________________________________________________________________________________
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON D.C. 20549
FORM 8-K/A
(AMENDMENT NO. 1)
CURRENT REPORT
Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
Date of report (Date of earliest event reported): July 22, 2004
TRIARC COMPANIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 1-2207 38-0471180
(State or other (Commission (IRS Employer
jurisdiction of File Number) Identification No.)
incorporation)
280 Park Avenue
New York, New York 10017
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (212) 451-3000
N/A
----------------------------------
(Former name or former address, if
changed since last report)
Check the appropriate box below if the Form 8-K filing is intended to
simultaneously satisfy the filing obligation of the registrant under any of the
following provisions:
[ ] Written communications pursuant to Rule 425 under the Securities Act (17 CFR
230.425)
[ ] Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR
240.14a-12)
[ ] Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange
Act (17 CFR 240.14d-2(b))
[ ] Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange
Act (17 CFR 240.13e-4(c))
________________________________________________________________________________
This Form 8-K/A of Triarc Companies, Inc. ('Triarc' and, together with its
subsidiaries, the 'Company') constitutes Amendment No. 1 to Triarc's Current
Report on Form 8-K (the 'Original Form 8-K') which was filed with the Securities
and Exchange Commission on July 22, 2004. This amendment has been prepared in
conformity with the requirements of Form 8-K, as amended by the Securities and
Exchange Commission effective August 23, 2004. This amendment furnishes
information required by Items 9.01 (a) and 9.01 (b) (formerly Items 7 (a) and 7
(b), respectively) omitted from the Original Form 8-K.
This Current Report on Form 8-K/A contains or incorporates by reference
certain statements that are not historical facts, including, most importantly,
information concerning possible or assumed future results of operations of the
Company. Those statements, as well as statements preceded by, followed by, or
that include the words 'may,' 'believes,' 'expects,' 'anticipates,' or the
negation thereof, or similar expressions, constitute 'forward-looking
statements' within the meaning of the Private Securities Litigation Reform Act
of 1995 (the 'Act'). All statements that address operating performance, events
or developments that are expected or anticipated to occur in the future,
including statements relating to revenue growth, earnings per share growth or
statements expressing general optimism about future operating results, are
forward-looking statements within the meaning of the Act. These forward-looking
statements are based on our current expectations, speak only as of the date
thereof and are susceptible to a number of risks, uncertainties and other
factors. Our actual results, performance and achievements may differ materially
from any future results, performance or achievements expressed or implied by
such forward-looking statements. For those statements, we claim the protection
of the safe harbor for forward-looking statements contained in the Act. Many
important factors could affect our future results and could cause those results
to differ materially from those expressed in the forward-looking statements
contained herein. Such factors include, but are not limited to, the following:
o competition, including pricing pressures, the potential impact of
competitors' new units on sales by Arby's'r' restaurants and consumers'
perceptions of the relative quality, variety and value of the food
products offered;
o success of operating initiatives;
o development costs;
o advertising and promotional efforts;
o brand awareness;
o the existence or absence of positive or adverse publicity;
o new product and concept development by the Company and its competitors,
and market acceptance of such new product offerings and concepts;
o changes in consumer tastes and preferences, including changes resulting
from concerns over nutritional or safety aspects of beef, poultry, french
fries or other foods or the effects of food-borne illnesses such as 'mad
cow disease' and avian influenza or 'bird flu';
o changes in spending patterns and demographic trends;
o the business and financial viability of key franchisees;
o the timely payment of franchisee obligations due to the Company;
o availability, location and terms of sites for restaurant development by
the Company and its franchisees;
o the ability of franchisees to open new restaurants in accordance with
their development commitments, including the ability of franchisees to
finance restaurant development;
o delays in opening new restaurants or completing remodels;
o anticipated or unanticipated restaurant closures by the Company and its
franchisees;
o the ability to identify, attract and retain potential franchisees with
sufficient experience and financial resources to develop and operate
Arby's restaurants;
2
o changes in business strategy or development plans, and the willingness of
franchisees to participate in the Company's strategy;
o business abilities and judgment of the Company's and franchisees'
management and other personnel;
o availability of qualified restaurant personnel to the Company and to
franchisees;
o the Company's ability, if necessary, to secure alternative distribution of
supplies of food, equipment and other products to Arby's restaurants at
competitive rates and in adequate amounts, and the potential financial
impact of any interruptions in such distribution;
o adverse weather conditions;
o changes in commodity (including beef), labor, supplies and other operating
costs and availability and cost of insurance;
o significant reductions in the Company's client assets under management
(and thus in the Company's management fee revenue), due to such factors as
weak performance of the Company's investment products (either on an
absolute basis or relative to the Company's competitors), substantial
illiquidity or volatility in the fixed income instruments that the Company
trades, loss of key portfolio management personnel, reduced investor
demand for alternative fixed income investment products, and loss of
investor confidence due to adverse publicity;
o increased competition from other alternative fixed income investment
managers;
o pricing pressure on the management fees that the Company can charge for
its investment advisory services;
o difficulty in increasing assets under management, or managing existing
assets, due to market-related constraints on trading capacity;
o the removal of the Company as investment manager of one or more of the
collateralized debt obligations ('CDOs') it manages, or the reduction in
the Company's CDO management fees because of payment defaults by issuers
of the underlying collateral;
o availability, terms (including changes in interest rates) and deployment
of capital;
o changes in national, regional and local economic, market, business or
political conditions in the countries and other territories in which the
Company and its franchisees operate;
o changes in government regulations, including franchising laws, investment
management regulations, accounting standards, environmental laws, minimum
wage rates and taxation rates;
o the costs, uncertainties and other effects of legal, environmental and
administrative proceedings;
o the impact of general economic conditions on consumer spending, including
a slower consumer economy and the effects of war or terrorist activities;
o our ability to identify appropriate acquisition targets in the future and
to successfully integrate any future acquisitions into our existing
operations; and
o other risks and uncertainties affecting the Company referred to in
Triarc's most recent Annual Report on Form 10-K and its other current and
periodic filings with the Securities and Exchange Commission, all of which
are difficult or impossible to predict accurately and many of which are
beyond our control.
Readers are cautioned not to place undue reliance on forward-looking
statements, which speak only as of the date thereof. We will not undertake and
specifically decline any obligation to release publicly the result of any
revisions that may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events. In addition, it is our policy generally
not to make any specific projections as to future earnings, and we do not
endorse any projections regarding future performance that may be made by third
parties.
3
ITEM 9.01 FINANCIAL STATEMENTS AND EXHIBITS.
(a) FINANCIAL STATEMENTS OF BUSINESSES ACQUIRED
The financial statements, together with the notes thereto, of the business
acquired, reflecting the historical results of Deerfield & Company LLC
('Deerfield') required by this part, are set forth below.
(i) Audited consolidated financial statements of Deerfield for
the year ended December 31, 2002.
(ii) Audited consolidated financial statements of Deerfield for
the year ended December 31, 2003.
(iii) Unaudited consolidated financial statements of Deerfield for
the six months ended June 30, 2003.
(iv) Unaudited consolidated financial statements of Deerfield for
the six months ended June 30, 2004.
4
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Financial Statements
Year ended December 31, 2002
CONTENTS
Report of Independent Registered Public Accounting Firm..... 6
Consolidated Financial Statements
Consolidated Balance Sheet.................................. 7
Consolidated Statement of Operations........................ 8
Consolidated Statement of Members' Equity................... 9
Consolidated Statement of Cash Flows........................ 10
Notes to Consolidated Financial Statements.................. 11
5
Report of Independent Registered Public Accounting Firm
To the Members of
Deerfield & Company LLC
We have audited the accompanying consolidated balance sheet of Deerfield &
Company LLC (an Illinois limited liability company) as of December 31, 2002, and
the related consolidated statements of operations, members' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Deerfield &
Company LLC at December 31, 2002, and the consolidated results of their
operations and their cash flows for the year then ended, in conformity with U.S.
generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
March 7, 2003
6
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Balance Sheet
December 31, 2002
ASSETS
Cash and cash equivalents $ 7,812,462
Incentive and management fees receivable 5,892,380
Notes receivable 5,000,000
Notes receivable from employee 307,341
Investments, at fair value 3,354,088
Fixed assets (net of accumulated depreciation and
amortization of $3,194,708) 1,333,114
Intangible assets (net of accumulated amortization of
$513,028) 256,513
Other assets 2,269
-----------
Total assets $23,958,167
-----------
-----------
LIABILITIES AND MEMBERS' EQUITY
Accrued expenses $ 7,285,783
Notes payable 8,898,191
Payable to former member 750,000
-----------
Total liabilities 16,933,974
Members' equity (including accumulated other comprehensive
loss of $1,408,412) 7,024,193
-----------
Total liabilities and members' equity $23,958,167
-----------
-----------
See accompanying notes.
7
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Operations
Year ended December 31, 2002
Revenues:
Management fees $20,209,534
Incentive fees 8,348,739
Interest and dividends 472,978
Other income 1,860,903
-----------
30,892,154
Expenses:
Compensation and benefits 19,005,144
Travel and promotional 1,522,300
Data fees 1,019,654
Depreciation and amortization 813,315
Office and occupancy 688,230
Legal and professional 501,791
Other expenses 1,730,879
-----------
Total expenses 25,281,313
-----------
Net income $ 5,610,841
-----------
-----------
See accompanying notes.
8
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Members' Equity
Year ended December 31, 2002
MEMBERS' EQUITY
CLASS A CLASS B TOTAL
---------------------------------------------
Balance, January 1, 2002 $ 2,719,028 $ 105,605 $ 2,824,633
Equity-based compensation -- (2,869) (2,869)
Change in unrealized appreciation
on investments available for sale (1,246,824) (161,588) (1,408,412)
Net income 4,967,107 643,734 5,610,841
---------------------------------------------
Balance, December 31, 2002 $ 6,439,311 $ 584,882 $ 7,024,193
---------------------------------------------
---------------------------------------------
See accompanying notes.
9
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Cash Flows
Year ended December 31, 2002
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 5,610,841
Adjustments to reconcile net income to net cash provided by
operating activities:
Depreciation and amortization 813,315
Noncash compensation 132,835
Decrease in incentive and management fees receivable 40,720
Decrease in other assets 32,257
Increase in accrued expenses 1,920,624
Decrease in payable to former member (750,000)
-----------
Net cash provided by operating activities 7,800,592
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investments (6,262,500)
Proceeds from sale of investment 1,500,000
Purchases of fixed assets (170,016)
-----------
Net cash used in investing activities (4,932,516)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 6,250,000
Repayment of notes payable (4,436,179)
-----------
Net cash provided by financing activities 1,813,821
-----------
Net increase in cash and cash equivalents 4,681,897
Cash and cash equivalents, beginning of year 3,130,565
-----------
Cash and cash equivalents, end of year $ 7,812,462
-----------
-----------
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid $ 140,118
-----------
-----------
See accompanying notes.
10
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements
1. ORGANIZATION AND NATURE OF BUSINESS
Deerfield & Company LLC (the Company), an Illinois limited liability company,
was organized on February 24, 1997, and commenced operations on March 1, 1997.
The Company has two classes of membership interests, Class A and Class B, with
rights as described in the third amended and restated operating agreement of
Deerfield & Company LLC (the Operating Agreement). Class A is owned by Sachs
Capital Management LLC (SCM) and SLA Investments, Inc. (SLA), and has 100% of
the voting rights in the Company. As of December 31, 2002, there are three
owners of Class B membership interests, which have no voting privileges. Two of
the three Class B members have profits only interests.
The Company is the parent of two wholly-owned subsidiaries: Deerfield Capital
Management LLC, (DCM); and Badger Protection Services, Ltd. (Badger). DCM serves
as the trading advisor for five fixed income investment funds and three private
investment accounts (hereafter referred to collectively as the Funds). Badger is
a company which provides credit enhancement to investors in one of the Funds
managed by the Company. Additionally, DCM is a collateral manager for 13
collateralized debt obligations (CDO), collateralized loan obligations (CLO),
and collateralized bond obligations (CBO) (hereafter referred to collectively as
the CDOs). DCM earns management and incentive fees for the services provided to
the Funds and the CDOs. As of December 31, 2002, the Company had approximately
$7.2 billion in assets under management.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States.
Such preparation requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
11
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a summary of significant accounting policies followed by the
Company in the preparation of its financial statements.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For financial statement reporting purposes, the Company considers cash and all
highly liquid investments, including money market accounts and commercial paper,
with a maturity of 90 days or less to be cash and cash equivalents.
FIXED ASSETS
Office equipment, including computer equipment, is depreciated over five years
using the straight-line method. Office furniture is depreciated over seven years
using the straight-line method. Leasehold improvements are depreciated over the
remaining life of the lease using the straight-line method.
INVESTMENTS
Investments in limited partnerships are accounted for under the equity method of
accounting. Investments in preferred shares of CDOs are recorded at fair value,
and classified as securities available-for-sale. Unrealized gains and losses on
securities available-for-sale are recorded as a separate component of members'
equity.
12
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
REVENUE RECOGNITION
Management fees are received from the Funds and CDOs managed by the Company.
These fees are paid periodically in accordance with the individual management
agreements between the Company and the individual Funds and CDOs, and are based
upon the net asset values of the Funds and aggregate collateral amount of the
CDOs as defined in the individual management agreements. Management fees are
recognized as revenue when earned. In accordance with Emerging Issues Task Force
Topic D-96, 'Accounting for Management Fees Based on a Formula,' the Company
does not recognize these fees as revenue until all contingencies have been
removed.
Incentive fees are received from the Funds and certain of the CDOs managed by
the Company. These fees are paid periodically in accordance with the individual
management agreements between the Company and the individual Funds and CDOs, and
are based upon the performance of the funds and CDOs. Incentive fees are
recognized as revenues when the amounts are fixed and determinable.
Incentive income and other expenses include amounts earned or incurred under
arrangements with certain investors or guarantors in the CDOs the Company
manages. Income and expense is recorded when earned or incurred and is recorded
gross, except under circumstances where the income and expense are contractually
required to be settled with a net payment to or from the counterparty.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on an accrual basis and includes accretion of interest on certain investments in
accordance with EITF Issue No. 99-20, 'Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets.'
Other income primarily includes structuring and warehousing fees earned by the
Company for services provided to CDOs or placement agents for the CDOs. These
fees are recorded when earned.
13
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES
Income taxes are not provided for as the income (loss) of the Company is
includable in the returns of the Class A and Class B members. The Company
records Illinois state replacement tax expense, as applicable, in the
consolidated statement of operations.
Pursuant to Treasury Regulation Section 301.7701, the subsidiaries of the
Company have elected to be disregarded as separate entities for U.S. tax
purposes and are, therefore, treated as branches of the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002 the FASB issued Interpretation No. 45 (FIN 45), 'Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others,' which expands the disclosure requirements
to be made by a guarantor in its financial statements regarding its obligations
under certain guarantees that it has issued. FIN 45 also requires, under certain
circumstances, the recognition, at the inception of a guarantee, of a liability
for the fair value of the obligation as a result of issuing the guarantee. The
recognition provisions of FIN 45 are effective for any guarantees issued or
modified after December 31, 2002, while the disclosure requirements are
currently effective. The Company has adopted the disclosure requirements of
FIN 45 and is in the process of evaluating the impact of the remaining
provisions.
