NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS (Continued)
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS (Continued)
For the period January 1, 2006 through August 9, 2006, the Company recognized $4,748 as compensation cost representing the fair value of equity share option grants awarded to key management during the period January 1, 2006 through August 9, 2006 in accordance with the modified prospective method, for non-public companies prescribed in SFAS No. 123R. Under the modified prospective method, the fair value of each option award was estimated on the date of grant using the fair value of the Company stock as of August 9, 2006 (date of the acquisition). Portions of awards outstanding at the date of initial adoption of SFAS No. 123R continue to be accounted for using the accounting principles originally applied to those awards.
For the period January 1, 2006 through August 9, 2006, the effect of adopting the provisions of SFAS No. 123R was as follows: income from continuing operations and income before taxes reduced by $4,748, net income reduced by $3,086 (net of deferred tax benefit of $1,662), cash flows from operations reduced by $4,748 and cash flows from financing activities increased by $2,369.
For the period from August 10, 2006 through December 31, 2006, the Company recognized $13 as compensation cost representing the fair value of member units of the Parent awarded to key management during the period from August 10, 2006 through December 31, 2006 in accordance with the modified prospective method, for non-public companies prescribed in SFAS No. 123R. Under the modified prospective method, the fair value of each option award was estimated on the date of grant using the Intrinsic Value Method, computed by (a) the estimated current price of the stock reduced to exclude the present value of any expected dividends during the option’s life minus (b) the present value of the exercise price, with the following weighted average assumptions being used: risk-free interest rate of 4.6%, expected volatility of zero, dividend yield of zero and expected life of 5 years. As of December 31, 2006, there was $368 unrecognized compensation cost related to the non-vested portion of the member units granted since August 10, 2006. The cost of those options is expected to be recognized over a period of 5 years (the vesting period).
For the period from August 10, 2006 through December 31, 2006, the effect of adopting the provisions of SFAS No. 123R was as follows: income from continuing operations and income before taxes reduced by $13, net income reduced by $8 (net of deferred tax benefit of $5), cash flows from operations reduced by $13 and no effect on cash flows from financing activities.
Use of Estimates: The presentation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Concentration of Credit Risk: Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables. Trade receivables at any given time are concentrated in a relatively large number of primarily domestic customers. An allowance for doubtful accounts has been provided for estimated losses. To mitigate credit risk, the Company may require customers to make advance payments or secure obligations with letters of credit.
13
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE B - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES AND DETAIL OF CERTAIN BALANCE SHEET ACCOUNTS (Continued)
The Company maintains cash and cash equivalents in financial institutions, which exceeds federally insured limits. The Company monitors the financial condition of these financial institutions and has not experienced any losses associated with these accounts.
Fair Value of Financial Instruments: The Company’s financial instruments consist primarily of cash and cash equivalents, trade receivables, accounts payable and long-term debt. The carrying amounts of these accounts are representative of their respective fair values due to the short-term maturity of these instruments or their interest rate reflective of market rates.
New Accounting Pronouncements:In June 2006, FASB issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 establishes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006; however, the FASB has agreed to defer the effective date for non-public entities. The Company is currently evaluating the impact the adoption of this interpretation will have on its future financial statements.
In September 2006, FASB issued SFAS No. 157, “Fair Value Measurement.” This standard provides guidance for using fair value to measure assets and liabilities. SFAS No. 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, but does not expand the use of fair value in any new circumstances. Prior to SFAS No. 157, the methods for measuring fair value were diverse and inconsistent, especially for items that are not actively traded. The standard clarifies that for items that are not actively traded, such as certain kinds of derivatives, fair value should reflect the price in a transaction with a market participant, including an adjustment for risk, not just the company's mark-to-model value. SFAS No. 157 also requires expanded disclosure of the effect on earnings for items measured using unobservable data. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company is currently evaluating the impact of this statement on its financial statements and expects to adopt SFAS No. 157 on January 1, 2008.
