1. business and industrial

INDEX NO. 653652/2013
FILED: NEW YORK COUNTY CLERK 11/08/2013
NYSCEF DOC. NO. 12
RECEIVED NYSCEF: 11/08/2013
Affirmation of Daniel Tepper dated November 8, 2013
Exhibit B
CUM
AD V ISO RY
G R O UP
October 21, 2013
Mark C. Rifkin, Esq.
Wolf Haldenstein Adler Freeman &Herz LLP
270 Madison Avenue
New York, NY 10016
Re:
Zelouf International Corp. v. Nahal Zelouf
Dear Mr. Rifkin:
Executive Summary
Marcum LLP ("Marcum") was engaged by the law firm Wolf Haldenstein Adler Freeman &Herz
LLP ("Wolf Haldenstein") to provide consulting services in connection with your representation
of Mrs. Nahal Zelouf("Mrs. Zelouf'). Specifically, we are providing our opinion on (i) what
would be an appropriate range of discounts for lack of marketability, assuming such a discount
would apply, and (ii) the appropriate pass-through entity adjustment (if any), to the value of
Zelouf International Corp. ("ZIC" or the "Company"), including the Legacy Customers 1, as
presented in Kevin Vannucci's ("Vannucci") report (the "Vannucci Report") dated August 6,
2013.
Vannucci was engaged to:
A. Determine the fair value of ZIC as of December 31, 2012 under the following two scenarios
only:
I.
II.
On a controlling basis with no applicable discount for lack of marketability("DLOM")
On a controlling basis with the application of an appropriate DLOM.
B. Determine the fair value of Zelouf West customers that were, at one time, customers of ZIC
or are common to both ZIC and Zelouf West (collectively the "Legacy Customers") as of
December 31, 2012.
It is our understanding that the users of this report are familiar with the facts of the above named
litigation. Therefore we have not provided a detailed description of the case background.
Legacy Customers are defined as Zelouf West Ltd.("Zelouf West") customers that were, at one time, customers of
ZIC or are common to both ZIC and Zelouf West as of De~{nber 31, 2012.
LW
MARCUMGROI!P
M E M B ER
Marcum ur s 10 Melville Park Road ■Melville, New York 11747 ■Phone 631.414.4000 ■Fax 631.414.4001 ■ rtlarCufl111p.Cort1
Mark C. Riflcin, Esq.
October 21, 2013
Page 2
Based on our analysis of the Vannucci Report, our experience, education, and related research it
is our opinion that:
• If a DLOM is applied in this matter, which may not be applicable, the DLOM applicable
to a controlling interest in ZIC should be in the range of0 percent to 15 percent.
It was inappropriate for Vannucci to use the S Corporation Economic Adjustment Model
("SEAM")to take into account the benefit of ZIC's S corporation status when calculating
the fair value of ZIC on controlling interest basis. However, if apass-through premium
was to be applied, hypothetically, to the facts in this case, it is our opinion that a blended
income tax rate of the three shareholders of 29.7 percent would have been potentially
more applicable in the calculation of the SEAM. The use of a blended tax rate would
result in apass-through entity premium of 37.8 percent.
Documents Provided
We were provided with the following documentation for consideration in our analysis:
•
•
•
•
Valuation report for mediation purposes of Kevin Vannucci, dated August 6, 2013
Restated Affidavit of Elliot Lesser dated May 1, 2013
2007 to 2011 Kls from Zelouf International Corp. to Nahal Zelouf
2008 to 2010 Personal Income Tax Returns (Forms 1040) for Emil Zelouf and Nahal
Zelouf
• Summons and Complaint, dated December 14, 2009
• Plaintiff's Memorandum in Opposition of Individual Defendants' Motion for Summary
Judgment, dated July 31, 2012
Standard, Definition and Premise of Value
The standard of value applicable for the purpose of this engagement is fair value. Fair value is a
legally-created standard of value that is applied in certain situations. Generally, fair value is
applicable in cases involving a dissenting shareholder's valuation rights. New York BCL §623
sets forth the procedures to be utilized by a shareholder to enforce his or her right to receive
payment for his or her shares in the corporation. BCL §623 also states that the shareholder is to
be paid fair value for his or her shares.
Since the definition of fair value varies from state to state, we have been guided by New York
State case law dealing with fair value. It is our understanding that the fair value standard under
New York State case law is not equivalent to fair market value. Under New York case law, fair
value is the standard a dissenting shareholder should be paid for his or her proportionate interest
in the going concern of the business, not reduced by a DLOM.
Mark C. Riflcin, Esq.
