<PAGE> 1
================================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported):
November 19, 1998
SERVICE EXPERTS, INC.
------------------------------------------------------
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
Delaware 001-13037 62-1639453
- ---------------- ---------------- -----------------
<S> <C> <C>
(State or Other (Commission File (I.R.S. Employer
Jurisdiction of Number) Identification
Incorporation) Number)
</TABLE>
Six Cadillac Drive
Suite 400
Brentwood, Tennessee 37027
--------------------------------------------------
(Address of principal executive offices) (Zip Code)
(615) 371-9990
----------------------------------------------------
(Registrant's telephone number, including area code)
Not Applicable
-------------------------------------------------------------
(Former name or former address, if changed since last report)
================================================================================
<PAGE> 2
ITEM 5. OTHER EVENTS.
Service Experts, Inc., a Delaware corporation (the "Company"), operates
residential heating, ventilating and air conditioning ("HVAC") service and
replacement businesses. In connection with the acquisition of HVAC businesses,
the Company plans to offer shares of the Company's Common Stock, $.01 par value
per share (the "Common Stock"), warrants to purchase shares of Common Stock and
debt securities convertible into shares of Common Stock pursuant to its
Registration Statement on Form S-4. In order to comply with the disclosure
requirements of the Securities and Exchange Commission regarding the financial
statements of businesses acquired or to be acquired, the Company is filing this
Current Report containing the following audited and pro forma financial
statements:
(a) Financial Statements of Businesses Acquired
See Pages F-2 through F-37.
(b) Pro Forma Financial Information
See Pages F-38 through F-44.
2
<PAGE> 3
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
DODGE HEATING AND AIR CONDITIONING, INC. ET AL.
AND DH&A, INC. -- FINANCIAL STATEMENTS
FOR THE YEAR ENDED DECEMBER 31, 1997 AND THE NINE MONTHS
ENDED SEPTEMBER 30, 1998 (UNAUDITED)
Report of Independent Auditors........................................ F-2
Combined Balance Sheets............................................... F-3
Combined Statements of Income......................................... F-5
Combined Statement of Stockholder's Equity............................ F-6
Combined Statements of Cash Flows..................................... F-7
Notes to Combined Financial Statements................................ F-8
CLIMATE DESIGN SYSTEMS, INC. -- FINANCIAL STATEMENTS FOR
THE YEAR ENDED DECEMBER 31, 1997 AND THE SIX MONTHS ENDED
JUNE 30, 1998 (UNAUDITED)
Report of Independent Auditors....................................... F-21
Balance Sheets....................................................... F-22
Statements of Income................................................. F-23
Statement of Stockholder's Equity.................................... F-24
Statements of Cash Flows............................................. F-25
Notes to Financial Statements........................................ F-26
SERVICE EXPERTS, INC. -- UNAUDITED PRO FORMA COMBINED
FINANCIAL STATEMENTS
Basis of Presentation............................................... F-38
Unaudited Pro Forma Combined Balance Sheet as of September 30,
1998.............................................................. F-40
Unaudited Pro Forma Combined Statements of Income for the
Nine Months ended September 30, 1998 and for the Twelve
Months ended December 31, 1997.................................... F-41
Notes to Unaudited Pro Forma Combined Financial
Statements........................................................ F-43
</TABLE>
F-1
<PAGE> 4
Report of Independent Auditors
The Stockholder of
Dodge Heating and Air Conditioning, Inc. et al. and
DH&A, Inc.
We have audited the accompanying combined balance sheet of Dodge Heating and Air
Conditioning, Inc. et al. and DH&A, Inc. (see note 1) as of December 31, 1997,
and the related combined statements of income, stockholder's equity, and cash
flows for the year ended December 31, 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 combined financial position of Dodge Heating and Air
Conditioning, Inc. et al. and DH&A, Inc. at December 31, 1997, and the combined
results of their operations and their cash flows for the year ended December 31,
1997, in conformity with generally accepted accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
October 23, 1998
F-2
<PAGE> 5
Dodge Heating and Air Conditioning, Inc. et al.
and DH&A, Inc.
Combined Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ ------------
(Unaudited)
ASSETS
<S> <C> <C>
Current assets:
Cash............................................. $ 106,278 $ 1,031,530
Accounts receivable:
Trade, net of allowance for doubtful
accounts of $75,000 and $49,000 at
December 31, 1997 and September 30, 1998...... 1,128,748 1,774,163
Stockholder..................................... 40,877 298
Other........................................... 18,726 19,590
----------- -----------
1,188,351 1,794,051
Inventories........................................ 378,811 355,625
Costs and estimated earnings in excess of billings. 547,055 409,241
Deferred income taxes.............................. 88,684 --
----------- -----------
Total current assets............................... 2,309,179 3,590,447
Property, buildings and equipment:
Land............................................. 344,250 344,250
Buildings........................................ 38,250 38,250
Furniture and fixtures........................... 256,659 266,147
Machinery and equipment.......................... 474,067 479,064
Vehicles......................................... 1,165,972 1,093,149
Leasehold improvements........................... 84,159 98,921
----------- -----------
2,363,357 2,319,781
Less accumulated depreciation and amortization... (1,291,612) (1,336,259)
----------- -----------
1,071,745 983,522
Other assets....................................... 18,717 18,717
----------- -----------
Total assets....................................... $ 3,399,641 $ 4,592,686
=========== ===========
</TABLE>
F-3
<PAGE> 6
<TABLE>
<CAPTION>
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
(Unaudited)
LIABILITIES AND STOCKHOLDER'S EQUITY
<S> <C> <C>
Current liabilities:
Trade accounts payable and accrued liabilities... $ 524,758 $ 478,226
Accrued compensation............................. 86,040 182,497
Accrued warranties............................... 147,850 131,000
Income taxes payable............................. 179,093 454,054
Deferred revenue................................. 20,841 42,499
Deferred income taxes............................ -- 79,690
Billings in excess of costs and estimated
earnings....................................... 264,844 170,623
Current portion of long-term debt................ 172,087 83,089
----------- -----------
Total current liabilities.......................... 1,395,513 1,621,678
Long-term debt, net of current..................... 469,884 358,790
Deferred income taxes.............................. 128,962 128,842
Stockholder's equity:
Common stock, $10 par value, 25,000 shares
authorized, 300 shares issued and outstanding.. 3,000 3,000
Common stock, $1 par value, 100,000 shares
authorized, 500 shares issued and outstanding.. 500 500
Retained earnings................................ 1,401,782 2,479,876
----------- -----------
Total stockholder's equity......................... 1,405,282 2,483,376
----------- -----------
Total liabilities and stockholder's equity......... $ 3,399,641 $ 4,592,686
=========== ===========
</TABLE>
F-4
<PAGE> 7
Dodge Heating and Air Conditioning, Inc., et al.
and DH&A, Inc.