In February 2007, FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities - Including an amendment of FASB SFAS No. 115.” SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. SFAS No. 159 is effective for financial statements issued for fiscal years beginning after November 15, 2007. The Company has not determined the effect, if any, that the adoption of SFAS No. 159 will have on its financial position and results of operations.
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FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE C - BUSINESS COMBINATION
Effective on August 9, 2006, FR X Acquisitions completed the acquisition of all of the outstanding stock of HNT pursuant to the terms of a stock purchase agreement dated June 5, 2006. The purchase price was $207,900 consisting of the purchase price for the stock, a capital contribution and direct acquisition costs. The purchase price allocation was recorded in the accompanying consolidated financial statements based on estimated fair values for the assets acquired and liabilities assumed and resulted in initial goodwill of approximately $65,844 and identifiable intangibles of $113,700. The Company utilized an independent third party to appraise the assets acquired and liabilities assumed. The components of the purchase price, based on the third party allocation, are as follows (in thousands):
| | Working capital | | $ | 32,400 | |
| Property and equipment | | | 21,400 | |
| Identifiable intangibles | | | 113,700 | |
| Goodwill | | | 65,844 | |
| Deferred tax effects at purchase allocation | | | (25,444 | ) |
| | | | 207,900 | |
| Less: cash acquired | | | (3,500 | ) |
| Net assets acquired | | $ | 204,400 | |
Certain amounts totaling approximately $8,500 were required to be held in escrow for a period of one year for possible indemnification pursuant to the conditions specified in the stock purchase agreement. As of August 9, 2007, such amounts have been released to the prior owners of HNT. The owners of HNT have also indemnified FR X Acquisitions for any breach of representation and warranties provided at closing to the extent the aggregate amount of such losses exceeds 1% of the purchase price up to a maximum of 5% of the purchase price. Additionally, certain contractual payments of $21,837 required at the closing of the transaction effected by the stock purchase agreement to key management of HNT pursuant to executive agreements have been reflected in the consolidated statement of operations for the period January 1, 2006 through August 9, 2006 (the Pre-Acquisition Period).
Additionally, just prior to closing of the acquisition, the Company distributed its estimated claim for reimbursement of damages associated with Hurricane Rita totaling $1,811 to the owners.
NOTE D - LONG-TERM DEBT
As of December 31, 2006, long-term debt is as follows:
| | Syndicated credit agreement | | | |
| First lien | $ | | 109,000 |
| Second lien | | | 50,000 |
| Revolving credit line | | | - |
| | | | |
| Financing companies | | | 30 |
| | $ | | 159,030 |
15
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE D - LONG-TERM DEBT (Continued)
During 2005, the Company maintained a credit facility with Bank of America, N.A. (the “Bank”). The credit facility included a total commitment of $18,750, comprised of a $12,000 revolving line of credit, interest due monthly, maturing in June 2006, a $4,750 term loan, $56 plus interest due monthly, maturing in June 2010 and a $2 million advancing line of credit for equipment acquisitions, $22 plus interest due monthly, maturing in June 2010. In March 2006, the Company negotiated an amendment to the credit facility with the Bank, which extended the maturity of the revolving line of credit to June of 2007 and increased the maximum available revolving line of credit to $20,000. The borrowings under the credit facility bore interest at the Company’s option of either LIBOR or the prime interest rate. The borrowing availability of the revolving line of credit was governed by a monthly borrowing base calculation. The term loan was fixed with a seven year amortization. Under the terms of the credit facility, the Company had pledged its accounts receivable, inventory and real property. The credit facility also included certain financial restrictive covenants. Simultaneous with the acquisition, the Company closed this credit facility and had previously paid all related debt in full.
