<PAGE> 1
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NUMBER: 001-13037
SERVICE EXPERTS, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
DELAWARE 62-1639458
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)
SIX CADILLAC DRIVE, SUITE 400 37027
BRENTWOOD, TENNESSEE (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
</TABLE>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (615) 371-9990
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
<TABLE>
<S> <C>
COMMON STOCK, $.01 PAR VALUE PER SHARE NEW YORK STOCK EXCHANGE
(TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED)
</TABLE>
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
NONE
(TITLE OF CLASS)
Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the shares of Common Stock (based upon the
closing sale price of these shares as reported on the New York Stock Exchange on
March 23, 1999) of the registrant held by non-affiliates on March 23, 1999 was
approximately $173,453,805.
As of March 23, 1999, 17,466,127 shares of the registrant's Common Stock
were outstanding.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 2
DOCUMENTS INCORPORATED BY REFERENCE
Documents incorporated by reference and the part of Form 10-K into which
the document is incorporated:
Portions of the Company's Proxy Statement relating to its Annual Meeting of
Stockholders to be held on May 7, 1999.............................Part III
PART I
ITEM 1. BUSINESS
GENERAL
Service Experts, Inc., a Delaware corporation (the "Company"), was formed
in 1996 and has become one of the leading providers of residential heating,
ventilating and air conditioning ("HVAC") services and replacement equipment in
the United States. As of December 31, 1998, the Company operated 104 HVAC
service and replacement businesses ("Service Centers") in 34 states. The Company
also owns Contractor Success Group, Inc., a company that provides HVAC
businesses proprietary products, as well as marketing, management, educational
and advisory services ("CSG"). The Service Centers install, service and maintain
central air conditioners, furnaces and heat pumps, primarily in existing homes.
Management estimates that approximately 75% of the Company's pro forma net
revenue in 1998, giving effect to all completed Service Center acquisitions, was
related to replacing, maintaining and servicing HVAC equipment at existing
residences, and to the sale of ancillary products such as indoor air quality
("IAQ") devices and services.(1) The Company focuses on the service and
replacement market of the HVAC industry rather than the new construction market
because management believes that the service and replacement market offers
higher margins and exposes the Company to less credit risk. The service and
replacement market offers more attractive pricing because of customers' demands
for immediate, convenient and reliable service.
Management intends to develop national brand recognition of the Service
Experts name through acquisitions and establishing a national reputation for
superior, high quality service which will enable the Company to appeal to a
large number of customers. The Company has implemented an aggressive acquisition
strategy acquiring 43 Service Centers (the "1998 Acquired Service Centers")
during 1998 with aggregate annualized revenue for the year ended December 31,
1998 of approximately $139.4 million. Subsequent to December 31, 1998, the
Company has acquired 18 HVAC businesses, including six Service Centers (the
"1999 Acquired Service Centers"). The aggregate annualized revenue of the 1999
Acquired Service Centers is approximately $16.7 million. The Company's 1998 pro
forma net revenue, giving effect to the acquisition of the 1998 Acquired Service
Centers and the 1999 Acquired Service Centers, was approximately $494.6 million.
HVAC SERVICE AND REPLACEMENT INDUSTRY
The HVAC industry consists of the installation, replacement, maintenance,
service and repair of HVAC systems at existing residences and commercial
businesses and the installation of HVAC systems at newly constructed homes and
businesses. The Company primarily provides installation and replacement services
to existing homes and small to medium-sized businesses.
According to Air Conditioning, Heating and Refrigeration News, there are
approximately 43 million central air conditioners, 54 million furnaces and nine
million heat pumps in operation in homes in the United States. Management
estimates, based on industry information, that the market for the service and
replacement of HVAC systems in existing homes is approximately $24 billion
annually. The installation and replacement segment of the industry has increased
in size as a result of the aging of the installed base of residential systems,
the introduction of new, energy efficient systems and the upgrading of existing
homes to central air conditioning. According to the Air Conditioning and
- ---------------
(1) All references herein to the Company's 1998 pro forma results assume the
completion as of January 1, 1998 of the acquisitions of the Service Centers
being discussed.
2
<PAGE> 3
Refrigeration Institute, over 61 million central air conditioners have been
installed in the United States since 1975. Many of the units installed from the
mid-1970s to the mid-1980s are reaching the end of their useful lives, thus
providing a growing replacement market. In addition, in recent years, increased
governmental regulation restricting the use of ozone depleting refrigerants in
HVAC systems has contributed to the growing replacement market. See
"Regulation."
According to Air Conditioning, Heating, and Refrigeration News, over 30,000
HVAC contractors are currently operating in the United States. Management
believes that HVAC businesses are typically closely held, single-center
operations that serve a limited geographic area and are heavily dependent upon
referrals to generate business. Management believes that, in many cases, these
businesses are operated by former service technicians who lack the business and
marketing expertise to expand their businesses, increase their profitability and
compete effectively with larger operators. Management believes that larger
companies are able to operate more efficiently, offer customers a broader array
of products and services and provide a higher level of customer service than
smaller operators. Management believes that these competitive advantages are the
result of greater managerial and financial resources as well as economies of
scale in purchasing and marketing expenses. Management believes that these
factors will continue to promote a trend toward consolidation in the industry
and present an opportunity for well-capitalized operators to acquire additional
businesses on favorable terms.
ACQUISITIONS
The Company's goal is to become the leading provider of residential HVAC
services and replacement equipment in the United States through the acquisition
of HVAC businesses in new markets, the integration of HVAC businesses in
existing markets and the continued revenue and profit growth of its Service
Centers.
Strategy
The Company has implemented an aggressive acquisition program utilizing a
"hub and spoke" strategy for expansion into new geographic areas and further
penetration into existing markets. The U.S. residential HVAC service industry is
currently highly fragmented. Management believes that many HVAC businesses,
which lack the capital necessary to expand operations and the ability to exit
their business profitably, will desire to affiliate with the Company because the
Company provides (i) business and marketing systems that enable a company to
operate more profitably, (ii) the opportunity to increase the operator's focus
on customer service rather than administration, (iii) the potential for national
name recognition and (iv) the opportunity for the owner to gain liquidity while,
in some cases, continuing to manage the operations of the business.
Expanding Geographic Presence through Hub Acquisitions. The Company plans
to continue to make "hub" acquisitions of existing HVAC businesses in new
markets that are not being served by the Company. Management targets for
acquisition HVAC businesses that operate successfully in the Company's targeted
markets. Typically, these businesses have annual net revenue ranging from $1.0
million to $10.0 million. In evaluating such acquisitions, the Company considers
candidates that are in attractive markets, financially stable, experienced in
the industry and characterized by strong management. A hub acquisition becomes a
Service Center of the Company.
Expanding Market Penetration of Hubs through the Acquisition of Other HVAC
Businesses. The Company expects to increase market share through "spoke"
acquisitions of other HVAC businesses that have large customer bases and that
present opportunities to leverage overhead or dispose of fixed assets to improve
profitability. The Company plans to integrate the operations of such businesses
into the operations of existing hubs in order to leverage overhead costs and
sell redundant assets and consolidate operations within existing areas served by
the Company.
3
<PAGE> 4
Recent Acquisitions
During 1998, the Company acquired 106 HVAC businesses (the "1998 Acquired
Companies"). The consideration paid by the Company for the 1998 Acquired
Companies was approximately $110.1 million, consisting of approximately 1.8
million shares of Common Stock, $56.3 million in cash, warrants to purchase
107,500 shares of Common Stock and $6.2 million in notes convertible into shares
of Common Stock. One of the transactions (the "1998 Pooled Company") was
accounted for using the pooling of interests method, and the remainder were
accounted for using the purchase method. The 1998 Pooled Company together with
Custom Air Conditioning, Inc. and Freschi Air Systems, Inc., two companies
acquired in 1996 and accounted for using the pooling of interests method, and C.
Iapaluccio Company, Inc., Hawk Heating & Air Conditioning, Inc., TML, Inc.,
Parrott Mechanical, Inc. and McAlister Heat & Air, Inc., five companies acquired
in 1997, all of which were accounted for using the pooling of interests method,
are sometimes referred to collectively as the "Pooled Companies." Of the
consideration paid for the 1998 Acquired Companies, $85.5 million was allocated
to intangible assets which are to be amortized over a 40-year period.
Subsequent to December 31, 1998, the Company has acquired 18 HVAC
businesses, including six Service Centers, for an aggregate consideration of
approximately $13.0 million, consisting of approximately $4.5 million in notes
convertible into shares of Common Stock and approximately $8.5 million in cash.
All of the 1999 Acquired Service Centers were accounted for using the purchase
method. Of the consideration paid for the 1999 Acquired Service Centers, $8.5
million was allocated to intangible assets which are to be amortized over a
40-year period.
The Company's acquisitions during 1998 expanded the geographic coverage of
the Company by providing entry to the Arizona, Colorado, New Jersey, New Mexico,
Pennsylvania and Virginia markets and increasing the Company's market presence
in California, Florida, Georgia, Missouri, Oklahoma and Tennessee. The Company
now operates 104 Service Centers in 34 states.
OPERATING STRATEGY
Management believes that successful implementation of the Company's
operating strategy will enable it to establish a national reputation for
superior, high quality service. By developing a national reputation, management
believes the Company will appeal to a large number of customers who are familiar
with and rely upon a large, national company. The Company's operating strategy
incorporates the methods developed by CSG and Ron Smith and Associates, a
subsidiary of the Company providing support services, and capitalizes on the
efficiencies resulting from the integration of those methods, systems, and
disciplines in its Service Centers. The key elements of the Company's operating
strategy are as follows:
Providing Superior, High Quality Service in a Professional Manner. The
Service Centers seek to provide high quality service at a competitive price and
in a friendly, professional manner. In order to provide such service, service
technicians, maintenance technicians and installers employed by the Company
complete comprehensive training programs designed to teach employees the
Company's operating procedures and customer relations. These training programs
are developed by experienced managers and consultants of the Company who provide
detailed instructions in areas such as residential replacement sales and
servicing equipment. Training programs in other areas such as preventive
maintenance agreements and IAQ products are currently under development. The
Company has standardized policies and operating procedures intended to result in
a uniform level of professional, high quality service, including installation
and maintenance procedures, random drug-testing of employees, the technician's
appearance and the use of "Carpet Saver" shoe coverings when inside a customer's
home. Substantially all of the Service Centers utilize a flat rate billing
system that advises the customer of the cost of service before work begins and
charges the quoted price regardless of the actual time necessary to repair the
system. The Service Centers are generally open for business from 7:00 a.m. to
7:00 p.m. on weekdays, and most are open on Saturday from 7:00 a.m. to 4:00 p.m.
Management believes that by providing evening and Saturday service, in addition
to 24 hour
4
<PAGE> 5
emergency service, the Service Centers are able to better accommodate customers
than most of their competitors.
Increasing Revenue at Service Centers. The Company actively promotes its
maintenance agreements to both new and existing customers. See "Service
Centers -- Maintenance and Service Agreements." The sale of maintenance
agreements not only generates recurring revenue through the payment of fees, but
also helps the Company develop a committed, loyal customer base and provides the
opportunity for cross-marketing of the Company's other services and products.
The Company offers a wide assortment of financing packages designed to enable
customers to purchase equipment and services from the Company in the most
convenient and cost-effective manner possible. Certain Service Centers also
offer their customers a Professional Courtesy credit card solely for use in
purchasing equipment and services from the Company. This financing, including
the Professional Courtesy credit card, is offered through a number of third
party lenders. Pursuant to its arrangements with such financing companies, the
Company receives an origination fee based on the amount financed, but does not
bear any credit risk from such financing.
The Service Centers utilize a variety of local print advertising and
targeted marketing promotions, some of which are designed by the Company's
marketing department, including maintenance technician referrals, service
technician referrals, yellow page listings and direct mail campaigns followed up
by telemarketing. During the off-peak spring and fall months, the Service
Centers aggressively market products and services which generate revenue during
such months and help to offset increased demand historically experienced in the
summer and winter months. In 1998, advertising and marketing expenditures (net
of marketing expenditures by manufacturers) were 3.4% as a percentage of the
Company's net revenue.
As technology has improved, HVAC businesses have begun to utilize equipment
that monitors the levels of certain harmful substances in the air of a
customer's home. The Company's Service Centers offer and actively promote a
number of IAQ services and products designed to detect and correct unhealthy air
quality that management believes are not available from most HVAC contractors.
Among these services are duct cleaning, fresh air ventilation and heat recovery
systems, ultraviolet light processes and the sale and installation of ozonators.
Achieving Operating Efficiencies. Manufacturers of HVAC equipment have
historically offered more favorable prices and rebates to high volume
purchasers. Since the Company's initial public offering (the "IPO"), the Company
has consolidated certain functions, including the purchase of insurance, the
leasing of service vehicles, the negotiation of inventory purchasing contracts,
the provision of legal support and the utilization of trainers in the areas of
marketing and IAQ products and services. The Company intends to review the
desirability of consolidating other functions, including national marketing.
The Company has implemented a uniform system of budgets, forecasts, reports
and financial controls, including an electronic mail system, for its Service
Centers. In addition, each of the Service Centers generates and provides to the
Company a daily management report of revenue and certain billing and collection
data.
Attracting and Retaining Quality Employees. Management believes the
Service Centers attract and retain quality employees by providing (i) an
environment that emphasizes professionalism and customer satisfaction and (ii)
extensive training that allows employees to advance to higher-earning positions.
The Company has established a bonus program for each Service Center pursuant to
which managers may earn bonuses based on the performance of the Service Center
and the Company relative to established goals set by the Service Center's
general manager and the Company. The Service Centers generally are operated by
managers who are trained in the CSG operating methods and procedures and who
management believes are better educated than a typical HVAC service business
operator.
5
<PAGE> 6
Potential employees of most Service Centers must pass extensive interviews
and background checks, where permitted, as well as technical tests prior to
being hired. Service technicians, maintenance technicians and installers
employed by the Company are required to complete training programs designed to
teach employees the Company's operating procedures. These training programs are
conducted both at the Service Centers and at CSG sponsored seminars. The Company
has implemented training programs relating to marketing and IAQ products that
are conducted at Service Centers by the Company's corporate trainers. Management
believes that these programs have resulted in a low rate of employee turnover.
See "Contractor Success Group."
CONTRACTOR SUCCESS GROUP
CSG, a wholly-owned subsidiary of the Company, was formed in 1991 to offer
HVAC companies (including subsidiaries of the Company) proprietary products and
marketing, management, educational and advisory services not available from
industry trade associations. Currently, there are approximately 260 members
(including 104 subsidiaries of the Company) of CSG serving distinct market areas
in the United States defined primarily by zip codes. CSG offers its members a
competitive edge over other contractors in the market by teaching useful
management and technical skills and providing training programs and other
proprietary products. In exchange, CSG members pay an initial fee upon joining
CSG and a monthly fee thereafter. In 1998, CSG generated fees totaling
approximately $3.1 million ($0.8 million of which was from subsidiaries of the
Company). CSG members are granted exclusive rights to the territory in which
they operate. Although the Company has acquired 67 CSG members since its
formation, other HVAC companies have joined CSG. The Company intends to continue
to build and expand the CSG membership.
CSG licenses to its members copyrighted training manuals that cover in
specific detail the aspects of owning and operating an HVAC service and
replacement company, including residential replacement sales, residential
maintenance, service contracts, residential installation, business planning and
service dispatch. In addition, CSG members receive materials and attend
conferences regarding methods and procedures for the operation of an efficient,
profitable HVAC company, including (i) daily report forms designed to provide
accurate and timely sales and cost information essential to determining the
performance of an HVAC business, (ii) "Scorecard," a monthly report distributed
to CSG members comparing top producers among members, (iii) contracts and forms,
including sales and service contracts and non-competition agreements for
employees, (iv) marketing promotions that are tested and proven with specific
instructions on how to tailor advertising for the member's market and (v)
quarterly projects introducing CSG members to new products and services designed
to increase productivity.
Seminars and Services
Potential CSG subscribers are invited to attend an informational seminar
where they are introduced to the CSG concept and are invited to join the
organization. Upon paying the initial fee, CSG subscribers attend four two-day
workshops conducted by CSG. At these workshops, HVAC contractors are educated on
all aspects of operating an HVAC service and replacement business. Attendees
receive presentations and materials that explain in specific detail the methods
and procedures successfully utilized by CSG members. Topics covered include
administration, sales, service, advertising, direct marketing, maintenance,
service contracts, acquisitions and accounting. CSG members may also attend
"Success Convention," which is a quarterly two-day convention of CSG members
designed to allow the members to compare ideas and projects and at which
quarterly projects are presented, and "Sales Extravaganza," which is an annual
convention designed to encourage and motivate a member's salespeople, selling
technicians and telemarketers.
Future University
In connection with the acquisition of its Service Centers, the Company has
acquired approximately 47% of the issued and outstanding common stock of Future
University, Inc. ("Future
6
<PAGE> 7
University(R)"). The remaining shares of Future University Common Stock are held
by a number of CSG members and their shareholders. Future University is a
corporation formed in 1991 that offers to CSG members (including subsidiaries of
the Company), for an additional enrollment fee, technical and operational
educational programs designed to improve the profitability of the CSG member's
business. The technical programs offer installers and technicians a combination
of classroom and on-the-job training during one and two week sessions.
Technicians receive skills training that will enable them to effectively analyze
customer problems and offer efficient solutions. In the maintenance training
classes, for example, technicians are trained to maximize the operating
efficiency of HVAC systems, assure safe operation of systems and reduce the
chances of future breakdowns. In the sales training classes, technicians are
trained to deal with customer expectations, use and promote various products and
services, develop leads, explain financing programs and improve on various
customer relations skills. In sending technicians to the Future University
program, CSG members are able to develop a high level of commitment in their
employees. The technical programs are held in Little Rock, Arkansas under an
exclusive licensing arrangement with Hardwick Air Masters, Inc., one of the
Company's Service Centers. The operational programs offer general managers and
salespeople a variety of classes covering residential sales training,
replacement sales, marketing and promotions, telemarketing and general
operations. In January 1999, the Company began implementing internal training
programs in lieu of sending Company employees to Future University. The Company
does not plan to send its employees to Future University in the future.
SERVICE CENTERS
General
Management estimates that during 1998 the Service Centers' service and
maintenance technicians responded to approximately one million maintenance,
repair and service calls. The services offered by each Service Center include
(i) the sale of replacement central air conditioners, furnaces and heat pumps,
(ii) the maintenance and repair of HVAC units, (iii) diagnostic analysis of the
condition of existing units and (iv) the sale of ancillary products such as IAQ
devices and monitors. Most of the Service Centers employ an in-house sales force
that sells replacement units, installation technicians who install replacement
equipment in existing homes, service technicians who service and maintain the
equipment, and an administrative staff to perform dispatching, purchasing and
other administrative functions. In addition, some of the Service Centers offer
plumbing services. Management believes that in 1998 the installation and
servicing of plumbing systems represented less than 3% of the Company's pro
forma net revenue. The Company anticipates that these Service Centers will
continue to offer, and that Service Centers acquired in the future may offer,
plumbing services, but currently does not intend to expand this business.
Most of the Service Centers' technicians are trained to promote the
Company's preventive maintenance agreements and to cross-market IAQ equipment
and other ancillary services and products offered by the Company. Service
technicians are trained to perform service and maintenance in a professional
manner, to identify problems with existing HVAC systems and to offer customers
the most practical, cost-effective solution to their problem, whether that
involves repairing the existing system or suggesting a replacement system or
part. Often this involves providing customers with information on products to
upgrade their system and improve efficiency as well as informing them about the
advantages and disadvantages of a particular product or service. Maintenance
technicians perform routine maintenance examinations of HVAC systems in an
effort to keep the systems in working order and to identify potential problems
before they become too costly to correct.
Management believes that most HVAC contractors charge the cost of the
materials and the hourly rate for the actual time it takes to install or repair
the system. In contrast, the Company utilizes a flat rate pricing system that
advises the customer of the cost of service for the particular job before work
begins and charges the quoted price regardless of the time necessary to repair
the system. While this may result in parts, labor and other costs incurred in
repairing a customer's system exceeding the quoted price from time to time, the
Company is able to alter its pricing on a per job basis. The
7
<PAGE> 8
Company's experience is that customers generally prefer this pricing method
because it eliminates surprise or hidden costs. This pricing method also creates
an incentive for the Company to hire quality technicians and to provide them
with the training necessary to service customer needs efficiently.
Sale of Replacement Units
The replacement market for residential HVAC equipment is dependent upon the
base of installed units, the mechanical life and usage of the equipment and
technological advances in the efficiency of newer units. Management believes the
replacement market for HVAC units offers the potential for growth given the
number of HVAC systems that will need replacement in the future. The market for
replacement units is highly fragmented, with no single manufacturer dominating
the market. In order to service the replacement market, the Company maintains
relationships with several national, regional and local manufacturers of
replacement units in order to offer a wide variety of products to its customers.
The Company maintains a preferred vendor program (the "Preferred Vendor
Program") pursuant to which the Company has established strategic relationships
with selected vendors. The Company encourages its Service Centers to use these
preferred vendors which offer discounts and rebates to the Service Centers. The
Company provides the retail customer with a warranty on parts and labor ranging
from one to ten years from the date of installation of the HVAC unit. This
warranty generally runs concurrent with the manufacturer's warranty on parts for
the first year and for five to ten years on the compressor and heat exchanger.
At the time of sale, a customer is offered a wide assortment of financing
packages by the Service Center. A Service Center's installers and technicians,
in addition to the salespeople, are trained to educate customers as to the
financing options available, assist the customer in completing the credit
application forms and determine whether the customer's financing is approved.
Certain Service Centers also offer their customers a Professional Courtesy
credit card solely for use in purchasing equipment and services from the
Company. Such financing, including the Professional Courtesy credit card, is
offered through a number of third party lenders. Pursuant to its arrangements
with such financing companies, the Company receives an origination fee based on
the amount financed, but does not bear any credit risk from such financing.
Maintenance and Service Agreements
The Company currently has approximately 190,000 maintenance agreements with
customers. These agreements are generally for a term of one to three years and
generally provide for two diagnostic and precision maintenance visits during the
year at an average cost to the customer of approximately $135 per year. The sale
of maintenance agreements not only generates recurring revenue through the
payment of fees, but also helps the Company develop a committed, loyal customer
base and provides the opportunity for cross-marketing of the Company's other
services and products. Management believes that customers with maintenance
agreements are among the Company's most satisfied customers because of the many
benefits offered by these agreements, including (i) energy savings resulting
from a more efficient HVAC system, (ii) fewer and less costly emergency repairs,
(iii) longer useful life for the HVAC system, (iv) discounted rates for service
and (v) guaranteed same-day service in the event of an emergency repair.
Maintenance agreements also allow the Company to more fully utilize its
technicians during the historically slower spring and fall months by scheduling
maintenance appointments during such time. Because systems under maintenance
agreements are less likely to require emergency repairs, the Service Centers are
able to provide more prompt service to emergency and new service calls.
The Company's service agreements are generally for a term of one year and
provide for the repair of any problem with the customer's system at no
additional cost to the customer. Pursuant to the terms of the service
agreements, if the cost of repair exceeds the value of the customer's HVAC
system, the Company is not required to repair the system, and the customer
receives a discount on the purchase of a replacement unit from the Company. In
some states, warranties provided for in the Company's service agreements may be
deemed insurance contracts by applicable state insurance regulatory
8
<PAGE> 9
agencies, thereby subjecting the Company and the service agreements to the
insurance laws and regulations of any such state. In such states, the Company
insures its service agreements through licensed insurers. Management believes
that the Company has made adequate provision for potential claims under these
agreements. See "Regulation."
Commercial Service and Replacement
Some of the Service Centers offer HVAC services to small and medium-sized
businesses. In 1998, non-residential revenue generated from the provision of
services and sale of products, including those related to commercial, electrical
and plumbing services and products, represented approximately 25% of the
Company's pro forma net revenue. The Service Centers target restaurants, small
office buildings, warehouses and theaters as potential prospects for their
commercial services. The Company's commercial sales representatives receive
extensive training designed to enable the representatives to promote the
Company's services and products effectively. The services offered to commercial
customers are generally the same as services offered to residential customers,
including the analysis, maintenance and repair of existing HVAC systems, the
sale of replacement systems and the sale of ancillary products, including IAQ
devices and services. While management does not plan to develop further its
commercial HVAC business beyond existing operations given the potential for
growth in the residential service and replacement market, the Company intends to
continue to provide, and may acquire Service Centers that provide, commercial
HVAC services.
SERVICES AND OPERATIONS
The Company, through SEI Management Company, LLC ("SEI Management
Company"), provides management, financial and accounting support services for
all of the Service Centers' operations, as well as insurance coverage and
certain marketing and legal support. SEI Management Company personnel provide
certain financial control support, including budgets, forecasts and reports,
while allowing each general manager of a Service Center to manage its day-to-day
operations. SEI Management Company has continued to add various management and
staff personnel to provide support services for the Service Centers and to
facilitate the acquisition of additional HVAC businesses.
The Company provides the following services to its Service Centers:
Purchasing
Each Service Center generally purchases the HVAC units, parts and
supplies it uses from distributors. The Company's Preferred Vendor Program
was designed to ensure competitive prices and services at the local level
and to reduce certain administrative and operational costs of the Company.
At each Service Center, the general manager has the freedom to determine
the best suppliers of products for the customer. The Company has developed
a strategic relationship with several vendors and requests that the Service
Centers support them when practical. The benefits available to the Service
Centers by utilizing this select list of vendors are significant, and
although the Preferred Vendor Program is voluntary, it is widely used in
most of the Service Centers. The Preferred Vendor Program offers several
recognized national brands in manufacturing including The Trane Company,
Lennox Industries, Inc., Amana and Carrier Corporation, and distribution
channels including Pameco Corp., Hughes Supply, Inc., Johnstone Supply and
R.E. Michel Co., Inc.
Management Information Systems
The Service Centers currently utilize various management and financial
information systems. The Company is in the process of converting the
majority of the Service Centers' current systems to an integrated system.
The implementation of an integrated system will allow the Company to
maintain greater control over the operations of its Service Centers. The
Company tracks
9
<PAGE> 10
important data related to the Service Centers' operations and financial
performance and monitors all advertising expenditures. In addition, the
Service Centers generate and provide to the Company a daily management
report of revenue information and certain billing and collection data.
Employee Screening and Training
Prior to employment, potential employees of the Company are tested to
determine their technical expertise. In addition, as permitted by local
law, employees of the Company are required to pass a drug test prior to
employment and are thereafter subject to random drug testing. Failure to
take or pass a drug test may result in immediate termination of employment.
Once hired, employees of the Company generally complete various training
programs covering technical skills and communication and sales techniques.
In addition, employees periodically attend educational seminars and
conventions conducted by CSG. See "Contractor Success Group." The Company
has established training programs relating to marketing and IAQ products
that are conducted at the Company's Service Centers.
Advertising and Marketing
The Company's advertising and marketing programs are designed to
attract new customers and to stimulate increased demand from existing
customers. Each Service Center, generally utilizing materials produced by
CSG, develops customized marketing programs tailored to meet the needs of
its local customer base. Emphasizing superior, high quality service, the
Service Centers market directly to prospective and existing customers
through various means, including local print advertising, yellow page
listings and direct mail campaigns followed up by telemarketing. In 1998,
advertising and marketing expenditures (net of marketing expenditures by
manufacturers) were 3.4% as a percentage of the Company's net revenue. The
Company intends, over time, to develop the Service Experts name as a key
element of its marketing strategy. As a part of this strategy, management
has begun and gradually will continue to integrate the Company's name and
logo in advertising while continuing to utilize established local brand
names.
REGULATION
HVAC systems are subject to various environmental statutes and regulations,
including, but not limited to, laws and regulations implementing the Clean Air
Act, as amended (the "Clean Air Act"), relating to minimum energy efficiency
standards of HVAC systems and the production, servicing and disposal of certain
ozone depleting refrigerants used in such systems. The Company's Service Centers
are also subject to various federal, state and local environmental regulations,
including, but not limited to, laws and regulations governing the generation of
hazardous substances and maintenance of underground storage tanks. In connection
with the entry into new markets, the Company may become subject to compliance
with additional regulations. Although, there can be no assurance that the
regulatory environment in which the Company operates will not change
significantly in the future, compliance with existing regulatory requirements
has not had a material effect on the Company.
Various local, state and federal laws and regulations, including, but not
limited to, laws and regulations implementing the Clean Air Act, impose
licensing standards on technicians who service HVAC units. While the installers
and technicians employed by the Service Centers are duly certified by applicable
local, state and federal agencies and have been able to meet or exceed such
standards to date, there can be no assurance that they will be able to meet
stricter future standards. In addition, installers must comply with local
building codes when installing HVAC units in residences and commercial
buildings.
In some states, warranties provided for in the Company's service agreements
may be deemed insurance contracts by applicable state insurance regulatory
agencies, thereby subjecting the Company and the service agreements to the
insurance laws and regulations of any such state.
10
<PAGE> 11
TRADEMARKS
"Service Experts" is registered as a federal trademark with the United
States Patent and Trademark Office. The Company currently licenses the Service
Experts name and logo to two companies that are members of CSG. The Company owns
and licenses numerous proprietary products used by the Service Centers and other
CSG members. See "Contractor Success Group." In addition, the Company owns
approximately 47% of the issued and outstanding common stock of "Future
University," which is registered as a federal trademark with the United States
Patent and Trademark Office. See "Contractor Success Group -- Future
University." The Company regards its trademarks as having significant value and
being an important factor in the development and marketing of its operations.
The Company's policy is to pursue registration of its trademarks whenever
possible and to oppose vigorously any infringement of its trademarks.
COMPETITION
The HVAC service and replacement industry is highly competitive in each of
the markets in which the Company operates. The Company's Service Centers compete
with utility companies and other full-service HVAC businesses primarily on the
basis of quality, reliability, customer service and price. Some of these
companies have access to capital, personnel, marketing and technological
resources that are equal to or greater than those of the Company. Certain of
these companies are pursuing a consolidation strategy in the industry and
compete with the Company for potential acquisitions as well as for customers.
Because of the fragmented nature of the industry and relative low barriers to
entry, additional competitors, including companies that offer other home
improvement services in addition to HVAC services, may emerge that have greater
access than the Company to capital, personnel, marketing and technological
resources.
EMPLOYEES
Management estimates that the Company currently has approximately 4,500
employees, all but approximately 100 of who are employed at Service Centers.
None of the Company's employees is represented by a collective bargaining
agreement.
INSURANCE
The Company maintains general liability, workers compensation, property,
employment practices liability and director and officer insurance. The costs of
insurance coverage vary, and the availability of certain coverage has fluctuated
in recent years. While management believes, based upon its claims experience,
that the Company's present insurance coverage is adequate for its current
operations, there can be no assurance that the coverage is sufficient for all
future claims or will continue to be available in adequate amounts or at
reasonable rates.
ITEM 2. PROPERTIES
The Company currently occupies the building and underlying real estate on
which all but six of its Service Centers are located pursuant to leases
primarily with various stockholders of the Company on terms generally ranging
from five to ten years and on terms the Company believes to be commercially
reasonable. Total rental expense for the Company's leased centers, including
certain leased vehicles and equipment, in 1998 was approximately $5.9 million,
of which $3.0 million was to related parties. The Company purchased the building
and underlying real estate on which six of its Service Centers are located. The
Company generally plans to continue to lease rather than purchase space for the
Service Centers to maximize the Company's available capital.
SEI Management Company, the Company's management services provider,
maintains its corporate headquarters in approximately 20,000 square feet of
space in Brentwood, Tennessee. This operating lease is for a term of five years
expiring on April 30, 2003.
11
<PAGE> 12
ITEM 3. LEGAL PROCEEDINGS
The Company does not have any material litigation. The Company and its
Service Centers currently, and from time to time, are parties to litigation or
administrative proceedings which arise in the normal course of their business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the stockholders during the fourth
quarter ended December 31, 1998.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table sets forth the reported high and low sales prices of
the Common Stock for the quarters indicated as reported on the Nasdaq National
Market and the New York Stock Exchange. The Company completed its IPO on August
16, 1996 at a price per share of $13.00. The Common Stock was traded on the
Nasdaq National Market under the symbol "SERX" from the Company's IPO on August
16, 1996 until June 6, 1997. The Common Stock is currently traded on the New
York Stock Exchange under the symbol "SVE."
<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1997
First Quarter.............................................. $28.25 $21.25
Second Quarter............................................. 30.25 21.25
Third Quarter.............................................. 30.38 24.38
Fourth Quarter............................................. 30.38 24.63
1998
First Quarter.............................................. $31.44 $25.75
Second Quarter............................................. 34.50 30.69
Third Quarter.............................................. 37.13 20.63
Fourth Quarter............................................. 32.38 22.00
1999
First Quarter (through March 23, 1999)..................... $29.06 $10.00
</TABLE>
On March 23, 1999, the last reported sale price of the Common Stock was
$10.50 per share. As of March 23, 1999, there were approximately 395 holders of
record of the Company's Common Stock.
Since the IPO, the Company has not declared or paid dividends on its Common
Stock. The Company expects that future earnings will be retained to finance the
growth and development of the Company's business and, accordingly, does not
intend to declare or pay any dividends on the Common Stock for the foreseeable
future. The declaration, payment and amount of future dividends, if any, will be
subject to the discretion of the Company's Board of Directors and will depend
upon the future earnings, results of operations, financial condition and capital
requirements of the Company, among other factors. Under Delaware law, the
Company is prohibited from paying any dividends unless it has capital surplus or
net profits available for this purpose. In addition, the Company's credit
facilities impose restrictions on the ability of the Company to pay dividends.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
From time to time, the Company issues subordinated notes convertible into
shares of the Company's Common Stock in connection with the acquisition of HVAC
service and replacement businesses. The subordinated notes are convertible into
shares of the Company's Common Stock at conversion prices ranging from 140% to
200% of the average market price of the Common Stock for the five trading days
preceding the date the note is issued. The Company has issued convertible
12
<PAGE> 13
subordinated notes and the shares of Common Stock issued upon conversion of
notes, pursuant to the Company's shelf Registration Statement on Form S-4
(Registration No. 333-12319) (the "Shelf Registration Statement") and in
transactions intended to be exempt from the registration requirements of the
Securities Act of 1933, as amended, pursuant to Sections 3(a)(11), 3(b) or 4(2)
thereunder. In the future, the Company intends to issue convertible subordinated
notes and the shares of Common Stock issued upon conversion primarily pursuant
to the Shelf Registration Statement.