October 21, 2013
Page 3
DISCOUNT FOR LACK OF MARKETABILITY
As stated above, Vannucci was engaged to determine the fair value of ZIC as of December 31,
2012 under the following two scenarios only:
On a controlling basis with no applicable discount for lack of marketability("DLOM")
II.
On a controlling basis with the application of an appropriate DLOM.
Both scenarios include valuing ZIC on a "controlling basis" and as such the use of a large
DLOM (30 percent) is incorrect. A DLOM is applied in order to account for the non-marketable
nature of the shares being valued, converting anon-marketable level of value into a marketable
level of value. The Vannucci Report applies a DLOM that is applicable to a minority interest
(the resultant DLOM in the Vannucci Report approximates the median DLOM of the restricted
stock studies and is above the discounts calculated utilizing the protective put analysis).
However, the Vannucci Report applies this minority level DLOM to a controlling interest in the
Company, which is an obvious mismatch. DLOMs for controlling interests are typically less
than those for minority interests because it is much easier to sell a "controlling interest" in a
company. The Vannucci Report values the Company on a controlling basis; therefore a lower
DLOM than those indicated by the restricted stock studies should have been applied to the
Company. Therefore, the DLOM applied to a controlling interest in ZIC should be eliminated or
should be much lower than the 30 percent utilized in the Vannucci Report.
The Vannucci Report acknowledges that this mismatch does exist(See Vannucci Report, Page 9,
Footnote 22).
"I note that typically, a discount for lack of marketability is usually only
applicable for valuations of minority interests in closely-held companies under the
assumption that a controlling owner would be able to force the sale of the
company. However, at the direction of counsel, and consistent with the scope of
my valuation assignment I have assumed a hypothetical condition by including
the discount for lack of marketability to conclude on what the value of ZIC is on a
controlling, non-marketable basis."
We disagree with this hypothetical condition for the reasons discussed below.
The Vannucci Report determines the DLOM based on an analysis of restricted stock studies, an
analysis of Mandelbaum Factors and the preparation of a protective put analysis.
Restricted Stock Studies
Vannucci uses a DLOM of 30 percent based on the use of Empirical Studies (see Vannucci
Report Schedule D 1), which results in a mean discount of 29.9 percent and a median discount of
31.9 percent. Based on these studies Vannucci selects a DLOM of 30 percent. Vannucci
footnotes in his report that "The selected DLOM is based on the DLOM studies and the
qualitative company specific factors discussed on Schedule D2 [of the Vannucci Report] —
Discount for Lack of Marketability: Company Specific Mendelbaum [sic] Factors (See the
Vannucci Report, Schedule D1, Footnote 3)."
Mark C. Rifkin, Esq.
October 21, 2013
Page 4
However, the restricted stock studies are based on minority interests and are therefore not
applicable to a control interest. In valuing a control interest at an enterprise level, a small
DLOM may be applied to account for the non-marketability of the shares, if one is taken at all.
Mandelbaum Factors
Vannucci Report- Discount for Lack of Marketability: Company Specific Mandelbaum Factors
Description
' Effed on Adjust
Factor
Level of assurance embodied in the financial
information provided
Federal income tax returns and reviewed
financial statements
Neutral
At the discretion of the Board of Directors,
historically dividends not paid
Increase
Dividend policy
Nature of the company, its history, its position in
the industry, and its economic outlook
Company's economic outlook indicate above'
average risk
increase
Management
Competent management
Neutral
Amount of control in transferred interest
Dissenting shareholder case
N/A
Restrictions on transferability of interest
'Requires consent from general partners
Increase
Expected holding period for the interest
'Long-term
Increase
Company's redemption policy
None
Neutral
As can be seen from the above excerpt from the Vannucci Report (Schedule D2), there are four
factors that Vannucci believes lead to an increase in the DLOM adjustment, three factors that he
believes are neutral and one factor that he believes is not applicable. However, in ignoring the
control aspects of the subject interest being valued, the Vannucci Report overstates the
applicable DLOM.
Dividend Policy
The Vannucci Report lists the "dividend policy" of the Company as a factor that would increase
the DLOM applicable to the subject interest. The Vannucci Report states that the dividends are
paid at the discretion of the Board of Directors and that historically dividends were nod paid.
However, Vannucci makes a normalization adjustment to his valuation for excess compensation
and non-business related perks paid through ZIC for the benefit of Danny Zelouf and Rony
Zelouf, the controlling shareholders. The excess compensation and non-business related perks
paid through ZIC for the benefit of Danny Zelouf and Rony Zelouf are actually disguised
distributions. The Vannucci Report apparently ignores the fact that the subject interest is
Mark C. Rifkin, Esq.
