<PAGE> 1
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): January 8, 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>
111 Westwood Place
Suite 420
Brentwood, Tennessee 37027
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(Address of principal executive offices) (Zip Code)
(615) 371-9990
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(Registrant's telephone number, including area code)
Not Applicable
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(Former name or former address, if changed since last report)
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<PAGE> 2
ITEM 5. OTHER EVENTS.
Service Experts, Inc., a Delaware corporation (the "Company"), operates
residential heating, ventilating and air conditioning ("HVAC") service and
replacement equipment businesses. In May 1997 and September 1997, the Company
completed business combinations (the "Business Combinations") with C. Iapaluccio
Company, Inc., Hawk Heating & Air Conditioning, Inc., TML, Inc. and MT
Partnership, Parrott Mechanical, Inc., including real property operations used
by the company ("Parrott Mechanical et al.") and McAlister Heat & Air, Inc.
(collectively, the "1997 Pooled Companies") through the exchange of 92,553,
34,426, 240,526, 171,230 and 32,786 shares, respectively, of the Company's
Common Stock, $.01 par value per share (the "Common Stock").
For accounting purposes, the Business Combinations have been treated as
poolings of interests. Accordingly, the accompanying selected consolidated
financial data, management's discussion and analysis of financial condition and
results of operations and consolidated financial statements give retroactive
effect to the Business Combinations and include the combined operations of the
Company and the 1997 Pooled Companies for all periods presented. In addition,
the historical financial information related to Parrott Mechanical et al. for
the year ended September 30, 1996 (which prior to the business combination was
reported on a fiscal year ending September 30) has been recast to conform to the
Company's annual reporting period ending December 31, 1996.
In order to comply with the disclosure requirements of the Securities and
Exchange Commission (the "Commission") regarding the financial statements of
businesses acquired or to be acquired, the Company is filing this Current Report
containing the following audited financial statements of Parrott Mechanical et
al. Pro forma financial statements giving effect to the acquisition of Parrott
Mechanical et al. have previously been filed with the Commission by the Company
on Form 8-K.
Set forth below is an index of the information presented in this Current
Report:
(a) Selected Consolidated Financial Data. See Page 2.
(b) Management's Discussion and Analysis of Financial Condition and Results
of Operations. See Pages 3 through 6.
(c) Ratio of Earnings to Fixed charges. See Page 7.
(d) Consolidated Financial Statements of Service Experts, Inc. See Pages
F-1 through F-21.
(e) Financial Statements of Parrott Mechanical et al. See Pages F-22
through F-32.
1
<PAGE> 3
SERVICE EXPERTS, INC.
SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial data of the
Company. The Company was incorporated on March 27, 1996. On August 21, 1996 and
simultaneously with the closing of the Company's initial public offering of its
Common Stock (the "IPO"), the Company acquired 12 HVAC companies and Contractor
Success Group, Inc. (collectively, the "Predecessor Companies") in exchange for
shares of Common Stock and cash (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 the
Commission's 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 the Pooled Companies (as defined
below), which were acquired effective December 1996, May 1997 and September 1997
in business combinations accounted for as poolings of interests, and the
operations of all other companies acquired by the Company (collectively, the
"Acquired Companies") are included from their respective effective dates of
acquisition. The Pooled Companies are Custom Air Conditioning, Inc., Freschi Air
Systems, Inc., C. Iapaluccio Company, Inc., Parrott Mechanical et al., TML, Inc.
and MT Partnership, Hawk Heating & Air Conditioning, Inc. and McAlister Heat &
Air, Inc. The following should be read with the historical consolidated
financial statements and notes thereto appearing elsewhere herein.
The selected consolidated financial data for the fiscal years ended
December 31, 1994, 1995 and 1996 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 years ended December 31, 1992 and 1993 have been
derived from unaudited financial statements not included herein. 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 consolidated financial position and consolidated results of operations
for the periods presented.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Net revenue.............................. $29,430 $35,151 $47,545 $49,748 $74,913
Cost of goods sold....................... 21,159 26,934 36,369 38,227 52,628
------- ------- ------- ------- -------
Gross margin............................. 8,271 8,217 11,176 11,521 22,285
Selling, general and administrative
expenses............................... 7,424 7,716 9,240 11,185 17,384
------- ------- ------- ------- -------
Income from operations................... 847 501 1,936 336 4,901
Other income (expense)................... 101 (59) (199) (359) (26)
------- ------- ------- ------- -------
Income (loss) before tax................. 948 442 1,737 (23) 4,875
Provision for income tax expense......... 149 46 251 146 1,136
------- ------- ------- ------- -------
Net income (loss)........................ $ 799 $ 396 $ 1,486 $ (169) $ 3,739
======= ======= ======= ======= =======
Net income (loss) per share.............. $ .37 $ .19 $ .70 $ (.08) $ .74
Weighted average shares outstanding...... 2,132 2,132 2,132 2,132 5,022
Ratio of earnings to fixed charges....... 8.41x 2.69x 5.92x (1) 7.03x
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------------------------------
1992 1993 1994 1995 1996
------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital.......................... $ 2,579 $ 2,025 $ 1,460 $ 395 $12,878
Total assets............................. 8,351 10,778 13,522 16,833 80,170
Total debt............................... 2,724 3,715 3,603 7,614 6,083
Stockholders' equity..................... 3,183 3,177 3,886 3,321 55,319
</TABLE>
- ---------------
(1) Earnings are inadequate to cover fixed charges for the year ended December
31, 1995. The coverage deficiency was $23,000.
2
<PAGE> 4
SERVICE EXPERTS, INC.
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, including the
Notes thereto.
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 $105.1 million and contributed
operating income of approximately $9.8 million.
Since the IPO, the Company has acquired 49 Service Centers. The
consideration paid by the Company for the Acquired Companies was approximately
$141.8 million, consisting of approximately 5.0 million shares of Common Stock,
warrants to purchase 200,000 shares of Common Stock and approximately $43.8
million in cash. Seven 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 $94.1 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 Acquired Companies 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 Acquired
Companies have agreed to certain reductions in their compensation in connection
with the acquisitions.
COMPONENTS OF INCOME
Net revenue of the Acquired Companies 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 pending acquisitions on the
Company's results of operations, the Company's historical
3
<PAGE> 5
results of operations and period-to-period comparisons will not be indicative of
future results and may not be meaningful. The Company plans to continue
acquiring Service Centers in the future. The integration of acquired Service
Centers and the addition of management personnel to support existing and future
acquisitions may positively or negatively affect the Company's results of
operations during the period immediately following acquisition.
The following table sets forth certain selected financial data as a
percentage of net revenue for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
Net revenue................................................. 100.0% 100.0% 100.0%
Cost of goods sold.......................................... 76.5 76.8 70.3
----- ----- -----
Gross margin................................................ 23.5 23.2 29.7
Selling, general and administrative expenses................ 19.4 22.5 23.2
----- ----- -----
Income from operations...................................... 4.1 0.7 6.5
===== ===== =====
</TABLE>
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Net Revenue. Net revenue increased $25.2 million, or 50.6%, from $49.7
million for the year ended December 31, 1995 to $74.9 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 $14.4 million, or 37.7%,
from $38.2 million for the year ended December 31, 1995 to $52.6 million for the
year ended December 31, 1996. As a percentage of net revenue, cost of goods sold
decreased from 76.3% for the year ended December 31, 1995 to 70.3% for the year
ended December 31, 1996. 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 $10.8 million, or 93.4%, from $11.5
million for the year ended December 31, 1995 to $22.3 million for the year ended
December 31, 1996. As a percentage of net revenue, gross margin increased from
23.2% for the year ended December 31, 1995 to 29.7% 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 $6.2 million, or 55.4%, from $11.2 million for
the year ended December 31, 1995 to $17.4 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 increased from 22.5% for the
year ended December 31, 1995 to 23.2% for the year ended December 31, 1996.