For the year ended December 31, 1998, the Company issued convertible
subordinated notes bearing interest at rates ranging from 4.51% to 5.54% in an
aggregate principal amount of approximately $6.2 million.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table presents selected consolidated financial data of the
Company. The Company was incorporated on March 27, 1996. As a result of the
adoption of Securities and Exchange Commission ("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 eight subsequent
acquisitions accounted for as poolings of interests. 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 HVAC replacement and service businesses and CSG (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 acquirer
entity in this transaction in accordance with SAB 97. The operations of the
Predecessor 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 Commission Staff Accounting Bulletin No. 48 ("SAB 48"). The
following should be read with the consolidated financial statements and notes
thereto appearing elsewhere herein.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF INCOME DATA:
Net revenue.................................... $54,535 $59,754 $85,184 $248,110 $407,835
Cost of goods sold............................. 41,704 46,820 61,405 161,281 261,670
------- ------- ------- -------- --------
Gross margin................................... 12,831 12,934 23,779 86,829 146,165
Selling, general and administrative expenses... 10,985 12,255 18,837 62,103 104,627
------- ------- ------- -------- --------
Income from operations......................... 1,846 679 4,942 24,726 41,538
Other income (expense)......................... (214) (428) (117) 599 (2,853)
------- ------- ------- -------- --------
Income before federal and state income taxes... 1,632 251 4,825 25,325 38,685
Provision for income tax expense............... 325 240 1,104 9,380 15,260
------- ------- ------- -------- --------
Net income..................................... $ 1,307 $ 11 $ 3,721 $ 15,945 $ 23,425
======= ======= ======= ======== ========
Pro forma net income(1)........................ $ 932 $ 207 $ 3,180 $ 15,315 $ 23,028
======= ======= ======= ======== ========
</TABLE>
13
<PAGE> 14
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
Net income per share:
Basic........................................ $ .50 $ .00 $ .68 $ 1.08 $ 1.39
======= ======= ======= ======== ========
Diluted...................................... $ .50 $ .00 $ .67 $ 1.07 $ 1.37
======= ======= ======= ======== ========
Pro forma net income per share:
Basic........................................ $ .36 $ .08 $ .58 $ 1.04 $ 1.36
======= ======= ======= ======== ========
Diluted...................................... $ .36 $ .08 $ .58 $ 1.03 $ 1.35
======= ======= ======= ======== ========
Weighted average shares outstanding:
Basic........................................ 2,601 2,601 5,491 14,774 16,875
======= ======= ======= ======== ========
Diluted...................................... 2,601 2,601 5,520 14,922 17,068
======= ======= ======= ======== ========
</TABLE>
- ---------------
(1) Reflects a pro forma tax adjustment on income of the Acquiring Company and
Pooled Companies previously taxed as Subchapter S corporations.
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital................................ $ 879 $ 531 $12,756 $ 35,696 $ 83,037
Total assets................................... 15,638 20,697 83,398 198,210 356,555
Total debt..................................... 4,887 8,899 6,928 16,579 109,172
Stockholders' equity........................... 4,501 4,094 56,059 143,807 206,382
</TABLE>
ITEM 7. 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 approximately 4.5
million shares of Common Stock and approximately $18.7 million in cash. No
intangible assets were recorded as a result of the Combination because of the
accounting treatment in accordance with SAB 48.
As of December 31, 1998, the Company had acquired 194 HVAC businesses and
one consulting business (the "Acquired Companies") since the IPO, of which 92
are Service Centers. The consideration paid by the Company for the Acquired
Companies was approximately $255.7 million, consisting of approximately 6.8
million shares of Common Stock, warrants to purchase 307,500 shares of Common
Stock, $6.2 million in notes convertible into shares of Common Stock and
approximately $101.9 million in cash. Eight of the Acquired Companies were
accounted for using the pooling of interests method, and the remainder were
accounted for using the purchase method. Approximately $196.6 million of the
consideration paid by the Company 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.
14
<PAGE> 15
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
acquirer 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 the Pooled Companies) 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 and certain
fringe benefits in connection with the acquisitions.
COMPONENTS OF INCOME
Net revenue of the Acquired Companies has been derived primarily from the
installation, service and maintenance of central air conditioners, furnaces and
heat pumps in existing homes and commercial businesses. 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,
legal and professional fees, insurance expense and promotion and advertising
expenses.
PREFERRED VENDOR PROGRAM
The Company's Preferred Vendor Program was designed to ensure competitive
prices and services at the local level and to reduce certain administrative and
operational costs of the Company. At each Service Center, the general manager
has the freedom to determine the best suppliers of products for the customer.
The Company has developed a strategic relationship with several vendors and
requests that the Service Centers support them when practical. The benefits
available to the Service Centers by utilizing this select list of vendors are
significant, and although the Preferred Vendor Program is voluntary, it is
widely used in most of the Service Centers.
RESULTS OF OPERATIONS
Because of the significant effect and timing of acquisitions and the
anticipated effect of future acquisitions on the Company's results of
operations, the Company's historical results of operations and period-to-period
comparisons will not be indicative of future results and may not be meaningful.
The Company plans to continue acquiring HVAC businesses in the future. The
integration of acquired HVAC businesses 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.
15
<PAGE> 16
The following table sets forth certain selected financial data and
percentages of net revenue for the periods indicated:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------------------
1996 1997 1998
------------- -------------- --------------
(IN MILLIONS)
<S> <C> <C> <C> <C> <C> <C>
Net revenue............................ $85.2 100.0% $248.1 100.0% $407.8 100.0%
Cost of goods sold..................... 61.4 72.1 161.3 65.0 261.7 64.2
----- ----- ------ ----- ------ -----
Gross margin........................... 23.8 27.9 86.8 35.0 146.1 35.8
Selling, general and administrative
expenses............................. 18.9 22.1 62.1 25.0 104.6 25.6
----- ----- ------ ----- ------ -----
Income from operations................. $ 4.9 5.8% $ 24.7 10.0% $ 41.5 10.2%
===== ===== ====== ===== ====== =====
</TABLE>
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
Net Revenue. Net revenue increased $159.7 million, or 64.4%, from $248.1
million for the year ended December 31, 1997 to $407.8 million for the year
ended December 31, 1998. Approximately $15.7 million of the increase is
attributable to an increase in revenue from Service Centers reporting for 12
months in both periods, approximately $71.0 million of the increase is
attributable to Service Centers acquired in 1997 reporting results for a full
year in 1998 and approximately $72.0 million of the increase is attributable to
the 1998 Acquired Service Centers.
Cost of Goods Sold. Cost of goods sold increased $100.4 million, or 62.2%,
from $161.3 million for the year ended December 31, 1997 to $261.7 million for
the year ended December 31, 1998. As a percentage of net revenue, cost of goods
sold decreased from 65.0% for the year ended December 31, 1997 to 64.2% for the
year ended December 31, 1998. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on more profitable products and a $2.5
million decrease in the cost of equipment and supplies as a result of the
Preferred Vendor Program.
Gross Margin. Gross margin increased $59.3 million, or 68.3%, from $86.8
million for the year ended December 31, 1997 to $146.1 million for the year
ended December 31, 1998. As a percentage of net revenue, gross margin increased
from 35.0% for the year ended December 31, 1997 to 35.8% for the year ended
December 31, 1998. The increase in gross margin as a percentage of net revenue
is primarily attributable to the inclusion of 106 companies acquired in 1998 and
the reduction in costs as a result of the Preferred Vendor Program.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $42.5 million, or 68.5%, from $62.1 million
for the year ended December 31, 1997 to $104.6 million for the year ended
December 31, 1998. This increase is attributable to the inclusion of 106
companies acquired in 1998, a $4.7 million increase in depreciation and
amortization expense, a $2.6 million increase in corporate payroll expense, a
$1.4 million increase in the provision for bad debts and a $1.0 million increase
in information system consulting expenses during the year. As a percentage of
net revenue, selling, general and administrative expenses increased from 25.0%
for the year ended December 31, 1997 to 25.6% for the year ended December 31,
1998.
Income from Operations. Income from operations increased $16.8 million
from $24.7 million for the year ended December 31, 1997 to $41.5 million for the
year ended December 31, 1998. Income from operations as a percentage of net
revenue increased from 10.0% in 1997 to 10.2% in 1998 as a result of the factors
mentioned above.
Other Income (Expense). Other expense for the year ended December 31, 1998
was $2.8 million as compared to $0.6 million of other income for the year ended
December 31, 1997, representing an increase in other expense of $3.4 million.
The increase is attributable to an increase in interest expense incurred as a
result of increased borrowings primarily on the line of credit and senior
unsecured notes.
16
<PAGE> 17
Provision for Income Taxes. The Company's effective tax rate of 39.4% for
the year ended December 31, 1998 differed from the federal statutory rate of 35%
primarily as a result of goodwill amortization, portions of which are not
deductible for federal income tax purposes, and offset by income of a Subchapter
S corporation accounted for using the pooling of interests method which is not
subject to federal income tax, and state income taxes. The effective tax rate of
37% for the year ended December 31, 1997 differed from the federal statutory
rate of 35% primarily as a result of state income taxes, goodwill amortization,
portions of which are not deductible for federal income tax purposes, and offset
by income of Subchapter S corporations accounted for using the pooling of
interests method which is not subject to federal income tax.
YEAR ENDED DECEMBER 31, 1997 COMPARED TO YEAR ENDED DECEMBER 31, 1996
Net Revenue. Net revenue increased $162.9 million, or 191.3%, from $85.2
million for the year ended December 31, 1996 to $248.1 million for the year
ended December 31, 1997. Approximately $6.9 million of the increase is
attributable to an increase in revenue from Service Centers reporting for 12
months in both periods, approximately $107.1 million of the increase is
attributable to Service Centers acquired in 1996 reporting results for a full
year in 1997 and approximately $47.6 million of the increase is attributable to
Service Centers acquired in 1997.
Cost of Goods Sold. Cost of goods sold increased $99.9 million, or 162.7%,
from $61.4 million for the year ended December 31, 1996 to $161.3 million for
the year ended December 31, 1997. As a percentage of net revenue, cost of goods
sold decreased from 72.1% for the year ended December 31, 1996 to 65.0% for the
year ended December 31, 1997. The decrease as a percentage of net revenue was
primarily attributable to an emphasis on more profitable products, the inclusion
of the Predecessor Companies and the December 1996 acquisitions for a full year,
the inclusion of the 66 companies acquired in 1997 and a $1.8 million decrease
in the cost of equipment and supplies as a result of the Preferred Vendor
Program.
Gross Margin. Gross margin increased $63.0 million, or 265.1%, from $23.8
million for the year ended December 31, 1996 to $86.8 million for the year ended
December 31, 1997. As a percentage of net revenue, gross margin increased from
27.9% for the year ended December 31, 1996 to 35.0% for the year ended December
31, 1997. The increase as a percentage of net revenue was primarily attributable
to an emphasis on more profitable products, the inclusion of the Predecessor
Companies and the December 1996 acquisitions for a full year, the inclusion of
the 66 companies acquired in 1997 and a $1.8 million decrease in the cost of
equipment and supplies as a result of the Preferred Vendor Program.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses increased $43.2 million, or 229.7%, from $18.9 million
for the year ended December 31, 1996 to $62.1 million for the year ended
December 31, 1997. This increase is attributable to the inclusion of 66
companies acquired in 1997, a $1.8 million increase in amortization expense and
an increase in management personnel during the year. As a percentage of net
revenue, selling, general and administrative expenses increased from 22.1% for
the year ended December 31, 1996 to 25.0% for the year ended December 31, 1997
as a result of the factors mentioned above.
Income from Operations. Income from operations increased $19.8 million
from $4.9 million for the year ended December 31, 1996 to $24.7 million for the
year ended December 31, 1997. Income from operations as a percentage of net
revenue increased from 5.8% in 1996 to 10.0% in 1997 as a result of the factors
mentioned above.
Other Income (Expense). Other income for the year ended December 31, 1997
was $.6 million as compared to $0.1 million of other expense for the year ended
December 31, 1996. The increase is attributable to an increase in interest and
other income.
Provision for Income Taxes. The Company's effective tax rate of 37% for
the year ended December 31, 1997 differed from the federal statutory rate of 35%
primarily as a result of state income
17
<PAGE> 18
taxes, goodwill amortization, portions of which are not deductible for federal
income tax purposes, and offset by income of Subchapter S corporations accounted
for using the pooling of interests method which is not subject to federal income
tax. The effective tax rate of 22.9% for the year ended December 31, 1996
differed from the federal statutory rate of 34% primarily as a result of state
income taxes, offset by the effect of income of Subchapter S corporations
accounted for using the pooling of interests method which is not subject to
federal income tax, the effect of graduated tax rates utilized by the
Predecessor Companies and the benefit recorded upon the termination of the
Subchapter S election of the Acquiring Company.
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 and capital expenditures.
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 HVAC
businesses, that the Company can integrate such new HVAC businesses into the
Company's operations or that the Company's new HVAC businesses will generate
sales revenue or profit margins consistent with those of the Company's existing
HVAC businesses.
The Company currently has a $100.0 million unsecured revolving credit
facility with a banking syndication available through April 30, 2001 (the
"Credit Facility"), of which $49.6 million was outstanding at December 31, 1998
and $69.1 million was outstanding at March 23, 1999. At December 31, 1998, $50.4
million was available under the Credit Facility. Borrowings under the Credit
Facility bear interest at either (i) the higher of the agent's base lending rate
or the federal funds rate plus one-half of one percent per annum or (ii) a
variable rate equal to the 30, 60, 90 or 180-day LIBOR, as such rates change
from time to time, plus a variable margin of from 62.5 to 150 basis points
depending on the Company's funded debt to EBITDA ratio determined on a quarterly
basis, at the election of the Company. All of the Company's subsidiaries have
guaranteed the repayment of indebtedness under the Credit Facility. The Credit
Facility contains covenants with respect to (i) the maintenance of certain
financial ratios and specified net worth, (ii) the limitation of (A) the
aggregate outstanding principal balance of the Senior Notes (as defined below)
to $75.0 million and (B) the aggregate outstanding principal balance of any debt
issued by the Company directly to sellers of acquired HVAC businesses to $50.0
million, (iii) the sale of substantial assets, consolidations or mergers by the
Company and (iv) the payment of dividends. Based on the Company's total funded
debt to pro forma EBITDA ratio at December 31, 1998, the Company is limited to
the incurrence of an additional $75.4 million of debt in the aggregate.
On June 23, 1998, the Company issued $32.5 million of 6.97% senior
unsecured notes, due June 15, 2003, and $17.5 million of 7.13% senior unsecured
notes, due June 15, 2005 (collectively, the "Senior Notes"), in a private
placement to a group of institutional investors. The Senior Notes provide for
interest to be paid on December 15 and June 15 of each year, with principal due
at maturity. All of the Company's subsidiaries have guaranteed the repayment of
the Senior Notes. The Note Purchase Agreement, pursuant to which the Senior
Notes were issued, contains covenants with respect to maintaining certain
financial ratios and specified net worth and limiting the incurrence of
additional indebtedness and the sale of substantial assets, consolidations or
mergers by the Company.
During 1998, the Company issued convertible subordinated notes (the
"Notes") totaling approximately $6,164,000 as consideration in certain
acquisitions. Principal is payable in four equal annual installments beginning
one year from the date of issuance. Interest, at an average rate of 4.85%
(ranging from 4.51% to 5.54%), is payable quarterly. The Notes are convertible,
at the option of the
18
<PAGE> 19
holder, into the Company's Common Stock at any time, at an average conversion
price of $36.70 per share (ranging from $31.56 to $42.09), subject to adjustment
in certain events. If the closing sales price of a share of Common Stock exceeds
the conversion price for five consecutive trading days, the Company may elect to
convert the Notes into shares of Common Stock at the conversion price.
For the year ended December 31, 1998, net cash used in operations was $15.6
million compared to cash provided by operations of $13.9 million for the year
ended December 31, 1997. The primary reasons for the $15.6 million in net cash
used in operations were a $16.5 million increase in accounts receivable, a $12.2
million increase in inventory, an $11.1 million decrease in accounts payable and
accrued liabilities and a $2.8 million increase in refundable income taxes. The
increase in inventory is primarily attributable to the effect of bulk inventory
purchases made directly from the manufacturers during 1998. These purchases
generally bypass the distribution channel thereby allowing manufacturers to
offer the Company rebate and cash discount incentives for its participation in
these programs when offered. In addition to the increase in inventory on hand,
the bulk purchases have the effect of reducing accounts payable as payment is
due when inventory is received. The Company has determined that the reduced
costs realized through these bulk purchases more than offset the carrying cost
of the additional inventory and the reduction in payment terms. The $16.5
million increase in accounts receivable for the year ended December 31, 1998 is
primarily attributable to the increase of light commercial revenue during the
year and to a $4.1 million increase in rebate receivables. Most rebates are paid
to the Company on an annual basis although some payment terms are quarterly. The
increase in refundable income taxes was attributable to state and local tax
expense being lower than expected which resulted in an over payment of taxes.
For the year ended December 31, 1998, net cash used in investing activities
was $73.0 million as compared to $50.9 million for the year ended December 31,
1997. The increase in the use of cash for investing activities is attributable
to the payment of $65.6 million to purchase HVAC businesses and the purchase of
$12.4 million of property, plant and equipment additions. For the year ended
December 31, 1997, net cash used in investing activities was $50.9 million
compared to $16.4 million for the year ended December 31, 1996. The increase in
the use of cash for investing activities is attributable to the payment of $46.6
million for the purchase of HVAC businesses and the purchase of $10.0 million of
property, plant and equipment.
For the year ended December 31, 1998, net cash provided by financing
activities was $85.8 million as compared to $37.5 million for the year ended
December 31, 1997. The increase in cash provided by financing activities is
primarily attributable to the issuance of $50.0 million of Senior Notes and a
$34.1 million increase in the Credit Facility as compared to a $15.5 million
increase in the Credit Facility and the issuance of $38.0 million of Common
Stock to acquire HVAC businesses in 1997. For the year ended December 31, 1997,
net cash provided by financing activities was $37.5 million as compared to $25.1
million for the year ended December 31, 1996. The increase in cash provided by
financing activities is primarily attributable to a $15.5 million increase in
the Credit Facility and the issuance of $38.0 million of Common Stock to acquire
HVAC businesses in 1997 as compared to the issuance of $28.1 million of Common
Stock to acquire HVAC businesses in 1996.
The Company currently has on file with the Commission 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 convertible into shares of
Common Stock in connection with acquisitions.
Management believes that the Company's existing cash balances and available
borrowings will be sufficient to fund the Company's operating needs,
acquisitions, 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. Prior to September 1998,
such acquisitions were predominantly funded by issuing shares of Common Stock
and cash. Since September 1998, the Company has used convertible subordinated
notes and cash to fund its acquisitions. Future acquisi-
19
<PAGE> 20
tions could be effected using Common Stock, warrants, debt securities or cash.
Although the Company believes that its financial resources will enable it to
consider potential acquisitions, should the Company's actual results of
operations fall short of, or its rate of expansion significantly exceed, its
plans, or should its costs or capital expenditures exceed expectations, the
Company may need to seek additional financing in the future. In negotiating such
financing, there can be no assurance that the Company will be able to raise
additional capital on terms satisfactory to the Company. Failure to obtain
additional financing on reasonable terms could have a negative effect on the
Company's plans to acquire additional HVAC businesses.
NEWLY ISSUED ACCOUNTING STANDARDS
In 1998, the Company adopted a new disclosure pronouncement, Statement of
Financial Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive
Income." SFAS No. 130 establishes new rules for the reporting and display of
comprehensive income and its components. SFAS No. 130 requires unrealized gains
or losses on the Company's available-for-sale securities to be included in other
comprehensive income. The adoption of SFAS No. 130 had no effect on
stockholders' equity as previously reported, and comprehensive income was the
same as net income for the year ended December 31, 1996 and 1997.
The Company also adopted another new disclosure pronouncement, SFAS No.
131, "Disclosures About Segments of an Enterprise and Related Information." SFAS
No. 131 requires companies to report selected segment information when certain
size tests are met. Management has determined that the Company operates in only
one reportable segment meeting the applicable tests.
The Company adopted Statement of Position ("SOP") 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal Use," earlier than
required. SOP 98-1 requires capitalization of certain costs to purchase or
develop internal-use software, and the amortization of these costs over the
estimated useful life of the software. During 1998, the Company capitalized
approximately $2.5 million of purchased internal-use software and development
costs. These costs are included in furniture and fixtures. In years prior to
1998, the Company did not incur significant software development costs. Costs
related to software developed for internal use will be amortized using the
straight-line method over an estimated two and five year life.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is
required to be adopted by the Company in 2000. Management does not anticipate
that the adoption of SFAS No. 133 will have a significant effect on the
financial position or results of operations of the Company.
IMPACT OF YEAR 2000
The following disclosure is designated as Year 2000 readiness disclosure
for purposes of the Year 2000 Information and Readiness Disclosure Act.
Many computer systems in use today were designed and developed using two
digits, rather than four, to specify the year. As a result, such systems will
recognize the Year 2000 as "00" and may assume that the year is 1900 rather than
2000. This could cause many computer applications to fail completely or to
create erroneous results unless corrective measures are taken. The Company
recognizes the need to minimize the risk that its operations will be adversely
affected by Year 2000 software failures and is in the process of preparing for
the Year 2000.
The Company has evaluated its Year 2000 risk in three separate categories:
information technology systems ("IT"), non-IT systems ("Non-IT") and material
third party relationships. The Company has
20
<PAGE> 21
developed a plan in which the risks in each of these categories are being
reviewed and addressed by the appropriate level of management as follows:
IT. The Company is actively engaged in developing and installing new
financial, information and operational systems which are expected to be
completed and installed in all Service Centers. The Company's new financial,
information and operational systems have been installed at the SEI Management
Company support center and in certain Service Centers. Two modules of the
Company's new financial system currently being installed are not Year 2000
compliant. Modifications are being made on these modules and management expects
that these modifications will be completed by July 1999. The Company is
prioritizing the installation of its new systems at Service Centers which are
not Year 2000 compliant to minimize its IT risk. In connection with this
implementation, system programs have been designed so that the Year 2000 will be
recognized as a valid date and will not affect the processing of date-sensitive
information. Current systems in place at various Service Centers that have not
installed the Company's new financial, information and operational systems are
being evaluated for Year 2000 compliance, and the assessment efforts are 90%
complete. In certain situations, current systems may need to be upgraded to Year
2000 compliant versions or replaced with the new financial, information and
operational systems. Management believes that all upgrades and replacements
necessary to ensure Year 2000 readiness of IT systems for currently owned
Service Centers will be completed by September 1999.
Non-IT. Non-IT systems involve embedded technologies, such as
microcontrollers or microprocessors. Examples of Non-IT systems include
telephones, time clocks and security systems. Management believes the Company's
Non-IT risks are minimal. The Company is in the process of performing an
inventory and assessment of the embedded systems at the Service Centers and SEI
Management Company support center. The assessment effort is scheduled to be
completed by September 1999, and the Company expects to complete any required
upgrade or replacement of Non-IT systems by October 1999. This actual completion
date may be affected by the number of non-Year 2000 ready embedded systems
identified during the assessment. The Company is not able to reasonably estimate
the costs to be incurred for the review and modification of the Company's Non-IT
systems as it has not completed its inventory and assessment.
The Company plans to acquire additional Service Centers during 1999. Each
new Service Center will be assessed for Year 2000 readiness, and the Company
expects that any required IT or Non-IT system upgrades or replacements will be
made before January 1, 2000.
Third Party Risk. The Company's review of its third party risk includes
detailed review of material relationships with vendors and certain business
partners. To operate its business, the Company relies upon government agencies,
utility companies, providers of telecommunication services, suppliers and other
third party service providers ("Material Relationships"), over which it can
assert little control. The Company's ability to conduct its core business is
dependent upon the ability of these Material Relationships to fix their Year
2000 issues to the extent they affect the Company. The Company is monitoring and
assessing the progress of its Material Relationships to determine whether they
will be able to successfully interact with the Company in the Year 2000. The
Company has contacted and received oral or written responses from approximately
50% of its Material Relationships and is currently awaiting responses from the
remainder of its Material Relationships. The majority of the responses received
indicate that the vendors are Year 2000 compliant. The Company expects to
complete its Year 2000 readiness assessment of its Material Relationships by
June 1999.
If the steps taken by the Company and its Material Relationships to be Year
2000 compliant are not successful, the Company would likely experience various
operational difficulties resulting in a material adverse effect upon the
Company's financial condition and results of operations. These could include,
among other things, processing transactions to an incorrect accounting period,
difficulties in posting general ledger entries, inability to service customers
and lapses of service by vendors. If the Company's plan to install new systems
which effectively address the Year 2000 issue is not successfully or timely
implemented, the Company may need to devote more resources to the process, and
21
<PAGE> 22
additional costs may be incurred. Management believes that the Year 2000 issue
is being appropriately addressed through the implementation of these new systems
and software development or the upgrade of current systems in place and by its
Material Relationships. Management does not expect the Year 2000 issue to have a
material adverse effect on the financial position, results of operations or cash
flows of the Company in future periods. The Company's forward-looking statements
regarding Year 2000 issues are dependent on many factors, including the ability
of the Company's vendors to achieve Year 2000 compliance, the proper functioning
of the new IT and Non-IT systems installed by the Company, the integration of
such systems and the development of software, some of which are beyond the
Company's control.
Through March 15, 1999, the Company has incurred approximately $450,000 of
systems and related costs that address Year 2000 compliance. The Company expects
to spend an additional $790,000 to complete its Year 2000 compliance plans. The
Company expenses costs associated with Year 2000 system changes as the costs are
incurred.
The costs of Year 2000 compliance and the date on which the Company
believes it will complete the project are based on management's best estimates,
which were derived utilizing numerous assumptions of future events, including
the continued availability of certain resources, third party modification plans
and other factors. However, there can be no guarantee that these estimates will
be achieved and actual results could differ materially from those anticipated.
Specific factors that might cause such material differences include, but are not
limited to, the availability and cost of personnel trained in this area,
supplier compliance and contingency actions and similar uncertainties. The
Company's total Year 2000 project costs do not include the estimated costs and
time associated with anticipated third party Year 2000 issues based on presently
available information.
The Company's Year 2000 contingency plan, although still in development,
addresses recovery solutions for Year 2000 related issues which may be
encountered by the Company. The contingency plan will mitigate the effects
arising from the most likely Year 2000 scenarios, based on current information
available to the Company. These scenarios could include the Company's failure to
complete all of its remediation plans in a timely manner or any third parties'
failure to deliver goods and services essential to the Company's business.
Management expects development of the contingency plan to conclude during the
second quarter.
INFLATION
The HVAC industry is labor intensive. Wages and other expenses increase
during periods of inflation and when shortages in marketplaces occur. In
addition, suppliers pass along rising costs to the Company in the form of higher
prices. The Company has generally been able to offset increases in operating
costs by increasing charges, expanding services and implementing cost control
measures to curb such increases. The Company cannot predict its ability to
offset or control future cost increases.
RISK FACTORS
This report contains forward-looking statements regarding our business and
industry. Such statements include the successful integration of the businesses
of our subsidiaries, the availability of additional HVAC businesses for
acquisition, the adequacy of our capital resources and other statements
regarding trends relating to the HVAC industry and various revenue and expense
items. Many factors, including the uncertainties described below, could cause
actual results to differ materially from those discussed in the forward-looking
statements made in this report.
BECAUSE WE HAVE ONLY BEEN OPERATING SINCE 1996 AS NOW STRUCTURED, WE MAY
ENCOUNTER DIFFICULTIES IN INTEGRATING ACQUIRED BUSINESSES AND MANAGING OUR
GROWTH.
The Company was incorporated in March 1996. We completed the acquisition
of our first 13 businesses simultaneously with the completion of our initial
public offering on August 21, 1996. Since the initial public offering, we have
acquired 92 additional Service Centers. We have a limited history
22
<PAGE> 23
operating as a combined entity, and therefore we cannot assure you that we will
be able to integrate the acquired businesses or that we will be able to operate
profitably in the future. We may not be able to manage our growth effectively.
Failure to do so would have a material adverse effect on our net revenue and
earnings.
OUR GROWTH DEPENDS ON OUR ABILITY TO IDENTIFY, ACQUIRE AND INTEGRATE HVAC
BUSINESSES AND OUR ABILITY TO FINANCE ACQUISITIONS.
The success of our acquisition strategy depends on a number of factors,
including:
- our ability to locate and negotiate the acquisition of HVAC businesses,
- our ability to successfully integrate the operations of acquired HVAC
businesses into our operations, and
- the availability of adequate financing to develop or acquire additional
HVAC businesses.
In addition, we compete with other HVAC and residential service companies
for desirable acquisition candidates. Some of these companies have greater
resources and other competitive advantages. Our capital needs over the next
several years, primarily for acquisitions, will likely exceed capital generated
from our operations. Consequently, we plan to incur indebtedness and to
occasionally issue additional debt or equity securities to finance future
acquisitions. If our common stock does not maintain a sufficient market value,
or potential acquisition candidates are not willing to accept stock or notes as
part of the consideration for the sale of their businesses, we may have to use
more cash, if available, to maintain our acquisition program. We cannot assure
you that our acquisition strategy will be successful, that we will not change
our strategy or that we will be able to finance the development or acquisition
of additional HVAC service businesses.
DELAYS OR FAILURES TO DEVELOP, IMPLEMENT AND INTEGRATE OUR OPERATING SYSTEMS
COULD ADVERSELY AFFECT OUR BUSINESS.
As a rapidly growing provider of HVAC services, we must develop, implement
and integrate company-wide policies and systems. Our existing subsidiaries and
any companies we acquire in the future may need to modify systems and policies
they have used in the past in order to conform to our systems and policies. We
are implementing a uniform computer system and electronic mail system at each of
the Service Centers. We have established and integrated certain other
information and operating systems and procedures for the Service Centers,
including uniform purchasing and centralized marketing programs. We will
continue to review other areas of our business for opportunities to increase
efficiencies. We may experience delays, complications and expenses in
implementing, integrating and operating these systems, any of which could have a
material adverse effect on our operations, net revenue and earnings.
COMPETITION IN THE HVAC INDUSTRY COULD ADVERSELY AFFECT OUR OPERATIONS AND OUR
ABILITY TO ACQUIRE HVAC BUSINESSES.
The HVAC service and replacement industry is highly competitive. Our
Service Centers compete with other full-service HVAC businesses primarily in the
areas of quality, reliability, customer service and price. Several companies
have been organized to acquire businesses that offer HVAC services. Some
competitors, including utility companies, have financial, personnel, marketing
and technological resources greater than ours. Additionally, the HVAC industry
is fragmented, and there are relatively low barriers to entry. Therefore
additional competitors, including companies that offer other home improvement
services in addition to HVAC services, may emerge with greater competitive
advantages. We may not be able to compete successfully and may encounter
significant competition in our efforts to achieve our growth objectives.
23
<PAGE> 24
THE LOSS OF KEY EXECUTIVES WOULD ADVERSELY AFFECT OUR BUSINESS.
Our success depends on the continued services of our senior management,
particularly our Chairman, President and Chief Executive Officer, Alan R.
Sielbeck. If Mr. Sielbeck or any of our senior management is ever unable or
unwilling to continue in their present positions, our business will be
materially adversely affected.
LABOR SHORTAGES COULD ADVERSELY AFFECT OUR BUSINESS.
The ability of our Service Centers to provide timely, high-quality service
requires an adequate supply of skilled labor. In addition, high turnover in
skilled positions may adversely affect the operating costs of each Service
Center. Accordingly, our ability to increase productivity and net earnings
depends upon our ability to employ the skilled laborers necessary to meet our
service requirements. We cannot assure you that we will be able to maintain the
skilled labor force necessary to operate our Service Centers efficiently, or
that our labor expenses will not increase because of a shortage of skilled
workers.
WEATHER PATTERNS COULD ADVERSELY AFFECT OUR BUSINESS.
The HVAC service industry generally experiences increased demand during the
summer and winter months. These seasonal trends may, in certain periods, affect
our business. Extended periods of unseasonably mild or wet weather may cause
unpredictable fluctuations in operating results. If the HVAC service and
replacement industry experiences future declines, our business may be affected
adversely.
FAILURE TO COMPLY WITH ENVIRONMENTAL STATUTES AND REGULATIONS COULD ADVERSELY
AFFECT OUR BUSINESS.
Various environmental statutes and regulations, including those
implementing the Clean Air Act, apply to HVAC systems and our Service Centers.
These laws and regulations relate to minimum energy efficiency standards of HVAC
systems and the production, servicing and disposal of certain ozone depleting
refrigerants used in such systems. Laws regulating the production or management
of hazardous or petroleum substances and the maintenance of underground storage
tanks also apply to us. Additionally, the regulatory environment in which we
operate may change significantly in the future.
Various local, state and federal laws and regulations, including those
implementing the Clean Air Act, impose licensing standards on technicians who
service HVAC units. While the installers and technicians employed by the Service
Centers are duly certified by applicable local, state and federal agencies and
have been able to meet or exceed these standards to date, we cannot be sure that
they will meet future standards.
In some states, insurance regulatory agencies may consider warranties in
our service agreements to be insurance contracts.
ANTI-TAKEOVER PROVISIONS COULD MAKE AN ACQUISITION OF OUR COMPANY MORE
DIFFICULT.
Certain provisions of our Restated Certificate of Incorporation and Bylaws
and Delaware law may make a change in the control of our business more difficult
to accomplish, even if a change in control were in the stockholders' interest.
Section 203 of the Delaware General Corporation Law prevents an "interested
stockholder" from engaging in a "business combination" with our company for
three years after that person became an interested stockholder unless certain
conditions, including approval by the Board of Directors, are met.
Our Restated Certificate and Bylaws include certain provisions that may
make a change in control more difficult. For example, certain actions require a
vote of greater than a majority of the common stock. In addition, the Board may
determine the terms of preferred stock that may be issued without approval of
the holders of common stock. The Board's ability to issue preferred stock in
this manner could prevent changes in management and control of our business.
Pursuant to the Restated
24
<PAGE> 25
Certificate, we have three classes of directors, who are elected for staggered
three-year terms. These staggered terms may affect the ability of the
stockholders to change control of our business.
Certain provisions of the employment agreements with our executive officers
may make a change in control more difficult. Under these employment agreements,
we must pay each executive officer severance pay upon a change in control equal
to three times the officer's annual base salary and three times the officer's
average bonus for the preceding two years. In addition, all awards granted to an
executive officer under our stock incentive plans will become exerciseable, and
the executive officer will continue to enjoy benefits under our benefit plans
for three years.
OUR QUARTERLY OPERATING RESULTS AND GENERAL ECONOMIC CONDITIONS COULD
ADVERSELY AFFECT THE MARKET PRICE OF OUR COMMON STOCK.
Occasionally, the market price of the common stock may fluctuate
significantly. Developments that could cause this fluctuation include:
- quarterly operating results,
- changes in earnings estimated by analysts, or
- changes in general conditions in the economy or the financial markets.
Additionally, in recent years, the stock market has fluctuated
significantly in terms of price and volume. This volatility has had a
significant effect on the market prices of securities issued by many companies
for reasons unrelated to their operating performance.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to market risk from changes in interest rates and
changes in the market value of its investments. Management does not believe that
it has any foreign currency exchange rate risk or commodity price risk.
INTEREST RATES
As of December 31, 1998, the Company had both fixed rate and variable rate
debt.
Debt instruments with both fixed and variable interest rates carry a degree
of interest rate risk. Fixed rate debt may have its fair value adversely
affected if interest rates decline, and variable rate debt may incur a higher
cost if interest rates rise.
At December 31, 1998, the fair value of the Company's total fixed rate debt
was estimated to be $50.1 million based on the Company's current incremental
borrowing rate for similar types of borrowing arrangements. At this borrowing
level, a hypothetical 10% adverse change in interest rates on the fixed rate
debt would decrease the fair value of the debt by approximately $1.6 million.
