Understanding Valuation and the ESOP Valuation Report

IOWA-NEBRASKA ESOP CHAPTER CONFERENCE

2013 WINTER CONFERENCE CORALVILLE, IOWA

Matthew Drake
Senior Associate 630.413.5589 mdrake@prairiecap.com

Craig Olinger
Financial Consultant 262.646.6490 colinger@esi-enterprise.com

VALUATION PROCESS
The Essentials.
The Process A typical valuation engagement lasts anywhere from 30 to 45 days.

Step 1 Engagement

Step 3 On-site due diligence

Step 5 Review of projections with management team

Step 7 Present conclusions of value

Step 2 Collection of Data Background & history Financial statements Budgets/Projections Customer lists

Step 4 Build valuation models

Step 6 Prepare reports/deliverables

Step 8 Complete engagement and issue final reports/deliverables

CONCEPTS OF VALUATION
Approaches to Value
Income Approach There are two widely accepted methods used under this approach: Discounted cash flow method Capitalized earnings method Discounted Cash Flow Method (DCF) The DCF method involves projecting normalized free cash flows and discounting them back to present value using a discount rate The discount rate should reflect the degree of perceived risk associated with achieving the Companys earnings expectations Capitalized Earnings Method This approach determines the value of a business by looking at the historical cash flow results instead of expected future cash flows. This is done by taking historical earnings and dividing them by the capitalization rate (discount rate growth rate) Market Approach There are two widely accepted methods used under this approach: Guideline public company method M&A comparable method Guideline Public Company Method This method assesses the subject company relative to a group of similar, publicly traded companies Applies valuation multiples derived from this public company group to the subject companys earnings M&A Comparable Method This is another commonly used method that focuses on the terms, prices, and conditions found in sales of companies in the subject companys respective industry Transactions multiples are screened and then applied to the subject companys earnings Asset-Based Approach The most widely accepted method used under this approach: Underlying Asset Method Underlying Asset Method This method analyzes the individual assets and liabilities comprising the business Involves the estimation of the current reproduction cost of the assets, less an estimate of accrued depreciation to reflect physical, functional, and economic obsolescence This approach is typically not applied in the valuation of a going concern Reserved for companies that are often in the liquidation process or comprised of large fixed assets (i.e. REITs)

KEY VALUATION DRIVERS

Valuation Basics
What do we look for We want to reflect the economics of The Company itself Its competitive marketplace The general economy and capital markets Our goal is to think like investors As such, we must look inside and outside of the Company Established valuation approaches, such as the income and market approach, follow these concepts This is how the market prices stock Research analysts developing recommendations Investment bankers considering mergers and acquisitions Corporate development professionals evaluating acquisitions Sub-debt/mezzanine lenders pricing warrants on their facilities We want to MIMIC the marketplace
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What drives company value? External Drivers Market multiples Lending conditions Interest rates Industry trends Investor psychology Capital markets debt/equity Economic policies Political environment International markets Competition Internal Drivers Growth prospects Profitability Revenue sources Balance sheet Intangible assets Management team Customer diversification Size Capital requirements Litigation & Environmental

KEY VALUATION DRIVERS

Equity Value can Grow in Two Ways

Equity Starting Point Net Working Capital (NWC)

Pay Off Debt

Grow Asset Values

Long-Term Liabilities

NWC

NWC

Long-Term Liabilities

Fixed Assets & Other Assets

Equity

Fixed Assets & Other Assets

Equity

Fixed Assets & Other Assets

Equity

KEY VALUATION DRIVERS

Invested Capital Value NWC

What Cash Flow Streams Are We Solving To?