October 21, 2013
Page 5
assumed to be a controlling interest and could therefore control discretionary expenses as
discussed above, and can determine the Company's dividend/distribution paying policy.
Therefore, the "dividend policy" factor should actually decrease (or even eliminate) the
appropriate DLOM to the subject interest. We discuss other pertinent factors below.
Control adjustments: As discussed in the Vannucci Report, based on the unreliability of ZIC's
financial information, Vannucci normalized ZIC's cost of goods sold and corresponding gross
profit margin to be consistent with industry benchmarks2. Additionally, Vannucci adjusted the
level of officers' and owners' compensation to industry levels based on industry data and
removed the compensation for the "no show" employee. Vannucci also adjusted for excess car
payments made by ZIC and for non-operating litigation related income and expenses.
Specifically, Vannucci adjusted operating expenses by $649,000 in 2010, $1,625,000 in 2011,
and $1,471,000 in 2012 (See Vannucci Report Schedule A9). Adjustments were made for the
excess payment of salaries compared to industry benchmarks, excess rent expense, excess auto
expense, shareholder dispute legal expenses and other litigation related expenses. These
adjustments were for expenses paid through ZIC that would not have been paid by a third party
owner as business expenses, therefore an adjustment was made to normalize ZIC's net operating
income. It is our opinion that these normalization adjustments are disguised distributions to
Danny Zelouf and Rony Zelouf, which if not paid to Danny Zelouf and Rony Zelouf through
excess salary and perks would have been available to all of the shareholders in the form of
distributions. There was no need for ZIC's controlling shareholders to declare a dividend, which
they would have had to share with Mrs. Zelouf, when they were paying themselves excess
compensation and non-business related perks. This is part of the oppressed shareholder facts of
the case.
Accounts Receivable: Furthermore, unadjusted accounts receivable grew from approximately
$2.9 million in 2007 to $6.4 million in 2012, which is a CAGR of 17.13 percent (See Vannucci
Report, Schedule A1). However unadjusted gross revenue grew from approximately $32.5
million in 2007 to approximately $36.5 million in 2012, which is a CAGR of 2.35 percent (See
Vannucci Report, Schedule AS). Vannucci does not include an analysis or explanation for why
accounts receivable grew at a much faster pace when compared to gross revenue. From a
forensic point of view one theory for the disproportionate increase in accounts receivable
compared to revenue would be that loans were made from ZIC to individuals or other related
entities, which were recorded in ZIC's books and records as accounts receivable. This theory
leads to the possibility of additional disguised dividends paid from ZIC for the benefit of Danny
Zelouf and Rony Zelouf.
~ Risk Management Association eStatement Studies for NAICS 424310 —Piece Goods, Notions &Other Apparel
Wholesaling, companies with over $25 million of sales.
Mark C. Rifkin, Esq.
October 21, 2013
Page 6
Available EBITDA/Cash Flow: Historical EBITDA ranged from a low of(7.3%) of revenue in
2008 to a high of 4.6% of revenue in 2010 (See Vannucci Report, Schedule A6). Historical
EBITDA was 4.6% of revenue in 2010, (0.8%) of revenue in 2011 and (0.9%) of revenue in
2012. Adjusted EBITDA ranged from a low of 2.1% of revenue in 2012 to a high of 9.5% of
revenue in 2007 (See Vannucci Report, Schedule A8). Adjusted EBITDA was 7.9% of revenue
in 2010, 5.3% of revenue in 2011 and 2.1% of revenue in 2012. Based on Vannucci's adjusted
EBITDA percentages, there were sufficient EBITDA to pay dividends to all shareholders.
For these reasons, we believe Vannucci's opinion that "historically dividends were not paid" is
not entirely accurate. Dividends were paid to Danny Zelouf and Rony Zelouf, the controlling
shareholders, in the form of excess compensation and non-business related perks. By paying
themselves excess compensation and paying for non-business related expenses through the
business, Danny Zelouf and Rony Zelouf bypassed having to pay Mrs. Zelouf her share of
distributions, resulting in her oppressed shareholder claim. As a result of the disguised
distributions, we believe Vannucci erroneously labels the effect on the DLOM for non-payment
of dividends as an increase in the DLOM when in effect since disguised distributions were
actually paid and adjusted EBITDA was sufficient to pay dividends the effect on the DLOM
adjustment should actually be a decrease in the DLOM.
Furthermore, since, a controlling shareholder could control both discretionary expenses and the
Company's dividend/distribution paying policy, the "dividend policy" factor should actually
decrease (or even eliminate) the appropriate DLOM to the subject interest.
