replacement units is highly fragmented, with
no single manufacturer dominating the market. In order to service the
replacement market, the Company maintains relationships with several national,
regional and local manufacturers of replacement units in order to offer a wide
variety of products to its customers. The Company is not dependent on any
manufacturers or distributors of replacement units, but rather has access to
products from all over the country allowing the Company to offer products that
its competition may be unable to provide.
At the time of sale, a customer is offered a wide assortment of financing
packages by the Service Center. A Service Center's installers and technicians,
in addition to the salespeople, are trained to educate customers as to the
financing options available, assist the customer in completing the credit
application forms and determine whether the customer's financing is approved.
The Company also offers its customers a Professional Courtesy credit card solely
for use in purchasing equipment and services from the Company. Such financing,
including the Professional Courtesy credit card, is offered through a number of
third party lenders. Pursuant to its arrangements with such financing companies,
the Company receives an origination fee based on the amount financed, but does
not bear any credit risk from such financing.
Maintenance and Service Agreements
Management estimates that the Company currently has approximately 70,000
maintenance agreements with customers. These agreements are for a term of one to
three years and generally provide for two diagnostic and precision maintenance
visits during the year at an average cost to the customer of approximately $135
per year. The sale of maintenance agreements not only generates recurring
revenue through the payment of fees, but also helps the Company develop a
committed, loyal customer base and provides the opportunity for cross-marketing
of the Company's other services and products. Management believes that customers
with maintenance agreements are the Company's most satisfied customers because
of the many benefits offered by these
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agreements, including (i) energy savings resulting from a more efficient HVAC
system, (ii) fewer and less costly emergency repairs, (iii) longer useful life
for the HVAC system, (iv) discounted rates for service and (v) guaranteed
same-day service in the event of an emergency repair. Maintenance agreements
also allow the Company to more fully utilize its technicians during the
historically slower spring and fall months by scheduling maintenance
appointments during such time. Because systems under maintenance agreements are
less likely to require emergency repairs, the Service Centers are able to
provide more prompt service to emergency and new service calls.
The Company's service agreements are generally for a term of one year and
provide for the repair of any problem with the customer's system at no
additional cost to the customer. Pursuant to the terms of the service
agreements, if the cost of repair exceeds the value of the customer's HVAC
system, the Company is not required to repair the system and the customer
receives a $300 discount if he purchases a replacement unit from the Company. In
some states, certain warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies thereby subjecting the Company and the service agreements to the
insurance laws and regulations of any such state. In such states, the Company
will insure its service agreements through licensed insurers or otherwise comply
with applicable laws and regulations. Management believes that the Company has
made adequate provision for potential claims under these agreements. See
"Regulation."
Commercial Service and Replacement
Some of the Service Centers offer HVAC services to small and medium-sized
businesses. In 1996, revenues generated from the provision of services and sale
of products to commercial customers represented less than 20% of the Company's
pro forma net revenue. The Service Centers target restaurants, small office
buildings, warehouses and theaters as potential prospects for its commercial
services. The Company's commercial sales representatives receive extensive
training designed to enable the representatives to promote the Company's
services and products effectively. The services offered to commercial customers
are generally the same as services offered to residential customers, including
the analysis, maintenance and repair of existing HVAC systems, the sale of
replacement systems and the sale of ancillary products, including IAQ devices
and services. While management does not plan to further develop its commercial
HVAC business beyond existing operations given the potential for growth in the
residential service and replacement market, the Company intends to continue to
provide, and may acquire Service Centers that provide, commercial HVAC services.
SERVICES AND OPERATIONS
The Company provides management, financial and accounting services for all
of the Service Centers' operations, as well as insurance and certain marketing
and legal support. Management provides certain financial control support,
including budgets, forecasts and reports, while allowing each general manager of
a Service Center to manage its day-to-day operations.
Since the IPO, the Company has added various corporate management and staff
personnel including three regional vice presidents, a controller, a human
resources manager, a management information systems director, a general counsel,
a regional accountant, two staff accountants and two corporate trainers.
In order to better organize its corporate support structure, the Company
has divided its Service Centers into three regions. Each Service Center in a
region reports directly to a regional vice president. In addition, the Company
intends to appoint area presidents who will coordinate various functions among
groups of Service Centers located in the same geographic area while continuing
to operate as president of a Service Center. These individuals will report to
their respective regional vice presidents.
The Company provides the following services:
Purchasing
Each Service Center generally purchases the HVAC units, parts and supplies
it uses from distributors. Because of the number of Service Centers operated by
the Company, management believes that it will be able to
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<PAGE> 27
negotiate at a lower cost the purchase of these items. The principal
manufacturers of the products sold by the Company include The Trane Company,
Carrier Air Conditioning, Inc., Lennox Industries, Inc. and Rheem Manufacturing
Company. The Service Centers generally order equipment only upon receipt of a
contract for purchase from a customer, enabling them to maintain low inventory.
Management Information Systems
The Service Centers currently utilize various compatible management and
financial information systems. The Company intends to convert the Service
Centers' current systems to an integrated system within the next 12 months. The
Company has recently implemented a general ledger system utilizing SuccessWare
software at each of its Service Centers. See "Certain Transactions." The
implementation of an integrated system will allow the Company to maintain
greater control over the operations of its Service Centers. The Company tracks
important data related to the Service Centers' operations and financial
performance and monitors all advertising expenditures. In addition, the Service
Centers generate and provide to the Company a daily management report of revenue
and expense information and certain billing and collection data. The Company
uses such information to prepare and provide to each Service Center monthly and
quarterly comparative financial data, which enable each Service Center to track
and compare its performance with the other Service Centers.
Employee Screening and Training
Prior to employment, potential employees of the Company are tested to
determine their technical expertise. In addition, as permitted by local law,
employees of the Company are required to pass a drug test prior to employment
and are thereafter subject to random drug testing. Failure to take or pass a
drug test results in immediate termination of employment. Once hired, employees
of the Company generally complete various training programs covering technical
skills and communication and sales techniques. In addition, employees
periodically attend educational seminars and conventions conducted by CSG. See
"Contractor Success Group." The Company has recently established training
programs relating to marketing and IAQ products that are conducted at the
Company's Service Centers by two corporate trainers.
Advertising and Marketing
The Company's advertising and marketing programs are designed to attract
new customers and to stimulate increased demand from existing customers. Each
Service Center, utilizing materials produced by CSG, develops customized
marketing programs tailored to meet the needs of its local customer base.
Emphasizing superior, high quality service, the Service Centers market directly
to prospective and existing customers through various means, including local
print advertising, yellow page advertising and direct mail campaigns followed up
by telemarketing. In 1996, advertising and marketing expenditures (net of
marketing expenditures by manufacturers) were 3.4% as a percentage of the
Company's net revenue. The Company intends, over time, to develop the Service
Experts name as a key element of its marketing strategy. As a part of this
strategy, management intends gradually to integrate the Company's name and logo
in advertising while continuing to utilize established local brand names.
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, relating to minimum energy efficiency standards of HVAC systems and the
production, servicing and disposal of certain ozone depleting refrigerants used
in such systems. In connection with the entry into new markets, the Company may
become subject to compliance with additional regulations. Although, there can be
no assurance that the regulatory environment in which the Company operates will
not change significantly in the future, compliance with existing regulatory
requirements has not had a material effect on the Company.
Various local, state and federal laws and regulations, including, but not
limited to, laws and regulations implementing the Clean Air Act, impose
licensing standards on technicians who service heating and air conditioning
units. While the installers and technicians employed by the Service Centers are
duly certified by
26
<PAGE> 28
applicable local, state and federal agencies and have been able to meet or
exceed such standards to date, there can be no assurance that they will be able
to meet stricter future standards. In addition, installers must comply with
local building codes when installing HVAC units in residences and commercial
buildings.
In some states, warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies thereby subjecting the Company and the service agreements to the
insurance laws and regulations of any such state.
TRADEMARKS
"Service Experts" is registered as a federal trademark with the United
States Patent and Trademark Office. The Company currently licenses the Service
Experts name and logo to two companies that are members of CSG. The Company owns
and licenses numerous proprietary products used by the Service Centers and other
CSG members. See "Contractor Success Group." In addition, the Company owns
approximately 37% of the issued and outstanding common stock of "Future
University," which is registered as a federal trademark with the United States
Patent and Trademark Office. See "Contractor Success Group -- Future
University." The Company regards its trademarks as having significant value and
being an important factor in the development and marketing of its operations.
The Company's policy is to pursue registration of its trademarks whenever
possible and to oppose vigorously any infringement of its trademarks.
COMPETITION
The HVAC service and replacement industry is highly competitive in each of
the markets in which the Company operates. The Company's Service Centers compete
with utility companies and other full-service HVAC businesses primarily on the
basis of quality, reliability, customer service and price. Some of these
companies have access to capital, personnel, marketing and technological
resources that are equal to or greater than those of the Company. Because of the
fragmented nature of the industry and relative low barriers to entry, additional
competitors, including companies that offer other home improvement services in
addition to HVAC services, may emerge that have greater access than the Company
to capital, personnel and technological resources. Certain of these companies
are pursuing a consolidation strategy in the industry and compete with the
Company for potential acquisitions as well as for customers.
EMPLOYEES
Management estimates that the Company has approximately 1,700 employees,
all but approximately 20 of which are employed at Service Centers. None of the
Company's employees is represented by a collective bargaining agreement.
PROPERTIES
The Company currently occupies the building and underlying real estate on
which all but two of its Service Centers are located pursuant to leases with
terms generally ranging from five to ten years on terms the Company believes to
be commercially reasonable. Total rental expense for the Company's leased
centers, including certain leased vehicles and equipment, in 1996 was
approximately $490,000 and is expected to be approximately $2.4 million in 1997.
In connection with the acquisition of Roland J. Down, Inc., the Company
purchased the building and underlying real estate on which the Service Center is
located for approximately $1.6 million in cash. In connection with the
acquisition of ProAir Services, L.P., the Company purchased the building and
underlying real estate on which the Service Center in Dallas, Texas is located.
The Company generally plans to continue to lease rather than purchase space for
the Service Centers to maximize the Company's available capital.
The Company's corporate headquarters are located in approximately 6,580
square feet of space in Brentwood, Tennessee. The remaining term of the lease on
this office space is approximately five years, and the Company pays annual rent
of $115,200. The Company also maintains an office in approximately 3,600 square
feet of office space leased in Chesterfield, Missouri. The remaining term of the
lease on this office space is approximately five months, and the Company pays
annual rent of approximately $60,000.
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<PAGE> 29
INSURANCE
The Company maintains general liability, workers compensation and property
insurance. The costs of insurance coverage varies, and the availability of
certain coverage has fluctuated in recent years. As of February 1, 1997, the
Company consolidated the purchase of insurance for its operations under a single
policy, excluding major medical insurance. This coverage will result in savings
from the amounts previously paid by the Subsidiaries. While management believes,
based upon its claims experience, that the Company's present insurance coverage
is adequate for its current operations, there can be no assurance that the
coverage is sufficient for all future claims or will continue to be available in
adequate amounts or at reasonable rates.
LEGAL PROCEEDINGS
The Company does not have pending any litigation that, separately or in the
aggregate, if adversely determined, would have a material adverse effect on the
Company. The Company and its Subsidiaries may, from time to time, be parties to
litigation or administrative proceedings which arise in the normal course of
their businesses.
THE PENDING ACQUISITIONS
OVERVIEW
The Company has entered into agreements in principle to acquire 12 HVAC
businesses (the "Combining Companies"). The Company plans to enter into an
Agreement and Plan of Merger (the "Merger Agreements") with seven Combining
Companies pursuant to which such Combining Companies will be merged with wholly-
owned subsidiaries of the Company. The Company plans to enter into a Stock
Purchase Agreement (the "Stock Purchase Agreements") with five Combining
Companies pursuant to which the Company will acquire all of the issued and
outstanding capital stock of such Combining Companies (the Merger Agreements and
the Stock Purchase Agreements are hereinafter referred to collectively as the
"Agreements").
Pursuant to the terms of the Merger Agreements, the shares of capital stock
of the Combining Companies outstanding immediately prior to the closing, other
than treasury shares and shares held by dissenting stockholders, will be
converted into the right to receive shares of Common Stock and cash. Pursuant to
the terms of the Stock Purchase Agreements, the Company will acquire all of the
issued and outstanding capital stock of the Combining Companies in exchange for
shares of Common Stock and cash.
The aggregate consideration to be paid by the Company in connection with
the Pending Acquisitions is estimated to be approximately $25.2 million,
consisting of shares of Common Stock and cash. In general, the purchase price to
be paid to the stockholders of each of the Combining Companies is based on the
Combining Company's after tax net income for its most recent fiscal year or such
other 12 month period as agreed to by the parties (the "Valuation Period"),
adjusted to exclude all nonrecurring income and expense and to include (i) all
adjustments necessary to present rents at market, (ii) such adjustments to
salary as are agreed to by the parties, (iii) all adjustments necessary to give
effect to federal and state income taxes as if a Combining Company that is not a
C corporation had been a C corporation during the year, and (iv) certain other
adjustments agreed to by the parties.
In certain of the Pending Acquisitions, a portion of the consideration to
be paid by the Company to the stockholders of a Combining Company is contingent
upon the future performance of the Combining Company. In such transactions, the
Combining Company may be paid all or part of the contingent consideration based
upon certain predetermined performance goals, provided those goals are met.
Generally, this earn-out period is for the 12 month period beginning on the
first day of the month following the acquisition of the Combining Company or
beginning on the first day of the Combining Company's fiscal year.
Prior to the acquisition of a Combining Company, the Company will make an
initial adjustment to the purchase price based on the difference between the
Combining Company's net income for the Valuation Period, as presented in the
Combining Company's financial statements for such period, with such adjustments
as set forth above, and the Combining Company's net income for the Valuation
Period, as presented in the Final Valuation
28
<PAGE> 30
Statement (as defined in the Agreements). Promptly following the acquisition of
a Combining Company, final adjustments to the purchase price for each Combining
Company will be made based on a Closing Balance Sheet (as defined in the
Agreements). Generally, the consideration to be paid by the Company will be
reduced by (i) the amount of outstanding indebtedness of a Combining Company at
the time of the closing, other than indebtedness incurred subsequent to the
Valuation Period for the purchase of fixed assets, and (ii) in the case of any
stockholder, the amount of any indebtedness of such stockholder payable to the
Combining Company at the time of closing.
The consideration to be paid to each Combining Company was determined
through arm's length negotiations between the parties. The terms of the
Agreements entered into by the Combining Companies are substantially the same,
including the procedures used to determine the consideration to be paid to each
Combining Company, based on the adjusted net income of the Combining Company.
The factors considered by the Company in determining the consideration to be
paid included, among others, the historical operating results, the net worth,
the levels and type of indebtedness and the future prospects of each of the
Combining Companies.
The Pending Acquisitions, in addition to increasing the Company's presence
in certain existing markets, will expand the geographic coverage of the Company
by providing entry to the Iowa, Nebraska, Pennsylvania and West Virginia
markets. Upon completion of the Pending Acquisitions, the Company will operate
52 Service Centers in 24 states.
THE AGREEMENTS
Representations and Warranties of the Combining Companies
Each of the Agreements contains customary representations and warranties
relating to, among other things, due organization and good standing of the
Combining Company, good and marketable title to the shares of capital stock of
the Combining Company, the absence of preemptive rights, the absence of any
options, warrants or other rights to acquire the stock of the Combining Company,
good and marketable title to all of the Combining Company's assets, adequate
insurance, the accuracy of the Combining Company's financial statements, the
absence of litigation and compliance with applicable laws.
Common Stock Issued to Affiliates
Certain stockholders of the Combining Companies may be deemed to be
"affiliates" for purposes of Rule 145 of the Securities Act. Pursuant to the
Agreements, the Combining Companies acknowledge and agree with respect to each
person who is deemed to be an affiliate that (i) the Common Stock issuable to
such person will be held pursuant to the provisions of the Securities Act and
the rules and regulations thereunder, (ii) no sale or disposition of such shares
of Common Stock will be made except pursuant to the terms of the Registration
Statement, the Securities Act and Rule 145(d) thereunder, and (iii) the
certificates representing the Common Stock issued to such person will bear a
restrictive legend setting forth the restrictions on transfer referred to above.
Indemnification
Pursuant to the terms of the Agreements, each Combining Company agrees to
indemnify and hold harmless the Company and its officers, directors, employees
or agents thereof against any and all claims, losses, damages, liabilities and
expenses, including reasonable attorney's fees, suffered because of (i) the
untruth, inaccuracy, misrepresentation, omission, or breach or nonfulfillment by
the Combining Company of any representation, warranty, covenant or other
agreement contained in the Agreement or (ii) any untrue statement of a material
fact relating to the Combining Company that is contained in any preliminary
prospectus, the Registration Statement or any prospectus forming a part thereof,
or any amendment thereof or supplement thereto, or any omission to state therein
a material fact relating to the Combining Company required to be stated therein
or necessary to make such statements therein not misleading.
Pursuant to indemnification agreements ("Indemnification Agreements") to be
entered into between the stockholders of the Combining Companies and the
Company, the stockholders of the Combining Companies will
29
<PAGE> 31
agree to indemnify and hold harmless the Company and its officers, directors,
employees and agents thereof against any and all claims, losses, damages,
liabilities and expenses, including reasonable attorney's fees, suffered because
of (i) the untruth, inaccuracy, misrepresentation, omission, or breach or
nonfulfillment by the Combining Company of any representation, warranty,
covenant or other agreement contained in the Agreement, (ii) any untrue
statement of a material fact relating to the Combining Company that is contained
in any preliminary prospectus, the Registration Statement or any prospectus
forming a part thereof, or any amendment thereof or supplement thereto, or any
omission to state therein a material fact relating to the Combining Company
required to be stated therein or necessary to make such statements therein not
misleading, (iii) any and all amounts of federal, state and/or local income,
franchise, property and/or sales and use taxes that may be assessed against the
Company with respect to any taxable period ending on or before the date of the
Agreement, for which adequate provisions therefor have not been made through the
date of closing, and the amount of any interest and/or penalties relating to
such tax assessments or (iv) any claim or demand by any person asserting any
interest in any share of capital stock of the Combining Company. Each Combining
Company and its stockholders have indemnification obligations only to the extent
that the aggregate of all indemnifiable claims, losses, damages, liabilities and
expenses, including reasonable attorney's fees, for such Combining Company or
stockholder exceeds $25,000.
The Company agrees to indemnify, defend and hold harmless each of the
stockholders of the Combining Companies against any and all claims, losses,
damages, liabilities and expenses, including reasonable attorney's fees,
suffered because of (i) the untruth, inaccuracy, misrepresentation, omission,
breach or nonfulfillment by the Company of any representation, warranty,
covenant or other agreement contained in the Agreements or (ii) any untrue
statement of a material fact relating to the Company that is contained in the
preliminary prospectus, the Registration Statement or any prospectus forming a
part thereof, or any amendment thereof or supplement thereto, or arising out of
or based on any omission or alleged omission to state therein a material fact
relating to the Company required to be stated therein or necessary to make the
statements therein not misleading.
Employment Agreements and Covenants Not to Compete
In connection with the Pending Acquisitions, the president and/or general
manager of each Combining Company will enter into an employment agreement with
the Company. The annual salaries pursuant to such agreements are expected to
range from $45,000 to $150,000 based upon the size of the HVAC company and the
duties of the president/general manager. In addition, each president/general
manager will be eligible for cash bonuses based on the performance of his
service center and the Company relative to established goals set by the
president/general manager and the Company. Most employment agreements will have
a term of two years and generally provide, among other things, that such
employee will not compete with the Company during the term of such employment
and for a period of two years thereafter within 50 miles of any Service Center.
Escrow Agreement
Pursuant to the terms of the Agreements, each of the stockholders of the
Combining Companies is required to enter into an escrow agreement (the "Escrow
Agreement") with the Company and an escrow agent to be selected by the Company
(the "Escrow Agent"). Each Escrow Agreement provides that the stockholders of a
Combining Company will deliver to the Escrow Agent stock certificates or cash,
as the case may be (the "Escrow Funds"), representing 10% of the purchase price
paid to such stockholders. Under the terms of the Escrow Agreement, the Escrow
Agent will hold the Escrow Funds for a period of one year commencing upon
consummation of the Pending Acquisition, and during such period, the Company
will be entitled to receive reimbursement and recovery from the Escrow Funds for
any loss, liability, damage or expense for which the Company is indemnified
under the Agreement or for any reduction in purchase price after the closing.
The Escrow Funds will not be the Company's exclusive remedy in the event of such
loss, liability, damage, expense or reduction. During the period stock
certificates are held by the Escrow Agent, the stockholders of the Combining
Companies will be entitled to receive any dividends paid on, and have the right
to vote, such stock.
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<PAGE> 32
Lockup Agreement
Pursuant to the terms of the Agreements, certain stockholders of the
Combining Companies who receive shares of Common Stock as consideration will be
required to enter into a lockup agreement (the "Lockup Agreement") with the
Company. The Lockup Agreements generally provide that the stockholders of a
Combining Company will not sell, offer to sell, grant any option for the sale
of, or otherwise dispose of any shares of Common Stock, any options, rights or
warrants to purchase any shares of Common Stock, or any other securities
convertible into or exchangeable for shares of Common Stock owned directly by
such stockholder or with respect to which he has the power of disposition, for a
period of six months following the effective time of the Pending Acquisition,
without the prior written consent of the Company. Beginning six months after the
acquisition of a Combining Company, the stockholders of the Combining Company
will be entitled to sell or otherwise dispose of up to 25% of the shares of
Common Stock held by such stockholder, and an additional 25% of the shares of
Common Stock held by such stockholder during each of the three successive six
month periods until the twenty-fourth month following the acquisition of a
Combining Company, at which time such stockholder will be entitled to sell all
shares of Common Stock held by such stockholder.
Conditions Precedent to Closing of the Agreements
The obligation of the Company to consummate each Pending Acquisition is
subject to certain conditions, including a satisfactory due diligence review of
the operations and financial condition of the Combining Company, delivery of the
schedules to the Agreement and a satisfactory review thereof, the stockholders
of the Combining Company having good and marketable title, free and clear of any
material liens, encumbrances or restrictions, to the capital stock of such
Combining Company, the Combining Company's audited financial statements
complying in all material respects with all applicable accounting requirements
and being fairly presented in conformity with generally accepted accounting
principles, delivery of a favorable opinion of counsel to the stockholders of
the Combining Company, the receipt of all necessary consents, the execution of
Lockup Agreements, Indemnification Agreements and Escrow Agreements by the
stockholders of the Combining Company, the approval of the transaction by the
Company's board of directors and the effectiveness of the Registration
Statement. The obligation of a Combining Company and its stockholders to
consummate an acquisition is subject to certain conditions, including the
approval of the transaction by the stockholders of the Combining Company, the
accuracy of the representations and warranties of the Company contained in the
Agreement and delivery of a favorable opinion of counsel to the Company.
Expenses
Each of the Agreements provides that each of the parties shall bear its
respective expenses incurred in connection with the preparation, execution and
performance of the Agreement and the transactions contemplated therein, provided
that the Company will reimburse each of the Combining Companies for fees paid by
it for professional accounting services upon closing.
ACCOUNTING TREATMENT
The Company expects to account for all of the Pending Acquisitions pursuant
to the purchase method of accounting. One effect of such accounting treatment is
that the earnings of such Combining Companies will be combined with the earnings
of the Company only from and after the closing of such Pending Acquisitions.
Furthermore, the earnings of such Combining Companies will, for purposes of the
earnings or losses of the Company, be reduced by certain depreciation and
amortization changes arising out of purchase accounting adjustments.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
The table below sets forth certain information concerning each of the
executive officers, directors and other key employees of the Company.
<TABLE>
<CAPTION>
EXECUTIVE OFFICERS AND DIRECTORS AGE POSITION
- -------------------------------- --- --------
<S> <C> <C>
Alan R. Sielbeck.......................... 44 Chairman of the Board and Chief Executive Officer
James D. Abrams........................... 49 President, Chief Operating Officer and Director
Anthony M. Schofield...................... 43 Chief Financial Officer, Secretary and Treasurer
Raymond J. De Riggi(1).................... 49 Director
Timothy G. Wallace(1)(2).................. 39 Director
William G. Roth(2)........................ 58 Director
Norman T. Rolf, Jr........................ 50 Director
<CAPTION>
OTHER KEY EMPLOYEES
- ------------------------------------------
<S> <C> <C>
Louis N. Laderman......................... 46 Vice President and General Counsel
Robert E. Reece........................... 41 Regional Vice President
Michael S. Robinson....................... 36 Regional Vice President
Peter J. Zabaski.......................... 48 Regional Vice President
</TABLE>
- ---------------
(1) Member of the Audit Committee.
(2) Member of the Compensation Committee.
The Company's Board of Directors is divided into three classes, each
consisting of two members. At each annual stockholders meeting, directors of one
class are elected to three year terms. The terms of Messrs. Abrams and Roth
expire in 1998, Messrs. Sielbeck and Wallace in 1999 and Messrs. De Riggi and
Rolf in 2000. See "Description of Capital Stock -- Anti-Takeover Provisions."
Alan R. Sielbeck has served as Chairman of the Board and Chief Executive
Officer of the Company since its inception in March 1996. Mr. Sielbeck has
served as Chairman of the Board and President of AC Service and Installation
Co., Inc. and Donelson Air Conditioning Company, Inc., each a Subsidiary, since
1990 and 1991, respectively. From 1985 to 1990, Mr. Sielbeck served as President
of RC Mathews Contractor, Inc., a commercial building general contractor, and
Chief Financial Officer of RCM Interests, Inc., a commercial real estate
developing company.
James D. Abrams has served as President, Chief Operating Officer and as a
director of the Company since its inception in March 1996. From 1990 to 1996,
Mr. Abrams served as Chief Executive Officer and a director of CSG. Mr. Abrams
has served as President of Air Experts and Service Experts of Palm Springs,
Inc., each a Subsidiary, since 1993. Mr. Abrams has served as President and sole
director of Air Comfort Services, Inc., an HVAC service and replacement business
located in Sarasota, Florida, since 1988. Mr. Abrams served, from 1992 to 1996,
as Chairman and President of Service Now, Inc. ("Service Now"), a holding
company that owns several HVAC businesses, and prior to the Combination owned
Air Experts and Service Experts of Palm Springs, Inc. He resigned from his
positions with Service Now prior to the closing of the Combination and the IPO.
Mr. Abrams previously served as Chief Executive Officer and a director of Future
University from 1991 to 1995. Mr. Abrams currently serves on the Advisory Board
of Boatmen's National Bank (Southern Region).
Anthony M. Schofield has served as Chief Financial Officer, Secretary and
Treasurer of the Company since June 1996. From 1982 to 1996, Mr. Schofield
served as Cost Manager, Vice-President-Controller, Senior Vice-President of
Finance, and Division Controller for Perrigo Company of Tennessee, formerly
Cumberland-Swan, Inc., a manufacturer of personal care health and beauty aid
products. Mr. Schofield is certified by the American Institute of Certified
Public Accountants as well as the Institute of Management Accountants holding
both CPA and CMA designations.
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<PAGE> 34
Raymond J. De Riggi has served as a director of the Company since June
1996. Mr. De Riggi has served as President of United Specialty Food Ingredients
Companies, a subsidiary of ConAgra Food Products, a diversified food processing
company, since November 1995. From 1992 to 1995, Mr. De Riggi served as
Executive Vice President of Pet, Incorporated, a diversified food processing
company, and from 1990 to 1992, he served as its Vice President of Operations.
From 1987 to 1990, Mr. De Riggi served as President of Whitman's Chocolates, a
division of Pet, Incorporated.
Timothy G. Wallace has served as a director of the Company since June 1996.
Mr. Wallace has served as Vice President of Finance and Chief Financial Officer
of Healthcare Realty Trust Incorporated, a company operating as a real estate
investment trust, since January 1993. Mr. Wallace was a Senior Manager with
responsibility for healthcare and real estate in the Nashville, Tennessee office
of Ernst & Young LLP from June 1989 to January 1993. Prior to joining Ernst &
Young LLP, he was employed by Arthur Andersen & Co. from September 1980 to June
1989.
William G. Roth has served as a director of the Company since August 1996.