Combined Statements of Income
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------ ----------------
(Unaudited)
<S> <C> <C>
Net Revenue.............................................. $9,418,317 $9,238,728
Cost of goods sold....................................... 6,683,364 5,350,916
---------- ----------
Gross margin............................................. 2,734,953 3,887,812
Selling, general and administrative expenses............. 1,884,841 1,551,728
---------- ----------
Income from operations................................... 850,112 2,336,084
Other income (expense):
Interest expense........................................ (84,041) (39,876)
Interest income......................................... 17,706 9,686
Other income (expense).................................. 85,216 (30,478)
---------- ----------
18,881 (60,668)
---------- ----------
Income before taxes...................................... 868,993 2,275,416
Provision (benefit) for income tax:
Current................................................. 195,263 491,914
Deferred................................................ (5,198) 168,254
---------- ----------
Total income taxes....................................... 190,065 660,168
---------- ----------
Net income............................................... $ 678,928 $1,615,248
========== ==========
</TABLE>
See accompanying notes.
F-5
<PAGE> 8
Dodge Heating and Air Conditioning, Inc. et al.
and DH&A, Inc.
Combined Statements Of Stockholder's Equity
<TABLE>
<CAPTION>
TOTAL
----------
<S> <C>
Balance at January 1, 1997................... $ 740,303
Capital distributions...................... (14,449)
Capital contributions...................... 500
Net income................................. 678,928
----------
Balance at December 31, 1997................. 1,405,282
Capital distributions (unaudited).......... (537,154)
Net income (unaudited)..................... 1,615,248
----------
Balance at September 30, 1998 (unaudited).... $2,483,376
==========
</TABLE>
See accompanying notes.
F-6
<PAGE> 9
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS ENDED
DECEMBER 31, 1997 SEPTEMBER 30, 1998
------------------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income ............................................................ $ 678,928 $1,615,248
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization....................................... 235,059 193,994
(Benefit) provision for deferred income taxes....................... (5,198) 168,254
Provision (recoveries) for loss on accounts receivable.............. 56,227 (18,856)
Loss on asset disposals............................................. -- 37,047
Changes in assets and liabilities
Accounts receivable............................................... 105,371 (586,844)
Inventories....................................................... (56,777) 23,186
Other current assets.............................................. (3,048) --
Trade accounts payable and accrued liabilities.................... (328,740) (46,532)
Accrued compensation.............................................. 12,105 96,457
Accrued warranties................................................ 7,850 (16,850)
Deferred revenue.................................................. (18,291) 21,658
Income taxes payable.............................................. 144,645 274,961
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.............. (395,461) 43,593
-----------------------------------------
Net cash flow provided by operating activities......................... 432,670 1,805,316
INVESTING ACTIVITIES
Purchase of property, buildings and equipment.......................... (146,010) (142,818)
-----------------------------------------
Net cash used in investing activities.................................. (146,010) (142,818)
FINANCING ACTIVITIES
Lines of Credit Advances............................................... 165,000 --
Lines of Credit Payments............................................... (260,000) --
Payments on long-term debt............................................. (191,759) (200,092)
Proceeds from long-term debt........................................... 83,545 --
Issuance of stock...................................................... 500 --
Distribution to stockholder............................................ (14,449) (537,154)
-----------------------------------------
Net cash used in financing activities.................................. (217,163) (737,246)
Increase in cash....................................................... 69,497 925,252
-----------------------------------------
Cash at beginning of period............................................ 36,781 106,278
Cash at end of period.................................................. $ 106,278 $1,031,530
=========================================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid.......................................................... $ 84,041 $ 39,876
=========================================
Income taxes paid...................................................... $ 50,618 $ 216,955
=========================================
</TABLE>
See accompanying notes.
F-7
<PAGE> 10
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Note to Combined Financial Statements
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Dodge Heating and Air Conditioning, Inc., et al., including certain real
property operations used by the Company ("Dodge"), and DH&A, Inc., ("DH&A")
(collectively, the "Company") are under common ownership. Dodge operates in one
industry segment and is engaged in the installation and servicing of air
conditioning and heating systems for commercial and residential customers in the
State of Georgia. Dodge began operations in 1981. DH&A provides air
conditioning, electrical, plumbing and other maintenance services and materials
and parts, under two contracts with Warner Robins Air Force Base ("Warner
Robins") in Georgia. DH&A was formed on June 6, 1997 and began operations
in September, 1997.
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of Dodge Heating and Air
Conditioning, Inc. et al. and DH&A, Inc. All intracompany transaction have been
eliminated in the combination.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The combined balance sheet as of September 30, 1998 and the related combined
statements of income, stockholder's equity, and cash flows for the nine months
then ended ("interim financial statements") have been prepared by the Company's
management and are unaudited. The interim financial statements include all
adjustments, consisting of only normal recurring adjustments, necessary for a
fair presentation of the interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December 31,
1997 audited financial statements appearing herein. The results of the nine
months ended September 30, 1998 may not be indicative of operating results for
the full year.
RECOGNITION OF REVENUE
Revenue 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. Revenue on all of the Company's Contracts for residential
installation and service and maintenance revenue and revenue relating to the two
maintenance service contracts are recognized upon completion of the services,
which is usually within one to two days.
F-8
<PAGE> 11
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF REVENUE (CONTINUED)
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 12 months.
Trade accounts receivable includes billings and billed retainage on Contracts.
Trade accounts receivable also includes unbilled retainage of approximately
$311,000 at December 31, 1997. The Company classifies these amounts as current
assets because all balances are expected to be collected in the current year.
The asset, "cost and estimated earnings in excess of billings", represents
revenue recognized in excess of amounts billed on in-progress Contracts. The
liability, "billings in excess of costs and estimated earnings", represents
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 approximate fair
value.
Accounts Receivable, Notes Payable, Accounts Payable and Accrued Liabilities
The carrying amounts reported in the balance sheet for accounts receivable,
notes payable, accounts payable and accrued liabilities approximate fair value.
Accounts receivable are generally unsecured.
F-9
<PAGE> 12
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATION OF CREDIT
At times, cash balances in the Company's accounts may exceed FDIC insurance
limits. The Company primarily purchases HVAC units and parts from Mingledorf,
Inc. Total purchases of equipment and parts from this supplier during 1997
totaled approximately $861,000.
At December 31, 1997, the Company had approximately $32,800 on deposit with a
bank in excess of FDIC Insurance limits.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1997, amounts charged to bad debt expense and
totaled approximately $56,000. There were no accounts written off during the
year.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out ("FIFO") method for all inventories.
F-10
<PAGE> 13
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost. Depreciation
and amortization are provided on the straight-line method and declining-balance
methods over the following useful lives:
<TABLE>
<CAPTION>
Years
-----
<S> <C>
Building 31.5
Furniture and fixtures 7
Machinery and equipment 5
Vehicles 5
Leasehold improvements 10
</TABLE>
LONG-LIVED ASSETS
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed
Of", requires that companies consider whether indicators of impairment of
long-lived assets held for use are present. If such indicators are present,
companies determine whether the sum of the estimated undiscounted future cash
flows attributable to such assets is less than their carrying amount, and if so,
companies recognize an impairment loss based on the excess of the carrying
amount of the assets over their fair value. Accordingly, management periodically
evaluates the ongoing value of property, buildings and equipment and has
determined that there were no indications of impairment as of December 31, 1997.
