##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 10-QSB
 þ
    
    QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended December 31, 2005
 OR
 o
    
    TRANSITION REPORT UNDER SECTION 13 or 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 Commission file number I-4334
 SUNAIR
SERVICES CORPORATION
  FLORIDA
    
    59-0780772(STATE OR OTHER JURISDICTION OF
INCORPORATION OR ORGANIZATION)
    
    (I.R.S. EMPLOYER
IDENTIFICATION NO.)3005 SW THIRD AVE., FT. LAUDERDALE, FL
    
    33315(ADDRESS OR PRINCIPAL EXECUTIVE OFFICE)
    
    (ZIP CODE)ISSUERS
TELEPHONE NUMBER (INCLUDING AREA CODE)  (954) 525-1505
  
  þ o
 o þ
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PART I. FINANCIAL INFORMATION:ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)CONSOLIDATED CONDENSED BALANCE SHEETS  DECEMBER 31, 2005 AND SEPTEMBER 30, 2005
    
    
    3CONSOLIDATED CONDENSED STATEMENTS OF INCOME  THREE MONTHS ENDED DECEMBER 31, 2005 AND 2004
    
    
    5CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS  THREE MONTHS ENDED DECEMBER 31, 2005 AND 2004
    
    
    6NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
    
    
    8ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
    
    
    15ITEM 3. CONTROLS AND PROCEDURES
    
    
    17PART II. OTHER INFORMATIONITEM 1. LEGAL PROCEEDINGS
    
    
    18ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
    
    
    18ITEM 3. DEFAULTS UPON SENIOR SECURITIES
    
    
    18ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    18ITEM 5. OTHER INFORMATION
    
    
    18ITEM 6. EXHIBITS
    
    
    18SIGNATURES
    
    
    19Section 302 Certification of CEOSection 302 Certification of CFOSection 906 Certification of CEOSection 906 Certification of CFO
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12/31/05
    
    
    9/30/05ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    3,478,483
    
    
    $
    3,220,699Accounts receivable, net
    
    
    5,058,027
    
    
    
    4,983,714Interest receivable
    
    
    6,009
    
    
    
    14,488Inventories
    
    
    7,585,087
    
    
    
    7,609,727Deferred tax asset
    
    
    431,781
    
    
    
    315,837Prepaid and other current assets
    
    
    1,447,513
    
    
    
    1,435,146Total Current Assets
    
    
    18,006,900
    
    
    
    17,579,611NOTE RECEIVABLE
    
    
    334,986
    
    
    
    334,986PROPERTY, PLANT, AND EQUIPMENT, net
    
    
    2,299,774
    
    
    
    2,321,008DEFERRED TAX ASSET
    
    
    15,879
    
    
    
    OTHER ASSETSSoftware
Costs, net
    
    
    3,898,046
    
    
    
    3,938,402Customer List
    
    
    10,189,750
    
    
    
    10,262,250Goodwill
    
    
    49,121,311
    
    
    
    43,599,379Other Assets
    
    
    99,937
    
    
    
    80,393Total Other Asset
    
    
    63,309,044
    
    
    
    57,880,424TOTAL ASSETS
    
    $
    83,966,583
    
    
    $
    78,116,029
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12/31/05
    
    
    9/30/05LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Accounts payable
    
    $
    5,297,688
    
    
    $
    4,630,304Accrued expenses
    
    
    1,903,447
    
    
    
    2,274,312Unearned revenues
    
    
    262,696
    
    
    
    181,216Customer deposits
    
    
    1,644,710
    
    
    
    1,490,677Capital leases, current portion
    
    
    24,922
    
    
    
    41,561Notes payable, current portion
    
    
    91,866
    
    
    
    90,645Total Current Liabilities
    
    
    9,225,329
    
    
    
    8,708,715LONG TERM LIABILITYCapitalized leases, net of current
position
    
    
    
    
    
    
    6,712Notes payable, net of current position
    
    
    274,124
    
    
    
    287,549Notes
payable  related party
    
    
    5,000,000
    
    
    
    5,000,000Revolving line of credit
    
    
    8,500,000
    
    
    
    12,000,000Deferred tax liability
    
    
    
    
    
    
    188,400Total Long Term Liabilities
    
    
    13,774,124
    
    
    
    17,482,661Total Liabilities
    
    
    22,999,453
    
    
    