In conjunction with the purchase of HNT, the Company entered into a credit facility with a syndicate of lenders providing a First Lien Credit Agreement of $115,000, a Second Lien Credit Agreement of $50,000, and a Revolving Facility Commitment and Letter of Credit of $30,000 (the “Credit Facility”). The First Lien Credit Agreement matures in August 2013 and requires quarterly payments of $288 plus interest of LIBOR plus 3%. The Second Lien Credit Agreement matures in August 2014 and requires quarterly interest payments of LIBOR plus 7%. The Revolving Facility Commitment and Letter of Credit mature in August 2011. Under the terms of the Credit Facility, the collateral consists of all capital stock and substantially all tangible and intangible assets of the Company. The Credit Facility also included certain financial restrictive covenants. As of December 31, 2006, the Company was in compliance with all covenants. As of December 31, 2006, borrowings under the Credit Facility totaled approximately $159,000 at interest rates of 8.3% for the First Lien and 12.3% for the Second Lien. For the period August 10, 2006 through December 31, 2006, the Company made prepayments totaling $6 million to the First Lien and as a result is not required to make quarterly principal payments until 2012.
The Company has purchased equipment under installment contracts with financing companies bearing interest at various rates ranging from 0% to 14% payable in 36 to 48 equal monthly installments. As of December 31, 2006, $30 is payable under such installment notes, with $11 classified as current and $19 classified as non-current. As of December 31, 2005, $5 was payable under such installment notes and is classified as current. The notes are collateralized by the equipment purchased and have varying maturities through 2009.
16
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE D - LONG-TERM DEBT (Continued)
Principal payments due on long-term debt as of December 31, 2006 are as follows:
| | Year Ending December 31, | | | | |
| | | | |
| 2007 | | $ | 11 |
| 2008 | | | 12 |
| 2009 | | | 7 |
| 2010 | | | - |
| 2011 | | | - |
| Thereafter | | | 159,000 |
| | | | |
| | | $ | 159,030 |
Under the Credit Facility, the Company entered into two interest rate swap agreements in the total amount of approximately $86 million effective November 9, 2006. The swap agreements will terminate on November 9, 2009 and 2011, each agreement has a fixed rate quarterly payment date on each of February 9, May 9, August 9, and November 9 and end on the termination date. On August 24, 2006, the swap agreements were designated as cash flow hedges on the exposure of the variability of future cash flows subject to the variable quarterly interest rates on approximately $86 million of the term loan portion of the Credit Facility. As of December 31, 2006, the fair market value of the interest rate swap agreements in effect was a liability of $391. The swap agreements have an average fixed rate of 5.47% and 5.58%
NOTE E - RELATED PARTY TRANSACTIONS
The Company paid a management fee to an affiliate for various management services provided prior to the acquisition of the Company on August 9, 2006. For the period from January 1, 2006 through August 9, 2006, the Company incurred approximately $167 of management fees with the affiliate. No such fees have been paid post acquisition.
NOTE F - CONTRACTS
The Company obtains substantially all of its contracts through competitive bids. The Company's prerequisites for billing on contracts vary with individual contract terms. The Company utilizes letters of credit as collateral on trade receivables, when necessary and, generally, all amounts are due in the month following performance under the contract except for retainages that are collected upon completion of the contract. The Company has lien rights on certain contracts.
17
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE G - COMMITMENTS AND CONTINGENCIES
The Company and its subsidiaries are obligated under various leases for office equipment and vehicles. The leases are currently on a month-to-month basis or provide for cancellation by the Company. The leases also provide for payment of maintenance and other expenses by the Company. Rent expense was $88 and $136 for the period from August 10, 2006 through December 31, 2006 and the period from January 1, 2006 through August 9, 2006, respectively.