F-11
<PAGE> 14
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 the service is performed.
WARRANTIES
The Company generally provides the customer with a one year warranty on parts
and labor from the date of installation of the heating and air conditioning
units. 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
Dodge uses the liability method of accounting for federal and state income taxes
as provided by SFAS No. 109, "Accounting for Income Taxes." Under the liability
method, the deferred tax liability or asset is based on temporary differences
between the financial statement and income tax bases of assets and liabilities,
measured at tax rates that will be in effect when the differences reverse.
The stockholder of DH&A has elected under Subchapter S of the Internal Revenue
Code to include income of DH&A in his own income for federal income tax
purposes. Accordingly, DH&A was not subject to federal or state income taxes
prior to the business combination on September 24, 1998 (See Note 9).
F-12
<PAGE> 15
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Note to Combined Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1997, the Company
expensed approximately $38,000.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 establishes standards for reporting and displaying comprehensive
income and its components in a full set of general purpose financial statements.
SFAS No. 130 is effective for interim and annual periods beginning after
December 15, 1997. Comprehensive income encompasses all changes in stockholder's
equity (except those arising from transactions from owners) and includes net
income, net unrealized capital gains or losses on available for sale securities
and foreign currency translation adjustments. The adoption of SFAS No. 130 in
1998 did not have an impact on the Company's financial statements.
F-13
<PAGE> 16
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contracts $ 4,193,828
Estimated earnings 1,421,679
------------
5,615,507
Less applicable billings (5,333,296)
------------
$ 282,211
------------
Included in the accompanying balance sheet under the
following captions:
Costs and estimated earnings in excess of billings
on uncompleted contracts $ 547,055
Billings in excess of costs and estimated earnings on
uncompleted contracts 264,844
------------
$ 282,211
============
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are not
indicative of the ultimate profit or loss on a contract.
F-14
<PAGE> 17
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
December 31,
1997
------------
<S> <C>
Mortgage note payable $ 264,985
Installment and equipment notes 376,986
---------
641,971
Less current portion (172,087)
---------
$ 469,884
=========
</TABLE>
The Company has two lines of credit with financial institutions with a total
borrowing limit of $150,000 and $500,000, respectively. The lines of credit
bear interest at a rate of prime plus one, which was 9.5% at December 31, 1997.
There were no borrowings outstanding under either line as of December 31, 1997.
The Company has a mortgage note payable which is secured by the related office
building and land. This loan requires monthly installments of $3,015, including
principal and interest (8.51% at December 31, 1997) through July 2009.
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 6.5% to 11.0% per annum at December 31, 1997. These
loans require monthly payments ranging from $304 to $3,250 and are due through
July 2001.
F-15
<PAGE> 18
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
3. DEBT (CONTINUED)
As of December 31, 1997, the aggregate amounts of annual principal maturities of
long-term debt are as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $172,087
1999 153,794
2000 96,282
2001 23,888
2002 19,907
Thereafter 176,013
--------
$641,971
========
</TABLE>
F-16
<PAGE> 19
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
4. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code. Substantially all
employees of the Company are eligible to participate in the plan. Under the
plan's provisions, a plan member may make contributions, on a tax deferred
basis, not to exceed the maximum established by the Internal Revenue Service.
The Company provides matching contributions of 100% of total contributions by a
plan member, to a maximum of 3% of the employee's total calendar year
compensation. The Company's matching contributions totaled approximately $15,000
for 1997.
5. 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.
6. SIGNIFICANT CUSTOMER
All of DH&A's revenue is from two contracts with Warner Robins. These two
contracts, which were entered into in September 1997, represented 7% of the
Company's revenue for the year ended December 31, 1997. For the nine months
ended September 30, 1998, the two contracts represented approximately 20% of the
Company's revenue and 45% of income before taxes. The contracts expire in
October 2000.
F-17
<PAGE> 20
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
7. INCOME TAXES
Income tax expense (benefit) consists of the following at December 31, 1997:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Current:
Federal $ 165,881
State 29,382
Deferred (5,198)
------------
$ 190,065
============
</TABLE>
Significant components of the deferred tax assets and liabilities as of December
31, 1997, are as follows:
<TABLE>
<S> <C>
Deferred tax liabilities:
Deferred revenue $152,490
Depreciation and amortization 10,927
--------
Total deferred tax liabilities 163,417
Deferred tax assets:
Accounts receivable 28,470
Compensation and warranty reserves 94,669
--------
Total gross deferred tax assets 123,139
Valuation allowance --
--------
Deferred tax assets 123,139
--------
Net deferred tax liabilities $ 40,278
========
</TABLE>
Management has evaluated the need for a valuation allowance against the gross
deferred tax assets and determined that the deferred tax assets will likely be
realized through taxable income from reversing taxable temporary differences and
future pretax book income. Accordingly, no valuation allowance was recorded at
December 31, 1997.
F-18
<PAGE> 21
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
7. INCOME TAXES (CONTINUED)
The provision for income taxes differs from the amount computed by applying the
statutory federal income tax rate of 34% to income before income taxes. The
differences are summarized as follows.
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Tax provision at statutory rate of 34% $ 295,458
State income tax less applicable federal tax benefit 18,850
Adjustment to eliminate S corporation earnings not
subject to federal or state income tax (126,178)
Other, net 1,935
-----------
$ 190,065
===========
</TABLE>
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
DH&A operates under Subchapter S of the Internal Revenue Code and is not subject
to corporate federal income tax. Had DH&A filed federal and state income tax
returns as a C corporation for 1997, income tax expense under the provisions of
SFAS No. 109 would have been approximately $139,000.
Effective September 18, 1998, DH&A entered into an Amended and Restated
Agreement and Plan of Merger with Service Experts, Inc. ("Service Experts"). As
a result, DH&A merged with and into Dodge which became a wholly-owned subsidiary
of Service Experts effective September 24, 1998, and the Subchapter S election
was terminated. DH&A was required to provide deferred taxes for cumulative
temporary differences between financial reporting and tax reporting basis of
assets and liabilities at the date of the termination of S corporation status.
The effect of recognizing the $198,000 net deferred tax liability was included
in income from continuing operations as of September 30, 1998.
F-19
<PAGE> 22
Dodge Heating and Air Conditioning, Inc. et al. and DH&A, Inc.
Notes to Combined Financial Statements (continued)
8. IMPACT OF YEAR 2000 (UNAUDITED)
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has completed an assessment and implemented a plan which will
include testing, modifying and replacing portions of its software so that its
computer systems will function properly with respect to dates in the Year 2000
and thereafter. According to management estimates, the total Year 2000 project
cost will not materially affect the operating results or the financial position
of the Company.