Income from Operations. Income from operations increased $4.6 million, or
1,358.6%, from $0.3 million for the year ended December 31, 1995 to $4.9 million
for the year ended December 31, 1996. Income from operations as a percentage of
net revenue increased from 0.7% in the 1995 period to 6.5% in the 1996 period.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Net Revenue. Net revenue increased $2.2 million, or 4.6%, from $47.5
million in 1994 to $49.7 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 $1.9 million, or 5.1%,
from $36.4 million in 1994 to $38.2 million in 1995. As a percentage of net
revenue, cost of goods sold increased from 76.5% in 1994 to 76.8% in 1995. The
increase as a percentage of net revenue was primarily attributable to an
increased volume of less profitable products.
4
<PAGE> 6
Gross Margin. Gross margin increased $0.3 million, or 3.1%, from $11.2
million for the year ended December 31, 1994 to $11.5 million for the year ended
December 31, 1995. As a percentage of net revenue, gross margin decreased from
23.5% for the year ended December 31, 1994 to 23.2% for the year ended December
31, 1995. The decrease as a percentage of net revenue was primarily attributable
to an increased volume of less profitable products.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $1.9 million, or 21.0%, from $9.2 million in
1994 to $11.2 million in 1995. As a percentage of net revenue, selling, general
and administrative expenses increased from 19.4% in 1994 to 22.5% in 1995. The
increase as a percentage of net revenue was primarily attributable to increased
labor costs added to support recent growth.
Income from Operations. Income from operations decreased $1.6 million, or
82.6%, from $1.9 million in 1994 to $0.3 million in 1995. As a percentage of net
revenue, income from operations decreased from 4.1% in 1994 to 0.7% in 1995.
LIQUIDITY AND CAPITAL RESOURCES
The Company's principal capital needs arise from the acquisition of new
HVAC businesses and the costs associated with such expansion. Cash used in
investing activities was primarily attributable to the acquisition of HVAC
businesses.
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 favorable target businesses and to negotiate favorable acquisition
terms, the availability of adequate financing and other factors, many of which
are beyond the control of the Company. In addition, there can be no assurance
that the Company will be successful in identifying and acquiring Service
Centers, 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 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 replacement and service businesses.
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 used the proceeds for planned capital expenditures,
acquisitions and general corporate purposes.
The Company has a $50 million unsecured revolving credit facility with a
banking syndication available through September 3, 1999 (the "Credit Facility").
Borrowings under the Credit Facility bear interest at either (i) the higher of
(x) the agent's base lending rate and (y) the federal funds rate plus one-half
of one percent per annum or (ii) a variable rate equal to the 30-day LIBOR, as
such rate changes from time to time, plus a variable margin of from 75 to 150
basis points depending on the Company's funded debt to EBIA ratio determined on
a quarterly basis, at the election of the Company. Certain of the Company's
subsidiaries have guaranteed the repayment of indebtedness under the Credit
Facility. The Credit Facility contains 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 has on file with the Commission a shelf Registration
Statement on Form S-4 (Registration No. 333-12319) (the "Shelf Registration
Statement") covering securities with a collective aggregate offering price of
$50.0 million for use in the acquisition of HVAC businesses. Under the Shelf
Registration Statement, the Company may issue shares of Common Stock, warrants
to purchase Common Stock and debt securities in connection with acquisitions.
5
<PAGE> 7
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.
This discussion contains certain forward-looking statements, including
those relating to the acquisition of additional HVAC service and replacement
businesses, each of which is accompanied by specific, cautionary language that
could cause different results than expected by the Company.
Newly Issued Accounting Standards
In February 1997, the Financial Accounting Standards Board ("FASB") 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. Management
does not believe this change will 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.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("Statement 130"). Statement 130 establishes standards for reporting and
displaying comprehensive income and its components in a full set of general
purpose financial statements. Statement 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions with
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of Statement 130 to have
a material impact on the Company's financial statements because there are
currently no items of comprehensive income that are not reported in its
Consolidated Statement of Operations.
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("Statement 131"). Statement
131 establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and requires
these enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. Statement 131 is effective for periods beginning after December 15,
1997. Management of the Company is currently reviewing the impact of Statement
131.
6
<PAGE> 8
RATIO OF EARNINGS TO FIXED CHARGES(1)
The Company's Shelf Registration Statement currently on file with the
Commission contains a ratio of earnings to fixed charges for prior periods. Set
forth below is the ratio of earnings to fixed charges for the Company for the
periods indicated reflecting the acquisition of the Pooled Companies:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1992 1993 1994 1995 1996
---- ---- ---- ---- -----
<S> <C> <C> <C> <C> <C>
Ratio of earnings to fixed charges........... 8.41x 2.69x 5.92x (2) 7.03x
</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.
(2) Earnings are inadequate to cover fixed charges for the year ended December
31, 1995. The coverage deficiency was $23,000.
7
<PAGE> 9
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, Inc. -- see Note 1) as of December 31, 1995 and 1996, and
the related statements of operations, 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, Inc. -- see Note 1) at December 31, 1995 and 1996, and
the consolidated results of its operations and its 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
December 9, 1997
F-1
<PAGE> 10
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1996
------- -------
(IN THOUSANDS)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 882 $10,806
Accounts Receivable:
Trade, net of allowance for doubtful accounts of
$302,000 in 1995 and $773,000 in 1996................. 5,924 13,405
Related party.......................................... 298 130
Employee............................................... 84 114
Other.................................................. 69 208
------- -------
6,375 13,857
Inventories............................................... 1,470 5,245
Costs and estimated earnings in excess of billings........ 254 525
Prepaid expenses and other current assets................. 384 785
Current portion of notes receivable -- related parties.... -- 14
Current portion of notes receivable -- other.............. 8 294
Deferred income taxes..................................... 17 1,918
------- -------
Total current assets.............................. 9,390 33,444
Property, buildings and equipment:
Land...................................................... 789 1,198
Buildings................................................. 2,224 1,649
Furniture and fixtures.................................... 1,187 1,737
Machinery and equipment................................... 2,303 3,290
Vehicles.................................................. 3,429 7,078
Leasehold improvements.................................... 801 1,277
------- -------
10,733 16,229
Less accumulated depreciation and amortization.............. (3,938) (4,976)
------- -------
6,795 11,253
Notes receivable -- related parties, net of current
portion................................................... -- 352
Notes receivable -- other, net of current portion........... 182 679
Investment in affiliate..................................... -- 674
Goodwill.................................................... 6 33,038
Other assets................................................ 460 730
------- -------
Total assets...................................... $16,833 $80,170
======= =======
</TABLE>
See accompanying notes.
F-2
<PAGE> 11
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------
1995 1996
------- -------
(IN THOUSANDS,
EXCEPT SHARE
DATA)
<S> <C> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit and short-term debt........................ $ 2,500 $ 1,477
Trade accounts payable and accrued liabilities............ 3,355 7,696
Cash consideration payable................................ -- 1,495
Accrued compensation...................................... 1,033 1,933
Accrued warranties........................................ 281 1,076
Income taxes payable...................................... 132 1,724
Deferred revenue.......................................... 594 3,685
Billings in excess of costs and estimated earnings........ 458 798
Current portion related party notes....................... 31 24
Current portion of long-term debt and capital lease
obligations............................................ 611 658
------- -------
Total current liabilities......................... 8,995 20,566
Related party notes, net of current portion................. 686 9
Long-term debt and capital lease obligations, net of current
portion................................................... 3,786 3,915
Deferred income taxes....................................... 45 361
Commitments (Note 11).......................................
Stockholders' equity:
Common stock $.01 par value; 30,000,000 shares authorized;
2,132,433 and 11,621,847 shares issued and outstanding
at December 31, 1995 and 1996, respectively............ 21 116
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares issued and outstanding........... -- --
Additional paid-in capital................................ 1,384 50,459
Retained earnings......................................... 1,916 4,759
Equity notes receivable................................... -- (15)
------- -------
Total stockholders' equity........................ 3,321 55,319
------- -------
Total liabilities and stockholders' equity........ $16,833 $80,170
======= =======
</TABLE>
See accompanying notes.