    26,191,376STOCKHOLDERS EQUITY:Preferred stock, no par value, 2,000,000
shares authorized, none issued and
outstandingCommon stock, $.10 par value, 25,000,000
shares authorized, 12,186,380, and
10,186,380 shares issued and outstanding at
December 31, 2005 and September 30, 2005
respectively
    
    
    1,218,638
    
    
    
    1,018,638Additional paid-in-capital
    
    
    47,017,185
    
    
    
    37,759,670Retained earnings
    
    
    12,806,231
    
    
    
    13,170,774Translation adjustment
    
    
    ( 74,924
    )
    
    
    ( 24,429
    )Total Stockholders Equity
    
    
    60,967,130
    
    
    
    51,924,653TOTAL LIABILITIES AND STOCKHOLDERS EQUITY
    
    $
    83,966,583
    
    
    $
    78,116,029
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THREE MONTHS ENDED12/31/05
    
    
    12/31/04SALES
    
    $
    12,965,990
    
    
    $
    5,093,988COST OF SALES
    
    
    5,272,295
    
    
    
    2,800,799GROSS PROFIT
    
    
    7,693,695
    
    
    
    2,293,189SELLING GENERAL AND ADMINISTRATIVE EXPENSES
    
    
    7,979,165
    
    
    
    1,790,515INCOME (LOSS) FROM OPERATIONS
    
    
    (285,470
    )
    
    
    502,674OTHER INCOME (LOSS):Interest income
    
    
    16,668
    
    
    
    35,776Interest expense
    
    
    (411,175
    )
    
    
    (19,882
    )Other expense
    
    
    (4,789
    )
    
    
    (6,846
    )Total Other
Income (Loss)
    
    
    (399,296
    )
    
    
    9,048INCOME (LOSS) BEFORE BENEFIT (PROVISION)
FOR INCOME TAXES
    
    
    (684,766
    )
    
    
    511,722BENEFIT (PROVISION) FOR INCOME TAXES
    
    
    320,223
    
    
    
    (139,317
    )NET INCOME (LOSS)
    
    $
    (364,543
    )
    
    $
    372,405NET INCOME (LOSS) PER COMMON SHARE:BASIC
    
    $
    (0.03
    )
    
    $
    0.09DILUTED
    
    $
    (0.03
    )
    
    $
    0.09WEIGHTED AVERAGE SHARES OUTSTANDING:BASIC
    
    
    10,512,464
    
    
    
    4,008,055DILUTED
    
    
    10,654,566
    
    
    
    4,105,592
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THREE MONTHS ENDED12/31/05
    
    
    12/31/04CASH FLOWS FROM OPERATING ACTIVITIES:Net income
(loss)
    
    $
    (364,543
    )
    
    $
    372,405Adjustments to reconcile net income
(loss) tonet cash provided by operating activities:Depreciation
    
    
    202,734
    
    
    
    52,850Amortization
    
    
    466,172
    
    
    
    79,719Deferred taxes
    
    
    (320,223
    )
    
    
    143,349Translation adjustment
    
    
    (50,495
    )
    
    
    67,236Bad debt reserve
    
    
    1,936
    
    
    
    Inventories reserve
    
    
    (2,774
    )
    
    
    25,493Gain (loss) on disposal of assets
    
    
    9,789
    
    
    
    (Increase) decrease in assets:Accounts receivable
    
    
    56,680
    
    
    
    990,930Interest receivable
    
    
    8,479
    
    
    
    103,836Inventories
    
    
    93,889
    
    
    
    332,262Prepaid and other current assets
    
    
    (12,367
    )
    
    
    (587,708
    )Other assets
    
    
    (19,544
    )
    
    
    Increase (decrease) in Liabilities:Accounts payable and accrued expenses
    
    
    296,519
    
    
    
    (408,857
    )Unearned revenue
    
    
    81,480
    
    
    
    108,340Income taxes payable
    
    
    
    
    
    
    30,518Customer deposits
    
    
    (125,884
    )
    
    
    Net Cash Provided By Operating Activities
    
    
    321,848
    
    
    
    1,310,373CASH FLOWS FROM INVESTING ACTIVITIES:Purchase of property, plant, and equipment
    
    
    (161,289
    )
    
    
    (32,619
    )Software development costs
    
    
    (91,316
    )
    
    
    (124,273
    )Cash paid for acquisition of Telecom FM
    
    
    
    
    
    
    (1,500,000
    )Cash paid for acquisition of Pest Environmental
    
    
    (5,733,419
    )
    