Mr. Roth served as Chairman of the Board of Directors of Dravo Corporation, a
natural resources company that is the largest producer of lime in the United
States, from 1989 to 1994. Mr. Roth also served as Chief Executive of Dravo
Corporation from 1987 to 1989. Prior to that time, Mr. Roth served as President,
Chief Operating Officer and a director of American Standard, Inc., a worldwide
manufacturer of air conditioning, plumbing and transportation system products,
from 1985 to 1987. From 1978 to 1985, Mr. Roth served as Chairman and Chief
Executive Officer of The Trane Company, an international manufacturer and
marketer of HVAC systems. Mr. Roth currently serves as a director of Amcast
Industrial Corporation and Teknowledge Corporation.
Norman T. Rolf, Jr. has served as a director of the Company since August
1996. Since 1988, Mr. Rolf has served as President of Rolf Coal and Fuel Corp.,
a Subsidiary for which he previously served as a director and has been employed
in various positions since 1966.
Louis N. Laderman has served as Vice President and General Counsel of the
Company since January 1997. Since 1996, Mr. Laderman has served as general
counsel of CSG, Service Now, Future University and SuccessWare. From 1986 to
1996, Mr. Laderman practiced law as a member of McCarthy, Leonard, Kaemmerer,
Owen, Laderman & Lamkin, LLC in St. Louis, Missouri.
Robert E. Reece has served as a Regional Vice President of the Company
since January 1997. From 1991 to 1997, Mr. Reece served as Vice President and a
director of Pardee Refrigeration Company Incorporated and Island Air
Conditioning, Inc., each a Subsidiary, and as Secretary and a director of
Sanders Indoor Comfort, Inc., a Subsidiary.
Michael S. Robinson has served as a Regional Vice President of the Company
since January 1997. From 1993 to 1996, Mr. Robinson served as Vice President and
a director of Arrow Heating & Air Conditioning, Inc., a Subsidiary. From 1992 to
1993, Mr. Robinson served as a marketing and sales representative for J. D.
Edwards, Inc., a worldwide provider of financial, distribution and manufacturing
software. Prior to that time, Mr. Robinson served as a marketing and sales
representative for IBM from 1988 to 1992. Mr. Robinson is a certified public
accountant in Illinois.
Peter J. Zabaski has served as a Regional Vice President of the Company
since February 1997. From 1994 to 1997, Mr. Zabaski served as Regional Vice
President of Hughes Supply, Inc., a distributor of industrial products and
supplies. From 1990 to 1994, Mr. Zabaski served as President of One Stop Supply
Inc., a HVAC wholesale supplier and subsidiary of Hughes Supply, Inc.
The Compensation Committee of the Board of Directors is responsible for
establishing salaries, bonuses and other compensation for the Company's
executive officers and administering stock option and other employee benefit
plans of the Company. The Audit Committee is responsible for the annual
appointment of the Company's auditors and reviewing the scope of audit and
non-audit assignments and related fees, accounting principles used by the
Company in financial reporting, internal auditing procedures and the adequacy of
the Company's internal control procedures with the Company's auditors.
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<PAGE> 35
EXECUTIVE COMPENSATION AND OTHER INFORMATION
Summary of Compensation Table. The following table sets forth the total
compensation paid or accrued by the Company for the Company's last completed
fiscal year on behalf of the (i) Company's Chief Executive Officer and (ii) the
two other executive officers of the Company as of the end of 1996:
SUMMARY COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
------------------------------ ----------------------
NAME AND OTHER ANNUAL SECURITIES
PRINCIPAL POSITION YEAR SALARY($) COMPENSATION($)(2) UNDERLYING OPTIONS(#)
- ------------------------------------------- ---- --------- ------------------ ----------------------
<S> <C> <C> <C> <C>
Alan R. Sielbeck........................... 1996 $86,538 -- 40,000
Chairman of the Board and Chief Executive
Officer
James D. Abrams............................ 1996 86,538 -- 40,000
President and Chief Operating Officer
Anthony M. Schofield....................... 1996 58,385 -- 40,000
Chief Financial Officer
</TABLE>
- ---------------
(1) Does not include amounts paid by the Company's Subsidiaries prior to the
Combination in August 1996.
(2) Perquisites and other personal benefits paid to each of the Named Executive
Officers was less than $50,000 or 10% of the total salary and bonus reported
for the Named Executive Officers, and, therefore, the amount of such other
annual compensation is not reported.
Options Granted in Last Fiscal Year
The following table summarizes certain information regarding stock options
issued to the Company's executive officers during 1996. No stock appreciation
rights ("SARs") have been granted by the Company.
OPTION GRANTS IN LAST FISCAL YEAR
<TABLE>
<CAPTION>
POTENTIAL REALIZABLE
INDIVIDUAL GRANTS VALUE AT ASSUMED
----------------------------------------------------------- ANNUAL RATES OF
NUMBER OF PERCENT OF TOTAL STOCK APPRECIATION FOR
SECURITIES OPTIONS GRANTED EXERCISE OPTION TERM
UNDERLYING TO EMPLOYEES IN PRICE EXPIRATION -----------------------
NAME OPTIONS GRANTED FISCAL 1996 ($/SHARE) DATE 5%($) 10%($)
---- --------------- ---------------- --------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Alan R. Sielbeck(1)....... 40,000 7.72% $17.25 9/26/06 $433,937 $1,099,682
James D. Abrams(1)........ 40,000 7.72 17.25 9/26/06 433,937 1,099,682
Anthony M. Schofield(2)... 40,000 7.72 13.00 8/15/06 327,025 828,746
</TABLE>
- ---------------
(1) All options were granted pursuant to the Service Experts, Inc. 1996
Incentive Stock Plan (the "Incentive Plan") and vest in one-third increments
annually beginning September 26, 1998. Potential realizable value is
calculated from a base stock price of $17.25, the exercise price of the
options granted.
(2) All options were granted pursuant to the Incentive Plan and vest in
one-third increments annually beginning August 15, 1998. Potential
realizable value is calculated from a base stock price of $13.00, the
exercise price of the options granted.
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<PAGE> 36
Options Exercised in Last Fiscal Year, Fiscal Year End Option Values
No options were exercised in the year ended December 31, 1996. The
following table summarizes certain information regarding year end option values
of the Company's executive officers.
<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING UNEXERCISED IN-THE-MONEY
OPTIONS HELD AT OPTIONS HELD AT
DECEMBER 31, 1996 DECEMBER 31, 1996($)(1)
--------------------------- ---------------------------
NAME EXERCISABLE UNEXERCISABLE EXERCISABLE UNEXERCISABLE
---- ----------- ------------- ----------- -------------
<S> <C> <C> <C> <C>
Alan R. Sielbeck................................ -- 40,000 -- $350,000
James D. Abrams................................. -- 40,000 -- 350,000
Anthony M. Schofield............................ -- 40,000 -- 520,000
</TABLE>
- ---------------
(1) Reflects the market value of the underlying securities at the closing sales
price reported on the Nasdaq Stock Market's National Market on December 31,
1996 ($26.00), less the exercise price.
EMPLOYMENT AGREEMENTS
Pursuant to employment agreements, effective as of August 21, 1996, Messrs.
Sielbeck, Abrams and Schofield (the "executive officers") are employed as
executive officers of the Company. The employment agreements of Messrs.
Sielbeck, Abrams and Schofield provide for annual base salaries of $250,000,
$250,000 and $110,000, respectively, which salaries are subject to annual review
by the Compensation Committee, and bonuses, which amounts will be determined by
the Compensation Committee. The term of each employment agreement is three
years.
Each of the executive officers may terminate his respective employment
agreement without cause by giving the Company 90 days prior written notice.
Pursuant to the terms of his respective employment agreement, each executive
officer has agreed not to disclose the Company's confidential information and
not to compete against the Company during the term of his employment agreement
and for a period of two years thereafter.
In the event the executive officer is terminated upon a "change-in-control"
(as defined in the employment agreement), each of the executive officers will be
paid all accrued base salary, bonus compensation to the extent earned, vested
deferred compensation (other than plan benefits which will be paid in accordance
with the applicable plan) and other benefits through the date of termination. In
addition, each executive officer will receive as severance pay his base salary
in monthly installments through the remaining term of the agreement, or at his
election, a lump sum severance payment equal to the present value of the flow of
severance payments that would otherwise be paid to him. Notwithstanding the
foregoing, the Company is not required to pay any amount which is not deductible
for federal income tax purposes.
Each executive officer is entitled to receive his accrued base salary,
earned bonus, vested deferred compensation (other than plan benefits which will
be paid in accordance with the applicable plan) and other benefits through the
date of termination in the event that the Company terminates his employment
without cause. In addition, he will receive as severance compensation his base
salary for the greater of two years or the remaining term of his employment
agreement.
In the event the executive officer is terminated for cause (as defined in
the agreement), he is entitled to receive all accrued base salary, earned bonus
compensation, vested deferred compensation (other than plan benefits which will
be payable in accordance with the applicable plan) and other benefits through
the date of termination, but shall receive no other severance benefits. Each
executive officer's employment agreements may also be terminated if he dies, in
which event his estate will receive these same payments and severance payments
equal to three months' salary.
In the event the executive officer becomes disabled for a period of 60
consecutive days, he is entitled to receive his base salary, insurance, bonus
and other benefits for a period of six months from the date such disability
began or for such shorter period as he is unable to perform his duties
hereunder. In the event he is unable to perform his duties hereunder after the
expiration of the six-month period, his employment agreement will terminate.
35
<PAGE> 37
COMPENSATION OF DIRECTORS
Directors who are employees of the Company do not receive additional
compensation for serving as directors of the Company. Non-employee directors of
the Company are entitled to receive a fee of $10,000 per year. All directors are
also entitled to reimbursement for their actual out-of-pocket expenses incurred
in connection with attending meetings. In addition, each of the non-employee
directors of the Company is entitled to participate in the Service Experts, Inc.
1996 Non-Employee Director Stock Option Plan (the "Director Plan").
COMPENSATION PURSUANT TO PLANS
Incentive Stock Plan. In June 1996, the Company adopted the Incentive
Plan. The Company has reserved 1,300,000 of the authorized shares of Common
Stock for issuance pursuant to stock options and SARs to be granted under the
Incentive Plan. Under the Incentive Plan and pursuant to action of the Board,
the Compensation Committee appointed by the Board of Directors will administer
the Incentive Plan and may grant to officers and key employees (i) options to
purchase shares of Common Stock and (ii) SARs. The options are for terms not
longer than ten years (five years in the case of incentive stock options granted
to an individual who, at the time of the grant, owns more than 10% of the total
combined voting power of all classes of stock of the Company), at prices to be
determined by the Board of Directors or the Compensation Committee. Such prices
may not be less than 100% of the fair market value of the Common Stock on the
date of grant (110% in the case of an individual who, at the time of grant of
incentive stock options, owns more than 10% of the total combined voting power
of all classes of stock of the Company) in the case of incentive stock options
under Section 422 of the Code. Incentive stock options may be granted only to
employees and may not be less than 85% of the fair market value of the Common
Stock on the date of grant in the case of non-qualified stock options. Options
granted under the Incentive Plan may be exercisable in installments. The Company
is authorized to loan, or guarantee loans of, the purchase price of shares
issuable upon exercise of options granted under the Incentive Plan. Unless
terminated earlier, the Incentive Plan will terminate in 2006. The aggregate
fair market value of Common Stock with regard to which incentive stock options
are exercisable by an individual for the first time during any calendar year may
not exceed $100,000. The Company has granted options to purchase 657,811 shares
of Common Stock under the Incentive Plan. These options are exercisable at
prices ranging from $13.00 to $25.75 per share and vest one-third per year
commencing on the second anniversary of the date of grant.
SARs will entitle the holder to receive an amount equal to the excess of
the fair market value of a specified number of shares of Common Stock as of the
date such right is exercised over a specified price which shall not be less than
85% of the fair market value of the Common Stock at the time the SAR is granted.
SARs may be granted separately or in connection with a non-qualified stock
option. No SAR is exercisable more than ten years after it is granted.
Nonqualified Stock Option Plan. In May 1997, the Company adopted the
Service Experts, Inc. 1997 Nonqualified Stock Option Plan (the "Nonqualified
Option Plan"). The Compensation Committee is authorized to administer the
Nonqualified Option Plan and to award options to employees of the Company and
certain others who provide significant services to the Company. The Compensation
Committee determines which individuals are to receive options, the number of
shares of Common Stock that may be purchased thereunder, the exercise price of
an option, and the vesting and termination dates of the option. Under the
Nonqualified Option Plan, options granted at any time by the Compensation
Committee may not exceed that number of shares which equals the sum of (i) 9.5%
of the total number of outstanding shares of Common Stock at that time, minus
(ii) the number of shares of Common Stock that are authorized for issuance under
the Incentive Plan.
Options granted under the Nonqualified Option Plan will not be treated as
"incentive stock options" for purposes of Section 422 of the Code. Once an
option has become exercisable in whole or in part, under the terms of an option
agreement, the holder may purchase shares of Common Stock from the Company by
paying the exercise price in cash or in other consideration acceptable to the
Compensation Committee. The number of shares of Common Stock that may be
purchased under an option is automatically adjusted for certain corporate
changes, including stock dividends, recapitalizations, stock splits and
consolidations.
Non-Employee Director Stock Option Plan. In June 1996, the Company adopted
the Director Plan. The Company has reserved for issuance under the Director Plan
100,000 shares of Common Stock. The Director Plan
36
<PAGE> 38
provides for the granting of nonqualified stock options to each director of the
Company who is not also an employee or officer of the Company ("Non-Employee
Directors") at an exercise price equal to the fair market value of the Common
Stock on the date the options are granted. The Director Plan contains provisions
providing for adjustment of the number of shares available for option and
subject to unexercised options in the event of stock splits, dividends payable
in Common Stock, business combinations or certain other events. The Board shall
have no authority, discretion or power to select the participants who will
receive options pursuant to the Director Plan, to set the number of shares of
Common Stock to be covered by each option, to set the exercise price or the
period within which the options may be exercised or to alter other terms or
conditions specified in the options.
Pursuant to the Director Plan, each Non-Employee Director is granted
options to purchase 5,000 shares of Common Stock on the date of such director's
election to the Board of Directors at an exercise price equal to the fair market
value of the Common Stock on the date the options are granted. In addition, the
Director Plan provides for the grant to each Non-Employee Director of options to
purchase 1,000 shares of Common Stock on each January 1 (each date of grant
being referred to as the "Grant Date"). The Board of Directors may revoke, on or
prior to each January 1, the next automatic grant of options otherwise provided
for by the Director Plan if no options have been granted to employees since the
preceding January 1 under the Incentive Plan or any other employee stock option
plan that the Company might adopt. Each option shall be exercisable in full upon
receipt and shall expire ten years after the Grant Date (the "Option Period"),
unless cancelled sooner due to termination of service or death, or unless the
option is fully exercised prior to the end of the Option Period. The Company has
granted options to purchase 18,000 shares of Common Stock under the Director
Plan, of which 15,000 options have an exercise price of $13.00 and 3,000 options
have an exercise price of $26.00.
Employee Stock Purchase Plans. The 1996 Plan was adopted in June 1996 and
became effective simultaneously with the IPO. A total of 200,000 shares of
Common Stock have been reserved for issuance under the 1996 Plan, which is
intended to qualify under Section 423 of the Code. Employees are eligible to
participate in the 1996 Plan if they are employed by the Company or a
participating subsidiary for at least 20 hours a week and more than five months
in any calendar year and have been employed for at least six months since their
last date of hire. The 1996 Plan allows participants to purchase shares of
Common Stock in connection with option periods commencing on January 1 of each
year and ending the following December 31.
In June 1997, the Company adopted the Service Experts, Inc. 1997
Nonqualified Stock Purchase Plan (the "1997 Plan"). The Company has reserved
100,000 shares of Common Stock for issuance under the 1997 Plan. Participation
in the 1997 Plan is generally limited to individuals who were not employed by
the Company or one of its subsidiaries on January 1 of a calendar year and,
accordingly, were not eligible to receive an option under the 1996 Plan. The
1997 Plan allows participants to purchase shares of Common Stock in connection
with option periods commencing on July 1 of each year and ending the following
December 31. The 1996 Plan and the 1997 Plan are referred to collectively as the
"Purchase Plans."
Each Purchase Plan permits eligible employees of the Company and certain of
its subsidiaries to purchase Common Stock through payroll deductions, which may
not exceed 10% of the employee's base compensation, at a price equal to 85% of
the fair market value of the Common Stock at the beginning of the option period
or at the end of the option period, whichever is lower (subject to a minimum
price specified in the Purchase Plan). In the event of a change of control of
the Company (as defined in the Purchase Plans), each option under the Purchase
Plans will (if the Company is the surviving corporation) pertain to and apply to
the securities to which a holder of the number of shares of the Company subject
to such option would have been entitled in such transaction. If the Company is
not the surviving corporation in such change in control, then all options under
the Purchase Plans will terminate provided that the Compensation Committee may
determine that such options shall be exercisable on the day prior to such change
in control transaction.
In September 1996, the Company filed a registration statement on Form S-8
with respect to 900,000 shares of Common Stock covered by the Incentive Plan,
the Director Plan and the 1996 Plan.
37
<PAGE> 39
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee is comprised of directors who are not employees
of the Company. The Compensation Committee is responsible for establishing
salaries, bonuses and other compensation for the Company's officers.
INDEMNIFICATION OF DIRECTORS AND OFFICERS
Pursuant to the Company's Restated Certificate and Bylaws, the Company is
obligated to indemnify each of its directors and officers to the fullest extent
permitted by law with respect to all liability and losses suffered and
reasonable expenses incurred by such person in any action, suit or proceeding in
which such person was or is made or threatened to be made a party or is
otherwise involved by reason of the fact that such person is or was a director
or officer of the Company. The Company is obligated to pay the reasonable
expenses of the directors or officers incurred in defending such proceedings if
the indemnified party agrees to repay all amounts advanced by the Company if it
is ultimately determined that such indemnified party is not entitled to
indemnification. See "Description of Capital Stock -- Limitations on Liability
of Officers and Directors."
CERTAIN TRANSACTIONS
Prior to the IPO, Mr. Abrams, Mr. Sielbeck, John R. Young, a principal
stockholder of CSG, and R. Edward Hutton, Jr., a principal stockholder of the
Acquiring Company, received 500,695, 243,706, 473,992 and 243,707 shares of
Common Stock, respectively, as founders of the Company for their services in
forming the Company, developing its business plans and procedures and in
acquiring the Predecessor Companies. These shares do not include the shares of
Common Stock received in exchange for their interests in certain of the
Predecessor Companies. Following the issuance of such shares, Messrs. Abrams and
Young transferred 103,407 and 97,891 shares, respectively, to the other
stockholders of Service Now.
Pursuant to the Combination, and as consideration for their interests in
the Predecessor Companies, certain officers, directors and holders of 5% or more
of the outstanding Common Stock received cash and shares of Common Stock as
follows: Mr. Sielbeck -- $2,513,959 and 576,549 shares; Mr. Abrams -- $2,000,505
and 390,612 shares; Mr. Young -- $2,000,505 and 390,612 shares; Mr.
Hutton -- $2,513,959 and 576,549 shares; and Norman T. Rolf, Jr. -- $636,217 and
133,661 shares. Such amounts were determined on the basis of the evaluation by
the Company and the representatives of the underwriters of the IPO of the
following factors: the financial and operational history and trends of the
Predecessor Companies, the experience of the Company's management, the position
of the Company in the HVAC service and replacement industry, the Company's
prospects and financial results, market conditions for new offerings of
securities and the prices of similar securities of comparable companies.
In connection with the Combination, the Company acquired approximately 36%
of the issued and outstanding common stock of Future University in exchange for
$2,000 per share in cash, an aggregate of $590,000. The consideration paid was
determined by arms length negotiations between the Company and the stockholders
of Future University who agreed to sell their shares to the Company. Mr. Abrams
and Mr. Young, who were principal stockholders of Future University, each
received $248,000 in the transaction. The Company intends to continue to send
its employees to Future University for training. See "Business -- Contractor
Success Group."
Service Now, of which Mr. Abrams and Mr. Young are principal stockholders,
is a 48% stockholder of SuccessWare, a corporation that provides management and
financial information systems software to the Company. The Company has
implemented a general ledger system utilizing SuccessWare software in all of its
Service Centers and plans to expand its use of other SuccessWare products. In
1996, the Company and its Subsidiaries made aggregate payments to SuccessWare of
approximately $50,000. The Company has entered into a letter of intent with
SuccessWare to license its software and expects to make payments to SuccessWare
in 1997 of approximately $220,000. See "Business -- Services and
Operations -- Management Information Systems." In connection with the
Combination, the Company acquired all of the capital stock of Air Experts, a
United Services Co., Inc. and Service Experts of Palm Springs, Inc., both of
which were wholly owned subsidiaries of
38
<PAGE> 40
Service Now. Service Now continues to own and operate other HVAC companies, none
of which are located in geographic areas served by existing Service Centers. In
addition, the Company purchased from Service Now the exclusive rights to the
name "Service Experts" in exchange for $60,000.
Mr. Abrams and Mr. Young are the sole stockholders of Fusion Filters, Inc.
("Fusion"), which licenses air filters and other products from manufacturers and
sublicenses them to HVAC contractors, including certain of the Subsidiaries. The
Company has not entered into any definitive agreements with Fusion, but certain
Service Centers purchase filters from Fusion from time to time. In 1996, the
Company's Service Centers made aggregate payments to Fusion of approximately
$450,000. The Company and many of the Subsidiaries also utilize, from time to
time, the services of Travel Now, Inc., a travel agency, of which Mr. Abrams and
Mr. Young are principal stockholders.
At March 31, 1996, Mr. Sielbeck had outstanding indebtedness payable to the
Acquiring Company in the amount of $133,800, consisting of a note payable in the
principal amount of $100,000, bearing annual interest at 5% and payable upon
demand, and an interest-free advance of $33,800. At March 31, 1996, Mr. Hutton
had outstanding indebtedness payable to the Acquiring Company in the amount of
$133,800, consisting of a note payable in the principal amount of $100,000,
bearing annual interest at 5% and payable upon demand, and an interest-free
advance of $33,800. All of this indebtedness was repaid during 1996.
Prior to the Combination, Messrs. Sielbeck and Hutton purchased from the
Acquiring Company the building and underlying real estate on which the Acquiring
Company is located and certain residential property for approximately $826,000
and $61,000, respectively. The Acquiring Company purchased the building and real
estate for its main facility in 1992 for approximately $729,000 and made certain
improvements to such property costing approximately $78,000. The Acquiring
Company purchased the residential property in 1994 for approximately $61,000.
The sale price for such properties was determined by the board of directors of
the Acquiring Company. The Acquiring Company has entered into a lease with
Messrs. Sielbeck and Hutton whereby the Acquiring Company will make annual
rental payments of approximately $140,000 to Messrs. Sielbeck and Hutton.
Management of the Company believes such transactions are on terms that are
commercially reasonable and no less favorable to the Acquiring Company than
those which could be obtained from unaffiliated third parties.
On June 20, 1996, the Board of Directors adopted a policy that any
transactions between the Company and any of its officers, directors or principal
stockholders or affiliates thereof, must be on terms no less favorable than
those which could be obtained from unaffiliated parties and must be approved by
a majority of the disinterested members of the Board of Directors. The Audit
Committee of the Board of Directors is responsible for reviewing all related
party transactions on a continuing basis and potential conflict of interest
situations where appropriate.
39
<PAGE> 41
PRINCIPAL STOCKHOLDERS
The table below sets forth information regarding the beneficial ownership
of the Common Stock, as of the date hereof, by (i) each person known to the
Company to be the beneficial owner of more than 5% of the outstanding shares of
Common Stock, (ii) each director and executive officer of the Company and (iii)
all directors and executive officers of the Company as a group. Unless otherwise
indicated, each of the stockholders listed below has sole voting and investment
power with respect to the shares beneficially owned.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY OWNED(1)
----------------------------
BENEFICIAL OWNER NUMBER PERCENT
---------------- ----------- ---------
<S> <C> <C>
Alan R. Sielbeck(2)......................................... 781,252 5.5%
James D. Abrams(2).......................................... 705,413(3) 5.0
John R. Young(4)............................................ 769,222(3) 5.4
Anthony M. Schofield........................................ 3,000 *
Raymond J. De Riggi......................................... 6,000(5) *
Timothy G. Wallace.......................................... 6,000(5) *
William G. Roth............................................. 11,000(5) *
Norman T. Rolf, Jr.......................................... 129,385 *
All executive officers and directors as a group (seven
persons).................................................. 1,642,050(3)(6) 11.6
</TABLE>
- ---------------
* Represents less than 1%.
(1) The table above includes shares of the Company's Common Stock which an
individual has a right to acquire, whether upon conversion of convertible
securities or upon exercise of options and warrants, within 60 days of the
date of this Prospectus. Such shares are deemed to be outstanding for the
purposes of calculating the percentage ownership of the individual holding
such shares, but are not deemed outstanding for purposes of computing the
percentage of any other person shown on the table.
(2) The indicated person's address is c/o Service Experts, Inc., 111 Westwood
Place, Suite 420, Brentwood, Tennessee 37027.
(3) Includes 59,340 shares owned by Service Now, of which Messrs. Abrams and
Young are principal stockholders.
(4) Mr. Young's address is c/o John Young & Associates, 13950 Switzer, Overland
Park, Kansas 66221.
(5) Includes 6,000 shares subject to outstanding options held by such
individuals.
(6) Includes 18,000 shares subject to outstanding options held by such
individuals.
40
<PAGE> 42
RATIO OF EARNINGS TO FIXED CHARGES(1)
Set forth below is the ratio of earnings to fixed charges for the Company
for the periods indicated:
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
--------------------------------- ----------------
1992 1993 1994 1995 1996 1996 1997
---- ---- ---- ---- ----- ------ ------
<S> <C> <C> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges.... 2.42 1.67 5.71 8.90 69.35 3.05 34.87
</TABLE>
- ---------------
(1) Because the Company has no shares of Preferred Stock outstanding, the ratio
of earnings to combined fixed charges and preferred stock dividends is
identical to the ratio of earnings to fixed charges for each period listed
above.
PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY
The following table sets forth the reported high and low sales prices of
the Common Stock for the quarters indicated as reported on the Nasdaq National
Market. The Company commenced its IPO on August 16, 1996 at a price per share of
$13.00. The Common Stock is traded on the NYSE under the symbol "SVE."
<TABLE>
<CAPTION>
HIGH LOW
------ -------
<S> <C> <C>
1996
Third Quarter (beginning August 16, 1996)................. $20.75 $ 13.75
Fourth Quarter............................................ 28.50 19.00
1997
First Quarter............................................. $28.25 $ 21.25
Second Quarter............................................ 30.25 21.25
Third Quarter (through July 9, 1997)...................... 27.50 24.38
</TABLE>
On July 9, 1997, the last reported sale price of the Common Stock was
$26.75 per share. As of July 9, 1997, there were approximately 210 holders of
record of the Company's Common Stock.
The Company has never declared or paid dividends on its Common Stock. The
Company expects that future earnings will be retained to finance the growth and
development of the Company's business and, accordingly, does not intend to
declare or pay any dividends on the Common Stock for the foreseeable future. The
declaration, payment and amount of future dividends, if any, will be subject to
the discretion of the Company's Board of Directors and will depend upon the
future earnings, results of operations, financial condition and capital
requirements of the Company, among other factors. Under Delaware law, the
Company is prohibited from paying any dividends unless it has capital surplus or
net profits available for this purpose. In addition, the Company's credit
facilities impose restrictions on the ability of the Company to pay dividends.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
41
<PAGE> 43
DESCRIPTION OF CAPITAL STOCK
GENERAL
The Company is authorized to issue 30,000,000 shares of Common Stock, $.01
par value per share, and 10,000,000 shares of preferred stock, $.01 par value
per share (the "Preferred Stock"). As of the date of this Prospectus, the
Company has 14,165,092 shares of Common Stock and no shares of Preferred Stock
outstanding. The following description of capital stock of the Company is
qualified in its entirety by reference to the Company's Restated Certificate, a
copy of which is filed as an exhibit to the Registration Statement of which this
Prospectus forms a part. An additional 1,400,000 shares of Common Stock are
reserved for issuance upon exercise of employee and director stock options, of
which options to purchase 675,811 shares have been granted as of the date
hereof. An additional 300,000 shares of Common Stock are reserved for issuance
under the Purchase Plans, of which 22,655 shares have been issued as of the date
hereof. See "Management -- Compensation Pursuant to Plans." As of July 9, 1997,
there were approximately 210 holders of Common Stock.