The planned project is estimated to be completed not later than June 30, 1999,
which is prior to any anticipated impact on its operating systems. The Company
believes that with modifications to existing software and conversions to new
software, the Year 2000 issue will not pose significant operational problems for
its computer systems. However, if such modifications and conversions are not
made or are not completed in a timely manner, the Year 2000 issue could have a
material effect on the operations of the Company.
If the steps taken by the Company and its material vendors and business
partners to be Year 2000 compliant are not successful, the Company would likely
experience various operational difficulties resulting in a material adverse
effect upon the Company's financial condition and results of operations. These
could include, among other things, processing transactions to an incorrect
accounting period, difficulties in posting general ledger entries and lapses of
service by vendors. If the Company's plan to install new systems which
effectively address the Year 2000 issue is not successfully or timely
implemented, the Company may need to devote more resources to the process and
additional costs may be incurred. The Company believes that the Year 2000 issue
is being appropriately addressed and does not expect the Year 2000 issue to have
a material adverse effect on the financial position, results of operations or
cash flows of the Company in future periods.
The Company currently does not have a contingency plan to address the failure of
the Company's IT or non-IT systems or the systems of material third parties to
be Year 2000 compliant. Should the remaining review of the Company's Year 2000
risks reveal potentially non-compliant computer systems or material third party
risks, contingency plans will be developed to address the deficiencies revealed
at that time.
9. SUBSEQUENT EVENT
Subsequent to year end, the Company signed an Amended and Restated Agreement and
Plan of Merger with Service Experts. In accordance with the Amended and Restated
Agreement and Plan of Merger, the Company became a wholly-owned subsidiary of
Service Experts effective September 24, 1998.
F-20
<PAGE> 23
Report of Independent Auditors
The Stockholder of
Climate Design Systems, Inc.
We have audited the accompanying balance sheet of Climate Design Systems, Inc.
as of December 31, 1997, and the related statements of income, stockholder's
equity, and cash flows for the year ended December 31, 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 Climate Design Systems, Inc.
at December 31, 1997, and the results of its operations and its cash flows for
the year ended December 31, 1997, in conformity with generally accepted
accounting principles.
/s/ Ernst & Young LLP
Nashville, Tennessee
October 30, 1998
F-21
<PAGE> 24
Climate Design Systems, Inc.
Balance Sheets
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1997 1998
----------- --------
(Unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash......................................................$ 20,214 $ 75,100
Accounts receivable:
Trade, net of allowance for doubtful accounts
of $10,000 at December 31, 1997 and June 30, 1998..... 1,840,162 1,508,466
Related party........................................... -- 29,273
Employee................................................ 2,471 6,781
---------- ----------
1,842,633 1,544,520
Inventories................................................. 99,385 125,871
Costs and estimated earnings in excess of billings.......... 16,818 52,776
Prepaid expenses and other current assets................... 19,678 14,743
---------- ----------
Total current assets........................................ 1,998,728 1,813,010
Property and equipment:
Furniture and fixtures.................................... 203,109 234,339
Machinery and equipment................................... 143,942 143,942
Vehicles.................................................. 340,849 438,946
Leasehold improvements.................................... 96,795 96,795
---------- ----------
784,695 914,022
Less accumulated depreciation and amortization............ (539,107) (574,303)
---------- ----------
245,588 339,719
---------- ----------
Total assets................................................$2,244,316 $2,152,729
========== ==========
LIABILITIES AND STOCKHOLDER'S EQUITY
Current liabilities:
Line of credit........................................... $ 505,000 $ 345,000
Trade accounts payable and accrued liabilities........... 570,808 626,314
Accrued compensation..................................... 16,148 33,477
Accrued warranties....................................... 11,000 11,000
Deferred revenue......................................... 39,400 40,000
Billings in excess of costs and estimated earnings....... 72,532 116,080
Current portion of long-term debt........................ 39,897 50,749
---------- ----------
Total current liabilities.................................. 1,254,785 1,222,620
Long-term debt, net of current portion..................... 16,533 70,685
Stockholder's equity:
Common stock, no par value, 500 shares
authorized, issued and outstanding..................... 31,852 31,852
Retained earnings........................................ 941,146 827,572
---------- ----------
Total stockholder's equity................................. 972,998 859,424
---------- ----------
Total liabilities and stockholder's equity................. $2,244,316 $2,152,729
========== ==========
</TABLE>
See accompanying notes.
F-22
<PAGE> 25
Climate Design Systems, Inc.
Statements of Income
<TABLE>
<CAPTION>
SIX MONTHS
YEAR ENDED ENDED
DECEMBER 31, JUNE 30,
1997 1998
------------ -----------
(Unaudited)
<S> <C> <C>
Net revenue......................................$7,189,258 $3,502,758
Cost of goods sold............................... 5,657,309 2,793,203
---------- ----------
Gross margin..................................... 1,531,949 709,555
Selling, general and administrative expenses..... 1,051,874 542,933
---------- ----------
Income from operations........................... 480,075 166,622
Other expense:
Interest expense............................... 56,107 16,236
---------- ----------
Net income.....................................$ 423,968 $ 150,386
========== ==========
</TABLE>
See accompanying notes.
F-23
<PAGE> 26
Climate Design Systems, Inc.
Statements of Stockholder's Equity
<TABLE>
<CAPTION>
Common Stock
No Par Value Retained
Shares Amount Earnings Total
-------------------------------------------
<S> <C> <C> <C> <C>
Balance at January 1, 1997 500 $31,852 $ 556,149 $ 588,001
Capital distributions -- -- (38,971) (38,971)
Net income -- -- 423,968 423,968
-------------------------------------------
Balance at December 31, 1997 500 31,852 941,146 972,998
Capital distributions (unaudited) -- -- (263,960) (263,960)
Net income (unaudited) -- -- 150,386 150,386
-------------------------------------------
Balance at June 30, 1998 (unaudited) 500 $31,852 $ 827,572 $ 859,424
===========================================
</TABLE>
See accompanying notes.
F-24
<PAGE> 27
Climate Design Systems, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
YEAR ENDED SIX MONTHS ENDED
DECEMBER 31, 1997 JUNE 30, 1998
-----------------------------------
(Unaudited)
<S> <C> <C>
OPERATING ACTIVITIES
Net income $ 423,968 $ 150,386
Adjustments to reconcile net income
to net cash provided by operating
activities
Depreciation and amortization 79,793 35,196
Changes in assets and liabilities
Accounts receivable (204,948) 298,113
Inventories 727 (26,486)
Prepaid expenses and other current
assets 50,708 4,935
Trade accounts payable and accrued
liabilities (66,873) 55,506
Accrued compensation 596 17,329
Deferred revenue -- 600
Costs and estimated earnings in excess
of billings and billings in excess
of costs and estimated earnings 52,175 7,590
-----------------------------
Net cash flow provided by
operating activities 336,146 543,169
INVESTING ACTIVITIES
Purchase of property equipment (40,235) (129,327)
-----------------------------
Net cash used in investing activities (40,235) (129,327)
FINANCING ACTIVITIES
Line of Credit Advances 405,000 240,000
Line of Credit Payments (620,000) (400,000)
Distribution to stockholders (38,971) (263,960)
Payments on long-term debt (53,731) (27,176)
Proceeds from long-term debt 22,576 92,180
-----------------------------
Net cash used in financing
activities (285,126) (358,956)
Increase in cash 10,785 54,886
-----------------------------
Cash at beginning of period 9,429 20,214
Cash at end of period $ 20,214 $ 75,100
=============================
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 56,110 $ 16,236
=============================
</TABLE>
See accompanying notes.