F-3
<PAGE> 12
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1994 1995 1996
------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Net revenues.............................................. $47,545 $49,748 $74,913
Cost of goods sold........................................ 36,369 38,227 52,628
------- ------- -------
Gross margin.............................................. 11,176 11,521 22,285
Selling, general and administrative expenses.............. 9,240 11,185 17,384
------- ------- -------
Income from operations.................................... 1,936 336 4,901
Other income (expense):
Interest expense........................................ (276) (610) (613)
Interest income......................................... 35 66 361
Other income............................................ 42 185 226
------- ------- -------
(199) (359) (26)
------- ------- -------
Income (loss) before federal and state income taxes....... 1,737 (23) 4,875
Provision (benefit) for income taxes:
Current................................................. 301 102 2,677
Deferred................................................ (50) 44 (1,541)
------- ------- -------
251 146 1,136
------- ------- -------
Net income (loss)....................................... $ 1,486 $ (169) $ 3,739
======= ======= =======
Net income (loss) per common share........................ $ .70 $ (.08) $ .74
======= ======= =======
Weighted average shares................................... 2,132 2,132 5,022
======= ======= =======
</TABLE>
See accompanying notes.
F-4
<PAGE> 13
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..................... 2,133 $ 21 $ 885 $ 2,271 $ -- $ 3,177
Capital distributions........................ -- -- -- (1,088) -- (1,088)
Capital contributions........................ -- -- 311 -- -- 311
Net income................................... -- -- -- 1,486 -- 1,486
------ ---- ------- ------- ---- --------
Balance at December 31, 1994................... 2,133 21 1,196 2,669 -- 3,886
Capital distributions........................ -- -- -- (584) -- (584)
Capital contributions........................ -- -- 188 -- -- 188
Net loss..................................... -- -- -- (169) -- (169)
------ ---- ------- ------- ---- --------
Balance at December 31, 1995................... 2,133 21 1,384 1,916 -- 3,321
Change in retained earnings due to conversion
of Pooled Company to calendar year-end..... -- -- -- (4) -- (4)
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........................ -- -- -- (892) -- (892)
Capital contributions........................ -- -- 750 -- -- 750
Net income................................... -- -- -- 3,739 -- 3,739
------ ---- ------- ------- ---- --------
Balance at December 31, 1996................... 11,622 $116 $50,459 $ 4,759 $(15) $ 55,319
====== ==== ======= ======= ==== ========
</TABLE>
See accompanying notes.
F-5
<PAGE> 14
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1994 1995 1996
------ ------ --------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)........................................... $1,486 $ (169) $ 3,739
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization............................. 835 1,158 1,258
Equity in affiliate earnings.............................. -- -- (30)
(Benefit) provision for deferred income taxes............. (50) 44 (1,541)
Loss (gain) on asset disposals............................ 8 (51) (44)
Provision for loss on accounts receivable................. 145 171 290
Changes in operating assets and liabilities:
Receivables............................................. (604) (632) (1,031)
Inventories............................................. (290) (200) (365)
Prepaid expenses and other current assets............... 1 3 (318)
Trade accounts payable and accrued liabilities.......... 1,240 143 (1,594)
Accrued compensation.................................... 269 32 (713)
Accrued warranties...................................... 56 59 150
Deferred revenue........................................ 225 56 435
Income taxes payable.................................... 517 (207) 287
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings..... 115 (436) 37
------ ------ --------
Net cash flow provided by (used in) operating
activities.......................................... 3,653 (29) 560
INVESTING ACTIVITIES
Advances on notes receivable................................ -- -- (250)
Purchase of property, buildings, and equipment.............. (2,500) (2,472) (1,033)
Proceeds from sale of property, buildings, and equipment.... 9 93 273
Cash acquired through acquisitions.......................... -- -- 3,961
Payment of cash for acquired companies...................... -- (25) (18,699)
Increase in other assets.................................... (95) (90) (304)
------ ------ --------
Net cash used in investing activities............... (2,586) (2,494) (16,052)
FINANCING ACTIVITIES
(Decrease) increase in short-term debt...................... (841) 2,350 (1,341)
Proceeds from notes payable to shareholders and related
parties................................................... 7 -- 59
Payments on notes payable to shareholders and related
parties................................................... -- (9) (900)
Issuance of stock, net of issuance costs.................... -- -- 28,113
Proceeds of long-term debt and capital leases............... 1,432 1,426 2,424
Payments of long-term debt and capital leases............... (595) (681) (2,270)
Cash contributions received................................. 311 163 320
Distributions paid.......................................... (1,089) (583) (892)
------ ------ --------
Net cash (used in) provided by financing activities......... (775) 2,666 25,513
------ ------ --------
Increase in cash and cash equivalents....................... 292 143 10,021
Cash and cash equivalents at beginning of period............ 447 739 882
Change in cash and cash equivalents due to conversion of
Pooled Company to calendar year-end....................... -- -- (97)
------ ------ --------
Cash and cash equivalents at end of period.................. $ 739 $ 882 $ 10,806
====== ====== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 288 $ 562 $ 613
====== ====== ========
Income tax paid............................................. $ 76 $ 99 $ 1,907
====== ====== ========
Fair value of land contributed by stockholders.............. $ -- $ -- $ 430
====== ====== ========
ACQUISITION OF COMPANIES:
Fair value of assets acquired............................. $ -- $ 971 $ 42,333
Cash paid................................................. -- 23 1,478
Common stock issued....................................... -- -- 34,068
Other capital contribution................................ -- 25 --
------ ------ --------
Liabilities assumed....................................... $ -- $ 923 $ 6,787
====== ====== ========
DISPOSAL OF PLUMBING DIVISION:
Fair value of assets disposed............................. $ -- $ 200 $ --
Note receivable received.................................. -- 195 --
------ ------ --------
Cash received............................................. $ -- $ 5 $ --
====== ====== ========
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-6
<PAGE> 15
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. (collectively, the "Acquiring Company") and seven
subsequent acquisitions accounted for as poolings of interests (see Note 2). AC
Service & Installation Co., Inc. and Donelson Air Conditioning Company, Inc.
were under common control prior to August 21, 1996. 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 units
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 REVENUE
Revenues on all of the Company's heating and air conditioning installation
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.
Trade accounts receivable includes billings and billed retainage on
contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $152,000 and $718,000 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-7
<PAGE> 16
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and Cash Equivalents
The carrying amounts reported in the balance sheets for cash and cash
equivalents approximate fair value.
Accounts Receivable, Notes Receivable, Accounts Payable and Accrued
Liabilities
The carrying amounts reported in the balance sheets for accounts
receivable, notes receivable, accounts payable and accrued liabilities
approximate fair value. Accounts receivable and notes receivable are usually
unsecured.
Long-Term Debt and Related Party Notes Payable
Based upon the borrowing rates currently available to the Company, the
carrying amounts reported in the balance sheets for long-term debt and related
party notes payable approximate fair value.
CONCENTRATIONS OF CREDIT RISK
At times, cash balances in the Company's accounts may exceed FDIC insurance
limits.
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 and accounts written off, net of recoveries, were as follows:
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO CHARGED TO BALANCE AT
BEGINNING OF COSTS AND OTHER END OF
PERIOD ENDING PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
------------- ------------ ---------- ---------- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
December 31, 1994..................... 113 241 -- 95(1) 259
December 31, 1995..................... 259 213 -- 170(1) 302
December 31, 1996..................... 302 391 390(2) 310(1) 773
</TABLE>
- ---------------
(1) Uncollectible accounts written off, net of recoveries.
(2) Allowance for bad debts of acquired companies.
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-8
<PAGE> 17
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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>
Depreciation expense totaled $780,000, $1,067,000 and $1,145,000 for the
years ended December 31, 1994, 1995 and 1996, respectively.
