Draft Form of Solvency Opinion
June 13, 1994
Empire Gas Corporation (the "Company" or "Empire Gas")
1700 S. Jefferson
P.O. Box 303
Lebanon, Missouri 65536
Ladies & Gentlemen:
This letter is provided by Valuation Research Corporation ("VRC") reporting the
performance of certain procedures described herein pursuant to Section 9.2 of
the Stock Repurchase Agreement.
For the purposes of this opinion (the "Opinion") capitalized terms defined in
the Company's Form S-1 (the "S-1") will be used herein as defined therein unless
defined herein.
Pursuant to the Stock Repurchase Agreement the Company will implement a change
in ownership and management by repurchasing shares of its common stock from its
controlling shareholder and certain other departing officers in exchange for all
of the shares of a subsidiary that owns 133 retail service centers located
primarily in the southeast. The Company's Chief Operating Officer and Vice
Chairman of the Board, will become the Company's controlling shareholder, Chief
Executive Officer, and President. The change in ownership and management will
enable the Company to pursue a growth strategy focusing on acquiring propane
operating companies. Contemporaneously with this transaction, the Company will
acquire the assets of PSNC Propane Corporation, a company located in North
Carolina that has six retail service centers and five additional bulk storage
facilities with annual volume of approximately 9.5 million gallons, for an
aggregate purchase price of approximately $14.0 million. Pursuant to the Stock
Repurchase Agreement, the Company will transfer 100% of the common stock of its
subsidiary, Energy ("Energy Common Stock"), to the current controlling
shareholder and certain departing directors, officers and employees in exchange
for 12,004,430 of their shares of Common Stock. Certain of the departing
officers and employees will receive $7.00 per share for the remaining 346,220 of
shares of Common Stock that they hold. Energy owns the common stock of
approximately 136 subsidiaries, 133 of which are retail service centers located
in ten states, primarily in the Southeast, and certain other assets. Empire Gas
will retain ownership of 158 retail service centers located in 20 states and 8
non-retail subsidiaries that provide services related to the Company's retail
propane business.
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Financing for the transaction will come from the issuance of Senior Secured
Notes due 2004 (the "Notes"), anticipated to be issued at a substantial discount
from par and expected to result in aggregate offering proceeds of $100,000,000.
In addition the Company intends to enter into a new $15,000,000 secured
revolving line of credit facility (the "New Credit Facility") with Continental
Bank, to provide working capital for general corporate purposes.
The net proceeds to the Company from the issuance and sale of the Notes will be
approximately $95.0 million. The Company intends to use approximately $72.1
million of the net proceeds to retire existing indebtedness. Approximately
$22.3 million will be used to redeem the Company's 12% Senior Subordinated
Debentures due 2002, which currently have an annual sinking fund requirement of
$690,000. Approximately $20.0 million will be used to redeem the Company's 9%
Convertible Subordinated Debentures due 1998, which currently have an annual
sinking fund requirement of $1.25 million. Approximately $16.1 million will be
used to repay the term loan (currently accruing interest at 6.125% per annum)
under the Existing Credit Facility (the "Term Loan"), which matures June 30,
1998 and which currently has a quarterly sinking fund requirement of $650,000.
Approximately $13.7 million will be used to repurchase $13.7 million principal
amount 2007 9% Subordinated Debentures. Approximately $12.0 million of the
remaining net proceeds will be used by the Company to complete the Acquisition,
which has an aggregate purchase price of $14.0 million. Approximately $2.6
million of the net proceed will be used to repurchase, at $7.00 per share,
approximately 346,220 shares of Common Stock held by the departing directors,
officers and employees, and approximately 31,640 shares of Common Stock held by
other shareholders. The Company will use approximately $4.1 million of the net
proceeds to make a payment to Energy in connection with the Stock Purchase,
reduced to the extent Energy may be required to make a payment to the Company
based on the balance, as of the Effective Date, of certain of the Company's
liabilities net of certain of its assets.
Following the Transaction, Empire Gas will consist of 158 retail service centers
with 22 additional bulk storage facilities operating in 20 states (the
"Business").
