Background Founded in 1996 by Perry Hardwick in Houston, TX, Texas Contract Carpet (TCC) has serviced multi-family home builders throughout the United States since the company's inception With an emphasis on building relationships with its customers, vendors and installers, the company experienced growth year after year for well over a decade. As shown in the 2011 year- end financial statements (Exhibit 1), TCC possesses optimal liquidity and profitability. TCC's goal for 2011 and 2012 was to grow through acquisition and were fortunate to identify a prospective opportunity within BSI Building Products & Services (BSI). Founded in 1998 by Norman Bowman in Stafford, TX, BSI has been a leading provider of finish products on a turn-key basis for the new construction, multi-family industry. BSI's market sectors included garden style apartments, high density projects, student housing, retirement and assisted living projects, and military housing. Their product offerings include: Flooring Window coverings Ventilated shelving Shower enclosures Door hardware Bathroom accessories Toilet partitions BSI is licensed to operate in CA, AZ, WA, FL and VA and their projects are fully bonded, which protects against slow or no pay situations. Their business model allows the company to maintain substantial margins and to hold little inventory. They also rely on strong partnerships with key vendors to provide the best pricing, service, and delivery times to its customers. Industry The multi-family housing industry saw a sharp downturn in starts due to the US credit crunch in the fall of 2008, as with the single-family housing industry. Overall U.S. apartment vacancy rates dropped to 5.6%, their lowest point since 2001. Thus, occupancy rates and rents are rising, pointing to increased demand for new apartments. According to a 2011 Cushman & Wakefield report, developers are showing signs of moving quickly to begin new projects and multi-family starts were up nearly 48% compared to the same period in 2010. Growth rates are expected to return to historical levels, at a minimum once the competitive landscape improves. CURRENT ASSETS Cash Accounts Receivable Trade Retainage Employees and Misc. Prepaid Expenses Inventory Costs and Estimated Earnings In Excess of Billings on Uncompleted Contracts TOTAL CURRENTS ASSETS PROPERTY AND EQUIPMENT Land Office and Warehouse Building Office Equipment Office Furniture Warehouse Equipment Vehicles Less-Accumulated Depreciation TOTAL PROPERTY AND EQUIPMENT TOTAL ASSETS CURRENT LIABILITIES. Accounts Payable Payroll Taxes Payable Accrued Expenses Insurance Payable Accrued Shareholder Distributions ASSETS Note Payable-Line of Credit Current Portion-Long Term Debt Profit Sharing Contribution LONG TERM DEBT. LIABILITIES State Taxes Payable Billings in Excess of Costs and Estimated Eamings on Uncompleted Contracts TOTAL CURRENT LIABILITIES 803,956 395,428 17.341 CONTROLLING INTERESTS COMMON STOCK-Authorized 10,000 Shares of 5.10 Par Value, Issued and Outstanding 1,000 Shares ADDITIONAL PAID-IN CAPITAL RETAINED EARNINGS NONCONTROLLING INTERESTS 120,864 880,628 187,113 72,113 61,701 102.009 1,425,068 611.190 $ 304,224 1,349 0 3,275 65,319 0 41,051 56.256 38,243 8.033 540,155 41.051 1,000 199,000 3.703.713 $ 2,076,126 TOTAL STOCKHOLDERS & NONCONTROLLING INTERESTS EQUITY TOTAL LIABILITIES AND STOCKHOLDERS & NONCONTROLLING INTERESTS EQUITY 1,216,725 33.509 885.231 470,889 $4,600,480 813,878 Mortgage Payable Less-Current Portion TOTAL LONG TERM DEBT TOTAL LIABILITIES STOCKHOLDERS' EQUITY AND NONCONTROLLING INTERESTS EQUITY $5.502.358 $ 517.750 499.104 1,016,854 3,903,713 581.791 4.485.504 15.502.350 CONTRACT INCOME Contracts Completed During the Year Contracts in Progress at December 31, 2011 TOTAL CONTRACT INCOME GENERAL AND ADMINISTRATIVE EXPENSES INCOME FROM OPERATIONS OTHER INCOME Macellaneous Gain on Sale of Assets OTHER EXPENSES Interest Expense Bad Debts Penalties GROSS EARNED COST PROFIT $ 10,348,334 $8.026,187 $2.322.147 -2.190.209 