Statement of Financial Accounting Standards 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, 1996.
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 HVAC 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.
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., TML, Inc. and Hawk Heating & Air
Conditioning, Inc. (see Note 2) 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 and partners of AC Service & Installation Co.,
Inc., Custom Air Conditioning, Inc., Freschi Air Systems, Inc., C. Iapaluccio
Company, Inc., Parrott Mechanical, Inc., including real property operations used
by the company ("Parrott Mechanical et al."), MT Partnership and McAlister Heat
& Air, Inc.
F-9
<PAGE> 18
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(see Note 2) elected under either Subchapter S or Subchapter K of the Internal
Revenue Code, to include such company's income in their own income for federal
income tax purposes. Accordingly, these companies are not subject to federal
income taxes. This election is not available for Tennessee and Connecticut state
income tax reporting; accordingly, AC Service & Installation Co., Inc. and C.
Iapaluccio Company, Inc. used the liability method of accounting for Tennessee
and Connecticut state income taxes.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1994, 1995 and
1996, the Company expensed $671,000, $916,000, and $1,782,000, 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 $1,000 and
$88,000 at December 31, 1995 and 1996, respectively.
INTANGIBLE ASSETS
Included in other assets are covenants not to compete and prepaid loan
fees. Covenants not to compete are amortized on the straight line basis over the
term of the respective agreements. Prepaid loan fees are amortized on a straight
line basis over the term of the respective note payable. Amortization expense
totalled $55,000, $91,000 and $100,000, for the years ended December 31, 1994,
1995 and 1996, respectively.
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 STANDARDS
In February 1997, the Financial Accounting Standards Board ("FASB") 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. Management
does not believe that this change will 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.
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("Statement 130"). Statement 130 establishes standards for reporting and
displaying comprehensive income and its components in a full set of general
purpose financial statements. Statement 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in stockholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or losses on
available for sale securities and foreign currency translation adjustments.
Management of the Company does not expect the adoption of Statement 130 to have
a material impact on the Company's financial statements.
F-10
<PAGE> 19
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1997, the FASB issued Statement No. 131, "Disclosures about
Segments of an Enterprise and Related Information" ("Statement 131"). Statement
131 establishes standards for the way public business enterprises are to report
information about operating segments in annual financial statements and requires
these enterprises to report selected information about operating segments in
interim financial reports issued to shareholders. It also establishes standards
for related disclosures about products and services, geographic areas, and major
customers. Statement 131 is effective for periods beginning after December 15,
1997. Management of the Company is currently reviewing the impact of Statement
131.
RECLASSIFICATIONS
Certain reclassifications have been made in the Company's 1994 and 1995
financial statements to conform to the 1996 presentation. These
reclassifications had no effect on the results of operations previously
reported.
2. BUSINESS COMBINATIONS
In December 1996, the Company completed business combinations with Custom
Air Conditioning, Inc. ("Custom") and Freschi Air Systems, Inc. ("Freschi")
through the exchange of 230,049 and 177,765 shares of the Company's Common
Stock, respectively. The Company completed a business combination with C.
Iapaluccio Company, Inc. ("Iapaluccio") through the exchange of 171,230 shares
of the Company's Common Stock in May 1997. The Company also completed business
combinations with Parrott Mechanical et al., TML, Inc. and MT Partnership
(collectively, "TML"), Hawk Heating & Air Conditioning, Inc. ("Hawk") and
McAlister Heat & Air, Inc. ("McAlister") through the exchange of 171,230,
240,526, 34,426 and 32,786 shares, respectively, of the Company's Common Stock.
F-11
<PAGE> 20
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
These seven business combinations 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 these pooled
companies. The following is a summary of results of operations of the separate
entities for periods prior to the business combinations.
<TABLE>
<CAPTION>
ELEVEN
YEAR ENDED MONTHS
DECEMBER 31, ENDED YEAR ENDED
------------------ NOVEMBER 30, DECEMBER 31,
1994 1995 1996 1996
------- ------- -------------- --------------
(IN THOUSANDS) (UNAUDITED) (IN THOUSANDS)
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Net Revenues
Service Experts................................ $14,299 $16,453 $29,167 $46,856
Custom......................................... 4,638 5,169 5,068 N/A
Freschi........................................ 3,256 3,254 4,116 N/A
Iapaluccio..................................... 1,488 1,756 N/A 2,591
Parrott........................................ 13,830 12,383 N/A 14,607
TML............................................ 7,439 8,182 N/A 8,064
Hawk........................................... 1,100 1,041 N/A 1,206
McAlister...................................... 1,495 1,510 N/A 1,589
------- ------- ------- -------
Combined....................................... $47,545 $49,748 $38,351 $74,913
======= ======= ======= =======
Net Income (loss)
Service Experts................................ $ 179 $ 629 $ 1,751 $ 3,110
Custom......................................... 245 173 213 N/A
Freschi........................................ (41) (94) 406 N/A
Iapaluccio..................................... 71 27 N/A 84
Parrott........................................ 603 (1,371) N/A 360
TML............................................ 367 380 N/A 38
Hawk........................................... 32 19 N/A 26
McAlister...................................... 30 68 N/A 121
------- ------- ------- -------
Combined....................................... $ 1,486 $ (169) $ 2,370 $ 3,739
======= ======= ======= =======
</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 on or before December 31, 1996. Two of these acquisitions
completed on or before 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
approximately 2,069,000 shares at a fair market value of approximately
$34,068,000, excluding stock issuance costs of approximately $1,572,000, and
cash of approximately
F-12
<PAGE> 21
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$1,499,000. The Company established an escrow account equal to 10% of the
purchase price for each acquisition subject to final closing adjustments. The
purchase price was allocated to the acquired assets based on the fair values of
those assets as determined by the Company as set forth below (in thousands):
<TABLE>
<CAPTION>
<S> <C>
Current Assets.............................................. $ 7,032
Property, Buildings and Equipment........................... 2,593
Other Assets................................................ 392
Goodwill.................................................... 32,337
Liabilities Assumed......................................... (6,787)
-------
Purchase Price............................... $35,567
=======
</TABLE>
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase
method of accounting except as indicated in Note 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 operations 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........................................... $136,928 $148,137
Net income............................................. 4,360 6,682
Income per common share................................ $ .38 $ .57
</TABLE>
Subsequent to December 31, 1996, the Company completed the acquisition of
36 Service Centers by issuing approximately 2,470,000 shares of stock, warrants
to purchase 200,000 shares of Common Stock and paying cash consideration of
approximately $98,346,000. 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......................................... $ 232,299 $ 254,530
Net income........................................... 7,289 12,215
Income per common share.............................. $ .58 $ .81
</TABLE>
F-13
<PAGE> 22
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..................... $3,444 $6,944
Estimated earnings....................................... 1,122 2,348
------ ------
4,566 9,292
Less applicable billings................................... (4,770) (9,565)
------ ------
$ (204) $ (273)
====== ======
Included in the accompanying balance sheets under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. $ 254 $ 525
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (458) (798)
------ ------
$ (204) $ (273)
====== ======
</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. NOTES RECEIVABLE
Notes receivable are accepted from members of Contractor Success Group,
Inc. who desire to finance a portion of their initial membership fee. The
original principal balance generally does not exceed $15,000 and the notes
typically involve a three-year term, accrue interest at 18% and are payable in
equal monthly installments of principal and interest. The notes are periodically
reviewed for collectibility and reserves are established at the time it appears
that collectibility is uncertain.
Also included in notes receivable is a note receivable with a balance of
$180,508 at December 31, 1996 (190,585 in 1995) which bears interest at 9.0% and
is due in monthly installments with all unpaid principle due and payable as a
balloon payment on July 1, 2009.