    
    Proceeds from redemption of held-to-maturity investments
    
    
    
    
    
    
    2,913,601Net Cash (Used In) Provided By Investing Activities
    
    $
    (5,986,024
    )
    
    $
    1,256,709
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CASH FLOWS FROM FINANCING ACTIVITIES:Repayment of line of credit
    
    $
    (3,500,000
    )
    
    $
    (2,000,000
    )Proceeds from exercise of stock options
    
    
    
    
    
    
    18,563Proceeds from the sale of common stock
    
    
    10,500,000
    
    
    
    Costs associated with the sale of common stock
    
    
    (1,042,485
    )
    
    
    Payment on capital leases
    
    
    (23,351
    )
    
    
    Repayment of notes payable
    
    
    (12,204
    )
    
    
    (5,505
    )Net Cash Provided By (Used In) Financing Activities
    
    
    5,921,960
    
    
    
    (1,986,942
    )NET INCREASE IN CASH
AND CASH EQUIVALENTS
    
    
    257,784
    
    
    
    580,140CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD
    
    
    3,220,699
    
    
    
    3,872,224CASH AND CASH EQUIVALENTS, END OF PERIOD
    
    $
    3,478,483
    
    
    $
    4,452,364SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Cash paid during the year for income taxes
    
    $
    
    
    
    $
    125,000Cash paid during the year for interest
    
    $
    406,497
    
    
    $
    18,930
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1.
    
    Basis of Consolidated Financial Statement PresentationThe accompanying unaudited consolidated financial statements have been prepared by the
Company pursuant to the rules and regulations of the Securities and Exchange Commission
and in accordance with the instructions to Form 10-QSB and do not include all the
information and footnote disclosures normally included in consolidated financial
statements prepared in accordance with accounting principles generally accepted in the
United States of America. The information furnished in the interim financial statements
includes normal recurring adjustments and reflects all adjustments, which, in the
opinion of management, are necessary for a fair presentation of such financial
statements. For further information refer to the consolidated financial statements and
footnotes thereto included in the Companys most recent audited consolidated financial
statements and notes thereto included in its September 30, 2005 annual report on Form
10-KSB. Operating results for the three months ended December 31, 2005 are not
necessarily indicative of the results that may be expected for the
fiscal year ending September
30, 2006.2.
    
    Significant Accounting PoliciesUse of EstimatesThe preparation of 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 in the consolidated financial
statements and accompanying notes. Actual results could differ from those estimates.Accounts ReceivableAccounts receivable consist of balances due from sales. The Company monitors accounts
receivable and provides allowances when considered necessary. As of December 31, 2005
and September 30, 2005, the Company established an allowance of $298,200 and $144,194
respectively.InvestmentsCertain investments that management has the intent and ability to hold to maturity are
reported at cost, adjusted for amortization of premiums and accretion of discounts that
are recognized in interest income using the interest method over the period to maturity.Marketable and debt securities which management has classified as trading are carried at
fair value with net unrealized gains and losses reported in operations. Realized gains
and losses on marketable equity and debt securities are recognized upon sale using the
specific identification method.InventoriesInventories, which consist of raw materials, work-in-process, and finished goods, are
stated at the lower of cost or market value, cost being determined using the first in,
first out method. Fixed and variable manufacturing costs and overhead are included in
the carrying values of finished goods and work-in-process. The Company records reserves
for inventory shrinkage and obsolescence, when considered necessary. For the three
months ended December 31, 2005 inventory shrinkage and obsolescence reserves decreased
$2,774.
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Property, Plant, And EquipmentProperty, plant and equipment are carried at cost. Depreciation is provided over the
estimated useful lives of the assets using both the straight-line and accelerated
methods. The estimated useful lives used to compute depreciation are as follows:
 Buildings and improvements
    
    10 to 30 yearsMachinery and equipment
    
    4 to 10 years
  Software Costs
  Customer List
    Impairment
of Long-Lived Assets and Long-Lived Assets to be Disposed
of
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Income (Loss) Per Share
  Revenue Recognition
  Advertising Costs
  Research and Development
  Foreign Currency Translation
  Comprehensive Income
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3.
    