1.704.504 3.12.544.002 5.8.730.771 INCOME BEFORE TAX PROVISION PROVISION FOR INCOME TAXES Federal State NET INCE BEFORE NONCONTROLLING INTERESTS LESS-NONCONTROLLING INTERESTS EARNINGS NET INCOME 265,876 4.000 58,388 158 11 NONE 42.440 491.685 2,813,832 1.820.835 1.192.997 269.876 58.557 1,404.316 42.440 1.361.870 33.749 $ 1.328,127 BSI Financials Income Statement: Total Revenue % Growth COGS Gross Profit Gross Profit Margin Operating Expenses Corporate Fees (1) Total Expenses EBITDA EBITDA Margin 12/31/11 $1,933,784 -7% $ 1,492,920 $440,864 23% $677,842 $677,842 ($236,978) -12% Balance Sheet Cash Receivables Inventory Prepaid and Other Current Assets Property Plant and Equipment, net Goodwill and Trademarks, net Other Intangible Investments Other Assets Total Assets 4 Notes Payable Accounts Payable Accrued Liabilities. Current Liabilities Long Term Debt Deferred Inc Tax, Other Interest Mi Total Liabilities. Preferred Stock Masco Investment Retained Earnings OCI Total Shareholders Equity Total Liabilities and S/E SSS $ $ $ $ $ SSSS ss $ Dec-11 $ 547,455 $ 5,000 $ 325,044 $ 173,824 $ 43,588 $ 5,126 $ $ 552,581 $ SSS $ (732,954) $ 1,101,598 $ $ SSSSS 183,937 $ $ 179,539 $ 4,398 $ 183,937 S $ 368,644 $ 552,581 $ $ Assignment Questions: 1. Would you consider TCC and BSI to be a related or an unrelated business? Answer one of the following: a. If you feel they are related, what makes them similar? Is there synergy (better-off test) between the two companies? b. If you feel they are unrelated businesses, how could TCC build shareholder value in BSI? What are some reasons for pursuing an unrelated transaction with BSI? What are some drawbacks? 2. What would be an appropriate structure of combination? 3. What is your evaluation of the industry attractiveness? 4. Do you think TCC should acquire BSI? Why? a. If they decide to complete the acquisition: i. ii. What are some potential advantages/disadvantages of acquiring BSI? What are some strategic fit opportunities? Any cross-business fits? Background Founded in 1996 by Perry Hardwick in Houston, TX, Texas Contract Carpet (TCC) has serviced multi-family home builders throughout the United States since the company's inception With an emphasis on building relationships with its customers, vendors and installers, the company experienced growth year after year for well over a decade. As shown in the 2011 year- end financial statements (Exhibit 1), TCC possesses optimal liquidity and profitability. TCC's goal for 2011 and 2012 was to grow through acquisition and were fortunate to identify a prospective opportunity within BSI Building Products & Services (BSI). Founded in 1998 by Norman Bowman in Stafford, TX, BSI has been a leading provider of finish products on a turn-key basis for the new construction, multi-family industry. BSI's market sectors included garden style apartments, high density projects, student housing, retirement and assisted living projects, and military housing. Their product offerings include: Flooring Window coverings Ventilated shelving Shower enclosures Door hardware Bathroom accessories Toilet partitions BSI is licensed to operate in CA, AZ, WA, FL and VA and their projects are fully bonded, which protects against slow or no pay situations. Their business model allows the company to maintain substantial margins and to hold little inventory. They also rely on strong partnerships with key vendors to provide the best pricing, service, and delivery times to its customers. Industry The multi-family housing industry saw a sharp downturn in starts due to the US credit crunch in the fall of 2008, as with the single-family housing industry. Overall U.S. apartment vacancy rates dropped to 5.6%, their lowest point since 2001. Thus, occupancy rates and rents are rising, pointing to increased demand for new apartments. According to a 2011 Cushman & Wakefield report, developers are showing signs of moving quickly to begin new projects and multi-family starts were up nearly 48% compared to the same period