F-14
<PAGE> 23
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. LEASES
Total rental expense for all operating leases was $231,000, $254,000 and
$574,000 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 $208,000, $215,000, and $362,000, 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 $ 422 $1,526 $2,008
1998...................................... 55 308 1,520 1,883
1999...................................... 47 239 1,470 1,756
2000...................................... 23 151 1,472 1,646
2001...................................... -- 105 1,154 1,259
Thereafter................................ -- -- 1,171 1,171
---- ------ ------ ------
185 $1,225 $8,313 $9,723
====== ====== ======
Amounts representing interest............. 27
----
Present value of net minimum
rentals (including $48 classified as
current)................................ $156
====
</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.
8. LONG-TERM DEBT
Long-term debt consists of the following (in thousands):
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1995 1996
------ ------
<S> <C> <C>
Line of credit and short-term debt......................... $2,500 $1,477
Mortgage notes payable..................................... 1,757 1,167
Installment and equipment notes............................ 610 207
Other...................................................... 2,071 3,076
------ ------
6,938 5,927
Less current portion....................................... 3,135 2,111
------ ------
$3,803 $3,816
====== ======
</TABLE>
The Company had a $2,500,000 line of credit agreement with a financial
institution during 1995. In 1996 the line of credit was reduced to $1,500,000.
The line of credit bears interest at a variable rate of the lender's prime rate
of interest plus 1.75% (9.875% at December 31, 1996). The line of credit is
secured by the Company's accounts receivable and inventory. The Company is
required to apply all cash collections on accounts receivable to pay principal
amounts outstanding. Amounts outstanding at December 31, 1995 and 1996 were
$2,500,000 and $1,477,000, respectively.
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
F-15
<PAGE> 24
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 these lines 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. Subsequent to December 31, 1996, the
Company renegotiated the above lines of credit (see note 15).
As long as any indebtedness is outstanding, these lines of credit require,
among other things, that the Company maintain various financial ratios at
specified levels including minimum levels for stockholders' equity. These 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 13). The Company also has
various mortgage notes payable to various lenders which are secured by real
estate. These loans require monthly installments of $633 to $4,000, including
principal and interest at various fixed rates ranging from 7.8% to 9.4% and one
variable interest loan at the lender's prime rate of interest plus 2.0% (10.5%
at September 30, 1996) and are due through November 2010.
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 13.0% per annum with maturity dates
through 2014.
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........................................................ $2,111
1998........................................................ 556
1999........................................................ 550
2000........................................................ 509
2001........................................................ 357
Thereafter.................................................. 1,844
------
$5,927
======
</TABLE>
F-16
<PAGE> 25
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. 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" ("Statement 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 Statement 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-17
<PAGE> 26
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.................................................. $ 3,739
Pro forma compensation expense from stock options, net of
taxes..................................................... (121)
--------
Pro forma net income........................................ $ 3,618
========
Pro forma earnings per common and common equivalent share... $ .72
========
</TABLE>
Under Statement 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.
NON-EMPLOYEE DIRECTOR STOCK OPTION PLAN
The Company has a Non-Employee Director Stock Option Plan that provides for
a maximum issuance of 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 an
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 (the "Purchase Plan") under
which the sale of 100,000 shares of Common Stock has been authorized. Employees
may designate up to 10% of their base compensation, at a price equal to 85% of
the lessor of the fair market value of the Common Stock on 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.
10. EMPLOYEE BENEFIT PLANS
The Company has defined-contribution employee benefit plans incorporating
provisions of section 401(k) of the Internal Revenue Code and the Davis-Bacon
Act. 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 $236,000, $358,000
and $309,000 as of December 31, 1994, 1995 and 1996, respectively.
F-18
<PAGE> 27
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. 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.
12. 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................................................... $233 $ 56 $2,214
State..................................................... 68 46 463
Deferred.................................................... (50) 44 (1,541)
---- ---- ------
$251 $146 $1,136
==== ==== ======
</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......................................... $ 42 $ 168
Accounts receivable....................................... 29 33
Inventory................................................. 25 9
Depreciation and amortization............................. 19 378
Other-net................................................. -- 71
------ ------
Deferred tax liabilities.................................... 115 659
Deferred tax assets:
Depreciation and amortization............................. 2 --
Accounts receivable....................................... 25 268
Warranty reserves......................................... 36 355
Deferred revenue.......................................... 2 1,045
Accrued expenses.......................................... 3 369
Accounts payable.......................................... 12 19
Prepaid expenses.......................................... 7 11
Carryforwards, net........................................ -- 44
Other-net................................................. -- 105
------ ------
Total gross deferred tax assets............................. 87 2,216
------ ------
Net deferred tax (liabilities) assets....................... $ (28) $1,557
====== ======
</TABLE>
F-19
<PAGE> 28
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.................... $591 $ (4) $1,661
State income tax less applicable federal tax
benefit.......................................... 43 58 146
Less benefit of graduated tax rates and adjustments
to eliminate S corporation....................... (383) 92 (475)
Less benefit recognized upon termination of
Subchapter S election for AC Service &
Installation Co., Inc............................ (236)
Other-net.......................................... -- -- 40
---- ------ ------
$251 $ 146 $1,136
==== ====== ======
</TABLE>
PRO FORMA INCOME TAX INFORMATION (UNAUDITED)
As discussed previously, AC Service & Installation Co., Inc., Custom,
Freschi, Iapaluccio, Parrott Mechanical et al., MT Partnership and McAlister
operated under either Subchapter S or Subchapter K of the Internal Revenue Code
and were not subject to corporate federal income tax. The Subchapter S and
Subchapter K 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 and partnership status. AC Service & Installation
Co., Inc., Custom, Freschi, Iapaluccio, Parrott Mechanical et al., MT
Partnership and McAlister had net operating income (loss) for income tax
purposes of $994,000, $(417,000) and $2,317,000 for 1994, 1995 and 1996,
respectively. Had AC Service & Installation Co., Inc., Custom, Freschi,
Iapaluccio, Parrott Mechanical et al., MT Partnership and McAlister filed
federal and state income tax returns as C corporations for 1994, 1995 and 1996,
income tax expense (benefit) under the provisions of Financial Accounting
Standard No. 109 would have been $442,000, $(188,000) and $533,000,
respectively.
At the date of termination of S corporation and partnership status, AC
Service & Installation Co., Inc., Custom, Freschi, Iapaluccio, Parrott
Mechanical et al., MT Partnership and McAlister 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 and partnership 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.
13. 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 9.0%.
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
F-20
<PAGE> 29
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$343,000, and accrued compensation of $365,000 to the former shareholders of AC
Service & Installation Co., Inc. and Donelson Air Conditioning Company, Inc.
Notes Payable to Related Parties
At December 31, 1995, the Company had notes payable to related parties,
including current and former shareholders, which bear interest ranging from 0.0%
to 12.5% and were due through 2009. These notes were repaid during 1996.
14. 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................................ $11,269 14,676 20,916 28,052
Income before income taxes.................. 224 322 1,899 2,430
Net income.................................. 235 432 1,628 1,444
Income per common share..................... $ .11 .20 .29 .14
</TABLE>
15. SUBSEQUENT EVENTS
Subsequent to December 31, 1996, the Company has acquired 67 HVAC
businesses in exchange for an aggregate of approximately 2,470,000 shares of
Common Stock, warrants to purchase 200,000 shares of Common Stock and
approximately $98,346,000 cash.
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 used the proceeds for planned capital expenditures,
acquisitions and general corporate purposes.
In connection with various acquisitions, the Company paid off substantially
all notes payable outstanding of wholly-owned subsidiaries.
In September 1997, the Company renegotiated its lines of credit. The
Company has a $50 million unsecured revolving credit facility with a banking
syndication available through September 3, 1999 (the "Credit Facility").
Borrowings under the Credit Facility bear interest at either (i) the higher of
(x) the agent's base lending rate and (y) the federal funds rate plus one-half
of one percent per annum or (ii) a variable rate equal to the 30-day LIBOR, as
such rate changes from time to time, plus a variable margin of from 75 to 150
basis points depending on the Company's funded debt to EBIA ratio determined on
a quarterly basis, at the election of the Company. Certain of the Company's
subsidiaries have guaranteed the repayment of indebtedness under the Credit
Facility. The Credit Facility contains 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.