Long-Term Liabilities

Debt-free streams provide a return on invested capital Discounting them to present value leads to INVESTED CAPITAL VALUE Debt-free earnings streams include: EBIAT (earnings before interest after tax) Debt-free cash flow EBITDA EBIT

Fixed Assets & Other Assets

Equity

Equity Value NWC Long-Term Liabilities

Equity streams provide a return on equity Discounting them to present value leads to EQUITY VALUE Equity earnings streams include: Net income Net cash flow Earnings before taxes

Fixed Assets & Other Assets

Equity

KEY VALUATION DRIVERS

Adjustments to Earnings
What Do We Look For What Qualifies as an Earnings Adjustment

In order to reflect an accurate representation of the Companys true earnings, certain items may be adjusted
Income/expenses deemed to be one-time in nature Expenses that are in excess of normal market levels Expenses that will no longer occur in the future

Examples of Adjustments/Add-backs to Earnings Excess compensation Non-continuing compensation Personal (entertainment) expenses (cars, plane) Extraordinary legal fees Extraordinary professional fees Significant bad debt/inventory write-offs Income/expenses from discontinued operations Environmental litigation/remediation Excess employee benefits/compensation Gain on sale of assets Investment income

KEY VALUATION DRIVERS

How Multiples Are Calculated
Invested Capital Value EBITDA Multiple Calculation ($000s) Equity Value Total Debt Invested Capital Value $10,000 $2,000 $12,000 Equity Value

Net Income Multiple Calculation ($000s) Invested Capital Less: Total Debt Equity Value $12,000 -$2,000 $10,000

Company EBITDA

$2,000

Company Net Income

$1,000

EBITDA Multiple (IC/EBITDA)

6.0x ($12,000/2,000)

Net Income Multiple (Equity Value/NI)

10.0x ($10,000/1,000)

Income Approach

INCOME APPROACH

Discounted Cash Flow Method

DCF Looking Inside the Company DCF modeling can vary in duration
Single or multiple-year models are used Ultimately, we have to value all future years Typically, a discrete period and a terminal value are used

DCF Example
Free Cash Flow EBIAT D&A Change in Working Capital Capital Expenditures Debt-Free Cash Flow Discount Factor @ 15.25% Midyear Adjustment Factor NPV of Free Cash Flows $ 2011 2,924.8 $ 751.4 2,295.9 (1,000.0) 3,265.3 0.9426 1.0300 3,170.2 22,073.8 2012 3,545.8 $ 1,986.5 (949.3) (1,987.9) 2,595.1 0.8179 1.0735 2,278.6 2013 4,041.5 $ 2,186.9 (727.8) (2,186.7) 3,313.8 0.7097 1.0735 2,524.6 2014 4,385.9 $ 2,399.3 (480.3) (2,317.9) 3,986.9 0.6158 1.0735 2,635.5 2015 ... 4,543.4 2,622.3 (424.3) (2,433.8) 4,307.6 0.5343 1.0735 2,470.7 2020 $ 6,177.9 2,226.0 (421.0) (2,989.5) 4,993.4 0.2628 1.0735 1,408.6

Revenue, expenses, reinvestment, and other assumptions are reflected in the DCF Prairie uses a 10-year DCF model
What causes value change? Value changes directly as revenue and profitability expectations rise and fall Value also changes as risks and costs of capital fluctuate

Sum of NPV of FCFs

Perpetuity Growth Model Present Value of CF (Years: 1 -10) Terminal Value (CF10 + g) / (K-g) Present Value Factor PV of Terminal Value Enterprise Value (Years: 1-10 + TV) $ 22,073.8 $ 53,219.7 0.282 15,012.6 $ 37,086.3

Capitalization rate of 11.25% used (K-g) = 15.25%-4.0%

Equity Value Conclusion Enterprise Value Less: Total Funded Debt Equity Value (1) $ 37,086.3 (7,500.0) $ 29,586.3

(1) Based on a marketable minority value premise or "publicly traded equivalent" (2) K = Discount Rate, g = Long-Term Growth Rate

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INCOME APPROACH
Discount Rate