The amount was determined by considering the effect of the hypothetical interest
rate decrease on the Company's borrowing cost at the December 31, 1998 borrowing
level.
At December 31, 1998, the fair value of the Company's total variable rate
debt was estimated to be $59.2 million, which approximated carrying value based
on the Company's current incremental borrowing rates for similar types of
borrowing arrangements. At this borrowing level, a hypothetical 10% adverse
change in interest rates on the variable rate debt would increase interest
expense and decrease income before income taxes by approximately $300,000. The
amount was determined by considering the impact of the hypothetical interest
rate increase on the Company's borrowing cost at the December 31, 1998 borrowing
level.
INVESTMENTS
The Company holds investments in a publicly traded stock. Accordingly, the
Company recognizes that there is a risk associated with such investments. The
risk to the Company includes all those risks
25
<PAGE> 26
associated with investments in the stock markets, including losses associated
with volatile movements within the stock markets.
At December 31, 1998, the fair value of the Company's investments in a
publicly traded stock was $962,000 based on the quoted closing market price. A
hypothetical 10% adverse change in the quoted market price would decrease the
fair value by $96,000.
The above market risk discussion and the estimated amounts presented are
forward-looking statements of market risk assuming the occurrence of certain
adverse market conditions. Actual results in the future may differ materially
from those projected as a result of actual developments in the market.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Appendix A.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
26
<PAGE> 27
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
EXECUTIVE OFFICERS
Information with respect to the executive officers of the Company is
incorporated by reference to the information contained under the caption
"Executive Compensation -- Executive Officers of the Company" included in the
Company's Proxy Statement relating to its Annual Meeting of Stockholders to be
held on May 7, 1999.
DIRECTORS
Information with respect to the Company's directors is incorporated by
reference to the information contained under the caption "Election of Directors"
included in the Company's Proxy Statement relating to its Annual Meeting of
Stockholders to be held on May 7, 1999.
COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT
Information with respect to compliance with Section 16(a) of the Securities
Exchange Act of 1934 is incorporated by reference to the information contained
under the heading "Section 16(a) Beneficial Ownership Reporting Compliance"
included in the Company's Proxy Statement relating to its Annual Meeting of
Stockholders to be held on May 7, 1999.
ITEM 11. EXECUTIVE COMPENSATION
This information is incorporated by reference to the information contained
under the heading "Executive Compensation" included in the Company's Proxy
Statement relating to its Annual Meeting of Stockholders to be held on May 7,
1999, except that the Comparative Performance Graph and the Compensation
Committee Report on Executive Compensation included in the Proxy Statement are
expressly not incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
This information is incorporated by reference to the information contained
under the caption "Voting Securities and Principal Holders Thereof" included in
the Company's Proxy Statement relating to its Annual Meeting of Stockholders to
be held on May 7, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
This information is incorporated by reference to the information contained
under the caption "Certain Relationships and Related Transactions" included in
the Company's Proxy Statement relating to its Annual Meeting of Stockholders to
be held on May 7, 1999.
27
<PAGE> 28
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Index to Consolidated Financial Statements, Financial Statement
Schedules and Exhibits:
(1) CONSOLIDATED FINANCIAL STATEMENTS: See Item 8 herein.
The Consolidated Financial Statements of the Company required to be
included in Part II, Item 8, are indexed on Page A-1 and submitted as a
separate section of this report.
(2) CONSOLIDATED FINANCIAL STATEMENT SCHEDULES:
All schedules are omitted, because they are not applicable or not
required, or because the required information is included in the
consolidated financial statements or notes thereto.
(3) EXHIBITS
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4.1 -- Form of Common Stock Certificate
4.2 -- Note Purchase Agreement, dated as of June 1, 1998, among the
Registrant and the Purchasers named therein (including a
form of Senior Note and form of Subsidiary Guaranty)(b)
4.3 -- Form of Convertible Subordinated Note (for unregistered
Notes)(c)
4.4 -- Indenture, dated as of February 2, 1999, by the Company to
SunTrust Bank, Nashville, N.A., as Trustee(d)
4.5 -- First Supplemental Indenture, dated as of February 2, 1999,
by the Company to SunTrust Bank, Nashville, N.A., as
Trustee(d)
4.6 -- Form of Convertible Subordinated Note (for registered
Notes)(d)
10.1 -- Registrant's 1996 Incentive Stock Plan(a)
10.2 -- Amendment No. 1 to Registrant's 1996 Incentive Stock Plan(e)
10.3 -- Amendment No. 2 to Registrant's 1996 Incentive Stock Plan(e)
10.4 -- Amendment No. 3 to Registrant's 1996 Incentive Stock Plan
10.5 -- Registrant's 1996 Non-Employee Director Stock Option Plan(a)
10.6 -- Registrant's 1996 Employee Stock Purchase Plan(a)
10.7 -- Amendment No. 1 to Registrant's 1996 Employee Stock Purchase
Plan(e)
10.8 -- Amendment No. 2 to Registrant's 1996 Employee Stock Purchase
Plan(e)
10.9 -- Amendment No. 3 to Registrant's 1996 Employee Stock Purchase
Plan
10.10 -- Registrant's 1997 Nonqualified Stock Option Plan(f)
10.11 -- Amendment No. 1 to Registrant's 1997 Nonqualified Stock
Option Plan
10.12 -- Registrant's 1997 Nonqualified Stock Purchase Plan(f)
10.13 -- Amendment No. 1 to Registrant's 1997 Nonqualified Stock
Purchase Plan(e)
10.14 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Alan R. Sielbeck
10.15 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Anthony M. Schofield
</TABLE>
28
<PAGE> 29
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
10.16 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Alfred W. Taylor III
10.17 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Ronald L. Smith
10.18 -- Second Amended and Restated Credit Agreement, dated April
28, 1998, between the Registrant and SunTrust Bank,
Nashville, N.A., as agent for the lenders(b)
10.19 -- First Amendment to Second Amended and Restated Credit
Agreement, dated September 30, 1998, between the Registrant
and SunTrust Bank, Nashville, N.A., as agent for the
lenders(c)
10.20 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(f)
10.21 -- Form of Stock Purchase Agreement between the former
stockholders of certain of the Registrant's subsidiaries and
the Registrant(g)
21 -- List of subsidiaries of the Registrant
23 -- Consent of Ernst & Young LLP
27.1 -- Financial Data Schedule for the Year Ended December 31, 1998
(for SEC use only)
27.2 -- Restated Financial Data Schedule for the Year Ended December
31, 1997 (for SEC use only)
27.3 -- Restated Financial Data Schedule for the Six Months Ended
June 30, 1997 (for SEC use only)
27.4 -- Restated Financial Data Schedule for the Three Months Ended
March 31, 1997 (for SEC use only)
27.5 -- Restated Financial Data Schedule for the Year Ended December
31, 1996 (for SEC use only)
27.6 -- Restated Financial Data Schedule for the Nine Months Ended
September 30, 1996 (for SEC use only)
</TABLE>
- ---------------
(a) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-l, Registration No. 333-07037.
(b) Incorporated by reference to the exhibits filed with the Registrant's
Quarterly Report on Form 10-Q for the three months ended June 30, 1998, File
No. 001-13037.
(c) Incorporated by reference to the exhibits filed with the Registrant's
Quarterly Report on Form 10-Q for the three months ended September 30, 1998,
File No. 001-13037.
(d) Incorporated by reference to the exhibits filed with the Registrant's
Current Report on Form 8-K, dated February 5, 1999.
(e) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-8, Registration No. 333-59711.
(f) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-4, File No. 333-12319.
(g) Incorporated by reference to the exhibits filed with the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997, File No.
001-13037.
29
<PAGE> 30
EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS
The following is a list of all executive compensation plans and
arrangements filed as exhibits to this Annual Report on Form 10-K:
1. Registrant's 1996 Incentive Stock Plan, as amended (filed as
Exhibit 10.1 through 10.4)
2. Registrant's 1996 Non-Employee Director Stock Option Plan (filed
as Exhibit 10.5)
3. Registrant's 1996 Employee Stock Purchase Plan, as amended (filed
as Exhibit 10.6 through 10.9)
4. Registrant's 1997 Nonqualified Stock Option Plan, as amended
(filed as Exhibit 10.10 through 10.11)
5. Registrant's 1997 Nonqualified Stock Purchase Plan, as amended
(filed as Exhibit 10.12 through 10.13)
6. Employment Agreement, dated October 26, 1998, between the Company
and Alan R. Sielbeck (filed as Exhibit 10.14)
7. Employment Agreement, dated October 26, 1998, between the Company
and Anthony M. Schofield (filed as Exhibit 10.15)
8. Employment Agreement, dated October 26, 1998, between the
Registrant and Alfred W. Taylor III (filed as Exhibit 10.16)
9. Employment Agreement, dated October 26, 1998, between the
Registrant and Ronald L. Smith (filed as Exhibit 10.17)
(b) Reports on Form 8-K
The Company filed a Current Report on Form 8-K on November 19, 1998
containing the financial statements of Dodge Heating and Air Conditioning, Inc.,
DH&A, Inc. and Climate Design Systems, Inc. and pro forma financial statements
pursuant to Item 5 of Form 8-K. The Company also filed a Current Report on Form
8-K on November 24, 1998 reporting combined operating results for the month of
October 1998 for the Company and Dodge Heating and Air Conditioning, Inc. and
DH&A, Inc. pursuant to Item 5 of Form 8-K. In addition, the Company filed a
Current Report on Form 8-K on December 21, 1998 containing the financial
statements of Midland Heating and Air Conditioning, Inc., Strand Brothers, Inc.,
Ben Peer Heating, Inc. and Womack-O'Bannon & Choco, Inc. and pro forma financial
statements pursuant to Item 5 of Form 8-K.
30
<PAGE> 31
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Nashville, State of Tennessee, on March 23, 1999.
SERVICE EXPERTS, INC.
By: /s/ ALAN R. SIELBECK
------------------------------------
Alan R. Sielbeck
Chairman, President and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed by the following persons on behalf of the Registrant in
the capacities and on the date indicated.
<TABLE>
<CAPTION>
NAME TITLE DATE
---- ----- ----
<C> <S> <C>
/s/ ALAN R. SIELBECK Chairman, President and March 23, 1999
- --------------------------------------------------- Chief Executive Officer
Alan R. Sielbeck (principal executive
officer)
/s/ ANTHONY M. SCHOFIELD Chief Financial March 23, 1999
- --------------------------------------------------- Officer, Secretary and
Anthony M. Schofield Treasurer
/s/ ALLEN L. HOVIOUS Director March 23, 1999
- ---------------------------------------------------
Allen L. Hovious
/s/ RAYMOND J. DE RIGGI Director March 23, 1999
- ---------------------------------------------------
Raymond J. De Riggi
/s/ NORMAN T. ROLF, JR. Director March 23, 1999
- ---------------------------------------------------
Norman T. Rolf, Jr.
/s/ WILLIAM G. ROTH Director March 23, 1999
- ---------------------------------------------------
William G. Roth
/s/ TIMOTHY G. WALLACE Director March 23, 1999
- ---------------------------------------------------
Timothy G. Wallace
</TABLE>
31
<PAGE> 32
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
SERVICE EXPERTS, INC. -- AUDITED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
Report of Independent Auditors.............................. A-2
Consolidated Balance Sheets................................. A-3
Consolidated Statements of Income........................... A-4
Consolidated Statements of Stockholders' Equity............. A-5
Consolidated Statements of Cash Flows....................... A-6
Notes to Consolidated Financial Statements.................. A-7
</TABLE>
A-1
<PAGE> 33
REPORT OF INDEPENDENT AUDITORS
The Stockholders
Service Experts, Inc.
We have audited the accompanying consolidated balance sheets of Service
Experts, Inc. as of December 31, 1997 and 1998, and the related consolidated
statements of income, stockholders' equity, and cash flows for each of the three
years in the period ended December 31, 1998. 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 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 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. at December 31, 1997 and 1998, and the consolidated
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1998, in conformity with generally accepted
accounting principles.
ERNST & YOUNG LLP
Nashville, Tennessee
February 22, 1999
A-2
<PAGE> 34
SERVICE EXPERTS, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
DECEMBER 31,
------------------------
1997 1998
--------- ---------
(IN THOUSANDS, EXCEPT
SHARE INFORMATION)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 11,298 $ 8,408
Accounts receivable:
Trade, net of allowance for doubtful accounts of $1,625
in 1997 and $2,050 in 1998............................. 30,258 50,211
Related parties......................................... 243 312
Employees............................................... 365 581
Other................................................... 2,118 6,351
--------- ---------
32,984 57,455
Refundable income taxes................................... -- 2,836
Inventories............................................... 11,949 29,715
Costs and estimated earnings in excess of billings........ 2,352 5,911
Prepaid expenses.......................................... 2,458 6,558
Current portion of notes receivable -- related party...... 14 14
Current portion of notes receivable -- other.............. 284 140
Deferred income taxes..................................... 3,985 4,008
--------- ---------
Total current assets................................ 65,324 115,045
Property, buildings and equipment:
Land...................................................... 1,709 1,904
Buildings................................................. 3,290 5,001
Furniture and fixtures.................................... 6,157 13,801
Machinery and equipment................................... 6,192 8,150
Vehicles.................................................. 15,920 23,197
Leasehold improvements.................................... 2,561 3,850
--------- ---------
35,829 55,903
Less accumulated depreciation and amortization.............. (10,278) (17,283)
--------- ---------
25,551 38,620
Notes receivable -- related party, net of current portion... 338 324
Notes receivable -- other, net of current portion........... 591 508
Goodwill, net of accumulated amortization of $1,883 in 1997
and $5,609 in 1998........................................ 105,158 191,016
Unallocated purchase price.................................. -- 8,738
Other assets................................................ 1,248 2,304
--------- ---------
Total assets........................................ $ 198,210 $ 356,555
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Short-term note payable................................... $ -- $ 2,418
Trade accounts payable and accrued liabilities............ 18,346 17,677
Accrued compensation...................................... 6,215 5,523
Accrued warranties........................................ 2,287 2,847
Income taxes payable...................................... 787 --
Billings in excess of costs and estimated earnings........ 1,547 1,268
Current portion of long-term debt and capital lease
obligations............................................. 446 2,275
--------- ---------
Total current liabilities........................... 29,628 32,008
Long-term debt and capital lease obligations, net of current
portion................................................... 16,133 104,479
Deferred revenue............................................ 6,837 9,883
Deferred income taxes....................................... 1,805 3,682
Minority interest........................................... -- 121
Commitments (Note 9)........................................
Stockholders' equity:
Common stock, $.01 par value; 30,000,000 shares
authorized; 15,890,859 and 17,450,664 shares issued and
outstanding at December 31, 1997 and 1998,
respectively............................................ 159 175
Preferred stock, $.01 par value; 10,000,000 shares
authorized, no shares issued and outstanding............ -- --
Additional paid-in capital................................ 122,671 163,302
Deferred compensation..................................... -- (941)
Retained earnings......................................... 20,977 43,865
Accumulated other comprehensive income (loss)............. -- (19)
--------- ---------
Total stockholders' equity.......................... 143,807 206,382
--------- ---------
Total liabilities and stockholders' equity.......... $ 198,210 $ 356,555
========= =========
</TABLE>
See accompanying notes.
A-3
<PAGE> 35
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1997 1998
--------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net revenue................................................. $85,184 $248,110 $407,835
Cost of goods sold.......................................... 61,405 161,281 261,670
------- -------- --------
Gross margin................................................ 23,779 86,829 146,165
Selling, general and administrative expenses................ 18,837 62,103 104,627
------- -------- --------
Income from operations...................................... 4,942 24,726 41,538
Other income (expense):
Interest expense.......................................... (718) (772) (3,708)
Interest income........................................... 377 793 419
Other income.............................................. 224 578 436
------- -------- --------
(117) 599 (2,853)
------- -------- --------
Income before federal and state income taxes................ 4,825 25,325 38,685
Provision (benefit) for income taxes:
Current................................................... 2,645 9,838 14,677
Deferred.................................................. (1,541) (458) 583
------- -------- --------
1,104 9,380 15,260
------- -------- --------
Net income................................................ $ 3,721 $ 15,945 $ 23,425
======= ======== ========
Net income per share:
Basic..................................................... $ .68 $ 1.08 $ 1.39
======= ======== ========
Diluted................................................... $ .67 $ 1.07 $ 1.37
======= ======== ========
Weighted average shares outstanding:
Basic..................................................... 5,491 14,774 16,875
======= ======== ========
Diluted................................................... 5,520 14,922 17,068
======= ======== ========
Pro forma net income data (unaudited), reflecting pro forma
tax provision on income of the Acquiring Company and
pooled companies previously taxed as Subchapter S
corporations (see Note 10):
Historical net income applicable to common stock............ $ 3,721 $ 15,945 $ 23,425
Pro forma adjustment to provision for income taxes.......... (541) (630) (397)
------- -------- --------
Pro forma net income applicable to common stock............. $ 3,180 $ 15,315 $ 23,028
======= ======== ========
Pro forma net income per common share:
Basic..................................................... $ .58 $ 1.04 $ 1.36
======= ======== ========
Diluted................................................... $ .58 $ 1.03 $ 1.35
======= ======== ========
</TABLE>
See accompanying notes.
A-4
<PAGE> 36
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
ACCUMULATED
OTHER
COMMON STOCK ADDITIONAL EQUITY COMPREHENSIVE
----------------- PAID-IN DEFERRED RETAINED NOTES INCOME
SHARES AMOUNT CAPITAL COMPENSATION EARNINGS RECEIVABLE (LOSS) TOTAL
-------- ------ ---------- ------------ --------- ---------- ------------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at January 1, 1996.... 2,602 $ 26 $ 1,382 $ -- $ 2,686 $ -- $ -- $ 4,094
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
Issuance of stock for
predecessor companies (see
Note 2).................... 4,832 48 6,462 -- -- (15) -- 6,495
Capital distributions........ -- -- (18,699) -- -- -- -- (18,699)
Issuance of stock for
acquired companies (see
Note 2).................... 2,069 21 32,475 -- -- -- -- 32,496
Capital distributions........ -- -- -- -- (907) -- -- (907)
Capital contributions........ -- -- 750 -- -- -- -- 750
Net income................... -- -- -- -- 3,721 -- -- 3,721
-------- ----- --------- ----- ------- ---- ----- --------
Balance at December 31,
1996......................... 12,091 121 50,457 -- 5,496 (15) -- 56,059
Issuance of stock at
secondary offering......... 1,850 19 38,029 -- -- -- -- 38,048
Issuance of stock for
employee stock purchase
plan....................... 23 -- 250 -- -- -- -- 250
Issuance of stock for
acquired companies (see
Note 2).................... 1,927 19 33,905 -- -- -- -- 33,924
Capital distributions........ -- -- -- -- (464) -- -- (464)
Capital contributions........ -- -- 30 -- -- 15 -- 45
Net income................... -- -- -- -- 15,945 -- -- 15,945
-------- ----- --------- ----- ------- ---- ----- --------
Balance at December 31,
1997......................... 15,891 159 122,671 -- 20,977 -- -- 143,807
Issuance of stock for
employee stock purchase
plan, options and warrants
exercised.................. 94 1 2,294 -- -- -- -- 2,295
Capital distributions........ -- -- -- -- (537) -- -- (537)
Issuance of restricted
stock...................... 30 -- 941 (941) -- -- -- --
Issuance of stock for
acquired companies (see
Note 2).................... 1,436 15 37,318 -- -- -- -- 37,333
Tax benefit of options
exercised.................. -- -- 78 -- -- -- -- 78
Net income................... -- -- -- -- 23,425 -- -- 23,425
Net unrealized loss on
marketable securities, net
of tax of $13.............. -- -- -- -- -- -- (19) (19)
--------
Comprehensive income......... 23,406
-------- ----- --------- ----- ------- ---- ----- --------
Balance at December 31,
1998......................... 17,451 $ 175 $ 163,302 $(941) $43,865 $ -- $ (19) $206,382
======== ===== ========= ===== ======= ==== ===== ========
</TABLE>
See accompanying notes.
A-5
<PAGE> 37
SERVICE EXPERTS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income.................................................. $ 3,721 $ 15,945 $ 23,425
Adjustments to reconcile net income to net cash provided by
(used in) operating activities:
Depreciation.............................................. 1,409 4,513 7,227
Amortization.............................................. 72 1,810 3,781
Provision (benefit) for deferred income taxes............. (1,541) (458) 583
Loss (gain) on asset disposals............................ (44) 151 38
Provision for loss on accounts receivable................. 447 363 1,731
Changes in operating assets and liabilities:
Receivables............................................. (601) (8,404) (16,541)
Inventories............................................. (342) (1,286) (12,153)
Refundable income taxes................................. -- -- (2,836)
Prepaid expenses........................................ (319) (634) (3,609)
Trade accounts payable and accrued liabilities.......... (1,684) 2,411 (11,060)
Accrued compensation.................................... (766) 2,336 (1,725)
Accrued warranties...................................... 154 245 (963)
Deferred revenue........................................ 462 (306) 1,299
Income taxes payable.................................... 265 (1,895) (834)
Costs and estimated earnings in excess of billings and
billings in excess of costs and estimated earnings..... 197 (896) (4,007)
-------- -------- --------
Net cash provided by (used in) operating activities... 1,430 13,895 (15,644)
INVESTING ACTIVITIES
Payments (advances) on notes receivable..................... (236) 378 241
Purchase of property, buildings and equipment............... (1,387) (10,032) (12,387)
Proceeds from sale of property, buildings and equipment..... 273 553 460
Cash acquired through acquisitions.......................... 3,961 3,995 5,150
Payment of cash for acquired companies...................... (18,699) (46,568) (65,562)
Purchase of investments..................................... -- -- (994)
Increase (decrease) in other assets......................... (337) 775 54
-------- -------- --------
Net cash used in investing activities................. (16,425) (50,899) (73,038)
FINANCING ACTIVITIES
Increase (decrease) in short-term debt...................... (1,768) (1,573) 2,418
Proceeds from notes payable to stockholders and related
parties................................................... 59 -- --
Payments on notes payable to stockholders and related
parties................................................... (900) (1,495) --
Issuance of stock at secondary offering, net of issuance
costs..................................................... 28,113 38,048 --
Issuance of stock, employee stock purchase plan............. -- 251 1,429
Issuance of stock pursuant to exercise of warrants.......... -- -- 762
Issuance of stock pursuant to options exercised............. -- -- 77
Issuance of stock -- other................................. -- -- 27
Proceeds of long-term debt.................................. 2,424 83 50,000
Net increase in line of credit.............................. -- 15,500 34,100
Payments of long-term debt and capital lease obligations.... (2,282) (12,936) (2,484)
Cash contributions received................................. 320 45 --
Distributions paid.......................................... (907) (464) (537)
-------- -------- --------
Net cash provided by financing activities........... 25,059 37,459 85,792
-------- -------- --------
Increase (decrease) in cash and cash equivalents............ 10,064 455 (2,890)
Cash and cash equivalents at beginning of year.............. 779 10,843 11,298
-------- -------- --------
Cash and cash equivalents at end of year.................... $ 10,843 $ 11,298 $ 8,408
======== ======== ========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid............................................... $ 718 $ 612 $ 3,790
======== ======== ========
Income taxes paid........................................... $ 1,907 $ 11,087 $ 16,045
======== ======== ========
Fair value of land contributed by stockholders.............. $ 430 $ -- $ --
======== ======== ========
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.
A-6
<PAGE> 38
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 ("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 eight 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 acquirer entity in this transaction in accordance
with SAB 97. The operations of the Predecessor 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 Commission Staff Accounting
Bulletin No. 48 ("SAB 48"). The Company operates in one reportable 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
34 states.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements of Service Experts, Inc. include the
accounts of the Company and its subsidiaries. All material intercompany
transactions have been eliminated in consolidation. Investments in affiliates
less than 50.0% owned are generally recorded on the equity method, except where
the Company controls the affiliate.
RECOGNITION OF REVENUE
Revenue on all of the Company's heating and air conditioning installation
contracts for commercial buildings and residential new construction contracts
("Contracts") is recognized on the percentage of completion method in the ratio
that total incurred costs bear to total estimated costs. Revenue on all of the
Company's residential heating and air conditioning installation, service and
maintenance jobs is 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 12 months.
Trade accounts receivable includes billings and billed retainage on
Contracts. Also included in trade accounts receivable are unbilled retainage
amounts of $1,687,000 and $4,742,000 at December 31, 1997 and 1998,
respectively. The Company classifies these amounts as current assets because all
balances are expected to be collected in the current year.
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.
A-7
<PAGE> 39
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
LABOR AVAILABILITY
The HVAC industry is labor intensive. The ability of Service Centers to
provide timely, high-quality service requires an adequate supply of skilled
labor.
CASH EQUIVALENTS
The Company considers all highly liquid investments with a maturity of
three months or less when acquired to be cash equivalents.
ALLOWANCE FOR DOUBTFUL ACCOUNTS
During the years ended December 31, 1996, 1997 and 1998 amounts charged to
bad debt expense and accounts written off, net of recoveries, were as follows:
<TABLE>
<CAPTION>
BALANCE CHARGED
AT TO CHARGED BALANCE
BEGINNING COSTS TO AT
OF AND OTHER END OF
YEAR ENDED PERIOD EXPENSES ACCOUNTS DEDUCTIONS PERIOD
- ---------- --------- -------- -------- ---------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
December 31, 1996...................... $ 364 $ 447 $390(2) $ 331(1) $ 870
December 31, 1997...................... 870 363 569(2) 177(1) 1,625
December 31, 1998...................... 1,625 1,731 675(2) 1,981(1) 2,050
</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 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 and
declining-balance methods over the following useful lives:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Buildings.............................................. 31.5
Furniture and fixtures................................. 2-7
Machinery and equipment................................ 5
Vehicles............................................... 5
Leasehold improvements................................. 7-30
</TABLE>
MARKETABLE SECURITIES
Marketable equity securities are accounted for in accordance with Statement
of Financial Accounting Standards ("SFAS") No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," and are classified as
available-for-sale. Available-for-sale investments are carried at fair value,
which is based on quoted prices. Unrealized gains and losses, net of tax, are
reported as a separate component of stockholders' equity. Realized gains and
losses and declines in value judged to be other-than-temporary, are included in
other income.
A-8
<PAGE> 40
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
LONG-LIVED ASSETS
The Company reviews its long-lived assets for impairment whenever events or
changes in circumstances indicate that the carrying amount may not be
recoverable. The measurement of possible impairment is based upon determining
whether projected undiscounted future cash flows from the use of the asset over
the remaining depreciation or amortization period is less than the carrying
value of the asset. As of December 31, 1998, in the opinion of management, there
has been no such impairment.
DEFERRED REVENUE
The Company pre-sells maintenance agreements to customers. Revenue on these
agreements is recorded as deferred revenue and recognized as income when the
service is performed.
PREFERRED STOCK
Preferred stockholders are entitled to such preferences to the Common Stock
as to dividends and distributions of assets of the Company on dissolution as
determined by the Board of Directors. The Board of Directors has the power and
authority to establish preferences related to dividends, redemptions, payment on
liquidation, conversion privileges and voting rights. As of December 31, 1998,
the Company had no shares of preferred stock issued and outstanding.
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 for the first year and for five to ten years on the compressor and heat
exchanger. The Company provides an accrual for future warranty costs based upon
the relationship of prior years' sales to actual warranty costs. It is the
Company's practice to classify the entire warranty accrual as a current
liability.
USE OF ESTIMATES
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
INCOME TAXES
The Company uses the liability method of accounting for 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.
ADVERTISING COSTS
The Company expenses advertising costs as incurred. During 1996, 1997 and
1998, the Company expensed $1,820,000, $8,221,000 and $14,017,000, respectively.
A-9
<PAGE> 41
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NET INCOME AND PRO FORMA NET INCOME PER SHARE
The Company calculates net income per share in accordance with SFAS No.
128, "Earnings Per Share." Under SFAS No. 128, basic earnings per share excludes
any dilutive effects of options, warrants and convertible securities, and uses
the treasury stock method in calculating dilution. Pro forma net income per
share has been presented to show what the effect would have been if the
Acquiring Company and acquired companies accounted for as poolings of interests,
which were previously Subchapter S corporations, had been taxed as C
corporations.
NEWLY ISSUED ACCOUNTING STANDARDS
In 1998, the Company adopted a new disclosure pronouncement, SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes new rules for the
reporting and display of comprehensive income and its components. SFAS No. 130
requires unrealized gains or losses on the Company's available-for-sale
securities to be included in other comprehensive income. The adoption of SFAS
No. 130 had no effect on stockholders' equity as previously reported, and
comprehensive income was the same as net income for the years ended December 31,
1996 and 1997.
In 1998, the Company also adopted another new disclosure pronouncement,
SFAS No. 131, "Disclosures About Segments of an Enterprise and Related
Information." SFAS No. 131 requires companies to report selected segment
information when certain size tests are met. Management has determined that the
Company operates in only one reportable segment meeting the applicable tests.
In 1998, the Company adopted Statement of Position ("SOP") 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use," earlier than required. SOP 98-1 requires capitalization of
certain costs to purchase or develop internal-use software, and the amortization
of these costs over the estimated useful life of the software. During 1998, the
Company capitalized approximately $2.5 million of purchased internal-use
software and development costs. These costs are included in furniture and
fixtures. The Company expenses training costs as incurred. In years prior to
1998, the Company did not incur significant software development costs. Costs
related to software developed for internal use will be amortized using the
straight-line method over an estimated period from two to five years.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." SFAS No. 133 is
required to be adopted by the Company in 2000. Management does not anticipate
that the adoption of SFAS No. 133 will have a significant effect on the
financial position or results of operations of the Company.
RECLASSIFICATIONS
Certain reclassifications have been made to the prior year financial
statements to conform to the 1998 presentation. These reclassifications had no
effect on net income as previously reported.
2. BUSINESS COMBINATIONS
POOLINGS OF INTERESTS
In December 1996, the Company acquired Custom Air Conditioning, Inc.
("Custom") and Freschi Air Systems, Inc. ("Freschi") by issuing a total of
407,814 shares of the Company's Common Stock. In 1997, the Company acquired C.
Iapaluccio Company, Inc. ("Iapaluccio"), Parrott Mechanical, Inc., including
real property operations used by the company ("Parrott Mechanical et al."), TML,
Inc. and MT Partnership (collectively, "TML"), Hawk Heating & Air Conditioning,
Inc. ("Hawk") and
A-10
<PAGE> 42
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
McAlister Heat & Air, Inc. ("McAlister") by issuing a total of 571,521 shares of
the Company's Common Stock. The seven business combinations have been accounted
for as poolings of interests.
In September 1998, the Company completed a business combination with Dodge
Heating and Air Conditioning, Inc. et al. and DH&A, Inc. (collectively, "Dodge")
through the exchange of 468,590 shares of the Company's Common Stock. This
business combination was accounted for as a pooling of interests, and
accordingly, the consolidated financial statements for the periods presented
have been restated to include the accounts of the pooled company. The following
is a summary of results of operations of the pooled company acquired in 1998 for
periods prior to the business combination.
<TABLE>
<CAPTION>
NINE MONTHS
YEAR ENDED ENDED
DECEMBER 31, SEPTEMBER 30,
------------------- 1998
1996 1997 (UNAUDITED)
------- -------- -------------
(IN THOUSANDS)
<S> <C> <C> <C>
Net revenue
Service Experts................................ $74,913 $238,692 $284,365
Dodge.......................................... 10,271 9,418 9,239
------- -------- --------
Combined....................................... $85,184 $248,110 $293,604
======= ======== ========
Net income
Service Experts................................ $ 3,739 $ 15,266 $ 16,548
Dodge.......................................... (18) 679 1,615
------- -------- --------
Combined....................................... $ 3,721 $ 15,945 $ 18,163
======= ======== ========
Basic net income per share
Service Experts................................ $ .74 $ 1.07 $ 1.02
======= ======== ========
Combined....................................... $ .68 $ 1.08 $ 1.09
======= ======== ========
Diluted net income per share
Service Experts................................ $ .74 $ 1.06 $ 1.01
======= ======== ========
Combined....................................... $ .67 $ 1.07 $ 1.07
======= ======== ========
</TABLE>
Certain pooled companies had historically paid dividends and their dividend
payments are reflected in the consolidated statements of stockholders' equity.
A-11
<PAGE> 43
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
PURCHASES
The following table sets forth certain information regarding acquisitions
accounted for under the purchase method:
<TABLE>
<CAPTION>
SERVICE TOTAL TOTAL TOTAL
CENTERS COMPANIES SHARES CASH CONVERTIBLE TOTAL
ACQUIRED ACQUIRED ISSUED CONSIDERATION DEBT CONSIDERATION
-------- --------- --------- ------------- -------------- -------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1996
Fourth Quarter....... 11 15 2,090,000 $ 2,983 $ -- $37,309
1997
First Quarter........ 7 13 772,000 15,126 -- 28,287
Second Quarter....... 8 7 377,000 10,788 -- 19,450
Third Quarter........ 8 16 238,000 10,252 -- 17,302
Fourth Quarter....... 12 20 540,000 6,949 -- 22,612
1998
First Quarter........ 10 19 389,000 8,585 -- 19,243
Second Quarter....... 12 34 593,000 25,077 -- 43,504
Third Quarter........ 8 29 222,000 11,710 667 19,314
Fourth Quarter....... 12 23 232,000 11,681 5,497 22,034
</TABLE>
The Company established an escrow account ranging from 10% to 20% 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 for the
acquisitions accounted for under the purchase method:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current assets........................................... $ 7,032 $23,622 $ 21,816
Property, buildings and equipment........................ 2,593 11,106 8,645
Other assets............................................. 392 1,665 503
Goodwill................................................. 32,337 73,930 77,549
Unallocated purchase price............................... -- -- 8,738
Liabilities assumed...................................... (6,787) (20,494) (17,509)
------- ------- --------
Purchase price......................................... $35,567 $89,829 $ 99,742
======= ======= ========
</TABLE>
The Company expects to complete its allocation of the unallocated purchase
price during the first quarter of 1999.
The Company has one purchase agreement for a 1998 acquisition which
provides for contingent payments based on the acquired company achieving
specified levels of net income for a 12-month period. The maximum additional
consideration under this earn-out agreement is approximately $2.1 million. Any
payment will be capitalized as goodwill.
In connection with acquisitions, the Company incurred $148,000 and $57,000
in 1997 and 1998, respectively, in costs associated with the termination of
acquired companies' 401(k) plans. These amounts were capitalized as a part of
the purchase price.
