Annual report pursuant to Section 13 and 15(d)

Purchase of Palmer of Texas (Notes)

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Purchase of Palmer of Texas (Notes)
 12 Months Ended
Dec. 29, 2012
Business Combinations [Abstract]  
Purchase of Palmer of Texas
Purchase of Palmer of Texas
On August 21, 2012, the Company completed the purchase of all of the outstanding shares of capital stock of Palmer. Palmer is a manufacturer of liquid storage solutions and separation equipment for the petroleum, municipal water, wastewater, chemical and food industries. The Company views the Palmer acquisition as an excellent complement to the Metals Segment as both companies service many of the same markets and the Company has the ability to drive Palmer efficiencies in purchasing and operations. Palmer's results of operations since the acquisition date are reflected in the Company's consolidated statements of operations, and the Palmer acquisition added approximately 130 employees at December 29, 2012. Effective January 22, 2013, Lee-Var, Inc. changed its name to Palmer of Texas Tanks, Inc.
The purchase price for the acquisition was $25,575,000. The adjustment for working capital increased the purchase price to $26,951,209. In addition, the amount of maintenance capital expenditures over the 18-month period following closing and the final cost of a production expansion capital project currently underway could also result in purchase price adjustments. Currently, the Company does not expect to realize any material purchase price adjustments from these two items. The sellers of Palmer will also have the ability to receive earn-out payments ranging from $2,500,000 to $10,500,000 if the business unit achieves targeted levels of Adjusted EBITDA, as defined in the SPA, over a three year period following closing; and the Company will have the ability to claw-back portions of the purchase price over a two-year period following closing if EBITDA falls below baseline levels. Palmer had recorded liabilities of approximately $1.2 million related to certain contingencies for which the former Palmer shareholders have agreed to indemnify the Company. Accordingly, the Company has carried over these liabilities in its consolidated financial statements and has recorded an asset of approximately $1.2 million in prepaid expenses reflecting the indemnification against these potential payments.
At the end of each year (based on the acquisition date) for the next three years, if Palmer's EBITDA for the year is below $5,825,000, there will not be an earn-out paid for that year. If EBITDA for the year is greater than $5,825,000 but less than $6,825,000, the sellers of Palmer will be paid $2,500,000 for that year. If EBITDA exceeds $6,825,000 for the year, the earn-out would be $3,500,000. At the conclusion of the three-year earn-out period, in the event that the cumulative adjusted EBITDA for the earn-out period is more than $17,475,000, the sellers of Palmer will receive an additional earn-out payment, if any, as follows. In the event that the cumulative EBITDA for the earn-out period is greater than $17,475,000 but less than $20,475,000, the Company will make an additional earn-out payment so that the total cumulative earn-out payments for the three-year earn-out period equals $7,500,000. If the cumulative EBITDA exceeds $20,475,000, the Company will make an additional earn-out payment so that the total cumulative earn-out payments for the three-year period equals $10,500,000. The Company is currently forecasting earn-out payments totaling $8,500,000, which was discounted to a present value of $8,152,000 using our incremental borrowing rate of two percent. $2,500,000 of this liability was classified as a current liability since the first payment is expected to be made within the next year. The various assumptions and projections used in the earn-out projections were reviewed at December 29, 2012 with no additional adjustments required. Any future changes to the projected earn-out payments as a result of our quarterly review of forecasted EBITDA would be reflected as an adjustment to earnings in that period.
Pursuant to the SPA, the Company has entered into a three-year employment agreement with the current Chief Operating Officer of Palmer and a one-year employment agreement with the current Controller of Palmer.
The purchase price for the Palmer acquisition was funded through an increase in the Company's current credit facility and a new term loan with the Company's bank which is discussed in Note 3.
The total purchase price was allocated to Palmer's net tangible and identifiable assets based on their estimated fair values as of August 21, 2012. An intangible asset representing the fair value of Palmer's customer base acquired by the Company was valued at $9,000,000, which is being amortized over a 15-year period using an accelerated amortization method. The excess of the consideration transferred over the fair value of the net tangible and identifiable assets and intangible assets is reflected as goodwill. The Company believes the amount of goodwill resulting from the purchase price allocation is attributable to the workforce of the acquired business (which is not eligible for separate recognition as an identifiable asset) and the expected synergistic benefits of being able to leverage Palmer's expertise with the Company's existing manufacturing and fabrication processes. All of the goodwill was allocated to the Company's Metals Segment. Since the Company purchased the stock of Palmer, goodwill is not deductible for tax purposes. The current allocation of the total consideration paid to the fair value of the assets acquired and liabilities assumed is as follows:
 
 
 
Purchase
 
 
 
 
 
accounting and
 
 

As recorded
 
fair value
 
As recorded
 
by Palmer
 
adjustments
 
by Synalloy
Cash and cash equivalents
$
1,389,054

 
$
—

 
$
1,389,054

Accounts receivable, net
4,969,030

 
—

 
4,969,030

Inventories, net
5,678,368

 
—

 
5,678,368

Prepaid expenses
75,804

 
1,536,000

 
1,611,804

Net fixed assets
4,799,692

 
2,691,370

 
7,491,062

Goodwill
—

 
15,897,948

 
15,897,948

Intangible asset - customer base
—

 
9,000,000

 
9,000,000

Contingent consideration
—

 
(8,152,031
)
 
(8,152,031
)
Other liabilities assumed
(6,833,315
)
 
(3,156,711
)
 
(9,990,026
)
 
$
10,078,633

 
$
17,816,576

 
$
27,895,209


The purchase accounting and fair value adjustment for prepaid expenses represents the indemnification provided by the sellers of Palmer for certain liabilities assumed at acquisition, as mentioned earlier in this note, plus the Controller's retention bonus. The adjustment for net fixed assets increases the book value of the property, plant and equipment to their estimated fair value as of the acquisition date. Contingent consideration is the present value of projected earn-out payments to the prior owners of Palmer. The majority of the adjustments to other liabilities assumed represents current and deferred income taxes inherent with the acquisition.
The amount of Palmer's revenues and pre-tax earnings included in the consolidated statements of operations for the three months and year ended December 29, 2012 were $8,323,000 and $12,619,000, respectively, for revenues and $98,000 and $977,000, respectively, for pre-tax earnings. The following unaudited pro forma information is provided to present a summary of the combined results of the Company's operations with Palmer as if the acquisition had occurred on January 2, 2011. The unaudited pro forma financial information is for information purposes only and is not necessarily indicative of what the results would have been had the acquisition been completed on the date indicated above.
Pro Forma (Unaudited)
 
2012
 
2011
Pro forma revenues
$
220,955,000

 
$
202,689,000

Pro forma net income
5,537,000

 
6,478,000

Earnings per share:


 


  Basic
$
0.87

 
$
1.03

  Diluted
0.87

 
1.02


The pro-forma calculation excludes non-recurring acquisition costs of $881,000 during 2012. These expenditures included $355,000 for professional audit fees associated with due diligence, preparation and audit of historical financial statements and intangible asset identification and valuation, $337,000 related to bank fees associated with the swap agreement, $93,000 of legal fees, $25,000 of travel costs and other various charges of $71,000. These expenses were all recorded at the corporate level and are included as a separate line item in the consolidated statement of operations.