In January 2003 the FASB issued Interpretation No. 46, 'Consolidation of
Variable Interest Entities,' which provides new criteria for determining whether
or not consolidation accounting is required by a variable interest holder in
certain entities. The Interpretation may require the Company to consolidate
financial information for certain of the Funds and CDOs it manages. This
Interpretation is effective for Funds and CDOs created after January 31, 2003;
otherwise, it is applicable for the annual reporting period beginning
January 1, 2004. If applicable, the Interpretation would require the Company to
consolidate a Fund or CDOs assets and liabilities, and results of operations,
with a minority interest recorded for the ownership share applicable to other
investors. The effect of such
14
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
consolidation would not change the net income or loss of the Company. Where
consolidation is not required, additional disclosures may be required. FIN 46 is
effective immediately for variable interest entities created after January 31,
2003, and on July 1, 2003, for investments in variable interest entities
acquired before February 1, 2003. The Company is in the process of evaluating
the impact of FIN 46.
3. INVESTMENTS
The Company's investments at December 31, 2002, were comprised of an investment
in a limited partnership and an investment in preferred shares of a CDO for
which it provides management services. The following is a summary of the
Company's investments at December 31, 2002:
VALUE
-----
Available-for-sale:
Investment in CDO preferred shares
(cost $4,250,000) $3,341,412
Equity method:
Investment in limited partnership 12,676
----------
$3,354,088
----------
----------
4. FIXED ASSETS
The Company's fixed assets at December 31, 2002, are summarized as follows:
Computer equipment and software $ 3,189,815
Leasehold improvements 673,633
Office furniture and fixtures 664,374
-----------
4,527,822
Less: Accumulated depreciation and amortization (3,194,708)
-----------
$ 1,333,114
-----------
-----------
15
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
5. LEASE COMMITMENTS
The Company has a sublease agreement (the agreement) to lease office facilities
through May 30, 2007. In conjunction with the agreement, a standby letter of
credit has been issued by a financial institution to the sublessor in the amount
of $600,000. The Company pledged a $600,000 cash balance as collateral against
the standby letter of credit. Under the agreement, beginning January 1, 1999,
the standby letter of credit and related collateral can be reduced by $50,000
per year until the standby letter of credit reaches $400,000. At December 31,
2002, the pledged collateral was approximately $404,000, and was included in
cash and cash equivalents on the balance sheet. The balance of the letter of
credit facility is $400,000 as of December 31, 2002. Management does not believe
the standby letter of credit will be utilized. Rent expense for 2002 was
approximately $485,000.
Future base lease commitments on the Company's operating leases are as follows:
2003 $ 468,236
2004 462,983
2005 472,730
2006 482,477
2007 205,093
----------
$2,091,519
----------
----------
6. NOTES RECEIVABLE AND NOTES PAYABLE
The Company manages a private synthetic CLO for an investment banking firm (the
Investor). A guarantor (the Guarantor), unrelated to the Company and the
Investor, has provided a guarantee against losses in the CLO to the Investor
(the guarantee agreement) for up to the first $50 million of the Investor's
principal losses. As a premium for the guarantee, the Guarantor receives all of
the residual cash flows from the CLO. The Guarantor does not have any direct
investment in the CLO and will only make payments in the event of a principal
loss, as defined in the CLO's guarantee agreement with the Guarantor.
As a condition of entering into a collateral management agreement with the CLO,
the Company has entered into agreements with the Guarantor and another
counterparty (the Counterparty) to share in the guarantee agreement with the
16
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
Guarantor up to 10% of the total guaranteed amount (e.g. maximum loss guarantee
of $5 million). The Company's share of the first $50 million of losses in CDO
will be on a pro rata basis, up to $5 million. Under the agreement with the
Guarantor, the Company has deposited $5,000,000 in escrow (the escrow account)
for the benefit of the Guarantor evidenced by a note receivable from the
Guarantor with a principal amount of $5,000,000, recorded as a note receivable
on the consolidated balance sheet. Interest on the note receivable is equal to
10% of the Guarantor's guarantee fee premium and 100% of the amounts earned on
the amount in escrow. In the event of any payment by the Guarantor under the
guarantee agreement, the Company's share will be taken from the escrow account
and the note receivable will be forgiven by the Company in the amount of 10% of
the guarantee payments made by the Guarantor.
To offset its exposure under the guarantee, the Company entered into a separate
agreement with a third party counterparty (the Counterparty), under which the
Counterparty agreed to make payments to the Company in the event it has to fund
the Guarantor under the agreement described above. Under the agreement with the
Counterparty, the Company received $5,000,000, which was utilized to fund the
escrow account and issued a note payable to the Counterparty in the amount of
$5,000,000. Interest on the note payable is equal to the interest on the note
receivable from the Guarantor, except that only 50% of any amounts in excess of
LIBOR plus 4% are payable to the Counterparty. In the event of any forgiveness
of the note receivable from the Guarantor, as described above, an equal amount
of the Company's note payable to the Counterparty will be forgiven by the
Counterparty. The Company has pledged its future senior management fees from two
other CDOs it manages as collateral for payment of any amounts owed to the
Counterparty.
Separate from the above transaction, during 2002, the Company financed its
purchase of preferred shares of one of the CDOs for which it provides management
services by issuing a non-recourse note to an investment banking firm for
$6,250,000, which bears interest at LIBOR, and has no stated maturity. The
preferred shares are pledged as collateral against the note, and all management
fees earned by the Company for managing the underlying assets of the CDO and any
distributions received on the preferred shares will be remitted to the note
holder until all principal and interest on the note are paid in full.
17
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
During 2002, the Company recorded interest on the note of $57,944 and repaid
$2,409,753 of principal and interest. At December 31, 2002, the balance of the
note was $3,898,191.
7. MEMBERS' EQUITY
Effective January 1, 2001, a Class B member of the Company resigned and redeemed
his 5.74% ownership interest in the Company. The Company paid the member
$2,230,460 in accordance with the terms of the Operating Agreement. The member
was also paid $769,540 to sign a three-year noncompete agreement, which is being
amortized over three years. This amount is recorded as an intangible asset, net
of accumulated amortization, on the consolidated balance sheet. As of
December 31, 2002, the remaining amount due the member is $750,000, which is
recorded as a payable to former member on the consolidated balance sheet. The
final redemption payment will be made on December 31, 2003. If the former member
fails to abide by any covenant set forth in the noncompete agreement, any future
redemption payment will no longer be due and the Company shall be entitled to
the return of any previous redemption payments made.
Effective January 1, 1999, an individual was granted a Class B interest
constituting a .5% ownership interest in the Company. In accordance with
Accounting Principles Bulletin No. 25, 'Accounting for Stock Issued to
Employees' (APB 25), and FASB Interpretation No. 44, 'Accounting for Certain
Transactions involving Stock Compensation -- an interpretation of APB Opinion
No. 25' (FIN 44), variable plan accounting applies to this grant, and noncash
compensation expense is recorded for changes in the value of the grant, as
determined by the Operating Agreement. During 2002, the value of the employee's
interest decreased approximately $72,000, which was recorded as a decrease to
compensation expense and to the employee's member equity account.
Effective January 1, 2002, Class B nonvoting Profits Only Interests representing
an 11% membership interest in the Company were granted to two employees. The
employees' interest in future profits was fully vested at the date of grant. The
employees' earnings payout value, as defined in the Operating Agreement, cliff
18
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
7. MEMBERS' EQUITY (CONTINUED)
vests on their 20th anniversary of employment with the Company. These grants are
accounted for under the variable plan accounting rules of APB 25 and FIN 44, and
amortized compensation expense is recorded for changes in the employees'
earnings pay out value over 20 years. During 2002, approximately $69,000 was
recorded as non-cash compensation expense in the members' equity accounts
related to the cliff vesting of the earnings payout value.
8. EMPLOYEE BENEFIT PLANS
The Company has a voluntary contribution 401(k) plan (the Plan). Under the Plan,
employees are eligible to contribute a percentage of their salary into the Plan
after completing an initial employment period. The Company has the option to
match a percentage of the employee contributions for the year. All Plan
contributions are paid into the Deerfield & Company LLC 401(k) Savings Trust
(the Trust). The Trust is allowed to invest the contributions in a variety of
instruments defined in the Plan agreement. The Company's matching contribution
for 2002 was approximately $145,000.
The Company sponsors a Key Employee Equity Participation Plan (KEEP Plan), which
is a 'phantom' equity appreciation plan. Under the KEEP Plan, participants are
awarded stock appreciation rights (SAR) by the Company. Upon redemption, the
KEEP Plan provides participants with the positive difference, if any, between
the value of a SAR and its strike price. The value of a SAR is defined in the
KEEP Plan as the average of the three most recent year's annual net earnings
multiplied by five and divided by the number of SARs authorized. The stock
appreciation rights do not represent an equity interest in the Company. The
Company retains the sole discretion to determine the employees who will receive
awards under the KEEP Plan. The awards vest one fourth each year, on the first,
second, third, and fourth anniversaries of the award date, and are not
exercisable until the fourth anniversary of the award date. As of December 31,
2002, there were 291,000 SARs outstanding with a value of $1.26 per award.
Strike prices for the SARs were either $4.00 or $4.21 per award, depending on
the date of the award. No SARs were granted or forfeited during 2002.
Participants were either 25% or 50% vested in the KEEP Plan awards depending on
the date of the award. The SARs are accounted for under the variable accounting
rules of
19
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
APB25 and FIN 44 and the total compensation expense recognized related to the
KEEP Plan during 2002 was $(8,269).
9. CONTINGENT FEE ARRANGEMENTS
The Company acts as collateral manager for various CDOs, capitalized by third
party investors. Typically, the transactions are sponsored and underwritten by
third party investment banks, who may warehouse the collateral and place the
debt and equity of the CDOs with the ultimate investors. The underlying
collateral of the CDOs, which is typically purchased in the open market,
consists of corporate debt, structured notes, commercial loans, synthetic
instruments, and the notional amount of credit default instruments, and is owned
by separate special purpose entities for each CDO, which issue various classes
of notes and beneficial interests to third party investors, including the
Company or related entities in certain instances. The Company manages the
underlying collateral on behalf of the investors under the terms of collateral
management agreements.
As of December 31, 2002, the Company managed 13 CDOs. The total par/notional
value of the underlying collateral under management was approximately $6.5
billion at December 31, 2002. The total debt outstanding of the CDOs was
approximately $4.0 billion.
TYPE OF CDO/ NUMBER OF CDOs PAR VALUE OF
COLLATERAL MANAGED COLLATERAL
----------------------------------------------------------------
Bank loans 5 $1,938,000,000
Credit default swaps 2 1,995,000,000
Corporate bonds 3 1,611,000,000
Asset-backed securities 3 939,000,000
------------------------------
13 $6,483,000,000
------------------------------
------------------------------
The CDOs have various terms/maturities, ranging from 5 to 35 years.
Pursuant to the underlying collateral management agreements, the Company is
compensated for managing the underlying collateral of the CDOs. The Company
receives various fees for its services, as follows: (1) base collateral
investment management fees (Senior), which are paid before interest to the debt
holders in the transaction, and range from five to 31.5 basis points annually,
(2) base
20
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
collateral investment management fees (Junior), which are subordinate to a
certain return to the debt and/or equity holders in the CDO, and range from
seven to 55 basis points annually, and in certain instances (3) incentive fees
(Incentive) that are paid after certain investors' returns exceed a hurdle
internal rate of return (IRR). The Incentive fees range from 25 to 38 basis
points or 10-20% of residual cash flows above the hurdle IRR and vary by
transaction. In accordance with the Company's accounting policies, management
fees are accrued as Management Fee income is earned. Incentive fees, which are
contingent upon achieving certain performance objectives, are recognized as
income once the contingencies are resolved and the fees are fixed and
determinable.
From time to time, the Company enters into agreements with investors or
providers of guarantees to the CDOs. In some of these agreements, the Company
enters into contractual arrangements with the investor or guarantee provider
whereby the Company is required to make payments upon the occurrence of certain
events. In other agreements, the Company will provide credit enhancement to
provide additional protection to a certain investor. These agreements vary by
transaction. In instances where the Company is required pursuant to a
contractual arrangement to make a payment to an investor or guarantee provider,
the Company may subordinate receipt of all or a portion of its future Senior
fees, Junior fees, if any, and Incentive fees, if any, until the Company's
obligation to the investor or guarantee provider has been met. The Company
typically records such amounts as other expenses. In all cases, the subordinated
amounts are limited to the extent of future fees earned on specific CDOs. As of
December 31, 2002, approximately $509,000 in such payments were made and
included in other expenses. In consideration of these agreements, the Company
may share in the excess returns (as defined in the individual agreements)
realized by the investor. The Company records any such shared excess amounts as
incentive fee revenue. During 2002, approximately $775,000 in such amounts were
received and included in incentive fee revenue. In addition the Company has
provided credit enhancement in the form of notes payable, and escrow deposits
for $5 million to various third parties (See Note 6).
At December 31, 2002, the Company does not have a direct ownership interest in
any of the CDOs, except for one, where its ownership of preferred shares is less
than 5% of the CDO's total debt and equity. In addition, the Company has
21
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
determined that it does not have the substantive residual risks or substantially
all of the residual rewards of the underlying assets and obligations imposed by
the underlying debt. Pursuant to the provisions of EITF Issue 90-15, 'Impact of
Nonsubstantive Lessors, Residual Value Guarantees, and Other Provisions in
Leasing Transactions,' the underlying assets and liabilities related to these
transactions are not consolidated with Deerfield's financial statements. See
Note 2 for a discussion of the recently issued FASB Interpretation No. 46 on
Variable Interest Entities.
10. RELATED PARTIES
An entity affiliated through common ownership owns 26.6%, and 4.3%,
respectively, of the equity of two CDOs managed by the Company.
The Company owns 15.8% of the equity of a CDO managed by the Company, as
described in Note 3.
A privately managed investment account managed by the Company owns 33.3% and
38.9%, respectively, of the equity of two CDOs managed by the Company. This
managed account is also the Counterparty described in Note 6.
The Company has provided two notes to an employee of the Company for $250,000
each. The interest rate on the notes is equal to the Federal Funds Rate, and is
calculated monthly. Each year on the employee's anniversary of employment with
the Company, 20% of the balance of the note and all accrued interest is forgiven
as long as the employee is still employed with the Company. During 2002
approximately $143,000 in principal and interest on the note were forgiven.
22
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Financial Statements
Year ended December 31, 2003
CONTENTS
Report of Independent Registered Public Accounting Firm..... 24
Consolidated Financial Statements
Consolidated Balance Sheet.................................. 25
Consolidated Statement of Operations........................ 26
Consolidated Statement of Members' Equity................... 27
Consolidated Statement of Cash Flows........................ 28
Notes to Consolidated Financial Statements.................. 29
23
Report of Independent Registered Public Accounting Firm
To the Members of
Deerfield & Company LLC
We have audited the accompanying consolidated balance sheet of Deerfield &
Company LLC (an Illinois limited liability company) as of December 31, 2003, and
the related consolidated statements of operations, members' equity, and cash
flows for the year then ended. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audit.
We conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audit provides a
reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Deerfield &
Company LLC at December 31, 2003, and the consolidated results of their
operations and their cash flows for the year then ended in conformity with U.S.
generally accepted accounting principles.
/s/ Ernst & Young LLP
Chicago, Illinois
March 12, 2004
24
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Balance Sheet
December 31, 2003
ASSETS
Cash and cash equivalents $ 6,338,353
Incentive and management fees receivable 8,860,136
Notes receivable 5,000,000
Notes receivable from employee 200,000
Investments, at fair value 15,033,675
Fixed assets (net of accumulated depreciation and
amortization of $1,939,208) 1,040,924
Prepaid expenses 945,307
Other assets 5,031
-----------
Total assets $37,423,426
-----------
-----------
LIABILITIES AND MEMBERS' EQUITY
Accrued expenses $ 8,414,506
Notes payable 17,045,662
-----------
Total liabilities 25,460,168
Members' equity (including accumulated other comprehensive
loss of $647,564) 11,963,258
-----------
Total liabilities and members' equity $37,423,426
-----------
-----------
See accompanying notes.
25
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Operations
Year ended December 31, 2003
Revenues:
Management fees $27,316,935
Incentive fees 7,621,458
Interest and dividends 1,598,541
Other income 351,193
-----------
36,888,127
Expenses:
Compensation and benefits 19,464,136
Travel and promotional 1,349,410
Legal and professional 908,677
Data fees 776,582
Depreciation and amortization 721,009
Office and occupancy 627,865
Interest expense 502,576
Taxes 249,023
Other expenses 1,175,886
-----------
Total expenses 25,775,164
-----------
Net income $11,112,963
-----------
-----------
See accompanying notes.
26
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Members' Equity
Year ended December 31, 2003
MEMBERS' EQUITY
CLASS A CLASS B TOTAL
----------------------------------------------
Balance, January 1, 2003 $ 6,439,311 $ 584,882 $ 7,024,193
Capital distribution (6,000,161) (999,839) (7,000,000)
Equity-based compensation -- 65,254 65,254
Change in unrealized appreciation
on investments available for
sale 636,136 124,712 760,848
Net income 9,321,201 1,791,762 11,112,963
----------------------------------------------
Balance, December 31, 2003 $10,396,487 $1,566,771 $11,963,258
----------------------------------------------
----------------------------------------------
See accompanying notes.
27
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Cash Flows
Year ended December 31, 2003
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 11,112,963
Adjustments to reconcile net income to net cash provided by
operating activities:
Accretion of interest income 467,461
Depreciation and amortization 721,009
Noncash compensation 172,595
Increase in incentive and management fees receivable (2,967,756)
Increase in other assets and prepaid expenses (973,100)
Increase in accrued expenses 1,116,650
Decrease in payable to former member (750,000)
------------
Net cash provided by operating activities 8,899,822
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investments (11,386,200)
Purchases of fixed assets (147,275)
------------
Net cash used in investing activities (11,533,475)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 12,575,000
Repayment of notes payable (4,415,456)
Distributions to members (7,000,000)
------------
Net cash provided by financing activities 1,159,544
------------
Net decrease in cash and cash equivalents (1,474,109)
Cash and cash equivalents, beginning of year 7,812,462
------------
Cash and cash equivalents, end of year $ 6,338,353
------------
------------
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 211,572
------------
------------
See accompanying notes.
28
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements
1. ORGANIZATION AND NATURE OF BUSINESS
Deerfield & Company LLC (the Company), an Illinois limited liability company,
was organized on February 24, 1997, and commenced operations on March 1, 1997.
The Company has two classes of membership interests, Class A and Class B, with
rights as described in the third amended and restated operating agreement of
Deerfield & Company LLC (the Operating Agreement). Class A is owned by Sachs
Capital Management LLC (SCM), SLA Investments, Inc. (SLA), and Deerfield
Partners Fund III and has 100% of the voting rights in the Company. As of
December 31, 2003, there are three owners of Class B membership interests, which
have no voting privileges. Two of the three Class B members have profits only
interests.
The Company is the parent of two wholly owned subsidiaries: Deerfield Capital
Management LLC, (DCM) and Badger Protection Services, Ltd. (Badger). DCM serves
as the trading advisor for five fixed income investment funds and three private
investment accounts (hereafter referred to collectively as the Funds). Badger is
a company which provides credit enhancement to investors in one of the Funds
managed by the Company. Additionally, DCM is a collateral manager for 15
collateralized debt obligations (CDO), collateralized loan obligations (CLO),
and collateralized bond obligations (CBO) (hereafter referred to collectively as
the CDOs). DCM earns management and incentive fees for the services provided to
the Funds and the CDOs. As of December 31, 2003, the Company had approximately
$8.1 billion in assets under management.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States.
Such preparation requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
29
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a summary of significant accounting policies followed by the
Company in the preparation of its financial statements.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For financial statement reporting purposes, the Company considers cash and all
highly liquid investments, including money market accounts and commercial paper,
with a maturity of 90 days or less to be cash and cash equivalents.
FIXED ASSETS
Office equipment, including computer equipment, is depreciated over five years
using the straight-line method. Office furniture is depreciated over seven years
using the straight-line method. Leasehold improvements are depreciated over the
remaining life of the lease using the straight-line method.
DEFERRED COSTS
Certain costs associated with the acquisition of CDO management contracts and
debt financing of preferred share acquisitions are recorded as prepaid expenses
in the consolidated balance sheet and amortized over the expected life of the
related contract or loan.
INVESTMENTS
Investments in limited partnerships are accounted for under the equity method of
accounting. Investments in preferred shares of CDOs are recorded at fair value,
30
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
and classified as securities available-for-sale. Unrealized gains and losses on
securities available-for-sale are recorded as a separate component of members'
equity.
REVENUE RECOGNITION
Management fees are received from the Funds and CDOs managed by the Company.
These fees are paid periodically in accordance with the individual management
agreements between the Company and the individual Funds and CDOs and are based
upon the net asset values of the Funds and aggregate collateral amount of the
CDOs as defined in the individual management agreements. Management fees are
recognized as revenue when earned. In accordance with Emerging Issues Task Force
Topic (EITF) D-96, 'Accounting for Management Fees Based on a Formula,' the
Company does not recognize these fees as revenue until all contingencies have
been removed.
Incentive fees are received from the Funds and certain of the CDOs managed by
the Company. These fees are paid periodically in accordance with the individual
management agreements between the Company and the individual Funds and CDOs and
are based upon the performance of the funds and CDOs. Incentive fees are
recognized as revenues when the amounts are fixed and determinable.
Incentive income and other expenses include amounts earned or incurred under
arrangements with certain investors or guarantors in the CDOs the Company
manages. Income and expense is recorded when earned or incurred and is recorded
gross, except under circumstances where the income and expense are contractually
required to be settled with a net payment to or from the counterparty.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on an accrual basis and includes accretion of interest on certain investments in
accordance with EITF Issue No. 99-20, 'Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets.'
31
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Other income primarily includes structuring and warehousing fees earned by the
Company for services provided to CDOs or placement agents for the CDOs. These
fees are recorded when earned.
INCOME TAXES
Income taxes are not provided for as the taxable income (loss) of the Company is
includable in the returns of the Class A and Class B members. The Company
records Illinois State replacement tax expense, as applicable, in the
consolidated statement of operations.
Pursuant to Treasury Regulation Section 301.7701, the subsidiaries of the
Company have elected to be disregarded as separate entities for U.S. tax
purposes and are, therefore, treated as branches of the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), 'Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others,' which expands the disclosure requirements
to be made by a guarantor in its financial statements regarding its obligations
under certain guarantees that it has issued. FIN 45 also requires, under certain
circumstances, the recognition, at the inception of a guarantee, of a liability
for the fair value of the obligation as a result of issuing the guarantee. The
adoption of FIN 45 has not had a material effect on the Company's financial
statements.
In December 2003, the FASB revised Interpretation No. 46, 'Consolidation of
Variable Interest Entities,' which provides new criteria for determining whether
or not consolidation accounting is required by a variable interest holder in
certain entities. The Interpretation may require the Company to consolidate
financial information for certain of the Funds and CDOs it manages. The
Interpretation may require the Company to consolidate certain Funds' or CDOs'
assets and liabilities, and results of operations, with a minority interest
recorded for the
32
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ownership share applicable to other investors. The effect of such consolidation
would not change the net income or loss of the Company. Where consolidation is
not required, additional disclosures may be required. FIN 46 is effective
immediately for variable interest entities created after December 31, 2003, and
as of the end of the first fiscal year beginning after December 15, 2004, to
variable interest entities acquired before December 31, 2003 (December 31, 2005,
for the Company). The Company is in the process of evaluating the impact of
FIN 46.
3. INVESTMENTS
The Company's investments at December 31, 2003, were comprised of an investment
in a limited partnership and investments in the preferred shares of 3 CDOs for
which it provides management services. The following is a summary of the
Company's investments at December 31, 2003:
VALUE
-----
Available for sale:
Investment in CDO preferred shares
(amortized cost $15,667,839) $15,020,275
Equity method:
Investment in limited partnership 13,400
-----------
$15,033,675
-----------
-----------
4. FIXED ASSETS
The Company's fixed assets at December 31, 2003, are summarized as follows:
Computer equipment and software $ 1,563,319
Leasehold improvements 685,477
Office furniture and fixtures 731,336
-----------
2,980,132
Less: Accumulated depreciation and amortization (1,939,208)
-----------
$ 1,040,924
-----------
-----------
33
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
5. LEASE COMMITMENTS
The Company has a sublease agreement (the agreement) to lease office facilities
through May 30, 2007. In conjunction with the agreement, a standby letter of
credit has been issued by a financial institution to the sublessor in the amount
of $600,000. The Company pledged a $600,000 cash balance as collateral against
the standby letter of credit. Under the agreement, beginning January 1, 1999,
the standby letter of credit and related collateral can be reduced by $50,000
per year until the standby letter of credit reaches $400,000. At December
31, 2003, the pledged collateral was approximately $409,000 and was included in
cash and cash equivalents on the consolidated balance sheet. The balance of the
letter of credit facility is $400,000 as of December 31, 2003. Management
believes the standby letter of credit will not be utilized. Rent expense for
2003 was approximately $471,000.
Future base lease commitments on the Company's operating leases are as follows:
2004 $ 462,983
2005 472,730
2006 482,477
2007 205,093
----------
$1,623,283
----------
----------
6. NOTES RECEIVABLE AND NOTES PAYABLE
The Company manages a private synthetic CLO for an investment banking firm (the
Investor). A guarantor (the Guarantor), unrelated to the Company and the
Investor, has provided a guarantee against losses in the CLO to the Investor
(the guarantee agreement) for up to the first $50 million of the Investor's
principal losses. As a premium for the guarantee, the Guarantor receives all of
the residual cash flows from the CLO. The Guarantor does not have any direct
investment in the CLO and will only make payments in the event of a principal
loss, as defined in the CLO's guarantee agreement with the Guarantor.
As a condition of entering into a collateral management agreement with the CLO,
the Company has entered into agreements with the Guarantor and another
counterparty (the Counterparty) to share in the guarantee agreement with the
34
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
Guarantor up to 10% of the total guaranteed amount (e.g. maximum loss guarantee
of $5 million). The Company's share of the first $50 million of losses in the
CLO will be on a pro rata basis, up to $5 million. Under the agreement with the
Guarantor, the Company has deposited $5,000,000 in escrow (the escrow account)
for the benefit of the Guarantor evidenced by a note receivable from the
Guarantor with a principal amount of $5,000,000, recorded as a note receivable
on the consolidated balance sheet. Interest on the note receivable is equal to
10% of the Guarantor's guarantee fee premium and 100% of the amounts earned on
the amount in escrow. In the event of any payment by the Guarantor under the
guarantee agreement, the Company's share will be taken from the escrow account
and the note receivable will be forgiven by the Company in the amount of 10% of
the guarantee payments made by the Guarantor.
To offset its exposure under the guarantee, the Company entered into a separate
agreement with a third party counterparty (the Counterparty), under which the
Counterparty agreed to make payments to the Company in the event the Company has
to fund the Guarantor under the agreement described above. Under the agreement
with the Counterparty, the Company received $5,000,000, which was utilized to
fund the escrow account and issued a note payable to the Counterparty in the
amount of $5,000,000. Interest on the note payable is equal to the interest on
the note receivable from the Guarantor, except that only 50% of any amounts in
excess of LIBOR plus 4% are payable to the Counterparty. In the event of any
forgiveness of the note receivable from the Guarantor, as described above, an
equal amount of the Company's note payable to the Counterparty will be forgiven
by the Counterparty. The Company has pledged its future senior management fees
from two other CDOs it manages as collateral for payment of any amounts owed to
the Counterparty.
Separate from the above transaction, during 2002, the Company financed its
purchase of 6,250,000 preferred shares of one of the CDOs for which it provides
management services by issuing a nonrecourse note to an investment banking firm
for $6,250,000, which bears interest at LIBOR, and has no stated maturity.
Concurrent with the Company's sale of 1,500,000 of these preferred shares soon
after their purchase in 2002, the Company repaid $1,500,000 of principal plus
accrued interest on the note. The remaining 4,750,000 preferred shares are
pledged as collateral against the note, and all management fees earned by the
35
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
Company for managing the underlying assets of the CDO and any distributions
received on the preferred shares will be remitted to the note holder until all
principal and interest on the note are paid in full. During 2003, the Company
recorded interest on the note of $59,619 and repaid $2,530,137 of principal. At
December 31, 2003, the balance of the note was $1,371,170.
During 2003, the Company financed its purchase of preferred shares of one of the
CDOs for which it provides management services by issuing a nonrecourse note to
an investment banking firm for $8,000,000 (including $888,800 of prepaid fees),
which bears interest at LIBOR plus 100 basis points and has no stated maturity.
The preferred shares are pledged as collateral against the note, and 62.5% of
all management fees earned by the Company for managing the underlying assets of
the CDO and of any distributions received on the preferred shares will be
remitted to the note holder until all principal and interest on the note are
paid in full. During 2003, the Company recorded interest on the note of $108,739
and repaid $375,698 of principal. At December 31, 2003, the balance of the note
was $7,624,302.
Also during 2003, the Company financed its purchase of preferred shares of one
of the CDOs for which provides management services by issuing a nonrecourse note
to a large investment bank for $4,575,000 (including $300,000 of prepaid fees),
which bears interest at LIBOR, plus 100 basis points and has no stated maturity.
The preferred shares are pledged as collateral against the note, and 65% of all
management fees earned by the Company for managing the underlying assets of the
CDO and all distributions received on the preferred shares will be remitted to
the note holder until all principal and interest on the note are paid in full.
During 2003, the Company recorded interest on the note of $75,780 and repaid
$1,524,811 of principal and interest. At December 31, 2003, the balance of the
note was $3,050,189.
7. MEMBERS' EQUITY
Effective January 1, 2001, a Class B member of the Company resigned and redeemed
his 5.74% ownership interest in the Company. The Company paid the member
$2,230,460 in accordance with the terms of the Operating Agreement.