COMMON STOCK
Holders of Common Stock are entitled to one vote per share on all matters
submitted to a vote of stockholders. Stockholders have no right to cumulate
their votes in the election of directors. Accordingly, holders of a majority of
the shares of Common Stock entitled to vote in any election of directors may
elect all of the directors standing for election. Holders of Common Stock are
entitled to receive dividends and other distributions when, as and if declared
from time to time by the Board of Directors out of funds legally available
therefor. In the event of a voluntary or involuntary liquidation, dissolution or
winding up of the Company, the holders of Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities, including all
distributions to holders of Preferred Stock having a liquidation preference over
the Common Stock. The Company's Restated Certificate gives the holders of Common
Stock no preemptive or other subscription or conversion rights, and there are no
redemption provisions with respect to such shares. All outstanding shares of
Common Stock are, and the shares offered hereby will be, when issued and paid
for, fully paid and non-assessable. The rights, preferences and privileges of
holders of Common Stock are subject to, and may be adversely effected by, the
rights of holders of shares of any series of Preferred Stock which the Company
may designate and issue in the future.
PREFERRED STOCK
The Board of Directors has the authority, without any further vote or
action of the stockholders of the Company, to issue shares of the Preferred
Stock in one or more series and to fix the number of shares, designations,
relative rights (including voting rights), preferences and limitations of such
series to the fullest extent now or hereafter permitted by Delaware law. The
Company has no present intention to issue any series of Preferred Stock.
STOCK PURCHASE WARRANTS
Equitable Securities Corporation was engaged to provide financial advisory
and investment banking services in the formation of the Company and the
structuring of the Combination. In connection with this engagement, Equitable
Securities Corporation received warrants (the "ESC Warrants") to purchase 82,391
shares of the Common Stock. The ESC Warrants are exercisable until August 16,
2001, in whole or in part, are subject to anti-dilution adjustments, and the
holder is entitled to one demand registration right for the underlying Common
Stock exercisable until August 16, 2001 and incidental registration rights
exercisable until August 16, 2003.
In connection with the acquisition of ProAir Services, L.P. on June 15,
1997, the Company issued warrants to purchase 200,000 shares of Common Stock at
an exercise price of $22.00 per share. Warrants to purchase 60,000 shares of
Common Stock vested immediately, and warrants to purchase 140,000 shares of
Common Stock vest in one-third increments annually beginning June 15, 1998.
42
<PAGE> 44
LIMITATIONS ON LIABILITY OF OFFICERS AND DIRECTORS
The Company's Restated Certificate and Bylaws provide for indemnification
of the officers and directors of the Company to the fullest extent permitted by
Delaware law, including some instances in which indemnification is otherwise
discretionary under Delaware law. The Restated Certificate contains provisions
that eliminate the personal liability of the Company's directors for monetary
damages resulting from breaches of their fiduciary duty other than liability for
breaches of the director's duty of loyalty to the Company or its stockholders,
for acts or omissions not in good faith or which involve intentional misconduct
or a knowing violation of law, violations under Section 174 of the Delaware
General Corporation Law, or for any transaction from which the director derived
an improper personal benefit. The Company believes that these provisions are
essential to attracting and retaining qualified persons as officers and
directors.
There is no pending litigation or proceeding involving a director or
officer of the Company as to which indemnification is being sought, nor is the
Company aware of any threatened litigation that may result in claims for
indemnification by any officer or director.
ANTI-TAKEOVER PROVISIONS
Section 203 of the Delaware General Corporation Law prevents an "interested
stockholder" (defined in Section 203, generally, as a person owning 15% or more
of a corporation's outstanding voting stock) from engaging in a "business
combination" (as defined in Section 203) with a publicly-held Delaware
corporation for three years following the date such person became an interested
stockholder unless (i) before such person became an interested stockholder, the
board of directors of the corporation approved the transaction in which the
interested stockholder became an interested stockholder or approved the business
combination; (ii) upon consummation of the transaction that resulted in the
interested stockholder's becoming an interested stockholder, the interested
stockholder owns at least 85% of the voting stock of the corporation outstanding
at the time the transaction commenced (excluding stock held by directors who are
also officers of the corporation and by employee stock plans that do not provide
employees with the right to determine confidentially whether shares held subject
to the plan will be tendered in a tender or exchange offer); or (iii) following
the transaction in which such person became an interested stockholder, the
business combination is approved by the board of directors of the corporation
and authorized at a meeting of stockholders by the affirmative vote of the
holders of two-thirds of the outstanding voting stock of the corporation not
owned by the interested stockholder.
Certain provisions of the Company's Restated Certificate and Bylaws may
make a change in the control of the Company difficult to effect, even if a
change in control were in the stockholders' interest. These include certain
super-majority vote requirements to amend or repeal certain provisions of the
Company's Restated Certificate or Bylaws, including provisions relating to the
election of a staggered Board of Directors and the limitation that directors be
removed only for cause by a majority of the outstanding voting stock. See
"Management -- Executive Officers, Directors and Key Employees." The Company's
Restated Certificate eliminates the right of stockholders to take action by
written consent. In addition, the Company's Restated Certificate allows the
Board to determine the terms of the Preferred Stock which may be issued by the
Company without approval of the holders of the Company's Common Stock. The
ability of the Company to issue Preferred Stock in such manner could enable the
Board of Directors to prevent changes in management and control of the Company.
These provisions are expected to discourage certain types of coercive takeover
practices and inadequate takeover bids and to encourage persons seeking to
acquire control of the Company first to negotiate with the Company. Management
believes that the benefits of increased protection of the Company's potential
ability to negotiate with the proponent of an unfriendly or unsolicited proposal
to acquire or restructure the Company outweigh the disadvantages of discouraging
such proposals. Management believes that negotiations of such proposals, among
other things, could result in an improvement of their terms.
TRANSFER AGENT AND REGISTRAR
The transfer agent and registrar for the Company's Common Stock is
ChaseMellon Shareholder Services, L.L.C.
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DESCRIPTION OF COMMON STOCK WARRANTS
The Company may issue warrants for the purchase of Common Stock ("Common
Stock Warrants"). Common Stock Warrants may be issued independently or together
with any other Securities pursuant to any Prospectus Supplement or
Post-Effective Amendment, as applicable, and may be attached to or separate from
such Securities. Each series of Common Stock Warrants will be issued under a
separate warrant agreement (each, a "Warrant Agreement") to be entered into
between the Company and the warrant recipient or, if the recipients are
numerous, a warrant agent identified in the Prospectus Supplement or
Post-Effective Amendment, as applicable (the "Warrant Agent"). The Warrant
Agent, if engaged, will act solely as an agent of the Company in connection with
the Common Stock Warrants of such series and will not assume any obligation or
relationship of agency or trust for or with any holders or beneficial owners of
Common Stock Warrants. Further terms of the Common Stock Warrants and the
applicable Warrant Agreements will be set forth in the Prospectus Supplement or
Post-Effective Amendment, as applicable.
The Prospectus Supplement or Post-Effective Amendment, as applicable, will
describe the terms of any Common Stock Warrants in respect of which this
Prospectus is being delivered, including, where applicable, the following: (a)
the title of such Common Stock Warrants; (b) the aggregate number of such Common
Stock Warrants; (c) the price or prices at which such Common Stock Warrants will
be issued; (d) the designation, number and terms of the shares of Common Stock
purchasable upon exercise of such Common Stock Warrants; (e) the designation and
terms of the other Securities with which such Common Stock Warrants are issued
and the number of such Common Stock Warrants issued with each such offered
Security; (f) the date, if any, on and after which such Common Stock Warrants
and the related Common Stock will be separately transferable; (g) the price at
which each share of Common Stock purchasable upon exercise of such Common Stock
Warrants may be purchased; (h) the date on which the right to exercise such
Common Stock Warrants shall commence and the date on which such right shall
expire; (i) the minimum or maximum amount of such Common Stock Warrants which
may be exercised at any one time; (j) information with respect to book-entry
procedures, if any; (k) a discussion of certain federal income tax
considerations; and (l) any other terms of such Common Stock Warrants, including
terms, procedures and limitations relating to the exchange and exercise of such
Common Stock Warrants.
As of the date of this Prospectus, warrants to purchase 282,391 shares of
Common Stock have been issued by the Company and are outstanding.
DESCRIPTION OF DEBT SECURITIES
The Company may issue Debt Securities under one or more trust indentures
(each an "Indenture") to be executed by the Company and a specified trustee. The
terms of Securities will include those stated in an Indenture and those made a
part of an Indenture (before any supplements) by reference to the Trust
Indenture Act of 1939, as amended (the "TIA"). The Indenture will be qualified
under the TIA.
The following description sets forth certain anticipated general terms and
provisions of the Debt Securities to which any Prospectus Supplement or
Post-Effective Amendment, as applicable, may relate. The particular terms of the
Debt Securities offered by any Prospectus Supplement or Post-Effective
Amendment, as applicable (which terms may be different than those stated below)
and the extent, if any, to which such general provisions may apply to the Debt
Securities so offered will be described in the Prospectus Supplement or
Post-Effective Amendment, as applicable, relating to such Debt Securities.
Accordingly, for a description of the terms of a particular issue of Debt
Securities, reference must be made to both the Prospectus Supplement or
Post-Effective Amendment, as applicable, relating thereto and the following
description. A form of Indenture has been filed as an exhibit to the
Registration Statement of which this Prospectus is a part.
GENERAL
The indebtedness represented by Debt Securities will be subordinated in
right of payment to the prior payment in full of the Senior Debt (as such term
is defined in the Indenture) of the Company. The Debt Securities will be issued
pursuant to an Indenture between the Company and a trustee.
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<PAGE> 46
Except as set forth in an Indenture and described in a Prospectus
Supplement or Post-Effective Amendment, as applicable, relating thereto, the
Debt Securities may be issued without limit as to aggregate principal amount, in
one or more series, secured or unsecured, in each case as established from time
to time in or pursuant to authority granted by a resolution of the Board of
Directors of the Company or as established in an Indenture. All Debt Securities
of one series need not be issued at the time and, unless otherwise provided, a
series may be reopened, without the consent of the holders of the Debt
Securities of such series, for issuance of additional Debt Securities of such
series.
The Prospectus Supplement or Post-Effective Amendment, as applicable,
relating to any series of Debt Securities being offered will contain the
specific terms thereof, including, without limitation:
(a) the title of such Debt Securities;
(b) the aggregate principal amount of such Debt Securities and any
limit on such aggregate principal amount;
(c) the percentage of the principal amount at which such Debt
Securities will be issued and, if other than the principal amount thereof,
the portion of the principal amount thereof payable upon declaration of
acceleration of the maturity thereof, or (if applicable) the portion of the
principal amount of such Debt Securities which is convertible into Common
Stock, or the method by which any such portion shall be determined;
(d) if convertible, any applicable limitations on the ownership or
transferability of the Common Stock into which such Debt Securities are
convertible;
(e) the date or dates, or the method for determining such date or
dates, on which the principal of such Debt Securities will be payable;
(f) the rate or rates (which may be fixed or variable), or the method
by which such rate or rates shall be determined, at which such Debt
Securities will bear interest, if any;
(g) the date or dates, or the method for determining such date or
dates, from which any interest will accrue, the interest payment dates on
which any such interest will be payable, the regular record dates for such
interest payment dates, or the method by which any such date shall be
determined, the person to whom such interest shall be payable, and the
basis upon which interest shall be calculated if other than that of a
360-day year of twelve 30-day months;
(h) the place or places where the principal of (and premium, if any)
and interest, if any, on such Debt Securities will be payable, such Debt
Securities may be surrendered for conversion or registration of transfer or
exchange and notices or demands to or upon the Company in respect of such
Debt Securities and an Indenture may be served;
(i) the period or periods within which, the price or prices at which
and the terms and conditions upon which such Debt Securities may be
redeemed, as a whole or in part, at the option of the Company, if the
Company is to have such an option;
(j) the obligation, if any, of the Company to redeem, repay or
purchase such Debt Securities pursuant to any sinking fund or analogous
provision or at the option of a holder thereof, and the period or periods
within which, the price or prices at which and the terms and conditions
upon which such Debt Securities will be redeemed, repaid or purchased, as a
whole or in part, pursuant to such obligation;
(k) if other than U.S. dollars, the currency or currencies in which
such Debt Securities are denominated and payable, which may be a foreign
currency or units of two or more foreign currencies or a composite currency
or currencies, and the terms and conditions relating thereto;
(l) whether the amount of payments of principal of (and premium, if
any) or interest, if any, on such Debt Securities may be determined with
reference to an index, formula or other method (which index, formula or
method may, but need not be, based on a currency, currencies, currency unit
or units or composite currency or currencies) and the manner in which such
amounts shall be determined;
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<PAGE> 47
(m) any additions to, modifications of or deletions from the terms of
such Debt Securities with respect to the Events of Default (as defined in
an Indenture) or covenants set forth in an Indenture;
(n) any provisions for collateral security for repayment of such Debt
Securities;
(o) whether such Debt Securities will be issued in certificated and/or
book-entry form;
(p) whether such Debt Securities will be in registered or bearer form
and, if in registered form, the denominations thereof if other than $1,000
and any integral multiple thereof and, if in bearer form, the denominations
thereof and terms and conditions relating thereto;
(q) the applicability, if any, of defeasance and covenant defeasance
provisions of an Indenture;
(r) the terms, if any, upon which such Debt Securities may be
convertible into Common Stock of the Company and the terms and conditions
upon which such conversion will be effected, including, without limitation,
the initial conversion price or rate and the conversion period;
(s) whether and under what circumstances the Company will pay
additional amounts as contemplated in an Indenture on such Debt Securities
in respect of any tax assessment or governmental charge and, if so, whether
the Company will have the option to redeem such Debt Securities in lieu of
making such payment; and
(t) any other terms of such Debt Securities not inconsistent with the
provisions of the applicable Indenture.
The Debt Securities may provide for less than the entire principal amount
thereof to be payable upon declaration of acceleration of the maturity thereof
("Original Issue Discount Securities"). Special federal income tax, accounting
and other considerations applicable to Original Issue Discount Securities will
be described in the applicable Prospectus Supplement or Post-Effective
Amendment, as applicable.
Except as set forth in an Indenture, an Indenture will not contain any
provisions that would limit the ability of the Company to incur indebtedness or
that would afford holders of Debt Securities protection in the event of a highly
leveraged or similar transaction involving the Company or in the event of a
change of control. Reference is made to the applicable Prospectus Supplement or
Post-Effective Amendment, as applicable, for information with respect to any
deletions from, modifications of or additions to the Events of Default or
covenants of the Company that are described below, including any addition of a
covenant or other provision providing event risk or similar protection.
MERGER, CONSOLIDATION OR SALE
It is expected that an Indenture will provide that the Company may
consolidate with, or sell, lease or convey all or substantially all of its
assets to, or merge with or into, any other corporation, provided that (a)
either the Company shall be the continuing corporation, or the successor
corporation (if other than the Company) formed by or resulting from any such
consolidation or merger or which shall have received the transfer of such assets
shall expressly assume payment of the principal of (and premium, if any), and
interest on, all of the Debt Securities and the due and punctual performance and
observance of all of the covenants and conditions contained in an Indenture; (b)
immediately after giving effect to such transaction and treating any
indebtedness which becomes an obligation of the Company or any subsidiary as a
result thereof as having been incurred by the Company or such subsidiary at the
time of such transaction, no Event of Default under an Indenture, and no event
which, after notice or the lapse of time, or both, would become such an Event of
Default, shall have occurred and be continuing; and (c) an officer's certificate
and legal opinion covering such conditions shall be delivered to the trustee.
COVENANTS
An Indenture will contain covenants requiring the Company to take certain
actions and prohibiting the Company from taking certain actions. The covenants
with respect to any series of Debt Securities will be described in the
Prospectus Supplement or Post-Effective Amendment, as applicable, relating
thereto.
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EVENTS OF DEFAULT, NOTICE AND WAIVER
An Indenture will describe specific "Events of Defaults" with respect to
any series of Debt Securities issued thereunder. Such "Events of Defaults" are
likely to include (with grace and cure periods): (i) default in the payment of
any installment of interest on any Debt Security of such series; (ii) default in
the payment of principal of (or premium, if any, on) any Debt Security of such
series at its maturity; (iii) default in making any required sinking fund
payment, if any, for any Debt Security of such series; (iv) default in the
performance or breach of any other covenant or warranty of the Company contained
in the Indenture (other than a covenant added to the Indenture solely for the
benefit of a series of Debt Securities issued thereunder other than such series)
that is continued for a specified period of days after written notice as
provided in the Indenture; (v) default in the payment of specified amounts of
indebtedness of the Company or any mortgage, indenture or other instrument under
which such indebtedness is issued or by which such indebtedness is secured, such
default having occurred after the expiration of any applicable grace period and
having resulted in the acceleration of the maturity of such indebtedness, but
only if such indebtedness is not discharged or such acceleration is not
rescinded or annulled; and (vi) certain events of bankruptcy, insolvency or
reorganization, or court appointment of a receiver, liquidator or trustee of the
Company or any significant subsidiary or the property of either.
If an Event of Default under an Indenture with respect to Debt Securities
of any series at the time outstanding occurs and is continuing, then in every
such case, subject to the rights of the holder of Senior Debt, the applicable
trustee or the holders of not less than 25% of the principal amount of the
outstanding Debt Securities of that series will have the right to declare the
principal amount (or, if the Debt Securities of that series are Original Issue
Discount Securities or indexed securities, such portion of the principal amounts
as may be specified in the terms thereof) of all the Debt Securities of that
series to be due and payable immediately by written notice thereof to the
Company (and to the applicable trustee if given by the holders). However, at any
time after such a declaration of acceleration with respect to Debt Securities of
such series (or of all Debt Securities then outstanding under any Indenture, as
the case may be) has been made, but before a judgment or decree for payment of
the money due has been obtained by the applicable trustee, the holders of not
less than a majority in principal amount of outstanding Debt Securities of such
series (or of all Debt Securities then outstanding under an Indenture, as the
case may be) may rescind and annul such declaration and its consequences if (a)
the Company shall have deposited with the trustee all required payments of the
principal of (and premium, if any) and interest on the Debt Securities of such
series (or of all Debt Securities then outstanding under an Indenture, as the
case may be), plus certain fees, expenses, disbursements and advances of the
trustee and (b) all events of default, other than the non-payment of accelerated
principal (or specified portion thereof), with respect to Debt Securities of
such series (or of all Debt Securities then outstanding under an Indenture, as
the case may be) have been cured or waived as provided in such Indenture. An
Indenture also will provide that the holders of not less than a majority in
principal amount of the outstanding Debt Securities of any series (or of all
Debt Securities then outstanding under an Indenture, as the case may be) may
waive any past default with respect to such series and its consequences, except
a default (x) in the payment of the principal of (or premium, if any) or
interest on any Debt Security of such series or (y) in respect of a covenant or
provision contained in an Indenture that cannot be modified or amended without
the consent of the holder of each outstanding Debt Security affected thereby.
The trustee will be required to give notice to the holders of Debt
Securities within 90 days of a default under an Indenture unless such default
shall have been cured or waived; provided, however, that such trustee may
withhold notice to the holders of any series of Debt Securities of any default
with respect to such series (except a default in the payment of the principal of
(or premium, if any) or interest on any Debt Security of such series or in the
payment of any sinking fund installment in respect of any Debt Security of such
series) if specified responsible officers of such trustee consider such
withholding to be in the interest of such holders.
An Indenture will provide that no holders of Debt Securities of any series
may institute any proceedings, judicial or otherwise, with respect to the
Indenture or for any remedy thereunder, except in the cases of failure of the
trustee, for 60 days, to act after it has received a written request to
institute proceedings in respect of an Event of Default from the holders of not
less than 25% in principal amount of the outstanding Debt Securities of such
series, as well as an offer of indemnity reasonably satisfactory to it. This
provision will not prevent, however, any holder of Debt Securities from
instituting suit for the enforcement of payment of the principal of (and
premium, if any) and interest on such Debt Securities at the respective due
dates thereof.
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Subject to provisions in an Indenture relating to its duties in case of
default, the trustee will not be under any obligation to exercise any of its
rights or powers under such Indenture at the request or direction of any holders
of any series of Debt Securities then outstanding under such Indenture, unless
such holders shall have offered to the trustee thereunder reasonable security or
indemnity. The holders of not less than a majority in principal amount of the
outstanding Debt Securities of any series (or of all Debt Securities then
outstanding under an Indenture, as the case may be) shall have the right to
direct the time, method and place of conducting any proceeding for any remedy
available to the trustee, or of exercising any trust or power conferred upon the
trustee. However, the trustee may refuse to follow any direction which is in
conflict with any law or an Indenture, which may involve the trustee in personal
liability or which may be unduly prejudicial to the holders of Debt Securities
of such series not joining therein.
Within 120 days after the close of each fiscal year, the Company will be
required to deliver to the trustee a certificate, signed by one of several
specified officers, stating whether or not such officer has knowledge of any
default under an Indenture and, if so, specifying each such default and the
nature and status thereof.
MODIFICATION OF AN INDENTURE
It is anticipated that modifications and amendments of an Indenture may be
made by the Company and the trustee, with the consent of the holders of not less
than a majority in aggregate principal amount of each series of the outstanding
Debt Securities issued under an Indenture which are affected by the modification
or amendment, provided that no such modification or amendment may, without the
consent of each holder of such Debt Securities affected thereby, (a) change the
stated maturity date of the principal of (or premium, if any) or any installment
of interest, if any, on any such Debt Security; (b) reduce the principal amount
of (or premium, if any) or the interest, if any, on any such Debt Security or
the principal amount due upon acceleration of an Original Issue Discount
Security; (c) change the place or currency of payment of principal of (or
premium, if any) or interest, if any, on any such Debt Security; (d) impair the
right to institute suit for the enforcement of any such payment on or with
respect to any such Debt Security; (e) reduce the above stated percentage of
holders of Debt Securities necessary to modify or amend such Indenture; or (f)
modify the foregoing requirements or reduce the percentage of outstanding Debt
Securities necessary to waive compliance with certain provisions of an Indenture
or for waiver of certain defaults. A record date may be set for any act of the
holders with respect to consenting to any amendment.
The holders of not less than a majority in principal amount of outstanding
Debt Securities of each series affected thereby will have the right to waive
compliance by the Company with certain covenants in an Indenture.
An Indenture will contain provisions for convening meetings of the holders
of Debt Securities of a series to take permitted action.
CONVERSION OF SECURITIES
The terms and conditions, if any, upon which the Debt Securities are
convertible into Common Stock will be set forth in the applicable Prospectus
Supplement or Post-Effective Amendment, as applicable, relating thereto. Such
terms will include whether such Debt Securities are convertible into Common
Stock, the conversion price (or manner of calculation thereof), the conversion
period, provisions as to whether conversion will be at the option of the holders
or the Company or such conversion will be automatic, the events requiring an
adjustment of the conversion price and provisions affecting conversion in the
event of the redemption of such Debt Securities.
SUBORDINATION
Upon any distribution to creditors of the Company in a liquidation,
dissolution or reorganization, the payment of the principal of and interest on
any Debt Securities will be subordinated to the extent provided in an Indenture
in right of payment to the prior payment in full of all Senior Debt. No payment
of principal or interest will be permitted to be made on Debt Securities at any
time if a default in Senior Debt exists that permits the holders of such Senior
Debt to accelerate their maturity and the default is the subject of judicial
proceedings or the Company receives notice of the default. After all Senior Debt
is paid in full and until the Debt Securities are paid in full, holders of Debt
Securities will be subrogated to the right of holders of Senior Debt to the
extent that
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distributions otherwise payable to holders of Debt Securities have been applied
to the payment of Senior Debt. By reason of such subordination, in the event of
a distribution of assets upon insolvency, certain general creditors of the
Company may recover more, ratably, than holders of Debt Securities. If this
Prospectus is being delivered in connection with a series of Debt Securities,
the accompanying Prospectus Supplement or Post-Effective Amendment, as
applicable, or the information incorporated herein by reference will contain the
approximate amount of Senior Debt outstanding as of the end of the Company's
most recent fiscal quarter.
SHARES ELIGIBLE FOR FUTURE SALE
No prediction can be made as to the effect, if any, that sales of shares or
the availability of such shares for sale in the public market will have on the
market prices prevailing from time to time. Nevertheless, sales of substantial
amounts of Common Stock in the public market could adversely affect prevailing
market prices and impair the Company's ability to raise capital through the sale
of equity securities.
As of the date of this Prospectus, the Company has outstanding 14,165,092
shares of Common Stock of which approximately 5,728,755 shares are freely
tradeable without restrictions or further registration under the Securities Act,
unless purchased by "affiliates" of the Company as that term is defined in Rule
144 under the Securities Act .
On March 27, 1996, the Company issued 1,462,100 shares of Common Stock to
Messrs. Sielbeck, Abrams, Young and Hutton as founders of the Company. These
shares and 4,522,636 shares issued in connection with the Combination were
issued and sold by the Company in private transactions in reliance upon the
exemption from registration contained in Section 4(2) of the Securities Act and
are restricted securities under Rule 144. These shares may not be sold unless
they are registered under the Securities Act or are sold pursuant to an
applicable exemption from registration, pursuant to Rule 144. In general, under
Rule 144, a person who has beneficially owned these shares for at least one
year, including "affiliates" of the Company, would be entitled to sell in
broker's transactions or to market makers within any three-month period a number
of shares that does not exceed the greater of 1% of the then outstanding shares
of Common Stock or the average weekly trading volume of the Common Stock on the
NYSE during the four calendar weeks preceding the date on which notice of the
sale is filed with the Commission. Sales under Rule 144 are also subject to
certain manner of sale restrictions and notice requirements and to the
availability of current public information concerning the Company. A person (or
person whose shares are aggregated) who is not an "affiliate" of the Company at
any time during the 90 days preceding a sale, and who has beneficially owned
such shares for at least two years, would be entitled to sell such shares under
Rule 144(k) without regard to the availability of current public information,
volume limitations, manner of sale provisions or notice requirements. The above
is a summary of Rule 144 and is not intended to be a complete description
thereof.
In connection with acquisitions completed after the Combination, the
Company issued approximately 3,681,237 shares of Common Stock registered under
the Securities Act which are eligible for sale in the public market in
accordance with Rule 145. Certain stockholders of such acquired companies may be
deemed "affiliates" for purposes of Rule 145 under the Securities Act. In
general, under Rule 145 as currently in effect, a stockholder who is an
"affiliate" may sell shares in broker's transactions subject to the volume
limitations and requirements as to the manner and notice of sale and the
availability of public information described above. In addition to the
requirements of Rule 145, certain stockholders of such acquired companies are
subject to lockup agreements that generally prohibit a stockholder from selling,
offering to sell, granting any option for the sale of, or otherwise disposing of
any shares of Common Stock, any options, rights or warrants to purchase any
shares of Common Stock, or any other securities convertible into or exchangeable
for shares of Common Stock owned directly by such stockholder or with respect to
which he has the power of disposition, for a period of six months following the
effective time of the acquisition, without the prior written consent of the
Company. Beginning six months after the closing of the acquisition, such
stockholders will be entitled to sell or otherwise dispose of up to 25% of the
shares of Common Stock held by such stockholder, and an additional 25% of the
shares of Common Stock held by such stockholder during each of the three
successive six month periods until the twenty-fourth month following the closing
of the acquisition, at which time such stockholder will be entitled to sell all
shares of Common Stock held by such stockholder. The Company also plans to issue
shares of its Common Stock that have
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been registered under the Securities Act in connection with future acquisitions.
The Company anticipates that, upon the issuance thereof, these shares will
generally be eligible for sale in accordance with Rule 145 unless the resale
thereof is contractually restricted.
The Company, its officers and directors and certain of its present
stockholders have agreed that they will not, directly or indirectly, offer,
sell, offer to sell, contract to sell, grant any option to purchase or otherwise
sell or dispose (or announce any offer, sale, offer of sale, contract of sale,
grant of any option to purchase or other sale or disposition) of any shares of
Common Stock or any securities convertible into or exercisable or exchangeable
therefor or other capital stock of the Company or any right to purchase or
acquire Common Stock or other capital stock of the Company for a period of 120
days after March 18, 1997 without the prior written consent of Equitable
Securities Corporation on behalf of the underwriters in the Offering.