F-21
<PAGE> 30
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Parrott Mechanical, Inc. et al.
We have audited the accompanying combined balance sheet of Parrott
Mechanical, Inc. et al., a subchapter S Corporation, (see Note 1) as of
September 30, 1996, and the related combined statements of income, stockholders'
equity and cash flows for the year ended September 30, 1996. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the combined financial position of Parrott Mechanical,
Inc. et al. at September 30, 1996, and the combined results of their operations
and their cash flows for the year ended September 30, 1996, in conformity with
generally accepted accounting principles.
Nashville, Tennessee
November 14, 1997
F-22
<PAGE> 31
PARROTT MECHANICAL, INC. ET AL.
(SEE NOTE 1)
COMBINED BALANCE SHEETS
<TABLE>
<CAPTION>
SEPTEMBER 30, JUNE 30,
1996 1997
------------- -----------
(UNAUDITED)
<S> <C> <C>
ASSETS
Current assets:
Cash...................................................... $ 99,663 $ 64,140
Receivables:
Trade, net of allowance for doubtful accounts of
$122,000 at September 30, 1996 and June 30, 1997...... 2,899,634 3,242,532
Employee............................................... 7,035 8,874
----------- -----------
2,906,669 3,251,406
Inventories................................................. 953,117 846,121
Costs and estimated earnings in excess of billings.......... 629,827 171,983
Notes receivable -- current portion......................... 7,905 9,047
Prepaid expenses and other current assets................... 38,031 52,322
----------- -----------
Total current assets.............................. 4,635,212 4,395,019
Property, buildings and equipment:
Land...................................................... 1,069,861 1,069,861
Buildings................................................. 1,888,425 1,908,525
Furniture and fixtures.................................... 433,675 452,481
Machinery and equipment................................... 1,083,783 1,099,622
Vehicles.................................................. 910,891 923,826
----------- -----------
5,386,635 5,454,315
Less accumulated depreciation and amortization............ (1,113,383) (1,443,344)
----------- -----------
4,273,252 4,010,971
Intangible assets, net of accumulated amortization of
$100,018 and $135,719 at September 30, 1996 and June 30,
1997, respectively........................................ 290,731 240,279
Notes receivable -- long term............................... 174,526 199,723
----------- -----------
Total assets...................................... $ 9,373,721 $ 8,845,992
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Line of credit payable.................................... $ 1,462,594 $ 1,161,123
Trade accounts payable and accrued liabilities............ 2,095,104 1,632,991
Accrued compensation...................................... 192,423 86,145
Accrued taxes, other than income.......................... 144,658 64,265
Accrued warranties........................................ 40,108 52,408
Deferred revenue.......................................... 82,567 120,156
Billings in excess of costs and estimated earnings........ 454,092 573,146
Liability to Company's benefit plans...................... 34,346 53,008
Current portion of long-term debt......................... 450,001 447,423
----------- -----------
Total current liabilities......................... 4,915,893 4,150,665
Long-term debt, net of current.............................. 3,812,036 3,790,196
Commitments and contingencies (Note 7)
Stockholders' equity........................................ 605,792 865,131
----------- -----------
Total liabilities and stockholders' equity........ $ 9,373,721 $ 8,845,992
=========== ===========
</TABLE>
See accompanying notes.
F-23
<PAGE> 32
PARROTT MECHANICAL, INC. ET AL.
(SEE NOTE 1)
COMBINED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
SEPTEMBER 30, ENDED JUNE 30,
1996 1997
------------- --------------
(UNAUDITED)
<S> <C> <C>
Net revenues................................................ $13,439,106 $13,020,029
Cost of goods sold.......................................... 10,906,378 10,327,188
----------- -----------
Gross margin................................................ 2,532,728 2,692,841
Selling, general and administrative expenses................ 1,873,149 1,878,223
----------- -----------
Income from operations...................................... 659,579 814,618
Other income (expense):
Interest expense.......................................... (470,991) (402,882)
Interest income........................................... 16,921 12,476
Other income.............................................. 33,356 24,378
----------- -----------
(420,714) (366,028)
----------- -----------
Net income.................................................. $ 238,865 $ 448,590
=========== ===========
</TABLE>
See accompanying notes.
F-24
<PAGE> 33
PARROTT MECHANICAL, INC. ET AL.
(SEE NOTE 1)
COMBINED STATEMENT OF STOCKHOLDERS' EQUITY (DEFICIT)
<TABLE>
<CAPTION>
TOTAL
---------
<S> <C>
Balance at October 1, 1995.................................. $(242,474)
Capital contributions..................................... 725,106
Distributions............................................. (115,705)
Net income................................................ 238,865
---------
Balance at September 30, 1996............................... 605,792
Distributions (unaudited)................................. (189,251)
Net income (unaudited).................................... 448,590
---------
Balance at June 30, 1997 (unaudited)........................ $ 865,131
=========
</TABLE>
See accompanying notes.
F-25
<PAGE> 34
PARROTT MECHANICAL, INC. ET AL.
COMBINED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED NINE MONTHS
SEPTEMBER 30, ENDED JUNE 30,
1996 1997
------------- --------------
(UNAUDITED)
<S> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 238,865 $ 448,590
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization............................. 514,516 401,765
Provision for loss on accounts receivable................. 127,535 9,590
(Loss) gain on asset disposals............................ (10,462) 3,310
Changes in operating assets and liabilities:
Accounts and notes receivable.......................... (1,091,314) (380,666)
Inventories............................................ (221,118) 106,996
Prepaid expenses and other current assets.............. 51,454 (14,291)
Trade accounts payable and accrued liabilities......... 536,731 (462,163)
Accrued compensation................................... 47,353 (87,616)
Accrued taxes, other than income....................... 103,662 (80,393)
Accrued warranties..................................... 2,836 12,300
Deferred revenue....................................... 18,487 37,589
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings.... (234,245) 576,948
----------- ----------
Net cash flow provided by operating activities.............. 84,300 571,959
INVESTING ACTIVITIES
Purchase of property, buildings and equipment............... (67,229) (83,492)
Proceeds from sale of property, buildings and equipment..... 39,400 3,690
Change in intangible assets................................. (49,749) (12,540)
----------- ----------
Net cash used in investing activities....................... (77,578) (92,342)
FINANCING ACTIVITIES
Change in line of credit payable............................ (1,037,406) (301,471)
Distribution to stockholders................................ (115,705) (189,251)
Capital contributions....................................... 295,106 --
Payments on long-term debt.................................. (1,446,853) (24,418)
Proceeds from long-term debt................................ 2,275,000 --
----------- ----------
Net cash used in financing activities....................... (29,858) (515,140)
Decrease in cash............................................ (23,136) (35,523)
Cash at beginning of period................................. 122,799 99,663
----------- ----------
Cash at end of period....................................... $ 99,663 $ 64,140
=========== ==========
CASH FLOW INFORMATION
Interest paid............................................... $ 495,590 $ 406,028
=========== ==========
Fair value of land contributed by stockholders.............. $ 430,000 $ --
=========== ==========
EXCHANGE OF BAD DEBT FOR LAND
Accounts receivable forgiven................................ $ 21,081 $ --
Liabilities assumed......................................... 52,828 --
----------- ----------
Fair value of land received................................. $ 73,909 $ --
=========== ==========
</TABLE>
See accompanying notes.
F-26
<PAGE> 35
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS
SEPTEMBER 30, 1996
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
REPORTING ENTITY
Parrott Mechanical, Inc. et al., including certain real property operations
used by the company (the "Company"), operates in one industry segment and is
primarily engaged in the installation and servicing of air conditioning and
heating systems for commercial and residential customers in the states of Idaho,
Washington and Oregon.