in 2010. Growth rates are expected to return to historical levels, at a minimum once the competitive landscape improves. CURRENT ASSETS Cash Accounts Receivable Trade Retainage Employees and Misc. Prepaid Expenses Inventory Costs and Estimated Earnings In Excess of Billings on Uncompleted Contracts TOTAL CURRENTS ASSETS PROPERTY AND EQUIPMENT Land Office and Warehouse Building Office Equipment Office Furniture Warehouse Equipment Vehicles Less-Accumulated Depreciation TOTAL PROPERTY AND EQUIPMENT TOTAL ASSETS CURRENT LIABILITIES. Accounts Payable Payroll Taxes Payable Accrued Expenses Insurance Payable Accrued Shareholder Distributions ASSETS Note Payable-Line of Credit Current Portion-Long Term Debt Profit Sharing Contribution LONG TERM DEBT. LIABILITIES State Taxes Payable Billings in Excess of Costs and Estimated Eamings on Uncompleted Contracts TOTAL CURRENT LIABILITIES 803,956 395,428 17.341 CONTROLLING INTERESTS COMMON STOCK-Authorized 10,000 Shares of 5.10 Par Value, Issued and Outstanding 1,000 Shares ADDITIONAL PAID-IN CAPITAL RETAINED EARNINGS NONCONTROLLING INTERESTS 120,864 880,628 187,113 72,113 61,701 102.009 1,425,068 611.190 $ 304,224 1,349 0 3,275 65,319 0 41,051 56.256 38,243 8.033 540,155 41.051 1,000 199,000 3.703.713 $ 2,076,126 TOTAL STOCKHOLDERS & NONCONTROLLING INTERESTS EQUITY TOTAL LIABILITIES AND STOCKHOLDERS & NONCONTROLLING INTERESTS EQUITY 1,216,725 33.509 885.231 470,889 $4,600,480 813,878 Mortgage Payable Less-Current Portion TOTAL LONG TERM DEBT TOTAL LIABILITIES STOCKHOLDERS' EQUITY AND NONCONTROLLING INTERESTS EQUITY $5.502.358 $ 517.750 499.104 1,016,854 3,903,713 581.791 4.485.504 15.502.350 CONTRACT INCOME Contracts Completed During the Year Contracts in Progress at December 31, 2011 TOTAL CONTRACT INCOME GENERAL AND ADMINISTRATIVE EXPENSES INCOME FROM OPERATIONS OTHER INCOME Macellaneous Gain on Sale of Assets OTHER EXPENSES Interest Expense Bad Debts Penalties GROSS EARNED COST PROFIT $ 10,348,334 $8.026,187 $2.322.147 -2.190.209 1.704.504 3.12.544.002 5.8.730.771 INCOME BEFORE TAX PROVISION PROVISION FOR INCOME TAXES Federal State NET INCE BEFORE NONCONTROLLING INTERESTS LESS-NONCONTROLLING INTERESTS EARNINGS NET INCOME 265,876 4.000 58,388 158 11 NONE 42.440 491.685 2,813,832 1.820.835 1.192.997 269.876 58.557 1,404.316 42.440 1.361.870 33.749 $ 1.328,127 BSI Financials Income Statement: Total Revenue % Growth COGS Gross Profit Gross Profit Margin Operating Expenses Corporate Fees (1) Total Expenses EBITDA EBITDA Margin 12/31/11 $1,933,784 -7% $ 1,492,920 $440,864 23% $677,842 $677,842 ($236,978) -12% Balance Sheet Cash Receivables Inventory Prepaid and Other Current Assets Property Plant and Equipment, net Goodwill and Trademarks, net Other Intangible Investments Other Assets Total Assets 4 Notes Payable Accounts Payable Accrued Liabilities. Current Liabilities Long Term Debt Deferred Inc Tax, Other Interest Mi Total Liabilities. Preferred Stock Masco Investment Retained Earnings OCI Total Shareholders Equity Total Liabilities and S/E SSS $ $ $ $ $ SSSS ss $ Dec-11 $ 547,455 $ 5,000 $ 325,044 $ 173,824 $ 43,588 $ 5,126 $ $ 552,581 $ SSS $ (732,954) $ 1,101,598 $ $ SSSSS 183,937 $ $ 179,539 $ 4,398 $ 183,937 S $ 368,644 $ 552,581 $ $ Assignment Questions: 1. Would you consider TCC and BSI to be a related or an unrelated business? Answer one of the following: a. If you feel they are related, what makes them similar? Is there synergy (better-off test) between the two companies? b. If you feel they are unrelated businesses, how could TCC build shareholder value in BSI? What are some reasons for pursuing an unrelated transaction with BSI? What are some drawbacks? 2. What would be an appropriate structure of combination? 3. What is your evaluation of the industry attractiveness? 4. Do you think TCC should acquire BSI? Why? a. If they decide to complete the acquisition: i. ii. What are some potential advantages/disadvantages of acquiring BSI? What are some strategic fit opportunities? Any cross-business fits