SELLING STOCKHOLDERS
The Company intends to offer Securities, from time to time, pursuant to
this Prospectus in connection with its acquisition of the assets or stock of
HVAC service and replacement businesses, as described herein. The recipients of
the Securities issued in connection with such transactions may determine to
reoffer the Common Stock issued in such transactions, the Common Stock issued
upon the exercise of the Common Stock Warrants or Common Stock issued upon the
conversion of the Debt Securities from time to time. Specific information
regarding the resale transactions by Selling Stockholders who may be deemed to
be "underwriters" as defined in the Securities Act, the identity of the Selling
Stockholders, and the number of shares of Common Stock to be reoffered shall be
provided at the time of such acquisition by means of a Post-Effective Amendment
or Prospectus Supplement, as applicable.
LEGAL MATTERS
Certain legal matters with respect to the validity of the Securities
offered hereby will be passed upon for the Company by Waller Lansden Dortch &
Davis, A Professional Limited Liability Company, Nashville, Tennessee.
EXPERTS
The consolidated financial statements of Service Experts, Inc. and the
financial statements of Artic Aire of Chico, Inc. appearing in this Prospectus
and Registration Statement have been audited by Ernst & Young LLP, independent
auditors, to the extent indicated in their reports thereon also appearing
elsewhere herein and in the Registration Statement. Such financial statements
have been included herein in reliance upon such reports given upon the authority
of such firm as experts in accounting and auditing.
The financial statements of ProAir Services, L.P. appearing in this
Prospectus and Registration Statement have been audited by Arthur Andersen LLP,
independent public accountants, as indicated in their report with respect
thereto, and are included herein in reliance upon the authority of such firm as
experts in accounting and auditing in giving said report.
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INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SERVICE EXPERTS, INC. -- UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
Basis of Presentation....................................... F-2
Unaudited Pro Forma Combined Balance Sheet as of March 31,
1997...................................................... F-3
Unaudited Pro Forma Combined Statements of Income for the
Three Months ended March 31, 1997 and for the Twelve
Months ended December 31, 1996............................ F-4
Notes to Unaudited Pro Forma Combined Financial
Statements................................................ F-6
</TABLE>
SERVICE EXPERTS, INC. -- FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996 AND THE THREE
MONTHS ENDED MARCH 31, 1996 AND 1997 (UNAUDITED)
Report of Independent Auditors.............................. F-9
Consolidated Balance Sheets................................. F-10
Consolidated Statements of Income........................... F-12
Consolidated Statements of Stockholders' Equity............. F-13
Consolidated Statements of Cash Flows....................... F-14
Notes to Consolidated Financial Statements.................. F-15
ARTIC AIRE OF CHICO, INC.
FINANCIAL STATEMENTS FOR THE YEAR ENDED FEBRUARY 28, 1997
AND THREE MONTHS ENDED MAY 31, 1997 (UNAUDITED)
Report of Independent Auditors.............................. F-27
Balance Sheets.............................................. F-28
Statements of Operations.................................... F-29
Statements of Stockholders' Equity.......................... F-30
Statements of Cash Flows.................................... F-31
Notes to Financial Statements............................... F-32
PROAIR SERVICES, L.P.
FINANCIAL STATEMENTS FOR THE YEAR ENDED DECEMBER 26, 1996
AND THREE MONTHS ENDED MARCH 27, 1997 (UNAUDITED)
Report of Independent Auditors.............................. F-37
Balance Sheets.............................................. F-38
Statements of Operations.................................... F-39
Statements of Changes in Partners' Deficit.................. F-40
Statements of Cash Flows.................................... F-41
Notes to Financial Statements............................... F-42
F-1
<PAGE> 53
PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
The Company was incorporated on March 27, 1996. On August 21, 1996, and
simultaneous with the closing of the IPO, the Company acquired the Predecessor
Companies in the Combination. In accordance with the provisions of SAB 97, the
historical financial statements of the Company for periods prior to August 21,
1996 are the combined financial statements of the Acquiring Company. Such
historical financial statements have been restated for the Pooled Companies,
which were acquired in December 1996 in business combinations accounted for as
poolings of interests. The operations of the Subsidiaries other than the Pooled
Companies have been included in the Company's financial statements from their
respective effective dates of acquisition. The acquisitions of the Predecessor
Companies have been accounted for using the historical cost basis of the
Predecessor Companies in accordance with SAB 48. The Predecessor Companies are
the Acquiring Company; Hardwick Air Masters, Inc. d/b/a Airmasters, Inc.;
Norrell Heating and Air Conditioning Company, Inc.; Vision Holding Company,
Inc.; Comerford's Heating and Air Conditioning, Inc.; Rolf Coal and Fuel Corp.;
Brand Heating & Air Conditioning, Inc.; Coastal Air Conditioning Service, Inc.;
Contractor Success Group, Inc.; Arrow Heating & Air Conditioning, Inc.; Air
Experts, a United Services Co., Inc.; Gilley's Heating & Cooling, Inc.; and
Service Experts of Palm Springs, Inc.
The following unaudited pro forma combined financial statements give effect
to the acquisition by the Company of 28 Acquired Companies and to one Pending
Acquisition in exchange for shares of the Company's Common Stock, cash, warrants
to purchase shares of Common Stock and the assumption of certain debt. The pro
forma combined financial statements do not give effect to the acquisition of one
Acquired Company and to 11 Pending Acquisitions which have aggregate residential
service and replacement revenue of approximately $22.0 million and an estimated
aggregate purchase price of $23.6 million.
The unaudited pro forma combined balance sheet as of March 31, 1997 gives
effect to the acquisition of seven Acquired Companies closed subsequent to March
31, 1997 and to one Pending Acquisition as if such transactions had occurred on
March 31, 1997. The Pending Acquisition is Artic Aire of Chico, Inc. The seven
Acquired Companies closed subsequent to March 31, 1997 are Claire's Air
Conditioning and Refrigeration, Inc., Claire & Sanders, Inc., Royden, Inc.,
Piedmont Service Experts, Inc., Stark Services Company, Inc., C. Iapaluccio
Company, Inc. and ProAir Services, L.P. The unaudited pro forma combined
statement of income for the three months ended March 31, 1997 gives effect to
the acquisition of eight Acquired Companies closed during the three month period
ended March 31, 1997, seven Acquired Companies which were closed subsequent to
March 31, 1997 and to one Pending Acquisition as if such transactions had
occurred as of January 1, 1996. The eight Acquired Companies closed during the
three month period ended March 31, 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 and Roland J. Down, 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, eight Acquired
Companies closed during the three month period ended March 31, 1997, seven
Acquired Companies closed subsequent to March 31, 1997 and to one Pending
Acquisition as if such transactions had occurred on January 1, 1996. The 11
Acquired Companies closed during 1996 are Service Experts of Indianapolis, Inc.,
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 combining financial
statements.
The pro forma combined financial statements should be read in conjunction
with the historical financial statements of the Company, including the related
notes thereto, and "Management's Discussion and Analysis of Financial Condition
and Results of Operations" that appear elsewhere in this Prospectus.
F-2
<PAGE> 54
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED BALANCE SHEET
MARCH 31, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
-------- --------- ------------ ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Current assets:
Cash and cash equivalents............................... $33,155 $ 565 $ 68 $ (8,936)(a) $ 21,924
(2,928)(b)
Receivables:
Trade receivables, net.................................. 12,176 1,400 313 -- 13,889
Related party........................................... 62 -- -- -- 62
Employee................................................ 237 8 10 -- 255
Other................................................... 310 64 -- -- 374
-------- ------ ------ -------- --------
12,785 1,472 323 -- 14,580
Inventories............................................... 6,266 1,380 530 -- 8,176
Cost and estimated earnings in excess of billings......... 1,148 21 30 -- 1,199
Prepaid expenses and other current assets................. 1,872 78 57 -- 2,007
Current portion of notes receivable -- related parties.... 14 1 -- -- 15
Current portion of notes receivable -- other.............. 285 -- -- -- 285
Deferred income taxes..................................... 2,426 -- -- -- 2,426
-------- ------ ------ -------- --------
Total current assets............................. 57,951 3,517 1,008 (11,864) 50,612
Property, buildings and equipment, net.................... 10,016 1,283 150 -- 11,449
Notes receivable -- related parties....................... 327 -- -- -- 327
Notes receivable -- other................................. 508 -- -- -- 508
Investment in affiliate................................... 573 55 -- -- 628
Goodwill.................................................. 47,460 -- -- -- 47,460
Unallocated purchase price................................ 8,054 -- -- 18,588(a) 26,642
Other assets.............................................. 703 669 -- -- 1,372
-------- ------ ------ -------- --------
Total assets..................................... $125,592 $5,524 $1,158 $ 6,724 $138,998
======== ====== ====== ======== ========
Current liabilities:
Short-term debt......................................... $ 183 $ -- $ -- $ (183)(b) $ --
Trade accounts payable and accrued liabilities.......... 5,383 1,572 203 -- 7,158
Cash consideration payable.............................. 1,120 -- -- -- 1,120
Accrued compensation.................................... 3,642 268 68 -- 3,978
Accrued warranties...................................... 1,361 177 48 -- 1,586
Income taxes payable.................................... 2,475 19 88 -- 2,582
Deferred revenue........................................ 4,978 1,504 13 -- 6,495
Billings in excess of costs and estimated earnings...... 732 15 37 -- 784
Current portion of long-term debt and capital lease
obligations........................................... 243 405 24 (672)(b) --
-------- ------ ------ -------- --------
Total current liabilities........................ 20,117 3,960 481 (855) 23,703
Long-term debt and capital lease obligations, net of
current................................................. 137 1,845 49 (2,031)(b) --
Related parties notes..................................... -- 42 -- (42)(b) --
Deferred income taxes..................................... 583 25 12 -- 620
Common stock.............................................. 137 -- -- 5(a) 142
Additional paid-in-capital................................ 98,382 -- -- 9,915(a) 108,297
Retained earnings......................................... 6,236 (348) 616 (268)(a) 6,236
-------- ------ ------ -------- --------
$125,592 $5,524 $1,158 $ 6,724 $138,998
======== ====== ====== ======== ========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-3
<PAGE> 55
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE THREE MONTHS ENDED MARCH 31, 1997
<TABLE>
<CAPTION>
ACQUIRED PENDING PRO FORMA
COMPANY COMPANIES ACQUISITION ADJUSTMENTS PRO FORMA
-------- --------- ------------ ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net revenues....................................... $33,355 $8,035 $ 734 $ -- $ 42,124
Cost of goods sold................................. 20,913 5,481 511 4(c) 26,909
------- ------ ------ ------- --------
Gross margin....................................... 12,442 2,554 223 (4) 15,215
Selling, general and administrative expenses....... 9,635 2,515 235 (163)(d) 12,222
------- ------ ------ ------- --------
Income from operations............................. 2,807 39 (12) 159 2,993
Other income (expense):
Interest expense................................. (87) (60) (2) 149(e) --
Interest income.................................. 127 -- 1 -- 128
Other income (expense)........................... 100 8 -- -- 108
------- ------ ------ ------- --------
140 (52) (1) 149 236
------- ------ ------ ------- --------
Income before tax.................................. 2,947 (13) (13) 308 3,229
Provision for income taxes......................... 1,120 3 -- 161(g) 1,284
------- ------ ------ ------- --------
Net income $ 1,827 $ (16) $ (13) $ 147 $ 1,945
======= ====== ====== ======= ========
Pro forma net income per share..................... $ 0.15 $ 0.14
Pro forma weighted average shares outstanding...... 12,269 2,037(h) 14,306
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-4
<PAGE> 56
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....................................... $46,856 $134,639 $3,815 $ -- $185,310
Cost of goods sold................................. 30,198 89,878 2,603 (124)(c) 122,555
------- -------- ------ ------ --------
Gross margin....................................... 16,658 44,761 1,212 124 62,755
Selling, general and administrative expenses....... 12,837 39,109 997 (6,376)(d) 46,567
------- -------- ------ ------ --------
Income from operations............................. 3,821 5,652 215 6,500 16,188
Other income (expense):
Interest expense................................. (63) (703) (12) 778(e) --
Interest income.................................. 334 277 8 -- 619
Other income (expense)........................... 214 (90) -- 40(f) 164
------- -------- ------ ------ --------
485 (516) (4) 818 783
------- -------- ------ ------ --------
Income before tax.................................. 4,306 5,136 211 7,318 16,971
Provision for income taxes......................... 1,196 404 69 5,409(g) 7,078
------- -------- ------ ------ --------
Net income $ 3,110 $ 4,732 $ 142 $1,909 $ 9,893
======= ======== ====== ====== ========
Pro forma net income per share..................... $ 0.70 $ 0.70
Pro forma weighted average shares outstanding...... 4,451 9,780(i) 14,231
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-5
<PAGE> 57
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 one Pending Acquisition and seven
Acquired Companies of $8,936,000 in cash and 422,800 shares of common stock
resulting in an increase in unallocated purchase price of $18,588,000 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 elimination of all outstanding debt.
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1996 1997
-------------- ------------
(IN THOUSANDS)
<C> <C> <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 of real estate depreciation..................... (19) 4
-------- -------
$ (124) $ 4
======== =======
(d) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $(12,430) $ (319)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 3,700 156
(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....................................... 1,939 162
(x) Elimination of general and administrative expenses.......... (871) (162)
(xi) Three regional vice presidents and one MIS director......... 700 --
-------- -------
$ (6,376) (163)
======== =======
(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 shareholders
of AC Service & Installation Co., Inc. and Custom Air
Conditioning, Inc. ......................................... 15 --
(iii) Elimination of all other debt assumed in the transaction to
be paid at closing.......................................... 718 149
-------- -------
$ 778 $ 149
======== =======
</TABLE>
F-6
<PAGE> 58
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
1996 1997
-------------- ------------
<C> <C> <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.......................... $ 2,035 $ 79
(ii) Additional income taxes on adjustments (d) thru (f)......... 2,598 17
(iii) Additional income tax provision for state and federal taxes
due to the non-deductibility of goodwill.................... 776 65
-------- -------
$ 5,409 $ 161
======== =======
</TABLE>
(h) Reflects adjustments to weighted average shares outstanding as follows: (i)
450,000 shares and the dilutive effect of warrants issued to the owners of
the Acquired Companies, (ii) 24,000 shares issued to the owners of one
Pending Acquisition, (iii) 1,563,000 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)
1,228,000 shares and the dilutive effect of warrants issued to the owners of
the Acquired Companies, (ii) 24,000 shares issued to the owners of one
Pending Acquisition, (iii) 1,850,000 shares issued in the Secondary
Offering, (iv) 6,678,000 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.
F-7
<PAGE> 59
(This page intentionally left blank)
F-8
<PAGE> 60
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Service Experts, Inc.
We have audited the accompanying consolidated balance sheets of Service
Experts, Inc. (formerly AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company -- see Note 1) as of December 31, 1995 and 1996, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1996. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free from
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Service Experts, Inc. (formerly AC Service & Installation Co., Inc. and Donelson
Air Conditioning Company -- see Note 1) at December 31, 1995 and 1996, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended December 31, 1996, in conformity with generally
accepted accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
February 12, 1997
F-9
<PAGE> 61
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MARCH 31,
1995 1996 1997
------- ------- ---------
(IN THOUSANDS) (UNAUDITED)
<S> <C> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 445 $10,726 $ 33,155
Accounts Receivable:
Trade, net of allowance for doubtful accounts of
$135,000 in 1995, $620,000 in 1996 and $632,000 in
1997................................................. 2,334 9,048 12,176
Related party.......................................... 298 129 62
Employee............................................... 66 113 237
Other.................................................. 77 208 310
------- ------- --------
2,775 9,498 12,785
Inventories............................................... 472 3,923 6,266
Costs and estimated earnings in excess of billings........ 31 283 1,148
Prepaid expenses and other current assets................. 265 697 1,872
Current portion of notes receivable -- related parties.... -- 14 14
Current portion of notes receivable -- other.............. -- 286 285
Deferred income taxes..................................... 17 1,893 2,426
------- ------- --------
Total current assets.............................. 4,005 27,320 57,951
Property, buildings and equipment:
Land...................................................... 105 10 105
Buildings................................................. 767 67 1,578
Furniture and fixtures.................................... 472 841 1,793
Machinery and equipment................................... 364 1,913 2,223
Vehicles.................................................. 2,149 5,339 7,032
Leasehold improvements.................................... 80 620 856
------- ------- --------
3,937 8,790 13,587
Less accumulated depreciation and amortization.............. (2,002) (2,461) (3,571)
------- ------- --------
1,935 6,329 10,016
Notes receivable -- related parties, net of current
portion................................................... -- 352 327
Notes receivable -- other, net of current portion........... -- 500 508
Investment in affiliate..................................... -- 674 573
Goodwill.................................................... -- 33,032 47,460
Unallocated purchase price.................................. -- -- 8,054
Other assets................................................ 80 297 703
------- ------- --------
Total assets...................................... $ 6,020 $68,504 $125,592
======= ======= ========
See accompanying notes.
</TABLE>
F-10
<PAGE> 62
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
----------------- MARCH 31,
1995 1996 1997
------- ------- ---------
<S> <C> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term debt........................................... $ -- $ -- $ 183
Trade accounts payable and accrued liabilities............ 740 5,174 5,383
Cash consideration payable................................ -- 1,495 1,120
Accrued compensation...................................... 743 1,601 3,642
Accrued warranties........................................ 169 963 1,361
Income taxes payable...................................... 67 1,723 2,475
Deferred revenue.......................................... 471 3,502 4,978
Billings in excess of costs and estimated earnings........ 228 340 732
Current portion related party notes....................... 7 -- --
Current portion of long-term debt and capital lease
obligations............................................ 244 135 243
------- ------- --------
Total current liabilities......................... 2,669 14,933 20,117
Long-term debt and capital lease obligations, net of current
portion................................................... 610 140 137
Related party notes, net of current portion................. 669 -- --
Deferred income taxes....................................... 8 360 583
Commitments (Note 10).......................................
Stockholders' equity:
Common stock $.01 par value; 30,000,000 shares authorized;
1,560,912, 11,050,326 and 13,694,377 (unaudited) shares
issued and outstanding at December 31, 1995 and 1996
and March 31, 1997, respectively....................... 16 111 137
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares issued and outstanding........... -- -- --
Additional paid-in capital................................ 241 48,566 98,382
Retained earnings......................................... 1,807 4,409 6,236
Equity notes receivable................................... -- (15) --
------- ------- --------
Total stockholders' equity........................ 2,064 53,071 104,755
------- ------- --------
Total liabilities and stockholders' equity........ $ 6,020 $68,504 $125,592
======= ======= ========
</TABLE>
See accompanying notes.
F-11
<PAGE> 63
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
----------------------------- ----------------------
1994 1995 1996 1996 1997
------- ------- ------- ------- -----------
(IN THOUSANDS, EXCEPT PER
SHARE DATA) (UNAUDITED) (UNAUDITED)
<S> <C> <C> <C> <C> <C>
Net revenues........................... $22,193 $24,876 $46,856 $ 5,134 $33,355
Cost of goods sold..................... 15,999 16,916 30,198 3,392 20,913
------- ------- ------- ------- -------
Gross margin........................... 6,194 7,960 16,658 1,742 12,442
Selling, general and administrative
expenses............................. 5,723 7,162 12,837 1,714 9,635
------- ------- ------- ------- -------
Income from operations................. 471 798 3,821 28 2,807
Other income (expense):
Interest expense..................... (90) (100) (63) (8) (87)
Interest income...................... 26 44 334 2 127
Other income......................... 17 48 214 17 100
------- ------- ------- ------- -------
(47) (8) 485 11 140
Income before federal and state income
taxes................................ 424 790 4,306 39 2,947
Provision (benefit) for income taxes:
Current.............................. 48 105 2,675 6 1,688
Deferred............................. (7) (23) (1,479) -- (568)
------- ------- ------- ------- -------
41 82 1,196 6 1,120
------- ------- ------- ------- -------
Net income........................... $ 383 $ 708 $ 3,110 $ 33 $ 1,827
======= ======= ======= ======= =======
Net income per common share............ $ 0.25 $ 0.45 $ 0.70 $ 0.02 $ 0.15
======= ======= ======= ======= =======
Weighted average shares................ 1,561 1,561 4,451 1,561 12,269
======= ======= ======= ======= =======
</TABLE>
See accompanying notes.
F-12
<PAGE> 64
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL EQUITY
--------------- PAID-IN RETAINED NOTES
SHARES AMOUNT CAPITAL EARNINGS RECEIVABLE TOTAL
------ ------ ---------- --------- ---------- ---------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1994.................... 1,561 $ 16 $ 241 $ 1,193 -- $ 1,450
Capital distributions....................... -- -- -- (284) -- (284)
Net income.................................. -- -- -- 383 -- 383
------ ---- ------- --------- --------- ---------
Balance at December 31, 1994.................. 1,561 16 241 1,292 -- 1,549
Capital distributions....................... -- -- -- (193) -- (193)
Net income.................................. -- -- -- 708 -- 708
------ ---- ------- --------- --------- ---------
Balance at December 31, 1995.................. 1,561 16 241 1,807 -- 2,064
Issuance of stock at initial public
offering.................................. 2,588 26 28,087 -- -- 28,113
Predecessor Companies (see Note 3)
Issuance of stock........................... 4,832 48 6,462 -- (15) 6,495
Cash distributions.......................... -- -- (18,699) -- -- (18,699)
Issuance of stock for Acquired Companies
(see Note 4).............................. 2,069 21 32,475 -- -- 32,496
Capital distributions....................... -- -- -- (508) -- (508)
Net income.................................. -- -- -- 3,110 -- 3,110
------ ---- ------- --------- --------- ---------
Balance at December 31, 1996.................. 11,050 111 48,566 4,409 (15) 53,071
------ ---- ------- --------- --------- ---------
Payment of Equity notes (unaudited)......... -- -- -- -- 15 15
Issuance of stock (unaudited)............... 2,645 26 49,816 -- -- 49,842
Net income (unaudited)...................... -- -- -- 1,827 -- 1,827
------ ---- ------- --------- --------- ---------
Balance at March 31, 1997 (unaudited)......... 13,695 $137 $98,382 $ 6,236 $ -- $ 104,755
====== ==== ======= ========= ========= =========
</TABLE>
See accompanying notes.
F-13
<PAGE> 65
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE MONTHS ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
-------------------------- -------------------------
1994 1995 1996 1996 1997
------ ------ -------- ----------- -----------
(UNAUDITED) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 383 $ 708 $ 3,110 $ 33 $ 1,827
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation and amortization............................. 449 572 650 195 978
Equity in affiliate earnings.............................. -- -- (30) -- --
Benefit for deferred income taxes......................... (7) (23) (1,479) -- (568)
(Loss) gain on asset disposals............................ 8 (13) (40) -- --
Changes in assets and liabilities:
Receivables............................................. (752) (232) 115 272 1,644
Inventories............................................. (76) (2) (203) 40 (1,491)
Prepaid expenses and other current assets............... 28 (7) (336) (19) (1,052)
Trade accounts payable and accrued liabilities.......... 227 (227) (1,745) (31) (2,811)
Accrued compensation.................................... 156 50 (910) 102 1,337
Accrued warranties...................................... 15 56 148 (52) 234
Deferred revenue........................................ 225 (44) 404 170 551
Income taxes payable.................................... 4 41 363 (27) 1,005
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.... 59 18 (128) 79 (483)
------ ------ -------- ----------- --------
Net cash flow provided by (used in) operating
activities........................................ 719 897 (81) 762 1,171
INVESTING ACTIVITIES
Advances on notes receivable................................ -- -- (250) -- --
Payments on notes receivable................................ -- -- -- -- 119
Purchase of property, buildings, and equipment.............. (630) (766) (638) (116) (2,638)
Proceeds from sale of property, buildings, and equipment.... 9 30 225 -- --
Purchase of investments..................................... -- -- -- 10 3
Cash acquired through acquisitions.......................... -- -- 3,961 -- 1,224
Payment of cash for acquired companies...................... -- -- (18,699) -- (12,701)
(Increase) decrease in other assets......................... (96) (96) (304) 28 (22)
------ ------ -------- ----------- --------
Net cash used in investing activities............... (717) (832) (15,705) (78) (14,015)
FINANCING ACTIVITIES
Proceeds from notes payable to shareholders and related
parties................................................... -- -- 59 -- --
Payments on notes payable to shareholders and related
parties................................................... -- -- (886) -- (375)
Issuance of stock, net of issuance costs.................... -- -- 28,113 -- 35,518
Proceeds of long-term debt and capital leases............... 423 648 104 87 130
Payments of long-term debt and capital leases............... (365) (437) (815) -- --
Distributions paid.......................................... (284) (193) (508) -- --
------ ------ -------- ----------- --------
Net cash (used in) provided by financing activities......... (226) 18 26,067 87 35,273
------ ------ -------- ----------- --------
Increase (decrease) in cash and cash equivalents............ (224) 83 10,281 771 22,429
Cash and cash equivalents at beginning of period............ 586 362 445 445 10,726
------ ------ -------- ----------- --------
Cash and cash equivalents at end of period.................. $ 362 $ 445 $ 10,726 $ 1,216 $ 33,155
====== ====== ======== =========== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 103 $ 100 $ 63 $ 19 $ 88
====== ====== ======== =========== ========
Income tax paid............................................. $ 49 $ 67 $ 1,880 $ 6 $ 1,201
====== ====== ======== =========== ========
ACQUISITION OF COMPANIES:
Fair value of assets acquired............................. $ -- $ -- $ 42,333 $ -- $ 31,973
Cash paid................................................. -- -- 1,478 -- 12,701
Common stock issued....................................... -- -- 34,068 -- 12,481
------ ------ -------- ----------- --------
Liabilities assumed....................................... $ -- $ -- $ 6,787 $ -- $ 6,791
====== ====== ======== =========== ========
DISTRIBUTION OF ASSETS TO STOCKHOLDERS
Book value of assets distributed............................ $ -- $ -- $ 1,324 $ -- $ --
====== ====== ======== =========== ========
Long-term debt assumed by stockholders...................... $ -- $ -- $ 488 $ -- $ --
====== ====== ======== =========== ========
Notes payable to stockholders retired....................... $ -- $ -- $ 343 $ -- $ --
====== ====== ======== =========== ========
</TABLE>
See accompanying notes.
F-14
<PAGE> 66
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Service Experts, Inc. ("the Company") was incorporated on March 27, 1996.
As a result of the adoption of Securities and Exchange Commission Staff
Accounting Bulletin No. 97 ("SAB 97") on July 31, 1996, the historical financial
statements of 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. ("the Acquiring Company") and subsequent acquisitions
accounted for under pooling of interests. (See Note 2). AC Service &
Installation Co., Inc. and Donelson Air Conditioning Company, Inc. were under
common control. On August 21, 1996 and simultaneous with the closing of its
initial public offering, the Company acquired in separate transactions, 12
heating, ventilating and air conditioning ("HVAC") replacement and service
businesses and Contractor Success Group, Inc. (collectively, the "Predecessor
Companies") in exchange for shares of the Company's Common Stock and cash (the
"Combination"). The Acquiring Company was treated as the acquiror entity in this
transaction in accordance with SAB 97. The operations of the acquired companies
have been included in the Company's financial statements from the date of
acquisition. The above-mentioned acquisitions have been accounted for using the
historical cost basis of the acquired companies in accordance with Securities
and Exchange Commission Staff Accounting Bulletin No. 48 ("SAB 48"). The Company
operates in one industry segment and is primarily engaged in the replacement and
servicing of HVAC for residential and commercial customers. The Company has
Service Centers located in cities across the United States.
PRINCIPALS OF CONSOLIDATION
The consolidated financial statements of Service Experts, Inc. include the
accounts of the Company and its subsidiaries. All intercompany transactions have
been eliminated in consolidation. Investments in affiliates less than 50 percent
owned are generally recorded on the equity method.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts ("Contracts") for commercial buildings are recognized on the
percentage of completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues on all of the Company's residential heating and
air conditioning installation, service and maintenance jobs are recognized upon
completion of the services which is usually within one to two days.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within six to 18 months.
Nonidentifiable selling, general, and administrative expenses are charged to
income as incurred and are not allocated to Contract costs.
Trade accounts receivable includes billings and billed retainage on
Contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $76,000 and $359,000 at December 31, 1995 and 1996, respectively. The
Company classifies these amounts as current assets because all balances are
expected to be collected in the current year. Concentrations of credit risk with
respect to trade receivables are limited due to the large number of customers
comprising the Company's customer base, and their dispersions across many
different industries and geographies.
The asset, "costs and estimated earnings in excess of billings," represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings," represents
billings in excess of revenue recognized on in-progress contracts.
F-15
<PAGE> 67
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheets for accounts receivable
and accounts payable approximate fair value. Accounts receivable are usually
unsecured.