A-12
<PAGE> 44
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
OTHER INFORMATION REGARDING ACQUISITIONS
All of the foregoing acquisitions were accounted for using the purchase
method. The allocation of the purchase price associated with the acquisitions
has been determined by the Company based upon available information and in
certain cases is subject to further refinement. In computing the purchase price
for accounting purposes, the value of shares is determined using the value of
shares set forth in the acquisition agreement, less a discount averaging 15.6%
(as determined by an independent investment banking firm), as a result of
restrictions on the transferability of the shares issued. The discount to the
purchase price on acquisitions for 1997 and 1998 is approximately $6.7 million
and $4.7 million, respectively. Asset and equity balances have been reduced
accordingly, with no effect on net income. The operating results of the acquired
Service Centers have been included in the accompanying consolidated statements
of income from the respective dates of acquisition. The following unaudited pro
forma results of operations give effect to the operations of the Service Centers
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 financial statements do not reflect the net revenue or net income prior to
the acquisition date of acquired HVAC businesses that are not Service Centers
because these are not significant. 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,
--------------------------------------
1996 1997 1998
---------- ---------- ----------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C>
Net revenue........................................ $267,700 $426,189 $477,855
Net income......................................... 12,147 21,930 27,344
Net income per common share:
Basic............................................ $ .90 $ 1.51 $ 1.57
Diluted.......................................... $ .90 $ 1.50 $ 1.55
</TABLE>
Subsequent to December 31, 1998, the Company completed the acquisition of
six Service Centers by issuing $4.5 million in notes convertible into shares of
Common Stock and paying cash consideration of approximately $6.8 million. The
following unaudited pro forma results of operations give effect to the
operations of the Service Centers acquired in 1998 and 1999 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, 1998
----------------------
(IN THOUSANDS,
EXCEPT PER SHARE DATA)
<S> <C>
Net revenue................................................. $494,551
Net income.................................................. 28,083
Net income per common share:
Basic..................................................... $ 1.61
Diluted................................................... $ 1.59
</TABLE>
A-13
<PAGE> 45
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. MARKETABLE SECURITIES
The Company holds investments in marketable equity securities which it
classifies as available-for-sale. These investments are included in other
assets. As of December 31, 1998, investments consisted of the following:
<TABLE>
<CAPTION>
GROSS
UNREALIZED ESTIMATED
COST LOSSES FAIR VALUE
---- ---------- ----------
(IN THOUSANDS)
<S> <C> <C> <C>
U.S. corporate securities........................... $994 $32 $962
</TABLE>
As of December 31, 1997, the Company did not hold any investments in
marketable equity securities.
4. CONTRACTS IN PROCESS
Information relative to contracts in process is as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------
1997 1998
-------- --------
(IN THOUSANDS)
<S> <C> <C>
Contracts on the percentage-of-completion method:
Expenditures on uncompleted contracts..................... $ 24,168 $ 28,579
Estimated earnings........................................ 8,548 11,275
-------- --------
32,716 39,854
Less applicable billings.................................... (31,911) (35,211)
-------- --------
$ 805 $ 4,643
======== ========
Included in the accompanying consolidated balance sheets
under the following captions:
Costs and estimated earnings in excess of billings........ $ 2,352 $ 5,911
Billings in excess of costs and estimated earnings........ (1,547) (1,268)
-------- --------
$ 805 $ 4,643
======== ========
</TABLE>
Progress billings on contracts bear a relation to costs incurred, but are
not indicative of the ultimate profit or loss on a contract.
A-14
<PAGE> 46
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. LEASES
The Company leases certain vehicles and office and warehouse facilities
under operating leases with terms of two to ten years and generally providing
renewal options for terms up to five additional years. Rental expense for these
third party operating leases was $212,000, $1,350,000 and $3,025,000 for 1996,
1997 and 1998, respectively. The Company also leases office and warehouse space
from various stockholders of the Company. These lease agreements expire at
various dates through 2006. Related party rental expense for 1996, 1997 and 1998
was $362,000, $1,513,000 and $2,899,000, respectively. Minimum rental
commitments at December 31, 1998 under a non-cancelable term of one year or more
are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING RELATED
LEASES LEASES PARTY TOTAL
------- --------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
1999......................................... $61 $2,637 $2,566 $ 5,264
2000......................................... 31 1,669 2,517 4,217
2001......................................... -- 1,384 2,246 3,630
2002......................................... -- 873 1,509 2,382
2003......................................... -- 370 585 955
Thereafter................................... -- 65 376 441
--- ------ ------ -------
92 $6,998 $9,799 $16,889
====== ====== =======
Less amounts representing interest........... 14
---
Present value of net minimum rentals
(including $52 classified as current)...... $78
===
</TABLE>
The carrying value of assets under capital leases, which are included with
owned assets in the accompanying consolidated balance sheets, is $120,000 at
December 31, 1997 and $85,000 at December 31, 1998. Amortization of the assets
under capital leases is included in depreciation expense.
6. LONG-TERM DEBT
Long-term debt consists of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1997 1998
------- --------
(IN THOUSANDS)
<S> <C> <C>
Line of credit.............................................. $15,500 $ 49,600
Mortgage notes payable...................................... 265 300
Installment and equipment notes............................. 693 405
Senior unsecured notes...................................... -- 50,000
Convertible notes payable................................... -- 6,164
Other....................................................... -- 207
------- --------
16,458 106,676
Less current portion........................................ 396 2,223
------- --------
$16,062 $104,453
======= ========
</TABLE>
At December 31, 1997, the Company had a $50.0 million revolving credit
facility with a banking syndication available through September 3, 1999 (the
"Credit Facility"). On April 28, 1998, the Company renegotiated its Credit
Facility, increasing the amount available to $100.0 million and extending the
maturity date to April 30, 2001. In addition to a revolving credit loan, the
Credit Facility
A-15
<PAGE> 47
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
provides for a swing line commitment and competitive bid loans. The Credit
Facility also provides standby letters of credit of up to an aggregate of $10.0
million. There were no amounts outstanding under letters of credit at December
31, 1997 and 1998. The maximum total amount available to be advanced under the
Credit Facility is $100.0 million. At December 31, 1998, $50.4 million was
available under the Credit Facility. The Company may make principal payments
under the Credit Facility at any time, subject to minimum repayment amounts, for
non-LIBOR advances and at the end of the interest period for LIBOR advances.
Borrowings under the revolving credit loan bear interest, at the Company's
option, at (i) the higher of the agent's base rate or the federal funds rate
plus .5% or (ii) a 30, 60, 90, or 180-day LIBOR, plus a variable margin of from
62.5 to 150.0 basis points depending on the Company's funded debt to EBITDA
ratio determined on a quarterly basis. Advances under the swing line bear
interest at the banks' base rate. All of the Company's subsidiaries have
guaranteed the repayment of indebtedness under the Credit Facility. The Credit
Facility requires a quarterly commitment fee, ranging from 17.5 to 45.0 basis
points, depending on the Company's funded debt to EBITDA ratio determined on a
quarterly basis.
The Credit Facility contains covenants with respect to (i) the maintenance
of certain financial ratios and specified minimum net worth, (ii) the limitation
of (A) the aggregate outstanding principal balance of the Senior Notes (as
defined below) to $75.0 million and (B) the aggregate outstanding principal
balance of any debt issued by the Company directly to sellers of acquired HVAC
businesses to $50.0 million, (iii) the sale of substantial assets,
consolidations or mergers by the Company and (iv) the payment of dividends. At
December 31, 1998, the Company was in compliance with all covenants. Based on
the Company's total funded debt to pro forma EBITDA ratio at December 31, 1998,
the Company is limited to the incurrence of an additional $75.4 million of debt
in the aggregate.
The Company has various installment and equipment loans to various lenders
which are secured by vehicles and equipment. These loans bear interest at
various fixed rates ranging from 8.25% to 15.50% per annum with maturity dates
through 2002.
On June 23, 1998, the Company issued $32.5 million of 6.97% senior
unsecured notes, due June 15, 2003, and $17.5 million of 7.13% senior unsecured
notes, due June 15, 2005 (collectively, the "Senior Notes"), in a private
placement to a group of institutional investors. The Senior Notes provide for
interest to be paid on December 15 and June 15 of each year, with principal due
at maturity. In connection with the Senior Notes, the Company incurred $253,000
of deferred financing costs. These costs are being amortized over the term of
the related debt. Accumulated amortization at December 31, 1998 totaled $23,000.
All of the Company's subsidiaries have guaranteed the repayment of the Senior
Notes. The Note Purchase Agreement pursuant to which the Senior Notes were
issued contains covenants with respect to the maintenance of certain financial
ratios and specified net worth and limiting the incurrence of additional
indebtedness and the sale of substantial assets, consolidations or mergers by
the Company. The Company may, at its option, prepay at any time all, or from
time to time any part of, the Senior Notes, in an amount not less than $2.0
million in the aggregate in the case of a partial prepayment, at 100% of the
principal amount so prepaid, plus limited prepayment penalties determined for
the prepayment date with respect to such principal amount. Prepayments are
subject to limitation by the Credit Facility. In addition, upon a change of
control, the Company must offer to prepay the entire principal amount of the
Senior Notes at 100% of the principal amount, plus the limited prepayment
penalties as determined for the prepayment date with respect to such principal
amount. At December 31, 1998, the Company was in compliance with all covenants.
During the year ended December 31, 1998, the Company entered into an
interest rate lock agreement to synthetically hedge interest rate risk prior to
completing its private placement of $50.0 million in fixed rate debt. The
interest rate lock agreement involved a third-party financial institution,
A-16
<PAGE> 48
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and allowed the Company to "lock in" the interest rate on the reference security
that was used to determine the coupon rate for its future private placement of
debt. The agreement was settled during 1998, and the $255,000 gain on the
termination of the interest rate lock agreement was deferred and is being
amortized as an adjustment to interest expense related to the private placement
debt over the five and seven year terms of the debt. During 1998, the Company
issued convertible subordinated notes (the "Notes") totaling approximately
$6,164,000 as consideration in certain acquisitions (see Note 2). Principal is
payable in four equal annual installments beginning one year from the date of
issuance. Interest, at an average rate of 4.85% (ranging from 4.51% to 5.54%),
is payable quarterly.
The Notes are convertible, at the option of the holder, into the Company's
Common Stock at any time, at an average conversion price of $36.70 per share
(ranging from $31.56 to $42.09), subject to adjustment in certain events. If the
closing sales price of a share of Common Stock exceeds the conversion price for
five consecutive trading days, the Company may elect to convert the Notes into
shares of Common Stock at the conversion price.
As of December 31, 1998, the aggregate amounts of annual principal
maturities of long-term debt are as follows (in thousands):
<TABLE>
<S> <C>
1999............................................ $ 2,223
2000............................................ 1,605
2001............................................ 51,159
2002............................................ 1,561
2003............................................ 32,522
Thereafter...................................... 17,606
--------
$106,676
========
</TABLE>
7. STOCKHOLDERS' EQUITY AND STOCK PLANS
The Company has stock incentive plans pursuant to which officers,
employees, directors or certain others who provide significant services to the
Company can purchase shares of Common Stock upon exercise of stock options.
Stock options are granted to employees at a price equal to the fair market value
of the stock on the date of grant and become exercisable over periods of up to
four years. Unexercised options lapse ten years after the date of grant.
A-17
<PAGE> 49
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company accounts for its stock incentive plans in accordance with APB
25. The Company has not recognized compensation expense for stock options
because the exercise price of the options equals the market price of the
underlying stock on the date of grant, which is the measurement date. If the
alternative method of accounting for stock incentive plans prescribed by SFAS
No. 123 had been followed, the Company's net income and net income per share
would have been reduced to the pro forma amounts in the table below. The
weighted average fair value of options granted was determined using the
Black-Scholes option pricing model with the indicated assumptions.
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Pro forma
Net income (in thousands)...................... $3,600 $15,327 $21,666
Basic net income per share..................... .66 1.04 1.28
Diluted net income per share................... .65 1.03 1.27
Weighted average fair value per share of options
granted........................................ 4.27 7.91 9.51
Assumptions (weighted average)
Risk-free interest rate........................ 5.97%-6.34% 5.37%-5.71% 4.56%-4.85%
Expected dividend yield........................ 0.0% 0.0% 0.0%
Expected volatility............................ .25 and .55 .34 .40
Expected life (in years)....................... 3 3 3
</TABLE>
The resulting pro forma disclosures may not be representative of that to be
expected in future years.
A progression of activity and various other information relative to stock
options is presented in the table below.
<TABLE>
<CAPTION>
1996 1997 1998
-------------------------- -------------------------- ----------------------------
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
COMMON EXERCISE PRICE COMMON EXERCISE PRICE COMMON EXERCISE PRICE
SHARES PER SHARE SHARES PER SHARE SHARES PER SHARE
------- ---------------- ------- ---------------- --------- ----------------
<S> <C> <C> <C> <C> <C> <C>
Outstanding -- beginning of
year........................ -- $ -- 517,811 $16.92 665,396 $19.96
Granted....................... 517,811 16.92 220,000 26.19 941,691 29.62
Exercised..................... -- -- -- -- (4,455) 17.25
Canceled...................... -- -- (72,415) 16.92 (56,383) 18.17
------- ------- ---------
Outstanding -- end of year.... 517,811 16.92 665,396 19.96 1,546,249 26.09
======= ======= =========
Exercisable -- end of year.... 15,000 13.00 18,000 15.17 161,733 17.37
======= ======= =========
</TABLE>
Shares of Common Stock available for future grants of options totaled
899,720 at December 31, 1997, and 541,647 at December 31, 1998. Exercise prices
per share and various other information for options outstanding at December 31,
1998 are segregated into ranges as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE WEIGHTED AVERAGE WEIGHTED AVERAGE
EXERCISE PRICE EXERCISE PRICE REMAINING EXERCISE PRICE
PER SHARE SHARES PER SHARE CONTRACTUAL LIFE EXERCISABLE PER SHARE
- -------------- --------- ---------------- ---------------- ----------- ----------------
<S> <C> <C> <C> <C> <C>
$13.00-$17.25 404,394 $16.67 7.7 150,733 $16.45
$25.75-$35.41 1,141,855 29.43 9.2 11,000 30.01
--------- -------
1,546,249 161,733
========= =======
</TABLE>
A-18
<PAGE> 50
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In 1998, the Company granted 30,000 shares of restricted stock with a fair
market value of approximately $941,000 at the time of grant. The restricted
stock vests in full on June 8, 2000. Vesting may be accelerated if the closing
price of the Company's Common Stock attains certain levels.
EMPLOYEE STOCK PURCHASE PLANS
In June 1996, the Company adopted an Employee Stock Purchase Plan (the
"Employee Purchase Plan"). A total of 350,000 shares of Common Stock have been
reserved for issuance under the Employee Purchase Plan. Employees are eligible
to participate in the Employee Purchase Plan if they are employed by the Company
or a participating subsidiary for at least 20 hours a week and more than five
months in any calendar year and have been employed for at least six months since
their last date of hire. The Employee Purchase Plan allows participants to
purchase shares of Common Stock in connection with option periods commencing on
January 1 of each year and ending the following December 31.
In June 1997, the Company adopted a nonqualified stock purchase plan (the
"Nonqualified Purchase Plan"). The Company has reserved 150,000 shares of Common
Stock for issuance under the Nonqualified Purchase Plan. Participation in the
Nonqualified Purchase Plan is generally limited to individuals who were not
employed by the Company or one of its subsidiaries on January 1 of a calendar
year and, accordingly, were not eligible to receive an option under the Employee
Purchase Plan. The Nonqualified Purchase Plan allows participants to purchase
shares of Common Stock in connection with option periods commencing on July 1 of
each year and ending the following December 31. The Employee Purchase Plan and
the Nonqualified Purchase Plan are referred to collectively as the "Purchase
Plans."
Each Purchase Plan permits eligible employees of the Company and certain of
its subsidiaries to purchase shares of Common Stock through payroll deductions,
which may not exceed 10% of the employee's base compensation, at a price equal
to 85% of the fair market value of the shares of Common Stock at the beginning
of the option period or at the end of the option period, whichever is lower.
During 1997 and 1998, the Company issued 22,355 and 53,523 shares, respectively,
under the Purchase Plans.
WARRANTS
In connection with the Company's initial public offering, SunTrust
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. The Company also issued
warrants in connection with its acquisition of ProAir Services, L.P., Eveready
Corporation and Steel City Heating and Air, Inc. to purchase 200,000, 7,500 and
100,000 shares, respectively, of the Company's Common Stock at an exercise price
of $22.00, $21.76 and $30.24 per share, respectively. These warrants are
exercisable for a period of five years. No warrants had been exercised at
December 31, 1997 and warrants to purchase 34,634 shares of Common Stock had
been exercised at December 31, 1998.
A-19
<PAGE> 51
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NET INCOME PER SHARE
The following table sets forth the computation of basic and diluted net
income per share:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1997 1998
------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE
DATA)
<S> <C> <C> <C>
Numerator:
Net income........................................... $3,721 $15,945 $23,425
------ ------- -------
Numerator for basic net income per share -- net
income available to common stockholders........... 3,721 15,945 23,425
------ ------- -------
Numerator for diluted net income per share -- net
income available to common stockholders after
assumed conversions............................. 3,721 15,945 23,425
Denominator:
Denominator for basic net income per
share--weighted-average shares.................. 5,491 14,774 16,875
Effect of dilutive securities:
Employee stock options.......................... 21 111 138
Contingent shares............................... -- -- 29
Warrants........................................ 8 37 26
------ ------- -------
Dilutive potential common shares.................. 29 148 193
Denominator for diluted net income per share --
adjusted weighted-average shares and assumed
conversions.................................. $5,520 $14,922 $17,068
====== ======= =======
Basic net income per share........................... $ .68 $ 1.08 $ 1.39
====== ======= =======
Diluted net income per share......................... $ .67 $ 1.07 $ 1.37
====== ======= =======
</TABLE>
8. 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 1.0% to 20.0%
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 1.0% to 50.0% of total contributions by a
plan member, to a maximum of between 2.0% and 6.0% of the employee's total
calendar year compensation. The Company's matching contributions totaled
$311,000, $591,000 and $1,158,000 as of December 31, 1996, 1997 and 1998,
respectively.
9. COMMITMENTS AND CONTINGENT LIABILITIES
The Company is a party to a number of claims and suits 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, worker compensation, property,
employment practices liability insurance, director and officer liability
insurance and an umbrella policy to ensure itself against any liabilities
occurring in the normal course of business. The Company believes that its
A-20
<PAGE> 52
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
insurance coverage is adequate; however, there can be no assurances that the
coverage is sufficient for any future claims.
10. INCOME TAXES
Income tax expense (benefit) consists of the following:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1997 1998
------- ------ -------
(IN THOUSANDS)
<S> <C> <C> <C>
Current:
Federal.............................................. $ 2,183 $7,706 $13,336
State................................................ 462 2,132 1,341
------- ------ -------
2,645 9,838 14,677
Deferred:
Federal.............................................. (1,299) (223) 477
State................................................ (242) (235) 106
------- ------ -------
(1,541) (458) 583
------- ------ -------
Provision for income taxes............................. $ 1,104 $9,380 $15,260
======= ====== =======
</TABLE>
Significant components of the deferred tax assets and liabilities are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31,
----------------
1997 1998
------ ------
(IN THOUSANDS)
<S> <C> <C>
Deferred tax liabilities:
Contract billings......................................... $ 391 $ 297
Deferred revenue.......................................... 16 14
Inventory................................................. 20 900
Depreciation and amortization............................. 1,725 3,504
Other -- net.............................................. -- 228
------ ------
Deferred tax liabilities.................................... 2,152 4,943
Deferred tax assets:
Accounts receivable....................................... 581 763
Warranty reserves......................................... 848 792
Deferred revenue.......................................... 2,683 2,633
Accrued expenses.......................................... 183 315
Accrued compensation...................................... -- 434
Carryforwards, net........................................ 37 115
Other -- net.............................................. -- 217
------ ------
Total gross deferred tax assets............................. 4,332 5,269
------ ------
Net deferred tax assets........................... $2,180 $ 326
====== ======
</TABLE>
Management has evaluated the need for a valuation allowance for all or a
portion of the deferred tax assets and believes that the deferred tax assets
will likely be realized through the reversal of existing taxable temporary
differences and future taxable income. Accordingly, no valuation allowance has
been recognized for the year ended December 31, 1998.
As discussed in Note 2, the Company completed business combinations with
Custom, Freschi, Iapaluccio, Parrott Mechanical et al., TML (including MT
Partnership), Hawk, McAlister, and Dodge
A-21
<PAGE> 53
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(including DH&A, Inc.) during 1996, 1997 and 1998 through the exchange of shares
of the Company's Common Stock. Custom, Freschi, Iapaluccio, Parrott Mechanical
et al., MT Partnership, McAlister and DH&A, Inc. operated under either
Subchapter K or Subchapter S of the Internal Revenue Code and were not subject
to corporate federal or state income taxes. Had Custom, Freschi, Iapaluccio,
Parrott Mechanical et al., MT Partnership, McAlister and DH&A, Inc. filed
federal and state income tax returns as C corporations for 1996, 1997 and 1998,
income tax expense under the provisions of SFAS No. 109 would have been
$541,000, $630,000 and $397,000, respectively.
The historical income tax expense differs from the amount computed by
applying the federal statutory rate to income before income taxes as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1996 1997 1998
------ ------ -------
(IN THOUSANDS)
<S> <C> <C> <C>
Tax provision at statutory rate (34% in 1996 and 35% in
1997 and 1998)........................................ $1,641 $8,863 $13,540
State income tax less applicable federal tax benefit.... 146 1,233 861
Adjustments to eliminate S corporations................. (218) (595) (493)
Benefit of graduated tax rates.......................... (269) --
Provision (benefit) recognized upon termination of
Subchapter S election for the Acquiring Company and
the pooled companies in 1996, 1997 and 1998........... (236) 48 198
Goodwill amortization................................... -- 525 1,075
Other -- net............................................ 40 (694) 79
------ ------ -------
$1,104 $9,380 $15,260
====== ====== =======
</TABLE>
The termination of S corporation status resulted in the recording of a
$236,000 deferred tax asset in 1996 for the Acquiring Company and the 1996
pooled companies, a $48,000 deferred tax liability in 1997 for the 1997 pooled
companies, and a $198,000 deferred tax liability in 1998 for the 1998 pooled
company. The effect of recognizing the deferred tax asset and deferred tax
liabilities was included in the provision for income taxes.
11. FINANCIAL INSTRUMENTS
Concentrations of Credit Risk
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist principally of cash and trade accounts
receivable. At times, cash balances in the Company's accounts may exceed FDIC
insurance limits. Concentrations of credit risk with respect to trade
receivables are limited to some extent as a result of the large number of retail
customers comprising the Company's customer base, and their dispersions across
many different industries and geographies. The Company does not generally
require collateral from its customers. The Company primarily purchases HVAC
units from vendors participating in the Company's Preferred Vendor Program.
Purchases of equipment and parts from these vendors during 1997 and 1998 totaled
approximately $38.1 million and $55.8 million, respectively.
A-22
<PAGE> 54
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in
estimating its fair value disclosures for financial instruments:
Cash, cash equivalents and accounts payable: The carrying amounts
reported in the consolidated balance sheets for cash, cash equivalents and
accounts payable approximate their fair value because of the short maturity
of such instruments.
Accounts receivable: The carrying amounts reported in the
consolidated balance sheets for accounts receivable approximate their fair
value because of the short maturity of such instruments, except for certain
receivables that will be collected over an extended period.
Available-for-sale securities: The fair value of the
available-for-sale securities is based on quoted market prices.
Notes Receivable: The fair market value of notes receivable is
estimated by discounting expected cash flows using rates at which loans of
similar maturities would be made as of the date of the consolidated balance
sheets.
Short and long-term debt: The carrying amounts of the Company's
borrowings under its revolving credit arrangement approximate fair value.
The fair value of the Company's long-term debt is estimated using
discounted cash flow analyses, based on the Company's current incremental
borrowing rates for similar types of borrowing arrangements.
The carrying amounts and fair values of the Company's financial instruments
at December 31 are as follows:
<TABLE>
<CAPTION>
1997 1998
------------------- --------------------
CARRYING FAIR CARRYING FAIR
AMOUNT VALUE AMOUNT VALUE
-------- ------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C>
Cash and cash equivalents......................... $11,298 $11,298 $ 8,408 $ 8,408
Accounts receivable............................... 32,984 32,905 57,455 57,320
Notes receivable.................................. 1,227 1,227 986 986
Available-for-sale securities..................... -- -- 962 962
Accounts payable.................................. 18,346 18,346 17,677 17,677
Short and long-term debt.......................... 16,458 16,458 109,094 109,254
</TABLE>
12. RELATED PARTY TRANSACTIONS
In addition to the lease agreements with related parties in Note 5, the
Company has the following related party transactions:
The Company has one outstanding note receivable from a stockholder of the
Company totaling $352,000 and $338,000 at December 31, 1997 and 1998,
respectively. The note is payable in 180 monthly installments of $3,905 and
bears annual interest of 9.0%.
In December 1998, the Company paid Ronald L. Smith, Chief Operating Officer
of the Company, a negotiated earn-out payment of $250,000 in cash in connection
with the acquisition of Venture International, Ltd. d/b/a Ron Smith and
Associates ("Venture"). The negotiated payment settles the earn-out provision
contained in the Agreement and Plan of Merger and was based on the profitability
of Venture following acquisition by the Company.
A-23
<PAGE> 55
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
James D. Abrams, a former director and former chief operating officer of
the Company, and John R. Young, a former employee and a stockholder of the
Company, are principal stockholders of Service Now, Inc. ("Service Now").
Service Now is a 48% stockholder of SuccessWare, Inc. ("SuccessWare"), a
corporation that provides management and financial information systems software
to the Company. In 1997 and 1998, the Company and its subsidiaries made
aggregate payments to SuccessWare of approximately $450,000 and $108,000,
respectively.
Mr. Abrams and Mr. Young are the sole stockholders of Fusion Filters, Inc.
("Fusion"), which licenses air filters and other products from manufacturers and
sublicenses them to HVAC contractors, including certain of the Company's
subsidiaries. The Company has not entered into any definitive agreements with
Fusion, but certain Service Centers purchase filters from Fusion from time to
time. In 1997 and 1998, the Company's Service Centers made aggregate payments to
Fusion of approximately $895,000 and $291,000, respectively. The Company and
many of its subsidiaries also utilize, from time to time, the services of Travel
Now, Inc., a travel agency, of which Mr. Abrams and Mr. Young are principal
stockholders.
13. QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
Quarterly financial information for the years ended December 31, 1997 and
1998 are summarized below:
<TABLE>
<CAPTION>
1997 QUARTER
----------------------------------------
1ST 2ND 3RD 4TH
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenue................................. $44,446 $62,751 $67,676 $73,237
Gross profit................................ 15,093 21,329 24,938 25,469
Net income.................................. 2,343 4,729 4,991 3,882
Net income per share
Basic..................................... $ 0.18 $ 0.31 $ 0.33 $ 0.25
Diluted................................... $ 0.18 $ 0.31 $ 0.32 $ 0.24
</TABLE>
<TABLE>
<CAPTION>
1998 QUARTER
-------------------------------------------
1ST 2ND 3RD 4TH
------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C>
Net revenue.............................. $70,662 $102,894 $120,048 $114,231
Gross profit............................. 24,517 37,790 43,214 40,644
Net income............................... 3,035 7,398 7,730 5,262
Net income per share
Basic.................................. $ 0.19 $ 0.44 $ 0.45 $ 0.30
Diluted................................ $ 0.19 $ 0.44 $ 0.45 $ 0.30
</TABLE>
The quarterly information for 1997 and 1998 have been restated to reflect
the results of Dodge.
During the fourth quarter, management increased deferred costs, related
primarily to preventive maintenance agreements, by approximately $900,000. This
adjustment was necessary to more closely match costs against recognized revenue
incurred in the completion of these agreements. In addition, management adjusted
warranty reserve, accounts receivable and allowance for doubtful accounts,
inventory and depreciation that in the aggregate had no effect on income before
federal and state income taxes. The largest single adjustment was to warranty
reserve, which was reduced $700,000 based on a more favorable cost experience.
A-24
<PAGE> 56
SERVICE EXPERTS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. SUBSEQUENT EVENTS
Subsequent to December 31, 1998, the Company has acquired 18 HVAC
businesses, including six Service Centers (the "1999 Acquired Service Centers"),
for an aggregate consideration of approximately $13.0 million, consisting of
approximately $4.5 million in notes convertible into shares of Common Stock and
approximately $8.5 million in cash. All of the 1999 Acquired Service Centers
were accounted for using the purchase method. Of the consideration paid for the
1999 Acquired Service Centers, $8.5 million was allocated to intangible assets
which are to be amortized over a 40-year period. On a pro forma basis, the 1999
Acquired Service Centers' 1998 revenue was approximately $16.7 million.
A-25
<PAGE> 57
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION OF EXHIBITS
- ------- -----------------------
<C> <C> <S>
3.1 -- Restated Certificate of Incorporation of the Registrant(a)
3.2 -- Bylaws of the Registrant(a)
4.1 -- Form of Common Stock Certificate
4.2 -- Note Purchase Agreement, dated as of June 1, 1998, among the
Registrant and the Purchasers named therein (including a
form of Senior Note and form of Subsidiary Guaranty)(b)
4.3 -- Form of Convertible Subordinated Note (for unregistered
Notes)(c)
4.4 -- Indenture, dated as of February 2, 1999, by the Company to
SunTrust Bank, Nashville, N.A., as Trustee(d)
4.5 -- First Supplemental Indenture, dated as of February 2, 1999,
by the Company to SunTrust Bank, Nashville, N.A., as
Trustee(d)
4.6 -- Form of Convertible Subordinated Note (for registered
Notes)(d)
10.1 -- Registrant's 1996 Incentive Stock Plan(a)
10.2 -- Amendment No. 1 to Registrant's 1996 Incentive Stock Plan(e)
10.3 -- Amendment No. 2 to Registrant's 1996 Incentive Stock Plan(e)
10.4 -- Amendment No. 3 to Registrant's 1996 Incentive Stock Plan
10.5 -- Registrant's 1996 Non-Employee Director Stock Option Plan(a)
10.6 -- Registrant's 1996 Employee Stock Purchase Plan(a)
10.7 -- Amendment No. 1 to Registrant's 1996 Employee Stock Purchase
Plan(e)
10.8 -- Amendment No. 2 to Registrant's 1996 Employee Stock Purchase
Plan(e)
10.9 -- Amendment No. 3 to Registrant's 1996 Employee Stock Purchase
Plan
10.10 -- Registrant's 1997 Nonqualified Stock Option Plan(f)
10.11 -- Amendment No. 1 to Registrant's 1997 Nonqualified Stock
Option Plan
10.12 -- Registrant's 1997 Nonqualified Stock Purchase Plan(f)
10.13 -- Amendment No. 1 to Registrant's 1997 Nonqualified Stock
Purchase Plan(e)
10.14 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Alan R. Sielbeck
10.15 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Anthony M. Schofield
10.16 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Alfred W. Taylor III
10.17 -- Employment Agreement, dated October 26, 1998, between the
Registrant and Ronald L. Smith
10.18 -- Second Amended and Restated Credit Agreement, dated April
28, 1998, between the Registrant and SunTrust Bank,
Nashville, N.A., as agent for the lenders(b)
10.19 -- First Amendment to Second Amended and Restated Credit
Agreement, dated September 30, 1998, between the Registrant
and SunTrust Bank, Nashville, N.A., as agent for the
lenders(c)
10.20 -- Form of Agreement and Plan of Merger among certain of the
Registrant's subsidiaries, a wholly-owned subsidiary of the
Registrant and the Registrant(f)
10.21 -- Form of Stock Purchase Agreement between the former
stockholders of certain of the Registrant's subsidiaries and
the Registrant(g)
21 -- List of subsidiaries of the Registrant
23 -- Consent of Ernst & Young LLP
27.1 -- Financial Data Schedule for the Year Ended December 31, 1998
(for SEC use only)
27.2 -- Restated Financial Data Schedule for the Year Ended December
31, 1997 (for SEC use only)
27.3 -- Restated Financial Data Schedule for the Six Months Ended
June 30, 1997 (for SEC use only)
27.4 -- Restated Financial Data Schedule for the Three Months Ended
March 31, 1997 (for SEC use only)
27.5 -- Restated Financial Data Schedule for the Year Ended December
31, 1996 (for SEC use only)
27.6 -- Restated Financial Data Schedule for the Nine Months Ended
September 30, 1996 (for SEC use only)
</TABLE>
<PAGE> 58
- ---------------
(a) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-l, Registration No. 333-07037.
(b) Incorporated by reference to the exhibits filed with the Registrant's
Quarterly Report on Form 10-Q for the three months ended June 30, 1998, File
No. 001-13037.
(c) Incorporated by reference to the exhibits filed with the Registrant's
Quarterly Report on Form 10-Q for the three months ended September 30, 1998,
File No. 001-13037.
(d) Incorporated by reference to the exhibits filed with the Registrant's
Current Report on Form 8-K, dated February 5, 1999.
(e) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-8, Registration No. 333-59711.
(f) Incorporated by reference to the exhibits filed with the Registrant's
Registration Statement on Form S-4, File No. 333-12319.
(g) Incorporated by reference to the exhibits filed with the Registrant's Annual
Report on Form 10-K for the fiscal year ended December 31, 1997, File No.
001-13037.
<PAGE> 1
EXHIBIT 4.1
COMMON STOCK THIS CERTIFICATE IS TRANSFERABLE IN
NEW YORK, N.Y. AND RIDGEFIELD PARK, N.J.
SERVICE
[LOGO]
EXPERTS
NUMBER SHARES
SE
SERVICE EXPERTS, INC.
CUSIP 817567 10 0
SEE REVERSE FOR CERTAIN DEFINITIONS
INCORPORATED UNDER THE LAWS OF THE STATE OF DELAWARE
THIS CERTIFIES THAT
IS THE OWNER OF
FULLY PAID AND NON-ASSESSABLE SHARES OF THE COMMON STOCK, $.01 PAR VALUE, OF
Service Experts, Inc. transferable on the books of the Corporation by the
holder hereof in person or by duly authorized Attorney upon surrender of this
Certificate properly endorsed. This Certificate is not valid unless
countersigned and registered by the Transfer Agent and Registrar.
Witness the facsimile signatures of the duly authorized
officers of the Corporation.
Dated:
Picture of service man standing in front of service vehicle
/s/ ALAN R. SIELBECK
---------------------------------------
CHAIRMAN AND CHIEF EXECUTIVE OFFICER
COUNTERSIGNED AND REGISTERED:
ChaseMellon Shareholder Services, L.L.C.
TRANSFER AGENT
AND REGISTRAR
BY
AUTHORIZED SIGNATURE /s/ ANTHONY M. SCHOFIELD
---------------------------------------
CHIEF FINANCIAL OFFICER, SECRETARY
AND TREASURER
<PAGE> 2
THE CORPORATION WILL FURNISH WITHOUT CHARGE TO EACH SHAREHOLDER WHO SO
REQUESTS THE POWERS, DESIGNATIONS, PREFERENCES AND RELATIVE, PARTICIPATING,
OPTIONAL OR OTHER SPECIAL RIGHTS OF EACH CLASS OF STOCK OR SERIES THEREOF
OF THE CORPORATION, AND THE QUALIFICATIONS, LIMITATIONS OR RESTRICTIONS OF
SUCH PREFERENCES AND/OR RIGHTS. SUCH REQUEST MAY BE MADE TO THE CORPORATION
OR ITS TRANSFER AGENT.
The following abbreviations, when used in the inscription on the face of
this certificate, shall be construed as though they were written out in full
according to applicable laws or regulations.