    AcquisitionsAcquisition of Middleton Pest Control, Inc.On June 7, 2005, the Company, Sunair Southeast Pest Holdings, Inc., a wholly owned
subsidiary of the Company (Pest Holdings), and the selling shareholders (collectively,
the Sellers) of Middleton Pest Control, Inc., a Florida corporation (Middleton),
entered into a Stock Purchase Agreement (the Stock Purchase Agreement) pursuant to
which, on the same date, Pest Holdings acquired from the Sellers 100% of the issued and
outstanding shares of capital stock of Middleton. The aggregate purchase price for the
outstanding capital stock of Middleton was $50,000,000, which was comprised of: (i)
$35,000,000 in cash; (ii) $5,000,000 in the form of a subordinated promissory note; and
(iii) 1,028,807 shares of the companys common stock. The Company also incurred closing
costs of $1,610,541 and a charge of $1,400,000 for Middletons built-in capital gains
tax for a total purchase price of $53,010,541.The following table sets forth the preliminary allocation of the purchase price to
Middletons tangible and intangible assets acquired and liabilities assumed as of May
31, 2005:
 Cash
    
    $
    1,377,035Accounts receivable
    
    
    1,504,821Inventory
    
    
    546,129Prepaid assets
    
    
    662,565Fixed assets
    
    
    1,587,781Other assets
    
    
    63,762Customer list
    
    
    10,500,000Goodwill
    
    
    40,297,345Accounts payable
    
    
    (590,377
    )Accrued liabilities
    
    
    (930,739
    )Customer deposits
    
    
    (1,550,611
    )Notes payable
    
    
    (457,170
    )Total
    
    $
    53,010,541
 Acquisition of Four Seasons Lawn and Pest Control, Inc.
  Acquisition
of Spa Creek Services, LLC.
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Goodwill
    
    $
    5,521,932Customer list
    
    
    262,000AR
    
    
    132,929Inventory
    
    
    66,475PPE
    
    
    30,000Customer deposits
    
    
    (279,917
    )Total
    
    $
    5,733,419
 Pro-Forma Results Of Operations
  Three Months Ended December 31,2005
    
    
    2004Revenues
    
    $
    13,721,294
    
    
    $
    14,076,797Net income
    
    $
    (393,493
    )
    
    $
    277,624Earnings per shareBasic
    
    $
    (.04
    )
    
    $
    .07Diluted
    
    $
    (.04
    )
    
    $
    .07
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4.
    
    InventoriesInventories consist of the following:
 12/31/05
    
    
    9/30/05Materials
    
    $
    1,699,149
    
    
    $
    2,942,827Work In Progress
    
    
    4,446,674
    
    
    
    3,533,734Finished Goods
    
    
    1,439,264
    
    
    
    1,133,166$
    7,585,087
    
    
    $
    7,609,727
 5.
    
    Earnings Per Common ShareBasic earnings per share amounts are computed by dividing the net income by the weighted
average number of common shares outstanding. Diluted earnings per share amounts are
computed by dividing net income by the weighted average number of shares of common
stock, common stock equivalents, and stock options outstanding during the period.6.
    
    Preferred StockAt December 31, 2005, the Company had 8,000,000 authorized shares of preferred
stock, no par value, that may be issued at such terms and provisions as determined by
the board of directors. None are outstanding.7.
    
    Stock OptionsDuring the fiscal year ended September 30, 2005, the shareholders approved the
cancellation of the Stock Option Plan, previously adopted by the shareholders at the
January 24, 2004 shareholders meeting, and in its place, approved the 2004 Stock
Incentive Plan with an aggregate of 800,000 shares of the Companys unissued common
stock to be reserved for issuance to employees and non-employee
directors. The
option price, numbers of shares and grant date are determined at the discretion of the
Companys board of directors.During the quarter ended December 31, 2005, 105,000 stock options were granted at
a price of $5.60 per share.On January 27, 2006, the Company completed the sale of its securities to investors in
a private placement pursuant to purchase agreements, dated December 15, 2005, by and
among the Company and the investors of our common stock named therein (the Purchase
Agreements). Pursuant to the Purchase Agreements, the Company agreed to sell up to
an aggregate of 2,857,146 shares of its common stock at a price per share of $5.25 and
warrants to purchase 1,000,000 shares of its common stock (the Private Placement) at
an exercise price of $6.30 (subject to adjustment). The sale and issuance of the
securities closed in two tranches. The first closing was completed on December 16,
2005, pursuant to which the Company issued and sold an aggregate of 2,000,003 shares
of its common stock and warrants to purchase 700,000 shares of its common stock. The
second closing was completed on January 27, 2006, pursuant to which the Company sold
an additional 857,143 shares of its common stock and warrants to purchase 300,000
shares of its common stock.8.
    