Long-Term Debt
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt approximate
fair value.
CASH EQUIVALENTS
The Company considers all highly liquid investments with an original
maturity of three months or less to be cash equivalents.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1994, 1995 and 1996 amounts charged to
bad debts expense totaled $95,000, $42,000 and $98,000, respectively and
accounts written off, net of recoveries, were $11,000, $13,000 and $3,000,
respectively.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined principally by the first-in, first-out (FIFO) method for all
inventories.
PROPERTY, BUILDING AND EQUIPMENT
Property, building and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings................................................... 31.5
Furniture and fixtures...................................... 5-10
Machinery and equipment..................................... 5-10
Vehicles.................................................... 5-10
Leasehold improvements...................................... 7-30
</TABLE>
DEFERRED REVENUE
The Company pre-sells maintenance contracts in the form of extended service
agreements ("ESA"). ESA revenue is recorded as deferred revenue and recognized
as income when service is performed.
WARRANTIES
The Company provides the retail customer with a warranty ranging from one
to ten years on parts and labor from the date of installation of the heating and
air conditioning unit. This warranty generally runs concurrent with the
manufacturer's warranty on parts and for the first year on labor. The Company
provides an 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-16
<PAGE> 68
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (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
Donelson Air Conditioning Company, Inc. used the liability method of
accounting for federal and state income taxes as provided by SFAS No. 109,
"Accounting for Income Taxes." Under the liability method, the deferred tax
liability or asset is based on temporary differences between the financial
statement and income tax bases of assets and liabilities, measured at tax rates
that will be in effect when the differences reverse.
The former stockholders of AC Service & Installation Co., Inc., Custom Air
Conditioning, Inc. and Freschi Air Systems, Inc. (see Note 2) elected under
Subchapter S of the Internal Revenue Code to include the Company's income in
their own income for federal income tax purposes. Accordingly, AC Service &
Installation Co., Inc., Custom Air Conditioning, Inc. and Freschi Air Systems,
Inc. are not subject to federal income taxes. This election is not available for
Tennessee state income tax reporting; accordingly, AC Service & Installation
Co., Inc. used the liability method of accounting for Tennessee state income
taxes.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1994, 1995 and
1996, the Company expensed $530,000, $524,000, and $1,584,000, respectively.
GOODWILL
Goodwill consists of the excess of purchase price over the fair value of
acquired tangible and identifiable intangible assets. Excess cost over the fair
value of net assets acquired (or goodwill) is amortized on a straight-line basis
over 40 years. The carrying value of goodwill is reviewed if the facts and
circumstances suggest that it may be impaired. If this review indicates that
goodwill will not be recoverable, as determined based on the undiscounted cash
flows of the entity acquired over the remaining amortization period, the
Company's carrying value of the goodwill will be reduced by the estimated
shortfall of cash flow. Accumulated amortization of goodwill was $87,000 at
December 31, 1996.
INCOME PER COMMON SHARE
Income per common share is based on the weighted average number of shares
of common stock outstanding and common stock equivalents consisting of dilutive
stock options and warrants. Fully diluted earnings per share for 1994, 1995 and
1996 are not materially different from primary earnings per share and,
therefore, are not presented.
NEWLY ISSUED ACCOUNTING STANDARD
In February 1997, the Financial Accounting Standards Board issued Statement
No. 128, Earnings per Share ("Statement 128"), which is required to be adopted
on December 31, 1997. At that time, the Company will be required to change the
method currently used to compute earnings per share and to restate all prior
periods. Under the new requirements for calculating primary earnings per share,
the dilutive effect of stock options will be excluded. This change will not have
a material effect on primary earnings per share as previously reported.
Statement 128 is not expected to have a material effect on the calculation of
fully diluted earnings per share.
F-17
<PAGE> 69
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RECLASSIFICATIONS
Certain reclassifications have been made in 1994 and 1995 financial
statements to conform to the 1996 presentation. These reclassifications had no
effect on the results of operations previously reported.
2. MERGERS
In December 1996, the Company completed mergers with Custom Air
Conditioning, Inc. ("Custom") and Freschi Air Systems, Inc. ("Freschi") through
the exchange of 230,049 and 177,765 shares, respectively, of the Company's
Common Stock.
These mergers have been accounted for as poolings of interests and,
accordingly, the consolidated financial statements for the periods presented
have been restated to include the accounts of Custom and Freschi. The following
is a summary of results of operations of the separate entities for periods prior
to the mergers.
<TABLE>
<CAPTION>
ELEVEN
YEAR ENDED MONTHS
DECEMBER 31, ENDED
------------------ NOVEMBER 30,
1994 1995 1996
------- ------- --------------
(IN THOUSANDS) (UNAUDITED)
(IN THOUSANDS)
<S> <C> <C> <C>
Net Revenues
Service Experts.......................................... $14,299 $16,453 $29,167
Custom................................................... 4,638 5,169 5,068
Freschi.................................................. 3,256 3,254 4,116
------- ------- -------
Combined................................................. $22,193 $24,876 $38,351
======= ======= =======
Net Income (loss)
Service Experts.......................................... $ 179 $ 629 $ 1,751
Custom................................................... 245 173 213
Freschi.................................................. (41) (94) 406
------- ------- -------
Combined................................................. $ 383 $ 708 $ 2,370
======= ======= =======
</TABLE>
3. RECAPITALIZATION AND INITIAL PUBLIC OFFERING
On August 21, 1996, the Company completed an initial public offering
("IPO") of 2,587,500 shares of Common Stock at $13.00 per share. Simultaneously
with the closing of the IPO, the Company issued 3,369,538 shares of Common Stock
and distributed $18,699,000 in cash (exclusive of 1,153,098 shares issued and
$5,027,947 cash distributed to the former stockholders of the Acquiring Company)
in exchange for the stock of the Predecessor Companies. The exchange is being
accounted for utilizing the historical cost basis in accordance with SAB 48 with
the stock being valued at the historical cost of the net assets exchanged. Cash
consideration given in these acquisitions is treated for accounting purposes as
a dividend from the Company.
4. ACQUISITIONS
On November 18, 1996, the Company filed a Registration Statement on Form
S-4 (the "Shelf Registration Statement") covering securities with a collective
aggregate offering price of $50.0 million for use in acquisitions, including the
acquisition of 23 unrelated HVAC replacement and service businesses. Of the 23
companies to be acquired, the Company had completed the acquisition of 15 of
these companies as of December 31, 1996. Two of these acquisitions completed by
December 31, 1996 were accounted for as poolings of interests as discussed in
Note 2. In connection with the 13 acquisitions accounted for using the purchase
method of accounting, the Company issued 2,069,000 shares at a fair market value
of $34,068,000, excluding stock issuance costs of $1,572,000, and cash of
$1,499,000. The Company established an escrow account equal to 10% of the
purchase
F-18
<PAGE> 70
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
price for each acquisition subject to final closing adjustments. The purchase
price was allocated to the acquired assets based on the fair values of those
assets as determined by the Company as set forth below (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Current Assets.............................................. $ 7,032
Property, Buildings and Equipment........................... 2,593
Other Assets................................................ 392
Goodwill.................................................... 32,337
Liabilities Assumed......................................... (6,787)
-------
Purchase Price............................... $35,567
=======
</TABLE>
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase
method of accounting except as indicated in Note 2. The allocation of the
purchase price associated with the acquisitions has been determined by the
Company based upon available information and is subject to further refinement.
The operating results of the acquired companies have been included in the
accompanying consolidated statements of income from the respective dates of
acquisition. The following unaudited pro forma results of operations give effect
to the operations of the entities acquired as if the respective transactions had
occurred as of the first day of the fiscal year immediately preceding the year
of the transactions. The pro forma results of operations do not purport to
represent what the Company's results of operations would have been had such
transactions in fact occurred at the beginning of the years presented or to
project the Company's results of operations in any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Net revenues........................................... $112,056 $120,083
Net income............................................. 5,227 6,043
Income per common share................................ $ .47 $ .55
</TABLE>
Subsequent to December 31, 1996, the Company completed the acquisition of
the remaining eight companies included in the previously mentioned Shelf
Registration Statement by issuing 680,758 shares of stock and paying cash
consideration of $2.0 million. The following unaudited pro forma results of
operations give effect to the operations of the entities acquired during 1996
and subsequent to December 31, 1996 as if the respective transactions had
occurred as of the first day of the fiscal year immediately preceding the year
of the transactions. The pro forma results of operations do not purport to
represent what the Company's results of operations would have been had such
transactions in fact occurred at the beginning of the years presented or to
project the Company's results of operations in any future period.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1995 1996
---------- ----------
(IN THOUSANDS, EXCEPT
PER SHARE DATA)
<S> <C> <C>
Net revenues........................................... $131,788 $140,654
Net income............................................. 5,727 8,490
Income per common share................................ $ .52 $ .71
</TABLE>
F-19
<PAGE> 71
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------ ------
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts..................... $ 911 $2,903
Estimated earnings....................................... 487 1,147
------ ------
$1,398 $4,050
Less applicable billings................................... $1,595 $4,107
------ ------
$ (197) $ (57)
====== ======
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. $ 31 $ 283
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (228) (340)
------ ------
$ (197) $ (57)
====== ======
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
6. LEASES
Total rental expense for all operating leases was $174,000, $191,000 and
$490,000 for 1994, 1995 and 1996, respectively. The Company leases office and
warehouse space from various stockholders of the Company. These lease agreements
expire at various dates through 2000. Related party rental expense for 1994,
1995 and 1996 was $151,000, $161,000, and $295,000, respectively. The Company
leases certain vehicles and office and warehouse facilities under terms of
noncancelable operating lease agreements which expire at various dates through
2006. Minimum rental commitments at December 31, 1996 under operating leases
having an initial noncancelable term of one year or more are as follows (in
thousands):
<TABLE>
<CAPTION>
CAPITAL OPERATING RELATED
LEASES LEASES PARTY TOTAL
------- --------- ------- ------
<S> <C> <C> <C> <C>
1997...................................... $ 60 $ 421 $1,485 $1,966
1998...................................... 55 308 1,483 1,846
1999...................................... 47 239 1,432 1,718
2000...................................... 23 151 1,432 1,606
2001...................................... -- 105 1,112 1,217
Thereafter................................ -- -- 1,171 1,171
---- ------ ------ ------
185 $1,224 $8,115 $9,524
====== ====== ======
Amounts representing interest............. 32
----
Present value of net minimum
rentals (including $45 classified as
current)................................ $153
====
</TABLE>
The carrying value of assets under capital leases, which are included with
owned assets in the accompanying balance sheets is $154,000.
Amortization of the assets under capital leases is included in depreciation
expense.
F-20
<PAGE> 72
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
------------
1995 1996
---- ----
<S> <C> <C>
Mortgage note payable....................................... $516 $ --
Installment and equipment notes............................. 314 94
Other....................................................... 24 28
---- ----
854 122
Less current portion........................................ 244 90
---- ----
$610 $ 32
==== ====
</TABLE>
On September 10, 1996, the Company entered into a Revolving Line of Credit
agreement with a Nashville, Tennessee bank for up to $10,000,000 to be used for
working capital purposes and acquisitions. On the same date, the Company also
entered into a Discretionary Line of Credit agreement with a Nashville,
Tennessee bank for up to $10,000,000 to be used for acquisitions or such other
purposes as may be approved by the bank. Any principal amounts outstanding on
the Line of Credit are due on September 10, 1998. On December 31, 1996, there
were no amounts outstanding under the above lines of credit.
Interest on any outstanding portion of the lines of credit is the LIBOR
rate plus applicable rate margin ranging from 125 basis points per annum to 250
basis points per annum (8.5% at December 31, 1996) dependent upon the funded
debt to EBITDA ratio. The Company pays an annual fee of 0.25% of the unused
portion of the available borrowings.
As long as any indebtedness is outstanding, the Lines of Credit require,
among other things, that the Company maintain various financial ratios at
specified levels including minimum levels for stockholders' equity. The Lines of
Credit also limit consolidations and mergers, and incurrence of indebtedness or
liens and prohibit dividends and distributions. At December 31, 1996, the
Company was in compliance with all covenants.
The Company had a mortgage note payable to Free Will Baptist, Inc. that was
secured by the Company's office building and related land. The loan required
monthly installments of $8,400, including fixed principal and imputed interest
(6.1% at December 31, 1995). The mortgage was transferred to the former
shareholders of AC Service & Installation Co., Inc. and Donelson Air
Conditioning Company, Inc. on June 30, 1996 (see Note 12).
The Company has various installment and equipment loans to various lenders
which are secured by vehicles and equipment. These loans bear interest at
various fixed rates ranging from 4.8% to 13% per annum with maturity dates
through 1999.
As of December 31, 1996, the aggregate amounts of annual principal
maturities of long-term debt are as follows (in thousands):
<TABLE>
<S> <C>
1997........................................................ $ 90
1998........................................................ 29
1999........................................................ 3
----
$122
====
</TABLE>
F-21
<PAGE> 73
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
8. STOCK PLANS
INCENTIVE STOCK OPTION PLAN
The Company has reserved 700,000 shares of common stock under an incentive
stock option plan. A summary of the status of the plan follows:
<TABLE>
<CAPTION>
YEAR ENDED WEIGHTED
DECEMBER 31, AVERAGE
1996 EXERCISE PRICE
-------------- --------------
<S> <C> <C>
Granted........................................ 517,811 $16.92
Exercised...................................... -- --
Canceled....................................... -- --
-------------- ------
Outstanding at end of year..................... 517,811 $16.92
============== ======
Option price range per share at end of year.... $13.00 - $17.25 $16.92
============== ======
Options exercisable at end of year............. --
==============
</TABLE>
Stock options are exercisable over a period determined by the Board of
Directors, but no longer than ten years after the date of the grant. At December
31, 1996, options to purchase 182,189 shares were available for grant.
The Company has elected to follow Accounting Principles Board Opinion No.
25, "Accounting for Stock Issued to Employees" (APB 25) and related
interpretations in accounting for its employee stock options because, as
discussed below, the alternative fair value accounting provided for under FASB
Statement No. 123, "Accounting for Stock-Based Compensation" (FAS 123), requires
use of option valuation models that were not developed for use in valuing
employee stock options. Under APB 25, because the exercise price of the
Company's employee stock options equals the market price of the underlying stock
on the date of grant, no compensation expense is recognized.
Pro Forma information regarding net income and earnings per share is
required by FAS 123, and has been determined as if the Company had accounted for
its employee stock options under the fair value method of that Statement. The
fair value of these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following weighted-average
assumptions for 1996, respectively; risk-free interest rates of 5.97% to 6.34%;
dividends yields of 0.0%; volatility factors of the expected market price of the
Company's common stock of .55 and .25; and a weighted-average expected life of
the options of three years.
The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those of traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate, in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.
F-22
<PAGE> 74
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of options
is amortized to expense over the options' vesting period. The Company's pro
forma information follows (in thousands except for earnings per share
information):
<TABLE>
<CAPTION>
1996
--------
<S> <C>
Net income.................................................. $ 3,110
Pro forma compensation expense from stock options, net of
taxes..................................................... (121)
--------
Pro forma net income........................................ $ 2,989
========
Pro forma earnings per common and common equivalent share... $ .67
========
</TABLE>
Under FAS 123, disclosure of exercise prices is required for the year ended
December 31, 1996 only. The weighted-average fair value of options granted
during 1996 was $4.27. The weighted-average remaining contractual life of those
options is 9.7 years.
NONEMPLOYEE DIRECTOR STOCK OPTION PLAN
The Company has a Director Stock Option Plan that provides for a maximum of
issuance 100,000 shares of Common Stock for grant to non-management members of
the Board of Directors.
Options to purchase a total of 15,000 shares of Common Stock with exercise
price of $13.00 per share were outstanding at December 31, 1996. Each option is
exercisable in full upon receipt and shall expire ten years after the Grant
Date.
EMPLOYEE STOCK PURCHASE PLAN
The Company has an Employee Stock Purchase Plan under which the sale of
100,000 shares of Common Stock have been authorized. Employees may designate up
to 10% of their base compensation, at a price equal to 85% of the lessor fair
market value of the Common Stock January 1 or December 31. Employees are
eligible to participate in the Purchase Plan if they are employed by the Company
or a participating subsidiary for at least 20 hours a week and more than five
months in any calendar year and have been employed for at least six months since
their date of hire. At December 31, 1996 no shares had been issued under this
plan.
WARRANTS
In connection with the Company's IPO, Equitable Securities Corporation
received warrants to purchase 82,391 shares of the Company's Common Stock at an
exercise price of $13.00 per share. The warrants are exercisable for a period of
five years.
9. EMPLOYEE BENEFIT PLANS
The Company has defined-contribution employee benefit plans incorporating
provisions of section 401(k) of the Internal Revenue Code. Generally, employees
of the Company must have one year of service and work 500 hours during the plan
year to be eligible. Under the plans' provisions, a plan member may make
contributions, on a tax-deferred basis, from 1% to 20% of total compensation not
to exceed the maximum established annually by the Internal Revenue Service.
Under the plans matching contributions are made by the Company in amounts
ranging from 1% to 50% of total contributions by a plan member, to a maximum of
between 2% and 6% of the employee's total calendar year compensation. The
Company's matching contributions totaled $126,000, $201,000 and $206,000 as of
December 31, 1994, 1995 and 1996, respectively.
F-23
<PAGE> 75
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of its business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the financial
position or results of operations of the Company.
The Company maintains general liability insurance coverage and an umbrella
policy to ensure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
11. INCOME TAXES
Income tax expense consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1994 1995 1996
----- ----- -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal................................................... $40 $ 65 $2,214
State..................................................... 8 40 461
Deferred.................................................... (7) (23) (1,479)
--- ---- ------
$41 $ 82 $1,196
=== ==== ======
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------ ------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Contract billings......................................... $ 22 $ 136
Depreciation and amortization............................. -- 360
Other-net................................................. -- 63
------ ------
Deferred tax liabilities.................................... 22 559
Deferred tax assets:
Depreciation and amortization............................. 2 --
Bad debts................................................. 18 256
Warranty reserves......................................... 11 330
Deferred revenue.......................................... -- 1,045
Accrued expenses.......................................... -- 365
Other-net................................................. -- 96
------ ------
Total gross deferred tax assets............................. 31 2,092
------ ------
Net deferred tax assets..................................... $ 9 $1,533
====== ======
</TABLE>
F-24
<PAGE> 76
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will be more likely than not realized. Accordingly, no valuation allowance has
been recognized.
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1994 1995 1996
---- ------ ------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax provision at statutory rate.................... $ 75 $ 241 $1,464
State income tax less applicable federal tax
benefit.......................................... 5 27 147
Less benefit of graduated tax rates and adjustments
to eliminate S corporation....................... (39) (186) (218)
Less benefit recognized upon termination of
Subchapter S election for AC Service &
Installation Co., Inc............................ -- -- (236)
Other-net.......................................... -- -- 39
---- ------ ------
$ 41 $ 82 $1,196
==== ====== ======
</TABLE>
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously, AC Service & Installation Co., Inc.; Custom Air
Conditioning, Inc.; and Freschi Air Systems, Inc. operated under Subchapter S of
the Internal Revenue Code and were not subject to corporate federal income tax.
The Subchapter S elections were terminated upon acquisition by the Company. As a
result, these companies are subject to corporate income taxes subsequent to the
termination of S corporation status. AC Service & Installation Co., Inc.; Custom
Air Conditioning, Inc. and Freschi Air Systems, Inc. had net operating income
for income tax purposes of $133,000, $682,000 and $1,760,000 for 1994, 1995 and
1996, respectively. Had AC Service & Installation Co., Inc.; Custom Air
Conditioning, Inc. and Freschi Air Systems, Inc. filed federal and state income
tax returns as regular C corporations for 1994, 1995, and periods ended during
1996, income tax expense under the provisions of Financial Accounting Standard
No. 109 would have been, $102,000, $242,000 and $316,000, respectively.
At the date of termination of S corporation status, AC Service &
Installation Co., Inc.; Custom Air Conditioning, Inc. and Freschi Air Systems,
Inc. were required to provide deferred taxes for cumulative temporary
differences between financial reporting and tax reporting basis of assets and
liabilities. Such deferred taxes were based on the cumulative temporary
differences at the date of termination of S corporation status.
The termination of S corporation status occurred on August 21, 1996 for AC
Service & Installation Co., Inc., and a deferred tax asset of $236,000 was
recorded. The effect of recognizing the deferred tax asset was included in the
provision for income taxes.
12. RELATED PARTY TRANSACTIONS
Notes Receivable from Related Parties
The Company has one outstanding note receivable of $366,000 from a
stockholder of the Company as of December 31, 1996. The note is payable in 180
monthly installments of $3,905 and bears annual interest of 9%.
Other Related Party Transactions
On June 30, 1996, the Company distributed land, buildings, accounts
receivable and other assets with a net book value of $1,096,000 in satisfaction
of mortgage notes payable of $488,000, shareholder notes payable of $343,000,
and accrued compensation of $365,000 to the former shareholders of AC Service &
Installation Co., Inc. and Donelson Air Conditioning, Inc.
F-25
<PAGE> 77
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Notes Payable to Related Parties
At December 31, 1995 the Company had notes payable to related parties,
including current and former shareholders, which bear interest ranging from 0.0%
to 12.5% and were due through 2009. These notes were repaid during 1996.
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the year ended December 31, 1996 is
summarized below:
<TABLE>
<CAPTION>
QUARTER
--------------------------------------
1ST 2ND 3RD 4TH
------ ------ ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenues.................................. $5,134 $7,693 $13,130 $20,899
Income before income taxes.................... 39 59 1,527 2,681
Net income.................................... 33 152 1,239 1,686
Income per common share....................... $ .02 $ .10 $ .25 $ .17
</TABLE>
14. UNAUDITED INTERIM FINANCIAL INFORMATION
The unaudited consolidated financial statements for the three months ended
March 31, 1996 and 1997 have been prepared by management. The interim financial
statements include all adjustments, consisting of only normal recurring
adjustments necessary for a fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statement should be read in conjunction with the December 31,
1994, 1995 and 1996 audited consolidated financial statements appearing herein.
The results of the three months ended March 31, 1997 may not be indicative of
operating results for the full year.
15. SUBSEQUENT EVENT
Subsequent to December 31, 1996, the Company entered into agreements in
principle to acquire eight HVAC businesses. Pursuant to these agreements in
principle, the Company will merge with or acquire the stock of the eight
companies for an aggregate of approximately $15.4 million cash and approximately
225,400 shares of Common Stock. Closing of the transactions is subject to
customary conditions and is expected to take place prior to June 30, 1997.
F-26
<PAGE> 78
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Artic Aire of Chico, Inc.
We have audited the accompanying balance sheet of Artic Aire of Chico, Inc.
as of February 28, 1997, and the related statements of operations, stockholders'
equity, and cash flows for the year ended February 28, 1997. 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 Artic Aire of Chico, Inc. at
February 28, 1997, and the results of its operations and its cash flows for the
year ended February 28, 1997, in conformity with generally accepted accounting
principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
May 19, 1997
F-27
<PAGE> 79
ARTIC AIRE OF CHICO, INC.
BALANCE SHEETS
<TABLE>
<CAPTION>
FEBRUARY 28, 1997 MAY 31, 1997
----------------- ------------
(UNAUDITED)
(IN THOUSANDS, EXCEPT SHARE
DATA)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 64 $ 68
Receivables:
Trade, net of allowance for doubtful accounts of $20 at
February 28, 1997 and May 31, 1997.................... 282 313
Employee............................................... 25 10
------- ------
307 323
Inventories................................................. 518 530
Costs and estimated earnings in excess of billings.......... 17 30
Prepaid expenses and other current assets................... 3 57
Deferred income taxes....................................... 12 5
------- ------
Total current assets.............................. 921 1,013
Property and equipment:
Furniture and fixtures.................................... 14 14
Machinery and equipment................................... 254 254
Vehicles.................................................. 216 216
Leasehold improvements.................................... 12 12
------- ------
496 496
Less accumulated depreciation and amortization............ (330) (345)
------- ------
166 151
------- ------
Total assets...................................... $1,087 $1,164
======= ======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Trade accounts payable and accrued liabilities............ $ 72 $ 203
Accrued compensation...................................... 82 68
Accrued warranties........................................ 40 48
Income taxes payable...................................... 88 88
Deferred revenue.......................................... 11 13
Billings in excess of costs and estimated earnings........ 62 37
Current portion of long-term debt and capital lease
obligations............................................ 23 24
------- ------
Total current liabilities......................... 378 481
Long-term debt and capital lease obligations, net of
current................................................... 55 49
Deferred income taxes....................................... 24 12
Stockholders' equity:
Common stock, $100 par value, 2,000 shares authorized, 349
shares issued and outstanding.......................... 35 35
Additional paid in capital................................ 69 69
Retained earnings......................................... 526 518
------- ------
Total stockholders' equity........................ 630 622
------- ------
Total liabilities and stockholders' equity........ $1,087 $1,164
======= ======
</TABLE>
See accompanying notes.
F-28
<PAGE> 80
ARTIC AIRE OF CHICO, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
THREE
MONTHS
YEAR ENDED ENDED
FEBRUARY 28, 1997 MAY 31, 1997
----------------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
Net revenues................................................ $3,815 $ 734
Cost of goods sold.......................................... 2,603 511
------- ------
Gross margin................................................ 1,212 223
Selling, general and administrative expenses................ 997 235
------- ------
Income from operations...................................... 215 (12)
Other income (expense):
Interest expense.......................................... (12) (2)
Interest income........................................... 8 1
------- ------
(4) (1)
------- ------
Income before taxes......................................... 211 (13)
Provision (benefit) for income tax:
Current................................................... 88 --
Deferred.................................................. (19) (5)
------- ------
Total income taxes.......................................... 69 (5)
------- ------
Net income.................................................. $ 142 $ (8)
======= ======
</TABLE>
See accompanying notes.
F-29
<PAGE> 81
ARTIC AIRE OF CHICO, INC.
STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
COMMON STOCK
$100 PAR VALUE ADDITIONAL
--------------- PAID-IN RETAINED
SHARES AMOUNT CAPITAL EARNINGS TOTAL
------ ------ ---------- -------- -----
(IN THOUSANDS, EXCEPT SHARE DATA)
<S> <C> <C> <C> <C> <C>
Balance at March 1, 1996.............................. 349 $35 $69 $384 $488
Net income.......................................... -- -- -- 142 142
--- --- --- ---- ----
Balance at February 28, 1997.......................... 349 $35 $69 $526 $630
--- --- --- ---- ----
Net loss............................................ -- -- -- (8) (8)
--- --- --- ---- ----
Balance at May 31, 1997 (unaudited)................... 349 $35 $69 $518 $622
=== === === ==== ====
</TABLE>
See accompanying notes.
F-30
<PAGE> 82
ARTIC AIRE OF CHICO, INC.
STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
THREE
MONTHS
YEAR ENDED ENDED
FEBRUARY 28, 1997 MAY 31, 1997
----------------- ------------
(UNAUDITED)
(IN THOUSANDS)
<S> <C> <C>
OPERATING ACTIVITIES
Net income (loss)........................................... $ 142 $ (8)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization............................. 51 15
Deferred income taxes..................................... (19) (5)
Provision for loss on accounts receivable................. 9 2
Gain on asset disposals................................... (3) --
Changes in assets and liabilities:
Accounts receivable.................................... 22 (18)
Inventories............................................ (240) (12)
Prepaid expenses and other current assets.............. 14 (54)
Trade accounts payable and accrued liabilities......... (128) 131
Accrued compensation................................... (21) (14)
Accrued warranties..................................... (15) 8
Deferred revenue....................................... 1 2
Income taxes payable................................... 66 --
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.... 100 (38)
------ -----
Net cash flow provided by (used in) operating activities.... (21) 9
INVESTING ACTIVITIES
Purchase of property and equipment.......................... (40) --
Proceeds from sale of properties and equipment.............. 4 --
------ -----
Net cash used in investing activities....................... (36) --
FINANCING ACTIVITIES
Payments on long-term debt and capital leases............... (20) (5)
------ -----
Net cash used in financing activities....................... (20) (5)
Increase (decrease) in cash and cash equivalents............ (77) 4
Cash and cash equivalents at beginning of period............ 141 64
------ -----
Cash and cash equivalents at end of period.................. $ 64 $ 68
====== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 12 $ 2
====== =====
Income taxes paid........................................... $ 10 $ --
====== =====
</TABLE>
See accompanying notes.