F-25
<PAGE> 28
Climate Design Systems, Inc.
Notes to Financial Statements
December 31, 1997
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Climate Design Systems, 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 states of
Massachusetts and New Hampshire.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The balance sheet as of June 30, 1998 and the related statements of income,
stockholder's equity, and cash flows for the six months then ended (interim
financial statements) have been prepared by the Company's management and are
unaudited. The interim financial statements include all adjustments, consisting
of only normal recurring adjustments, necessary for a fair presentation of the
interim results.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted from the interim financial statements. The
interim financial statements should be read in conjunction with the December
31, 1997 audited financial statements appearing herein. The results of the six
months ended June 30, 1998 may not be indicative of operating results for the
full year.
RECOGNITION OF REVENUE
Revenue 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. Revenue on all of the Company's Contracts for residential
installation and service and maintenance revenue are recognized upon completion
of the services, which is usually within one to two days.
F-26
<PAGE> 29
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RECOGNITION OF REVENUE (CONTINUED)
Earnings and estimated costs on Contracts are reviewed throughout the terms of
the Contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most Contracts are completed within three to 24 months.
Trade accounts receivable includes billings and billed retainage on Contracts.
Trade accounts receivable also includes unbilled retainage of
approximately $424,000 at December 31, 1997. The Company classifies these
amounts as current assets because all balances are expected to be collected in
the current year.
The asset, "cost and estimated earnings in excess of billings", represents
revenue recognized in excess of amounts billed on in-progress Contracts. The
liability, "billings in excess of costs and estimated earnings", represents
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 approximate fair
value.
Accounts Receivable, Notes Payable, Accounts Payable and Accrued Liabilities.
The carrying amounts reported in the balance sheet for accounts receivable,
notes payable, accounts payable and accrued liabilities approximate fair value.
Accounts receivable are generally unsecured.
F-27
<PAGE> 30
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
CONCENTRATIONS OF CREDIT
At times, cash balances in the Company's accounts may exceed FDIC insurance
limits.
The Company had trade receivable concentrations of $1,138,000 at December 31,
1997 from two significant customers. This amount represents 62% of trade
accounts receivable at December 31, 1997. Sales to these customers were
approximately $3,505,000 or 49% of revenue for 1997.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended December 31, 1997, amounts charged to bad debt expense
totaled approximately $18,000 and net recoveries were approximately $23,000.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out ("FIFO") method for all inventories.
F-28
<PAGE> 31
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (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 7
Machinery and equipment 5-7
Vehicles 5
Leasehold improvements 10-20
</TABLE>
LONG-LIVED ASSETS
Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for
the Impairment of Long-lived Assets and for Long-lived Assets to be Disposed Of"
requires that companies consider whether indicators of impairment of long-lived
assets held for use are present. If such indicators are present, companies
determine whether the sum of the estimated undiscounted future cash flows
attributable to such assets is less than their carrying amount, and if so,
companies recognize an impairment loss based on the excess of the carrying
amount of the assets over their fair value. Accordingly, management periodically
evaluates the ongoing value of property, buildings and equipment and has
determined that there were no indications of impairment as of December 31, 1997.
F-29
<PAGE> 32
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 the service is performed.
WARRANTIES
The Company generally provides the customer with a one year warranty on labor
from the date of installation of the heating and air conditioning unit. This
warranty runs concurrent with the manufacturer's warranty on parts. 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 stockholder of the Company has elected under Subchapter S of the Internal
Revenue Code to include the Company's income in his own income for federal
income tax purposes. Accordingly, the Company is not subject to federal income
tax.
F-30
<PAGE> 33
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1997, the Company
expensed approximately $91,000.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued SFAS No. 130, "Reporting Comprehensive Income."
SFAS No. 130 establishes standards for reporting and displaying comprehensive
income and its components in a full set of general purpose financial statements.
SFAS No. 130 is effective for interim and annual periods beginning after
December 15, 1997. Comprehensive income encompasses all changes in stockholders'
equity (except those arising from transactions from owners) and includes net
income, net unrealized capital gains or losses on available for sale securities
and foreign currency translation adjustments. The adoption of SFAS No. 130 in
1998 did not have an impact on the Company's financial statements.
F-31
<PAGE> 34
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contracts $ 2,654,521
Estimated earnings 759,910
-----------
3,414,431
Less applicable billings (3,470,145)
-----------
$ (55,714)
===========
Included in the accompanying balance sheet under
the following captions:
Costs and estimated earnings in excess of
billings on uncompleted contracts $ 16,818
Billings in excess of costs and estimated
earnings on uncompleted contracts (72,532)
-----------
$ (55,714)
===========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are not
indicative of the ultimate profit or loss on a contract.
F-32
<PAGE> 35
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
3. DEBT
Debt consists of:
<TABLE>
<CAPTION>
DECEMBER 31,
1997
------------
<S> <C>
Line of credit $505,000
Installment and equipment notes 56,430
--------
561,430
Less current portion 544,897
--------
$ 16,533
========
</TABLE>
The Company has a line of credit with a financial institution with a total
borrowing limit of $1,000,000. The line of credit bears interest at a rate of
prime plus one, which was 9.25% at December 31, 1997. The line of credit is
renewed annually. The line is secured by the assets of the Company and a
personal guarantee of the sole stockholder.
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 2.9% to 12.0% per annum at December 31, 1997. These
loans require monthly payments ranging from $333 to $925 and are due through
November 2000.
F-33
<PAGE> 36
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
3. DEBT (CONTINUED)
As of December 31, 1997, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<CAPTION>
<S> <C>
1998 $39,897
1999 10,875
2000 5,658
-------
$56,430
=======
</TABLE>
F-34
<PAGE> 37
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
5. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code. Substantially all
employees of the Company are eligible to participate in the plan. Under the
plan's provisions, a plan member may make contributions, on a tax deferred
basis, not to exceed the maximum established by the Internal Revenue Service. No
matching contributions are made by the Company.
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.
F-35
<PAGE> 38
Climate Design Systems, Inc.