Developing the Discount Rate

Discount Rate Example
CAPM Calculation (Ke = 1 + (2*3) + 4) Risk-free Rate (1) Equity Risk Premium (2) Beta (3) Subjective / Small Comp Risk Premium (4) Cost of Equity (Ke) Cost of Debt Tax Rate After - Tax Cost of Debt (Kd) WACC = (Ke * %E) + (Kd * %D) Equity % of Capital Debt % of Capital Calculated WACC (rounded) 4.13% 6.70% 1.15 6.36% 18.20% 6.00% 40.00% 3.60%

The discount rate is used to discount future cash flow streams back to present value Time value of money Risk We generally project the cash flow of the Company on a debt free basis In doing so, we use the weighted average cost of capital (WACC) to calculate the discount rate Projected rate of return that debt and equity holders would require to invest in this particular business The WACC involves: The cost of equity (Capital Asset Pricing Model) The cost of debt capital for the Company Calculating the WACC by multiplying the returns required for each component of capital by its contribution to total capital Determination of an appropriate discount rate cannot be reduced to a simple mathematical formula It requires judgment and knowledge developed from experience in securities valuation

79.78% 20.22% 15.25%

(1) U.S. Treasury yield 20-year constant maturity as of the valuation date, Fed Statistical Release (2) Ibbotson Associates' "SBBI Valuation Yearbook" long-term horizon (3) Beta derived from public company peer group, relevered with subject company's capital structure (4) Ibbotson Associates' "SBBI Valuation Yearbook" 10th decile

Market Approach

MARKET APPROACH

Public Guideline Company Method

PGC Looking Outside the Company Comparative public companies (or comparative private transactions) are selected as a representative group of alternate investments
Price to earnings (P/E) multiples are extracted from market data They are applied to comparable factors for the Company

PGC Architecture
Like the income approach, the market approach has stream-defined methods

Using Invested Capital Multiples EBIAT, EBIT, or EBITDA X Invested Capital Multiples = Invested Capital Value - Interest Bearing Debt = Equity Value

Using Equity Multiples Pretax Income or NI X Equity Multiples = Equity Value

Issue in todays market: Is our company on the same path? Value may be a significant function of THEIR ECONOMICS
Sources of valuation multiples Net income Cash flow EBIT EBITDA Revenue Book value

MARKET APPROACH
PGC Example

Public Guideline Company Method

Public Comparable Method Valuation Summary ( in thousands) Company Adjustment Equity Multiples Earnings Median 15.0% Near Term P/E - 2011 $2,900.0 11.0x 9.4x Latest P/E - 2010 1,100.0 16.0x 13.6x Five Year Average P/E 2,000.0 17.0x 14.5x Near Term CF - 2011 Latest CF - 2010 Five Year Average CF Invested Capital Multiples Near Term EBIT - 2011 Latest EBIT - 2010 Five Year Average EBIT Near Term EBITDA - 2011 Latest EBITDA - 2010 Five Year Average EBITDA IC to Revenue Valuation Conclusions Indicated Equity Value $4,700.0 2,700.0 3,400.0 9.0x 11.0x 12.0x 7.7x 9.4x 10.2x

Enterprise Value $27,115.0 14,960.0 28,900.0 35,955.0 25,245.0 34,680.0

Less: Total Debt NA NA NA NA NA NA

Equity Value $27,115.0 14,960.0 28,900.0 35,955.0 25,245.0 34,680.0

$4,900.0 2,000.0 3,500.0 $6,700.0 3,600.0 5,000.0 30,300.0

8.0x 10.0x 11.0x 7.0x 8.0x 9.0x 1.5x

6.8x 8.5x 9.4x 6.0x 6.8x 7.7x 1.3x Median 27,115.0

33,320.0 17,000.0 32,725.0 39,865.0 24,480.0 38,250.0 38,131.8

(7,500.0) (7,500.0) (7,500.0) (7,500.0) (7,500.0) (7,500.0) (7,500.0)