F-31
<PAGE> 83
ARTIC AIRE OF CHICO, INC.
NOTES TO FINANCIAL STATEMENTS
FEBRUARY 28, 1997
(IN THOUSANDS)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Artic Aire of Chico, 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
Chico and Redding, California areas.
RECOGNITION OF INCOME
Revenues on all of the Company's heating and air conditioning installation
contracts ("Contracts") for commercial buildings are recognized on the
percentage-of-completion method in the ratio that total incurred costs bear to
total estimated costs. Revenues on all of the Company's heating and air
conditioning installation for residential installation and service and
maintenance revenue are recognized upon completion of the services, which is
usually within one to two days.
Earnings and estimated costs on Contracts are reviewed throughout the terms
of the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within 6 to 18 months. Selling,
general, and administrative expenses are charged to income as incurred and are
not allocated to Contract costs.
Trade accounts receivable includes billings and billed retainage on
Contracts. 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.
The asset, "costs and estimated earnings in excess of billings", represents
revenue recognized in excess of amounts billed on in-progress contracts. The
liability, "billings in excess of costs and estimated earnings", represent
billings in excess of revenue recognized on in-progress contracts.
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheet for cash and cash
equivalents approximate fair value.
Accounts Receivable and Accounts Payable
The carrying amounts reported in the balance sheet 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 principally by the first-in, first-out (FIFO) method for all
inventories.
F-32
<PAGE> 84
ARTIC AIRE OF CHICO, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment are stated on the basis of cost. Depreciation and
amortization are provided on the straight-line method and declining-balance
methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
---------
<S> <C>
Furniture and fixtures...................................... 5
Machinery and equipment..................................... 5
Vehicles.................................................... 5
Leasehold improvements...................................... 15 - 31.5
</TABLE>
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation
expenses payable to various employees as of year end.
WARRANTIES
The Company offers its retail customers a one or 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.
INCOME TAXES
The Company uses the liability method of accounting for income taxes as
provided by SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, the deferred tax liability or asset is based on temporary differences
between the financial statement and income tax bases of assets and liabilities,
measured at tax rates that will be in effect when the differences reverse.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended February 28, 1997, amounts charged to bad debt
expense totaled $9 and recoveries of accounts previously written off was $-0-.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During fiscal 1997, the
Company expensed $79.
NEWLY ISSUED ACCOUNTING STANDARDS
The Company has considered the impact of newly issued financial accounting
pronouncements, principally Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of," and does not believe that adoption of this and any other newly
issued pronouncements would have a significant impact on the Company's financial
statements.
F-33
<PAGE> 85
ARTIC AIRE OF CHICO, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
FEBRUARY 28,
1997
------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts...................... $ 152
Estimated earnings........................................ 57
-----
209
Less applicable billings.................................... (254)
-----
$ (45)
=====
Included in the accompanying balance sheet under the
following captions:
Costs and estimated earnings in excess of billings........ $ 17
Billings in excess of costs and estimated earnings........ (62)
-----
$ (45)
=====
</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. LEASES
Total rental expense for all leases was $49 for the year ended February 28,
1997. The Company leases certain equipment and office and warehouse facilities
under terms of noncancellable operating and capital lease agreements which
expire at various dates through 1999. Minimum rental commitments at February 28,
1997, under capital and operating leases having an initial noncancellable term
of one year or more, are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
LEASES LEASES
------- ---------
<S> <C> <C>
1998........................................................ $22 $3
1999........................................................ 16 2
--- --
38 $5
==
Amounts representing interest............................... 6
---
Present value of net minimum rentals (including $17
classified as current).................................... $32
===
</TABLE>
The carrying value of assets under capital leases, which are included with
owned assets in the accompanying balance sheet, are as follows:
<TABLE>
<CAPTION>
FEBRUARY 28,
1997
------------
<S> <C>
Machinery and equipment..................................... $ 51
Less accumulated depreciation............................... (10)
----
Net equipment under capital leases.......................... $ 41
====
</TABLE>
Amortization of the assets under capital leases is included in depreciation
expense.
4. LONG-TERM DEBT
The Company has an unsecured note payable to an employee and former
shareholder with an outstanding balance of $46 at February 28, 1997. The note
requires monthly payments of $.8, including principal and interest
F-34
<PAGE> 86
ARTIC AIRE OF CHICO, INC.
NOTES TO FINANCIAL STATEMENTS -- (CONTINUED)
at 8% per annum. Annual principle maturities of $6, $7, $7, $8, $8, and $10 are
due in the years ending February 28, 1998, 1999, 2000, 2001, 2002 and
thereafter, respectively.
5. EMPLOYEE PROFIT SHARING PLAN
The Company has a defined-contribution employee benefit plan ("the Plan").
Employees are eligible to participate in the Plan following one year of service
and the attainment of age 21. Under the Plan's provisions, a plan member may
make nondeductible voluntary contributions to the Plan not to exceed 10% of the
employee's cumulative compensation while a plan participant. These nondeductible
contributions are subject to annual limits. A plan member may also voluntarily
make annual deductible contributions not to exceed the lesser of $2,000 or 100%
of the compensation received by the participant during the year. The Company may
make discretionary contributions. Participants immediately vest in their own
contributions. A participant is vested in the employer's discretionary
contributions 20% each year up to a maximum of 100%. The Company's contributions
totaled approximately $50 for the year ended February 28, 1997.
6. COMMITMENTS AND CONTINGENT LIABILITIES
The Company maintains general liability insurance coverage and umbrella
policies to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
7. INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED
FEBRUARY 28,
1997
------------
<S> <C>
Current..................................................... $ 88
Deferred.................................................... (19)
----
$ 69
====
</TABLE>
Significant components of the deferred tax assets and liabilities as of
February 28, 1997, are as follows:
<TABLE>
<S> <C>
Deferred tax liabilities:
Depreciation and amortization............................. $24
Deferred tax assets:
Accounts receivable....................................... 8
Deferred revenue.......................................... 4
---
Total gross deferred tax assets............................. 12
Valuation allowance......................................... --
---
Deferred tax assets......................................... 12
---
Net deferred tax liabilities................................ $12
===
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will more likely than not be realized during the carry forward period.
Accordingly, no valuation allowance has been recorded.
F-35
<PAGE> 87
ARTIC AIRE OF CHICO, 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>
FEBRUARY 28,
1997
------------
<S> <C>
Tax provision at statutory rate............................. $ 72
State income tax less applicable federal tax benefit........ 11
Graduated tax rates......................................... (14)
----
$ 69
====
</TABLE>
8. RELATED PARTY TRANSACTIONS
The Company leases certain office and warehouse facilities from a related
party on a month-to-month basis. The Company made total related party lease
payments of $30 during the year ended February 28, 1997.
9. SUBSEQUENT EVENT
Subsequent to year end the Company signed an agreement in principle with
Service Experts, Inc. to sell all of the Company's stock. Upon consummation of
the acquisition, the Company will become a wholly-owned subsidiary of Service
Experts, Inc.
F-36
<PAGE> 88
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Partners of
ProAir Services, L.P.:
We have audited the accompanying balance sheet of PROAIR SERVICES, L.P. (a
Delaware limited partnership) as of December 26, 1996 and the related statements
of operations, changes in partners' deficit, and cash flows for the year then
ended. These financial statements are the responsibility of the Partnership'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 ProAir Services, L.P. as of
December 26, 1996 and the results of its operations and its cash flows for the
year then ended in conformity with generally accepted accounting principles.
/s/ Arthur Andersen LLP
Atlanta, Georgia
May 30, 1997
(except with respect to
the matter discussed in
Note 7, as to which the date is
June 15, 1997)
F-37
<PAGE> 89
PROAIR SERVICES, L.P.
BALANCE SHEETS
DECEMBER 26, 1996 AND MARCH 27, 1997
<TABLE>
<CAPTION>
1996 1997
---------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current Assets:
Cash and cash equivalents................................. $ 572,204 $ 361,099
Accounts receivable, less allowance for doubtful accounts
of $90,131 at December 26, 1997 and $91,776 at March
31, 1997............................................... 461,293 316,299
Other receivables......................................... 24,418 30,285
Inventories............................................... 333,613 578,015
Work in process........................................... 71,449 86,281
Prepaid expenses and other................................ 53,400 64,909
---------- -----------
Total current assets.............................. 1,516,377 1,436,888
---------- -----------
Property and Equipment:
Land and buildings........................................ 166,352 168,040
Automobiles and trucks.................................... 508,909 522,998
Machinery and equipment................................... 160,041 162,987
Furniture and fixtures.................................... 46,929 49,651
---------- -----------
882,231 903,676
Less accumulated depreciation............................. (416,489) (453,128)
---------- -----------
Property and equipment, net....................... 465,742 450,548
---------- -----------
Intangible assets, net of accumulated amortization of
$2,724,818 at December 26, 1996 and $2,759,259 at March
31, 1997.................................................. 618,109 583,668
---------- -----------
Other assets................................................ 13,133 13,133
---------- -----------
$2,613,361 $ 2,484,237
========== ===========
LIABILITIES AND PARTNERS' DEFICIT
Current Liabilities:
Current portion of long-term debt and capital lease
obligations............................................... $ 253,372 $ 256,659
Accounts payable.......................................... 223,883 443,986
Accrued salaries and commissions.......................... 173,366 152,895
Accrued liabilities....................................... 153,130 57,504
Deferred revenue.......................................... 839,093 843,547
---------- -----------
Total current liabilities......................... 1,642,844 1,754,591
---------- -----------
Long-term debt and capital lease obligations, less current
portion................................................... 1,596,934 1,545,401
---------- -----------
Long-term deferred revenue.................................. 264,255 251,037
---------- -----------
Commitments and contingencies (Note 6)
Partners' deficit:
General Partners.......................................... (12,584) (14,345)
Class A limited partnership interest...................... (237,282) (284,394)
Class B limited partnership interest...................... (438,349) (525,388)
Class C limited partnership interest...................... (202,457) (242,665)
========== ===========
Total partners' deficit................................ (890,672) (1,066,792)
---------- -----------
$2,613,361 $ 2,484,237
========== ===========
</TABLE>
The accompanying notes are an integral part of these balance sheets.
F-38
<PAGE> 90
PROAIR SERVICES, L.P.
STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 26, 1996 AND
FOR THE THREE MONTHS ENDED MARCH 27, 1997
<TABLE>
<CAPTION>
1996 1997
---------- -----------
(UNAUDITED)
<S> <C> <C>
Net sales................................................... $9,516,584 $1,785,695
---------- ----------
Costs and Expenses:
Cost of sales............................................. 4,821,641 892,904
Selling, general, and administrative expenses............. 4,249,939 950,220
---------- ----------
Total costs and expenses.......................... 9,071,580 1,843,124
---------- ----------
Income (loss) before depreciation and amortization.......... 445,004 (57,429)
Depreciation and amortization............................... 293,810 76,493
---------- ----------
Income (loss) from operations............................... 151,194 (133,922)
---------- ----------
Other (expense) income:
Interest expense, net..................................... (202,545) (50,205)
Other, net................................................ 19,523 8,007
---------- ----------
(183,022) (42,198)
---------- ----------
Net loss.................................................... $ (31,828) $ (176,120)
========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
F-39
<PAGE> 91
PROAIR SERVICES, L.P.
STATEMENTS OF CHANGES IN PARTNERS' DEFICIT
FOR THE YEAR ENDED DECEMBER 26, 1996 AND
FOR THE THREE MONTHS ENDED MARCH 27, 1997
<TABLE>
<CAPTION>
LIMITED LIMITED LIMITED
PARTNERSHIP PARTNERSHIP PARTNERSHIP
GENERAL INTEREST INTEREST INTEREST
PARTNERS CLASS A CLASS B CLASS C TOTAL
-------- ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance, December 28, 1995.............. $(12,266) $(228,767) $(422,620) $(195,191) $ (858,844)
Net loss.............................. (318) (8,515) (15,729) (7,266) (31,828)
-------- --------- --------- --------- -----------
Balance, December 26, 1996.............. (12,584) (237,282) (438,349) (202,457) (890,672)
Net loss (unaudited).................. (1,761) (47,112) (87,039) (40,208) (176,120)
-------- --------- --------- --------- -----------
Balance, March 27, 1997 (unaudited)..... $(14,345) $(284,394) $(525,388) $(242,665) $(1,066,792)
======== ========= ========= ========= ===========
</TABLE>
The accompanying notes are an integral part of these statements.
F-40
<PAGE> 92
PROAIR SERVICES, L.P.
STATEMENTS OF CASH FLOWS
FOR THE YEAR ENDED DECEMBER 26, 1996 AND
FOR THE THREE MONTHS ENDED MARCH 27, 1997
<TABLE>
<CAPTION>
1996 1997
-------- -----------
(UNAUDITED)
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(31,828) $(176,120)
-------- ---------
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Depreciation and amortization.......................... 293,810 76,493
Amortization of discount on notes payable.............. 55,258 15,278
Loss on disposition of fixed assets.................... 3,250 0
Changes in assets and liabilities:
Accounts receivable.................................. 246,299 144,994
Other receivables.................................... 85,496 (5,867)
Inventories.......................................... (53,091) (244,402)
Work in process...................................... (7,186) (14,832)
Prepaid expenses and other........................... (5,802) (11,509)
Accounts payable..................................... (64,439) 220,103
Accrued liabilities.................................. (59,058) (116,097)
Deferred revenue..................................... 6,061 (8,764)
Other assets......................................... (1,782) 0
-------- ---------
Total adjustments................................. 498,816 55,397
-------- ---------
Net cash provided by (used in) operating
activities...................................... 466,988 (120,723)
-------- ---------
Cash flows from investing activities:
Purchases of property and equipment....................... (30,724) (26,858)
Proceeds from sale of property and equipment.............. 25,335 0
-------- ---------
Net cash used in investing activities............. (5,389) (26,858)
-------- ---------
Cash flows from financing activities:
Repayments of long-term debt and capital lease
obligations............................................ (234,958) (63,524)
-------- ---------
Increase (decrease) in cash and cash equivalents............ 226,641 (211,105)
Cash and cash equivalents, beginning of period.............. 345,563 572,204
-------- ---------
Cash and cash equivalents, end of period.................... $572,204 $ 361,099
======== =========
Cash paid for interest during the period.................... $147,000 $ 35,000
======== =========
</TABLE>
The accompanying notes are an integral part of these statements.
F-41
<PAGE> 93
PROAIR SERVICES, L.P.
NOTES TO FINANCIAL STATEMENTS
DECEMBER 26, 1996 AND MARCH 27, 1997
1. BUSINESS OPERATIONS AND TERMS OF LIMITED PARTNERSHIP AGREEMENT
ProAir Services, L.P. (the "Partnership") was formed on May 15, 1990 under
a limited partnership agreement between Morgenthaler Investments, Inc. (a
Delaware corporation) and Environmental Professional Management, Inc. (a
Delaware corporation) as the "General Partners" and MVP III Investment
Partnership (an Ohio general partnership -- "MVP") and four individual investors
as the "Limited Partners." The Partnership was formed to acquire, conduct, and
engage in the business of retail sale, installation, and servicing of heating,
ventilation, and air-conditioning equipment. The Partnership's operations are
located in Atlanta, Georgia, and Dallas, Texas.
Under the terms of the limited partnership agreement, an aggregate of 1% of
the profits and losses is allocated among the General Partners in proportion to
their respective interests and the remaining 99% of such profits and losses is
allocated among the Limited Partners by class of limited partnership interest,
as defined by the agreement.
No General Partner or Limited Partner may sell, assign, transfer, or
otherwise dispose of his interest in the Partnership except in accordance with
the limited partnership agreement.
Cyclical weather within its geographic markets may significantly affect
customer demand for air-conditioning and heating equipment sales and service.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF ACCOUNTING
The financial statements of the Partnership are presented on the accrual
basis of accounting.
CASH EQUIVALENTS
The Partnership considers all highly liquid short-term investments with a
maturity of three months or less to be cash equivalents.
INVENTORIES
Inventories are stated at the lower of cost (first-in, first-out) or
market.
REVENUE RECOGNITION
Revenue from equipment sales is recognized after the installation process
is completed. Any amounts billed prior to completion of the installation are
recorded as deferred revenue and are recognized upon completion of the
installation. Costs associated with an installation are recorded as work in
process during the installation period and are recognized as cost of sales when
the installation is completed. The Partnership sells service contracts
(generally for a one-year period) in which it agrees to perform certain
maintenance services during the service period. Generally, service contracts are
prebilled at the inception of the service agreement and are recorded as deferred
revenue. Revenue is recognized ratably over the service contract period. Costs
associated with these service contracts are expensed as incurred. Other service
and maintenance revenues are recognized when the work is performed.
PROPERTY AND EQUIPMENT
Property and equipment are stated at cost. Depreciation is provided over
the estimated useful lives, not to exceed lease terms, of the assets using the
straight-line method. Billings are depreciated over 30 years. Autos and trucks,
machinery and equipment, and furniture and fixtures are depreciated over three
to five years.
F-42
<PAGE> 94
WARRANTY COSTS
Estimated costs associated with product warranties are accrued as an
expense in the period the related sales are recognized.
INCOME TAXES
The Partnership is not subject to federal or state income taxes. Items of
income and expense are allocated to the partners for inclusion in their
respective income tax returns.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The Partnership's financial instruments consist primarily of cash and cash
equivalents, accounts and other receivables, accounts payable and long-term
debt, and capital lease obligations. The carrying amounts of these items
approximate their fair value due to their short maturity or for long-term debt
and capital lease obligations based upon borrowing rates currently available to
the Partnership.
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 reported amounts of assets and liabilities, the
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
IMPAIRMENT OF LONG-LIVED ASSETS
The Partnership has adopted SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of," which requires
impairment losses to be recorded on long-lived assets used in operations when
indicators of impairment are present and the undiscounted cash flows estimated
to be generated by these assets are less than the assets' carrying amount. SFAS
No. 121 also addresses the accounting for long-lived assets that are expected to
be disposed of. The adoption of SFAS No. 121 did not have a material effect on
the financial results of the Partnership.
INTERIM UNAUDITED FINANCIAL INFORMATION
The financial statements as and for the three month period ended March 27,
1997 are unaudited; however, in the opinion of the Partnership's management, all
adjustments (consisting solely of normal recurring adjustments) necessary for a
fair presentation of the unaudited financial statements for this interim period
have been included. The results of the interim period are not necessarily
indicative of the results to be obtained for a full year.
3. ACQUISITIONS
Effective November 2, 1995, the Partnership acquired certain assets of
Edwards Heating and Air Conditioning Company ("Cherokee/Edwards"), a heating,
ventilation, and air-conditioning company. The acquisition has been accounted
for as a purchase. Under the terms of the agreement, the Partnership issued a
promissory note to the seller for $797,354. The note, using a 9.75% effective
rate, is net of a $166,700 unamortized discount in the accompanying financial
statements. The note is payable in full on November 1, 2002, with interest
payments accruing at varying rates between 6% and 9%. Interest payments are
payable quarterly beginning November 1, 1998. In addition, $26,643 was paid in
connection with the acquisition and was capitalized as deferred acquisition
costs to be amortized over five years. The acquisition was accounted for as a
purchase, and accordingly, the purchase price was allocated to assets and
liabilities and their estimated fair values as of the date acquired. The excess
of the consideration paid over the estimated fair values of net assets acquired
in the amount of $616,500 has been recorded as an intangible to be amortized on
a straight-line basis over five years.
F-43
<PAGE> 95
4. INTANGIBLE ASSETS
Intangible assets are carried at cost, net of related amortization.
Intangible assets are generally amortized over periods of 5 to 7 years, except
for goodwill, which is amortized over 40 years. The Partnership continually
evaluates whether later events and circumstances have occurred which indicate
that the remaining estimated useful lives of goodwill or other intangible assets
may warrant revision. When factors indicate that goodwill should be evaluated
for possible impairment, the Partnership uses an estimate of undiscounted net
cash flows of the related assets over their remaining useful life in measuring
whether goodwill or other intangible assets are recoverable. Intangible assets
consist of the following at December 26, 1996:
<TABLE>
<S> <C>
Customer lists.............................................. $ 1,896,643
Noncompete agreements....................................... 825,000
Organization and start-up costs............................. 471,280
Goodwill.................................................... 150,004
-----------
3,342,927
Less accumulated amortization............................... (2,724,818)
-----------
$ 618,109
===========
</TABLE>
5. LONG-TERM DEBT
Long-term debt consists of the following as of December 26, 1996:
<TABLE>
<S> <C>
Subordinated note payable to a former owner, secured by the
assets of the Partnership, due in monthly installments of
$15,647 through November 30, 1997 and $18,547 thereafter,
including interest at 11.5% through November 30, 1997 and
10.5% thereafter, commencing on November 1, 1990 through
May 1, 2003............................................... $ 873,905
Note payable, net of unamortized discount of $166,700,
computed using a 9.75% effective interest rate, secured by
certain assets of the Partnership, accruing interest at
varying rates between 6% and 9% over the life of the note,
with principal due in full on November 1, 2002............ 630,654
Mortgage note payable, secured by land and building, due in
monthly installments of $2,869, including interest at
8.75%, commencing on September 22, 1995 through August 22,
2000...................................................... 107,654
Subordinated note payable, secured by a promissory note, due
in monthly installments of $2,922, including interest
imputed at 11%, commencing on October 1, 1990 through
October 1, 1997........................................... 25,130
----------
1,637,343
Less current portion........................................ 154,918
----------
$1,482,425
==========
</TABLE>
Aggregate scheduled maturities on long-term debt as of December 26, 1996
are as follows:
<TABLE>
<S> <C>
1997........................................................ $ 154,810
1998........................................................ 177,108
1999........................................................ 196,083
2000........................................................ 205,500
2001........................................................ 203,485
Thereafter.................................................. 700,357
----------
$1,637,343
==========
</TABLE>
F-44
<PAGE> 96
6. COMMITMENTS AND CONTINGENCIES
OPERATING AND CAPITAL LEASES
The Partnership leases office and warehouse space, automobiles, and
equipment under noncancelable operating leases. In addition, the Company leases
trucks under capital leases with various agents payable through July 1998;
interest is imputed at 12%. Total amounts recorded under capital leases at
December 26, 1996 was $419,660, and amortization during fiscal 1996 was
$104,511.
The following is a schedule by year of future minimum lease payments under
capital and noncancelable operating leases, together with the present value of
the net minimum lease payments under the capital leases, as of December 26,
1996:
<TABLE>
<CAPTION>
TOTAL
CAPITAL OPERATING FUTURE
LEASES LEASES PAYMENTS
-------- --------- ----------
<S> <C> <C> <C>
Fiscal year ending:
1997........................................ $121,959 $282,434 $ 404,393
1998........................................ 116,047 242,913 358,960
1999........................................ 3,091 171,278 174,369
2000........................................ 0 140,006 140,006
2001........................................ 0 24,656 24,656
Thereafter.................................. 0 0 0
-------- -------- ----------
Total minimum payments.............. 241,097 $861,287 $1,102,384
======== ==========
Less amount representing interest............. (28,134)
--------
Present value of minimum lease payments....... $212,963
========
</TABLE>
Rental expense under operating leases was approximately $297,858 for the
fiscal year ended December 26, 1996.
LITIGATION
The Partnership has recently been named as a defendant in a lawsuit
involving a former customer. The suit seeks damages of $1.2 million and punitive
damages of $2.4 million. The Partnership's insurance carrier is currently
defending this suit and the Partnership has insurance coverage available to
cover losses up to approximately $1.5 million, however, any losses in excess of
the insurance coverage would be the individual responsibility of the partners.
The Partnership's management believes that this suit is without merit and its
insurance carrier intends to vigorously defend the Partnership in this matter.
The Partnership is involved in certain other litigation arising in the
normal course of business. In the opinion of management, the ultimate resolution
of these matters will not have a material adverse effect on the Partnership's
financial position or results of operations.
7. SUBSEQUENT EVENT
Effective June 15, 1997, all of the Partnerships assets and liabilities
were acquired by Service Experts, Inc. ("SEI") in exchange for cash and shares
of SEI in the minimum amount of $6,500,000, and warrants issued to the general
partners and certain members of the Partnership's management.
F-45
<PAGE> 97
======================================================
NO PERSON HAS BEEN AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY
TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATION MUST NOT BE
RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY. THIS PROSPECTUS DOES NOT
CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF ANY OFFER TO BUY ANY OF THE
SECURITIES OFFERED HEREBY TO ANY PERSON OR BY ANYONE IN ANY JURISDICTION IN
WHICH IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. NEITHER THE DELIVERY OF
THIS PROSPECTUS NOR ANY SALE MADE HEREUNDER SHALL, UNDER ANY CIRCUMSTANCES,
CREATE ANY IMPLICATION THAT THE INFORMATION CONTAINED HEREIN IS CORRECT AS OF
ANY DATE SUBSEQUENT TO THE DATE HEREOF.
---------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Available Information................. 2
Prospectus Summary.................... 3
Risk Factors.......................... 6
Capitalization........................ 10
Selected Consolidated Financial
Data................................ 11
Management's Discussion and Analysis
of Financial Condition and Results
of Operations....................... 13
Business.............................. 18
The Pending Acquisitions.............. 28
Management............................ 32
Certain Transactions.................. 38
Principal Stockholders................ 40
Ratio of Earnings to Fixed Charges.... 41
Price Range of Common Stock and
Dividend Policy..................... 41
Description of Capital Stock.......... 42
Description of Common Stock
Warrants............................ 44
Description of Debt Securities........ 44
Shares Eligible for Future Sale....... 49
Selling Stockholders.................. 50
Legal Matters......................... 50
Experts............................... 50
Index to Financial Statements......... F-1
</TABLE>
======================================================
======================================================
[SERVICE EXPERTS LOGO]
$50,000,000
COMMON STOCK,
COMMON STOCK WARRANTS
AND DEBT SECURITIES
-------------------
PROSPECTUS
-------------------
July , 1997
======================================================
<PAGE> 98
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
ITEM 20. INDEMNIFICATION OF DIRECTORS AND OFFICERS.
(a) The Delaware General Corporation Law ("DGCL") provides that a
corporation may indemnify any person made party to an action by reason of such
person's status as a director, officer, employee or agent of the corporation
against expenses, judgments, fines and settlements provided such person acted
(i) in good faith, (ii) in a manner reasonably believed to be in or not opposed
to the best interests of the Corporation and (iii) with respect to a criminal
action, had no reasonable cause to believe such person's conduct was unlawful.
The termination of an action by a judgment, order, settlement, conviction or
plea of nolo contendere shall not create a presumption that a person did not
meet the standard of conduct set forth above. In actions brought by or in the
right of the corporation, however, the DGCL provides that no indemnification may
be made if the person was adjudged to be liable to the corporation unless and
only to the extent that the Court of Chancery or the court in which such action
was brought shall determine upon application that, despite the adjudication of
liability but in view of all circumstances of the case, such person is fairly
and reasonably entitled to indemnity for such expenses which the court shall
deem proper. To the extent that a person is successful, on the merits or
otherwise, in the defense of any proceeding instigated because of his or her
status as a director, officer, employee or agent of a corporation, the DGCL
mandates that the corporation indemnify such person against reasonable expenses
incurred in the proceeding. A corporation may advance litigation expenses,
including attorneys' fees, to a person who is a party to a proceeding upon such
person undertaking to repay such amount if it shall ultimately be determined
that such person is not entitled to indemnification. The indemnification and
advancement of expenses under the DGCL are not deemed exclusive of any other
rights to which a person may be entitled under any bylaw, agreement, vote of
shareholders or disinterested directors or otherwise.
(b) Article VII of the Registrant's Restated Certificate of Incorporation
provides as follows:
(i) The Corporation shall indemnify, and upon request shall advance
expenses (including attorneys' fees) to, in the manner and to the fullest
extent permitted by law, any officer or director (or the estate of any such
person) who was or is a party to, any threatened, pending or completed
action, suit or proceeding, whether civil, criminal, administrative,
investigative or otherwise, by reason of the fact that such person is or
was a director or officer of the Corporation, or is or was serving at the
request of the Corporation as a director, officer, partner, trustee,
employee or agent of another corporation, partnership, joint venture,
trust, other enterprise or employee benefit plan (an "indemnitee"). The
Corporation may, to the fullest extent permitted by law, purchase and
maintain insurance on behalf of any person who is or was a director,
officer, employee or agent of the Corporation, or is or was serving at the
request of the Corporation as a director, officer, partner, trustee,
employee or agent of another corporation, partnership, joint venture,
trust, other enterprise or employee benefit plan against any liability
which may be asserted against such person. To the fullest extent permitted
by law, the indemnification and advances provided for herein shall include
expenses (including attorneys' fees), judgments, penalties, fines and
amounts paid in settlement. The indemnification provided herein shall not
be deemed to limit the right of the Corporation to indemnify and any other
person for any such expenses (including attorneys' fees), judgments, fines
and amounts paid in settlement to the fullest extent permitted by law, both
as to action in his official capacity and as to action in another capacity
while holding such office.