36
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
7. MEMBERS' EQUITY (CONTINUED)
The member was also paid $769,540 to sign a three-year noncompete agreement,
which is being amortized over three years. This amount was recorded as an
intangible asset, net of accumulated amortization, on the consolidated balance
sheet. The final redemption payment of $750,000 was made on December 31, 2003.
Effective January 1, 1999, an individual was granted a Class B interest
constituting a .5% ownership interest in the Company. In accordance with
Accounting Principles Bulletin No. 25, 'Accounting for Stock Issued to
Employees' (APB 25), and FASB Interpretation No. 44, 'Accounting for Certain
Transactions involving Stock Compensation -- an interpretation of APB Opinion
No. 25' (FIN 44), variable plan accounting applies to this grant, and noncash
compensation expense is recorded for changes in the value of the grant, as
determined by the Operating Agreement. During 2003, the value of the employee's
interest decreased approximately $4,100, which was recorded as a decrease to
compensation expense and to Class B members' equity.
Effective January 1, 2002, Class B nonvoting Profits Only Interests representing
an 11% membership interest in the Company were granted to two employees. An
additional 5% was granted to one of the employees on May 1, 2003. The employees'
interest in future profits was fully vested at the date of grant. The employees'
earnings payout value, as defined in the Operating Agreement, cliff vests on
their 20th anniversary of employment with the Company. These grants are
accounted for under the variable plan accounting rules of APB 25 and FIN 44, and
amortized compensation expense is recorded for changes in the employees'
earnings pay out value over 20 years. During 2003, approximately $65,000 was
recorded as noncash compensation expense in the members' equity accounts related
to the cliff vesting of the earnings payout value.
8. EMPLOYEE BENEFIT PLANS
The Company has a voluntary contribution 401(k) plan (the Plan). Under the Plan,
employees are eligible to contribute a percentage of their salary into the Plan
after completing an initial employment period. The Company has the option to
match a percentage of the employee contributions for the year. All Plan
37
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
8. EMPLOYEE BENEFIT PLANS (CONTINUED)
contributions are paid into the Deerfield & Company LLC 401(k) Savings Trust
(the Trust). The Trust is allowed to invest the contributions in a variety of
instruments defined in the Plan agreement. The Company's matching contribution
for 2003 was approximately $150,000.
The Company sponsors a Key Employee Equity Participation Plan (KEEP Plan), which
is a 'phantom' equity appreciation plan. Under the KEEP Plan, participants are
awarded stock appreciation rights (SAR) by the Company. Upon redemption, the
KEEP Plan provides participants with the positive difference, if any, between
the value of a SAR and its strike price. The value of a SAR is defined in the
KEEP Plan as the average of the three most recent year's annual net earnings
multiplied by five and divided by the number of SARs authorized. The stock
appreciation rights do not represent an equity interest in the Company. The
Company retains the sole discretion to determine the employees who will receive
awards under the KEEP Plan. The awards vest one fourth each year, on the first,
second, third, and fourth anniversaries of the award date, and are not
exercisable until the fifth anniversary of the award date. As of December 31,
2003, there were 241,500 SARs outstanding with a value of $1.00 per award.
Strike prices for the SARs were either $4.00 or $4.21 per award, depending on
the date of the award. No SARs were granted during 2003. Participants were
either 50% or 75% vested in the KEEP Plan awards depending on the date of the
award. The SARs are accounted for under the variable accounting rules of APB 25
and FIN 44 and the total compensation expense recognized related to the KEEP
Plan during 2003 was $0.
9. CONTINGENT FEE ARRANGEMENTS
The Company acts as collateral manager for various CDOs, capitalized by
third-party investors. Typically, the transactions are sponsored and
underwritten by third-party investment banks, who may warehouse the collateral
and place the debt and equity of the CDOs with the ultimate investors. The
underlying collateral of the CDOs, which is typically purchased in the open
market, consists of corporate debt, structured notes, commercial loans,
synthetic instruments, and the notional amount of credit default instruments,
and is owned by separate special purpose entities for each CDO, which issue
various classes of notes and
38
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
beneficial interests to third-party investors, including the Company or related
entities in certain instances. The Company manages the underlying collateral on
behalf of the investors under the terms of collateral management agreements.
As of December 31, 2003, the Company managed 15 CDOs. The total par/notional
value of the underlying collateral under management was approximately $7 billion
at December 31, 2003. The total debt outstanding of the CDOs was approximately
$4.6 billion.
TYPE OF CDO/ NUMBER OF CDOs PAR VALUE OF
COLLATERAL MANAGED COLLATERAL
----------------------------------------------------------------
Bank loans 6 $2,235,000,000
Credit default swaps 2 2,005,000,000
Corporate bonds 3 1,545,000,000
Asset-backed securities 4 1,230,000,000
------------------------------
15 $7,015,000,000
------------------------------
------------------------------
The CDOs have various terms/maturities, ranging from 5 to 35 years.
Pursuant to the underlying collateral management agreements, the Company is
compensated for managing the underlying collateral of the CDOs. The Company
earns various fees for its services, as follows: (1) base collateral investment
management fees (Senior), which are paid before interest to the debt holders in
the transaction, and range from five to 31.5 basis points annually, (2) base
collateral investment management fees (Junior), which are subordinate to a
certain return to the debt and/or equity holders in the CDO, and range from 7 to
55 basis points annually, and in certain instances, (3) incentive fees
(Incentive) that are paid after certain investors' returns exceed a hurdle
internal rate of return (IRR). The Incentive fees range from 25 to 38 basis
points or 10-20% of residual cash flows above the hurdle IRR and vary by
transaction. In accordance with the Company's accounting policies, management
fees are accrued as earned. Incentive fees, which are contingent upon achieving
certain performance objectives, are recognized as income once the contingencies
are resolved and the fees are fixed and determinable.
39
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
From time to time, the Company enters into agreements with investors or
providers of guarantees to the CDOs. In some of these agreements, the Company
enters into contractual arrangements with the investor or guarantee provider
whereby the Company is required to make payments upon the occurrence of certain
events. In other agreements, the Company will provide credit enhancement to
provide additional protection to a certain investor. These agreements vary by
transaction. In instances where the Company is required pursuant to a
contractual arrangement to make a payment to an investor or guarantee provider,
the Company may subordinate receipt of all or a portion of its future Senior
fees, Junior fees, if any, and Incentive fees, if any, until the Company's
obligation to the investor or guarantee provider has been met. The Company
typically records such amounts as other expenses. In all cases, the subordinated
amounts are limited to the extent of future fees earned on specific CDOs. As of
December 31, 2003, approximately $185,705 in such payments were made and
included in other expenses. In consideration of these agreements, the Company
may share in the excess returns (as defined in the individual agreements)
realized by the investor. The Company records any such shared excess amounts as
incentive fee revenue. During 2003, approximately $138,920 in such amounts were
received and included in incentive fee revenue. In addition, the Company has
provided credit enhancement in the form of notes payable, and escrow deposits
for $17,575,000 to various third parties (see Note 6).
At December 31, 2003, the Company has a direct ownership interest in three CDOs,
where its ownership of preferred shares is less than 5% of the CDOs' total debt
and equity. In addition, the Company has determined that it does not have the
substantive residual risks or substantially all of the residual rewards of the
underlying assets and obligations imposed by the underlying debt. Pursuant to
the provisions of EITF Issue 90-15, 'Impact of Nonsubstantive Lessors, Residual
Value Guarantees, and Other Provisions in Leasing Transactions,' the underlying
assets and liabilities related to these transactions are not consolidated with
the Company's financial statements. See Note 2 for a discussion of the recently
issued FASB Interpretation No. 46 on Variable Interest Entities.
40
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
10. RELATED PARTIES
An entity affiliated through common ownership and a related person own 38%,
4.3%, 3.0%, and 5.6%, respectively, of the equity of four CDOs managed by the
Company.
The Company owns 15.8%, 32%, and 27.8%, respectively, of the equity of three
CDOs managed by the Company.
A privately managed investment account managed by the Company owns 49.1% and
49.9%, respectively, of the equity of two CDOs managed by the Company. This
managed account is also the Counterparty described in Note 6.
The Company has provided two notes to an employee of the Company for $250,000
each. The interest rate on the notes is equal to the Federal Funds Rate, and is
calculated monthly. Each year on the employee's anniversary of employment with
the Company, 20% of the balance of the note and all accrued interest is forgiven
as long as the employee is still employed with the Company. During 2003,
approximately $107,000 in principal and interest on the note were forgiven.
41
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Financial Statements
Six months ended June 30, 2003
(Unaudited)
CONTENTS
Consolidated Financial Statements
Consolidated Balance Sheet.................................. 43
Consolidated Statement of Operations........................ 44
Consolidated Statement of Members' Equity................... 45
Consolidated Statement of Cash Flows........................ 46
Notes to Consolidated Financial Statements.................. 47
42
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Balance Sheet
June 30, 2003
(Unaudited)
ASSETS
Cash and cash equivalents $ 4,652,009
Incentive and management fees receivable 5,275,057
Notes receivable 5,000,000
Notes receivable from employee 200,000
Investments, at fair value 15,104,600
Fixed assets (net of accumulated depreciation and
amortization of $1,724,061) 1,176,544
Prepaid expenses 1,097,437
Other assets 514,511
-----------
Total assets $33,020,158
-----------
-----------
LIABILITIES AND MEMBERS' EQUITY
Accrued expenses $ 3,703,073
Notes payable 19,560,967
Payable to former member 750,000
-----------
Total liabilities 24,014,040
Members' equity (including accumulated other comprehensive
loss of $736,478) 9,006,118
-----------
Total liabilities and members' equity $33,020,158
-----------
-----------
See accompanying notes.
43
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Operations
Six months ended June 30, 2003
(Unaudited)
Revenues:
Management fees $12,187,491
Incentive fees 3,008,620
Interest and dividends 652,522
Other income 238,736
-----------
16,087,369
Expenses:
Compensation and benefits 9,047,882
Travel and promotional 593,878
Legal and professional 285,730
Data fees 252,940
Depreciation and amortization 352,575
Office and occupancy 247,778
Interest expense 165,633
Taxes 79,456
Other expenses 781,733
-----------
Total expenses 11,807,605
-----------
Net income $ 4,279,764
-----------
-----------
See accompanying notes.
44
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Members' Equity
Six months ended June 30, 2003
(Unaudited)
MEMBERS' EQUITY
CLASS A CLASS B TOTAL
----------------------------------------------
Balance, January 1, 2003 $ 6,439,311 $ 584,882 $ 7,024,193
Capital distribution (2,655,809) (344,191) (3,000,000)
Equity-based compensation -- 30,227 30,227
Change in unrealized appreciation
on investments available for
sale 561,796 110,138 671,934
Net income 3,602,164 677,600 4,279,764
----------------------------------------------
Balance, June 30, 2003 $ 7,947,462 $1,058,656 $ 9,006,118
----------------------------------------------
----------------------------------------------
See accompanying notes.
45
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Cash Flows
Six months ended June 30, 2003
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,279,764
Adjustments to reconcile net income to net cash
provided by operating activities:
Net accretion of interest income 308,523
Depreciation and amortization 352,575
Noncash compensation 137,568
Decrease in incentive and management fees receivable 617,323
Increase in other assets and prepaid expenses (1,481,423)
Decrease in accrued expenses (3,582,710)
------------
Net cash provided by operating activities 631,620
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investments (11,387,100)
Purchases of fixed assets (67,749)
------------
Net cash used in investing activities (11,454,849)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 12,575,000
Repayment of notes payable (1,912,224)
Distributions to members (3,000,000)
------------
Net cash provided by financing activities 7,662,776
------------
Net decrease in cash and cash equivalents (3,160,453)
Cash and cash equivalents, beginning of period 7,812,462
------------
Cash and cash equivalents, end of period $ 4,652,009
------------
------------
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 65,576
------------
------------
See accompanying notes.
46
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements
1. ORGANIZATION AND NATURE OF BUSINESS
Deerfield & Company LLC (the Company), an Illinois limited liability company,
was organized on February 24, 1997, and commenced operations on March 1, 1997.
The Company has two classes of membership interests, Class A and Class B, with
rights as described in the third amended and restated operating agreement of
Deerfield & Company LLC (the Operating Agreement). Class A is owned by Sachs
Capital Management LLC (SCM), SLA Investments, Inc. (SLA), and Deerfield
Partners Fund III and has 100% of the voting rights in the Company. As of
June 30, 2003, there are three owners of Class B membership interests, which
have no voting privileges. Two of the three Class B members have profits only
interests.
The Company is the parent of two wholly owned subsidiaries: Deerfield Capital
Management LLC, (DCM) and Badger Protection Services, Ltd. (Badger). DCM serves
as the trading advisor for five fixed income investment funds and three private
investment accounts (hereafter referred to collectively as the Funds). Badger is
a company which provides credit enhancement to investors in one of the Funds
managed by the Company. Additionally, DCM is a collateral manager for 15
collateralized debt obligations (CDO), collateralized loan obligations (CLO),
and collateralized bond obligations (CBO) (hereafter referred to collectively as
the CDOs). DCM earns management and incentive fees for the services provided to
the Funds and the CDOs. As of June 30, 2003, the Company had approximately
$8.03 billion in assets under management.
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States.
Such preparation requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
47
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The following is a summary of significant accounting policies followed by the
Company in the preparation of its financial statements.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For financial statement reporting purposes, the Company considers cash and all
highly liquid investments, including money market accounts and commercial paper,
with a maturity of 90 days or less to be cash and cash equivalents.
FIXED ASSETS
Office equipment, including computer equipment, is depreciated over five years
using the straight-line method. Office furniture is depreciated over seven years
using the straight-line method. Leasehold improvements are depreciated over the
remaining life of the lease using the straight-line method.
DEFERRED COSTS
Certain costs associated with the acquisition of CDO management contracts and
debt financing of preferred share acquisitions are recorded as prepaid expenses
in the consolidated balance sheet and amortized over the expected life of the
related contract or loan.
48
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INVESTMENTS
Investments in limited partnerships are accounted for under the equity method of
accounting. Investments in preferred shares of CDOs are recorded at fair value
and classified as securities available-for-sale. Unrealized gains and losses on
securities available-for-sale are recorded as a separate component of members'
equity. Interest income is accreted and investments are assessed for impairment
in accordance with EITF Issue 99-20, 'Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets' (EITF 99-20).
REVENUE RECOGNITION
Management fees are received from the Funds and CDOs managed by the Company.
These fees are paid periodically in accordance with the individual management
agreements between the Company and the individual Funds and CDOs and are based
upon the net asset values of the Funds and aggregate collateral amount of the
CDOs as defined in the individual management agreements. Management fees are
recognized as revenue when earned. In accordance with Emerging Issues Task Force
Topic (EITF) D-96, 'Accounting for Management Fees Based on a Formula,' the
Company does not recognize these fees as revenue until all contingencies have
been removed.
Incentive fees are received from the Funds and certain of the CDOs managed by
the Company. These fees are paid periodically in accordance with the individual
management agreements between the Company and the individual Funds and CDOs and
are based upon the performance of the funds and CDOs. Incentive fees are
recognized as revenues when the amounts are fixed and determinable.