25,820.0 9,500.0 25,225.0 32,365.0 16,980.0 30,750.0 30,631.8

MARKET APPROACH
Continuing to Look Outside

M&A Comparable Method

M&A Market Statistics Private company M&A transactions
The data is derived from purchased databases or press releases Its generally less reliable than public company data; however, at times, could be more indicative of current market pricing

M&A data
Publically announced transactions (public company deals) Publicly disclosed transactions (private company deals) Summarized databases sorted by industry and company size

Some sources of M&A data

Capital IQ MergerStat Done Deals GF Data Resources

MARKET APPROACH
Application of the Method

M&A Comparable Method

M&A Comparable Method Example ($000s) Adjusted EBITDA Multiple Invested Capital Value Less: Total Debt Equity Value $6,679.0 5.7x $38,070.3 ($7,500.0) $30,570.3

Valuation Premises & Conclusion

VALUATION PREMISES & CONCLUSIONS

Standards of Value
Maximum Value
Controlling Interest
Change of control transaction Synergistic premium may be warranted Value of Enterprise as a whole Acquisition value Control premium

Value as if publicly traded Prairies valuation model starting point Is there any certainty of investment returns? Nature of exit strategy?

Marketable Minority

Value of illiquid minority interest Typically used for closely held companies (i.e. stock transfers, gifting, or estate planning) Uncertain returns, no market what would you pay?

Non-Marketable Minority

Minimum Value

VALUATION PREMISES & CONCLUSIONS

Value Conclusions & Weighting
Methodology Value Conclusions Discounted cash flow method
$29.6 million

Methodology Weighting Example

Methodology Weighting ($000s) DCF PGC M&A Total Value $29,600 $27,100 $30,600 Weighting 1/3 1/3 1/3 Weighted Value $9,768 $8,943 $10,098 $28,809

Public guideline company method

$27.3 million

M&A comparable method

$31.9 million

The following should be considered when determining the weighting of each methodology
Strength of assumptions and accuracy assumed in the DCF Comparability of public guideline companies Accuracy and validity of private company M&A transaction data Volatility of the market place A subject companys particular niche Growth profile of the subject company relative to the market Earnings profile of subject company relative to the market

Understanding the ESOP Valuation Report

BENCHMARKING

Key Ratios

Balance Sheet, Income Statement, Activity, Liquidity, Risk What percentile do you fall in

Stock Price Trends

How do you stack up against others in your industry Are you beating the Dow, S&P, Nasdaq Great communication message if you are

Capital Structure

How do other companies in your industry typically operate

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BENCHMARKING
RMA Comparisons
Balance Sheet Comparison
BALANCE SHEET ITEMS Current Assets as % of Assets Cash as % of Assets Trade Receivables as % Assets Inventory as % of Assets Net Fixed Assets as % of Assets Current Liabilities - % of Assets Long Term Debt as % of Assets Total IB Debt as % of Assets Net Worth as % of Assets INCOME STATEMENT ITEMS Gross Profit as % of Sales Operating Expense as % of Sales Operating Profit as % of Sales Pre-tax Income as % of Sales 41.4 10.1 3.1 25.6 14.4 29.0 36.2 48.7 32.4 44.8 12.1 4.6 25.3 38.8 37.3 21.4 29.0 34.3

Ratios
ACTIVITY/OPERATING RATIOS Sales/Receivables Days in Receivables Cost of Sales/Inventory Days in Inventory Sales/Net Fixed Assets Sales/Total Asset Sales/Working Capital LIQUIDITY / LEVERAGE Current Ratio Quick Ratio Total Liabilities/Equity RISK Interest Coverage: EBIT/Interest 166.4 2.2 14.7 25.0 35.7 5.1 41.4 161.2 2.0 15.5 24.0 13.2 4.8 62.1