(ii) Notwithstanding the foregoing, the Corporation shall not
indemnify any such indemnitee who was or is a party or is threatened to be
made a party to any threatened, pending or completed action or suit by or
in the right of the Corporation to secure a judgment in its favor against
such indemnitee with the Corporation, unless and only to the extent that,
the Court of Chancery or the court in which such action or suit was brought
shall determine upon application that, despite the adjudication of
liability but in view of all the circumstances of the case, such indemnitee
is fairly and reasonably entitled to indemnity for such expenses which the
Court of Chancery or such other court shall deem proper.
(iii) The rights to indemnification and advancement of expenses set
forth in this Article VII are intended to be greater than those which are
otherwise provided for in the General Corporation Law of the
II-1
<PAGE> 99
State of Delaware, are contractual between the Corporation and the person
being indemnified, his heirs, executors and administrators, and, with
respect to this Article VII are mandatory, notwithstanding a person's
failure to meet the standard of conduct required for permissive
indemnification under the General Corporation Law of the State of Delaware,
as amended from time to time. The rights to indemnification and advancement
of expenses set forth in this Article VII are nonexclusive of other similar
rights which may be granted by law, this Certificate, the Bylaws, a
resolution of the Board of Directors or stockholders or an agreement with
the Corporation, which means of indemnification and advancement of expenses
are hereby specifically authorized.
(iv) Any repeal or modification of the provisions of this Article VII,
either directly or by the adoption of an inconsistent provision of this
Certificate, shall be prospective only and shall not adversely affect any
right or protection set forth herein existing in favor of a particular
individual at the time of such repeal or modification. In addition, if an
amendment to the General Corporation Law of the State of Delaware limits or
restricts in any way the indemnification rights permitted by law as of the
date hereof, such amendment shall apply only to the extent mandated by law
and only to activities of persons subject to indemnification under this
Article VII which occur subsequent to the effective date of such amendment.
(c) The Company has obtained insurance for its directors and executive
officers in amounts of $5,000,000 per claim and $5,000,000 for aggregate claims.
ITEM 21. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a) Exhibits
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4.1 -- Form of Common Stock Certificate(b)
4.2 -- Form of Subordinated Indenture(c)
4.3 -- Form of Common Stock Warrant(c)
5 -- Opinion of Waller Lansden Dortch & Davis, A Professional
Limited Liability Company(c)
10.1 -- Registrant's 1996 Incentive Stock Plan(a)
10.2 -- Registrant's 1996 Non-Employee Director Stock Option Plan(a)
10.3 -- Registrant's 1996 Employee Stock Purchase Plan(a)
10.4 -- Registrant's 1997 Nonqualified Stock Option Plan
10.5 -- Registrant's 1997 Nonqualified Stock Purchase Plan
10.6 -- Form of Combination Agreement by and among each of the
Predecessor Companies, each of its respective stockholders
and the Registrant(a)
10.7 -- Form of Agreement and Plan of Merger among certain of the
Acquired Companies, a wholly-owned subsidiary of the
Registrant and the Registrant(d)
10.8 -- Form of Combination Agreement between certain of the
Acquired Companies and the Registrant(d)
10.9 -- Employment Agreement, dated June 26, 1996, between the
Registrant and Alan R. Sielbeck(a)
10.10 -- Employment Agreement, dated June 26, 1996, between the
Registrant and James D. Abrams(a)
10.11 -- Employment Agreement, dated June 26, 1996, between the
Registrant and Anthony M. Schofield(a)
10.12 -- Form of Employment Agreement between the Registrant and
certain of its employees(a)
10.13 -- Form of Escrow Agreement between the Registrant, each of the
stockholders of the Subsidiaries and the escrow agent(a)
10.14 -- Form of Equitable Securities Corporation Stock Purchase
Warrant(a)
10.15 -- Loan Agreement, dated September 10, 1996, between the
Registrant and SunTrust Bank, Nashville, N.A.(c)
12 -- Ratio of Earnings to Fixed Charges
21 -- List of subsidiaries of the Registrant
23.1 -- Consent of Ernst & Young LLP
23.2 -- Consent of Arthur Andersen LLP
</TABLE>
II-2
<PAGE> 100
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
23.3 -- Consent of Waller Lansden Dortch & Davis, A Professional
Limited Liability Company (included in Exhibit 5)(c)
24 -- Power of Attorney(c)
</TABLE>
- ---------------
(a) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 333-07037.
(b) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form 8-A, File No. 000-21173.
(c) Filed previously.
(d) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 333-21971.
(b) Financial Statement Schedules
All other schedules for which provision is made in the applicable
accounting regulations of the Commission are not required under the related
instructions or are inapplicable, and therefore have been omitted.
ITEM 22. UNDERTAKINGS.
The undersigned registrant hereby undertakes:
(1) To file, during any period in which offers or sales are being
made, a post-effective amendment to this Registration Statement:
(i) To include any prospectus required by Section 10(a)(3) of the
Securities Act of 1933;
(ii) To reflect in the prospectus any facts or events arising after
the effective date of the registration statement (or the most recent
post-effective amendment thereof) which, individually or in the
aggregate, represent a fundamental change in the information set forth
in the registration statement. Notwithstanding the foregoing, any
increase or decrease in volume of securities offered (if the total
dollar value of securities offered would not exceed that which was
registered) and any deviation from the low or high end of the estimated
maximum offering range may be reflected in the form of prospectus filed
with the Commission pursuant to Rule 424(b) if, in the aggregate, the
changes in volume and price represent no more than a 20% change in the
maximum aggregate offering price set forth in the "Calculation of
Registration Fee" table in the effective registration statement;
(iii) To include any material information with respect to the plan
of distribution not previously disclosed in the registration statement
or any material change to such information in the registration
statement.
(2) That, for the purpose of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed
to be a new registration statement relating to the securities offered
therein, and the offering of such securities at that time shall be deemed
to be the initial bona fide offering thereof.
(3) To remove from registration by means of a post-effective amendment
any of the securities being registered which remain unsold at the
termination of the offering.
The undersigned registrant hereby undertakes that, for purposes of
determining any liability under the Securities Act of 1933, each filing of the
registrant's annual report pursuant to section 13(a) or section 15(d) of the
Securities Exchange Act of 1934 (and, where applicable, each filing of an
employee benefit plan's annual report pursuant to section 15(d) of the
Securities Exchange Act of 1934) that is incorporated by reference in the
registration statement shall be deemed to be a new registration statement
relating to the securities offered therein and the offering of such securities
at that time shall be deemed to be the initial bona fide offering thereof.
II-3
<PAGE> 101
The undersigned registrant hereby undertakes as follows: that prior to any
public reoffering of the securities registered hereunder through use of a
prospectus which is a part of this registration statement, by any person or
party who is deemed to be an underwriter within the meaning of Rule 145(c), the
issuer undertakes that such reoffering prospectus will contain the information
called for by the applicable registration form with respect to reofferings by
persons who may be deemed underwriters, in addition to the information called
for by the other Items of the applicable form.
The registrant undertakes that every prospectus (i) that is filed pursuant
to the paragraph immediately preceding, or (ii) that purports to meet the
requirements of section 10(a)(3) of the Act and is used in connection with an
offering of securities subject to Rule 415 will be filed as part of an amendment
to the registration statement and will not be used until such amendment is
effective, and that, for purposes of determining any liability under the
Securities Act of 1933, each such post-effective amendment shall be deemed to be
a new registration statement relating to the securities offered therein, and the
offering of such securities at that time shall be deemed to be the initial bona
fide offering thereof.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933 may be permitted to directors, officers and controlling persons of the
registrant pursuant to the foregoing provisions, or otherwise, the registrant
has been advised that in the opinion of the Securities and Exchange Commission
such indemnification is against public policy as expressed in the Act and is,
therefore, unenforceable. In the event that a claim for indemnification against
such liabilities (other than the payment by the registrant of expenses incurred
or paid by a director, officer or controlling person of the registrant in the
successful defense of any action, suit or proceeding) is asserted by such
director, officer or controlling person in connection with the securities being
registered, the registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the Act and will be governed by the final adjudication of
such issue.
The undersigned registrant hereby undertakes to supply by means of a
post-effective amendment all information concerning a transaction, and the
company being acquired involved therein, that was not the subject of and
included in the registration statement when it became effective.
The undersigned Registrant hereby undertakes to file an application for the
purpose of determining the eligibility of the trustee to act under subsection
(a) of section 310 of the Trust Indenture Act (the "TIA") in accordance with the
rules and regulations prescribed by the Commission under Section 305(b)(2) of
the TIA.
II-4
<PAGE> 102
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Post-Effective Amendment No. 5 to Registration Statement to
be signed on its behalf by the undersigned, thereunto duly authorized, in the
City of Nashville, State of Tennessee, on July 10, 1997.
SERVICE EXPERTS, INC.
By: /s/ ALAN R. SIELBECK
------------------------------------
Alan R. Sielbeck
Chairman and
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1933, this
Post-Effective Amendment No. 5 to Registration Statement has been signed by the
following persons in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
NAME TITLE(S) DATE
---- -------- ----
<C> <S> <C>
/s/ ALAN R. SIELBECK Chairman of the Board and Chief July 10, 1997
- ----------------------------------------------------- Executive Officer (principal
Alan R. Sielbeck executive officer)
* President and Chief Operating July 10, 1997
- ----------------------------------------------------- Officer; Director
James D. Abrams
/s/ ANTHONY M. SCHOFIELD Chief Financial Officer July 10, 1997
- ----------------------------------------------------- (principal financial and
Anthony M. Schofield accounting officer)
* Director July 10, 1997
- -----------------------------------------------------
Raymond J. DeRiggi
* Director July 10, 1997
- -----------------------------------------------------
Norman T. Rolf
* Director July 10, 1997
- -----------------------------------------------------
William G. Roth
Director
- -----------------------------------------------------
Timothy G. Wallace
* /s/ ANTHONY M. SCHOFIELD July 10, 1997
- ----------------------------------------------------
Anthony M. Schofield, Attorney-in-Fact
</TABLE>
II-5
<PAGE> 103
INDEX TO EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4.1 -- Form of Common Stock Certificate(b)
4.2 -- Form of Subordinated Indenture(c)
4.3 -- Form of Common Stock Warrant(c)
5 -- Opinion of Waller Lansden Dortch & Davis, A Professional
Limited Liability Company(c)
10.1 -- Registrant's 1996 Incentive Stock Plan(a)
10.2 -- Registrant's 1996 Non-Employee Director Stock Option Plan(a)
10.3 -- Registrant's 1996 Employee Stock Purchase Plan(a)
10.4 -- Registrant's 1997 Nonqualified Stock Option Plan
10.5 -- Registrant's 1997 Nonqualified Stock Purchase Plan
10.6 -- Form of Combination Agreement by and among each of the
Predecessor Companies, each of its respective stockholders
and the Registrant(a)
10.7 -- Form of Agreement and Plan of Merger among certain of the
Acquired Companies, a wholly-owned subsidiary of the
Registrant and the Registrant(d)
10.8 -- Form of Combination Agreement between certain of the
Acquired Companies and the Registrant(d)
10.9 -- Employment Agreement, dated June 26, 1996, between the
Registrant and Alan R. Sielbeck(a)
10.10 -- Employment Agreement, dated June 26, 1996, between the
Registrant and James D. Abrams(a)
10.11 -- Employment Agreement, dated June 26, 1996, between the
Registrant and Anthony M. Schofield(a)
10.12 -- Form of Employment Agreement between the Registrant and
certain of its employees(a)
10.13 -- Form of Escrow Agreement between the Registrant, each of the
stockholders of the Subsidiaries and the escrow agent(a)
10.14 -- Form of Equitable Securities Corporation Stock Purchase
Warrant(a)
10.15 -- Loan Agreement, dated September 10, 1996, between the
Registrant and SunTrust Bank, Nashville, N.A.(c)
12 -- Ratio of Earnings to Fixed Charges
21 -- List of subsidiaries of the Registrant
23.1 -- Consent of Ernst & Young LLP
23.2 -- Consent of Arthur Andersen LLP
23.3 -- Consent of Waller Lansden Dortch & Davis, A Professional
Limited Liability Company (included in Exhibit 5)(c)
24 -- Power of Attorney(c)
</TABLE>
- ---------------
(a) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 333-07037.
(b) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form 8-A, File No. 000-21173.
(c) Filed previously.
(d) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-1, Registration No. 333-21971.
<PAGE> 1
EXHIBIT 10.4
SERVICE EXPERTS, INC.
1997 NONQUALIFIED STOCK OPTION PLAN
EFFECTIVE APRIL 3, 1997
<PAGE> 2
SERVICE EXPERTS, INC. 1997 NONQUALIFIED STOCK OPTION PLAN
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
<S> <C>
ARTICLE I. DEFINITIONS
1.1 Affiliate 1
1.2 Agreement 1
1.3 Board 1
1.4 Code 1
1.5 Committee 1
1.6 Company 1
1.7 Date of Exercise 1
1.8 Exchange Act 1
1.9 Fair Market Value 2
1.10 Option 2
1.11 Participant 2
1.12 Plan 2
1.13 Stock 2
1.14 Ten Percent Stockholder 2
ARTICLE II. PURPOSE OF PLAN 2
ARTICLE III. ADMINISTRATION
3.1 Administration of Plan 2
3.2 Authority to Grant Options 3
3.3 Persons Subject to Section 16(b) 3
ARTICLE IV. ELIGIBILITY AND LIMITATIONS ON GRANTS
4.1 Participation 3
4.2 Grant of Options 3
4.3 Limitations on Grants 3
ARTICLE V. STOCK SUBJECT TO PLAN
5.1 Source of Shares 4
5.2 Maximum Number of Shares 4
5.3 Forfeitures 4
</TABLE>
i
<PAGE> 3
<TABLE>
<S> <C>
ARTICLE VI. EXERCISE OF OPTIONS
6.1 Exercise Price 4
6.2 Right to Exercise 4
6.3 Maximum Exercise Period 4
6.4 Transferability 4
6.5 Employee Status 5
ARTICLE VII. METHOD OF EXERCISE
7.1 Exercise 5
7.2 Payment 5
7.3 Federal Withholding Tax Requirements 5
7.4 Stockholder Rights 5
7.5 Issuance and Delivery of Shares 5
ARTICLE VIII. ADJUSTMENT UPON CORPORATE CHANGES
8.1 Adjustments to Shares 5
8.2 Substitution of Options on Merger or Acquisition 6
8.3 Effect of Certain Transactions 6
8.4 No Preemptive Rights 6
8.5 Fractional Shares 7
ARTICLE IX. COMPLIANCE WITH LAW AND APPROVAL OF
REGULATORY BODIES
9.1 General 7
9.2 Representations by Participants 7
ARTICLE X. GENERAL PROVISIONS
10.1 Effect on Employment 7
10.2 Unfunded Plan 8
10.3 Rules of Construction 8
10.4 Governing Law 8
10.5 Compliance With Section 16 of the Exchange Act 8
10.6 Amendment 8
10.7 Effective Date of Plan 8
</TABLE>
ii
<PAGE> 4
SERVICE EXPERTS, INC. 1997 NONQUALIFIED STOCK OPTION PLAN
PREAMBLE
WHEREAS, Service Experts, Inc. (the "Company") desires to establish a
plan through which the Company may grant options to purchase the common stock of
the Company to directors, officers, employees, and consultants of the Company
and its affiliates;
WHEREAS, the Company intends that all options granted hereunder shall
not be treated as "incentive stock options" within the meaning of section 422 of
the Code; and
WHEREAS, the Company intends that this stock option plan and the
options granted hereunder (i) qualify as "performance-based compensation"
described in section 162(m)(4)(C) of the Code, and (ii) conform to the
provisions of Rule 16b-3 of the Securities Exchange Act of 1934, as amended;
NOW, THEREFORE, the Company hereby establishes the Service Experts,
Inc. 1997 Nonqualified Stock Option Plan (the "Plan"), effective April 3, 1997:
ARTICLE I. DEFINITIONS
1.1 Affiliate. A "parent corporation," as defined in section 424(e) of
the Code, or "subsidiary corporation," as defined in section 424(f) of the Code,
of the Company.
1.2 Agreement. A written agreement (including any amendment or
supplement thereto) between the Company or Affiliate and a Participant
specifying the terms and conditions of an Option granted to such Participant.
1.3 Board. The board of directors of the Company.
1.4 Code. The Internal Revenue Code of 1986, as amended.
1.5 Committee. A committee composed of at least two individuals (or
such number that satisfies section 162(m)(4)(C) of the Code and Rule 16b-3 of
the Exchange Act) who are members of the Board and are not employees of the
Company or an Affiliate, and who are designated by the Board as the
"compensation committee" or are otherwise designated to administer the Plan.
1.6 Company. Service Experts, Inc. and its successors.
1.7 Date of Exercise. The date that the Company accepts tender of the
Option exercise price.
1.8 Exchange Act. The Securities Exchange Act of 1934, as amended.
1
<PAGE> 5
1.9 Fair Market Value. On any given date, Fair Market Value shall be
(unless, where appropriate, the Committee determines in good faith the fair
market value of the Stock to be otherwise) the closing price of the Stock on the
Nasdaq National Market, as so published, on the trading day immediately
preceding the date as of which Fair Market Value is being determined, or the
closing price on the next preceding trading day on which such prices were
published if no Stock was traded on such trading day.
1.10 Option. The right that is granted hereunder to a Participant to
purchase from the Company a stated number of shares of Stock at the price set
forth in an Agreement.
1.11 Participant. A Board member, employee, consultant or advisor of
the Company or of an Affiliate who: either satisfies the requirements of Article
and is selected by the Committee to receive an Option, or receives an Option
pursuant to grant specified in this Plan.
1.12 Plan. The Service Experts, Inc. 1997 Nonqualified Stock Option
Plan.
1.13 Stock. The common stock of the Company.
1.14 Ten Percent Stockholder. An individual who owns more than 10% of
the total combined voting power of all classes of stock of the Company or an
Affiliate at the time he is granted an Option. For the purpose of determining if
an individual is a Ten Percent Stockholder, he shall be deemed to own any voting
stock owned (directly or indirectly) by or for his brothers and sisters (whether
by whole or half blood), spouse, ancestors or lineal descendants and shall be
considered to own proportionately any voting stock owned (directly or
indirectly) by or for a corporation, partnership, estate or trust of which such
individual is a stockholder, partner or beneficiary.
ARTICLE II. PURPOSE OF PLAN
The purpose of the Plan is to provide a performance incentive and to
encourage stock ownership by officers, directors, consultants and advisors of
the Company and its Affiliates, and to align the interests of such individuals
with those of the Company, its Affiliates and its stockholders. It is intended
that Participants may acquire or increase their proprietary interests in the
Company and be encouraged to remain in the employ or directorship of the Company
or of its Affiliates. The proceeds received by the Company from the sale of
Stock pursuant to this Plan may be used for general corporate purposes.
ARTICLE III. ADMINISTRATION
3.1 Administration of Plan. The Plan shall be administered by the
Committee. The express grant in the Plan of any specific power to the Committee
shall not be construed as limiting any power or authority of the Committee. Any
decision made or action taken by the Committee to administer the Plan shall be
final and conclusive. No member of the Committee shall be liable for any act
done in good faith with respect to this Plan or any Agreement or
2
<PAGE> 6
Option. The Company shall bear all expenses of Plan administration. In addition
to all other authority vested with the Committee under the Plan, the Committee
shall have complete authority to:
(a) Interpret all provisions of this Plan;
(b) Prescribe the form of any Agreement and notice and manner for
executing or giving the same;
(c) Make amendments to all Agreements;
(d) Adopt, amend, and rescind rules for Plan administration; and
(e) Make all determinations it deems advisable for the
administration of this Plan.
3.2 Authority to Grant Options. The Committee shall have authority to
grant Options upon such terms as the Committee deems appropriate and that are
not inconsistent with the provisions of this Plan. Such terms may include
conditions on the exercise of all or any part of an Option.
3.3 Persons Subject to Section 16(b). Notwithstanding anything in the
Plan to the contrary, the Committee, in its absolute discretion, may bifurcate
the Plan so as to restrict, limit or condition the use of any provision of the
Plan to participants who are officers and directors subject to section 16(b) of
the Exchange Act, without so restricting, limiting or conditioning the Plan with
respect to other Participants.
ARTICLE IV. ELIGIBILITY AND LIMITATIONS ON GRANTS
4.1 Participation. The Committee may from time to time designate
employees, consultants and advisors to whom Options are to be granted and who
are eligible to become Participants. Such designation shall specify the number
of shares of Stock, if any, subject to each Option. All Options granted under
this Plan shall be evidenced by Agreements which shall be subject to applicable
provisions of this Plan or such other provisions as the Committee may adopt that
are not inconsistent with the Plan.
4.2 Grant of Options. An Option shall be deemed to be granted to a
Participant at the time that the Committee designates in a writing that is
adopted by the Committee as the grant of an Option, and that makes reference to
the name of the Participant and the number of shares of Stock that may be
purchased under the Option. Accordingly, an Option may be deemed to be granted
prior to the approval of this Plan by the stockholders of the Company and prior
to the time that an Agreement is executed by the Participant and the Company.
4.3 Limitations on Grants. A person who is not an employee of the
Company or an Affiliate is not eligible to receive an Option. No person may
receive an Option to purchase
3
<PAGE> 7
more than 250,000 shares of stock (subject to increases and adjustments as
provided in Article VIII) in any three year period.
ARTICLE V. STOCK SUBJECT TO PLAN
5.1 Source of Shares. Upon the exercise of an Option, the Company shall
deliver to the Participant authorized but unissued Stock.
5.2 Maximum Number of Shares. The maximum number of shares of Stock
that may be issued pursuant to an award of Options at any time, when aggregated
with the shares subject to outstanding Options at such time, is 9.5% of the
total number of shares of Stock outstanding, subject to increases and
adjustments as provided in this Article and Article , minus the number of shares
of Stock authorized for issuance under the Company's 1996 Incentive Stock Plan
(the "Incentive Plan") (as of April 3, 1997, 700,000 shares of Stock are
authorized for issuance under the Incentive Plan, and the Company is seeking to
amend the Incentive Plan to increase the number of shares of Stock authorized
for issuance from 700,000 to 1,300,000 shares).
5.3 Forfeitures. If any Option granted hereunder expires or terminates
for any reason without having been exercised in full, the unpurchased shares
subject thereto shall again be available for issuance under this Plan.
ARTICLE VI. EXERCISE OF OPTIONS
6.1 Exercise Price. The exercise price of an Option shall be the price
determined by the Committee at the time the Option is granted. If the exercise
price of an Option is changed after the date it is granted, such change shall be
deemed to be a termination of the existing Option and the issuance of a new
Option.
6.2 Right to Exercise. An Option shall be exercisable on the date of
grant or on any other date established by the Committee or provided for in an
Agreement.
6.3 Maximum Exercise Period. The maximum period in which an Option may
be exercised shall be determined by the Committee on the date of grant. All
Options shall terminate on the date the Participant's employment with the
Company terminates, except as otherwise provided in the Agreement with respect
to termination of employment, death, disability or a "change of control" (as
defined in any change of control agreement to which the Company and any such
Participant are parties).
6.4 Transferability. Any Option granted under this Plan shall be
transferable by will or by the laws of descent and distribution only, except as
otherwise expressly provided for in an Agreement. No right or interest of a
Participant in any Option shall be liable for, or subject to, any lien,
obligation or liability of such Participant.
4
<PAGE> 8
6.5 Employee Status. The Committee shall determine the extent to which
a leave of absence for military or government service, illness, temporary
disability, or other reasons shall be treated as a termination or interruption
of employment for purposes of determining questions of forfeiture and exercise
of an Option after termination of employment.
ARTICLE VII. METHOD OF EXERCISE
7.1 Exercise. An Option granted hereunder shall be deemed to have been
exercised on the Date of Exercise. Subject to the provisions of Articles and ,
an Option may be exercised in whole or in part at such times and in compliance
with such requirements as the Committee shall determine.
7.2 Payment. Unless otherwise provided by the Agreement, payment of the
Option price shall be made in cash or, to the extent approved by the Committee,
Stock that was acquired prior to the exercise of the Option, other consideration
acceptable to the Committee, or a combination thereof.
7.3 Federal Withholding Tax Requirements. Upon exercise of an Option by
a Participant who is an employee of the Company or an Affiliate, the Participant
shall, upon notification of the amount due and prior to or concurrently with the
delivery of the certificates representing the shares, pay to the Company amounts
necessary to satisfy applicable federal, state and local withholding tax
requirements or shall otherwise make arrangements satisfactory to the Company
for such requirements.
7.4 Stockholder Rights. No Participant shall have any rights as a
stockholder with respect to shares subject to his Option prior to the Date of
Exercise of such Option.
7.5 Issuance and Delivery of Shares. Shares of Stock issued pursuant to
the exercise of Options hereunder shall be delivered to Participants by the
Company (or its transfer agent) as soon as administratively feasible after a
Participant exercises an Option hereunder and executes any applicable
stockholder agreement or agreement described in Section that the Company
requires at the time of exercise.
ARTICLE VIII. ADJUSTMENT UPON CORPORATE CHANGES
8.1 Adjustments to Shares. The maximum number and kind of shares of
stock with respect to which Options hereunder may be granted and which are the
subject of outstanding Options shall be adjusted by way of increase or decrease
as the Committee determines (in its sole discretion) to be appropriate, in the
event that:
(a) the Company or an Affiliate effects one or more stock
dividends, stock splits, reverse stock splits, subdivisions,
consolidations or other similar events;
5
<PAGE> 9
(b) the Company or an Affiliate engages in a transaction to which
section 424 of the Code applies; or
(c) there occurs any other event which in the judgment of the
Committee necessitates such action.
Provided, however, that if an event described in paragraph (a) or (b) occurs,
the Committee shall make adjustments to the limits on Options specified in
Section that are proportionate to the modifications of the Stock that are on
account of such corporate changes.
8.2 Substitution of Options on Merger or Acquisition. The Committee may
grant Options in substitution for stock awards, stock options, stock
appreciation rights or similar awards held by an individual who becomes an
employee of the Company or an Affiliate in connection with a transaction to
which section 424(a) of the Code applies. The terms of such substituted Options
shall be determined by the Committee in its sole discretion, subject only to the
limitations of Article .
8.3 Effect of Certain Transactions. Upon a merger, consolidation,
acquisition of property or stock, separation, reorganization or liquidation of
the Company, as a result of which the stockholders of the Company receive cash,
stock or other property in exchange for their shares of Stock (but not a public
offering of Stock by the Company), and the Company is not the surviving entity,
any Option granted hereunder shall terminate, provided that the Participant
shall have the right immediately prior to any such merger, consolidation,
acquisition of property or stock, separation, reorganization or liquidation to
exercise his Options in whole or in part whether or not the vesting requirements
set forth in any Agreement have been satisfied, unless the Committee elects to
convert all Options hereunder into options to purchase stock of an acquiring
corporation. Provided, however, that, notwithstanding the foregoing, a portion
of the acceleration of exercisability of Options shall not occur with respect to
any holder to the extent that such portion of acceleration would cause the
grantee or holder of such Option to be liable for the payment of taxes pursuant
to section 4999 of the Code. If the Committee so elects to convert the Options,
the amount and price of such converted options shall be determined by adjusting
the amount and price of the Options granted hereunder in the same proportion as
used for determining the number of shares of stock of the acquiring corporation
the holders of the Stock receive in such merger, consolidation, acquisition of
property or stock, separation or reorganization, and the vesting schedule set
forth in the Agreement shall continue to apply to the converted options.
8.4 No Preemptive Rights. The issuance by the Company of shares of
stock of any class, or securities convertible into shares of stock of any class,
for cash or property, or for labor or services rendered, either upon direct sale
or upon the exercise of rights or warrants to subscribe therefor, or upon
conversion of shares or obligations of the Company convertible into such shares
or other securities, shall not affect, and no adjustment by reason thereof shall
be made with respect to, outstanding Options.