Incentive income and other expenses include amounts earned or incurred under
arrangements with certain investors or guarantors in the CDOs the Company
manages. Income and expense is recorded when earned or incurred and is recorded
gross, except under circumstances where the income and expense are contractually
required to be settled with a net payment to or from the counterparty.
49
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on an accrual basis and includes accretion of interest on certain investments in
accordance with EITF 99-20.
Other income primarily includes structuring and warehousing fees earned by the
Company for services provided to CDOs or placement agents for the CDOs. These
fees are recorded when earned.
INCOME TAXES
Income taxes are not provided for as the taxable income (loss) of the Company is
includable in the returns of the Class A and Class B members. The Company
records Illinois State replacement tax expense, as applicable, in the
consolidated statement of operations.
Pursuant to Treasury Regulation Section 301.7701, the subsidiaries of the
Company have elected to be disregarded as separate entities for U.S. tax
purposes and are, therefore, treated as branches of the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), 'Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others,' which expands the disclosure requirements
to be made by a guarantor in its financial statements regarding its obligations
under certain guarantees that it has issued. FIN 45 also requires, under certain
circumstances, the recognition, at the inception of a guarantee, of a liability
for the fair value of the obligation as a result of issuing the guarantee. The
adoption of FIN 45 has not had a material effect on the Company's financial
statements.
In December 2003, the FASB revised Interpretation No. 46, 'Consolidation of
Variable Interest Entities,' which provides new criteria for determining whether
or not consolidation accounting is required by a variable interest holder in
certain entities. The Interpretation may require the Company to consolidate
financial
50
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
information for certain of the Funds and CDOs it manages. The Interpretation may
require the Company to consolidate certain Funds' or CDOs' assets and
liabilities, and results of operations, with a minority interest recorded for
the ownership share applicable to other investors. The effect of such
consolidation would not change the net income or loss of the Company. Where
consolidation is not required, additional disclosures may be required. FIN 46 is
effective immediately for variable interest entities created after December 31,
2003, and as of the end of the first fiscal year beginning after December 31,
2004, to variable interest entities acquired before December 31, 2003
(December 31, 2005, for the Company). The Company has evaluated the impact of
FIN 46 and does not believe that it will have a material impact on the financial
statements.
3. INVESTMENTS
The Company's investments at June 30, 2003, were comprised of an investment in a
limited partnership and investments in the preferred shares of 3 CDOs for which
it provides management services. The following is a summary of the Company's
investments at June 30, 2003:
VALUE
-----------
Available for sale:
Investment in CDO preferred shares
(amortized cost $15,827,678) $15,091,200
Equity method:
Investment in limited partnership 13,400
-----------
$15,104,600
-----------
-----------
51
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
4. FIXED ASSETS
The Company's fixed assets at June 30, 2003, are summarized as follows:
Computer equipment and software $1,511,441
Leasehold improvements 681,832
Office furniture and fixtures 707,332
----------
2,900,605
Less: Accumulated depreciation
and amortization (1,724,061)
----------
$1,176,544
----------
----------
5. LEASE COMMITMENTS
The Company has a sublease agreement (the agreement) to lease office facilities
through May 30, 2007. In conjunction with the agreement, a standby letter of
credit has been issued by a financial institution to the sublessor in the amount
of $600,000. The Company pledged a $600,000 cash balance as collateral against
the standby letter of credit. Under the agreement, beginning January 1, 1999,
the standby letter of credit and related collateral can be reduced by $50,000
per year until the standby letter of credit reaches $400,000. At June 30, 2003,
the pledged collateral was approximately $408,000 and was included in cash and
cash equivalents on the consolidated balance sheet. The balance of the letter of
credit facility is $400,000 as of June 30, 2003. Management does not believe the
standby letter of credit will be utilized. Rent expense for the first six months
of 2003 was approximately $234,000.
Future base lease commitments on the Company's operating leases are as follows:
2004 $ 462,983
2005 472,730
2006 482,477
2007 205,093
----------
$1,623,283
----------
----------
52
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE
The Company manages a private synthetic CLO for an investment banking firm (the
Investor). A guarantor (the Guarantor), unrelated to the Company and the
Investor, has provided a guarantee against losses in the CLO to the Investor
(the guarantee agreement) for up to the first $50 million of the Investor's
principal losses. As a premium for the guarantee, the Guarantor receives all of
the residual cash flows from the CLO. The Guarantor does not have any direct
investment in the CLO and will only make payments in the event of a principal
loss, as defined in the CLO's guarantee agreement with the Guarantor.
As a condition of entering into a collateral management agreement with the CLO,
the Company has entered into agreements with the Guarantor and another
counterparty (the Counterparty) to share in the guarantee agreement with the
Guarantor up to 10% of the total guaranteed amount (e.g., maximum loss guarantee
of $5 million). The Company's share of the first $50 million of losses in the
CLO will be on a pro rata basis, up to $5 million. Under the agreement with the
Guarantor, the Company has deposited $5,000,000 in escrow (the escrow account)
for the benefit of the Guarantor evidenced by a note receivable from the
Guarantor with a principal amount of $5,000,000, recorded as a note receivable
on the consolidated balance sheet. Interest on the note receivable is equal to
10% of the Guarantor's guarantee fee premium and 100% of the amounts earned on
the amount in escrow. In the event of any payment by the Guarantor under the
guarantee agreement, the Company's share will be taken from the escrow account
and the note receivable will be forgiven by the Company in the amount of 10% of
the guarantee payments made by the Guarantor.
To offset its exposure under the guarantee, the Company entered into a separate
agreement with a third-party counterparty (the Counterparty), under which the
Counterparty agreed to make payments to the Company in the event the Company has
to fund the Guarantor under the agreement described above. Under the agreement
with the Counterparty, the Company received $5,000,000, which was utilized to
fund the escrow account and issued a note payable to the Counterparty in the
amount of $5,000,000. Interest on the note payable is equal to the interest on
the note receivable from the Guarantor, except that only 50% of any amounts in
excess of LIBOR plus 4% are payable to the Counterparty. In the event of any
forgiveness of the note receivable from the Guarantor, as described above, an
equal amount of the Company's note payable to the Counterparty will
53
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
be forgiven by the Counterparty. The Company has pledged its future senior
management fees from two other CDOs it manages as collateral for payment of any
amounts owed to the Counterparty.
Separate from the above transaction, during 2002, the Company financed its
purchase of 6,250,000 preferred shares of one of the CDOs for which it provides
management services by issuing a nonrecourse note to an investment banking firm
for $6,250,000, which bears interest at LIBOR, and has no stated maturity.
Concurrent with the Company's sale of 1,500,000 of these preferred shares soon
after their purchase in 2002, the Company repaid $1,500,000 of principal plus
accrued interest on the note. The remaining 4,750,000 preferred shares are
pledged as collateral against the note, and all management fees earned and
received by the Company for managing the underlying assets of the CDO and any
distributions received on the preferred shares will be remitted to the note
holder until all principal and interest on the note are paid in full. During the
first six months of 2003, the Company recorded interest on the note of $30,415
and repaid $1,276,702 of principal. At June 30, 2003, the balance of the note
was $2,609,417.
During 2003, the Company financed its purchase of preferred shares of one of the
CDOs for which it provides management services by issuing a nonrecourse note to
a large investment bank for $8,000,000 (including $888,800 of prepaid fees),
which bears interest at LIBOR plus 100 basis points and has no stated maturity.
The preferred shares are pledged as collateral against the note, and 62.5% of
all management fees earned and received by the Company for managing the
underlying assets of the CDO and all distributions received on the preferred
shares will be remitted to the note holder until all principal and interest on
the note are paid in full. During the first six months of 2003, the Company
recorded interest on the note of $20,113 and repaid $0 of principal. At June 30,
2003, the balance of the note was $8,000,000.
Also during 2003, the Company financed its purchase of preferred shares of one
of the CDOs for which it provides management services by issuing a nonrecourse
note to an investment banking firm for $4,575,000 (including $300,000 of prepaid
fees), which bears interest at LIBOR, plus 100 basis points and has no stated
maturity. The preferred shares are pledged as collateral against the note, and
65% of all management fees earned and received by the Company for managing the
54
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
underlying assets of the CDO and all distributions received on the preferred
shares will be remitted to the note holder until all principal and interest on
the note are paid in full. During the first six months of 2003, the Company
recorded interest on the note of $35,814 and repaid $623,450 of principal. At
June 30, 2003, the balance of the note was $3,951,550.
7. MEMBERS' EQUITY
Effective January 1, 2001, a Class B member of the Company resigned and redeemed
his 5.74% ownership interest in the Company. The Company paid the member
$2,230,460 in accordance with the terms of the Operating Agreement. The member
was also paid $769,540 to sign a three-year noncompete agreement, which is being
amortized over three years. This amount was recorded as an intangible asset, net
of accumulated amortization, on the consolidated balance sheet. The final
redemption payment of $750,000 is scheduled to be made on December 31, 2003.
Effective January 1, 1999, an individual was granted a Class B interest
constituting a .5% ownership interest in the Company. In accordance with
Accounting Principles Bulletin No. 25, 'Accounting for Stock Issued to
Employees' (APB 25), and FASB Interpretation No. 44, 'Accounting for Certain
Transactions involving Stock Compensation -- an interpretation of APB Opinion
No. 25' (FIN 44), variable plan accounting applies to this grant, and noncash
compensation expense is recorded for changes in the value of the grant, as
determined by the Operating Agreement. During the first six months of 2003, the
value of the employee's interest decreased approximately $4,400, which was
recorded as a decrease to compensation expense and to Class B members' equity.
Effective January 1, 2002, Class B nonvoting Profits Only Interests representing
an 11% membership interest in the Company were granted to two employees. An
additional 5% was granted to one of the employees on May 1, 2003. The employees'
interest in future profits was fully vested at the date of grant. The employees'
earnings payout value, as defined in the Operating Agreement, cliff vests on
their 20th anniversary of employment with the Company. These grants are
accounted for under the variable plan accounting rules of APB 25 and FIN 44,
55
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
7. MEMBERS' EQUITY (CONTINUED)
and amortized compensation expense is recorded for changes in the employees'
earnings payout value over 20 years. During the first six months of 2003,
approximately $30,000 was recorded as noncash compensation expense in the
members' equity accounts related to the cliff vesting of the earnings payout
value.
8. EMPLOYEE BENEFIT PLANS
The Company has a voluntary contribution 401(k) plan (the Plan). Under the Plan,
employees are eligible to contribute a percentage of their salary into the Plan
after completing an initial employment period. The Company has the option to
match a percentage of the employee contributions for the year. All Plan
contributions are paid into the Deerfield & Company LLC 401(k) Savings Trust
(the Trust). The Trust is allowed to invest the contributions in a variety of
instruments defined in the Plan agreement. The Company's matching contribution
for 2003 is estimated to be approximately $150,000.
The Company sponsors a Key Employee Equity Participation Plan (KEEP Plan), which
is a 'phantom' equity appreciation plan. Under the KEEP Plan, participants are
awarded stock appreciation rights (SAR) by the Company. Upon redemption, the
KEEP Plan provides participants with the positive difference, if any, between
the value of a SAR and its strike price. The value of a SAR is defined in the
KEEP Plan as the average of the three most recent years' annual net earnings
multiplied by five and divided by the number of SARs authorized. The stock
appreciation rights do not represent an equity interest in the Company. The
Company retains the sole discretion to determine the employees who will receive
awards under the KEEP Plan. The awards vest one fourth each year, on the first,
second, third, and fourth anniversaries of the award date and are not
exercisable until the fifth anniversary of the award date. As of June 30, 2003,
there were 241,500 SARs outstanding with a value of $1.00 per award. Strike
prices for the SARs were either $4.00 or $4.21 per award, depending on the date
of the award. No SARs were granted during 2003. Participants were either 50% or
75% vested in the KEEP Plan awards depending on the date of the award. The SARs
are accounted for under the variable accounting rules of APB 25 and FIN 44, and
the total compensation expense recognized related to the KEEP Plan during the
first six months of 2003 was $0.
56
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS
The Company acts as collateral manager for various CDOs capitalized by
third-party investors. Typically, the transactions are sponsored and
underwritten by third-party investment banks, who may warehouse the collateral
and place the debt and equity of the CDOs with the ultimate investors. The
underlying collateral of the CDOs, which is typically purchased in the open
market, consists of corporate debt, structured notes, commercial loans,
synthetic instruments, and the notional amount of credit default instruments,
and is owned by separate special purpose entities for each CDO, which issue
various classes of notes and beneficial interests to third-party investors,
including the Company or related entities in certain instances. The Company
manages the underlying collateral on behalf of the investors under the terms of
collateral management agreements.
As of June 30, 2003, the Company managed 15 CDOs. The total par/notional value
of the underlying collateral under management was approximately $7.1 billion at
June 30, 2003. The total debt outstanding of the CDOs was approximately
$4.3 billion.
TYPE OF
CDO/ NUMBER OF CDOs PAR VALUE OF
COLLATERAL MANAGED COLLATERAL
------------------------------------------------------------
Bank loans 6 $2,345,000,000
Credit default swaps 2 2,000,000,000
Corporate bonds 3 1,500,000,000
Asset-backed securities 4 1,300,000,000
------------------------------
15 $7,145,000,000
------------------------------
------------------------------
The CDOs have various terms/maturities, ranging from 5 to 35 years.
Pursuant to the underlying collateral management agreements, the Company is
compensated for managing the underlying collateral of the CDOs. The Company
earns various fees for its services, as follows: (1) base collateral investment
management fees (Senior), which are paid before interest to the debt holders in
the transaction, and range from five to 31.5 basis points annually, (2) base
collateral investment management fees (Junior), which are subordinate to a
certain return to the debt and/or equity holders in the CDO, and range from 7 to
55 basis points annually, and in certain instances, (3) incentive fees
(Incentive) that are paid after certain investors' returns exceed a hurdle
internal rate of
57
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
return (IRR). The Incentive fees range from 25 to 38 basis points or 10-20% of
residual cash flows above the hurdle IRR and vary by transaction. In accordance
with the Company's accounting policies, management fees are accrued as earned.
Incentive fees, which are contingent upon achieving certain performance
objectives, are recognized as income once the contingencies are resolved and the
fees are fixed and determinable.
From time to time, the Company enters into agreements with investors or
providers of guarantees to the CDOs. In some of these agreements, the Company
enters into contractual arrangements with the investor or guarantee provider
whereby the Company is required to make payments upon the occurrence of certain
events. In other agreements, the Company will provide credit enhancement to
provide additional protection to a certain investor. These agreements vary by
transaction. In instances where the Company is required pursuant to a
contractual arrangement to make a payment to an investor or guarantee provider,
the Company may subordinate receipt of all or a portion of its future Senior
fees, Junior fees, if any, and Incentive fees, if any, until the Company's
obligation to the investor or guarantee provider has been met. In all cases, the
subordinated amounts are limited to the extent of future fees earned on specific
CDOs. In addition, the Company has provided credit enhancement in the form of
notes payable and escrow deposits for $17,575,000 to various third parties (see
Note 6).
