Question
From: (redacted)
Sent: Friday, December 16, 2005 3:35 PM
To: Verne,B. Michael
Subject: HSR Asset Valuation
Dear Mike:
This correspondencememorializes the conversations (i) (redacted) and I had with you on December 12, 2005 and (ii) you and I had on December 13, 2005, relating to a proposed agreementwhereby Purchaser would acquire certain assets of two operating companies (the"Sellers"), including stock and noncorporate interests of Sellers'subsidiaries. Please let me know if, upon consideration of this email, youradvice as set forth below, remains the same.
The parties havenegotiated a particular aggregate cash purchase price that is not readilyallocable among the assets, stock and noncorporate interests. In addition, thePurchaser will assume the Sellers' existing liabilities, including bank debtand accrued accounts payable. The cash purchase price will be adjusted based ona working capital calculation, generally defined as "current assets"less current liabilities. Relating to that calculation, Purchaser has agreed to"credit" the Sellers for certain outlays made by the Sellers at orprior to closing. Those outlays by the Company will be treated as "currentassets" for purposes of the adjusted working capital calculation eventhough they will not actually appear on the Sellers' balance sheet as assets.To the extent the adjusted working capital either exceeds or falls short of adefined target, the aggregate cash payable to the Sellers will be adjusted.Therefore, the treatment of these payments may have a direct impact on theamount of money that the Purchaser is required to pay to Sellers in connectionwith the transaction.
In ourdiscussion, you advised that Purchaser's agreement to effectively reimburse theSellers for these outlays may be treated as agreements ancillary to theagreement to acquire the assets, stock and noncorporate interests and theamount of these outlay effectively being paid by Purchaser do not need to befactored into the acquisition price for the Sellers' assets, voting securitiesand noncorporate interests being acquired.
We discussed thefollowing elements that impact the working capital adjustment:
(a)Transaction expenses -- Purchaser has agreed to cover transaction expensesincurred by the Sellers and the Sellers' stockholders in connection with thetransaction up to a particular threshold. Either Purchaser will pay these costsdirectly to Sellers' counsel and other advisors, or Sellers will initially paythese costs, and the amount of Sellers' payment will be treated as a"current asset" for purposes of the adjusted working capitalcalculation. To the extent the transaction expenses exceed the agreed uponthreshold, the additional amount will be treated as an accrued liability up toa certain threshold. If the expenses exceed a threshold, expenses that exceedthe threshold will be borne by the Seller' stockholders.
(b)Buyout of shareholder -- One of the Sellers has previously bought out oneshareholder in exchange for $X. Most of that amount has already been paid byone of the Sellers, and the remainder of that buyout amount will be paid atclosing by the Sellers. That payment will be treated as a "currentasset" for purposes of the adjusted working capital calculation.
(c)Appreciation Rights Settlement Amount -- The Sellers have agreed to pay acertain amount to certain of their employees and shareholders pursuant to acompany appreciation rights plan and
an optionagreement. The amount of Sellers' payment will be treated as a "currentasset" for purposes of the adjusted working capital calculation.
(d)Payment of 2005 Compensation -- The founding stockholders of the Sellers haveforegone salaries during 2005. As a result they are owed an aggregate of $X.The Sellers will pay the stockholders that amount owing immediately prior toclosing and that payment will be treated as a "current asset" forpurposes of the adjusted working capital calculation.
(e)Optionholder Settlement -- One of the Sellers has previously entered into anagreement to buy out an option holder. A portion of that settlement amount hasalready been paid by the Sellers and the Sellers will pay the remaining portionof that settlement immediately prior to closing. The aggregate settlementpayment made by the Sellers will be treated as a "current asset" forpurposes of the adjusted working capital calculation.
As discussed,the operative effect of the foregoing agreements will be that the Purchaserwill be indirectly financially responsible for those payments. Nevertheless,you have advised that those amounts are not relevant to the determination ofthe aggregate HSR acquisition price for the assets, votingsecurities and noncorporate interests that Purchaser will acquire.
If the Sellersdo not have sufficient cash available to make the foregoing payments, theSellers may need to borrow those amounts from an existing credit facility,thereby increasing the amount of bank debt being assumed by Purchaser. To theextent such additional borrowing increases bank debt, you advised me in our December 13, 2005 conversation that the additional amountof liabilities being assumed via the increased bank debt WOULD affectthe value of the acquisition.
In addition, theSellers' books reflect $X amount in deferred revenue as a liability. Thisreflects income received by the Sellers that cannot yet be recognized untilcertain future services are rendered. The Purchaser is assuming the obligationto provide those services. Once those services are provided, the liability willbe extinguished. You advised that the value of this deferred revenue is notincluded in the value of assumed liabilities.
Finally, youadvised that if an HSR filling is required for the transaction,the parties need not allocate the purchase price among assets, stock and noncorporateinterests in Item 2(d)(i) through 2(d)(iv) if that allocation is not readilyestimable at this time.
Please let meknow if this accurately reflects your advice to us, and if your advice remainsthe same after reviewing this description. Thanks, as always, for yourinvaluable assistance.