1.4 0.5 2.1

1.2 0.4 2.0

26.9 26.1 0.9 0.9

25.5 24.0 1.5 1.5

Debt Leverage: NI+ DA/Curr Debt

3.0 0.4

4.3 2.1

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BENCHMARKING
Public Company
Public Company Comparison
Financial Data ($ in 000) Total Revenue Operating Income Net Income EBIT EBITDA Total Assets Stockholders' Equity Arden Ingles 12/31/2011 9/29/2012 429,483 26,122 17,005 26,370 31,345 135,063 91,759 Harris 10/2/2012 Village Weis 7/28/2012 12/31/2011 1,422,243 55,552 31,445 58,123 77,882 409,538 230,311 All GPCs Mean Median 2,752,504 114,280 43,444 117,606 176,989 1,029,004 457,413

3,709,434 4,535,414 123,177 170,978 43,444 82,512 127,374 171,565 217,905 307,107 1,642,109 1,952,488 457,413 1,037,619

2,752,504 2,569,816 114,280 98,022 75,584 49,998 117,606 100,208 176,989 162,246 1,029,004 1,033,640 745,886 512,598

Activity Ratios Sales/Receivables Inventory Turnover Sales/Net Fixed Assets Sales/Total Assets Profitability Ratios Return on Equity (%) Return on Assets (%) EBITDA of Revenue (%) Operating Margin (%) Net Profit Margin (%) Effective Tax Rate (%) Liquidity/Leverage Quick Ratio Current Ratio Total Debt to Equity Growth 3 Year EBIT CAGR (%) 3 Year EBITDA CAGR (%)

Arden 9/29/2012 98.1 16.3 11.8 3.0

Ingles 9/29/2012 61.7 9.1 3.1 2.2

Harris 10/2/2012 85.1 10.7 4.3 2.3

Village 7/28/2012 144.1 26.1 8.2 3.6

Weis 9/29/2012 48.4 8.3 4.4 2.5

All GPCs Mean Median 87.5 14.1 6.4 2.7 85.1 10.7 4.4 2.5

20.3 14.2 9.1 6.1 4.0 40.8

9.6 2.6 5.9 3.3 1.2 35.5

8.2 4.2 6.7 3.8 1.8 35.4

14.4 7.9 5.3 3.9 2.2 41.5

8.9 6.4 5.7 4.2 2.7 36.9

12.3 7.1 6.5 4.2 2.4 38.0

9.6 6.4 5.9 3.9 2.2 36.9

2.4 3.0 0.0

0.2 1.4 1.8

0.6 1.4 0.2

1.1 1.7 0.2

0.9 2.2 NA

1.0 1.9 0.6

0.9 1.7 0.2

(14.8) (13.5)

5.2 4.3

(7.0) (4.1)

10.9 10.2

9.6 8.2

0.8 1.0

5.2 4.3

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SOURCES OF INFORMATION

Capital IQ BizMiner SBBI Yearbook Duff & Phelps RPR Industry and Trade Journals Pratts Stats RMA statement studies

Microbilt Compensation Studies Provided by Company Federal Reserve Wall Street Journal Mergerstat Review First Research

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ECONOMY/INDUSTRY

What has the overall economy done and what is forecasted

Growth Inflation

Industry outlook

Developments Trends

Local economy

In comparison to the national economy/global

How does your forecast relate to the above

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ACQUISITIONS

Current multiples in either the private or public marketplace Common metrics in the industry Current activity

Is consolidation prevalent right now Who is doing the buying

What makes a company more or less valuable

Characteristics

Is target company above or below industry averages

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VALUATION METHODOLOGIES

Replicate the models What if scenarios

Sales growth Expense reduction Impact on share price

Address any risk issues

External Factors Internal Factors

Training/Communication tool

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FINAL THOUGHTS

Valuation firm is an independent third party

This is how they see the firm in relation to the hundreds of other firms they work with

Gives the management team/board an opportunity to look objectively at the company Strategic decisions regarding the direction of the company can be made utilizing this information Wealth of information contained in these reports other than the per share price

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Questions?

Matthew Drake
Senior Associate 630.413.5589 mdrake@prairiecap.com

Craig Olinger
Financial Consultant 262.646.6490 colinger@esi-enterprise.com