<TABLE>
<S> <C>
TEN COM -- as tenants in common UNIF GIFT MIN ACT _________ Custodian ________
TEN ENT -- as tenants by the entireties (Cust.) (Minor)
JT TEN -- as joint tenants with right of under Uniform Gits to Minors
survivorship and not as tenants Act ________________________
in common (State)
Additional abbreviations may also be used though not in the above list
</TABLE>
For value received _______________________ hereby sell, assign and transfer unto
PLEASE INSERT SOCIAL SECURITY OR OTHER
IDENTIFYING NUMBER OF ASSIGNEE
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
________________________________________________________________________________
(PLEASE PRINT OR TYPEWRITE NAME AND ADDRESS
INCLUDING POSTAL ZIP CODE OF ASSIGNEE)
________________________________________________________________________________
________________________________________________________________________________
_________________________________________________________________________ shares
of the capital stock represented by the within Certificate, and do hereby
irrevocably constitute and appoint
_______________________________________________________________________ Attorney
to transfer the said stock on the books of the within named Corporation with
full power of substitution in the premises.
Dated ------------------------------------------
<TABLE>
<S> <C>
X
--------------------------------------------------------------
NOTICE: THE SIGNATURE(S) TO THIS
ASSIGNMENT MUST CORRESPOND WITH THE
NAME(S) AS WRITTEN UPON THE FACE OF
THE CERTIFICATE IN EVERY PARTICULAR,
WITHOUT ALTERATION OR ENLARGEMENT OR
ANY CHANGE WHATEVER
X
-------------------------------------------------------------
</TABLE>
- --------------------------------------------------------------------------------
ALL GUARANTEES MUST BE MADE BY A FINANCIAL INSTITUTION (SUCH AS A BANK OR
BROKER) WHICH IS A PARTICIPANT IN THE SECURITIES TRANSFER AGENTS MEDALLION
PROGRAM ("STAMP"), THE NEW YORK STOCK EXCHANGE, INC. MEDALLION SIGNATURE PROGRAM
("MSP"), OR THE STOCK EXCHANGES MEDALLION PROGRAM ("SEMP") AND MUST NOT BE
DATED. GUARANTEES BY A NOTARY PUBLIC ARE NOT ACCEPTABLE.
- --------------------------------------------------------------------------------
KEEP THIS CERTIFICATE IN A SAFE PLACE. IF IT IS LOST, STOLEN, MUTILATED OR
DESTROYED, THE CORPORATION WILL REQUIRE A BOND OF INDEMNITY AS A
CONDITION TO THE ISSUANCE OF A REPLACEMENT CERTIFICATE.
<PAGE> 1
EXHIBIT 10.4
AMENDMENT TO THE
SERVICE EXPERTS, INC.
1996 INCENTIVE STOCK PLAN
THIS AMENDMENT to the Service Experts, Inc. 1996 Incentive Stock Plan
(the "Plan") is made by Service Experts, Inc. (the "Company"), to be effective
on October 23, 1998.
RECITALS:
WHEREAS, the Plan was established by the Company by action of its board
of directors on August 16, 1996;
WHEREAS, the Plan was been amended effective April 3, 1997, to modify
certain administrative provisions; and
WHEREAS, the Company desires to further amend the Plan to modify the
effect of a change in control on the awards that are granted under the Plan.
NOW, THEREFORE, the Plan is hereby amended as follows, effective
October 23, 1998:
1. Section 6(g) of the Plan is restated as follows:
(g) Effect of Certain Transactions. The provisions of this
Section 6(g) shall apply to the extent that an Agreement does not
otherwise expressly address the matters contained herein.
(i) If the Company experiences an event which results
in a "Change in Control," as defined in Section 6(g)(ii),
then, whether or not the vesting requirements set forth in any
Agreement have been satisfied, (A) all shares of Restricted
Stock that are outstanding at the time of the Change in
Control shall become fully vested immediately prior to the
Change in Control event, and (B) all Options that are
outstanding at the time of the Change in Control shall become
fully vested and exercisable immediately prior to the Change
in Control event.
(ii) A Change in Control will be deemed to have
occurred for purposes hereof, upon a merger, consolidation,
acquisition of property or stock, separation, reorganization
or liquidation of the Company, as a result of which the
stockholders of the Company receive cash, stock or other
property in exchange for their shares of Stock (but not a
public offering of Stock by the Company), and the Company is
not the surviving entity.
(iii) Upon a Change in Control, all Options that are
held by the Participant immediately after the Change in
Control shall be assumed by the entity which is the survivor
of the transaction, or converted into options to purchase the
common stock of the surviving entity, in a transaction to
which section 424(a) of the Code applies.
<PAGE> 2
(iv) Notwithstanding the foregoing, a portion of the
acceleration of vesting described in this Section shall not
occur with respect to an Award to the extent such acceleration
of vesting would cause the Participant or holder of such Award
to realize less income, net of taxes, after deducting the
amount of excise taxes that would be imposed pursuant to
section 4999 of the Code, than if accelerated vesting of that
portion of the Award did not occur. This paragraph shall not
apply to the extent that the Participant is subject to and is
indemnified for such tax liability by the Company or
otherwise.
2. Section 9(e) of the Plan is restated as follows:
(e) In the event of any Change in Control (defined in Section
6(g)(ii)) in which shares of Stock are purchased for cash in a tender
offer or are to be converted into cash in a merger, then, unless the
Committee otherwise determines, each Option (other than an Option
granted within the last six months held by a person subject to Section
16(b) of the Exchange Act) shall be converted into a fully exercisable
right to receive an amount in cash per share subject to such Option
equal to (A) in the case of a tender offer or merger, the excess, if
any, of the price paid in such tender offer or merger over the exercise
price of such Option and (B) in the case of conversion, the excess, if
any, of the highest market price of the Stock on the date of conversion
over the exercise price of such Option; provided, however, that any
acceleration of the right to exercise an Option that occurs under this
Section 9(e) shall be limited in the manner described in Section
6(g)(iv).
IN WITNESS WHEREOF, the Company, acting by and through the undersigned
authorized officer, has executed this instrument this the 23rd day of October,
1998, but to be effective on the date first written above.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
---------------------------------------
Its: Chief Financial Officer, Secretary and
Treasurer
2
<PAGE> 1
EXHIBIT 10.9
AMENDMENT TO THE
SERVICE EXPERTS, INC.
1996 EMPLOYEE STOCK PURCHASE PLAN
THIS AMENDMENT to the Service Experts, Inc. 1996 Employee Stock
Purchase Plan (the "Plan") is made by Service Experts, Inc. (the "Company"), to
be effective on January 1, 1998.
RECITALS:
WHEREAS, the Plan was established by the Company by action of its board
of directors effective August 16, 1996, and was amended and restated effective
July 1, 1997; and
WHEREAS, the Company desires to amend the Plan to modify the terms of
eligibility and participation by employees of the Company and its affiliates;
NOW, THEREFORE, pursuant to action of the board of directors of the
Company taken on October 23, 1998, the Plan is amended as follows:
1. SECTION 3.1 IS RESTATED AS FOLLOWS:
3.1 Every Employee whose customary employment with an Employer on the
Effective Date is at least 20 hours per week and more than five months in a
calendar year shall be eligible to participate as of the Effective Date. Every
other Employee whose customary employment is at least 20 hours per week and more
than five months in a calendar year shall be eligible to participate as of any
Grant Date coincident with or immediately following his completion of at least
three months of Continuous Service. An Employee shall not be eligible to
participate, however, if immediately after the options are granted such Employee
would own stock possessing five percent or more of the total combined voting
power or value of all classes of the Sponsoring Employer or a subsidiary
corporation or parent corporation (as those terms are defined in Section 424(e)
and (f) of the Code). For purposes of this paragraph, the ownership attribution
rules of Section 424(d) of the Code shall apply in determining the stock
ownership of an Employee and stock which the Employee may purchase under
outstanding options (under this or any other agreement) shall be treated as
stock owned by the Employee.
2. SECTION 4.3 IS RESTATED AS FOLLOWS:
4.3 A Member may elect to discontinue his or her contributions
hereunder at any time during the Option Period by providing written notice to
the Employer; provided, however, that the election must be made at least 30 days
prior to the end of the Option Period in the form and manner that is prescribed
by the Committee.
<PAGE> 2
3. SECTION 4.4 IS RESTATED AS FOLLOWS:
4.4 A Member may elect to withdraw any or all of his or her
contributions during the first three months of an Option Period. Thereafter, a
Member may only withdraw contributions hereunder upon a showing of a financial
hardship that is described in Section 4.5. An election to withdraw contributions
must be made at least 30 days prior to the end of the Option Period in the form
and manner that is prescribed by the Committee.
4. A NEW SECTION 4.5 IS ADDED TO THE PLAN AS FOLLOWS:
4.5 For purposes of this Article IV, a financial hardship shall be
deemed to exist if the Member incurs an immediate and heavy financial need. All
hardship determinations shall be made by the vice president of human resources
of the Company, and his delegates, in accordance with the rules and procedures
and subject to the criteria established thereby.
IN WITNESS WHEREOF, the Company, acting by and through the undersigned
authorized officer, has executed this instrument this the 23rd day of October,
1998, but to be effective on the date first written above.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
---------------------------------------
Its: Chief Financial Officer, Secretary and
Treasurer
2
<PAGE> 1
EXHIBIT 10.11
AMENDMENT TO THE
SERVICE EXPERTS, INC.
1997 NONQUALIFIED STOCK OPTION PLAN
THIS AMENDMENT to the Service Experts, Inc. 1997 Nonqualified Stock
Option Plan (the "Plan") is made by Service Experts, Inc. (the "Company"), to be
effective on October 23, 1998.
RECITALS:
WHEREAS, the Plan was established by the Company by action of its board
of directors on April 3, 1998;
WHEREAS, the Company desires to amend the Plan to allow the grant of
cash awards and loans in connection with the grant or exercise of Options;
WHEREAS, the Company desires to amend the Plan to clarify the rights of
certain employees upon a change in the control of the Company; and
WHEREAS, the Company desires to further amend the Plan to modify the
effect of a change in control on the awards that are granted under the Plan.
NOW, THEREFORE, pursuant to action of the board of directors of the
Company taken on October 23, 1998, the Plan is amended as follows, to be
effective October 23, 1998:
1. A new Section 4.4 is added to the Plan as follows:
4.4 Guarantees and Loans. The Company is hereby authorized to
guarantee and make loans to a Participant to enable him to exercise an
Option. Any loan made or guaranteed herein shall be in such amount as
determined by the Committee but shall not exceed the exercise price of
the Options being exercised by the Participant. Any loans made or
guaranteed shall be with full recourse against the Participant, shall
be secured by the Stock received from exercise of the related Option,
shall provide for a market rate of interest, and shall contain such
other terms and conditions as are acceptable to the Committee. The
determination of whether loans are to be made or guaranteed shall be
made by the Committee.
2. A new Section 4.5 is added to the Plan as follows:
4.5 Other Compensation. Nothing contained in this Plan shall
prevent the Board from adopting other or additional compensation
arrangements, subject to shareholder approval if such approval is
required, and such arrangements may be either generally applicable or
applicable only in specific cases.
<PAGE> 2
3. Section 8.3 is restated as follows:
8.3 Effect of Certain Transactions. The provisions of this
Section 8.3 shall apply to the extent that an Agreement does not
otherwise expressly address the matters contained herein.
(a) If the Company experiences an event which results
in a "Change in Control," as defined in Section 8.3(b), then,
whether or not the vesting requirements set forth in any
Agreement have been satisfied, (i) all shares of Restricted
Stock that are outstanding at the time of the Change in
Control shall become fully vested immediately prior to the
Change in Control event, and (ii) all Options that are
outstanding at the time of the Change in Control shall become
fully vested and exercisable immediately prior to the Change
in Control event.
(b) A Change in Control will be deemed to have
occurred for purposes hereof, upon a merger, consolidation,
acquisition of property or stock, separation, reorganization
or liquidation of the Company, as a result of which the
stockholders of the Company receive cash, stock or other
property in exchange for their shares of Stock (but not a
public offering of Stock by the Company), and the Company is
not the surviving entity.
(c) Upon a Change in Control, all Options that are
held by the Participant immediately after the Change in
Control shall be assumed by the entity which is the survivor
of the transaction, or converted into options to purchase the
common stock of the surviving entity, in a transaction to
which section 424(a) of the Code applies.
(d) Notwithstanding the foregoing, a portion of the
acceleration of vesting described in this Section shall not
occur with respect to an Award to the extent such acceleration
of vesting would cause the Participant or holder of such Award
to realize less income, net of taxes, after deducting the
amount of excise taxes that would be imposed pursuant to
section 4999 of the Code, than if accelerated vesting of that
portion of the Award did not occur.
(e) In the event of any Change in Control in which
shares of Stock are purchased for cash in a tender offer or
are to be converted into cash in a merger, then, unless the
Committee otherwise determines, each Option (other than an
Option granted within the last six months held by a person
subject to Section 16(b) of the Exchange Act) shall be
converted into a fully exercisable right to receive an amount
in cash per share subject to such Option equal to (A) in the
case of a tender offer or merger, the excess, if any, of the
price paid in such tender offer or merger over the exercise
price of such Option and (B) in the case of conversion, the
excess, if any, of the highest market price of the Stock on
the date of conversion over the exercise price of such Option;
provided, however, that any acceleration of the right to
exercise an Option that occurs under this Section 8.3(e) shall
be limited in the manner described in Section 8.3(d).
2
<PAGE> 3
IN WITNESS WHEREOF, the Company, acting by and through the undersigned
authorized officer, has executed this instrument this the 23rd day of October,
1998, but to be effective on the date first written above.
SERVICE EXPERTS, INC.
By: /s/ Anthony M. Schofield
---------------------------------------
Its: Chief Financial Officer, Secretary and
Treasurer
3
<PAGE> 1
Exhibit 10.14
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made this 26th day of October, 1998, between Service
Experts Services, LLC, a Tennessee limited liability company (the "Company"),
and Alan R. Sielbeck ("Employee").
W I T N E S S E T H:
WHEREAS, the Company, which maintains its principal executive offices
at Six Cadillac Drive, Suite 400, Brentwood, Tennessee 37027, provides services
that are utilized in the management of the heating, ventilating and air
conditioning ("HVAC") service and replacement businesses owned by Service
Experts, Inc., a Delaware corporation ("SEI");
WHEREAS, Company desires to employ Employee and Employee, who is also
the Chairman, President & Chief Executive Officer of SEI, desires to accept such
employment by the Company subject to the terms and conditions contained herein;
WHEREAS, Employee has been subject to a written employment agreement
with SEI, which was originally effective on June 26, 1996, and the parties
desire that this Agreement be an amendment and restatement of the original
agreement to reflect that Employee's employment has been transferred to the
Company, to provide for automatic renewal of the Agreement, to provide certain
additional benefits to Employee in the event of a change in the Control of SEI
or the Company, and to further restrict Employee against entering into
activities that would compete against the business of the Company and/or SEI;
and
WHEREAS, in serving as an employee of the Company, Employee will
participate in the use and development of confidential proprietary information
about the Company, SEI, their respective customers and suppliers, and the
methods used by the Company, SEI and their employees in competition with other
companies, as to which the Company desires to protect fully its rights and the
rights of SEI;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein set forth, the parties hereto agree as follows:
1. Employment. The Company hereby employs Employee and Employee accepts
such employment with the Company, subject to the terms and conditions set forth
herein. Employee shall be employed as Chairman, President & Chief Executive
Officer of the Company, shall perform all duties and services incident to such
position, and such other duties and services as may be assigned or delegated to
Employee by the Company from time to time, in accordance with actions taken by
the board of directors of SEI (the "Board"); provided, however, that without
Employee's consent, the duties and services of Employee hereunder shall not be
materially increased or altered in a manner inconsistent with Employee's
position and duties hereunder that are set forth on Appendix I hereto. During
his employment hereunder, Employee shall devote his best efforts and attention,
on a full-time basis, to the performance of the duties required of him as an
employee of the Company.
<PAGE> 2
2. Compensation.
2.1 As compensation for services rendered by Employee hereunder,
Employee shall receive:
(a) An annual salary as set forth on Appendix II hereto, or such higher
salary as shall be established by the Compensation Committee of the Board, which
salary shall be payable in arrears in equal monthly installments, plus insurance
and other benefits equivalent to the benefits provided other similarly situated
employees of the Company;
(b) Compensated vacation time, for such duration as set forth on
Appendix II, to be taken at any time during each year of the term of this
Agreement;
(c) Bonus compensation to be determined in the sole discretion of the
Compensation Committee; and
(d) Reimbursement for all reasonable expenses incurred by Employee in
the performance of his duties under this Agreement, provided that Employee
submits verification of such expenses in accordance with the policies of the
Company and SEI.
2.2 Prior to the end of each anniversary of the Effective Date (defined
in Section 6) of this Agreement, the Compensation Committee or its delegate
shall review with Employee his compensation hereunder. Any increases in salary
or changes in fringe benefits agreed upon by Employee and the Compensation
Committee at such annual review shall become effective beginning on the month
following such review unless otherwise agreed to by the Company and Employee.
The Company shall promptly update the information on Appendix II with the
increases and changes effected hereunder from time to time.
3. Confidential Information and Trade Secrets.
3.1 Employee recognizes that Employee's position with the Company and
SEI requires considerable responsibility and trust, and, in reliance on
Employee's loyalty, the Company or SEI may entrust Employee with highly
sensitive confidential, restricted and proprietary information involving Trade
Secrets and Confidential Information (as hereinafter defined). For purposes of
this Section, references to SEI includes SEI's subsidiaries and business
entities that are owned or controlled by SEI or an SEI subsidiary.
3.2 For purposes of this Agreement, a "Trade Secret" is any scientific
or technical information, design, process, procedure, formula or improvement
that is valuable and not generally known to competitors of the Company or SEI.
"Confidential Information" is any data or information, other than Trade Secrets,
that is important, competitively sensitive, and not generally known by the
public, including, but not limited to, the Company's and SEI's business plans,
business prospects, customer lists, training manuals, product development plans,
bidding and pricing procedures, market strategies, internal performance
statistics, financial data, confidential personnel information concerning
employees of the Company or SEI, supplier data,
2
<PAGE> 3
operational or administrative plans, policy manuals, and terms and conditions of
contracts and agreements. The terms "Trade Secret" and "Confidential
Information" shall not apply to (i) information which is received by Employee
from a third party with no restriction on disclosure, or (ii) information which
is required to be disclosed by any applicable law, or (iii) processes or
methodologies pertaining to corporate development activities which are used by
the Employee in their position with the Company that were established prior to
Employee's employment with the Company or SEI.
3.3 Except as required to perform Employee's duties hereunder, Employee
will not use or disclose any Trade Secrets or Confidential Information of the
Company or SEI during employment, at any time after termination of employment
and prior to such time as they cease to be Trade Secrets or Confidential
Information through no act of Employee in violation of this Agreement.
3.4 Upon the request of the Company or SEI and, in any event, upon the
termination of employment hereunder, Employee will surrender to the Company or
SEI, as appropriate, all memoranda, notes, records, manuals or other documents
pertaining to the Company's or SEI's business or Employee's employment
(including all copies thereof). Employee will also leave with the Company all
materials involving any Trade Secrets or Confidential Information of the Company
or SEI. All such information and materials, whether or not made or developed by
Employee, shall be the sole and exclusive property of the Company, and Employee
hereby assigns to the Company all of Employee's right, title and interest in and
to any and all of such information and materials.
4. Covenant Not to Compete.
4.1 Employee hereby covenants and agrees with the Company that during
the term hereof and for a period expiring two years after the termination of
Employee's employment with the Company, Employee will not directly or indirectly
(i) operate, develop or own any interest, other than the ownership of less than
5% of the equity securities of a publicly traded company, in any business which
has significant (viewed in relation to the business of SEI) activities relating
to the ownership, management or operation of, or consultation regarding an HVAC
service and replacement company (an "HVAC Business"); (ii) compete with the
Company, SEI or their subsidiaries and affiliates in the operation or
development of any HVAC Business within 50 miles of any HVAC Business owned by
SEI; (iii) be employed by or consult with any business which owns, manages or
operates an HVAC Business within 50 miles of any HVAC Business owned by SEI;
(iv) interfere with, solicit, disrupt or attempt to disrupt any past, present or
prospective relationship, contractual or otherwise, between the Company, SEI or
their subsidiaries or affiliates, and any customer, client, supplier or employee
of SEI, or its subsidiaries or affiliates; or (v) solicit any past, present or
prospective management employee (including all corporate officers and managers,
all regional managers and all general managers) of the Company, SEI or their
subsidiaries or affiliates, to leave their employment with the Company, SEI or
their subsidiaries or affiliates, or hire any such employee to work in any
capacity; provided, however, that this provision shall not apply if Employee's
employment hereunder is terminated without cause prior to the expiration of the
Agreement.
3
<PAGE> 4
4.2 If a judicial determination is made that any of the provisions of
this Section 4 constitutes an unreasonable or otherwise unenforceable
restriction against Employee, the provisions of this Section 4 shall be rendered
void only to the extent that such judicial determination finds such provisions
to be unreasonable or otherwise unenforceable. In this regard, the parties
hereto hereby agree that any judicial authority construing this Agreement shall
be empowered to sever any portion of the territory or prohibited business
activity from the coverage of this Section 4 and to apply the provisions of this
Section 4 to the remaining portion of the territory or the remaining business
activities not so severed by such judicial authority. Moreover, notwithstanding
the fact that any provisions of this Section 4 are determined not to be
specifically enforceable, the Company and/or SEI shall nevertheless be entitled
to recover monetary damages as a result of the breach of such provision by
Employee. The time period during which the prohibitions set forth in this
Section 4 shall apply shall be tolled and suspended as to Employee for a period
equal to the aggregate quantity of time during which Employee violates such
prohibitions in any respect.
5. Specific Enforcement. Employee specifically acknowledges and agrees
that the restrictions set forth in Sections 3 and 4 hereof are reasonable and
necessary to protect the legitimate interests of the Company and SEI and that
the Company would not have entered into this Agreement in the absence of such
restrictions. Employee further acknowledges and agrees that any violation of the
provisions of Sections 3 or 4 hereof will result in irreparable injury to the
Company and SEI, that the remedy at law for any violation or threatened
violation of such Sections will be inadequate and that in the event of any such
breach, the Company and SEI, in addition to any other remedies or damages
available to them at law or in equity, shall be entitled to temporary injunctive
relief before trial from any court of competent jurisdiction as a matter of
course and to permanent injunctive relief without the necessity of proving
actual damages.
6. Term. This Agreement shall be effective on October 26, 1998, (the
"Effective Date") and shall continue in full force and effect for a period of
three years thereafter. The term of this Agreement shall be automatically
extended on the first day of each month for a period of one additional month so
that the remaining term of the Agreement on such date is always a period of 36
months. This Agreement may only be terminated in accordance with Sections 7, 8,
9, 10, 11 and 12.
7. Termination Upon Cessation of Company's Operations or Death of the
Employee. In the event the Company ceases its operations or the Employee dies
during the term of this Agreement, this Agreement shall immediately terminate
and neither the Employee nor the Company shall have any further obligations
hereunder, except that (i) the Company shall continue to be obligated under
Section 2.1 hereof for any unpaid salary, bonus, unreimbursed expenses or
payments pursuant to Section 10 hereof owed to Employee or his estate that have
accrued but not been paid as of the Termination Date, (ii) in the event of death
of the Employee during the term of this Agreement, the Company shall pay to
Employee's estate an amount equal to three months salary, and (iii) the awards
granted to Employee under SEI's stock incentive plans shall become fully vested,
as shall be provided thereunder. The Company shall be deemed to have ceased its
operations upon the liquidation of the Company through bankruptcy or insolvency
proceedings.
4
<PAGE> 5
8. Termination by Employee. Employee may at any time terminate his
employment by giving the Company 90 days prior written notice of his intent to
terminate the Agreement. At the Termination Date, the Company shall have no
further obligation to Employee and Employee shall have no further rights or
obligations hereunder, except as set forth in Sections 3 and 4 above, and except
for the Company's obligation under Section 2.1 hereof for unpaid salary, bonus
or unreimbursed expenses that have accrued but have not been paid as of the
Termination Date.
9. Termination for Cause. The Company shall have the right at any time
to terminate Employee's employment immediately for cause, which shall include
any of the following reasons:
(a) If Employee shall violate the provisions of Sections 3 or
4 of this Agreement, or shall fail to comply with any other material
term or condition of this Agreement which materially and adversely
affects the business or affairs of the Company; or
(b) If Employee shall commit (i) a felony or (ii) an act of
dishonesty, willful mismanagement, fraud or embezzlement against the
Company.
Employee's obligations under Sections 3 and 4 hereof shall survive the
termination of the Agreement pursuant to this Section 9. In the event Employee's
employment hereunder is terminated in accordance with this Section, the Company
shall have no further obligation to make any payments to Employee hereunder
except for unpaid salary, bonus or unreimbursed expenses that have accrued but
have not been paid as of the Termination Date.
10. Termination Without Cause. In the event that Employee's employment
is terminated after the Company or SEI materially breaches this Agreement, or
Employee is terminated "without cause" (defined below) during the term hereof,
the Company shall (i) pay Employee all bonuses and unreimbursed expenses owed to
Employee that have accrued but have not been paid as of the Termination Date;
(ii) continue to pay to Employee his salary set forth in Section 2.1 hereof for
a period of two years following the Termination Date; and (iii) continue to
provide the insurance and other benefits of Section 2.1 hereof for a period of
two years following the Termination Date. Moreover, the provisions of Sections 3
and 4 will be effective for a period of two years following the Termination
Date, provided that the Company continues it obligations during such period that
are described in this Section. In addition to the severance payment payable
under this Section 10, Employee shall be paid an amount equal to two times the
average annual bonus earned by Employee in the two years immediately preceding
the date of termination. Employee shall also be entitled to an accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which accelerated vesting shall be provided for thereunder. For purposes of this
Section 10, termination "without cause" includes any termination of employment
that is not made pursuant to Sections 7, 8, 9, 11 or 12.
5
<PAGE> 6
11. Termination Upon a Change in Control.
11.1 For purposes of this Agreement, a "Change in Control" shall mean
(a) the time that SEI first determines that any person and all other persons who
constitute a group (within the meaning of Section 13(d)(3) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), have acquired within any
12 month period (i) direct or indirect beneficial ownership (within the meaning
of Section 13(d)(3) under the Exchange Act) of 20% or more of SEI's outstanding
securities or (ii) assets of SEI having a fair market value in excess of
one-third of SEI's total assets, unless a majority of the Continuing Directors,
as hereinafter defined, approves the acquisition not later than ten business
days after SEI makes that determination, (b) the first day on which a majority
of the members of SEI's Board are not Continuing Directors, or (c) upon the
occurrence of a merger, consolidation, acquisition of property or stock,
separation, reorganization or liquidation of SEI, as a result of which the
stockholders of SEI receive cash, stock or other property in exchange for their
shares of SEI stock (but not a public offering of stock by SEI), and SEI is not
the surviving entity.
11.2 For purposes of this Agreement, "Continuing Directors" shall mean,
as of any date of determination, any member of the Board who (i) was a member of
the Board on August 16, 1996, (ii) has been a member of the Board for the two
years immediately preceding such date of determination or (iii) was nominated
for election or elected to the Board with the affirmative vote of a majority of
Continuing Directors who were members of the Board at the time of such
nomination or election.
11.3 In the event of Employee's termination of employment coincident
with or within 24 months following a Change in Control, whether at Employee's
direction or otherwise, Employee shall immediately be paid all accrued salary,
bonus compensation to the extent earned, vested deferred compensation (other
than plan benefits which will be paid in accordance with the applicable plan),
any benefits under any plans of the Company in which Employee is a participant
to the full extent of Employee's rights under such plans (including accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which shall provide for accelerated vesting), accrued vacation pay and any
appropriate business expenses incurred by Employee in connection with his duties
hereunder, all to the date of termination, and all severance compensation
provided in Section 11.4, but no other compensation or reimbursement of any
kind.
11.4 In addition to the compensation described in Section 11.3,
Employee shall be paid as severance compensation his base salary (at the rate
payable at the time of such termination) through the remaining term of this
Agreement and any extensions hereof in a single lump sum within 10 days
following the payment event described in Section 11.3. Employee is under no
obligation to mitigate the amount owed Employee pursuant to this Section 11.4 by
seeking other employment or otherwise. Nothing herein shall prevent Company from
making an offer to Employee prior to the time that payments are otherwise due
hereunder to pay the severance compensation in installments, an alternate form,
or to otherwise defer payment, provided that such offer is based on the business
purposes of the Company and Employee shall not be obliged to accept such offer.
6
<PAGE> 7
In addition to the severance payment payable under this Section 11.4,
Employee shall be paid an amount equal to three times the average annual bonus
earned by Employee in the two years immediately preceding the date of
termination. Employee shall also be entitled to an accelerated vesting of any
awards granted to Employee under SEI's stock incentive plans, which plans shall
provide for such acceleration. Employee shall continue to accrue retirement
benefits and shall continue to enjoy any benefits under any plans of the Company
or SEI in which Employee is a participant to the full extent of Employee's
rights under such plans, including any perquisites provided under this
Agreement, through the remaining term of this Agreement; provided, however, that
the benefits under any such plans of the Company or SEI in which Employee is a
participant, including any such perquisites, shall cease upon re-employment by a
new employer.
11.5 Employee will be entitled to additional payments with respect to
amounts that are payable due to a Change in Control, or otherwise, as follows:
(a) Gross Up Payment. Anything in this Agreement to the contrary
notwithstanding, in the event it shall be determined that any payment or
distribution by or on behalf of the Company to or for the benefit of Employee as
a result of a "change in control," as defined in section 280G of the Internal
Revenue Code of 1986, as amended, (the "Code") (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise, but determined without regard to any additional payments required
under this Section (a "Payment") would be subject to the excise tax imposed by
section 4999 of the Code or any interest or penalties are incurred by Employee
with respect to such excise tax (such excise tax, together with any such
interest and penalties, are hereinafter collectively referred to as the "Excise
Tax"), then Employee shall be entitled to receive an additional payment (a
"Gross-Up Payment") in an amount such that after payment by Employee of all
taxes (including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
Employee retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments.
(b) Tax Opinion. Subject to the provisions of Section 11.5(c), all
determinations required to be made under this Section 11.5, including whether
and when a Gross-Up Payment is required and the amount of such Gross-Up Payment
and the assumptions to be utilized in arriving at such determination, shall be
made by a nationally recognized accounting firm or law firm selected by the
Company (the "Tax Firm"); provided, however, that the Tax Firm shall not
determine that no Excise Tax is payable by Employee unless it delivers to
Employee a written opinion (the "Tax Opinion") that failure to pay the Excise
Tax and to report the Excise Tax and the payments potentially subject thereto on
or with Employee's applicable federal income tax return will not result in the
imposition of an accuracy-related or other penalty on Employee. All fees and
expenses of the Tax Firm shall be borne solely by the Company. Within 15
business days of the receipt of notice from Employee that there has been a
Payment, or such earlier time as is requested by the Company, the Tax Firm shall
make all determinations required under this Section, shall provide to the
Company and Employee a written report setting forth such determinations,
together with detailed supporting calculations, and, if the Tax Firm determines
that no Excise Tax is payable, shall deliver the Tax Opinion to Employee. Any
Gross-Up Payment, as determined pursuant to this Section, shall be paid by the
Company to Employee within fifteen days of the receipt of the Tax Firm's
determination. Subject to the remainder of this Section 11.5, any
7
<PAGE> 8
determination by the Tax Firm shall be binding upon the Company and Employee;
provided, however, that Employee shall only be bound to the extent that the
determinations of the Tax Firm hereunder, including the determinations made in
the Tax Opinion, are reasonable and reasonably supported by applicable law. As a
result of the uncertainty in the application of section 4999 of the Code at the
time of the initial determination by the Tax Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that it is ultimately determined in accordance with the
procedures set forth in Section 11.5(c) that Employee is required to make a
payment of any Excise Tax, the Tax Firm shall reasonably determine the amount of
the Underpayment that has occurred and any such Underpayment shall be promptly
paid by the Company to or for the benefit of Employee. In determining the
reasonableness of Tax Firm's determinations hereunder, and the effect thereof,
Employee shall be provided a reasonable opportunity to review such
determinations with Tax Firm and Employee's tax counsel. Tax Firm's
determinations hereunder, and the Tax Opinion, shall not be deemed reasonable
until Employee's reasonable objections and comments thereto have been
satisfactorily accommodated by Tax Firm.
(c) Notice of IRS Claim. Employee shall notify the Company in writing
of any claims by the Internal Revenue Service that, if successful, would require
the payment by the Company of the Gross-Up Payment. Such notification shall be
given as soon as practicable but no later than 30 calendar days after Employee
actually receives notice in writing of such claim and shall apprise the Company
of the nature of such claim and the date on which such claim is requested to be
paid; provided, however, that the failure of Employee to notify the Company of
such claim (or to provide any required information with respect thereto) shall
not affect any rights granted to Employee under this Section 11.5 except to the
extent that the Company is materially prejudiced in the defense of such claim as
a direct result of such failure. Employee shall not pay such claim prior to the
expiration of the 30-day period following the date on which he gives such notice
to the Company (or such shorter period ending on the date that any payment of
taxes with respect to such claim is due). If the Company notifies Employee in
writing prior to the expiration of such period that it desires to contest such
claim, Employee shall do all of the following:
(1) give the Company any information reasonably requested by the
Company relating to such claim;
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation with
respect to such claim by an attorney selected by the Company and
reasonably acceptable to Employee;
(3) cooperate with the Company in good faith in order effectively to
contest such claim;
(4) if the Company elects not to assume and control the defense of such
claim, permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and
8
<PAGE> 9
hold Employee harmless, on an after-tax basis, for any Excise Tax or income tax
(including interest and penalties with respect thereto) imposed as a result of
such representation and payment of costs and expenses. Without limiting the
foregoing provisions of this Section 11.5, the Company shall have the right, at
its sole option, to assume the defense of and control all proceedings in
connection with such contest, in which case it may pursue or forego any and all
administrative appeals, proceedings, hearings and conferences with the taxing
authority in respect of such claim and may either direct Employee to pay the tax
claimed and sue for a refund or contest the claim in any permissible manner, and
Employee agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or more
appellate courts, as the Company shall determine; provided, however, that if the
Company directs Employee to pay such claim and sue for a refund, the Company
shall advance the amount of such payment to Employee, on an interest-free basis
and shall indemnify and hold Employee harmless, on an after-tax basis, from any
Excise Tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income with
respect to such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for the taxable year of Employee
with respect to which such contested amount is claimed to be due is limited
solely to such contested amount. Furthermore, the Company's right to assume the
defense of and control the contest shall be limited to issues with respect to
which a Gross-Up Payment would be payable hereunder and Employee shall be
entitled to settle or contest, as the case may be, any other issue raised by the
Internal Revenue Service or any other taxing authority.