    Segment InformationCertain financial information for each segment is provided below as of December
31:
 2005
    
    
    2004Net revenues:Lawn and Pest Control Services
    
    $
    9,456,794
    
    
    $
    High Frequency Radio
    
    
    1,740,404
    
    
    
    2,534,507Telephone Communications
    
    
    1,768,792
    
    
    
    2,559,481Total net revenues
    
    $
    12,965,990
    
    
    $
    5,093,988Operating income (loss):Lawn and Pest Control Services
    
    $
    1,066,330
    
    
    $
    High Frequency Radio
    
    
    294,919
    
    
    
    281,845Telephone Communications
    
    
    (355,022
    )
    
    
    229,877Unallocated home office expenses
    
    
    (1,690,993
    )
    
    
    Total operating income (loss)
    
    $
    (684,766
    )
    
    $
    511,722
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9.
    
    Recent Accounting PronouncementsIn January 2003, the FASB issued Financial Interpretations (FIN) No. 46, Consolidation
of Variable Interest Entities, which requires the consolidation of, and disclosures
about, variable interest entities (VIEs). VIEs are entities for which control is
achieved through means other than voting rights. In December 2003, the FASB revised FIN
No 46 to incorporate all decisions, including those in previously issued FASB Staff
Positions (FSP), into one Interpretation. The revised Interpretation superseded the
original Interpretation. The Company does not have any variable interest entities as
defined by FIN No. 46 and therefore the interpretation did not affect the Companys
financial position, results of operations or cash flows.In April 2003, the FASB issued SFAS No. 149, Amendment of Statement No. 133 on Derivative Instruments
and Hedging Activities, which is effective for all derivative and hedging activities
initiated after June 30, 2003. The Company has no derivative or hedging activities.
Therefore, the adoption of Statement No. 149 is not expected to materially affect the
Companys financial statements.In May 2003, the FASB issued SAFS No. 150,
Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity, which is effective for
all financial instruments after June 15, 2003. Since the Company has no such financial
instruments, the adoption of Statement No. 150 is not expected to materially affect the
Companys financial statements.In December 2004, the FASB issued SFAS No 123 (revised
2004), Share-Based Payment. SFAS
No. 123 (R) will require the Company to recognize compensation expense for all stock-based
compensation in its consolidated statements of earnings. Pro forma disclosure will no
longer be an alternative. SFAS No. 123 (R) will also require the benefits of tax
deductions in excess of recognized compensation cost to be reported as a financing cash
flow, rather than as an operating cash flow, as required under current guidance. The new
requirement will reduce net operating cash flows and increase net financing cash flows
in periods after adoption. This statement is effective beginning with the first
quarterly or annual reporting period of the fiscal year beginning on or after December
15, 2005.In November 2004 the FASB issued SFAS No. 151,
Inventory Costs. SFAS No. 151 amends the
guidance in Accounting Research Bulletin 43, Inventory Pricing, to clarify the
accounting for abnormal amounts of idle facility expenses, freight, handling costs and
wasted material (spoilage) cost. SFAS No. 151 requires those items to be excluded from
the cost of inventory and expensed when incurred. It also requires that the allocation
of fixed production overheads to the costs of conversion be based on the normal capacity
of the production facilities. SFAS No. 151 is effective for fiscal years beginning after
June 15, 2005. The Company is still evaluating the impact of
adopting SFAS No 151, but it does not
expect it to have a material impact on its consolidated results of operations or
financial position.In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, a replacement
of APB Opinion No. 20 and FASB Statement No. 3. This Statement provides guidance on
accounting for reporting of accounting changes and error corrections. This statement is
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company does not expect the statement to have a
material effect on its financial statements.
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Item 2. Managements Discussion And Analysis Or Plan Of Operation
      4
  The Lawn and Pest Control Services Segment
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Item 3. Controls and Procedures
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31.1
    
    Certification by Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
 31.2
    
    Certification by Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
 32.1
    
    Certification by Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
 32.2
    
    Certification by Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
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SIGNATURES
  SUNAIR SERVICES CORPORATIONDate February 14, 2006
    
    
    
    /S/ John J. HayesJohn J. Hayes, Presidentand Chief Executive OfficerDate February 14, 2006
    
    
    
    /S/ Synnott B. DurhamSynnott B. Durham,Chief Financial Officer
 - 19 -