Notes to Financial Statements (continued)
7. INCOME TAXES (CONTINUED)
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
The Company operates under Subchapter S of the Internal Revenue Code and is not
subject to corporate federal income tax. In connection with the proposed
business combination, the Subchapter S election will be terminated. As a result,
the Company will be subject to corporate income taxes subsequent to the
termination of S corporation status. The Company had taxable income for income
tax purposes of $416,000 for 1997. Had the Company filed federal and state
income tax returns as a regular corporation for 1997, income tax expense under
the provisions of SFAS No. 109 would have been $168,000.
At the date of termination of S corporation status, the Company will be required
to provide deferred taxes for cumulative temporary differences between financial
reporting and tax reporting basis of assets and liabilities. Such deferred taxes
will be based on the cumulative temporary differences at the date of termination
of S corporation status. The effect of recognizing the deferred taxes will be
recorded as an adjustment to goodwill in purchase accounting. If the termination
of S corporation status had occurred at June 30, 1998, the deferred tax
liability would have been approximately $24,000.
F-36
<PAGE> 39
CLIMATE DESIGN SYSTEMS, INC.
Notes to Financial Statements (continued)
8. RELATED PARTY TRANSACTIONS
The Company leases its facility from its stockholder on a month-to-month
basis. Rental payments of $48,000 related to this lease were made in the year
ended December 31, 1997.
IMPACT OF YEAR 2000 (UNAUDITED)
The Year 2000 issue is the result of computer programs being written using two
digits rather than four to define the applicable year. Any of the Company's
computer programs that have time sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, send invoices, or
engage in similar normal business activities.
The Company has completed an assessment and implemented a plan which will
include testing, modifying and replacing portions of its software so that its
computer systems will function properly with respect to dates in the Year 2000
and thereafter. According to management estimates, the total Year 2000 project
cost will not materially affect the operating results or the financial positions
of the Company.
The planned project is estimated to be completed not later than June 30, 1999,
which is prior to any anticipated impact on its operating systems. The Company
believes that with modifications to existing software and conversions to new
software, the Year 2000 issue will not pose significant operational problems for
its computer systems. However, if such modifications and conversions are not
made or are not completed in a timely manner, the Year 2000 issue could have a
material effect on the operations of the Company.
If the steps taken by the Company and its material vendors and business
partners to be Year 2000 compliant are not successful, the Company would likely
experience various operational difficulties resulting in a material adverse
effect upon the Company's financial condition and results of operations. These
could include, among other things, processing transactions to an incorrect
accounting period, difficulties in posting general ledger entries and lapses
of service by vendors. If the Company's plan to install new systems which
effectively address the Year 2000 issue is not successfully or timely
implemented, the Company may need to devote more resources to the process and
additional costs may be incurred. The Company believes that the Year 2000 issue
is being appropriately addressed and does not expect the Year 2000 issue to
have a material adverse effect on the financial position, results of operations
or cash flows of the Company in future periods.
The Company currently does not have a contingency plan to address the failure
of the Company's systems of material third parties to be Year 2000 compliant.
Should the remaining review of the Company's Year 2000 risks reveal potentially
non-compliant computer systems or material third party risks, contingency plans
will be developed to address the deficiencies revealed at that time.
9. SUBSEQUENT EVENT
Subsequent to year end, the Company signed an Agreement and Plan of Merger with
Service Experts, Inc. ("Service Experts"). In accordance with the Agreement and
Plan of Merger, the Company became a wholly-owned subsidiary of Service Experts
effective September 18, 1998.
In connection with the business combination of the Company with Service
Experts, Service Experts paid all notes payable outstanding.
F-37
<PAGE> 40
PRO FORMA COMBINED FINANCIAL STATEMENTS OF
SERVICE EXPERTS, INC.
Service Experts, Inc. (the "Company") was incorporated on March 27, 1996.
The Company operates in one industry segment and is primarily engaged in the
replacement and servicing of HVAC units for residential and commercial
customers. The Company has Service Centers located in cities across the United
States. The operations of the Company's subsidiaries other than Pooled Companies
(as defined below) have been included in the Company's financial statements from
their respective effective dates of acquisition. The Company's historical
financial statements have been restated for all periods presented by including
the historical results of the 1997 Pooled Companies and the 1998 Pooled Company
(see Table I).
The following unaudited pro forma combined financial statements give effect
to the acquisition by the Company of 34 Acquired Companies (as defined below)
in exchange for shares of the Company's Common Stock, cash, warrants to purchase
shares of Common Stock, convertible subordinated notes and the assumption of
certain debt.
The unaudited pro forma combined balance sheet as of September 30, 1998
gives effect to the acquisition of eight Acquired Companies closed effective
after September 30, 1998 (see Table I). The unaudited pro forma combined
statement of income for the nine months ended September 30, 1998 gives effect to
the acquisition of 26 Acquired Companies closed effective during the nine month
period ended September 30, 1998 (see Table I), and the eight Acquired Companies
which were closed effective after September 30, 1998 as if such transactions had
occurred as of January 1, 1998. The unaudited pro forma combined statement of
income for the 12 months ended December 31, 1997 gives effect to the acquisition
of the 1997 and 1998 Pooled Companies as described below, 32 Acquired Companies
closed during 1997 (see Table I), the 26 Acquired Companies closed effective
during the nine month period ended September 30, 1998 and the eight Acquired
Companies closed effective after September 30, 1998 as if such transactions had
occurred on January 1, 1997.
TABLE I
The 1997 Pooled Companies
*1. C. Iapaluccio, Company, Inc.
2. Hawk Heating & Air Conditioning, Inc.
*3. TML, Inc.
*4. Parrott Mechanical, Inc.
5. McAlister Heat & Air, Inc.
The 1998 Pooled Company
*1. Dodge Heating and Air Conditioning, Inc., et al. and
DH&A, Inc.
Eight Acquired Companies closed subsequent to September 30, 1998
*1. Climate Design Systems, Inc.
2. Eveready Corporation
3. Austin Brothers, Inc.
4. Womack - O'Bannon, Inc.
5. Womack - O'Bannon & Choco, Inc.
6. Ben Peer Heating, Inc.
*7. PTM Enterprises, Inc.
8. Jansen's Heating & Air Conditioning, Inc.
26 Acquired Companies closed during the nine month period ended
September 30, 1998
1. Gulf Coast Cooling, Inc.
2. Jack Nelson Co., Inc.
3. Dan Jacobs Heating & Cooling, Inc.
4. Becht Heating & Cooling, Inc.
*5. Davis the Plumber, Inc.
6. Lee Voisard Plumbing & Heating, Inc.
7. Climate Control, Inc.
8. Triton Mechanical, Inc.
9. Strand Brothers, Inc.
10. Astron Residential, Inc.
11. Doler Plumbing & Heating, Inc.
12. Atlantic Air Conditioning and Heating, Inc.
*13. Steel City Heating & Air, Inc.