(d) Right to Tax Refund. If, after the receipt by Employee of an amount
advanced by the Company pursuant to Section 11.5 Employee becomes entitled to
receive any refund with respect to such claim, Employee shall (subject to the
Company's complying with the requirements of Section 11.5(c)) promptly pay to
the Company the amount of such refund (together with any interest paid or
credited thereon after taxes applicable thereto). If, after the receipt by
Employee of an amount advanced by the Company pursuant to Section 11.5(c), a
determination is made that Employee is not entitled to a refund with respect to
such claim and the Company does not notify Employee in writing of its intent to
contest such denial of refund prior to the expiration of 30 days after such
determination, then such advance shall, to the extent of such denial, be
forgiven and shall not be required to be repaid and the amount of forgiven
advance shall offset, to the extent thereof, the amount of Gross-Up Payment
required to be paid.
12. Disability of Employee. If, on account of physical or mental
disability, Employee shall fail or be unable to perform his assigned duties in
any material respect for a period of 60 consecutive days, the Company shall (i)
pay Employee his full salary as set forth in Section 2.1 hereof, (ii) provide
the insurance, bonus and other benefits of Section 2.1 for a period of six
months from the date such disability began or for such shorter period as
Employee is unable to perform his duties hereunder, and (iii) all awards granted
to Employee under SEI's stock incentive plans will become fully vested, as shall
be provided for thereunder; provided, however, that Employee's salary shall be
reduced by any disability income paid to him pursuant to any disability
insurance policy maintained under this Agreement. In the event Employee is
unable to perform his duties hereunder after the expiration of the six-month
period, this Agreement shall automatically terminate. Employee shall not be
required to perform his obligations under Section 1 hereof during any period of
disability.
9
<PAGE> 10
13. Assignment.
(a) The rights and benefits of Employee under this Agreement, other
than accrued and unpaid amounts due under Section 2 hereof, are personal to him
and shall not be assignable. Discharge of Employee's undertakings in Sections 3
and 4 hereof shall be an obligation of Employee's executors, administrators, or
other legal representatives or heirs.
(b) This Agreement may not be assigned by the Company except to an
affiliate of the Company or SEI, provided, however, that if the Company shall
merge or effect a share exchange with or into, or sell or otherwise transfer
substantially all its assets to, another corporation, the Company shall assign
its rights hereunder to that corporation and cause such corporation to assume
the Company's obligations under this Agreement.
14. Notices. Any notice or other communications under this Agreement
shall be in writing, signed by the party making the same, and shall be delivered
personally or sent by certified or registered mail, postage prepaid, addressed
as follows:
(a) If to Employee, to such address furnished to Company or at such
other address as may be furnished by him to Company in writing.
(b) If to the Company: SEI Management Company, LLC
Six Cadillac Drive, Suite 400
Brentwood, Tennessee 37027
Attention: Chief Manager
With a copy to: J. Chase Cole, Esq.
Waller Lansden Dortch & Davis
A Professional Limited Liability Company
2100 Nashville City Center
511 Union Street
Nashville, Tennessee 37219
or to such other address as may hereafter be designated by either party hereto.
All such notices shall be deemed given on the date personally delivered or
mailed.
15. Governing Law. This Agreement shall be interpreted and enforced in
accordance with the laws of the State of Tennessee.
16. Severability. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid, but if any one
or more of the provisions contained in this Agreement shall be invalid, illegal
or unenforceable in any respect for any reason, the validity, legality and
enforceability for any such provisions in every other respect and of the
remaining provisions of this Agreement shall not be in any way impaired.
10
<PAGE> 11
17. Modification. No waiver of modification of this Agreement or of any
covenant, condition, or limitation herein contained shall be valid unless in
writing and duly executed by the party to be charged therewith and no evidence
of any waiver or modification shall be offered or received in evidence of any
proceeding, arbitration or litigation between the parties hereunder, unless such
waiver or modification is in writing, duly executed as aforesaid and the parties
further agree that the provisions of this section may not be waived except as
herein set forth.
18. Entire Agreement. This Agreement contains the entire agreement of
the parties hereto with respect to the subject matter contained herein. There
are no restrictions, promises, covenants or undertakings, other than those
expressly set forth herein. This Agreement supersedes all prior agreements and
understandings between the parties with respect to such subject matter. This
Agreement may not be changed except by a writing executed by the parties.
19. Remedies. No remedy set forth in this Agreement or otherwise
conferred upon or reserved to any party shall be considered exclusive of any
other remedy available to any party, but the same shall be distinct, separate
and cumulative and may be exercised from time to time as often as occasion may
arise or as may be deemed expedient. In the event of any arbitration, equitable
or legal proceeding that is brought by either party regarding the subject matter
of this Agreement, the prevailing party shall be entitled to receive payment by
the other party of all costs and expenses, including reasonable attorney fees,
incurred in such proceeding. Except as expressly provided otherwise herein,
Employee's remedies hereunder for payment of compensation and benefits,
including payments for severance or payments after termination of employment,
shall not be diminished by the obtaining of new employment that does not violate
the terms of this Agreement.
20. Indemnity. At all times during and after Employee's employment and
the effectiveness of this Agreement, the Company, SEI and their successors shall
indemnify Employee (as a director, officer, employee and otherwise) to the
fullest extent permitted by law and shall at all times maintain appropriate
provisions in its Articles of Incorporation and Bylaws which mandate that such
indemnification be provided.
21. Survival. The provisions of Sections 3, 4, 5, 7, 10, 11, 12, 13,
14, 15, 16, 17, 18, 19 and 20 shall survive the termination of Employee's
employment and termination of this Agreement.
IN WITNESS WHEREOF, the undersigned have executed this Employment
Agreement on the day and year first above written.
EMPLOYEE SERVICE EXPERTS SERVICES, LLC
/s Alan R. Sielbeck /s/ Alan R. Sielbeck
- ------------------------------- -------------------------------------
Alan R. Sielbeck Alan R. Sielbeck, Chief Manager
11
<PAGE> 1
Exhibit 10.15
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made this 26th day of October, 1998, between Service
Experts Services, LLC, a Tennessee limited liability company (the "Company"),
and Anthony M. Schofield ("Employee").
W I T N E S S E T H:
WHEREAS, the Company, which maintains its principal executive offices
at Six Cadillac Drive, Suite 400, Brentwood, Tennessee 37027, provides services
that are utilized in the management of the heating, ventilating and air
conditioning ("HVAC") service and replacement businesses owned by Service
Experts, Inc., a Delaware corporation ("SEI");
WHEREAS, Company desires to employ Employee and Employee, who is also
the Executive Vice President & Chief Financial Officer of SEI, desires to accept
such employment by the Company subject to the terms and conditions contained
herein;
WHEREAS, Employee has been subject to a written employment agreement
with SEI, which was originally effective on June 26, 1996, and the parties
desire that this Agreement be an amendment and restatement of the original
agreement to reflect that Employee's employment has been transferred to the
Company, to provide for automatic renewal of the Agreement, to provide certain
additional benefits to Employee in the event of a change in the Control of SEI
or the Company, and to further restrict Employee against entering into
activities that would compete against the business of the Company and/or SEI;
and
WHEREAS, in serving as an employee of the Company, Employee will
participate in the use and development of confidential proprietary information
about the Company, SEI, their respective customers and suppliers, and the
methods used by the Company, SEI and their employees in competition with other
companies, as to which the Company desires to protect fully its rights and the
rights of SEI;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein set forth, the parties hereto agree as follows:
1. Employment. The Company hereby employs Employee and Employee accepts
such employment with the Company, subject to the terms and conditions set forth
herein. Employee shall be employed as Executive Vice President & Chief Financial
Officer of the Company, shall perform all duties and services incident to such
position, and such other duties and services as may be assigned or delegated to
Employee by the Company from time to time, in accordance with actions taken by
the board of directors of SEI (the "Board"); provided, however, that without
Employee's consent, the duties and services of Employee hereunder shall not be
materially increased or altered in a manner inconsistent with Employee's
position and duties hereunder that are set forth on Appendix I hereto. During
his employment hereunder, Employee shall devote his best efforts and attention,
on a full-time basis, to the performance of the duties required of him as an
employee of the Company.
<PAGE> 2
2. Compensation.
2.1 As compensation for services rendered by Employee hereunder,
Employee shall receive:
(a) An annual salary as set forth on Appendix II hereto, or such higher
salary as shall be established by the Compensation Committee of the Board, which
salary shall be payable in arrears in equal monthly installments, plus insurance
and other benefits equivalent to the benefits provided other similarly situated
employees of the Company;
(b) Compensated vacation time, for such duration as set forth on
Appendix II, to be taken at any time during each year of the term of this
Agreement;
(c) Bonus compensation to be determined in the sole discretion of the
Compensation Committee; and
(d) Reimbursement for all reasonable expenses incurred by Employee in
the performance of his duties under this Agreement, provided that Employee
submits verification of such expenses in accordance with the policies of the
Company and SEI.
2.2 Prior to the end of each anniversary of the Effective Date (defined
in Section 6) of this Agreement, the Compensation Committee or its delegate
shall review with Employee his compensation hereunder. Any increases in salary
or changes in fringe benefits agreed upon by Employee and the Compensation
Committee at such annual review shall become effective beginning on the month
following such review unless otherwise agreed to by the Company and Employee.
The Company shall promptly update the information on Appendix II with the
increases and changes effected hereunder from time to time.
3. Confidential Information and Trade Secrets.
3.1 Employee recognizes that Employee's position with the Company and
SEI requires considerable responsibility and trust, and, in reliance on
Employee's loyalty, the Company or SEI may entrust Employee with highly
sensitive confidential, restricted and proprietary information involving Trade
Secrets and Confidential Information (as hereinafter defined). For purposes of
this Section, references to SEI includes SEI's subsidiaries and business
entities that are owned or controlled by SEI or an SEI subsidiary.
3.2 For purposes of this Agreement, a "Trade Secret" is any scientific
or technical information, design, process, procedure, formula or improvement
that is valuable and not generally known to competitors of the Company or SEI.
"Confidential Information" is any data or information, other than Trade Secrets,
that is important, competitively sensitive, and not generally known by the
public, including, but not limited to, the Company's and SEI's business plans,
business prospects, customer lists, training manuals, product development plans,
bidding and pricing procedures, market strategies, internal performance
statistics, financial data, confidential personnel information concerning
employees of the Company or SEI, supplier data,
2
<PAGE> 3
operational or administrative plans, policy manuals, and terms and conditions of
contracts and agreements. The terms "Trade Secret" and "Confidential
Information" shall not apply to (i) information which is received by Employee
from a third party with no restriction on disclosure, or (ii) information which
is required to be disclosed by any applicable law, or (iii) processes or
methodologies pertaining to corporate development activities which are used by
the Employee in their position with the Company that were established prior to
Employee's employment with the Company or SEI.
3.3 Except as required to perform Employee's duties hereunder, Employee
will not use or disclose any Trade Secrets or Confidential Information of the
Company or SEI during employment, at any time after termination of employment
and prior to such time as they cease to be Trade Secrets or Confidential
Information through no act of Employee in violation of this Agreement.
3.4 Upon the request of the Company or SEI and, in any event, upon the
termination of employment hereunder, Employee will surrender to the Company or
SEI, as appropriate, all memoranda, notes, records, manuals or other documents
pertaining to the Company's or SEI's business or Employee's employment
(including all copies thereof). Employee will also leave with the Company all
materials involving any Trade Secrets or Confidential Information of the Company
or SEI. All such information and materials, whether or not made or developed by
Employee, shall be the sole and exclusive property of the Company, and Employee
hereby assigns to the Company all of Employee's right, title and interest in and
to any and all of such information and materials.
4. Covenant Not to Compete.
4.1 Employee hereby covenants and agrees with the Company that during
the term hereof and for a period expiring two years after the termination of
Employee's employment with the Company, Employee will not directly or indirectly
(i) operate, develop or own any interest, other than the ownership of less than
5% of the equity securities of a publicly traded company, in any business which
has significant (viewed in relation to the business of SEI) activities relating
to the ownership, management or operation of, or consultation regarding an HVAC
service and replacement company (an "HVAC Business"); (ii) compete with the
Company, SEI or their subsidiaries and affiliates in the operation or
development of any HVAC Business within 50 miles of any HVAC Business owned by
SEI; (iii) be employed by or consult with any business which owns, manages or
operates an HVAC Business within 50 miles of any HVAC Business owned by SEI;
(iv) interfere with, solicit, disrupt or attempt to disrupt any past, present or
prospective relationship, contractual or otherwise, between the Company, SEI or
their subsidiaries or affiliates, and any customer, client, supplier or employee
of SEI, or its subsidiaries or affiliates; or (v) solicit any past, present or
prospective management employee (including all corporate officers and managers,
all regional managers and all general managers) of the Company, SEI or their
subsidiaries or affiliates, to leave their employment with the Company, SEI or
their subsidiaries or affiliates, or hire any such employee to work in any
capacity; provided, however, that this provision shall not apply if Employee's
employment hereunder is terminated without cause prior to the expiration of the
Agreement.
3
<PAGE> 4
4.2 If a judicial determination is made that any of the provisions of
this Section 4 constitutes an unreasonable or otherwise unenforceable
restriction against Employee, the provisions of this Section 4 shall be rendered
void only to the extent that such judicial determination finds such provisions
to be unreasonable or otherwise unenforceable. In this regard, the parties
hereto hereby agree that any judicial authority construing this Agreement shall
be empowered to sever any portion of the territory or prohibited business
activity from the coverage of this Section 4 and to apply the provisions of this
Section 4 to the remaining portion of the territory or the remaining business
activities not so severed by such judicial authority. Moreover, notwithstanding
the fact that any provisions of this Section 4 are determined not to be
specifically enforceable, the Company and/or SEI shall nevertheless be entitled
to recover monetary damages as a result of the breach of such provision by
Employee. The time period during which the prohibitions set forth in this
Section 4 shall apply shall be tolled and suspended as to Employee for a period
equal to the aggregate quantity of time during which Employee violates such
prohibitions in any respect.
5. Specific Enforcement. Employee specifically acknowledges and agrees
that the restrictions set forth in Sections 3 and 4 hereof are reasonable and
necessary to protect the legitimate interests of the Company and SEI and that
the Company would not have entered into this Agreement in the absence of such
restrictions. Employee further acknowledges and agrees that any violation of the
provisions of Sections 3 or 4 hereof will result in irreparable injury to the
Company and SEI, that the remedy at law for any violation or threatened
violation of such Sections will be inadequate and that in the event of any such
breach, the Company and SEI, in addition to any other remedies or damages
available to them at law or in equity, shall be entitled to temporary injunctive
relief before trial from any court of competent jurisdiction as a matter of
course and to permanent injunctive relief without the necessity of proving
actual damages.
6. Term. This Agreement shall be effective on October 26, 1998, (the
"Effective Date") and shall continue in full force and effect for a period of
three years thereafter. The term of this Agreement shall be automatically
extended on the first day of each month for a period of one additional month so
that the remaining term of the Agreement on such date is always a period of 36
months. This Agreement may only be terminated in accordance with Sections 7, 8,
9, 10, 11 and 12.
7. Termination Upon Cessation of Company's Operations or Death of the
Employee. In the event the Company ceases its operations or the Employee dies
during the term of this Agreement, this Agreement shall immediately terminate
and neither the Employee nor the Company shall have any further obligations
hereunder, except that (i) the Company shall continue to be obligated under
Section 2.1 hereof for any unpaid salary, bonus, unreimbursed expenses or
payments pursuant to Section 10 hereof owed to Employee or his estate that have
accrued but not been paid as of the Termination Date, (ii) in the event of death
of the Employee during the term of this Agreement, the Company shall pay to
Employee's estate an amount equal to three months salary, and (iii) the awards
granted to Employee under SEI's stock incentive plans shall become fully vested,
as shall be provided thereunder. The Company shall be deemed to have ceased its
operations upon the liquidation of the Company through bankruptcy or insolvency
proceedings.
4
<PAGE> 5
8. Termination by Employee. Employee may at any time terminate his
employment by giving the Company 90 days prior written notice of his intent to
terminate the Agreement. At the Termination Date, the Company shall have no
further obligation to Employee and Employee shall have no further rights or
obligations hereunder, except as set forth in Sections 3 and 4 above, and except
for the Company's obligation under Section 2.1 hereof for unpaid salary, bonus
or unreimbursed expenses that have accrued but have not been paid as of the
Termination Date.
9. Termination for Cause. The Company shall have the right at any time
to terminate Employee's employment immediately for cause, which shall include
any of the following reasons:
(a) If Employee shall violate the provisions of Sections 3 or
4 of this Agreement, or shall fail to comply with any other material
term or condition of this Agreement which materially and adversely
affects the business or affairs of the Company; or
(b) If Employee shall commit (i) a felony or (ii) an act of
dishonesty, willful mismanagement, fraud or embezzlement against the
Company.
Employee's obligations under Sections 3 and 4 hereof shall survive the
termination of the Agreement pursuant to this Section 9. In the event Employee's
employment hereunder is terminated in accordance with this Section, the Company
shall have no further obligation to make any payments to Employee hereunder
except for unpaid salary, bonus or unreimbursed expenses that have accrued but
have not been paid as of the Termination Date.
10. Termination Without Cause. In the event that Employee's employment
is terminated after the Company or SEI materially breaches this Agreement, or
Employee is terminated "without cause" (defined below) during the term hereof,
the Company shall (i) pay Employee all bonuses and unreimbursed expenses owed to
Employee that have accrued but have not been paid as of the Termination Date;
(ii) continue to pay to Employee his salary set forth in Section 2.1 hereof for
a period of two years following the Termination Date; and (iii) continue to
provide the insurance and other benefits of Section 2.1 hereof for a period of
two years following the Termination Date. Moreover, the provisions of Sections 3
and 4 will be effective for a period of two years following the Termination
Date, provided that the Company continues it obligations during such period that
are described in this Section. In addition to the severance payment payable
under this Section 10, Employee shall be paid an amount equal to two times the
average annual bonus earned by Employee in the two years immediately preceding
the date of termination. Employee shall also be entitled to an accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which accelerated vesting shall be provided for thereunder. For purposes of this
Section 10, termination "without cause" includes any termination of employment
that is not made pursuant to Sections 7, 8, 9, 11 or 12.
5
<PAGE> 6
11. Termination Upon a Change in Control.
11.1 For purposes of this Agreement, a "Change in Control" shall mean
(a) the time that SEI first determines that any person and all other persons who
constitute a group (within the meaning of Section 13(d)(3) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), have acquired within any
12 month period (i) direct or indirect beneficial ownership (within the meaning
of Section 13(d)(3) under the Exchange Act) of 20% or more of SEI's outstanding
securities or (ii) assets of SEI having a fair market value in excess of
one-third of SEI's total assets, unless a majority of the Continuing Directors,
as hereinafter defined, approves the acquisition not later than ten business
days after SEI makes that determination, (b) the first day on which a majority
of the members of SEI's Board are not Continuing Directors, or (c) upon the
occurrence of a merger, consolidation, acquisition of property or stock,
separation, reorganization or liquidation of SEI, as a result of which the
stockholders of SEI receive cash, stock or other property in exchange for their
shares of SEI stock (but not a public offering of stock by SEI), and SEI is not
the surviving entity.
11.2 For purposes of this Agreement, "Continuing Directors" shall mean,
as of any date of determination, any member of the Board who (i) was a member of
the Board on August 16, 1996, (ii) has been a member of the Board for the two
years immediately preceding such date of determination or (iii) was nominated
for election or elected to the Board with the affirmative vote of a majority of
Continuing Directors who were members of the Board at the time of such
nomination or election.
11.3 In the event of Employee's termination of employment coincident
with or within 24 months following a Change in Control, whether at Employee's
direction or otherwise, Employee shall immediately be paid all accrued salary,
bonus compensation to the extent earned, vested deferred compensation (other
than plan benefits which will be paid in accordance with the applicable plan),
any benefits under any plans of the Company in which Employee is a participant
to the full extent of Employee's rights under such plans (including accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which shall provide for accelerated vesting), accrued vacation pay and any
appropriate business expenses incurred by Employee in connection with his duties
hereunder, all to the date of termination, and all severance compensation
provided in Section 11.4, but no other compensation or reimbursement of any
kind.
11.4 In addition to the compensation described in Section 11.3,
Employee shall be paid as severance compensation his base salary (at the rate
payable at the time of such termination) through the remaining term of this
Agreement and any extensions hereof in a single lump sum within 10 days
following the payment event described in Section 11.3. Employee is under no
obligation to mitigate the amount owed Employee pursuant to this Section 11.4 by
seeking other employment or otherwise. Nothing herein shall prevent Company from
making an offer to Employee prior to the time that payments are otherwise due
hereunder to pay the severance compensation in installments, an alternate form,
or to otherwise defer payment, provided that such offer is based on the business
purposes of the Company and Employee shall not be obliged to accept such offer.
6
<PAGE> 7
In addition to the severance payment payable under this Section 11.4,
Employee shall be paid an amount equal to three times the average annual bonus
earned by Employee in the two years immediately preceding the date of
termination. Employee shall also be entitled to an accelerated vesting of any
awards granted to Employee under SEI's stock incentive plans, which plans shall
provide for such acceleration. Employee shall continue to accrue retirement
benefits and shall continue to enjoy any benefits under any plans of the Company
or SEI in which Employee is a participant to the full extent of Employee's
rights under such plans, including any perquisites provided under this
Agreement, through the remaining term of this Agreement; provided, however, that
the benefits under any such plans of the Company or SEI in which Employee is a
participant, including any such perquisites, shall cease upon re-employment by a
new employer.
11.5 Employee will be entitled to additional payments with respect to
amounts that are payable due to a Change in Control, or otherwise, as follows:
(a) Gross Up Payment. Anything in this Agreement to the contrary
notwithstanding, in the event it shall be determined that any payment or
distribution by or on behalf of the Company to or for the benefit of Employee as
a result of a "change in control," as defined in section 280G of the Internal
Revenue Code of 1986, as amended, (the "Code") (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise, but determined without regard to any additional payments required
under this Section (a "Payment") would be subject to the excise tax imposed by
section 4999 of the Code or any interest or penalties are incurred by Employee
with respect to such excise tax (such excise tax, together with any such
interest and penalties, are hereinafter collectively referred to as the "Excise
Tax"), then Employee shall be entitled to receive an additional payment (a
"Gross-Up Payment") in an amount such that after payment by Employee of all
taxes (including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
Employee retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments.
(b) Tax Opinion. Subject to the provisions of Section 11.5(c), all
determinations required to be made under this Section 11.5, including whether
and when a Gross-Up Payment is required and the amount of such Gross-Up Payment
and the assumptions to be utilized in arriving at such determination, shall be
made by a nationally recognized accounting firm or law firm selected by the
Company (the "Tax Firm"); provided, however, that the Tax Firm shall not
determine that no Excise Tax is payable by Employee unless it delivers to
Employee a written opinion (the "Tax Opinion") that failure to pay the Excise
Tax and to report the Excise Tax and the payments potentially subject thereto on
or with Employee's applicable federal income tax return will not result in the
imposition of an accuracy-related or other penalty on Employee. All fees and
expenses of the Tax Firm shall be borne solely by the Company. Within 15
business days of the receipt of notice from Employee that there has been a
Payment, or such earlier time as is requested by the Company, the Tax Firm shall
make all determinations required under this Section, shall provide to the
Company and Employee a written report setting forth such determinations,
together with detailed supporting calculations, and, if the Tax Firm determines
that no Excise Tax is payable, shall deliver the Tax Opinion to Employee. Any
Gross-Up Payment, as determined pursuant to this Section, shall be paid by the
Company to Employee within fifteen days of the receipt of the Tax Firm's
determination. Subject to the remainder of this Section 11.5, any
7
<PAGE> 8
determination by the Tax Firm shall be binding upon the Company and Employee;
provided, however, that Employee shall only be bound to the extent that the
determinations of the Tax Firm hereunder, including the determinations made in
the Tax Opinion, are reasonable and reasonably supported by applicable law. As a
result of the uncertainty in the application of section 4999 of the Code at the
time of the initial determination by the Tax Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that it is ultimately determined in accordance with the
procedures set forth in Section 11.5(c) that Employee is required to make a
payment of any Excise Tax, the Tax Firm shall reasonably determine the amount of
the Underpayment that has occurred and any such Underpayment shall be promptly
paid by the Company to or for the benefit of Employee. In determining the
reasonableness of Tax Firm's determinations hereunder, and the effect thereof,
Employee shall be provided a reasonable opportunity to review such
determinations with Tax Firm and Employee's tax counsel. Tax Firm's
determinations hereunder, and the Tax Opinion, shall not be deemed reasonable
until Employee's reasonable objections and comments thereto have been
satisfactorily accommodated by Tax Firm.
(c) Notice of IRS Claim. Employee shall notify the Company in writing
of any claims by the Internal Revenue Service that, if successful, would require
the payment by the Company of the Gross-Up Payment. Such notification shall be
given as soon as practicable but no later than 30 calendar days after Employee
actually receives notice in writing of such claim and shall apprise the Company
of the nature of such claim and the date on which such claim is requested to be
paid; provided, however, that the failure of Employee to notify the Company of
such claim (or to provide any required information with respect thereto) shall
not affect any rights granted to Employee under this Section 11.5 except to the
extent that the Company is materially prejudiced in the defense of such claim as
a direct result of such failure. Employee shall not pay such claim prior to the
expiration of the 30-day period following the date on which he gives such notice
to the Company (or such shorter period ending on the date that any payment of
taxes with respect to such claim is due). If the Company notifies Employee in
writing prior to the expiration of such period that it desires to contest such
claim, Employee shall do all of the following:
(1) give the Company any information reasonably requested by the
Company relating to such claim;
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation
with respect to such claim by an attorney selected by the Company
and reasonably acceptable to Employee;
(3) cooperate with the Company in good faith in order effectively to
contest such claim;
(4) if the Company elects not to assume and control the defense of
such claim, permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and
8
<PAGE> 9
hold Employee harmless, on an after-tax basis, for any Excise Tax or income tax
(including interest and penalties with respect thereto) imposed as a result of
such representation and payment of costs and expenses. Without limiting the
foregoing provisions of this Section 11.5, the Company shall have the right, at
its sole option, to assume the defense of and control all proceedings in
connection with such contest, in which case it may pursue or forego any and all
administrative appeals, proceedings, hearings and conferences with the taxing
authority in respect of such claim and may either direct Employee to pay the tax
claimed and sue for a refund or contest the claim in any permissible manner, and
Employee agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or more
appellate courts, as the Company shall determine; provided, however, that if the
Company directs Employee to pay such claim and sue for a refund, the Company
shall advance the amount of such payment to Employee, on an interest-free basis
and shall indemnify and hold Employee harmless, on an after-tax basis, from any
Excise Tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income with
respect to such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for the taxable year of Employee
with respect to which such contested amount is claimed to be due is limited
solely to such contested amount. Furthermore, the Company's right to assume the
defense of and control the contest shall be limited to issues with respect to
which a Gross-Up Payment would be payable hereunder and Employee shall be
entitled to settle or contest, as the case may be, any other issue raised by the
Internal Revenue Service or any other taxing authority.
(d) Right to Tax Refund. If, after the receipt by Employee of an amount
advanced by the Company pursuant to Section 11.5 Employee becomes entitled to
receive any refund with respect to such claim, Employee shall (subject to the
Company's complying with the requirements of Section 11.5(c)) promptly pay to
the Company the amount of such refund (together with any interest paid or
credited thereon after taxes applicable thereto). If, after the receipt by
Employee of an amount advanced by the Company pursuant to Section 11.5(c), a
determination is made that Employee is not entitled to a refund with respect to
such claim and the Company does not notify Employee in writing of its intent to
contest such denial of refund prior to the expiration of 30 days after such
determination, then such advance shall, to the extent of such denial, be
forgiven and shall not be required to be repaid and the amount of forgiven
advance shall offset, to the extent thereof, the amount of Gross-Up Payment
required to be paid.
12. Disability of Employee. If, on account of physical or mental
disability, Employee shall fail or be unable to perform his assigned duties in
any material respect for a period of 60 consecutive days, the Company shall (i)
pay Employee his full salary as set forth in Section 2.1 hereof, (ii) provide
the insurance, bonus and other benefits of Section 2.1 for a period of six
months from the date such disability began or for such shorter period as
Employee is unable to perform his duties hereunder, and (iii) all awards granted
to Employee under SEI's stock incentive plans will become fully vested, as shall
be provided for thereunder; provided, however, that Employee's salary shall be
reduced by any disability income paid to him pursuant to any disability
insurance policy maintained under this Agreement. In the event Employee is
unable to perform his duties hereunder after the expiration of the six-month
period, this Agreement shall automatically terminate. Employee shall not be
required to perform his obligations under Section 1 hereof during any period of
disability.
9
<PAGE> 10
13. Assignment.
(a) The rights and benefits of Employee under this Agreement, other
than accrued and unpaid amounts due under Section 2 hereof, are personal to him
and shall not be assignable. Discharge of Employee's undertakings in Sections 3
and 4 hereof shall be an obligation of Employee's executors, administrators, or
other legal representatives or heirs.
(b) This Agreement may not be assigned by the Company except to an
affiliate of the Company or SEI, provided, however, that if the Company shall
merge or effect a share exchange with or into, or sell or otherwise transfer
substantially all its assets to, another corporation, the Company shall assign
its rights hereunder to that corporation and cause such corporation to assume
the Company's obligations under this Agreement.
14. Notices. Any notice or other communications under this Agreement
shall be in writing, signed by the party making the same, and shall be delivered
personally or sent by certified or registered mail, postage prepaid, addressed
as follows:
(a) If to Employee, to such address furnished to Company or at such
other address as may be furnished by him to Company in writing.
(b) If to the Company: SEI Management Company, LLC
Six Cadillac Drive, Suite 400
Brentwood, Tennessee 37027
Attention: Chief Manager
With a copy to: J. Chase Cole, Esq.
Waller Lansden Dortch & Davis
A Professional Limited Liability Company
2100 Nashville City Center
511 Union Street
Nashville, Tennessee 37219
or to such other address as may hereafter be designated by either party hereto.
All such notices shall be deemed given on the date personally delivered or
mailed.
15. Governing Law. This Agreement shall be interpreted and enforced in
accordance with the laws of the State of Tennessee.
16. Severability. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid, but if any one
or more of the provisions contained in this Agreement shall be invalid, illegal
or unenforceable in any respect for any reason, the validity, legality and
enforceability for any such provisions in every other respect and of the
remaining provisions of this Agreement shall not be in any way impaired.
17. Modification. No waiver of modification of this Agreement or of any
covenant, condition, or limitation herein contained shall be valid unless in
writing and duly executed by the
10
<PAGE> 11
party to be charged therewith and no evidence of any waiver or modification
shall be offered or received in evidence of any proceeding, arbitration or
litigation between the parties hereunder, unless such waiver or modification is
in writing, duly executed as aforesaid and the parties further agree that the
provisions of this section may not be waived except as herein set forth.
18. Entire Agreement. This Agreement contains the entire agreement of
the parties hereto with respect to the subject matter contained herein. There
are no restrictions, promises, covenants or undertakings, other than those
expressly set forth herein. This Agreement supersedes all prior agreements and
understandings between the parties with respect to such subject matter. This
Agreement may not be changed except by a writing executed by the parties.
19. Remedies. No remedy set forth in this Agreement or otherwise
conferred upon or reserved to any party shall be considered exclusive of any
other remedy available to any party, but the same shall be distinct, separate
and cumulative and may be exercised from time to time as often as occasion may
arise or as may be deemed expedient. In the event of any arbitration, equitable
or legal proceeding that is brought by either party regarding the subject matter
of this Agreement, the prevailing party shall be entitled to receive payment by
the other party of all costs and expenses, including reasonable attorney fees,
incurred in such proceeding. Except as expressly provided otherwise herein,
Employee's remedies hereunder for payment of compensation and benefits,
including payments for severance or payments after termination of employment,
shall not be diminished by the obtaining of new employment that does not violate
the terms of this Agreement.
20. Indemnity. At all times during and after Employee's employment and
the effectiveness of this Agreement, the Company, SEI and their successors shall
indemnify Employee (as a director, officer, employee and otherwise) to the
fullest extent permitted by law and shall at all times maintain appropriate
provisions in its Articles of Incorporation and Bylaws which mandate that such
indemnification be provided.
21. Survival. The provisions of Sections 3, 4, 5, 7, 10, 11, 12, 13,
14, 15, 16, 17, 18, 19 and 20 shall survive the termination of Employee's
employment and termination of this Agreement.
IN WITNESS WHEREOF, the undersigned have executed this Employment
Agreement on the day and year first above written.
EMPLOYEE SERVICE EXPERTS SERVICES, LLC
/s/ Anthony M. Schofield /s/ Alan R. Sielbeck
- ------------------------------ -------------------------------------
Anthony M. Schofield Alan R. Sielbeck, Chief Manager
11
<PAGE> 1
Exhibit 10.16
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made this 26th day of October, 1998, between Service
Experts Services, LLC, a Tennessee limited liability company (the "Company"),
and Alfred W. Taylor ("Employee").
W I T N E S S E T H:
WHEREAS, the Company, which maintains its principal executive offices
at Six Cadillac Drive, Suite 400, Brentwood, Tennessee 37027, provides services
that are utilized in the management of the heating, ventilating and air
conditioning ("HVAC") service and replacement businesses owned by Service
Experts, Inc., a Delaware corporation ("SEI");
WHEREAS, Company desires to employ Employee and Employee, who is also
the Executive Vice President of SEI, desires to accept such employment by the
Company subject to the terms and conditions contained herein;
WHEREAS, Employee has been subject to a written employment agreement
with SEI, which was originally effective on October 1, 1997, and the parties
desire that this Agreement be an amendment and restatement of the original
agreement to reflect that Employee's employment has been transferred to the
Company, to provide for automatic renewal of the Agreement, to provide certain
additional benefits to Employee in the event of a change in the Control of SEI
or the Company, and to further restrict Employee against entering into
activities that would compete against the business of the Company and/or SEI;
and
WHEREAS, in serving as an employee of the Company, Employee will
participate in the use and development of confidential proprietary information
about the Company, SEI, their respective customers and suppliers, and the
methods used by the Company, SEI and their employees in competition with other
companies, as to which the Company desires to protect fully its rights and the
rights of SEI;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein set forth, the parties hereto agree as follows:
1. Employment. The Company hereby employs Employee and Employee accepts
such employment with the Company, subject to the terms and conditions set forth
herein. Employee shall be employed as Executive Vice President, Corporate
Development of the Company, shall perform all duties and services incident to
such position, and such other duties and services as may be assigned or
delegated to Employee by the Company from time to time, in accordance with
actions taken by the board of directors of SEI (the "Board"); provided, however,
that without Employee's consent, the duties and services of Employee hereunder
shall not be materially increased or altered in a manner inconsistent with
Employee's position and duties hereunder that are set forth on Appendix I
hereto. During his employment hereunder, Employee shall devote his best efforts
and attention, on a full-time basis, to the performance of the duties required
of him as an employee of the Company.