At June 30, 2003, the Company has a direct ownership interest in three CDOs,
where its ownership of preferred shares is less than 5% of the CDOs' total debt
and equity. In addition, the Company has determined that it does not have the
substantive residual risks or substantially all of the residual rewards of the
underlying assets and obligations imposed by the underlying debt. Pursuant to
the provisions of EITF Issue 90-15, 'Impact of Nonsubstantive Lessors, Residual
Value Guarantees, and Other Provisions in Leasing Transactions,' the underlying
assets and liabilities related to these transactions are not consolidated with
the Company's financial statements. See Note 2 for a discussion of the recently
issued FASB Interpretation No. 46 on Variable Interest Entities.
58
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
10. RELATED PARTIES
An entity affiliated through common ownership and a related person own 38%,
4.3%, 3.0%, and 5.6%, respectively, of the equity of four CDOs managed by the
Company.
The Company owns 15.8%, 32%, and 27.8%, respectively, of the equity of three
CDOs managed by the Company.
A privately managed investment account managed by the Company owns 33.3% and
38.9%, respectively, of the equity of two CDOs managed by the Company. This
managed account is also the Counterparty described in Note 6.
The Company has provided two notes to an employee of the Company for $250,000
each. The interest rate on the notes is equal to the Federal Funds Rate and is
calculated monthly. Each year on the employee's anniversary of employment with
the Company, 20% of the balance of the note and all accrued interest is forgiven
as long as the employee is still employed with the Company. During the first six
months of 2003, approximately $109,000 in principal and interest on the note was
forgiven and recorded as compensation expense, and the balance of the notes
outstanding as of June 30, 2003, was $200,000.
59
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Financial Statements
Six months ended June 30, 2004
(Unaudited)
CONTENTS
Consolidated Financial Statements
Consolidated Balance Sheet.................................. 61
Consolidated Statement of Operations........................ 62
Consolidated Statement of Members' Equity................... 63
Consolidated Statement of Cash Flows........................ 64
Notes to Consolidated Financial Statements.................. 65
60
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Balance Sheet
June 30, 2004
(Unaudited)
ASSETS
Cash and cash equivalents $ 3,021,232
Incentive and management fees receivable 4,829,122
Notes receivable 5,000,000
Investments, at fair value 17,750,018
Fixed assets (net of accumulated depreciation and
amortization of $1,824,933) 993,567
Prepaid expenses 760,082
Other assets 178,918
-----------
Total assets $32,532,939
-----------
-----------
LIABILITIES AND MEMBERS' EQUITY
Accrued expenses $ 5,814,771
Notes payable 17,603,603
-----------
Total liabilities 23,418,374
Members' equity (including accumulated other comprehensive
loss of $1,383,071) 9,114,565
-----------
Total liabilities and members' equity $32,532,939
-----------
-----------
See accompanying notes.
61
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Operations
Six months ended June 30, 2004
(Unaudited)
Revenues:
Management fees $21,644,905
Incentive fees 2,243,207
Interest and dividends 1,531,974
Other income 2,184,168
-----------
27,604,254
Expenses:
Compensation and benefits 11,086,879
Travel and promotional 1,070,042
Legal and professional 657,497
Data fees 323,158
Depreciation and amortization 231,094
Office and occupancy 261,299
Interest expense 276,007
Taxes 196,982
Other expenses 685,920
-----------
Total expenses 14,788,878
-----------
Net income $12,815,376
-----------
-----------
See accompanying notes.
62
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Members' Equity
Six months ended June 30, 2004
(Unaudited)
MEMBERS' EQUITY
CLASS A CLASS B TOTAL
-----------------------------------------
Balance, January 1, 2004 $ 10,396,486 $ 1,566,772 $ 11,963,258
Capital distribution (12,541,318) (2,458,682) (15,000,000)
Equity-based compensation -- 71,438 71,438
Change in unrealized appreciation
on investments available for sale (614,947) (120,560) (735,507)
Net income 10,714,780 2,100,596 12,815,376
-----------------------------------------
Balance, June 30, 2004 $ 7,955,001 $ 1,159,564 $ 9,114,565
-----------------------------------------
-----------------------------------------
See accompanying notes.
63
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Consolidated Statement of Cash Flows
Six months ended June 30, 2004
(Unaudited)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 12,815,376
Adjustments to reconcile net income to net cash provided by
operating activities:
Net accretion of interest income (152,958)
Depreciation and amortization 231,094
Noncash compensation 271,438
Decrease in incentive and management fees receivable 4,031,013
Decrease in other assets and prepaid expenses 11,339
Decrease in accrued expenses (2,599,735)
------------
Net cash provided by operating activities 14,607,567
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of investments (3,298,887)
Purchases of fixed assets (183,737)
------------
Net cash used in investing activities (3,482,624)
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from issuance of notes payable 3,266,000
Repayment of notes payable (2,708,064)
Distributions to members (15,000,000)
------------
Net cash used in financing activities (14,442,064)
------------
Net decrease in cash and cash equivalents (3,317,121)
Cash and cash equivalents, beginning of period 6,338,353
------------
Cash and cash equivalents, end of period $ 3,021,232
------------
------------
SUPPLEMENTAL INFORMATION
Cash paid for interest $ 122,114
------------
------------
See accompanying notes.
64
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements
1. ORGANIZATION AND NATURE OF BUSINESS
Deerfield & Company LLC (the Company), an Illinois limited liability company,
was organized on February 24, 1997, and commenced operations on March 1, 1997.
The Company has two classes of membership interests, Class A and Class B, with
rights as described in the third amended and restated operating agreement of
Deerfield & Company LLC (the Operating Agreement). Class A is owned by Sachs
Capital Management LLC (SCM), SLA Investments, Inc. (SLA), and Deerfield
Partners Fund III and has 100% of the voting rights in the Company. As of
June 30, 2004, there are three owners of Class B membership interests, which
have no voting privileges. Two of the three Class B members have profits only
interests.
The Company is the parent of two wholly owned subsidiaries: Deerfield Capital
Management LLC, (DCM) and Badger Protection Services, Ltd. (Badger). DCM serves
as the trading advisor for five fixed income investment funds and three private
investment accounts (hereafter referred to collectively as the Funds). Badger is
a company which provides credit enhancement to investors in one of the Funds
managed by the Company. Additionally, DCM is a collateral manager for 16
collateralized debt obligations (CDO), collateralized loan obligations (CLO),
and collateralized bond obligations (CBO) (hereafter referred to collectively as
the CDOs). DCM earns management and incentive fees for the services provided to
the Funds and the CDOs. As of June 30, 2004, the Company had approximately $8.1
billion in assets under management.
The Company signed a definitive agreement (Sale Agreement) on June 26, 2004, to
sell 63.6% of the Company. The closing is expected to occur on or about
July 22, 2004. In connection with the proposed transaction, 61.33% of the SCM
Class A interest, the SLA Class A interest, the Class B capital (ownership)
interest and 43% of the Class B profits only interests will be sold to a third
party (Buyer). After the closing, the Company will become a subsidiary of the
Buyer and its financial statements will be consolidated with the Buyer's
financial statements.
65
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES
USE OF ESTIMATES
The consolidated financial statements of the Company have been prepared in
accordance with accounting principles generally accepted in the United States.
Such preparation requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, disclosure of contingent
liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates.
The following is a summary of significant accounting policies followed by the
Company in the preparation of its financial statements.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its subsidiaries. All intercompany transactions and balances have been
eliminated in consolidation.
CASH AND CASH EQUIVALENTS
For financial statement reporting purposes, the Company considers cash and all
highly liquid investments, including money market accounts and commercial paper,
with a maturity of 90 days or less to be cash and cash equivalents.
FIXED ASSETS
Office equipment, including computer equipment, is depreciated over five years
using the straight-line method. Office furniture is depreciated over seven years
using the straight-line method. Leasehold improvements are depreciated over the
remaining life of the lease using the straight-line method.
66
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEFERRED COSTS
Certain costs associated with the acquisition of CDO management contracts and
debt financing of preferred share acquisitions are recorded as prepaid expenses
in the consolidated balance sheet and amortized over the expected life of the
related contract or loan.
INVESTMENTS
Investments in limited partnerships are accounted for under the equity method of
accounting. Investments in preferred shares of CDOs are recorded at fair value
and classified as securities available-for-sale. Unrealized gains and losses on
securities available-for-sale are recorded as a separate component of members'
equity. Interest income is accreted and investments are assessed for impairment
in accordance with EITF Issue 99-20, 'Recognition of Interest Income and
Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets' (EITF 99-20).
REVENUE RECOGNITION
Management fees are received from the Funds and CDOs managed by the Company.
These fees are paid periodically in accordance with the individual management
agreements between the Company and the individual Funds and CDOs and are based
upon the net asset values of the Funds and aggregate collateral amount of the
CDOs as defined in the individual management agreements. Management fees are
recognized as revenue when earned. In accordance with Emerging Issues Task Force
Topic (EITF) D-96, 'Accounting for Management Fees Based on a Formula,' the
Company does not recognize these fees as revenue until all contingencies have
been removed.
Incentive fees are received from the Funds and certain of the CDOs managed by
the Company. These fees are paid periodically in accordance with the individual
management agreements between the Company and the individual Funds and CDOs and
are based upon the performance of the funds and CDOs. Incentive fees are
recognized as revenues when the amounts are fixed and determinable.
67
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
Incentive income and other expenses include amounts earned or incurred under
arrangements with certain investors or guarantors in the CDOs the Company
manages. Income and expense is recorded when earned or incurred and is recorded
gross, except under circumstances where the income and expense are contractually
required to be settled with a net payment to or from the counterparty.
Dividend income is recorded on the ex-dividend date. Interest income is recorded
on an accrual basis and includes accretion of interest on certain investments in
accordance with EITF 99-20.
Other income primarily includes structuring and warehousing fees earned by the
Company for services provided to CDOs or placement agents for the CDOs. These
fees are recorded when earned.
INCOME TAXES
Income taxes are not provided for as the taxable income (loss) of the Company is
includable in the returns of the Class A and Class B members. The Company
records Illinois State replacement tax expense, as applicable, in the
consolidated statement of operations.
Pursuant to Treasury Regulation Section 301.7701, the subsidiaries of the
Company have elected to be disregarded as separate entities for U.S. tax
purposes and are, therefore, treated as branches of the Company.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2002, the FASB issued Interpretation No. 45 (FIN 45), 'Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others,' which expands the disclosure requirements
to be made by a guarantor in its financial statements regarding its obligations
under certain guarantees that it has issued. FIN 45 also requires, under certain
circumstances, the recognition, at the inception of a guarantee, of a liability
for the fair value of the obligation as a result of issuing the guarantee.
68
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
2. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
The adoption of FIN 45 has not had a material effect on the Company's financial
statements.
In December 2003, the FASB revised Interpretation No. 46, 'Consolidation of
Variable Interest Entities,' which provides new criteria for determining whether
or not consolidation accounting is required by a variable interest holder in
certain entities. The Interpretation may require the Company to consolidate
financial information for certain of the Funds and CDOs it manages. The
Interpretation may require the Company to consolidate certain Funds' or CDOs'
assets and liabilities, and results of operations, with a minority interest
recorded for the ownership share applicable to other investors. The effect of
such consolidation would not change the net income or loss of the Company. Where
consolidation is not required, additional disclosures may be required. FIN 46 is
effective immediately for variable interest entities created after December 31,
2003, and as of the end of the first fiscal year beginning after December 31,
2004, to variable interest entities acquired before December 31, 2003
(December 31, 2005, for the Company). The Company has evaluated the impact of
FIN 46 and does not believe that it will have a material impact on the financial
statements.
3. INVESTMENTS
The Company's investments at June 30, 2004, were comprised of an investment in a
limited partnership and investments in the preferred shares of 4 CDOs for which
it provides management services. The following is a summary of the Company's
investments at June 30, 2004:
VALUE
-----------
Available for sale:
Investment in CDO preferred shares
(amortized cost $19,086,799) $17,703,728
Equity method:
Investment in limited partnership 46,290
-----------
$17,750,018
-----------
-----------
69
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
4. FIXED ASSETS
The Company's fixed assets at June 30, 2004, are summarized as follows:
Computer equipment and
software $1,390,817
Leasehold improvements 687,771
Office furniture and fixtures 739,912
----------
2,818,500
Less: Accumulated
depreciation and
amortization (1,824,933)
----------
$ 993,567
----------
----------
5. LEASE COMMITMENTS
The Company has a sublease agreement (the agreement) to lease office facilities
through May 30, 2007. In conjunction with the agreement, a standby letter of
credit has been issued by a financial institution to the sublessor in the amount
of $600,000. The Company pledged a $600,000 cash balance as collateral against
the standby letter of credit. Under the agreement, beginning January 1, 1999,
the standby letter of credit and related collateral can be reduced by $50,000
per year until the standby letter of credit reaches $400,000. At June 30, 2004,
the pledged collateral was approximately $400,000 and was included in cash and
cash equivalents on the consolidated balance sheet. The balance of the letter of
credit facility is $400,000 as of June 30, 2004. Management does not believe the
standby letter of credit will be utilized. Rent expense for the first six months
of 2004 was approximately $242,000.
Future base lease commitments on the Company's operating leases are as follows:
2005 $ 472,730
2006 482,477
2007 205,093
----------
$1,160,300
----------
----------
70
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE
The Company manages a private synthetic CLO for an investment banking firm (the
Investor). A guarantor (the Guarantor), unrelated to the Company and the
Investor, has provided a guarantee against losses in the CLO to the Investor
(the guarantee agreement) for up to the first $50 million of the Investor's
principal losses. As a premium for the guarantee, the Guarantor receives all of
the residual cash flows from the CLO. The Guarantor does not have any direct
investment in the CLO and will only make payments in the event of a principal
loss, as defined in the CLO's guarantee agreement with the Guarantor.
As a condition of entering into a collateral management agreement with the CLO,
the Company has entered into agreements with the Guarantor and another
counterparty (the Counterparty) to share in the guarantee agreement with the
Guarantor up to 10% of the total guaranteed amount (e.g., maximum loss guarantee
of $5 million). The Company's share of the first $50 million of losses in the
CLO will be on a pro rata basis, up to $5 million. Under the agreement with the
Guarantor, the Company has deposited $5,000,000 in escrow (the escrow account)
for the benefit of the Guarantor evidenced by a note receivable from the
Guarantor with a principal amount of $5,000,000, recorded as a note receivable
on the consolidated balance sheet. Interest on the note receivable is equal to
10% of the Guarantor's guarantee fee premium and 100% of the amounts earned on
the amount in escrow. In the event of any payment by the Guarantor under the
guarantee agreement, the Company's share will be taken from the escrow account
and the note receivable will be forgiven by the Company in the amount of 10% of
the guarantee payments made by the Guarantor.
To offset its exposure under the guarantee, the Company entered into a separate
agreement with a third-party counterparty (the Counterparty), under which the
Counterparty agreed to make payments to the Company in the event the Company has
to fund the Guarantor under the agreement described above. Under the agreement
with the Counterparty, the Company received $5,000,000, which was utilized to
fund the escrow account and issued a note payable to the Counterparty in the
amount of $5,000,000. Interest on the note payable is equal to the interest on
the note receivable from the Guarantor, except that only 50% of any amounts in
excess of LIBOR plus 4% are payable to the Counterparty. In the event of any
forgiveness of the note receivable from the Guarantor, as described above, an
equal amount of the Company's note payable to the Counterparty will be forgiven
by the Counterparty. The Company has pledged its future senior
71
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
management fees from two other CDOs it manages as collateral for payment of any
amounts owed to the Counterparty.