Through its subsidiary, Beaumont Real Estate Holdings Company (“BRH”), the Company acquired the property adjacent to the north of its Beaumont facility from Texas Metal Works, Inc. (“TMW”), a subsidiary of Westcott Holdings, Inc. (“Westcott”), in 2002. At the time of the acquisition, various constituents had been detected at the TMW site, including heavy metals and petroleum hydrocarbons in the soils and chlorinated solvents in the groundwater. Affected soils on the TMW site were excavated in the spring of 2005. On May 19, 2006, in the course of delineation of the TMW groundwater plume, a separate chlorinated solvent plume was detected beneath the original Ohmstede property to the south. The Company has drilled several monitoring wells on its Beaumont property (consisting of the former TMW property and the original Ohmstede property) to delineate the extent of the two groundwater plumes. In 2005, the City of Beaumont adopted an ordinance classifying all property within the City limits as Municipal Setting Designation (“MSD”), and prohibiting the use of groundwater beneath the City for potable purposes pursuant to environmental laws of the State of Texas. The MSD statute enables a property owner in Beaumont, after notifying surrounding well owners of its intent to participate in the MSD program, to obtain regulatory closure of groundwater plumes with significantly higher concentrations of contaminations remaining in place. No amounts have been recognized within the consolidated financial statements pursuant to SFAS No. 5, “Accounting for Contingencies,” relating to this situation since management believes it does not meet the conditions required by SFAS No. 5 to record a liability.
In May 2006, the Company filed an Affected Property Assessment Report (“APAR”) and Response Action Completion Report (“RACR”) with the Texas Commission of Environmental Quality (“TCEQ”). On May 19, 2006, the Company received its MSD certificate from the TCEQ. Following receipt of the MSD certification, the Company obtained regulatory closure of both plumes without the need for remediation, and received the Certificate of Completion from the TCEQ on April 16, 2007.
In addition, the Company has purchased an insurance policy that provides coverage for remediation costs that may result from unknown contaminants in the future. Management does not believe that environmental matters present a material liability to the business.
18
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE G - COMMITMENTS AND CONTINGENCIES (Continued)
Certain of the Company's subsidiaries are parties to legal proceedings in the ordinary course of business. While the outcome of lawsuits or other proceedings cannot be predicted with certainty, management does not expect these matters to have a material adverse effect on the financial condition, results of operations or liquidity of the Company.
NOTE H - INCOME TAXES
Provision (benefit) for federal and state income taxes is as follows:
| | | August 10, 2006 | | January 1, 2006 |
| | through | | through |
| | December 31, | | August 9 |
| | 2006 | | 2006 |
| Current: | | | | | | | | |
| Federal | | $ | 3,104 | | | $ | (708 | ) |
| State | | | 500 | | | | (326 | ) |
| | | | 3,604 | | | | (1,034 | ) |
| Deferred: | | | | | | | | |
| Federal | | | (2,646 | ) | | | 26 | |
| State | | | (181 | ) | | | 4 | |
| | | | (2,827 | ) | | | 30 | |
| |
| | Total provision (benefit) | | $ | 777 | | | $ | (1,004 | ) |
As of December 31, 2006, the tax effects of the financial reporting and income tax reporting basis differences, which give rise to deferred income tax assets and liabilities, are as follows:
| | Net current deferred income tax assets: | | | | |
| Accruals and reserves | | $ | 1,205 | |
| Contract accounting | | | 994 | |
| Valuation allowance | | | - | |
| | | | 2,199 | |
| Net non-current deferred income tax assets (liabilities): | | | | |
| Depreciation | | | (2,938 | ) |
| Goodwill and intangible assets | | | (24,779 | ) |
| Valuation allowance | | | - | |
| | | | (27,717 | ) |
| | | $ | (25,518 | ) |
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FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE H - INCOME TAXES (Continued)
Differences between the Company’s effective income tax rate and the statutory federal income tax rate is as follows:
| | | August 10, 2006 | | January 1, 2006 |
| | through | | through |
| | December 31, | | August 9, |
| | 2006 | | 2006 |
| | | | | | | | |
| Tax provision (benefit) at the federal | | | | | | | |
| statutory income tax rate | | $ | 718 | | $ | (701 | ) |
| State income taxes and other | | | 59 | | | (303 | ) |
| | | | | | | | |
| Total tax provision (benefit) | | $ | 777 | | $ | (1,004 | ) |
NOTE I - EMPLOYEE SAVINGS PLAN
The Company offers its employees a 401(k) employee savings plan. The Company, at its discretion, matches contributions made by its employees up to a maximum of 1.5% of an employee’s annual compensation. For the period August 10, 2006 through December 31, 2006 and January 1, 2006 through August 9, 2006, the Company provided matching funds to its employees of $81 and $71, respectively. The Company also contributes to union-sponsored retirement plans for its employees covered under collective bargaining agreements. Amounts contributed are determined based upon amounts per hour worked by such employees. For the period August 10, 2006 through December 31, 2006 and January 1, 2006 through August 9, 2006, the Company provided funds to union-sponsored retirement plans in the amount of $80 and $139, respectively.