Pursuant to our understanding of the above, VRC has been asked to provide its
opinion as of June [13], 1994 (the "Closing Date"), with respect to Empire Gas,
that both immediately before and immediately after, and giving effect to, the
consummation of the Transaction, as disclosed to VRC:
(a) The Fair Value of the assets of Empire Gas exceeds and will exceed
its liabilities (including, without limitation, the New Financing,
Stated Liabilities, and Identified Contingent Liabilities);
(b) The Present Fair Saleable Value of the assets of Empire Gas exceeds
and will exceed the probable liabilities on its debts (including,
without limitation, the New Financing, Stated Liabilities, and
Identified Contingent Liabilities) as such debts become absolute and
matured;
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(c) Empire Gas is and will be able to pay its debts (including, without
limitation, the New Financing, Stated Liabilities, and Identified
Contingent Liabilities) as such debts mature; and
(d) Empire Gas will not have Unreasonably Small Capital for the Business
in which it is and will be engaged.
The Opinion rendered is with respect to Empire Gas as a going concern, on a pro
forma basis, both immediately before and immediately after, and giving effect
to, the Stock Purchase, the Notes issuance and the funding under the New Credit
Facility. In the course of preparing this Opinion, nothing has come to our
attention that causes us to believe that Empire Gas, both immediately before and
immediately after, and giving effect to, the Transaction and the associated
indebtedness, is not and would not be a going concern. For the purposes of this
Opinion, the following terms are defined:
(a) Fair Value
The amount at which assets of Empire Gas would change hands between
a willing buyer and a willing seller, within a commercially
reasonable period of time, each having reasonable knowledge of the
relevant facts, neither being under any compulsion to act, with
equity to both.
(b) Present Fair Saleable Value
The aggregate amount that may be realized by an independent willing
seller from an independent willing buyer if a company's assets are
sold with reasonable promptness in an arm's-length transaction under
present conditions for the sale of assets of comparable business
enterprises.
(c) Stated Liabilities
"Stated Liabilities" means the existing liabilities as well as any
assumed liabilities related to the Transaction, determined in
accordance with generally accepted accounting principles ("GAAP")
consistently applied as set forth in the pro forma balance sheet
presented in the S-1, all of which information has been provided to
us by an officer of the Company responsible for financial and
accounting matters.
(d) New Financing
The indebtedness being incurred, assumed, or guaranteed by Empire
Gas, through borrowings from Continental Bank under the New Credit
Facility and the issuance of the Notes.
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(e) Identified Contingent Liabilities
The maximum reasonably estimated liabilities that may result from
pending litigation, asserted claims and assessments, guaranties,
environmental conditions, uninsured risks, and other contingent
liabilities as identified and explained to VRC in terms of their
nature and estimated dollar magnitude by responsible officers of
Empire Gas and their various advisors. These contingent liabilities
may not meet the criteria for accrual under Statement of Financial
Accounting Standards No. 5 and therefore may not be recorded as
liabilities under GAAP.
(f) Unreasonably Small Capital
This phrase relates to the ability of Empire Gas, after giving
effect to the incurrence of the New Financing and after consummation
of the Transaction, to continue as a going concern and not lack
sufficient capital for the needs and anticipated needs of Empire
Gas, including Identified Contingent Liabilities. In financial
accounting, information that significantly contradicts the going
concern assumption relates to an entity's ability to continue to
meet its obligations as they become due without substantial
unplanned disposition of assets outside the ordinary course of
business, restructuring of debt, externally forced revisions of its
operations, or similar actions. Generally accepted auditing
standards call for affirmative actions to test the going concern
concept. These auditing standards may identify certain information
that contradicts the financial accounting going concern assumption -
for example, recurring operating losses, defaults on loans, and
adverse financial ratios. Our determination of adequate capital is
made from an economic rather than financial accounting perspective.
During the course of our examination and review, we did not discover
any such information.
We believe the foregoing definitions are reasonable and appropriate for purposes
of rendering the Opinion, and we believe that the methodologies we use in our
analysis are appropriate for determining Fair Value and Present Fair Saleable
Value as defined herein. Based on the facts that have come to our attention
during the course of this engagement, we believe it is appropriate for us to
value Empire Gas as a going concern as part of our analysis relating to this
Opinion.
In expressing its Opinion, VRC has relied on information and analyses furnished
by and/or discussions held with officers and employees of the Company, which
information and analyses VRC has reviewed and which has been the subject of
discussion and inquiry. VRC does not assume any responsibility for the
sufficiency and accuracy of the information. Nothing has come to VRC's
attention in the course of this engagement which would lead it to believe that
any such information is incorrect in any material
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respect or that it was unreasonable for VRC to utilize and rely upon the
information. Such data has been accepted as reasonably reflecting the
Acquisition, the financial condition of Empire Gas and their past and future
operations. All items generally considered subject to audit pursuant to
generally accepted auditing standards and in conformity with generally accepted
accounting principles have been relied upon without review, check, or
verification, but nothing has come to our attention that would cause us to
believe the information is incorrect in any material respect or that it was
unreasonable for VRC to utilize and rely upon the information. VRC has
performed certain analyses, studies, and investigations more fully described
herein in support of its Opinion. Further, the Opinion expressed herein is
subject to the General Limiting Conditions and Assumptions attached hereto.