Separate from the above transaction, during 2002, the Company financed its
purchase of 6,250,000 preferred shares of one of the CDOs for which it provides
management services by issuing a nonrecourse note to an investment banking firm
for $6,250,000, which bears interest at LIBOR, and has no stated maturity.
Concurrent with the Company's sale of 1,500,000 of these preferred shares soon
after their purchase in 2002, the Company repaid $1,500,000 of principal plus
accrued interest on the note. The remaining 4,750,000 preferred shares are
pledged as collateral against the note, and all management fees earned and
received by the Company for managing the underlying assets of the CDO and any
distributions received on the preferred shares will be remitted to the note
holder until all principal and interest on the note are paid in full. During the
first six months of 2004, the Company recorded interest on the note of $6,025
and repaid $1,232,486 of principal. At June 30, 2004, the balance of the note
was $138,684.
During 2003, the Company financed its purchase of preferred shares of one of the
CDOs for which it provides management services by issuing a nonrecourse note to
an investment banking firm for $8,000,000 (including $888,800 of prepaid fees),
which bears interest at LIBOR plus 100 basis points and has no stated maturity.
The preferred shares are pledged as collateral against the note, and 62.5% of
all management fees earned and received by the Company for managing the
underlying assets of the CDO and of any distributions received on the preferred
shares will be remitted to the note holder until all principal and interest on
the note are paid in full. During the first six months of 2004, the Company
recorded interest on the note of $76,160 and repaid $849,535 of principal. At
June 30, 2004, the balance of the note was $6,774,773.
Also during 2003, the Company financed its purchase of preferred shares of one
of the CDOs for which it provides management services by issuing a nonrecourse
note to an investment banking firm for $4,575,000 (including $300,000 of prepaid
fees), which bears interest at LIBOR, plus 100 basis points and has no stated
maturity. The preferred shares are pledged as collateral against the note, and
65% of all management fees earned and received by the Company for managing the
underlying assets of the CDO and all distributions received on the preferred
shares will be remitted to the note holder until all principal and interest on
the
72
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
6. NOTES RECEIVABLE AND NOTES PAYABLE (CONTINUED)
note are paid in full. During the first six months of 2004, the Company recorded
interest on the note of $30,306 and repaid $626,043 of principal. At June 30,
2004, the balance of the note was $2,424,146.
During 2004, the Company financed its purchase of preferred shares of one of the
CDOs for which provides management services by issuing a nonrecourse note to an
investment banking firm for $3,266,000, which bears interest at LIBOR, plus 75
basis points and has no stated maturity. The preferred shares are pledged as
collateral against the note, and 70% of all management fees earned and received
by the Company for managing the underlying assets of the CDO and all
distributions received on the preferred shares will be remitted to the note
holder until all principal and interest on the note are paid in full. During the
first six months of 2004, the Company recorded interest on the note of $20,318
and repaid $0 of principal. At June 30, 2004, the balance of the note was
$3,266,000.
7. MEMBERS' EQUITY
Effective January 1, 2002, Class B nonvoting Profits Only Interests representing
an 11% membership interest in the Company were granted to two employees. An
additional 5% was granted to one of the employees on May 1, 2003. The employees'
earnings payout value, as defined in the Operating Agreement, cliff vests on
their 20th anniversary of employment with the Company. These grants are
accounted for under the variable plan accounting rules of APB 25 and FIN 44, and
amortized compensation expense is recorded for changes in the employees'
earnings payout value over 20 years. During the first six months of 2004,
approximately $71,000 was recorded as noncash compensation expense in the
members' equity accounts related to the vesting of the earnings payout value.
Approximately 43% of the Class B nonvoting Profits Only Interests will be sold
to a third party as part of the Sale Agreement (see Note 1). The vesting period
on the sold portion of the Class B nonvoting Profits Only Interests will be
accelerated upon sale.
73
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
8. EMPLOYEE BENEFIT PLANS
The Company has a voluntary contribution 401(k) plan (the Plan). Under the Plan,
employees are eligible to contribute a percentage of their salary into the Plan
after completing an initial employment period. The Company has the option to
match a percentage of the employee contributions for the year. All Plan
contributions are paid into the Deerfield & Company LLC 401(k) Savings Trust
(the Trust). The Trust is allowed to invest the contributions in a variety of
instruments defined in the Plan agreement.
The Company sponsors a Key Employee Equity Participation Plan (KEEP Plan), which
is a 'phantom' equity appreciation plan. Under the KEEP Plan, participants are
awarded stock appreciation rights (SAR) by the Company. Upon redemption, the
KEEP Plan provides participants with the positive difference, if any, between
the value of a SAR and its strike price. The value of a SAR is defined in the
KEEP Plan as the average of the three most recent years' annual net earnings
multiplied by five and divided by the number of SARs authorized. The stock
appreciation rights do not represent an equity interest in the Company. The
Company retains the sole discretion to determine the employees who will receive
awards under the KEEP Plan. The awards vest one fourth each year, on the first,
second, third, and fourth anniversaries of the award date, and are not
exercisable until the fifth anniversary of the award date. As of June 30, 2004,
there were 241,500 SARs outstanding with a value of $2.22 per award. Strike
prices for the SARs were either $4.00 or $4.21 per award, depending on the date
of the award. No SARs were granted during 2004. Participants were either 50% or
75% vested in the KEEP Plan awards depending on the date of the award. The SARs
are accounted for under the variable accounting rules of APB 25 and FIN 44, and
the total compensation expense recognized related to the KEEP Plan during 2004
was $0.
Effective July 7, 2004, the KEEP Plan was terminated, resulting in a total
payout of $118,000 which was recorded as compensation expense.
9. CONTINGENT FEE ARRANGEMENTS
The Company acts as collateral manager for various CDOs capitalized by third-
party investors. Typically, the transactions are sponsored and underwritten by
third-party investment banks, who may warehouse the collateral and place the
debt and equity of the CDOs with the ultimate investors. The underlying
74
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
collateral of the CDOs, which is typically purchased in the open market,
consists of corporate debt, structured notes, commercial loans, synthetic
instruments, and the notional amount of credit default instruments, and is owned
by separate special purpose entities for each CDO, which issue various classes
of notes and beneficial interests to third-party investors, including the
Company or related entities in certain instances. The Company manages the
underlying collateral on behalf of the investors under the terms of collateral
management agreements.
As of June 30, 2004, the Company managed 16 CDOs. The total par/notional value
of the underlying collateral under management was approximately $7.2 billion at
June 30, 2004. The total debt outstanding of the CDOs was approximately $4.9
billion.
TYPE OF CDO/ NUMBER OF CDOs PAR VALUE OF
COLLATERAL MANAGED COLLATERAL
----------------------------------------------------------------
Bank loans 6 $2,163,000,000
Credit default swaps 2 1,995,000,000
Corporate bonds 3 1,421,000,000
Asset-backed securities 5 1,574,000,000
------------------------------
16 $7,153,000,000
------------------------------
------------------------------
The CDOs have various terms/maturities, ranging from 5 to 35 years.
Pursuant to the underlying collateral management agreements, the Company is
compensated for managing the underlying collateral of the CDOs. The Company
earns various fees for its services, as follows: (1) base collateral investment
management fees (Senior), which are paid before interest to the debt holders in
the transaction, and range from five to 31.5 basis points annually, (2) base
collateral investment management fees (Junior), which are subordinate to a
certain return to the debt and/or equity holders in the CDO, and range from 7 to
55 basis points annually, and in certain instances, (3) incentive fees
(Incentive) that are paid after certain investors' returns exceed a hurdle
internal rate of return (IRR). The Incentive fees range from 25 to 38 basis
points or 10-20% of residual cash flows above the hurdle IRR and vary by
transaction. In accordance with the Company's accounting policies, management
fees are accrued as earned. Incentive fees, which are contingent upon achieving
certain performance
75
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
9. CONTINGENT FEE ARRANGEMENTS (CONTINUED)
objectives, are recognized as income once the contingencies are resolved and the
fees are fixed and determinable.
From time to time, the Company enters into agreements with investors or
providers of guarantees to the CDOs. In some of these agreements, the Company
enters into contractual arrangements with the investor or guarantee provider
whereby the Company is required to make payments upon the occurrence of certain
events. In other agreements, the Company will provide credit enhancement to
provide additional protection to a certain investor. These agreements vary by
transaction. In instances where the Company is required pursuant to a
contractual arrangement to make a payment to an investor or guarantee provider,
the Company may subordinate receipt of all or a portion of its future Senior
fees, Junior fees, if any, and Incentive fees, if any, until the Company's
obligation to the investor or guarantee provider has been met. In all cases, the
subordinated amounts are limited to the extent of future fees earned on specific
CDOs. In addition, the Company has provided credit enhancement in the form of
notes payable, escrow deposits, and/or deferred fees for $16,573,000 to various
third parties (see Note 6).
At June 30, 2004, the Company has a direct ownership interest in four CDOs,
where its ownership of preferred shares is less than 5% of the CDOs' total debt
and equity. In addition, the Company has determined that it does not have the
substantive residual risks or substantially all of the residual rewards of the
underlying assets and obligations imposed by the underlying debt. Pursuant to
the provisions of EITF Issue 90-15, 'Impact of Nonsubstantive Lessors, Residual
Value Guarantees, and Other Provisions in Leasing Transactions,' the underlying
assets and liabilities related to these transactions are not consolidated with
the Company's financial statements. See Note 2 for a discussion of the recently
issued FASB Interpretation No. 46 on Variable Interest Entities.
10. RELATED PARTIES
An entity affiliated through common ownership and a related person own 38%,
4.3%, 3.0%, and 5.6%, respectively, of the equity of four CDOs managed by the
Company.
76
Deerfield & Company LLC
(An Illinois Limited Liability Company)
Notes to Consolidated Financial Statements (continued)
10. RELATED PARTIES (CONTINUED)
The Company owns 15.8%, 32%, 27.8%, and 24.9%, respectively, of the equity of
four CDOs managed by the Company.
A privately managed investment account managed by the Company owns 33.3% and
38.9%, respectively, of the equity of two CDOs managed by the Company. This
managed account is also the Counterparty described in Note 6.
The Company has provided two notes to an employee of the Company for $250,000
each. The interest rate on the notes is equal to the Federal Funds Rate and is
calculated monthly. Each year on the employee's anniversary of employment with
the Company, 20% of the balance of the note and all accrued interest is forgiven
as long as the employee is still employed with the Company. During 2004,
approximately $201,000 in principal and interest on the note was forgiven and
recorded as compensation expense, and the balance of the notes outstanding as of
June 30, 2004, was $0.
77
(b) PRO FORMA FINANCIAL INFORMATION
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED
FINANCIAL STATEMENTS
The following unaudited pro forma condensed consolidated balance sheet of Triarc
Companies, Inc. ('Triarc' and, together with its subsidiaries, the 'Company') as
of June 27, 2004 and unaudited pro forma condensed consolidated statements of
operations of the Company for the year ended December 28, 2003 and for the six
months ended June 27, 2004 have been prepared by adjusting those financial
statements, as derived and condensed, as applicable, from (i) the consolidated
financial statements of the Company in the Company's Annual Report on Form 10-K
for the fiscal year ended December 28, 2003 (the 'Form 10-K') audited by
Deloitte & Touche LLP and (ii) the unaudited condensed consolidated financial
statements in Triarc's Quarterly Report on Form 10-Q for the fiscal quarter
ended June 27, 2004 (the 'Form 10-Q'), to reflect the acquisition (the
'Deerfield Acquisition') of a 63.6% interest in Deerfield on July 22, 2004 as
previously reported in the Original Form 8-K. The consolidated balance sheet of
Deerfield as of June 30, 2004 and the consolidated statements of operations of
Deerfield for the year ended December 31, 2003 and for the six months ended
June 30, 2004 included in the unaudited pro forma condensed consolidated
financial statements have been derived and condensed, as applicable, from (i)
the consolidated financial statements of Deerfield for the year ended
December 31, 2003 audited by Ernst & Young LLP and (ii) the unaudited
consolidated financial statements of Deerfield for the six months ended
June 30, 2004, both included elsewhere herein. The pro forma adjustments
reflecting the allocation of the purchase price of Deerfield on the pro forma
condensed consolidated balance sheet and the effect thereof on pro forma
adjustments to the pro forma condensed consolidated statements of operations are
based on preliminary estimates and are subject to finalization. The pro forma
condensed consolidated financial statements have been prepared as if the
Deerfield Acquisition had occurred as of June 27, 2004 for the pro forma
condensed consolidated balance sheet and as of December 30, 2002 for the pro
forma condensed consolidated statements of operations. The pro forma adjustments
are described in the accompanying notes to the pro forma condensed consolidated
balance sheet and statements of operations, which should be read in conjunction
with such statements. The unaudited pro forma condensed consolidated financial
statements should also be read in conjunction with (i) the Company's audited
consolidated financial statements and management's discussion and analysis of
financial condition and results of operations contained in the Form 10-K, (ii)
the Company's unaudited condensed consolidated financial statements and
management's discussion and analysis of financial condition and results of
operations contained in the Form 10-Q and (iii) the audited consolidated and
unaudited consolidated financial statements of Deerfield for the year ended
December 31, 2003 and the six months ended June 30, 2004, respectively, both
included elsewhere herein. The unaudited pro forma condensed consolidated
financial statements do not purport to be indicative of the actual financial
position or results of operations of the Company had the Deerfield Acquisition
actually been consummated on June 27, 2004 and December 30, 2002, respectively,
or of the future financial position or results of operations of the Company.