14. Deland Heating & Air Conditioning Company
15. Kozon, Inc.
16. Royden Commercial Services, Inc.
17. Albritten Plumbing Heating and Air Conditioning, Inc.
18. Alert Heating Service, Inc.
19. Russell Mechanical, Inc.
20. Andros Refrigeration, Inc.
21. Epperson, Inc.
22. Midland Heating & Air Conditioning, Inc.
23. Economy Heating and Air Conditioning, Inc.
24. Mathews Acquisition Sub, Inc.
25. Matz Sheet Metal Works, Inc.
26. Warshaw Acquisition Sub, Inc.
32 Acquired Companies closed during 1997
*1. B.W. Heating & Cooling, Inc.
*2. Chief/Bauer Heating & Air Conditioning, Inc.
*3. Gaddis Co.
*4. Dial One Raymond Plumbing, Heating & Cooling, Inc.
*5. Parker Heating & Air Conditioning Incorporated
*6. Sylvester Corp.
*7. Roland J. Down, Inc.
*8. Stark Services Company, Inc.
*9. Claire's Air Conditioning and Refrigeration, Inc.
*10. Claire & Sanders, Inc.
*11. Piedmont Air Conditioning Company
12. Royden, Inc.
13. Superior Air Conditioning, Inc.
*14. ProAir Services, Inc.
*15. Artic Aire of Chico, Inc.
16. A-1 Air Conditioning, Inc.
*17. Mid Fla Heating & Air, Inc.
18. All American Air Conditioning & Heating, Inc.
19. The McElroy Service Company
20. Bill Ingraham Service Company, Inc.
*21. S & W Conditioning, Inc.
*22. Berkshire Air Conditioning Company
*23. J.M. Jenks Incorporated
*24. Teays Valley Heating and Cooling, Inc.
25. Ainsley & Son Heating, Inc.
26. Knochelmann, Inc.
27. Stanley Heating and Air Conditioning, Inc.
28. George B. Givens Company, Inc.
*29. Holmes Sales & Service, Inc.
*30. Getzschman Heating & Sheet Metal Contractors
31. Thompson and Sons Heating and Air Conditioning Company
32. Air Experts, Inc.
* Indicates that audited financial statements for the Acquired Companies
previously have been filed in a Form 8-K or Form S-4 and these Acquired
Companies have been included in the pro forma financial statements of the
Company.
F-38
<PAGE> 41
The unaudited pro forma combined financial statements have been prepared by
the Company based on the historical financial statements of the Company and of
the companies referred to in Table I and certain preliminary estimates and
assumptions deemed appropriate by management of the Company. The pro forma
combined financial statements presented herein have been prepared based on
certain assumptions and include certain pro forma adjustments. The Company has
not completed all the evaluations necessary for the final purchase price
allocations related to certain of the acquired businesses; accordingly, actual
adjustments that reflect final evaluations of the purchased assets and assumed
liabilities may differ from the pro forma adjustments reflected herein.
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.
The pro forma combined financial statements should be read in conjunction
with the historical financial statements of the Company.
F-39
<PAGE> 42
Pro Forma Combined Financial Statements of Service Experts, Inc.
Unaudited Pro Forma Combined Balance Sheet
September 30, 1998
<TABLE>
<CAPTION>
Acquired Pro Forma Pro Forma
Company Companies Adjustments As Adjusted
-------------------------------------------------------------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Assets
Current assets:
Cash and cash equivalents............ $ 6,024 $ 1,347 $ (6,887) (a) $ 6
(478) (b)
Receivables:
Trade Receivables, net............. 46,454 2,271 -- 48,725
Related Party...................... 340 -- -- 340
Employee........................... 533 48 -- 581
Other.............................. 4,999 1 -- 5,000
------------ ------------- -------------- -------------
52,326 2,320 -- 54,646
Inventories 25,594 884 -- 26,478
Cost and estimated earnings in exce 4,885 17 -- 4,902
Prepaid expenses and other current assets 5,675 89 -- 5,764
Current portion of notes receivable --
related parties................... 14 -- -- 14
Current portion of notes receivable 177 -- -- 177
Deferred income taxes 3,972 -- -- 3,972
------------ ------------- -------------- ------------
Total current assets..... 98,667 4,657 (7,365) 95,959
Property, buildings and equipment, net 34,940 1,606 -- 36,546
Notes receivable--related parties........ 334 2 -- 336
Notes receivable--other.................. 567 -- -- 567
Goodwill................................. 169,766 1,227 10,674 (a) 181,667
Unallocated purchase price............... -- -- --
Other assets............................. 6,889 418 -- 7,307
------------ -------------- -------------- ------------
Total assets $ 311,163 $ 7,910 $ 3,309 $ 322,382
============ ============== ============== ============
Liabilities and Stockholders Equity
Current liabilities:
Trade accounts payable & accrued..... $ 16,292 $ 2,911 $ -- $ 19,203
Accrued compensation................. 8,287 26 -- 8,313
Accrued warranties................... 3,260 193 -- 3,453
Income taxes payable................. 1,118 10 -- 1,128
Deferred revenue..................... 10,295 459 -- 10,754
Deferred income taxes................ 80 5 -- 85
Billings in excess of costs and 1,663 -- -- 1,663
Current portion of long-term debt.... 274 87 (87) (b) 274
------------ ------------- --------------- -----------
Total current liabilities: 41,269 3,691 (87) 44,873
Long-term debt, and capital lease
obligations, net of current.......... 73,302 391 967 (a) 74,269
(391) (b)
Deferred income taxes.................... 1,875 -- -- 1,875
Common stock......................... 171 615 (612) (a) 174
Additional paid-in-capital........... 155,424 181 6,464 (a) 162,069
Retained earnings.................... 39,122 3,032 (3,032) (a) 39,122
----------- -------------- --------------- -----------
194,717 3,828 2,820 201,365
----------- -------------- --------------- -----------
$ 311,163 $ 7,910 $ 3,309 $ 322,382
=========== ============== =============== ===========
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-40
<PAGE> 43
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
<TABLE>
<CAPTION>
ACQUIRED PRO FORMA PRO FORMA
COMPANY COMPANIES ADJUSTMENTS ADJUSTED
----------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net Revenue.................................... $ 293,604 $ 42,277 -- $ 335,881
Cost of goods sold ............................ 188,083 24,487 -- 212,570
---------- --------- ------- ----------
Gross margin .................................. 105,521 17,790 -- 123,311
Selling, general and administrative ........... 73,660 14,562 (1,225) (c) 86,997
---------- --------- ------- ----------
Income from operations ........................ 31,861 3,228 1,225 36,314
Other income (expense):
Interest expense ............................ (2,395) (170) 129 (d) (2,436)
Interest income ............................. 355 69 -- 424
Other income ................................ 483 427 -- 910
---------- --------- ------- ----------
(1,557) 326 129 (1,102)
---------- --------- ------- ----------
Income before taxes ........................... 30,304 3,554 1,354 35,212
Provision for income taxes .................... 12,141 1,979 107 (e) 14,227
---------- --------- ------- ----------
Net income .................................... $ 18,163 $ 1,575 $1,247 $ 20,985
========== ========= ======= ==========
Pro forma net income per share:
Basic ....................................... $ 1.09 $ 1.21
Diluted ..................................... $ 1.07 $ 1.19
Pro forma weighted average shares outstanding:
Basic ....................................... 16,684 672 (f) 17,356
Diluted ..................................... 16,922 674 (g) 17,596
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements.