VRC was provided with audited financial statements for Empire Gas (pre
Transaction) for the fiscal years ended June 30, 1991 through June 30, 1993 and
the unaudited financial statements for Empire Gas Corporation for the nine-month
period ended March 31, 1994 and unaudited proforma financial statements, giving
effect to the Transaction for the twelve month period ended March 31, 1994.
These unaudited financial statements were prepared by Empire Gas management
("Management") and were represented as being prepared in accordance with GAAP.
As VRC is not a public accounting firm it does not certify financial statements
and has relied in good faith on the financial statements prepared by Management.
VRC has reviewed these financial statements, as well as historical data by
division and other internal financial data from the Company, in addition to
extensive background data and material considered appropriate to the Opinion
expressed. Such areas of investigation have included but are not limited to:
* An industry overview, including an analysis of companies engaged in
similar lines of business, as well as reviewing available data on
recent acquisitions of companies engaged in similar lines of
business.
* Inquiries of Management as to the impact of future trends on Empire
Gas and the industry; estimated future levels of current assets and
liabilities and capital expenditures; competitive conditions and
advantages; and key actions to be taken in the near term, among
other factors.
* Review of the draft Note Indenture agreement between Empire Gas and
Shawmut Bank Connecticut ("Shawmut Bank") filed with Amendment No. 2
of the Company's Form S-1 on June 10, 1994 ("Amendment No. 2").
* Review of Empire Gas's Projected Financial Statements for an eleven
year period ending June 30, 2004.
* Review of the Rating Agency presentation prepared by the Company and
dated March, 1994.
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* Review of Company's Form S-1 filed with the Securities and Exchange
Commission (the "SEC") on April 29, 1994, as amended by Amendment
No. 2.
* Review of the Basic Agreements.
* Review of a draft of the Warrant Agreement between Empire Gas and
Shawmut Bank dated June 1, 1994.
* Review of a draft of the Underwriting Agreement between Empire Gas
and the Underwriter dated June 1, 1994.
* Review of a draft of the Asset Purchase Agreement by and among
Empire Gas, Empiregas, Inc. of North Carolina, Public Service
Company of North Carolina, Incorporated and PSNC Propane
Corporation, dated June 13, 1994.
* Review of the Option Agreement dated April 9, 1994 by and between
Steve's Propane Service, Inc. ("Steve's Propane").
* Review of financial and operational data for Steve's Propane.
* Review of the Option Agreement dated February 11, 1994 by and
between Ginco Propane Inc. ("Ginco") and Empire Gas.
* Review of financial and operational data for Ginco.
* Review of the Acquisition Information Brochure on Ginco presented to
Empire Gas Board of Directors on December 2, 1993.
* Review of the March 31, 1994 Form 10-Q filed by Empire Gas with the
SEC.
* Review of the audited financial statements of PSNC as of March 31,
1994.
* Interviews with the management of Empire Gas.
* Review of the Schedule of Identified Liabilities provided to VRC in
writing, by a senior officer of Empire Gas which was represented by
this officer to include a listing of all appropriate items. Because
the Identified Contingent Liabilities are estimates of Management,
we express no opinion as to the completeness or propriety of such
items. However, after discussion with Management with respect
thereto, and our general familiarity with such liabilities, nothing
has come to our attention in the
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course of this engagement which would suggest that any such
information is incorrect in any material respect or unreasonable for
VRC to utilize.
* Inquiries of certain officers of Empire Gas who have responsibility
for legal, financial, and accounting matters as to the existence,
nature, and magnitude of Identified Contingent Liabilities.
For purposes of this Opinion, VRC has assumed that there will be no material
change in any documents in VRC's possession on June 13, 1994.