<PAGE> 2
2. Compensation.
2.1 As compensation for services rendered by Employee hereunder,
Employee shall receive:
(a) An annual salary as set forth on Appendix II hereto, or such higher
salary as shall be established by the Compensation Committee of the Board, which
salary shall be payable in arrears in equal monthly installments, plus insurance
and other benefits equivalent to the benefits provided other similarly situated
employees of the Company;
(b) Compensated vacation time, for such duration as set forth on
Appendix II, to be taken at any time during each year of the term of this
Agreement;
(c) Bonus compensation to be determined in the sole discretion of the
Compensation Committee; and
(d) Reimbursement for all reasonable expenses incurred by Employee in
the performance of his duties under this Agreement, provided that Employee
submits verification of such expenses in accordance with the policies of the
Company and SEI.
2.2 Prior to the end of each anniversary of the Effective Date (defined
in Section 6) of this Agreement, the Compensation Committee or its delegate
shall review with Employee his compensation hereunder. Any increases in salary
or changes in fringe benefits agreed upon by Employee and the Compensation
Committee at such annual review shall become effective beginning on the month
following such review unless otherwise agreed to by the Company and Employee.
The Company shall promptly update the information on Appendix II with the
increases and changes effected hereunder from time to time.
3. Confidential Information and Trade Secrets.
3.1 Employee recognizes that Employee's position with the Company and
SEI requires considerable responsibility and trust, and, in reliance on
Employee's loyalty, the Company or SEI may entrust Employee with highly
sensitive confidential, restricted and proprietary information involving Trade
Secrets and Confidential Information (as hereinafter defined). For purposes of
this Section, references to SEI includes SEI's subsidiaries and business
entities that are owned or controlled by SEI or an SEI subsidiary.
3.2 For purposes of this Agreement, a "Trade Secret" is any scientific
or technical information, design, process, procedure, formula or improvement
that is valuable and not generally known to competitors of the Company or SEI.
"Confidential Information" is any data or information, other than Trade Secrets,
that is important, competitively sensitive, and not generally known by the
public, including, but not limited to, the Company's and SEI's business plans,
business prospects, customer lists, training manuals, product development plans,
bidding and pricing procedures, market strategies, internal performance
statistics, financial data, confidential personnel information concerning
employees of the Company or SEI, supplier data,
2
<PAGE> 3
operational or administrative plans, policy manuals, and terms and conditions of
contracts and agreements. The terms "Trade Secret" and "Confidential
Information" shall not apply to (i) information which is received by Employee
from a third party with no restriction on disclosure, or (ii) information which
is required to be disclosed by any applicable law, or (iii) processes or
methodologies pertaining to corporate development activities which are used by
the Employee in their position with the Company that were established prior to
Employee's employment with the Company or SEI.
3.3 Except as required to perform Employee's duties hereunder, Employee
will not use or disclose any Trade Secrets or Confidential Information of the
Company or SEI during employment, at any time after termination of employment
and prior to such time as they cease to be Trade Secrets or Confidential
Information through no act of Employee in violation of this Agreement.
3.4 Upon the request of the Company or SEI and, in any event, upon the
termination of employment hereunder, Employee will surrender to the Company or
SEI, as appropriate, all memoranda, notes, records, manuals or other documents
pertaining to the Company's or SEI's business or Employee's employment
(including all copies thereof). Employee will also leave with the Company all
materials involving any Trade Secrets or Confidential Information of the Company
or SEI. All such information and materials, whether or not made or developed by
Employee, shall be the sole and exclusive property of the Company, and Employee
hereby assigns to the Company all of Employee's right, title and interest in and
to any and all of such information and materials.
4. Covenant Not to Compete.
4.1 Employee hereby covenants and agrees with the Company that during
the term hereof and for a period expiring two years after the termination of
Employee's employment with the Company, Employee will not directly or indirectly
(i) operate, develop or own any interest, other than the ownership of less than
5% of the equity securities of a publicly traded company, in any business which
has significant (viewed in relation to the business of SEI) activities relating
to the ownership, management or operation of, or consultation regarding an HVAC
service and replacement company (an "HVAC Business"); (ii) compete with the
Company, SEI or their subsidiaries and affiliates in the operation or
development of any HVAC Business within 50 miles of any HVAC Business owned by
SEI; (iii) be employed by or consult with any business which owns, manages or
operates an HVAC Business within 50 miles of any HVAC Business owned by SEI;
(iv) interfere with, solicit, disrupt or attempt to disrupt any past, present or
prospective relationship, contractual or otherwise, between the Company, SEI or
their subsidiaries or affiliates, and any customer, client, supplier or employee
of SEI, or its subsidiaries or affiliates; or (v) solicit any past, present or
prospective management employee (including all corporate officers and managers,
all regional managers and all general managers) of the Company, SEI or their
subsidiaries or affiliates, to leave their employment with the Company, SEI or
their subsidiaries or affiliates, or hire any such employee to work in any
capacity; provided, however, that this provision shall not apply if Employee's
employment hereunder is terminated without cause prior to the expiration of the
Agreement.
3
<PAGE> 4
4.2 If a judicial determination is made that any of the provisions of
this Section 4 constitutes an unreasonable or otherwise unenforceable
restriction against Employee, the provisions of this Section 4 shall be rendered
void only to the extent that such judicial determination finds such provisions
to be unreasonable or otherwise unenforceable. In this regard, the parties
hereto hereby agree that any judicial authority construing this Agreement shall
be empowered to sever any portion of the territory or prohibited business
activity from the coverage of this Section 4 and to apply the provisions of this
Section 4 to the remaining portion of the territory or the remaining business
activities not so severed by such judicial authority. Moreover, notwithstanding
the fact that any provisions of this Section 4 are determined not to be
specifically enforceable, the Company and/or SEI shall nevertheless be entitled
to recover monetary damages as a result of the breach of such provision by
Employee. The time period during which the prohibitions set forth in this
Section 4 shall apply shall be tolled and suspended as to Employee for a period
equal to the aggregate quantity of time during which Employee violates such
prohibitions in any respect.
5. Specific Enforcement. Employee specifically acknowledges and agrees
that the restrictions set forth in Sections 3 and 4 hereof are reasonable and
necessary to protect the legitimate interests of the Company and SEI and that
the Company would not have entered into this Agreement in the absence of such
restrictions. Employee further acknowledges and agrees that any violation of the
provisions of Sections 3 or 4 hereof will result in irreparable injury to the
Company and SEI, that the remedy at law for any violation or threatened
violation of such Sections will be inadequate and that in the event of any such
breach, the Company and SEI, in addition to any other remedies or damages
available to them at law or in equity, shall be entitled to temporary injunctive
relief before trial from any court of competent jurisdiction as a matter of
course and to permanent injunctive relief without the necessity of proving
actual damages.
6. Term. This Agreement shall be effective on October 26, 1998, (the
"Effective Date") and shall continue in full force and effect for a period of
three years thereafter. The term of this Agreement shall be automatically
extended on the first day of each month for a period of one additional month so
that the remaining term of the Agreement on such date is always a period of 36
months. This Agreement may only be terminated in accordance with Sections 7, 8,
9, 10, 11 and 12.
7. Termination Upon Cessation of Company's Operations or Death of the
Employee. In the event the Company ceases its operations or the Employee dies
during the term of this Agreement, this Agreement shall immediately terminate
and neither the Employee nor the Company shall have any further obligations
hereunder, except that (i) the Company shall continue to be obligated under
Section 2.1 hereof for any unpaid salary, bonus, unreimbursed expenses or
payments pursuant to Section 10 hereof owed to Employee or his estate that have
accrued but not been paid as of the Termination Date, (ii) in the event of death
of the Employee during the term of this Agreement, the Company shall pay to
Employee's estate an amount equal to three months salary, and (iii) the awards
granted to Employee under SEI's stock incentive plans shall become fully vested,
as shall be provided thereunder. The Company shall be deemed to have ceased its
operations upon the liquidation of the Company through bankruptcy or insolvency
proceedings.
4
<PAGE> 5
8. Termination by Employee. Employee may at any time terminate his
employment by giving the Company 90 days prior written notice of his intent to
terminate the Agreement. At the Termination Date, the Company shall have no
further obligation to Employee and Employee shall have no further rights or
obligations hereunder, except as set forth in Sections 3 and 4 above, and except
for the Company's obligation under Section 2.1 hereof for unpaid salary, bonus
or unreimbursed expenses that have accrued but have not been paid as of the
Termination Date.
9. Termination for Cause. The Company shall have the right at any time
to terminate Employee's employment immediately for cause, which shall include
any of the following reasons:
(a) If Employee shall violate the provisions of Sections 3 or
4 of this Agreement, or shall fail to comply with any other material
term or condition of this Agreement which materially and adversely
affects the business or affairs of the Company; or
(b) If Employee shall commit (i) a felony or (ii) an act of
dishonesty, willful mismanagement, fraud or embezzlement against the
Company.
Employee's obligations under Sections 3 and 4 hereof shall survive the
termination of the Agreement pursuant to this Section 9. In the event Employee's
employment hereunder is terminated in accordance with this Section, the Company
shall have no further obligation to make any payments to Employee hereunder
except for unpaid salary, bonus or unreimbursed expenses that have accrued but
have not been paid as of the Termination Date.
10. Termination Without Cause. In the event that Employee's employment
is terminated after the Company or SEI materially breaches this Agreement, or
Employee is terminated "without cause" (defined below) during the term hereof,
the Company shall (i) pay Employee all bonuses and unreimbursed expenses owed to
Employee that have accrued but have not been paid as of the Termination Date;
(ii) continue to pay to Employee his salary set forth in Section 2.1 hereof for
a period of two years following the Termination Date; and (iii) continue to
provide the insurance and other benefits of Section 2.1 hereof for a period of
two years following the Termination Date. Moreover, the provisions of Sections 3
and 4 will be effective for a period of two years following the Termination
Date, provided that the Company continues it obligations during such period that
are described in this Section. In addition to the severance payment payable
under this Section 10, Employee shall be paid an amount equal to two times the
average annual bonus earned by Employee in the two years immediately preceding
the date of termination. Employee shall also be entitled to an accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which accelerated vesting shall be provided for thereunder. For purposes of this
Section 10, termination "without cause" includes any termination of employment
that is not made pursuant to Sections 7, 8, 9, 11 or 12.
5
<PAGE> 6
11. Termination Upon a Change in Control.
11.1 For purposes of this Agreement, a "Change in Control" shall mean
(a) the time that SEI first determines that any person and all other persons who
constitute a group (within the meaning of Section 13(d)(3) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), have acquired within any
12 month period (i) direct or indirect beneficial ownership (within the meaning
of Section 13(d)(3) under the Exchange Act) of 20% or more of SEI's outstanding
securities or (ii) assets of SEI having a fair market value in excess of
one-third of SEI's total assets, unless a majority of the Continuing Directors,
as hereinafter defined, approves the acquisition not later than ten business
days after SEI makes that determination, (b) the first day on which a majority
of the members of SEI's Board are not Continuing Directors, or (c) upon the
occurrence of a merger, consolidation, acquisition of property or stock,
separation, reorganization or liquidation of SEI, as a result of which the
stockholders of SEI receive cash, stock or other property in exchange for their
shares of SEI stock (but not a public offering of stock by SEI), and SEI is not
the surviving entity.
11.2 For purposes of this Agreement, "Continuing Directors" shall mean,
as of any date of determination, any member of the Board who (i) was a member of
the Board on August 16, 1996, (ii) has been a member of the Board for the two
years immediately preceding such date of determination or (iii) was nominated
for election or elected to the Board with the affirmative vote of a majority of
Continuing Directors who were members of the Board at the time of such
nomination or election.
11.3 In the event of Employee's termination of employment coincident
with or within 24 months following a Change in Control, whether at Employee's
direction or otherwise, Employee shall immediately be paid all accrued salary,
bonus compensation to the extent earned, vested deferred compensation (other
than plan benefits which will be paid in accordance with the applicable plan),
any benefits under any plans of the Company in which Employee is a participant
to the full extent of Employee's rights under such plans (including accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which shall provide for accelerated vesting), accrued vacation pay and any
appropriate business expenses incurred by Employee in connection with his duties
hereunder, all to the date of termination, and all severance compensation
provided in Section 11.4, but no other compensation or reimbursement of any
kind.
11.4 In addition to the compensation described in Section 11.3,
Employee shall be paid as severance compensation his base salary (at the rate
payable at the time of such termination) through the remaining term of this
Agreement and any extensions hereof in a single lump sum within 10 days
following the payment event described in Section 11.3. Employee is under no
obligation to mitigate the amount owed Employee pursuant to this Section 11.4 by
seeking other employment or otherwise. Nothing herein shall prevent Company from
making an offer to Employee prior to the time that payments are otherwise due
hereunder to pay the severance compensation in installments, an alternate form,
or to otherwise defer payment, provided that such offer is based on the business
purposes of the Company and Employee shall not be obliged to accept such offer.
6
<PAGE> 7
In addition to the severance payment payable under this Section 11.4,
Employee shall be paid an amount equal to three times the average annual bonus
earned by Employee in the two years immediately preceding the date of
termination. Employee shall also be entitled to an accelerated vesting of any
awards granted to Employee under SEI's stock incentive plans, which plans shall
provide for such acceleration. Employee shall continue to accrue retirement
benefits and shall continue to enjoy any benefits under any plans of the Company
or SEI in which Employee is a participant to the full extent of Employee's
rights under such plans, including any perquisites provided under this
Agreement, through the remaining term of this Agreement; provided, however, that
the benefits under any such plans of the Company or SEI in which Employee is a
participant, including any such perquisites, shall cease upon re-employment by a
new employer.
11.5 Employee will be entitled to additional payments with respect to
amounts that are payable due to a Change in Control, or otherwise, as follows:
(a) Gross Up Payment. Anything in this Agreement to the contrary
notwithstanding, in the event it shall be determined that any payment or
distribution by or on behalf of the Company to or for the benefit of Employee as
a result of a "change in control," as defined in section 280G of the Internal
Revenue Code of 1986, as amended, (the "Code") (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise, but determined without regard to any additional payments required
under this Section (a "Payment") would be subject to the excise tax imposed by
section 4999 of the Code or any interest or penalties are incurred by Employee
with respect to such excise tax (such excise tax, together with any such
interest and penalties, are hereinafter collectively referred to as the "Excise
Tax"), then Employee shall be entitled to receive an additional payment (a
"Gross-Up Payment") in an amount such that after payment by Employee of all
taxes (including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
Employee retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments.
(b) Tax Opinion. Subject to the provisions of Section 11.5(c), all
determinations required to be made under this Section 11.5, including whether
and when a Gross-Up Payment is required and the amount of such Gross-Up Payment
and the assumptions to be utilized in arriving at such determination, shall be
made by a nationally recognized accounting firm or law firm selected by the
Company (the "Tax Firm"); provided, however, that the Tax Firm shall not
determine that no Excise Tax is payable by Employee unless it delivers to
Employee a written opinion (the "Tax Opinion") that failure to pay the Excise
Tax and to report the Excise Tax and the payments potentially subject thereto on
or with Employee's applicable federal income tax return will not result in the
imposition of an accuracy-related or other penalty on Employee. All fees and
expenses of the Tax Firm shall be borne solely by the Company. Within 15
business days of the receipt of notice from Employee that there has been a
Payment, or such earlier time as is requested by the Company, the Tax Firm shall
make all determinations required under this Section, shall provide to the
Company and Employee a written report setting forth such determinations,
together with detailed supporting calculations, and, if the Tax Firm determines
that no Excise Tax is payable, shall deliver the Tax Opinion to Employee. Any
Gross-Up Payment, as determined pursuant to this Section, shall be paid by the
Company to Employee within fifteen days of the receipt of the Tax Firm's
determination. Subject to the remainder of this Section 11.5, any
7
<PAGE> 8
determination by the Tax Firm shall be binding upon the Company and Employee;
provided, however, that Employee shall only be bound to the extent that the
determinations of the Tax Firm hereunder, including the determinations made in
the Tax Opinion, are reasonable and reasonably supported by applicable law. As a
result of the uncertainty in the application of section 4999 of the Code at the
time of the initial determination by the Tax Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that it is ultimately determined in accordance with the
procedures set forth in Section 11.5(c) that Employee is required to make a
payment of any Excise Tax, the Tax Firm shall reasonably determine the amount of
the Underpayment that has occurred and any such Underpayment shall be promptly
paid by the Company to or for the benefit of Employee. In determining the
reasonableness of Tax Firm's determinations hereunder, and the effect thereof,
Employee shall be provided a reasonable opportunity to review such
determinations with Tax Firm and Employee's tax counsel. Tax Firm's
determinations hereunder, and the Tax Opinion, shall not be deemed reasonable
until Employee's reasonable objections and comments thereto have been
satisfactorily accommodated by Tax Firm.
(c) Notice of IRS Claim. Employee shall notify the Company in writing
of any claims by the Internal Revenue Service that, if successful, would require
the payment by the Company of the Gross-Up Payment. Such notification shall be
given as soon as practicable but no later than 30 calendar days after Employee
actually receives notice in writing of such claim and shall apprise the Company
of the nature of such claim and the date on which such claim is requested to be
paid; provided, however, that the failure of Employee to notify the Company of
such claim (or to provide any required information with respect thereto) shall
not affect any rights granted to Employee under this Section 11.5 except to the
extent that the Company is materially prejudiced in the defense of such claim as
a direct result of such failure. Employee shall not pay such claim prior to the
expiration of the 30-day period following the date on which he gives such notice
to the Company (or such shorter period ending on the date that any payment of
taxes with respect to such claim is due). If the Company notifies Employee in
writing prior to the expiration of such period that it desires to contest such
claim, Employee shall do all of the following:
(1) give the Company any information reasonably requested by the
Company relating to such claim;
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation
with respect to such claim by an attorney selected by the Company
and reasonably acceptable to Employee;
(3) cooperate with the Company in good faith in order effectively to
contest such claim;
(4) if the Company elects not to assume and control the defense of
such claim, permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and
8
<PAGE> 9
hold Employee harmless, on an after-tax basis, for any Excise Tax or income tax
(including interest and penalties with respect thereto) imposed as a result of
such representation and payment of costs and expenses. Without limiting the
foregoing provisions of this Section 11.5, the Company shall have the right, at
its sole option, to assume the defense of and control all proceedings in
connection with such contest, in which case it may pursue or forego any and all
administrative appeals, proceedings, hearings and conferences with the taxing
authority in respect of such claim and may either direct Employee to pay the tax
claimed and sue for a refund or contest the claim in any permissible manner, and
Employee agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or more
appellate courts, as the Company shall determine; provided, however, that if the
Company directs Employee to pay such claim and sue for a refund, the Company
shall advance the amount of such payment to Employee, on an interest-free basis
and shall indemnify and hold Employee harmless, on an after-tax basis, from any
Excise Tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income with
respect to such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for the taxable year of Employee
with respect to which such contested amount is claimed to be due is limited
solely to such contested amount. Furthermore, the Company's right to assume the
defense of and control the contest shall be limited to issues with respect to
which a Gross-Up Payment would be payable hereunder and Employee shall be
entitled to settle or contest, as the case may be, any other issue raised by the
Internal Revenue Service or any other taxing authority.
(d) Right to Tax Refund. If, after the receipt by Employee of an amount
advanced by the Company pursuant to Section 11.5 Employee becomes entitled to
receive any refund with respect to such claim, Employee shall (subject to the
Company's complying with the requirements of Section 11.5(c)) promptly pay to
the Company the amount of such refund (together with any interest paid or
credited thereon after taxes applicable thereto). If, after the receipt by
Employee of an amount advanced by the Company pursuant to Section 11.5(c), a
determination is made that Employee is not entitled to a refund with respect to
such claim and the Company does not notify Employee in writing of its intent to
contest such denial of refund prior to the expiration of 30 days after such
determination, then such advance shall, to the extent of such denial, be
forgiven and shall not be required to be repaid and the amount of forgiven
advance shall offset, to the extent thereof, the amount of Gross-Up Payment
required to be paid.
12. Disability of Employee. If, on account of physical or mental
disability, Employee shall fail or be unable to perform his assigned duties in
any material respect for a period of 60 consecutive days, the Company shall (i)
pay Employee his full salary as set forth in Section 2.1 hereof, (ii) provide
the insurance, bonus and other benefits of Section 2.1 for a period of six
months from the date such disability began or for such shorter period as
Employee is unable to perform his duties hereunder, and (iii) all awards granted
to Employee under SEI's stock incentive plans will become fully vested, as shall
be provided for thereunder; provided, however, that Employee's salary shall be
reduced by any disability income paid to him pursuant to any disability
insurance policy maintained under this Agreement. In the event Employee is
unable to perform his duties hereunder after the expiration of the six-month
period, this Agreement shall automatically terminate. Employee shall not be
required to perform his obligations under Section 1 hereof during any period of
disability.
9
<PAGE> 10
13. Assignment.
(a) The rights and benefits of Employee under this Agreement, other
than accrued and unpaid amounts due under Section 2 hereof, are personal to him
and shall not be assignable. Discharge of Employee's undertakings in Sections 3
and 4 hereof shall be an obligation of Employee's executors, administrators, or
other legal representatives or heirs.
(b) This Agreement may not be assigned by the Company except to an
affiliate of the Company or SEI, provided, however, that if the Company shall
merge or effect a share exchange with or into, or sell or otherwise transfer
substantially all its assets to, another corporation, the Company shall assign
its rights hereunder to that corporation and cause such corporation to assume
the Company's obligations under this Agreement.
14. Notices. Any notice or other communications under this Agreement
shall be in writing, signed by the party making the same, and shall be delivered
personally or sent by certified or registered mail, postage prepaid, addressed
as follows:
(a) If to Employee, to such address furnished to Company or at such
other address as may be furnished by him to Company in writing.
(b) If to the Company: SEI Management Company, LLC
Six Cadillac Drive, Suite 400
Brentwood, Tennessee 37027
Attention: Chief Manager
With a copy to: J. Chase Cole, Esq.
Waller Lansden Dortch & Davis
A Professional Limited Liability Company
2100 Nashville City Center
511 Union Street
Nashville, Tennessee 37219
or to such other address as may hereafter be designated by either party hereto.
All such notices shall be deemed given on the date personally delivered or
mailed.
15. Governing Law. This Agreement shall be interpreted and enforced in
accordance with the laws of the State of Tennessee.
16. Severability. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid, but if any one
or more of the provisions contained in this Agreement shall be invalid, illegal
or unenforceable in any respect for any reason, the validity, legality and
enforceability for any such provisions in every other respect and of the
remaining provisions of this Agreement shall not be in any way impaired.
10
<PAGE> 11
17. Modification. No waiver of modification of this Agreement or of any
covenant, condition, or limitation herein contained shall be valid unless in
writing and duly executed by the party to be charged therewith and no evidence
of any waiver or modification shall be offered or received in evidence of any
proceeding, arbitration or litigation between the parties hereunder, unless such
waiver or modification is in writing, duly executed as aforesaid and the parties
further agree that the provisions of this section may not be waived except as
herein set forth.
18. Entire Agreement. This Agreement contains the entire agreement of
the parties hereto with respect to the subject matter contained herein. There
are no restrictions, promises, covenants or undertakings, other than those
expressly set forth herein. This Agreement supersedes all prior agreements and
understandings between the parties with respect to such subject matter. This
Agreement may not be changed except by a writing executed by the parties.
19. Remedies. No remedy set forth in this Agreement or otherwise
conferred upon or reserved to any party shall be considered exclusive of any
other remedy available to any party, but the same shall be distinct, separate
and cumulative and may be exercised from time to time as often as occasion may
arise or as may be deemed expedient. In the event of any arbitration, equitable
or legal proceeding that is brought by either party regarding the subject matter
of this Agreement, the prevailing party shall be entitled to receive payment by
the other party of all costs and expenses, including reasonable attorney fees,
incurred in such proceeding. Except as expressly provided otherwise herein,
Employee's remedies hereunder for payment of compensation and benefits,
including payments for severance or payments after termination of employment,
shall not be diminished by the obtaining of new employment that does not violate
the terms of this Agreement.
20. Indemnity. At all times during and after Employee's employment and
the effectiveness of this Agreement, the Company, SEI and their successors shall
indemnify Employee (as a director, officer, employee and otherwise) to the
fullest extent permitted by law and shall at all times maintain appropriate
provisions in its Articles of Incorporation and Bylaws which mandate that such
indemnification be provided.
21. Survival. The provisions of Sections 3, 4, 5, 7, 10, 11, 12, 13,
14, 15, 16, 17, 18, 19 and 20 shall survive the termination of Employee's
employment and termination of this Agreement.
IN WITNESS WHEREOF, the undersigned have executed this Employment
Agreement on the day and year first above written.
EMPLOYEE SERVICE EXPERTS SERVICES, LLC
/s/ Alfred W. Taylor /s/ Alan R. Sielbeck
- ------------------------------- --------------------------------------
Alfred W. Taylor Alan R. Sielbeck, Chief Manager
11
<PAGE> 1
Exhibit 10.17
EMPLOYMENT AGREEMENT
THIS AGREEMENT is made this 26th day of October, 1998, between Service
Experts Services, LLC, a Tennessee limited liability company (the "Company"),
and Ronald L. Smith ("Employee").
W I T N E S S E T H:
WHEREAS, the Company, which maintains its principal executive offices
at Six Cadillac Drive, Suite 400, Brentwood, Tennessee 37027, provides services
that are utilized in the management of the heating, ventilating and air
conditioning ("HVAC") service and replacement businesses owned by Service
Experts, Inc., a Delaware corporation ("SEI");
WHEREAS, Company desires to employ Employee and Employee, who is also
the Executive Vice President & Chief Operating Officer of SEI, desires to accept
such employment by the Company subject to the terms and conditions contained
herein;
WHEREAS, Employee has been subject to a written employment agreement
with SEI, which was originally effective on October 1, 1997, and the parties
desire that this Agreement be an amendment and restatement of the original
agreement to reflect that Employee's employment has been transferred to the
Company, to provide for automatic renewal of the Agreement, to provide certain
additional benefits to Employee in the event of a change in the Control of SEI
or the Company, and to further restrict Employee against entering into
activities that would compete against the business of the Company and/or SEI;
and
WHEREAS, in serving as an employee of the Company, Employee will
participate in the use and development of confidential proprietary information
about the Company, SEI, their respective customers and suppliers, and the
methods used by the Company, SEI and their employees in competition with other
companies, as to which the Company desires to protect fully its rights and the
rights of SEI;
NOW, THEREFORE, in consideration of the premises and the mutual
covenants and agreements herein set forth, the parties hereto agree as follows:
1. Employment. The Company hereby employs Employee and Employee accepts
such employment with the Company, subject to the terms and conditions set forth
herein. Employee shall be employed as Executive Vice President & Chief Operating
Officer of the Company, shall perform all duties and services incident to such
position, and such other duties and services as may be assigned or delegated to
Employee by the Company from time to time, in accordance with actions taken by
the board of directors of SEI (the "Board"); provided, however, that without
Employee's consent, the duties and services of Employee hereunder shall not be
materially increased or altered in a manner inconsistent with Employee's
position and duties hereunder that are set forth on Appendix I hereto. During
his employment hereunder, Employee shall devote his best efforts and attention,
on a full-time basis, to the performance of the duties required of him as an
employee of the Company.
<PAGE> 2
2. Compensation.
2.1 As compensation for services rendered by Employee hereunder,
Employee shall receive:
(a) An annual salary as set forth on Appendix II hereto, or such higher
salary as shall be established by the Compensation Committee of the Board, which
salary shall be payable in arrears in equal monthly installments, plus insurance
and other benefits equivalent to the benefits provided other similarly situated
employees of the Company;
(b) Compensated vacation time, for such duration as set forth on
Appendix II, to be taken at any time during each year of the term of this
Agreement;
(c) Bonus compensation to be determined in the sole discretion of the
Compensation Committee; and
(d) Reimbursement for all reasonable expenses incurred by Employee in
the performance of his duties under this Agreement, provided that Employee
submits verification of such expenses in accordance with the policies of the
Company and SEI.
2.2 Prior to the end of each anniversary of the Effective Date (defined
in Section 6) of this Agreement, the Compensation Committee or its delegate
shall review with Employee his compensation hereunder. Any increases in salary
or changes in fringe benefits agreed upon by Employee and the Compensation
Committee at such annual review shall become effective beginning on the month
following such review unless otherwise agreed to by the Company and Employee.
The Company shall promptly update the information on Appendix II with the
increases and changes effected hereunder from time to time.
3. Confidential Information and Trade Secrets.
3.1 Employee recognizes that Employee's position with the Company and
SEI requires considerable responsibility and trust, and, in reliance on
Employee's loyalty, the Company or SEI may entrust Employee with highly
sensitive confidential, restricted and proprietary information involving Trade
Secrets and Confidential Information (as hereinafter defined). For purposes of
this Section, references to SEI includes SEI's subsidiaries and business
entities that are owned or controlled by SEI or an SEI subsidiary.
3.2 For purposes of this Agreement, a "Trade Secret" is any scientific
or technical information, design, process, procedure, formula or improvement
that is valuable and not generally known to competitors of the Company or SEI.
"Confidential Information" is any data or information, other than Trade Secrets,
that is important, competitively sensitive, and not generally known by the
public, including, but not limited to, the Company's and SEI's business plans,
business prospects, customer lists, training manuals, product development plans,
bidding and pricing procedures, market strategies, internal performance
statistics, financial data, confidential personnel information concerning
employees of the Company or SEI, supplier data,
2
<PAGE> 3
operational or administrative plans, policy manuals, and terms and conditions of
contracts and agreements. The terms "Trade Secret" and "Confidential
Information" shall not apply to (i) information which is received by Employee
from a third party with no restriction on disclosure, or (ii) information which
is required to be disclosed by any applicable law, or (iii) processes or
methodologies pertaining to corporate development activities which are used by
the Employee in their position with the Company that were established prior to
Employee's employment with the Company or SEI.
3.3 Except as required to perform Employee's duties hereunder, Employee
will not use or disclose any Trade Secrets or Confidential Information of the
Company or SEI during employment, at any time after termination of employment
and prior to such time as they cease to be Trade Secrets or Confidential
Information through no act of Employee in violation of this Agreement.
3.4 Upon the request of the Company or SEI and, in any event, upon the
termination of employment hereunder, Employee will surrender to the Company or
SEI, as appropriate, all memoranda, notes, records, manuals or other documents
pertaining to the Company's or SEI's business or Employee's employment
(including all copies thereof). Employee will also leave with the Company all
materials involving any Trade Secrets or Confidential Information of the Company
or SEI. All such information and materials, whether or not made or developed by
Employee, shall be the sole and exclusive property of the Company, and Employee
hereby assigns to the Company all of Employee's right, title and interest in and
to any and all of such information and materials.
4. Covenant Not to Compete.
4.1 Employee hereby covenants and agrees with the Company that during
the term hereof and for a period expiring two years after the termination of
Employee's employment with the Company, Employee will not directly or indirectly
(i) operate, develop or own any interest, other than the ownership of less than
5% of the equity securities of a publicly traded company, in any business which
has significant (viewed in relation to the business of SEI) activities relating
to the ownership, management or operation of, or consultation regarding an HVAC
service and replacement company (an "HVAC Business"); (ii) compete with the
Company, SEI or their subsidiaries and affiliates in the operation or
development of any HVAC Business within 50 miles of any HVAC Business owned by
SEI; (iii) be employed by or consult with any business which owns, manages or
operates an HVAC Business within 50 miles of any HVAC Business owned by SEI;
(iv) interfere with, solicit, disrupt or attempt to disrupt any past, present or
prospective relationship, contractual or otherwise, between the Company, SEI or
their subsidiaries or affiliates, and any customer, client, supplier or employee
of SEI, or its subsidiaries or affiliates; or (v) solicit any past, present or
prospective management employee (including all corporate officers and managers,
all regional managers and all general managers) of the Company, SEI or their
subsidiaries or affiliates, to leave their employment with the Company, SEI or
their subsidiaries or affiliates, or hire any such employee to work in any
capacity; provided, however, that this provision shall not apply if Employee's
employment hereunder is terminated without cause prior to the expiration of the
Agreement.
3
<PAGE> 4
4.2 If a judicial determination is made that any of the provisions of
this Section 4 constitutes an unreasonable or otherwise unenforceable
restriction against Employee, the provisions of this Section 4 shall be rendered
void only to the extent that such judicial determination finds such provisions
to be unreasonable or otherwise unenforceable. In this regard, the parties
hereto hereby agree that any judicial authority construing this Agreement shall
be empowered to sever any portion of the territory or prohibited business
activity from the coverage of this Section 4 and to apply the provisions of this
Section 4 to the remaining portion of the territory or the remaining business
activities not so severed by such judicial authority. Moreover, notwithstanding
the fact that any provisions of this Section 4 are determined not to be
specifically enforceable, the Company and/or SEI shall nevertheless be entitled
to recover monetary damages as a result of the breach of such provision by
Employee. The time period during which the prohibitions set forth in this
Section 4 shall apply shall be tolled and suspended as to Employee for a period
equal to the aggregate quantity of time during which Employee violates such
prohibitions in any respect.
5. Specific Enforcement. Employee specifically acknowledges and agrees
that the restrictions set forth in Sections 3 and 4 hereof are reasonable and
necessary to protect the legitimate interests of the Company and SEI and that
the Company would not have entered into this Agreement in the absence of such
restrictions. Employee further acknowledges and agrees that any violation of the
provisions of Sections 3 or 4 hereof will result in irreparable injury to the
Company and SEI, that the remedy at law for any violation or threatened
violation of such Sections will be inadequate and that in the event of any such
breach, the Company and SEI, in addition to any other remedies or damages
available to them at law or in equity, shall be entitled to temporary injunctive
relief before trial from any court of competent jurisdiction as a matter of
course and to permanent injunctive relief without the necessity of proving
actual damages.
6. Term. This Agreement shall be effective on October 26, 1998, (the
"Effective Date") and shall continue in full force and effect for a period of
three years thereafter. The term of this Agreement shall be automatically
extended on the first day of each month for a period of one additional month so
that the remaining term of the Agreement on such date is always a period of 36
months. This Agreement may only be terminated in accordance with Sections 7, 8,
9, 10, 11 and 12.
7. Termination Upon Cessation of Company's Operations or Death of the
Employee. In the event the Company ceases its operations or the Employee dies
during the term of this Agreement, this Agreement shall immediately terminate
and neither the Employee nor the Company shall have any further obligations
hereunder, except that (i) the Company shall continue to be obligated under
Section 2.1 hereof for any unpaid salary, bonus, unreimbursed expenses or
payments pursuant to Section 10 hereof owed to Employee or his estate that have
accrued but not been paid as of the Termination Date, (ii) in the event of death
of the Employee during the term of this Agreement, the Company shall pay to
Employee's estate an amount equal to three months salary, and (iii) the awards
granted to Employee under SEI's stock incentive plans shall become fully vested,
as shall be provided thereunder. The Company shall be deemed to have ceased its
operations upon the liquidation of the Company through bankruptcy or insolvency
proceedings.
4
<PAGE> 5
8. Termination by Employee. Employee may at any time terminate his
employment by giving the Company 90 days prior written notice of his intent to
terminate the Agreement. At the Termination Date, the Company shall have no
further obligation to Employee and Employee shall have no further rights or
obligations hereunder, except as set forth in Sections 3 and 4 above, and except
for the Company's obligation under Section 2.1 hereof for unpaid salary, bonus
or unreimbursed expenses that have accrued but have not been paid as of the
Termination Date.