78
TRIARC COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED BALANCE SHEET
JUNE 27, 2004
RECLASSIFICATIONS
AND
AS ADJUSTMENTS FOR
REPORTED DEERFIELD THE ACQUISITION PRO FORMA
-------- --------- --------------- ---------
(IN THOUSANDS)
ASSETS
Current assets:
Cash and cash equivalents............................... $ 493,993 $ 3,021 $ (94,782)(a) $ 402,232
Short-term investments.................................. 205,148 17,750 -- 222,898
Receivables............................................. 22,391 9,829 179 (1) 37,430
5,031 (b)
Inventories............................................. 2,484 -- -- 2,484
Deferred income tax benefit............................. 11,751 -- -- 11,751
Prepaid expenses, restricted cash and other current
assets................................................ 6,934 939 (179)(1) 6,964
(331)(b)
(399)(b)
---------- ------- ------------ ----------
Total current assets................................ 742,701 31,539 (90,481) 683,759
Investment in Deerfield..................................... -- -- 94,782 (a) --
(94,782)(b)
Restricted cash equivalents................................. 32,462 -- -- 32,462
Investments................................................. 39,160 -- -- 39,160
Properties.................................................. 102,273 994 (99)(1) 103,168
Goodwill.................................................... 64,153 -- 57,153 (b) 121,306
Investment management contracts............................. -- -- 27,199 (b) 27,199
Other intangible assets..................................... 7,838 -- 99 (1) 9,240
890 (b)
413 (b)
Deferred costs and other assets............................. 20,937 -- 590 (b) 21,527
---------- ------- ------------ ----------
$1,009,524 $32,533 $ (4,236) $1,037,821
---------- ------- ------------ ----------
---------- ------- ------------ ----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable........................................... $ -- $17,604 $ (211)(b) $ 17,393
Current portion of long-term debt....................... 36,296 -- -- 36,296
Accounts payable........................................ 13,843 -- -- 13,843
Accrued expenses and other current liabilities.......... 78,650 5,815 1,772 (b) 86,237
Current liabilities relating to discontinued
operations............................................ 23,707 -- -- 23,707
---------- ------- ------------ ----------
Total current liabilities........................... 152,496 23,419 1,561 177,476
Long-term debt.............................................. 465,278 -- -- 465,278
Deferred compensation payable to related parties............ 30,694 -- -- 30,694
Deferred income taxes....................................... 45,048 -- -- 45,048
Other liabilities, deferred income and minority interests in
consolidated subsidiaries................................. 31,305 -- 3,317 (b) 34,622
Stockholders' equity:
Class A common stock.................................... 2,955 -- -- 2,955
Class B common stock.................................... 5,910 -- -- 5,910
Additional paid-in capital.............................. 131,754 -- -- 131,754
Retained earnings....................................... 328,314 -- -- 328,314
Common stock held in treasury........................... (227,463) -- -- (227,463)
Deferred compensation payable in common stock........... 43,553 -- -- 43,553
Accumulated other comprehensive deficit................. (320) -- -- (320)
Deerfield members' equity............................... -- 9,114 (9,114)(b) --
---------- ------- ------------ ----------
Total stockholders' equity.......................... 284,703 9,114 (9,114) 284,703
---------- ------- ------------ ----------
$1,009,524 $32,533 $ (4,236) $1,037,821
---------- ------- ------------ ----------
---------- ------- ------------ ----------
79
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED BALANCE SHEET
RECLASSIFICATIONS
(1) To reclassify certain amounts derived from Deerfield's
unclassified consolidated balance sheet as of June 30, 2004
to be consistent with the Company's classified condensed
consolidated balance sheet presentation.
PRO FORMA ADJUSTMENTS
(a) To reflect the Company's investment in Deerfield of
$94,782,000 consisting of the purchase price of $86,532,000
and estimated expenses of $8,250,000, including expenses
reimbursed to a seller.
(b) To record the allocation of the purchase price of Deerfield,
on a preliminary basis subject to finalization, as follows
(in thousands):
DEBIT
(CREDIT)
--------
Eliminate deferred financing costs included in 'Prepaid
expenses, restricted cash and other current assets'....... $ (331)
Record the Company's 63.6% interest in adjustment of
Deerfield's notes payable to fair value................... 211
Record the fair value of the Company's 63.6% interest in
estimated contingent and incentive fees receivable under
certain of Deerfield's investment management contracts in
accordance with a preliminary independent appraisal, the
amounts of which have not yet been recognized by Deerfield
under Deerfield's revenue recognition accounting policy
which is in accordance with accounting principles
generally accepted in the United States of America and of
which $5,031 is expected to be collected within one year
and $590 is expected to be collected after one year....... 5,621
Eliminate deferred acquisition costs included in 'Prepaid
expenses, restricted cash and other current assets'....... (399)
Record the fair value of the Company's 63.6% interest in
Deerfield's investment management contracts in accordance
with a preliminary independent appraisal, consisting of
$14,946 for contracts to serve as the trading advisor for
various fixed income and investment funds and private
investment accounts (the 'Fund Contracts') and $12,253 for
contracts to manage the collateral for various
collateralized debt, loan and bond obligations (the 'CDO
contracts')............................................... 27,199
Record the fair value of the Company's 63.6% interest in
Deerfield's investment management computer software
systems in accordance with a preliminary independent
appraisal................................................. 890
Record the fair value of the Company's 63.6% interest in
Deerfield's non-compete agreements in accordance with a
preliminary independent appraisal......................... 413
Record accrued employee incentive compensation associated
with the Company's interest in estimated contingent and
incentive fees receivable referred to above, in accordance
with an agreement......................................... (1,772)
Record the 36.4% of minority interests in the reported
Deerfield members' equity................................. (3,317)
Eliminate the Company's investment in Deerfield............. (94,782)
Eliminate the reported Deerfield members' equity............ 9,114
Record the excess of the Company's investment in Deerfield
over the Company's interest in the adjusted net assets of
Deerfield as 'Goodwill'................................... 57,153
--------
$ --
--------
--------
80
TRIARC COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
YEAR ENDED DECEMBER 28, 2003
RECLASSIFICATIONS
AND
AS ADJUSTMENTS FOR
REPORTED DEERFIELD THE ACQUISITION PRO FORMA
-------- --------- --------------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Revenues:
Net sales........................................... $201,484 $ -- $ -- $201,484
Royalties and franchise and related fees............ 92,136 -- -- 92,136
Investment management and related fees.............. -- 34,938 343 (1) 35,281
-------- ------- -------- --------
293,620 34,938 343 328,901
-------- ------- -------- --------
Costs and expenses:
Cost of sales, excluding depreciation and
amortization...................................... 151,612 -- -- 151,612
Cost of services, excluding depreciation and
amortization...................................... -- -- 1,627 (1) 2,157
530 (a)
Advertising and selling............................. 16,115 -- -- 16,115
General and administrative.......................... 91,043 23,126 1,176 (1) 116,032
(1,627)(1)
2,314 (a)
Depreciation and amortization, excluding
amortization of deferred financing costs.......... 14,051 721 (25)(b) 17,794
2,685 (c)
297 (d)
65 (e)
Goodwill impairment................................. 22,000 -- -- 22,000
-------- ------- -------- --------
294,821 23,847 7,042 325,710
-------- ------- -------- --------
Operating profit (loss)......................... (1,201) 11,091 (6,699) 3,191
Interest expense........................................ (37,225) (503) 271 (f) (37,629)
(172)(g)
Insurance expense related to long-term debt............. (4,177) -- -- (4,177)
Investment income, net.................................. 17,251 1,599 (1,327)(h) 17,523
Gain related to proposed business acquisition not
consummated........................................... 2,064 -- -- 2,064
Gain on sale of business................................ 5,834 -- -- 5,834
Other income (expense), net............................. 2,881 351 (343)(1) 2,889
(1,176) 1,176 (1)
-------- ------- -------- --------
Income (loss) from continuing operations before
income taxes and minority interests........... (14,573) 11,362 (7,094) (10,305)
(Provision for) benefit from income taxes............... 1,371 (249) (2,544)(i) 759
2,181 (j)
Minority interests in (earnings) loss of consolidated
subsidiaries.......................................... 119 -- (4,045)(k) (2,891)
1,035 (l)
-------- ------- -------- --------
Income (loss) from continuing operations........ $(13,083) $11,113 $(10,467) $(12,437)
-------- ------- -------- --------
-------- ------- -------- --------
Basic and diluted loss from continuing operations per
share of class A common stock and class B common
stock................................................. $ (.22) $ (.21)
-------- --------
-------- --------
81
TRIARC COMPANIES, INC. AND SUBSIDIARIES
UNAUDITED PRO FORMA CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
SIX MONTHS ENDED JUNE 27, 2004
RECLASSIFICATIONS
AND
AS ADJUSTMENTS FOR
REPORTED DEERFIELD THE ACQUISITION PRO FORMA
-------- --------- --------------- ---------
(IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
Revenues:
Net sales........................................... $ 99,385 $ -- $ -- $ 99,385
Royalties and franchise and related fees............ 47,271 -- -- 47,271
Investment management and related fees.............. -- 23,888 2,115 (1) 26,003
-------- ------- -------- --------
146,656 23,888 2,115 172,659
-------- ------- -------- --------
Costs and expenses:
Cost of sales, excluding depreciation and
amortization...................................... 78,989 -- -- 78,989
Cost of services, excluding depreciation and
amortization...................................... -- -- 950 (1) 1,215
265 (a)
Advertising and selling............................. 8,796 -- -- 8,796
General and administrative.......................... 48,782 13,399 686 (1) 63,652
(950)(1)
1,735 (a)
Depreciation and amortization, excluding
amortization of deferred financing costs.......... 6,815 231 (20)(b) 8,615
1,409 (c)
148 (d)
32 (e)
-------- ------- -------- --------
143,382 13,630 4,255 161,267
-------- ------- -------- --------
Operating profit................................ 3,274 10,258 (2,140) 11,392
Interest expense........................................ (18,638) (276) 143 (f) (18,862)
(91)(g)
Insurance expense related to long-term debt............. (1,949) -- -- (1,949)
Investment income, net.................................. 11,169 1,532 (1,232)(h) 11,469
Costs related to proposed business acquisition not
consummated........................................... (767) -- -- (767)
Other income (expense), net............................. 1,528 2,184 (2,115)(1) 1,597
(686) 686 (1)
-------- ------- -------- --------
Income (loss) before income taxes and minority
interests..................................... (5,383) 13,012 (4,749) 2,880
(Provision for) benefit from income taxes............... 941 (197) (2,934)(i) (742)
1,448 (j)
Minority interests in (earnings) loss of consolidated
subsidiaries.......................................... 10 -- (4,665)(k) (3,927)
728 (l)
-------- ------- -------- --------
Net income (loss)............................... $ (4,432) $12,815 $(10,172) $ (1,789)
-------- ------- -------- --------
-------- ------- -------- --------
Basic and diluted net loss per share of class A common
stock and class B common stock........................ $ (.07) $ (.03)
-------- --------
-------- --------
82
NOTES TO UNAUDITED PRO FORMA CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
RECLASSIFICATIONS
(1) To reclassify certain amounts derived from Deerfield's
consolidated statements of operations for the year ended
December 31, 2003 and the six months ended June 30, 2004 to
be consistent with the Company's condensed consolidated
statement of operations presentation.
PRO FORMA ADJUSTMENTS
(a) To record the increase in salaries and bonuses associated
with certain Deerfield employment contracts, the entrance
into which is directly attributable to the Deerfield
Acquisition.
(b) To reverse Deerfield's reported amortization of deferred
acquisition costs.
(c) To record the amortization of investment management
contracts recorded in the Deerfield Acquisition over the
estimated remaining life of 15 years for the Fund Contracts
and over the remaining respective lives ranging from less
than one year to over 27 years for the CDO Contracts.
(d) To record the amortization of investment management computer
software systems recorded in the Deerfield Acquisition over
their estimated remaining useful life of 3 years.
(e) To record the amortization of non-compete agreements
recorded in the Deerfield Acquisition over their respective
useful lives ranging from 2 1/2 to 8 years.
(f) To reverse Deerfield's reported amortization of deferred
financing costs.
(g) To record the amortization of the fair value adjustment to
notes payable recorded in the Deerfield Acquisition over the
expected remaining duration of the related notes.
(h) To reverse interest income on the $94,782,000 of cash and
cash equivalents used by the Company in the Acquisition,
consisting of purchase price and estimated expenses,
computed using the Company's average rates on its
interest-bearing investments of 1.4% and 2.6% per annum for
the year ended December 28, 2003 and the six months ended
June 27, 2004, respectively.
(i) To reflect Triarc's income tax provision on Deerfield's
reported net income, net of minority interests reflected in
entry (k) below, at Triarc's incremental income tax rate of
36%.
(j) To reflect the income tax provision on the net effect of the
above adjustments, net of the effect of minority interests
reflected in entry (l) below, at Triarc's incremental income
tax rate of 36%.
(k) To reflect the 36.4% of minority interests in Deerfield's
reported net income.
(l) To reflect the 36.4% of minority interests effect of entry
(a) above.
83
(c) EXHIBITS
EXHIBIT
NO. DESCRIPTION
------- -----------
10.6 Employment Agreement, dated as of June 26, 2004, by and
among Deerfield & Company LLC, Deerfield Capital Management
LLC and Gregory H. Sachs, previously filed as exhibit 10.6
to Triarc's Current Report on Form 8-K filed on July 22,
2004 (SEC file no. 1-2207).
10.7 Supplement, dated as of July 14, 2004, to the Employment
Agreement, dated as of June 26, 2004, by and among Deerfield
& Company LLC, Deerfield Capital Management LLC and Gregory
H. Sachs, previously filed as exhibit 10.7 to Triarc's
Current Report on Form 8-K filed on July 22, 2004 (SEC file
no. 1-2207).
10.8 First Amendment to Purchase Agreement, dated as of July 22,
2004, by and among Triarc Companies, Inc., Sachs Capital
Management LLC, Deerfield Partners Fund II LLC, Scott A.
Roberts, Marvin Shrear and Gregory H. Sachs, previously
filed as exhibit 10.8 to Triarc's Current Report on Form 8-K
filed on July 22, 2004 (SEC file no. 1-2207).
10.9 First Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of July 22,
2004, previously filed as exhibit 10.9 to Triarc's Current
Report on Form 8-K filed on July 22, 2004 (SEC file
no. 1-2207).
10.10 Second Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of August 16,
2004.
10.11 Third Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of August 20,
2004.
23.1 Consent of Independent Registered Public Accounting Firm.
99.1 Press release dated July 22, 2004, previously filed as
exhibit 99.1 to Triarc's Current Report on Form 8-K filed on
July 22, 2004 (SEC file no. 1-2207).
84
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
TRIARC COMPANIES, INC.
(Registrant)
Date: October 5, 2004 By: /s/ Francis T. McCarron
----------------------------
Francis T. McCarron
Senior Vice President and
Chief Financial Officer
85
EXHIBIT INDEX
EXHIBIT
NO. DESCRIPTION
------- -----------
10.6 Employment Agreement, dated as of June 26, 2004, by and
among Deerfield & Company LLC, Deerfield Capital Management
LLC and Gregory H. Sachs, previously filed as exhibit 10.6
to Triarc's Current Report on Form 8-K filed on July 22,
2004 (SEC file no. 1-2207).
10.7 Supplement, dated as of July 14, 2004, to the Employment
Agreement, dated as of June 26, 2004, by and among Deerfield
& Company LLC, Deerfield Capital Management LLC and Gregory
H. Sachs, previously filed as exhibit 10.7 to Triarc's
Current Report on Form 8-K filed on July 22, 2004 (SEC file
no. 1-2207).
10.8 First Amendment to Purchase Agreement, dated as of July 22,
2004, by and among Triarc Companies, Inc., Sachs Capital
Management LLC, Deerfield Partners Fund II LLC, Scott A.
Roberts, Marvin Shrear and Gregory H. Sachs, previously
filed as exhibit 10.8 to Triarc's Current Report on Form 8-K
filed on July 22, 2004 (SEC file no. 1-2207).
10.9 First Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of July 22,
2004, previously filed as exhibit 10.9 to Triarc's Current
Report on Form 8-K filed on July 22, 2004 (SEC file
no. 1-2207).
10.10 Second Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of August 16,
2004.
10.11 Third Supplement to Fourth Amended and Restated Operating
Agreement of Deerfield & Company LLC, dated as of August 20,
2004.
23.1 Consent of Independent Registered Public Accounting Firm.
99.1 Press release dated July 22, 2004, previously filed as
exhibit 99.1 to Triarc's Current Report on Form 8-K filed on
July 22, 2004 (SEC file no. 1-2207).
86