VRC has, to the extent necessary, discussed financial and operating matters of
Empire Gas with Management and/or its financial and legal advisors. VRC has
reviewed the forecasts of earnings, income, cash flows, and balance sheets of
Empire Gas prepared by Management referred to above and discussed such forecasts
with Management. This review included, but was not limited to, discussions of
basic assumptions made in the preparation of the forecasts relating to the type
of business; key markets; economic conditions; capital facilities and working
capital requirements; taxes; financing plans; and strategic positioning. We
consider such forecasts to be reasonable and attainable in light of current and
near term economic expectations and nothing has come to our attention that would
cause us to believe the basic assumptions used in the forecasts are
unreasonable. We believe that the review we have conducted and the analyses and
procedures undertaken are those generally considered appropriate for expressing
the Opinion herein.
On the basis of the review, procedures, and analyses performed, we express the
following opinions as of June [13], 1994 that both immediately before and
immediately after and giving effect to the Merger, all predicated on the General
Limiting Conditions and Assumptions:
(a) The Fair Value of the assets of Empire Gas exceeds and will exceed
its liabilities (including, without limitation, the New Financing,
Stated Liabilities, and Identified Contingent Liabilities);
(b) The Present Fair Saleable Value of the assets of Empire Gas exceeds
and will exceed the probable liabilities on its debts (including,
without limitation, the New Financing, Stated Liabilities, and
Identified Contingent Liabilities) as such debts become absolute and
matured;
(c) Empire Gas is and will be able to pay its debts (including, without
limitation, the New Financing, Stated Liabilities, and Identified
Contingent Liabilities) as such debts mature; and
(d) Empire Gas will not have Unreasonably Small Capital for the Business
in which it is and will be engaged.
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Exhibit A of this report sets forth the Present Fair Saleable Value and Fair
Value of the aggregate assets of Empire Gas, as well as its Stated and
Identified Contingent Liabilities, and the New Financing incurred, assumed or
guaranteed by Empire Gas.
This letter is solely for information and assistance to the parties to whom it
is addressed for matters in connection with the proposed Merger and New
Financing, except as set forth in the General Limiting Conditions and
Assumptions. Any other use is expressly prohibited and neither this letter nor
any of its parts may be circulated, quoted, or otherwise referred to for any
other purpose without the prior review and written consent of VRC, the exercise
of which will be at the sole discretion of VRC not unreasonably withheld.
The above limitations do not apply to related parties who you believe have a
legitimate business interest in receiving such copies, including counsel, future
participating lenders, courts, administrative agencies, and other appropriate
parties. However, in such instances, this Opinion must be provided to such
parties in its entirety. The term "related parties" shall not exclude
participants and assignees, regulators, additional lenders, successors, or
appropriate parties involved in litigation or court proceedings involving this
transaction or under other similar circumstances.
Valuation has no responsibility to update the opinion stated herein for events
and circumstances occurring after the date of this letter.
Respectfully submitted,
VALUATION RESEARCH CORPORATION
Engagement Number: 04-2313-00
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EXHIBIT A
EMPIRE GAS CORPORATION
EXCESS OF PRESENT FAIR SALEABLE VALUE
AND FAIR VALUE OF ASSETS OVER LIABILITIES
As of June 13, 1994
(dollars in millions)
PRESENT FAIR SALEABLE VALUE AND
FAIR VALUE OF ASSETS $142.8
LIABILITIES:
Stated Liabilities (1)(2) 12.2
New Financing:
Notes 106.9
New Credit Facility 0
Identified Contingent Liabilities 14.0
TOTAL LIABILITIES 133.1
-----
EXCESS OF PRESENT FAIR SALEABLE VALUE
AND FAIR VALUE OF ASSETS OVER LIABILITIES $ 9.7
-----
-----
SEE GENERAL LIMITING CONDITIONS AND ASSUMPTIONS
<FN>
Notes:
(1) Based on pro-forma March 31, 1994 balance sheet provided by Empire,
assuming no material changes to the financial statements in the interim
period.
(2) Stated Liabilities consist of $11.1 million in current liabilities and $1.1
million in accrued self insurance liabilities.
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GENERAL LIMITING CONDITIONS AND ASSUMPTIONS
In accordance with recognized professional standards as generally practiced in
the valuation industry, the fee for these services is not contingent upon the
conclusions of value contained herein. VRC has determined to the best of its
knowledge and in good faith that neither it nor any of its agents or employees
have a material financial interest in the Company.
Neither VRC, nor its agents or employees, assume any responsibility for matters
legal in nature, nor do they render any opinion as to any title to, or legal
status of, property which may be involved, both real and personal, tangible and
intangible.
VRC assumes that all laws, statutes, ordinances, other regulations, or
regulations of any governmental authority relevant to and in connection with
this engagement are complied with unless express written noncompliance is
brought to the attention of VRC and is stated and defined by those relied on by
VRC, including the Company and its management.