PRINCIPLES OF COMBINATION
The combined financial statements include the accounts of Parrott
Mechanical, Inc. and real property operations, which report on a calendar year
end, used by Parrott Mechanical, Inc. The combined entities share common
ownership interests. All intercompany transactions have been eliminated in
combination.
UNAUDITED INTERIM FINANCIAL STATEMENTS
The combined balance sheet as of June 30, 1997 and the related combined
statements of income, stockholders' 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 September
30, 1996 audited financial statements appearing herein. The results of the nine
months ended June 30, 1997 may not be indicative of operating results for the
full year.
RECOGNITION OF REVENUE
Revenues on all of the Company's heating and air conditioning installation
contracts 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, service and maintenance contracts are recognized upon
completion of the services, which is usually within one to two days.
Earnings and estimated costs on contracts are reviewed throughout the terms
of the contracts, and any required adjustments are reflected in the periods in
which they first become known. When estimates indicate a probable loss on a
contract, the full amount thereof is accrued in the period in which it is first
determined. Most contracts are completed within 6 to 18 months.
Trade accounts receivable includes billings and billed retainage on
contracts. The Company classifies these amounts as current assets because all
balances are expected to be collected in the current year. Concentrations of
credit risk with respect to trade receivables are limited due to the large
number of customers comprising the combined Company's customer base and their
dispersions across may different industries and geographics.
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.
F-27
<PAGE> 36
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash
The carrying amounts reported in the balance sheet for cash approximate
fair value.
Accounts Receivable, Notes Receivable, Accounts Payable and Accrued
Liabilities
The carrying amounts reported in the balance sheets for accounts
receivable, notes receivable, accounts payable and accrued liabilities
approximate fair value.
LONG-TERM DEBT
Based upon the borrowing rates currently available to the Company, the
carrying amount reported in the balance sheet for long-term debt approximates
fair value.
CONCENTRATIONS OF CREDIT
At September 30, 1996, the Company had approximately $121,000 on deposit
with a bank in excess of FDIC Insurance limits.
INVENTORIES
Inventories are stated at cost, which is not in excess of market. Cost is
determined by the first-in, first-out (FIFO) method for all inventories.
PROPERTY, BUILDINGS AND EQUIPMENT
Property, buildings and equipment are stated on the basis of cost.
Depreciation and amortization are provided on the straight-line method and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings................................................... 31-39
Furniture and fixtures...................................... 7
Machinery and equipment..................................... 7
Vehicles.................................................... 5
</TABLE>
Depreciation expense totaled $443,773 for the year ended September 30,
1996.
Statement of Financial Accounting Standards 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 September 30,
1996.
ACCRUED COMPENSATION
Accrued compensation consists of salary, bonus, commission and vacation
expenses payable to various employees.
F-28
<PAGE> 37
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
WARRANTIES
The Company provides its residential and commercial customers with a one
year warranty on parts and labor from the date of installation of the heating
and air conditioning unit. This warranty runs concurrent with the manufacturer's
warranty on parts. The Company provides an accrual for future warranty costs
based upon the relationship of prior years' sales to actual warranty costs. It
is the Company's practice to classify the entire warranty accrual as a current
liability.
DEFERRED REVENUE
The Company pre-sells maintenance contracts in the form of energy service
agreements ("ESA"). ESA revenue is recorded as deferred revenue and recognized
as income when the service is performed.
The Company requires advance customer deposits from certain residential
customers before service is performed. The customer deposits are recorded as
deferred revenue and recognized as income when the service is performed.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INTANGIBLE ASSETS
Included in other assets are covenants not to compete, goodwill and prepaid
loan fees. Covenants not to compete are amortized on the straight line basis
over the term of the respective agreements. Goodwill is amortized on a straight
line basis over 15 years. Prepaid loan fees are amortized on a straight line
basis over the term of the respective note payable. Amortization expense totaled
$70,743 for the year ended September 30, 1996.
INCOME TAXES
The stockholders of the Company have 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, the Company is not subject to federal
income taxes.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the year ended September 30, 1996, amounts charged to bad debt
expense and accounts written off, net of recoveries, totaled $127,535.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During the year ended
September 30, 1996, the Company expensed $157,540.
NEWLY ISSUED ACCOUNTING STANDARDS
In June 1997, the FASB issued Statement No. 130, "Reporting Comprehensive
Income" ("Statement 130"). Statement 130 establishes standards for reporting and
displaying comprehensive income and its components in a full set of general
purpose financial statements. Statement 130 is effective for interim and annual
periods beginning after December 15, 1997. Comprehensive income encompasses all
changes in shareholders' equity (except those arising from transactions from
owners) and includes net income, net unrealized capital gains or
F-29
<PAGE> 38
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
losses on available for sale securities and foreign currency translation
adjustments. Management of the Company does not expect the adoption of Statement
130 to have a material impact on the Company's financial statements.
2. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
<S> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contacts...................... $ 3,099,744
Estimated earnings........................................ 1,241,912
-----------
4,341,656
Less applicable billings.................................. (4,165,921)
-----------
$ 175,735
===========
Included in the accompanying balance sheet under the
following captions:
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................. $ 629,827
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. (454,092)
-----------
$ 175,735
===========
</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. NOTES RECEIVABLE
Note receivable of $182,431 is from a company whose owners are related
parties. The note, which bears interest at 9.0%, is due in monthly installments
with all unpaid principal due and payable as a balloon payment on July 1, 2009.
4. DEBT
Debt consists of:
<TABLE>
<CAPTION>
SEPTEMBER 30,
1996
-------------
<S> <C>
Line of credit.............................................. $1,462,594
Mortgage notes payable...................................... 1,149,474
Term loans payable.......................................... 3,112,563
----------
5,724,631
Less current portion........................................ (1,912,595)
----------
$3,812,036
==========
</TABLE>
During 1996, the Company refinanced a $2,500,000 line of credit agreement
with a financial institution to a total borrowing limit of $1,500,000. The line
of credit bears interest at a variable rate of the lender's prime rate of
interest plus 1.75% (9.875% at September 30, 1996). The line of credit is
secured by the Company's accounts receivable and inventory. The Company is
required to apply all cash collections on accounts receivable to pay principal
amounts outstanding.
The Company has various mortgage notes payable to various lenders which are
secured by real estate. These loans require monthly installments of $633 to
$4,000, including principal and interest at various fixed rates ranging from
7.8% to 9.4% and one variable interest loan at the lender's prime rate of
interest plus 2.0% (10.5% at September 30, 1996) and are due through November
2010.
F-30
<PAGE> 39
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has various term loans payable to various lenders which are
secured by inventory, vehicles and equipment. These loans bear interest at
various fixed rates ranging from 9.0% to 12.0% per annum and two variable
interest loans at the lender's prime rate of interest plus 1.5% (9.5% at
September 30, 1996). These loans require monthly payments ranging from $436 to
$21,500 and are due through September 2014.
As of September 30, 1996, the aggregate amounts of annual principal
maturities of long-term debt are as follows:
<TABLE>
<S> <C>
1997........................................................ $1,912,595
1998........................................................ 489,720
1999........................................................ 519,069
2000........................................................ 555,025
2001........................................................ 350,477
Thereafter.................................................. 1,897,745
----------
$5,724,631
==========
</TABLE>
5. LEASES
Total rental expense for all operating leases was $20,400 for the year
ended September 30, 1996. The Company leases certain office and warehouse
facilities under terms of noncancelable operating lease agreements which expire
March 1997. Minimum rental commitments at September 30, 1996 under operating
leases are as follows were $2,400.
6. EMPLOYEE BENEFIT PLANS
The Company has a defined-contribution employee benefit plan incorporating
provisions of Section 401(k) of the Internal Revenue Code and the Davis-Bacon
Act. All employees over age 18 who have been employed by the Company for at
least three months, and who are not covered by a collective bargaining agreement
are eligible to participate in the plan. Under the plan's provisions, a plan
member may make contributions, on a tax deferred basis, limited to a maximum of
10% of the employee's total wages. Any prevailing wages earned are not included
in the contribution calculation. No matching contributions are made by the
Company.