Nature o the Company, Its History Its Position in the Industry and Its Economic Outlook
The Vannucci Report states that ZIC's economic outlook indicates above average risk. While
Vannucci's industry analysis points to an industry in decline, ZIC's adjusted historical financial
statements report results that surpass industry benchmarks. ZIC also has a very strong balance
sheet; with assets far exceeding liabilities. Additionally, ZIC has no recorded debt on its balance
sheet from 2010 to 2012 and ZIC's debt ratio from 2007 to 2009 was between 2.8 percent and 15
percent(See Vannucci Report, Schedule B3). The industry benchmarks3 report a debt ratio from
2007 to 2012 between 23.3 percent (2010) and 30.8 percent (2009). The industry benchmark
debt ratio in 2012 was 25.9 percent. The absence of company debt makes ZIC an attractive
investment to a potential third party buyer and as a result would lower the DLOM. The absence
of debt also puts the company in a stronger position than the industry in a period of economic
downturn, further supporting a lower DLOM.
ZIC is also a very liquid company, its current ratio and quick ratio are both greater than the
industry benchmarks in all of the periods analyzed by Vannucci (See Vannucci Report, Schedule
B3). The current ratio is a liquidity ratio that measures a company's ability to pay its short term
Risk Management Association eStatement Studies for NAICS 424310 —Piece Goods, Notions &Other Apparel
Wholesaling, companies with over $25 million of sales.
3
Mark C. Riflcin, Esq.
October 21, 2013
Page 7
obligations. ZIC's current ratio ranged from 5.4 percent(2007)to 16.3 percent in 2008, while its
current ratio in 2012 was 5.9 percent. The industry benchmark's current ratio ranged from a low
of 1.3 percent in 2007 to 1.9 percent in 2010 and was 1.6 percent in 2012. ZIC's higher current
ratio puts it in a better position financially than the industry benchmarks, and this supports a
lower DLOM.
ZIC's quick ratio ranged from 3.0 percent (2007) to 8.4 percent (2010). The quick ratio
measures a company's ability to meet its short-term obligations with its most liquid assets. The
industry benchmark quick ratio ranged from a low of 0.6 percent in 2009 to 0.8 percent in 2010,
2011 and 2012. The quick ratio is also an indicator of a company's short-term liquidity. A
higher quick ratio typically indicates a better liquidity position for a company. Again, ZIC's
higher quick ratio when compared to the industry benchmarks would support a lower DLOM.
Restrictions on Trans erability ofthe Interest
The Vannucci Report lists the "restrictions on transferability of the interest" as a factor that
would increase the DLOM applicable to the subject interest, and states that transferability
requires consent from the general partners. This ignores the fact that a controlling interest would
be able to consent to the transfer of shares at their discretion, therefore increasing the
marketability of the subject interest. Therefore, the "restrictions on transferability of the
interest" factor should actually decrease (or even eliminate) the appropriate DLOM to the subject
interest.
Expected Holding Period ofthe Interest
The Vannucci Report lists the "expected holding period of the interest" as a factor that would
increase the DLOM applicable to the subject interest. This ignores the fact that a controlling
interest would be able to liquidate the Company at their discretion, therefore increasing the
marketability of the interest. Therefore, the "expected holding period of the interest" factor
should actually decrease (or even eliminate) the appropriate DLOM to the subject interest.
Amount ofControl in Transferred Interest
The Vannucci Report lists the "amount of control in transferred interest" as a factor that did not
impact the DLOM applicable to the subject interest. This ignores the fact that the Court
instructed the appraisal of a controlling interest. Based on the Vannucci Report, Page 9,
Footnote 22, if this factor were considered, no discount for lack of marketability world be
applicable.
Protective Put Analysis
Vannucci uses a protective put analysis to determine the floor of his implied DLOM (See
Vannucci Report, Schedule D3). Using a holding period of between one to seven years
Vannucci comes up with a discount ranging from 6.0 percent to 24.8 percent. Vannucci then
selects an even larger discount of 30.0 percent as the DLOM applicable to ZIC, which is even
greater than the "floor" range of value of 6.0 percent to 24.8 percent.
Mark C. Riflcin, Esq.
October 21, 2013
Page 8
However, this protective put analysis is inapplicable in this instance since there is no public
market evidence of protective puts for the entire interest of a company. This would assume,
among other things, that someone holds the other side of the put option. Further, there are
certain factors that go into a put analysis, (expected holding period, dividend yield) that are
conceivably controlled and could be modified by the controlling shareholders. Therefore,
applying the result of a protective put analysis to a controlling interest is incorrect.