VRC has relied on certain information furnished by others, including, but not
limited to, the Company, without verification, other than the procedures
specified in VRC's letter attached hereto. VRC believes such information to be
reliable as to accuracy and completeness but offers no warranty or
representation to that effect; however, nothing has come to our attention in the
course of this engagement that would cause us to believe that any furnished
information is inaccurate in any material respect or it is unreasonable to
utilize and rely upon such information. Such information generally includes,
but is not limited to, financial analyses and forecasts; historical, pro forma,
audited and unaudited financial statements; and management analyses and
forecasts.
Where there may be real property involved, and unless specifically stated, VRC
has not made a land survey of the property and has assumed that Empire Gas has
clear title to the property represented by the Company as owned by Empire Gas.
It is assumed that there are no hidden or unapparent conditions of the property,
subsoil, or structures thereon that render it more or less valuable except as
disclosed in the Environmental Assessment. No responsibility is assumed for
such unapparent conditions or for arranging for engineering studies that may be
required to discover such unapparent conditions or any such unapparent
conditions which may exist.
In some instances, public information and statistical information have been
obtained from sources VRC has accepted as being reliable; however, VRC makes no
representation as to the accuracy or completeness of such information and has
accepted the information without further verification.
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The opinion of VRC does not represent an assurance, guarantee, or warranty that
Empire Gas will not default on any debt obligations associated with the
Acquisition related transactions.
VRC makes no assurance, guarantee, or warranty that the covenants for the New
Financing will not be broken in the future.
No representation is made herein as to the legal sufficiency of the above
definitions (term definitions contained in the body of the Opinion) for any
purpose; such definitions are used solely for setting forth the scope of this
Opinion and VRC believes such definitions to be reasonable for the purposes of
rendering this Opinion.
The opinions of value expressed by VRC result from the development and analysis
of several valuation indications arrived at through the use of generally
accepted valuation procedures. These procedures included the Income and Market
Approaches, which we believe to be procedures appropriate to express the
opinions herein.
The Income Approach utilized cash flow projections discounted to a present
value. The discount rate selected was based on risk and return requirements
deemed appropriate by VRC, given the facts and circumstances surrounding the
transactions under consideration. In arriving at an appropriate discount rate,
VRC considered the Company's weighted average cost of capital, the weighted
average cost of capital for other companies in the industry, and the rate of
return on alternative investments. In addition, the risk inherent in the
business was also considered.
In addition to discounting the projected cash flows of the Company, VRC
performed sensitivity analysis which included varying the discount rates and
sales growth rates of the projections in estimating a range of values.
The Market (Guideline) Approach compared the subject company with
publicly-traded companies engaged in businesses which VRC deemed reasonably
similar to the subject's. The companies selected were either competitors of the
Company or engaged in distribution and marketing of products similar or related
to that of the Company. Ratios such as invested capital to earnings before
interest and taxes; invested capital to earnings before interest, depreciation,
amortization and taxes; invested capital to sales; and invested capital to debt
free after tax earnings were employed. Recent acquisitions of companies in
related industries were also reviewed.
Our opinion is necessarily based on economic, market, financial and other
conditions as they exist on the date of this letter. While various judgments
and estimates which we consider reasonable and appropriate under the
circumstances were made by us in the determination of value, no assurance can be
given by us that the sale price which might ultimately be realized in any actual
transaction, if and when effected, will be at the Fair Value or Present Fair
Saleable Value indicated.
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Material changes in the industry or in market conditions which might affect the
Company's business from and after the effective date of the proposed
transactions and which are not reasonably foreseeable are not taken into
account.
It has been represented to VRC that there will be no borrowings outstanding at
closing under the New Credit Facility.
Based on the projections provided in the Rating Agency Presentation which were
the subject of our investigation and analysis, VRC has assumed that the Company
will make no acquisitions exceeding $6,000,000 in total during any given year
during the projection period.
With respect to the Company's ability to repay debts as they mature, VRC has
assumed that 100% of the Company's excess cash flow is accumulated and
restricted to be applied to the repayment of any outstanding obligations
incurred under the Note Indenture and the New Credit Facility.
It has been represented to VRC that Empire Gas has accrued or reserved for all
Identified Contingent Liabilities on the proforma balance sheet provided to VRC.
All amounts are fully accounted for under Stated Liabilities on Exhibit A in
this report.
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