F-41
<PAGE> 44
PRO FORMA COMBINED FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC.
UNAUDITED PRO FORMA COMBINED STATEMENT OF INCOME
FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1997
<TABLE>
<CAPTION>
Acquired Pro Forma Pro Forma
Company Companies Adjustments Adjusted
-------- --------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net Revenue......................... $248,110 $152,128 $ -- $400,238
Cost of goods sold.................. 161,281 93,859 -- 255,140
-------- -------- -------- --------
Gross margin........................ 86,829 58,269 -- 145,098
Selling, general and administrative. 62,103 49,195 (1,637)(c) 109,661
-------- -------- -------- --------
Income from operations.............. 24,726 9,074 1,637 35,437
Other income (expense):
Interest expense.................. (772) (811) 757 (d) (826)
Interest income................... 793 127 -- 920
Other income...................... 578 520 -- 1,098
-------- -------- -------- --------
.................................... 599 (164) 757 1,192
-------- -------- -------- --------
Income before taxes................. 25,325 8,910 2,394 36,629
Provision for income taxes.......... 9,380 4,571 230 (e) 14,181
-------- -------- -------- --------
Net income.......................... $ 15,945 $ 4,339 $ 2,164 $ 22,448
======== ======== ======== ========
Pro forma net income per share:
Basic............................. $ 1.08 $ 1.34
Diluted........................... $ 1.07 $ 1.32
Pro forma weighted average shares
outstanding:
Basic............................. 14,774 2,029 (h) 16,803
Diluted........................... 14,922 2,070 (i) 16,992
</TABLE>
See accompanying notes to Unaudited Pro Forma Combined Financial Statements
F-42
<PAGE> 45
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 eight Acquired Companies of
$6,887,000 in cash, 734,000 shares of Common Stock and $967,000 in convertible
debt resulting in an increase in Goodwill of $10,674,000 which is amortized over
40 years. The allocation of the purchase price associated with the acquisitions
has been determined by the Company based on available information and is subject
to further refinement.
(b) Reflects the assumed payment of all acquired outstanding debt.
<TABLE>
<CAPTION>
TWELVE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
(IN THOUSANDS)
<S> <C> <C>
PRO FORMA STATEMENTS OF INCOME ADJUSTMENTS
(c) REFLECTS THE FOLLOWING ADJUSTMENTS TO SELLING, GENERAL, AND
ADMINISTRATIVE:
(i) Elimination of historical owners' compensation.............. $ (8,824) $ (2,824)
(ii) Additional compensation relating to new agreements with
previous owners............................................. 5,338 1,671
(iii) Adjust rent expense per new leases.......................... (51) (4)
(iv) Corporate office overhead expenses.......................... 1,521 423
(v) Goodwill amortization....................................... 2,212 567
(vi) Elimination of general and administrative expenses.......... (1,833) (1,058)
-------- --------
$ (1,637) $ (1,225)
======== ========
</TABLE>
F-43
<PAGE> 46
SERVICE EXPERTS, INC.
PRO FORMA COMBINED FINANCIAL STATEMENTS
NOTES TO UNAUDITED PRO FORMA COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
TWELVE MONTHS NINE MONTHS
ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
1997 1998
------------- -------------
(IN THOUSANDS)
<C> <S> <C> <C>
(d) REFLECTS THE FOLLOWING ADJUSTMENTS TO INTEREST EXPENSE RELATED TO:
(i) Elimination of all other debt assumed in the transaction to
be paid at closing.......................................... $ 811 $ 170
(ii) Additional interest on debt incurred with transaction....... (54) (41)
-------- --------
$ 757 $ 129
======== ========
(e) REFLECTS THE FOLLOWING ADJUSTMENTS TO INCOME TAXES:
(i) Additional income tax provision for state and federal taxes
at a combined effective rate of 40% as certain Acquired
Companies previously which were taxed as
Subchapter S corporations......... ......................... $ (1,007) $ (558)
(ii) Additional income taxes on adjustments (c) and (d).......... 352 438
(iii) Additional income tax provision for state and federal taxes
due to the non-deductibility of goodwill.................... 885 227
-------- --------
$ 230 $ 107
======== ========
(f) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 672,000 shares issued to the owners of the Acquired
Companies.
(g) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 672,000 shares issued to the owners of the Acquired
Companies.
(ii) 2,000 shares representing dilutive effect of warrants
issued to the owners of the Acquired Companies.
(h) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 2,029,000 shares issued to the owners of the Acquired
Companies.
(i) Reflects adjustments to weighted average shares outstanding as
follows:
(i) 2,029,000 shares issued to the owners of the Acquired
Companies.
(ii) 41,000 shares representing dilutive effect of warrants
issued to the owners of the Acquired Companies.
</TABLE>
F-44
<PAGE> 47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
----------------------------------
Anthony M. Schofield
Chief Financial Officer, Secretary
and Treasurer
Date: November 19, 1998
<PAGE> 48
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C>
23 Consent of Ernst & Young LLP
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Post-Effective Amendment No.
6 to the Registration Statement (Form S-4 No. 333-12319) and related Prospectus
of Service Experts, Inc. related to $50,000,000 aggregate amount of shares of
its $.01 par value common stock, warrants to purchase its common stock ("Common
Stock Warrants") and the shares of its common stock issued thereunder upon the
exercise of such Common Stock Warrants or debt securities ("Debt Securities"),
and the shares of common stock issued thereunder upon the conversion thereof; in
the Shelf Registration Statement on Form S-3 (No. 333-43917) and related
Prospectus pertaining to the resale of up to 500,000 shares of the Company's
Common Stock issued without registration under the Securities Act of 1933; in
the Registration Statement on Form S-8 (No. 333-11791) pertaining to the Service
Experts, Inc. 1996 Incentive Stock Plan, 1996 Non-Employee Director Stock
Option Plan, and 1996 Employee Stock Purchase Plan; in the Registration
Statement on Form S-8 (No. 333-59711) pertaining to the Service Experts, Inc.
Amended 1996 Incentive Stock Plan, Amended 1996 Employee Stock Purchase Plan,
1997 Nonqualified Stock Option Plan, Amended 1997 Nonqualified Stock Purchase
Plan and Amended Service Center Stock Option Plan; of our report dated October
23, 1998 with respect to the combined financial statements of Dodge Heating and
Air Conditioning, Inc. et al. and DH&A, Inc. and of our report dated October 30,
1998 with respect to financial statements of Climate Design Systems, Inc.
included in this Current Report on Form 8-K dated November 19, 1998, filed with
the Securities and Exchange Commission.
/s/ Ernst & Young LLP
Nashville, Tennessee
November 19, 1998