Effective January 1, 1997, the current plan was terminated and a new 401(k)
profit sharing plan was established. Substantially all assets were carried over
to the new plan.
In addition, the Company has a defined contribution retirement plan and
trust incorporating provisions of the Davis-Bacon Act. Substantially all
employees of the Company who render services under contracts subject to the
Davis-Bacon Act or any other federal, state, or municipal Prevailing Wage law
are eligible to participate in the plan. The Company makes contributions on
behalf of participants based on the statutory hourly rate designated for that
participant's employment classification for the project for which the work was
performed. Participant contributions are not allowed. The Company's contribution
totaled $48,000 for 1996.
Effective January 1, 1997, the current plan was terminated and a new
defined contribution plan was established at that date. Substantially all assets
were carried over to the new plan.
7. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of legal proceedings arising in the
ordinary course of business. In the opinion of management, the resolution of
these proceedings will not have a material adverse effect on the combined
financial position or results of operations of the Company.
The Company maintains general liability insurance coverage and umbrella
policies to insure itself against any liabilities occurring in the normal course
of business. The Company believes that its insurance coverage is adequate.
F-31
<PAGE> 40
PARROTT MECHANICAL, INC. ET AL.
NOTES TO COMBINED FINANCIAL STATEMENTS -- (CONTINUED)
8. 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 combination
with Service Experts, Inc., the Subchapter S election will be terminated. As a
result, the Company will be subject to corporate income taxes subsequent to the
termination of S corporation status. The Company had net operating income for
income tax purposes of $206,167 for the year ended September 30, 1996. Had the
Company filed federal and state income tax returns as a regular corporation for
the year ended September 30, 1996, income tax expense under the provisions of
SFAS Statement No. 109 would have been $80,982.
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 included in the provision for income taxes. If the termination of
S corporation status had occurred at June 30, 1997, the deferred tax asset would
have been approximately $216,809.
9. SUBSEQUENT EVENTS
Subsequent to year-end, the Company underwent a state sales tax audit
related to the three years ended September 30, 1996. In the opinion of
management, adequate provision has been made in the combined financial
statements for any possible loss as a result of this audit.
Effective September 30, 1997, the Company entered into an Agreement and
Plan of Reorganization with Service Experts, Inc. ("Service Experts") to
exchange all of the Company's common stock for Common Stock of Service Experts.
In accordance with the agreement, the Company became a wholly-owned subsidiary
of Service Experts on September 30, 1997. In addition, the stockholders of the
Company transferred to a wholly-owned subsidiary of Service Experts certain real
property utilized in the business of the Company in exchange for shares of
Common Stock of Service Experts.
In connection with the business combination of the Company with Service
Experts, Service Experts paid all notes payable outstanding. In connection with
the payoff of the outstanding notes payable, Service Experts was required to pay
approximately $28,000 in prepayment penalties.
F-32
<PAGE> 41
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: January 8, 1998
<PAGE> 42
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<S> <C>
11 Computation of Earnings Per Share
12 Computation of Ratio of Earnings
to Fixed Charges
23 Consent of Ernst & Young LLP
27.1 Restated Financial Data Schedule (for SEC use
only) - year ended December 31, 1996
27.2 Restated Financial Data Schedule (for SEC use
only) - nine months ended September 30, 1996
</TABLE>
<PAGE> 1
EXHIBIT 11
SERVICE EXPERTS, INC.
COMPUTATION OF EARNINGS PER SHARE
<TABLE>
<CAPTION>
Year ended December 31,
--------------------------
1994 1995 1996
------ ------ ------
(In thousands, except per share data)
<S> <C> <C> <C>
Primary
Average shares outstanding.......................... 2,132 2,132 4,995
Net effect of dilutive stock options based on the
treasury stock method using average market price.. -- -- 27
------ ------ ------
Totals ......................................... 2,132 2,132 5,022
====== ====== ======
Net income (loss) .................................. $1,486 $ (169) $3,739
====== ====== ======
Net income (loss) per common share ................. $ .70 $ (.08) $ .74
====== ====== ======
</TABLE>
<PAGE> 1
EXHIBIT 12
SERVICE EXPERTS, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHANGES(1)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
1992 1993 1994 1995 1996
<S> <C> <C> <C> <C> <C>
FIXED CHARGES:
Interest Expense $ 66 $ 196 $ 276 $ 610 $ 613
Portion of rents representative
of interest factor $ 62 $ 66 $ 77 $ 85 $ 191
Total fixed charges $ 128 $ 262 $ 353 $ 695 $ 804
EARNINGS:
Earnings before income tax expense $ 948 $ 442 $ 1,737 $ (23) $ 4,875
Undistributed equity in affiliate
earnings -- -- -- -- $ (30)
Fixed charges $ 128 $ 262 $ 353 $ 695 $ 804
Total earnings $ 1,076 $ 704 $ 2,090 $ 672 $ 5,649
Ratio of earnings to fixed charges 8.41x 2.69x 5.92x (2) 7.03x
</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.
(2) Earnings are inadequate to cover fixed charges for the year ended December
31, 1995. The coverage deficiency was $23,000.
<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 500,000 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
and the shares of common stock issued thereunder upon the conversion thereof;
and in the Registration Statement (Form S-8 No. 333-11791) pertaining to the
Service Experts, Inc. 1996 Incentive Stock Plan, Service Experts, Inc. 1996
Non-Employee Director Stock Option Plan, and Service Experts, Inc. 1996 Employee
Stock Purchase Plan, of our report dated December 9, 1997, with respect to the
consolidated financial statements of Service Experts, Inc. and of our report
dated November 14, 1997 with respect to the financial statements of Parrott
Mechanical, Inc. et al. included in this Current Report on Form 8-K dated
January 8, 1998, filed with the Securities and Exchange Commission.
/s/ Ernst & Young LLP
Nashville, Tennessee
January 8, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE YEAR ENDED
DECEMBER 31, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-1-1996
<PERIOD-END> DEC-31-1996
<CASH> 10,806
<SECURITIES> 0
<RECEIVABLES> 13,405
<ALLOWANCES> 773
<INVENTORY> 5,245
<CURRENT-ASSETS> 33,444
<PP&E> 16,229
<DEPRECIATION> 4,976
<TOTAL-ASSETS> 80,170
<CURRENT-LIABILITIES> 20,566
<BONDS> 0
0
0
<COMMON> 116
<OTHER-SE> 55,203
<TOTAL-LIABILITY-AND-EQUITY> 80,170
<SALES> 0
<TOTAL-REVENUES> 74,913
<CGS> 52,628
<TOTAL-COSTS> 70,012
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 613
<INCOME-PRETAX> 4,875
<INCOME-TAX> 1,136
<INCOME-CONTINUING> 3,739
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,739
<EPS-PRIMARY> .74
<EPS-DILUTED> .74
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE NINE MONTHS ENDED
SEPTEMBER 30, 1996 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> JAN-1-1996
<PERIOD-END> SEP-30-1996
<CASH> 14,118
<SECURITIES> 0
<RECEIVABLES> 10,512
<ALLOWANCES> 428
<INVENTORY> 3,292
<CURRENT-ASSETS> 31,641
<PP&E> 16,755
<DEPRECIATION> 7,992
<TOTAL-ASSETS> 42,719
<CURRENT-LIABILITIES> 14,069
<BONDS> 0
0
0
<COMMON> 91
<OTHER-SE> 22,168
<TOTAL-LIABILITY-AND-EQUITY> 42,719
<SALES> 0
<TOTAL-REVENUES> 46,860
<CGS> 33,145
<TOTAL-COSTS> 44,100
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 505
<INCOME-PRETAX> 2,415
<INCOME-TAX> 120
<INCOME-CONTINUING> 2,295
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,295
<EPS-PRIMARY> .71
<EPS-DILUTED> .71
</TABLE>