NOTE J - STOCKHOLDERS’ EQUITY
The Company’s parent issued two classes of profits units: service units and exit units. All service units vest ratably over a five year period or upon a change in control, as defined. Exit units are distributed to certain members of FR X Acquisitions management and vest in relationship to when certain financial parameters are met based upon minimum net returns as defined. Upon termination from the Company, the units issued upon initial capital contribution at time of formation may be put back to the Company and require the Company to repurchase such shares at the price defined in the agreement. All units owned are subject to transfer restrictions. On November 20, 2006, the Parent granted 2 service units and 6 exit units to certain members of the Company, at an exercise price of $1. Pursuant to SFAS No. 123R, for the period from August 10, 2006 through December 31, 2006, the Company recognized $13 as compensation expense for service units issued by the Parent, as they relate to services performed by employees of the Company. No compensation expense will be recognized on exit units until it becomes probable that events as defined will occur. As of December 31, 2006, no units have been exercised.
20
FR X OHMSTEDE ACQUISITIONS CO. AND SUBSIDIARIES
HNT HOLDINGS INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2006
(IN THOUSANDS)
NOTE J - STOCKHOLDERS’ EQUITY (Continued)
On August 9, 2006, the Company granted 7,500 stock options to key management of HNT which became fully vested and were exercised concurrent with the acquisition of HNT’s stock. Under SFAS No. 123R, the fair value of these options was estimated on the date of grant using the fair value of the Company stock as of August 9, 2006 (date of the acquisition). The Company recognized stock-based compensation of $4,748 for the period January 1, 2006 through August 9, 2006 related to these options.
Effective on August 9, 2006, 10,000 stock options issued to key management prior to the Company’s adoption of SFAS No. 123R were exercised concurrent with the acquisition of HNT’s stock. As defined in the stock option agreement, all options were fully vested at January 1, 2006.
NOTE K - SUBSEQUENT EVENTS
On March 12, 2007, in connection with a dividend payment of $86,140 to the existing shareholders of the Company, the Company amended the Credit Facility. Under the terms of the amendment to the First Lien Credit Agreement, borrowings increased by $65,000 and the maximum rate of interest was reduced from LIBOR plus 3% to LIBOR plus 2.5%. Under the terms of the amendment to the Second Lien Credit Agreement, borrowings increased by $20,000. All other terms of the First and Second Lien Credit Agreements remained unchanged.
On September 19, 2007, EMCOR Group, Inc. acquired all of the issued and outstanding shares of capital stock of the Company and its subsidiaries for a purchase price of approximately $455.4 million, net of cash acquired of approximately $1.5 million. The sale proceeds were used to extinguish the Credit Facility and interest rate swaps, including accrued interest, through the date of sale. Concurrent with the change in control of the Company, the two classes of profit units held by the Parent (service units and exit units) vested fully and the proceeds from the sale were used by the Company to satisfy the required settlement of the profit units.
21