9. Termination for Cause. The Company shall have the right at any time
to terminate Employee's employment immediately for cause, which shall include
any of the following reasons:
(a) If Employee shall violate the provisions of Sections 3 or
4 of this Agreement, or shall fail to comply with any other material
term or condition of this Agreement which materially and adversely
affects the business or affairs of the Company; or
(b) If Employee shall commit (i) a felony or (ii) an act of
dishonesty, willful mismanagement, fraud or embezzlement against the
Company.
Employee's obligations under Sections 3 and 4 hereof shall survive the
termination of the Agreement pursuant to this Section 9. In the event Employee's
employment hereunder is terminated in accordance with this Section, the Company
shall have no further obligation to make any payments to Employee hereunder
except for unpaid salary, bonus or unreimbursed expenses that have accrued but
have not been paid as of the Termination Date.
10. Termination Without Cause. In the event that Employee's employment
is terminated after the Company or SEI materially breaches this Agreement, or
Employee is terminated "without cause" (defined below) during the term hereof,
the Company shall (i) pay Employee all bonuses and unreimbursed expenses owed to
Employee that have accrued but have not been paid as of the Termination Date;
(ii) continue to pay to Employee his salary set forth in Section 2.1 hereof for
a period of two years following the Termination Date; and (iii) continue to
provide the insurance and other benefits of Section 2.1 hereof for a period of
two years following the Termination Date. Moreover, the provisions of Sections 3
and 4 will be effective for a period of two years following the Termination
Date, provided that the Company continues it obligations during such period that
are described in this Section. In addition to the severance payment payable
under this Section 10, Employee shall be paid an amount equal to two times the
average annual bonus earned by Employee in the two years immediately preceding
the date of termination. Employee shall also be entitled to an accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which accelerated vesting shall be provided for thereunder. For purposes of this
Section 10, termination "without cause" includes any termination of employment
that is not made pursuant to Sections 7, 8, 9, 11 or 12.
5
<PAGE> 6
11. Termination Upon a Change in Control.
11.1 For purposes of this Agreement, a "Change in Control" shall mean
(a) the time that SEI first determines that any person and all other persons who
constitute a group (within the meaning of Section 13(d)(3) of the Securities
Exchange Act of 1934, as amended (the "Exchange Act")), have acquired within any
12 month period (i) direct or indirect beneficial ownership (within the meaning
of Section 13(d)(3) under the Exchange Act) of 20% or more of SEI's outstanding
securities or (ii) assets of SEI having a fair market value in excess of
one-third of SEI's total assets, unless a majority of the Continuing Directors,
as hereinafter defined, approves the acquisition not later than ten business
days after SEI makes that determination, (b) the first day on which a majority
of the members of SEI's Board are not Continuing Directors, or (c) upon the
occurrence of a merger, consolidation, acquisition of property or stock,
separation, reorganization or liquidation of SEI, as a result of which the
stockholders of SEI receive cash, stock or other property in exchange for their
shares of SEI stock (but not a public offering of stock by SEI), and SEI is not
the surviving entity.
11.2 For purposes of this Agreement, "Continuing Directors" shall mean,
as of any date of determination, any member of the Board who (i) was a member of
the Board on August 16, 1996, (ii) has been a member of the Board for the two
years immediately preceding such date of determination or (iii) was nominated
for election or elected to the Board with the affirmative vote of a majority of
Continuing Directors who were members of the Board at the time of such
nomination or election.
11.3 In the event of Employee's termination of employment coincident
with or within 24 months following a Change in Control, whether at Employee's
direction or otherwise, Employee shall immediately be paid all accrued salary,
bonus compensation to the extent earned, vested deferred compensation (other
than plan benefits which will be paid in accordance with the applicable plan),
any benefits under any plans of the Company in which Employee is a participant
to the full extent of Employee's rights under such plans (including accelerated
vesting of any awards granted to Employee under SEI's stock incentive plans,
which shall provide for accelerated vesting), accrued vacation pay and any
appropriate business expenses incurred by Employee in connection with his duties
hereunder, all to the date of termination, and all severance compensation
provided in Section 11.4, but no other compensation or reimbursement of any
kind.
11.4 In addition to the compensation described in Section 11.3,
Employee shall be paid as severance compensation his base salary (at the rate
payable at the time of such termination) through the remaining term of this
Agreement and any extensions hereof in a single lump sum within 10 days
following the payment event described in Section 11.3. Employee is under no
obligation to mitigate the amount owed Employee pursuant to this Section 11.4 by
seeking other employment or otherwise. Nothing herein shall prevent Company from
making an offer to Employee prior to the time that payments are otherwise due
hereunder to pay the severance compensation in installments, an alternate form,
or to otherwise defer payment, provided that such offer is based on the business
purposes of the Company and Employee shall not be obliged to accept such offer.
6
<PAGE> 7
In addition to the severance payment payable under this Section 11.4,
Employee shall be paid an amount equal to three times the average annual bonus
earned by Employee in the two years immediately preceding the date of
termination. Employee shall also be entitled to an accelerated vesting of any
awards granted to Employee under SEI's stock incentive plans, which plans shall
provide for such acceleration. Employee shall continue to accrue retirement
benefits and shall continue to enjoy any benefits under any plans of the Company
or SEI in which Employee is a participant to the full extent of Employee's
rights under such plans, including any perquisites provided under this
Agreement, through the remaining term of this Agreement; provided, however, that
the benefits under any such plans of the Company or SEI in which Employee is a
participant, including any such perquisites, shall cease upon re-employment by a
new employer.
11.5 Employee will be entitled to additional payments with respect to
amounts that are payable due to a Change in Control, or otherwise, as follows:
(a) Gross Up Payment. Anything in this Agreement to the contrary
notwithstanding, in the event it shall be determined that any payment or
distribution by or on behalf of the Company to or for the benefit of Employee as
a result of a "change in control," as defined in section 280G of the Internal
Revenue Code of 1986, as amended, (the "Code") (whether paid or payable or
distributed or distributable pursuant to the terms of this Agreement or
otherwise, but determined without regard to any additional payments required
under this Section (a "Payment") would be subject to the excise tax imposed by
section 4999 of the Code or any interest or penalties are incurred by Employee
with respect to such excise tax (such excise tax, together with any such
interest and penalties, are hereinafter collectively referred to as the "Excise
Tax"), then Employee shall be entitled to receive an additional payment (a
"Gross-Up Payment") in an amount such that after payment by Employee of all
taxes (including any interest or penalties imposed with respect to such taxes),
including, without limitation, any income taxes (and any interest and penalties
imposed with respect thereto) and Excise Tax imposed upon the Gross-Up Payment,
Employee retains an amount of the Gross-Up Payment equal to the Excise Tax
imposed upon the Payments.
(b) Tax Opinion. Subject to the provisions of Section 11.5(c), all
determinations required to be made under this Section 11.5, including whether
and when a Gross-Up Payment is required and the amount of such Gross-Up Payment
and the assumptions to be utilized in arriving at such determination, shall be
made by a nationally recognized accounting firm or law firm selected by the
Company (the "Tax Firm"); provided, however, that the Tax Firm shall not
determine that no Excise Tax is payable by Employee unless it delivers to
Employee a written opinion (the "Tax Opinion") that failure to pay the Excise
Tax and to report the Excise Tax and the payments potentially subject thereto on
or with Employee's applicable federal income tax return will not result in the
imposition of an accuracy-related or other penalty on Employee. All fees and
expenses of the Tax Firm shall be borne solely by the Company. Within 15
business days of the receipt of notice from Employee that there has been a
Payment, or such earlier time as is requested by the Company, the Tax Firm shall
make all determinations required under this Section, shall provide to the
Company and Employee a written report setting forth such determinations,
together with detailed supporting calculations, and, if the Tax Firm determines
that no Excise Tax is payable, shall deliver the Tax Opinion to Employee. Any
Gross-Up Payment, as determined pursuant to this Section, shall be paid by the
Company to Employee within fifteen days of the receipt of the Tax Firm's
determination. Subject to the remainder of this Section 11.5, any
7
<PAGE> 8
determination by the Tax Firm shall be binding upon the Company and Employee;
provided, however, that Employee shall only be bound to the extent that the
determinations of the Tax Firm hereunder, including the determinations made in
the Tax Opinion, are reasonable and reasonably supported by applicable law. As a
result of the uncertainty in the application of section 4999 of the Code at the
time of the initial determination by the Tax Firm hereunder, it is possible that
Gross-Up Payments which will not have been made by the Company should have been
made ("Underpayment"), consistent with the calculations required to be made
hereunder. In the event that it is ultimately determined in accordance with the
procedures set forth in Section 11.5(c) that Employee is required to make a
payment of any Excise Tax, the Tax Firm shall reasonably determine the amount of
the Underpayment that has occurred and any such Underpayment shall be promptly
paid by the Company to or for the benefit of Employee. In determining the
reasonableness of Tax Firm's determinations hereunder, and the effect thereof,
Employee shall be provided a reasonable opportunity to review such
determinations with Tax Firm and Employee's tax counsel. Tax Firm's
determinations hereunder, and the Tax Opinion, shall not be deemed reasonable
until Employee's reasonable objections and comments thereto have been
satisfactorily accommodated by Tax Firm.
(c) Notice of IRS Claim. Employee shall notify the Company in writing
of any claims by the Internal Revenue Service that, if successful, would require
the payment by the Company of the Gross-Up Payment. Such notification shall be
given as soon as practicable but no later than 30 calendar days after Employee
actually receives notice in writing of such claim and shall apprise the Company
of the nature of such claim and the date on which such claim is requested to be
paid; provided, however, that the failure of Employee to notify the Company of
such claim (or to provide any required information with respect thereto) shall
not affect any rights granted to Employee under this Section 11.5 except to the
extent that the Company is materially prejudiced in the defense of such claim as
a direct result of such failure. Employee shall not pay such claim prior to the
expiration of the 30-day period following the date on which he gives such notice
to the Company (or such shorter period ending on the date that any payment of
taxes with respect to such claim is due). If the Company notifies Employee in
writing prior to the expiration of such period that it desires to contest such
claim, Employee shall do all of the following:
(1) give the Company any information reasonably requested by the
Company relating to such claim;
(2) take such action in connection with contesting such claim as the
Company shall reasonably request in writing from time to time,
including, without limitation, accepting legal representation
with respect to such claim by an attorney selected by the Company
and reasonably acceptable to Employee;
(3) cooperate with the Company in good faith in order effectively to
contest such claim;
(4) if the Company elects not to assume and control the defense of
such claim, permit the Company to participate in any proceedings
relating to such claim;
provided, however, that the Company shall bear and pay directly all costs and
expenses (including additional interest and penalties) incurred in connection
with such contest and shall indemnify and
8
<PAGE> 9
hold Employee harmless, on an after-tax basis, for any Excise Tax or income tax
(including interest and penalties with respect thereto) imposed as a result of
such representation and payment of costs and expenses. Without limiting the
foregoing provisions of this Section 11.5, the Company shall have the right, at
its sole option, to assume the defense of and control all proceedings in
connection with such contest, in which case it may pursue or forego any and all
administrative appeals, proceedings, hearings and conferences with the taxing
authority in respect of such claim and may either direct Employee to pay the tax
claimed and sue for a refund or contest the claim in any permissible manner, and
Employee agrees to prosecute such contest to a determination before any
administrative tribunal, in a court of initial jurisdiction and in one or more
appellate courts, as the Company shall determine; provided, however, that if the
Company directs Employee to pay such claim and sue for a refund, the Company
shall advance the amount of such payment to Employee, on an interest-free basis
and shall indemnify and hold Employee harmless, on an after-tax basis, from any
Excise Tax or income tax (including interest or penalties with respect thereto)
imposed with respect to such advance or with respect to any imputed income with
respect to such advance; and further provided that any extension of the statute
of limitations relating to payment of taxes for the taxable year of Employee
with respect to which such contested amount is claimed to be due is limited
solely to such contested amount. Furthermore, the Company's right to assume the
defense of and control the contest shall be limited to issues with respect to
which a Gross-Up Payment would be payable hereunder and Employee shall be
entitled to settle or contest, as the case may be, any other issue raised by the
Internal Revenue Service or any other taxing authority.
(d) Right to Tax Refund. If, after the receipt by Employee of an amount
advanced by the Company pursuant to Section 11.5 Employee becomes entitled to
receive any refund with respect to such claim, Employee shall (subject to the
Company's complying with the requirements of Section 11.5(c)) promptly pay to
the Company the amount of such refund (together with any interest paid or
credited thereon after taxes applicable thereto). If, after the receipt by
Employee of an amount advanced by the Company pursuant to Section 11.5(c), a
determination is made that Employee is not entitled to a refund with respect to
such claim and the Company does not notify Employee in writing of its intent to
contest such denial of refund prior to the expiration of 30 days after such
determination, then such advance shall, to the extent of such denial, be
forgiven and shall not be required to be repaid and the amount of forgiven
advance shall offset, to the extent thereof, the amount of Gross-Up Payment
required to be paid.
12. Disability of Employee. If, on account of physical or mental
disability, Employee shall fail or be unable to perform his assigned duties in
any material respect for a period of 60 consecutive days, the Company shall (i)
pay Employee his full salary as set forth in Section 2.1 hereof, (ii) provide
the insurance, bonus and other benefits of Section 2.1 for a period of six
months from the date such disability began or for such shorter period as
Employee is unable to perform his duties hereunder, and (iii) all awards granted
to Employee under SEI's stock incentive plans will become fully vested, as shall
be provided for thereunder; provided, however, that Employee's salary shall be
reduced by any disability income paid to him pursuant to any disability
insurance policy maintained under this Agreement. In the event Employee is
unable to perform his duties hereunder after the expiration of the six-month
period, this Agreement shall automatically terminate. Employee shall not be
required to perform his obligations under Section 1 hereof during any period of
disability.
9
<PAGE> 10
13. Assignment.
(a) The rights and benefits of Employee under this Agreement, other
than accrued and unpaid amounts due under Section 2 hereof, are personal to him
and shall not be assignable. Discharge of Employee's undertakings in Sections 3
and 4 hereof shall be an obligation of Employee's executors, administrators, or
other legal representatives or heirs.
(b) This Agreement may not be assigned by the Company except to an
affiliate of the Company or SEI, provided, however, that if the Company shall
merge or effect a share exchange with or into, or sell or otherwise transfer
substantially all its assets to, another corporation, the Company shall assign
its rights hereunder to that corporation and cause such corporation to assume
the Company's obligations under this Agreement.
14. Notices. Any notice or other communications under this Agreement
shall be in writing, signed by the party making the same, and shall be delivered
personally or sent by certified or registered mail, postage prepaid, addressed
as follows:
(a) If to Employee, to such address furnished to Company or at such
other address as may be furnished by him to Company in writing.
(b) If to the Company: SEI Management Company, LLC
Six Cadillac Drive, Suite 400
Brentwood, Tennessee 37027
Attention: Chief Manager
With a copy to: J. Chase Cole, Esq.
Waller Lansden Dortch & Davis
A Professional Limited Liability Company
2100 Nashville City Center
511 Union Street
Nashville, Tennessee 37219
or to such other address as may hereafter be designated by either party hereto.
All such notices shall be deemed given on the date personally delivered or
mailed.
15. Governing Law. This Agreement shall be interpreted and enforced in
accordance with the laws of the State of Tennessee.
16. Severability. Whenever possible, each provision of this Agreement
shall be interpreted in such manner as to be effective and valid, but if any one
or more of the provisions contained in this Agreement shall be invalid, illegal
or unenforceable in any respect for any reason, the validity, legality and
enforceability for any such provisions in every other respect and of the
remaining provisions of this Agreement shall not be in any way impaired.
10
<PAGE> 11
17. Modification. No waiver of modification of this Agreement or of any
covenant, condition, or limitation herein contained shall be valid unless in
writing and duly executed by the party to be charged therewith and no evidence
of any waiver or modification shall be offered or received in evidence of any
proceeding, arbitration or litigation between the parties hereunder, unless such
waiver or modification is in writing, duly executed as aforesaid and the parties
further agree that the provisions of this section may not be waived except as
herein set forth.
18. Entire Agreement. This Agreement contains the entire agreement of
the parties hereto with respect to the subject matter contained herein. There
are no restrictions, promises, covenants or undertakings, other than those
expressly set forth herein. This Agreement supersedes all prior agreements and
understandings between the parties with respect to such subject matter. This
Agreement may not be changed except by a writing executed by the parties.
19. Remedies. No remedy set forth in this Agreement or otherwise
conferred upon or reserved to any party shall be considered exclusive of any
other remedy available to any party, but the same shall be distinct, separate
and cumulative and may be exercised from time to time as often as occasion may
arise or as may be deemed expedient. In the event of any arbitration, equitable
or legal proceeding that is brought by either party regarding the subject matter
of this Agreement, the prevailing party shall be entitled to receive payment by
the other party of all costs and expenses, including reasonable attorney fees,
incurred in such proceeding. Except as expressly provided otherwise herein,
Employee's remedies hereunder for payment of compensation and benefits,
including payments for severance or payments after termination of employment,
shall not be diminished by the obtaining of new employment that does not violate
the terms of this Agreement.
20. Indemnity. At all times during and after Employee's employment and
the effectiveness of this Agreement, the Company, SEI and their successors shall
indemnify Employee (as a director, officer, employee and otherwise) to the
fullest extent permitted by law and shall at all times maintain appropriate
provisions in its Articles of Incorporation and Bylaws which mandate that such
indemnification be provided.
21. Survival. The provisions of Sections 3, 4, 5, 7, 10, 11, 12, 13,
14, 15, 16, 17, 18, 19 and 20 shall survive the termination of Employee's
employment and termination of this Agreement.
IN WITNESS WHEREOF, the undersigned have executed this Employment
Agreement on the day and year first above written.
EMPLOYEE SERVICE EXPERTS SERVICES, LLC
/s/ Ronald L. Smith /s/ Alan R. Sielbeck
- ------------------------------- -------------------------------------
Ronald L. Smith Alan R. Sielbeck, Chief Manager
11
<PAGE> 1
EXHIBIT 21
LIST OF SUBSIDIARIES OF THE REGISTRANT
--------------------------------------
<TABLE>
<CAPTION>
Company Name State of Incorporation
------------ ----------------------
<S> <C>
1st Call Heating & Cooling, Inc. Michigan
A-1 Air Conditioning, Inc. Tennessee
AC/DAC, L.P. Tennessee
Academy Air Service Experts, Inc. Tennessee
Ainsley & Son Heating, Inc. Tennessee
Air Conditioning and Heating, L.P. Tennessee
Air Experts, Inc. Georgia
d/b/a Massengale Heating and Air
Air Systems Acquisition Sub, Inc. Tennessee
Alert Heating Service, Inc. Tennessee
All American Air Conditioning & Heating, Inc. Tennessee
Allbritten Plumbing, Heating and Air Conditioning Tennessee
Service, Inc.
Andros Refrigeration, Inc. Tennessee
Arrow Heating & Air Conditioning, Inc. Wisconsin
d/b/a Air Comfort Heating & Sheet Metal
Artic Aire of Chico, Inc. California
</TABLE>
1
<PAGE> 2
<TABLE>
<CAPTION>
COMPANY NAME STATE OF INCORPORATION
------------ ----------------------
<S> <C>
Astron Residential, Inc. Tennessee
d/b/a Comfort Tech Cooling & Heating
Atlantic Air Conditioning and Heating, Inc. Tennessee
Austin Brothers, Inc. Tennessee
d/b/a Mesa Aire, Inc., Mesa Aire Service Experts
B&M Heating & Cooling, Inc. Tennessee
Becht Heating & Cooling, Inc. Indiana
Ben Peer Heating, Inc. Tennessee
Berkshire Air Conditioning Company Tennessee
d/b/a Frontier Heating & Cooling
Bill Ingraham Service Company, Inc. California
Bill's Commercial Air Conditioning, Inc. Tennessee
C. Iapaluccio Company, Inc. Connecticut
d/b/a The Original Hearth Shop
Chief/Bauer Heating & Air Conditioning, Inc. Tennessee
Claire's Air Conditioning and Refrigeration, Inc. Tennessee
d/b/a Service Experts of Wichita Falls, Service Experts of
the Permian Basin, Claire & Sanders Service Experts,
Claire's Service Experts, Alpine Air Conditioning
Climate Control, Inc. Tennessee
Climate Design System, Inc. Tennessee
</TABLE>
2
<PAGE> 3
<TABLE>
<CAPTION>
COMPANY NAME STATE OF INCORPORATION
------------ ----------------------
<S> <C>
Climate Masters Service Company Colorado
Coastal Air Conditioning Services, Inc. Georgia
Comerford's Heating & Air Conditioning, Inc. California
Comfortech, Inc. Tennessee
Contractor Success Group, Inc. Missouri
Custom Air Conditioning, Inc. Tennessee
d/b/a Service Experts of Palm Beach, Dan's Air
Conditioning & Heating
Dan Jacob's Heating & Cooling, Inc. Tennessee
d/b/a Kautz Heating & Air Conditioning, Inc.
Davis the Plumber, Inc. Tennessee
DeLand Heating & Air Conditioning Company Tennessee
Dial One Raymond Plumbing, Heating & Cooling, Inc. Tennessee
d/b/a Dial One Service Champions, Ace Superior
Dodge Heating & Air Conditioning, Inc. Georgia
Doler Plumbing & Heating, Inc. Indiana
Economy Heating and Air Conditioning, Inc. Tennessee
d/b/a Allied Heating and Cooling Co., Brentwood Heating
& Cooling
Eisenbach Enterprises, Inc. Texas
</TABLE>
3
<PAGE> 4
<TABLE>
<CAPTION>
COMPANY NAME STATE OF INCORPORATION
------------ ----------------------
<S> <C>
Epperson, Inc. Tennessee
Eveready Corporation Tennessee
Falso Service Experts, Inc. New York
d/b/a Falso Heating and Sheet Metal
Fras Air Conditioning, Inc. New Jersey
Frees Service Experts, Inc. Texas
d/b/a Service Experts of Northwest Louisiana
Freschi Air Systems, Inc. Tennessee
Gaddis Co. Tennessee
d/b/a Desert Air Conditioning
George B. Givens Company, Inc. Tennessee
d/b/a New Age Plumbing
Getzschman Heating & Sheet Metal Contractors, Inc. Tennessee
Gilley's Quality Heating & Cooling, Inc. Tennessee
Gordon's Specialty Company Tennessee
d/b/a Service Experts
Gregory's Plumbing Co., Inc. Oklahoma
Gulf Coast Cooling, Inc. Tennessee
d/b/a Service Experts of Southwest Florida
Hardwick Air Masters, Inc. Arkansas
d/b/a Service Experts of Arkansas
</TABLE>
4
<PAGE> 5
<TABLE>
<CAPTION>
COMPANY NAME STATE OF INCORPORATION
------------ ----------------------
<S> <C>
Holmes Sales & Service, Inc. Tennessee
J.M. Jenks Incorporated Utah
d/b/a JM Mechanical Systems
Jack Nelson Co., Inc. Oklahoma
Jansen's Heating & Air Conditioning, Inc. Illinois
Kenneth E. Martin, Inc. Georgia
d/b/a Air Tronics Company
Knochelmann, Inc. Tennessee
d/b/a Knochelmann Plumbing, Heating & Air
Conditioning, Clifton Heating & Air Conditioning,
Comfort Air, Knochelmann Service Experts
Kozon, Inc. Tennessee
Lake Arbor Heating, Inc. Colorado
d/b/a Westside Heating & Air Conditioning
Lee Voisard Plumbing & Heating, Inc. Tennessee
Local Furnace Co., Inc. Tennessee
Mathews Air Conditioning and Heating, Inc. Tennessee
Matz Heating & Air Conditioning, Inc. Tennessee
d/b/a Right Way Heating and Air Conditioning Service
McPhee, Inc. Colorado
d/b/a McPhee Plumbing & Heating, Inc.
Mid Fla Heating and Air, Inc. Tennessee
Midland Heating & Air Conditioning, Inc. Tennessee
</TABLE>
5
<PAGE> 6
<TABLE>
<CAPTION>
Company Name State of Incorporation
------------ ----------------------
<S> <C>
Neal Harris Heating & Air Conditioning Company, Inc. Missouri
Norrell Heating and Air Conditioning Company, Inc. Alabama
Pardee Refrigeration Company Incorporated Tennessee
d/b/a Pardee Heating & Air Conditioning, Mac-Huff, Inc.,
H&M Heating & A/C, Pardee Service Experts, Island Air
Service Experts, Service Experts of Charleston
Parker Heating and Air Conditioning, Incorporated Tennessee
Parrott Mechanical, Inc. Idaho
d/b/a Snappy Plumbing
ProAir Acquisition Sub, Inc. Tennessee
d/b/a Peachtree-Cherokee/Edwards Heating & A/C,
Plano Air Mart Services
PTM Enterprises, Inc. Georgia
d/b/a Macy's Air Conditioning & Heating, Bulldog
Heating & Air Conditioning
R&M Climate Control, Inc. Tennessee
Roland J. Down, Inc. New York
d/b/a Kool Temp, Pipe Solutions, Sunset Sheet Metal
Rolf Coal and Fuel Corp. Indiana
d/b/a Griffin Heating & Air Conditioning, Inc., Rolf
Heating & Air Conditioning
Russell Mechanical, Inc. Texas
S&W Air conditioning, Inc. Tennessee
d/b/a/ S&W Services
</TABLE>
6
<PAGE> 7
<TABLE>
<CAPTION>
Company Name State of Incorporation
------------ ----------------------
<S> <C>
Safari Services, Inc. Florida
d/b/a Joe's Air & Heat
Sanders Indoor Comfort, Inc. Tennessee
d/b/a Dgree Heating & Air Conditioning
SEI Holdings, Inc. Delaware
SEI Management Company, LLC Tennessee
d/b/a Travel Experts
SEI Management Subsidiary, Inc. Tennessee
SEI Newco, Inc. Tennessee
SEIIN GP, Inc. Indiana
SEITN GP, Inc. Tennessee
d/b/a Donelson Air Conditioning Company, AC Service
and Installation, Air Conditioning & Heating
Unlimited
SEITN LP, Inc. Delaware
Service Experts DFW, Inc. Tennessee
d/b/a Air Experts, Alliance Air Conditioning & Heating
Service Experts of Clearwater, Inc. Tennessee
Service Experts of Indiana, L.P. Tennessee
d/b/a B.W. Heating & Cooling, Brand Heating & Air
Conditioning, Service Experts of Indianapolis
Service Experts of Indianapolis, Inc. Indiana
</TABLE>
7
<PAGE> 8
<TABLE>
<CAPTION>
Company Name State of Incorporation
------------ ----------------------
<S> <C>
Service Experts of Palm Springs, Inc. California
Service Experts of Raleigh, Inc. Tennessee
d/b/a Piedmont Air Conditioning Co.
Service Experts of Salt Lake City, Inc. Tennessee
d/b/a Thompson and Sons Heating and Air
Conditioning Company
Service Experts of Utah, Inc. Utah
d/b/a Royden Commercial Services, Inc.,
David M. Steed
Service Experts Services, LLC Tennessee
Shelburne Refrigeration, Inc. California
Steel City Heating & Air, Inc. Alabama
Strand Brothers, Inc. Tennessee
Sunbeam Service Experts, Inc. New York
d/b/a Fleischmann Heating & Cooling
Sylvester's, L.P. Tennessee
d/b/a Sylvester's Corp.
Sylvesters Corp. Indiana
Teays Valley Heating and Cooling, Inc. West Virginia
The McElroy Service Company Nebraska
TML, Inc. Idaho
Total Comfort Specialists California
</TABLE>
8
<PAGE> 9
<TABLE>
<CAPTION>
Company Name State of Incorporation
------------ ----------------------
<S> <C>
Triton Mechanical, Inc. Tennessee
Venture International, Inc. Tennessee
d/b/a Ron Smith and Associates
</TABLE>
<PAGE> 1
EXHIBIT 23
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Post-Effective Amendment No.
6 to the Registration Statement on Form S-4 (Registration No. 333-12319) and
related Prospectus of Service Experts, Inc. related to $50,000,000 aggregate
amount of shares of its $.01 par value common stock, warrants to purchase its
common stock ("Common Stock Warrants") and the shares of its common stock issued
thereunder upon the exercise of such Common Stock Warrants or debt securities
("Debt Securities"), and the shares of common stock issued thereunder upon the
conversion of the Debt Securities; in the shelf Registration Statement on Form
S-3 (Registration No. 333-43917) and related Prospectus pertaining to the resale
of up to 500,000 shares of the Company's Common Stock issued without
registration under the Securities Act of 1933; in the Registration Statement on
Form S-8 (Registration No. 333-11791) pertaining to the Service Experts, Inc.
1996 Incentive Stock Plan, 1996 Non-Employee Director Stock Option Plan, and
1996 Employee Stock Purchase Plan; in the Registration Statement on Form S-8
(Registration No. 333-59711) pertaining to the Service Experts, Inc. Amended
1996 Incentive Stock Plan, Amended 1996 Employee Stock Purchase Plan, 1997
Nonqualified Stock Option Plan, Amended 1997 Nonqualified Stock Purchase Plan
and Amended Service Center Stock Option Plan; of our report dated February 22,
1999 with respect to the consolidated financial statements of Service Experts,
Inc. included in this Annual Report (Form 10-K) for the year ended December 31,
1998.
/s/ Ernst & Young LLP
Nashville, Tennessee
March 23, 1999
<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,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH
FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 8,408
<SECURITIES> 0
<RECEIVABLES> 59,505
<ALLOWANCES> 2,050
<INVENTORY> 29,715
<CURRENT-ASSETS> 115,045
<PP&E> 55,903
<DEPRECIATION> 17,283
<TOTAL-ASSETS> 356,555
<CURRENT-LIABILITIES> 32,008
<BONDS> 104,479
0
0
<COMMON> 175
<OTHER-SE> 206,207
<TOTAL-LIABILITY-AND-EQUITY> 356,555
<SALES> 407,835
<TOTAL-REVENUES> 407,835
<CGS> 261,670
<TOTAL-COSTS> 261,670
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,708
<INCOME-PRETAX> 38,685
<INCOME-TAX> 15,260
<INCOME-CONTINUING> 23,425
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 23,425
<EPS-PRIMARY> 1.39
<EPS-DILUTED> 1.37
</TABLE>
<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,
1997 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-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 11,298
<SECURITIES> 0
<RECEIVABLES> 34,609
<ALLOWANCES> 1,625
<INVENTORY> 11,949
<CURRENT-ASSETS> 65,324
<PP&E> 35,829
<DEPRECIATION> 10,278
<TOTAL-ASSETS> 198,210
<CURRENT-LIABILITIES> 29,628
<BONDS> 16,133
0
0
<COMMON> 159
<OTHER-SE> 143,648
<TOTAL-LIABILITY-AND-EQUITY> 198,210
<SALES> 248,110
<TOTAL-REVENUES> 248,110
<CGS> 161,281
<TOTAL-COSTS> 161,281
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 772
<INCOME-PRETAX> 25,325
<INCOME-TAX> 9,380
<INCOME-CONTINUING> 15,945
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 15,945
<EPS-PRIMARY> 1.08
<EPS-DILUTED> 1.07
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE SIX MONTHS ENDED JUNE 30,
1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> JUN-30-1997
<CASH> 19,286
<SECURITIES> 0
<RECEIVABLES> 30,225
<ALLOWANCES> 1,170
<INVENTORY> 8,824
<CURRENT-ASSETS> 62,961
<PP&E> 27,332
<DEPRECIATION> 8,046
<TOTAL-ASSETS> 153,892
<CURRENT-LIABILITIES> 32,908
<BONDS> 4,751
0
0
<COMMON> 149
<OTHER-SE> 115,493
<TOTAL-LIABILITY-AND-EQUITY> 153,892
<SALES> 107,197
<TOTAL-REVENUES> 107,197
<CGS> 70,775
<TOTAL-COSTS> 70,775
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 448
<INCOME-PRETAX> 11,103
<INCOME-TAX> 4,031
<INCOME-CONTINUING> 7,072
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 7,072
<EPS-PRIMARY> 0.50
<EPS-DILUTED> 0.50
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF SERVICE EXPERTS, INC. FOR THE THREE MONTHS ENDED MARCH
31, 1997 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL
STATEMENTS.
</LEGEND>
<RESTATED>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 33,567
<SECURITIES> 0
<RECEIVABLES> 20,674
<ALLOWANCES> 993
<INVENTORY> 7,756
<CURRENT-ASSETS> 67,510
<PP&E> 23,307
<DEPRECIATION> 7,156
<TOTAL-ASSETS> 141,787
<CURRENT-LIABILITIES> 28,128
<BONDS> 4,568
0
0
<COMMON> 147
<OTHER-SE> 108,354
<TOTAL-LIABILITY-AND-EQUITY> 141,787
<SALES> 44,446
<TOTAL-REVENUES> 44,446
<CGS> 29,353
<TOTAL-COSTS> 29,353
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 109
<INCOME-PRETAX> 3,605
<INCOME-TAX> 1,262
<INCOME-CONTINUING> 2,343
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,343
<EPS-PRIMARY> 0.18
<EPS-DILUTED> 0.18
</TABLE>
<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-01-1996
<PERIOD-END> DEC-31-1996
<CASH> 10,843
<SECURITIES> 0
<RECEIVABLES> 15,980
<ALLOWANCES> 870
<INVENTORY> 5,567
<CURRENT-ASSETS> 35,496
<PP&E> 18,445
<DEPRECIATION> 6,032
<TOTAL-ASSETS> 83,398
<CURRENT-LIABILITIES> 22,739
<BONDS> 4,029
0
0
<COMMON> 121
<OTHER-SE> 55,938
<TOTAL-LIABILITY-AND-EQUITY> 83,398
<SALES> 85,184
<TOTAL-REVENUES> 85,184
<CGS> 61,405
<TOTAL-COSTS> 61,405
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 718
<INCOME-PRETAX> 4,825
<INCOME-TAX> 1,104
<INCOME-CONTINUING> 3,721
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 3,721
<EPS-PRIMARY> 0.68
<EPS-DILUTED> 0.68
</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-01-1996
<PERIOD-END> SEP-30-1996
<CASH> 14,139
<SECURITIES> 0
<RECEIVABLES> 13,259
<ALLOWANCES> 508
<INVENTORY> 3,594
<CURRENT-ASSETS> 34,217
<PP&E> 18,423
<DEPRECIATION> 8,965
<TOTAL-ASSETS> 46,005
<CURRENT-LIABILITIES> 16,104
<BONDS> 6,246
0
0
<COMMON> 96
<OTHER-SE> 23,111
<TOTAL-LIABILITY-AND-EQUITY> 46,005
<SALES> 55,543
<TOTAL-REVENUES> 55,543
<CGS> 39,564
<TOTAL-COSTS> 39,564
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 583
<INCOME-PRETAX> 2,829
<INCOME-TAX> 263
<INCOME-CONTINUING> 2,566
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 2,566
<EPS-PRIMARY> 0.69
<EPS-DILUTED> 0.69
</TABLE>