6
<PAGE> 10
8.5 Fractional Shares. Only whole shares of Stock may be acquired
through the exercise of an Option. Any amounts tendered in the exercise of an
Option remaining after the maximum number of whole shares have been purchased
will be returned to the Participant.
ARTICLE IX. COMPLIANCE WITH LAW AND APPROVAL OF
REGULATORY BODIES
9.1 General. No Option shall be exercisable, no Stock shall be issued,
no certificates for shares of Stock shall be delivered, and no payment shall be
made under this Plan except in compliance with all federal or state laws and
regulations (including, without limitation, withholding tax requirements),
federal and state securities laws and regulations and the rules of all
securities exchanges or self-regulatory organizations on which the Company's
shares may be listed. The Company shall have the right to rely on an opinion of
its counsel as to such compliance. Any certificate issued to evidence shares of
Stock for which an Option is exercised may bear such legends and statements as
the Committee upon advice of counsel may deem advisable to assure compliance
with federal or state laws and regulations. No Option shall be exercisable, no
Stock shall be issued, no certificate for shares shall be delivered and no
payment shall be made under this Plan until the Company has obtained such
consent or approval as the Committee may deem advisable from any regulatory
bodies having jurisdiction over such matters.
9.2 Representations by Participants. As a condition to the exercise of
an Option, the Company may require a Participant to represent and warrant at the
time of any such exercise that the shares are being purchased only for
investment and without any present intention to sell or distribute such shares,
if, in the opinion of counsel for the Company, such representation is required
by any relevant provision of the laws referred to in Section . At the option of
the Company, a stop transfer order against any shares of stock may be placed on
the official stock books and records of the Company, and a legend indicating
that the stock may not be pledged, sold or otherwise transferred unless an
opinion of counsel was provided (concurred in by counsel for the Company) and
stating that such transfer is not in violation of any applicable law or
regulation may be stamped on the stock certificate in order to assure exemption
from registration. The Committee may also require such other action or agreement
by the Participants as may from time to time be necessary to comply with federal
or state securities laws. This provision shall not obligate the Company or any
Affiliate to undertake registration of Options or stock hereunder.
ARTICLE X. GENERAL PROVISIONS
10.1 Effect on Employment. Neither the adoption of this Plan, its
operation, nor any documents describing or referring to this Plan (or any part
thereof) shall confer upon any employee any right to continue in the employ of
the Company or an Affiliate or in any way affect any right and power of the
Company or an Affiliate to terminate the employment of any employee at any time
with or without assigning a reason therefor.
7
<PAGE> 11
10.2 Unfunded Plan. The Plan, insofar as it provides for grants, shall
be unfunded, and the Company shall not be required to segregate any assets that
may at any time be represented by grants under this Plan. Any liability of the
Company to any person with respect to any grant under this Plan shall be based
solely upon contractual obligations that may be created hereunder. No such
obligation of the Company shall be deemed to be secured by any pledge of, or
other encumbrance on, any property of the Company.
10.3 Rules of Construction. Headings are given to the articles and
sections of this Plan solely as a convenience to facilitate reference. The
masculine gender when used herein refers to both masculine and feminine. The
reference to any statute, regulation or other provision of law shall be
construed to refer to any amendment to or successor of such provision of law.
10.4 Governing Law. The laws of the State of Tennessee shall apply to
all matters arising under this Plan, to the extent that federal law does not
apply.
10.5 Compliance With Section 16 of the Exchange Act. With respect to
persons subject to section 16 of the Exchange Act, transactions under this Plan
are intended to comply with all applicable conditions of Rule 16b-3 or its
successors under the Exchange Act. To the extent any provision of this Plan or
action by Committee fails to so comply, it shall be deemed null and void to the
extent permitted by law and deemed advisable by the Committee.
10.6 Amendment. The Board may amend or terminate this Plan at any time;
provided, however, an amendment that would have a material adverse effect on the
rights of a Participant under an outstanding Option is not valid with respect to
such Option without the Participant's consent. Provided further that the
stockholders of the Company must approve any amendment:
(a) Before the effective date of an amendment that changes the
number of shares in the aggregate which may be issued pursuant
to Options granted under the Plan or the maximum number of
shares with respect to which any individual may receive
Options during any period specified herein, except pursuant to
Article .
(b) Before the effective date of an amendment that increases the
period during which Options may be granted or exercised.
10.7 Effective Date of Plan. This Plan shall be effective on the date
of its adoption by the Board, and Options may be granted hereunder at any time
after such adoption; provided, however, that the effectiveness of this Plan will
be retroactively revoked if it is not approved by the stockholders of the
Company within 12 months of the date that the Board took action to adopt the
Plan. All Options granted under the Plan will become void immediately following
the 12-month anniversary of the date the Board adopted the Plan if such approval
by stockholders has not yet been obtained.
8
<PAGE> 1
EXHBIT 10.5
SERVICE EXPERTS, INC.
1997 NONQUALIFIED STOCK PURCHASE PLAN
EFFECTIVE JULY 1, 1997
Service Experts, Inc., a Delaware corporation, hereby adopts the
Service Experts, Inc. Nonqualified Stock Purchase Plan (the "Plan") for the
benefit of its eligible employees and eligible employees of its subsidiaries,
effective July 1, 1997. The purpose of this Plan is to provide an opportunity
for eligible employees to share in the growth and prosperity of the Sponsoring
Employer (as defined in Section 1.16) and its subsidiaries by acquiring a
proprietary interest in the Sponsoring Employer through acquisition of shares
of the Sponsoring Employer's common stock. This Plan is not intended to
qualify as an "employee stock purchase plan" within the meaning of Section
423(b) of the Internal Revenue Code of 1986, as amended (the "Code").
Participation in this Plan is generally limited to individuals who
were not employed by an Employer on January 1st of a calendar year and,
accordingly, were not eligible to receive an option under the Service Experts,
Inc. 1996 Employee Stock Purchase Plan (the "ESPP"). It is expected that an
individual will be able to participate in this Plan only in the first year of
employment as a bridge to the date that he is eligible to participate in the
ESPP. The Sponsoring Employer intends for this Plan to enhance broad-based
participation by employees in the purchase of common stock.
ARTICLE I
DEFINITIONS
As used herein, the following words and phrases shall have the
meanings specified below, unless a different meaning is plainly required by the
context:
1.1 "Board of Directors" shall mean the Board of Directors of Service
Experts, Inc.
1.2 The "Committee" shall mean the Compensation Committee of the
Sponsoring Employer's Board of Directors.
1.3 "Continuous Service" shall mean the number of full years and
completed months of continuous employment with an Employer calculated from an
Employee's last hire date to the Employee's date of severance of employment for
any reason. Continuous Service shall not be broken and shall be credited for
absences due to vacation, temporary sickness or injury, other paid leaves of
absence authorized by an Employer, and leaves of absence which would not cause
an individual to cease to be an Employee.
1
<PAGE> 2
1.4 "Contribution Account" shall mean the account recorded on the
records of the Sponsoring Employer established on behalf of a Member to which
the amount of the Member's contributions made pursuant to Article IV shall be
credited.
1.5 "Eligible Employee" shall mean an individual who is (i) treated as
an employee by an Employer and is first employed after January 1 and prior to
July 1 in a calendar year, and (ii) ineligible to receive an option to purchase
stock under the Service Experts, Inc. 1996 Employee Stock Purchase Plan.
1.6 "Employer" shall mean the Sponsoring Employer, its successors, any
future parent (as defined in Section 424(e) of the Code) and each current or
future subsidiary (as defined in Section 424(f) of the Code).
1.7 "Exercise Date" shall mean December 31st of each calendar year.
1.8 "Grant Date" shall mean July 1st of each calendar year.
1.9 "Issue Price" shall mean the purchase price of the Sponsoring
Employer Stock to be charged to participating Members on the Exercise Date, as
determined under Section 5.2.
1.10 "Market Price" shall mean the last reported sale price for the day
upon which the Market Price is to be determined or, if there are no sales on
such date, the last reported sale price for the most recent day preceding such
date, in either case as reported on The New York Stock Exchange or, if
Sponsoring Employer Stock is not traded on the New York Stock Exchange, the
exchange on which the Sponsoring Employer Stock is traded or, if Sponsoring
Employer Stock is not traded on an exchange, the automated interdealer quotation
system sponsored by a registered national securities association on which the
Sponsoring Employer Stock is quoted. Notwithstanding the foregoing, if there
shall be any material alteration in the present system of reporting sale prices
of the Sponsoring Employer Stock, or if the Sponsoring Employer Stock shall no
longer be quoted on an automated interdealer quotation system sponsored by a
registered national securities association or listed on a national securities
exchange, the Market Price of the Sponsoring Employer Stock as of a particular
date shall be determined in good faith by the Committee.
1.11 "Member" shall mean any Employee of an Employer who has met the
conditions and provisions for becoming a Member as provided in Article III.
1.12 "Member's Contribution Rate" shall be an exact number of dollars
elected by the Member to be contributed by regular payroll deductions to his
Contribution Account as outlined in Section 4.1.
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<PAGE> 3
1.13 "Normal Pay" for purposes of determining the number of shares that
can be obtained in any Option Period shall be gross wages paid to Employees in
the Option Period, other than "executive bonuses."
1.14 "Option Period" shall mean the six-month period following each
Grant Date and ending with the Exercise Date.
1.15 "Plan" shall mean the Service Experts, Inc. Nonqualified Stock
Purchase Plan as set forth herein and all subsequent amendments hereto.
1.16 "Sponsoring Employer" shall mean Service Experts, Inc., a Delaware
corporation, or its successors, the Plan sponsor for all purposes.
1.17 "Sponsoring Employer Stock" shall mean, subject to adjustment as
provided in Article X, those shares of the Sponsoring Employer's Common Stock,
$.01 par value per share, which pursuant to Article II are reserved for issuance
upon the exercise of the options granted under this Plan.
ARTICLE II
ISSUANCE OF STOCK
The Sponsoring Employer hereby reserves 100,000 shares of Sponsoring
Employer Stock for issuance upon the exercise of the options granted hereunder;
provided, that the class and aggregate number of shares which may be issued
upon exercise of options granted hereunder shall be subject to adjustment in
accordance with the provisions of Article X. These shares may be authorized
and unissued shares, issued shares held in or acquired for the treasury of the
Sponsoring Employer, or shares of stock reacquired by the Sponsoring Employer
upon purchase in the open market or otherwise.
ARTICLE III
ELIGIBILITY
3.1 Every Eligible Employee whose customary employment with an Employer
on the Effective Date is at least 20 hours per week and more than five months in
a calendar year shall be eligible to participate in the Plan. The right to
participate shall expire at the time that the Eligible Employee is granted an
option under the Service Experts, Inc. 1996 Employee Stock Purchase Plan.
3.2 Upon becoming a Member, the Employee shall be bound by the terms of
this Plan, including any amendments thereto. Each Employee who becomes eligible
to participate shall be furnished a summary of the Plan and a form for election
to
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<PAGE> 4
participate. Each Employee electing to participate shall complete such form
and file it with the Employer no later than 15 days following the Grant Date.
The completed request for participation shall indicate the amount of the
Member's Contribution Rate authorized by the Member in accordance with Section
4.1. The member's written election to participate shall expire on the Exercise
Date.
ARTICLE IV
CONTRIBUTIONS
4.1 In order to participate in this Plan and exercise any option
granted hereunder, a Member must file with the Employer an election to
participate in accordance with Section 3.2 and must authorize his Employer to
deduct through a payroll deduction an exact number of dollars or percentage of
Normal Pay (in whole percentages) on each payroll date, but not less than $10
per month, such being the Member's "Contribution Rate." Such authorization shall
be in writing and on such forms as are provided by the Committee. Payroll
deductions shall begin as of the first pay period on or after a Grant Date
during each Option Period. For all purposes of this Plan, a Member's
contributions shall be allocated to and deemed a part of the Member's
Contribution Account. Member contributions will not be permitted to begin at any
time other than the first pay period on or after a Grant Date during an Option
Period. The Employers shall transfer all withheld amounts to the Sponsoring
Employer which may use such amounts for any valid corporate purposes. No
interest shall accrue or be paid on any amounts withheld under this Plan.
4.2 A Member may elect to discontinue his or her contributions
hereunder at any time during the Option Period by providing written notice to
the Employer on such forms as are provided by the Committee. Such discontinuance
shall become effective not more than 30 days following receipt of the written
notice by the Employer.
4.3 A Member may elect to withdraw any or all of their contributions at
any time during the Option Period by providing written notice to the Employer on
such forms as are provided by the Committee. If contributions are withdrawn
during the Option Period, however, no further contributions will be permitted
during that Option Period.
ARTICLE V
GRANT OF OPTIONS
5.1 Every Employee who is otherwise eligible to become a Member
hereunder shall, on the Grant Date of each Option Period and without further
action of the Committee, be granted an option to purchase a number of whole
shares of Sponsoring Employer Stock that, in the aggregate, has an Issue Price
that is not more than ten percent of such Employee's Normal Pay during the
Option Period; provided, however,
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<PAGE> 5
that the options granted hereunder are limited so that the total Market Price
of Sponsoring Employer Stock that can be purchased under such options does not
exceed $25,000 (determined on the date that options are granted) during any one
calendar year. Options granted under this Plan shall be subject to such
amendments or modifications as the Sponsoring Employer shall deem necessary to
comply with any applicable law or regulation, and shall contain such other
provisions as the Sponsoring Employer shall from time to time approve and deem
necessary. Options not exercised pursuant to Section 6.1 shall terminate at
11:59 p.m. (Eastern Time) on the Exercise Date. In the event an outstanding
option shall for any reason expire, the shares of Sponsoring Employer Stock
allocable to the unexercised portion of such option may again be subject to
option under the Plan.
5.2 The Issue Price of the Sponsoring Employer Stock under this Plan
shall, with respect to each Option Period, be equal to the lesser of: (i) 85% of
the Market Price on the applicable Exercise Date; or (ii) 85% of the Market
Price on the applicable Grant Date.
ARTICLE VI
EXERCISE OF OPTIONS
6.1 On each Exercise Date, the Member's Contribution Account shall be
used to purchase the maximum number of whole shares of Sponsoring Employer Stock
determined by dividing the Issue Price into the balance of the Member's
Contribution Account (subject to the limitations set forth in Section 5.1). Any
money remaining in a Member's Contribution Account after the Exercise Date which
was not used to exercise the Member's option shall be returned to the Member.
6.2 If the total number of shares to be purchased under option by all
Members exceeds the number of shares authorized under Article II of this Plan, a
pro-rata allocation of the available shares will be made among all Members
authorizing such payroll deductions based on the amount of their respective
payroll deductions through the Exercise Date.
6.3 The certificates for Sponsoring Employer Stock purchased through
the exercise of the option granted hereunder shall be issued as soon as
practicable after the Exercise Date.
5
<PAGE> 6
ARTICLE VII
TERMINATION OF EMPLOYMENT
7.1 Any Employee whose employment with all Employers is terminated for
any reason, except death or retirement, during the Option Period shall cease
being a Member immediately. The balance of the Member's Contribution Account
shall be paid to such Member, or to such Member's legal representative, as soon
as practicable after such Member's termination. Any right to purchase Sponsoring
Employer Stock under the option granted to such Member by participation in this
Plan shall be deemed null and void.
7.2 If a Member dies or retires for reasons of age or disability during
an Option Period, no further contributions on behalf of the Member shall be
accepted under the Plan. If such termination of employment with all Employers is
more than three months prior to the Exercise Date during such Option Period, the
Committee will direct that the balance of the Member's Contribution Account be
paid to the Member (or his personal representative if deceased) as soon as
administratively feasible. However, if such termination of employment occurs not
more than three months prior to the Exercise Date during such Option Period, the
balance accumulated in the Member's Contribution Account shall be used to
purchase Sponsoring Employer Stock in accordance with Article VI, unless the
Member (or his personal representative) notifies the Committee in writing of his
election to withdraw the balance of his Contribution Account prior to the
Exercise Date.
ARTICLE VIII
DISPOSITION OF STOCK
If a Member or former Member disposes of any shares of Sponsoring
Employer Stock obtained under this Plan (i) prior to two years after the Grant
Date of such share, or (ii) prior to one year after the Exercise Date of such
share, that Member or former Member must notify the Committee immediately of
such disposition in writing. All dispositions of Sponsoring Employer Stock
shall be made in compliance with applicable federal and state securities laws.
ARTICLE IX
ADMINISTRATION
The Plan shall be administered by the Committee. Meetings shall be
held at such times and places as shall be determined by the Committee. A
majority of the members of the Committee shall constitute a quorum for the
transaction of business, and the vote of a majority of those members present at
any meeting shall decide any question brought under the Plan. No member of the
Committee shall be liable for any act or omission of any other member of the
Committee or for any act or omission on his own
6
<PAGE> 7
part related to the Plan, including but not limited to the exercise of any
power or discretion given to him under the Plan, except those resulting from
his own gross negligence or willful misconduct. All questions of
interpretation and application of the Plan, or of options granted hereunder,
shall be subject to the determination, which shall be final and binding, of a
majority of the whole Committee.
ARTICLE X
CHANGES IN COMPANY'S CAPITAL STRUCTURE
10.1 The existence of this Plan shall not affect in any way the right
or power of the Sponsoring Employer or its stockholders to make or authorize any
or all adjustments, recapitalizations, reorganizations or other changes in the
Sponsoring Employer's capital structure or its business, or any merger or
consolidation of the Sponsoring Employer, or any issue of bonds, debentures,
preferred or prior preference stock ahead of or affecting the Sponsoring
Employer Stock or rights thereof, or the dissolution or liquidation of the
Sponsoring Employer, or any sale or transfer of all or part of its assets or
business, or any other corporate act or proceeding, whether of similar character
or otherwise.
10.2 In the event of a subdivision or consolidation of shares or other
capital readjustment, the payment of a stock dividend or other increase or
decrease of the number of shares of the Sponsoring Employer's Stock outstanding
without receiving compensation in money, services, or property, then the class
of shares of the Sponsoring Employer's Stock set forth in Section 1.17 of the
Plan, the number of shares of stock reserved pursuant to Article II, and the
number of options granted a Member shall be appropriately adjusted as determined
by the Committee. The Committee's determination shall be final, binding, and
conclusive.
10.3 Subject to any required action by the stockholders, if the
Sponsoring Employer is the surviving corporation in any merger or consolidation,
each outstanding option shall pertain to and apply to the securities to which a
holder of the number of shares of Sponsoring Employer Stock subject to the
option would have been entitled. Unless adopted by the surviving corporation, a
dissolution or liquidation of the Sponsoring Employer or a merger or
consolidation in which the Sponsoring Employer is not the surviving corporation,
shall cause each outstanding option to terminate; provided that the Committee in
its sole discretion, immediately prior to such dissolution or liquidation, or
merger or consolidation in which the Corporation is not the surviving
corporation, may direct that the Option Period end on a date immediately prior
to the effective date of such event.
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<PAGE> 8
ARTICLE XI
MISCELLANEOUS
11.1 Each Member, former Member, or any other person who shall claim a
right or benefit under this Plan, shall be entitled only to look to such
Member's Employer for such benefit.
11.2 The Board of Directors may at any time or from time to time amend
the Plan in any respect. The Sponsoring Employer may terminate the Plan at any
time. If the Plan is terminated, the date of termination shall be treated as the
Exercise Date and all funds in a Member's Contribution Account not expended to
purchase Sponsoring Employer Stock shall be refunded to the Member.
11.3 The Employers will pay all expenses that may arise in connection
with the administration of this Plan.
11.4 Any headings or subheadings in this Plan are inserted for
convenience of reference only and are to be disregarded in the construction of
any provisions hereof. All references in this Plan to Articles and Sections are
to Articles and Sections of this Plan unless specified otherwise.
11.5 This Plan shall be construed in accordance with the internal laws
of the state of incorporation of the Sponsoring Employer to the extent federal
law does not supersede and preempt such law.
11.6 A misstatement in the age, length of Continuous Service, date of
employment or any other such matter shall be corrected when it becomes known
that any such misstatement of fact has occurred.
11.7 The option to purchase Sponsoring Employer Stock arising by
participation in this Plan is not transferable by a Member other than by will or
the laws of descent and distribution and is exercisable during his lifetime only
by him.
11.8 This Plan will not be deemed to constitute a contract between an
Employer and any Member or to be in consideration of or an inducement for the
employment of any Member or Employee. Nothing contained in this Plan shall be
deemed to give any Member or Employee the right to be retained in the service of
an Employer or to interfere with the right of an Employer to discharge any
Member or Employee at any time regardless of the effect which such discharge
shall have upon him as a Member of the Plan.
11.9 No liability whatsoever shall attach to or be incurred by any
past, present or future stockholders, officers, or directors, as such, of an
Employer, under or by reason of any of the terms, conditions, or agreements
contained in this Plan or implied
8
<PAGE> 9
therefrom, and any and all liabilities of, and any and all rights and claims
against an Employer, or any stockholder, officer, or director, as such, whether
arising at common law or in equity or created by statute or constitution or
otherwise, pertaining to this Plan, are hereby expressly waived and released by
every Member, as a part of the consideration for any benefits provided by the
Employers under this Plan.
11.10 With respect to administration of the Plan, the Sponsoring
Employer shall indemnify each present and future member of the Committee and the
Board of Directors against, and each member of the Committee and the Board of
Directors shall be entitled without further act on his or her part to indemnity
from the Sponsoring Employer, for all expenses (including the amount of
judgments and the amount of approved settlements made with a view to the
curtailment of costs of litigation, other than amounts paid to the Sponsoring
Employer itself) reasonably incurred by him or her in connection with or arising
out of any action, suit or proceeding in which he or she may be involved by
reason of his or her being or having been a member of the Committee and the
Board of Directors, whether or not he or she continues to be such a member of
the Committee and the Board of Directors at the time of incurring such expenses;
provided, however, that such indemnity shall not include any expenses incurred
by any such member of the Committee and the Board of Directors (a) in respect of
matters as to which he shall be finally adjudged in any such action, suit, or
proceeding to have been guilty of gross negligence or willful misconduct in the
performance of his or her duty as such a member of the Committee and the Board
of Directors, or (b) in respect of any matter in which any settlement is
effected, to an amount in excess of the amount approved by the Sponsoring
Employer on the advice of its legal counsel; and provided further, that no right
of indemnification under the provisions set forth herein shall be available to
or enforceable by any such member of the Committee and the Board of Directors
unless, within 60 days after institution of any such action, suit, or
proceeding, he or she shall have offered the Sponsoring Employer, in writing,
the opportunity to handle and defend same at its own expense. The foregoing
right of indemnification shall inure to the benefit of the heirs, executors, or
administrators of each such member of the Committee and the Board of Directors
and shall be in addition to all other rights to which such member of the
Committee and the Board of Directors may be entitled as a matter of law,
contract, or otherwise.
11.11 The Sponsoring Employer's obligation to sell and deliver stock
under the Plan is at all times subject to all approvals of any governmental
authorities required in connection with the authorization, issuance, offer,
sale, or delivery of such stock and compliance with applicable state and federal
securities laws.
11.12 Whenever any notice is required or permitted hereunder, such
notice must be in writing and personally delivered or sent by mail. Any notice
required or permitted to be delivered hereunder shall be deemed to be delivered
on the date which it is personally delivered, or, whether actually received or
not, on the third business day after it is deposited in the United States mail,
certified or registered, postage prepaid,
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<PAGE> 10
addressed to the person who is to receive it at the address which such person
has theretofore specified by written notice delivered in accordance herewith.
Notwithstanding any of the foregoing, any notice required or permitted to be
given by or on behalf of a Member under Section 7.2 or Article IV hereof, shall
only be effective as of the date of its actual receipt. Any party may change,
at any time and from time to time, by written notice to the other, the address
which it, he, or she had theretofore specified for receiving notices. Until
changed in accordance herewith, the Sponsoring Employer shall be entitled to
use the address of a Member in the Employer's records. Any person entitled to
notice hereunder may waive such notice.
11.13 Any words herein used in the masculine shall be read and
construed in the feminine where they would so apply. Words in the singular shall
be read and construed as though in the plural in all cases where they would so
apply.
11.14 This Plan is intended to comply with Rule 16b-3 under the
Securities Exchange Act of 1934, as amended, and to the extent necessary or
appropriate shall be interpreted to comply with such Rule 16b-3.
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<PAGE> 1
EXHIBIT 12
SERVICE EXPERTS, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHANGES
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1st Qtr.
1992 1993 1994 1995 1996 1997
<S> <C> <C> <C> <C> <C> <C>
FIXED CHARGES:
Interest Expense $ 52 $ 92 $ 90 $ 100 $ 63 $ 87
Portion of rents representative
of interest factor $ 42 $ 47 $ 58 $ 64 $ 163 $ 123
Total fixed charges $ 94 $ 139 $ 148 $ 164 $ 226 $ 210
EARNINGS:
Earnings before income tax expense $ 120 $ 62 $ 424 $ 790 $ 4,306 $ 2,947
Undistributed equity in affiliate
earnings -- -- -- -- $ (30) --
Fixed charges $ 94 $ 164 $ 148 $ 164 $ 226 $ 210
Total earnings $ 214 $ 201 $ 572 $ 954 $ 4,502 $ 3,157
Ratio of earnings to fixed charges 2.28x 1.45x 3.86x 5.82x 19.92x 15.03x
</TABLE>
<PAGE> 1
EXHIBIT 21
SERVICE EXPERTS, INC.
LIST OF SUBSIDIARIES AS OF JULY 10, 1997
<TABLE>
<CAPTION>
Name State of Incorporation
---- ----------------------
<S> <C>
AC Service & Installation Co., Inc./
Donelson Air Conditioning Company, Inc. Tennessee
Air-Conditioning and Heating Unlimited, Inc. Tennessee
Air Experts, a United Services Co., Inc. Missouri
Arrow Heating & Air Conditioning, Inc. Wisconsin
Automated Air, Inc. Tennessee
B & B Air Conditioning, Inc. Tennessee
B. W. Heating & Cooling, Inc. Tennessee
Bauer Heating & Air Conditioning, Inc. Tennessee
Brand Heating & Air Conditioning, Inc. Indiana
C. Iapaluccio Company, Inc. Connecticut
Claire's Air Conditioning & Refrigeration, Inc. Tennessee
Coastal Air Conditioning Service, Inc. Georgia
Comerford's Heating and Air Conditioning, Inc. California
Comfortech, Inc. Tennessee
Contractor Success Group, Inc. Missouri
Custom Air Conditioning, Inc. Tennessee
Dial One Raymond Plumbing, Heating & Cooling, Inc. Tennessee
Eisenbach Enterprises, Inc. Texas
Falso Service Experts, Inc. New York
Frees Service Experts, Inc. Texas
Freschi Air Systems, Inc. Tennessee
Gaddis Co. Tennessee
Gilley's-Quality Heating & Cooling, Inc. Louisiana
Gordon's Specialty Company Tennessee
Griffin Heating & Air Conditioning, Inc. Indiana
Hardwick Air Masters, Inc. Arkansas
Island Air Conditioning, Inc. Tennessee
Lewis & Guymon, Inc. Utah
Norrell Heating and Air Conditioning Company, Inc. Alabama
Pardee Refrigeration Company Incorporated Tennessee
Parker Heating & Air Conditioning, Incorporated Tennessee
ProAir Services, Inc. Tennessee
Roland J. Down, Inc. New York
Rolf Coal and Fuel Corp. Indiana
Royden, Inc. Utah
Sanders Indoor Comfort, Inc. Tennessee
Service Experts of Indianapolis, Inc. Indiana
Service Experts of Palm Springs, Inc. California
Service Experts of Raleigh, Inc. Tennessee
Stark Services Co., Inc. Tennessee
Sunbeam Service Experts, Inc. New York
Superior Air Conditioning Co., Inc. Tennessee
Sylvester's Corp. Indiana
Vision Holding Company, Inc. Missouri
</TABLE>
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the reference to our firm under the caption "Experts" and
to the use of our report dated February 12, 1997 with respect to the
consolidated financial statements of Service Experts, Inc. and the use of our
report dated May 19, 1997, with respect to the financial statements of Artic
Aire of Chico, Inc. in the Post-Effective Amendment No. 5 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.
ERNST & YOUNG LLP
Nashville, Tennessee
July 10, 1997
<PAGE> 1
Exhibit 23.2
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
As independent public accountants, we hereby consent to the use of our report
(and to all references to our firm) included in or made a part of this
Registration Statement File No. 333-12319.
Arthur Andersen LLP
Atlanta, Georgia
July 9, 1997