New York State Case Law
Recent New York State case law points to the use of no DLOM or a DLOM that is generally
lower than the 30 percent used by Vannucci in his report(See Exhibit A).
S CORPORATION PREMIUM
The Vannucci Report calculates an S corporation premium of 18.4 percent as applicable to the
subject controlling interest. We note that S corparation premiums are typically not applicable to
controlling interests under the assumption that a controlling owner would be able to change the
structure of the company to maximize shareholder value. Therefore, in our opinion, it was
inappropriate to use the SEAM calculation to take into account the benefit of ZIC's S
corporation status when calculating ZIC's fair value on a controlling basis.
However, if the SEAM calculation was to be applied, hypothetically, under the facts of this case,
then it would be potentially more applicable to apply an individual income tax rate as if all three
shareholders were selling at fair value. Assuming that Danny Zelouf and Rony Zelouf were at
the highest individual income tax rate of 39.6 percent and Mrs. Zelouf's individual income tax
rate was zero, their blended individual income tax rate would be 29.7 percent.4
By using a 29.7 percent blended individual income tax rate, the SEAM adjustment would be 37.8
percent. I understand from Appendix C to the Vannucci Report that Vannucci did not consider
or rely upon Mrs. Zelouf's individual tax circumstances since he was not provided with any of
her recent income tax returns and was, therefore, unaware of her actual marginal tax rate.
Conclusion
Control value, refers to the value of the enterprise as a whole. As such, a valuation on a c9ntrol
basis, valuing the enterprise as a whole, is not consistent with the application of a DLOM.
However, taking into account a small discount for the non-marketability of the shares may be
appropriate with a valuation on a going concern basis and should be decided based on the
circumstances of each company.
4
This was calculated as((75% x 39.6% = 29.7%)+(25% x 0% = 0%))= 29.7%
Mark C. Rifkin, Esq.
October 21, 2013
Page 9
Based on our analysis of the specifics of the operations of ZIC, it is our opinion that if the Trier
of Fact decides that the application of a DLOM is appropriate to the subject interest, the
appropriate DLOM should range from 0 percent to 15 percent, much lower than the 30 percent
utilized in the Vannucci Report.
Further, while it is our opinion that the use of apass-through premium is not applicable to the
valuation of a controlling interest, if it was to hypothetically be applied in this case, the premium
potentially would have been more applicable had it been based on a blended tax rate of the three
shareholders' individual income tax rates of 29.7 percent and not the highest individual income
tax rate of 39.6 percent. This would result in apass-through entity premium of 37.8 percent,
which is much higher than the 18.4 percent used in the Vannucci Report.
We hold these opinions to a reasonable degree of certainty. We reserve the right to supplement
this report for additional information received.
Very truly yours,
cum LLP
~_
James T. Ashe, CPA, MAFF,CFF
KES/th
s:Abusiness\word~rocessing\common\finalized\advisory\zeloufl2013\letter\139079 report 102113.docx
Giaimo v. Vitale
36299/2012
Nilvia Ruggiero Individually and as Executrix of the Estate of
Anthony Ruggiero, PlaintifT, -against- Pasquale Ruggiero, and 784
8th Street Corp., dba Zan's Kosher Delicatessen &Restaurant,
Defendants
101 A.D3d 523(1st
Dept, December 20,
2012)
Index No.
002640/2006
Mater
Edward Murphy, et al., Petitioners, Shareholders in United States
Dredging Corporation, -against- United States Dredging Corporation,
et al., Respondents
Supreme Court of New York;
Appellate Division, First
Department
16%discount for lack of marketability
Supreme Court, State of New "The sole issue the Court had with Mr. Glazer's [Defendants expert]
York, Suffolk County
valuation was his 20%discount for lack oT marketability for which he did
not provide sufficient explanation. In this sense, the Court agreed with
Plaintiff's expert that Zan's does constitute a somewhat unique niche
business. Thus, the Court removed from Mr. Glazer's calculation the
deduction of the $54,620(20%]for lack of marketability."
Venue
Findines
Supreme Court of New York, Found that a "DLOM was appropriate in determining Fair Value.
Nassau County
Respondents expert used 15%,an amount that is less than that used in some
cases but an amount that Petitioner's expert would also use but for the fact
that he has concluded that no discount of this nature is appropriate under the
facts."
Recent New York State Court Cases
Nahal Zelouf v. Danny Zelou[, Rony Zelouf, and ZelouC International Corp.
REHC
Kosher
Delicatessen &
Restaurant
Tvne of Entiri
REHC
Exhibit A