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MAC Clauses and Indemnification Provisions in M&A Deals

Structuring Terms to Minimize Transaction Risks and Post-Closing Disputes

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John C. Partigan, Partner, Nixon Peabody, Washington, D.C. Jeff J. Litvak, Senior Managing Director—Forensic Litigation, FTI Consulting, Chicago

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MAC Clauses and Indemnification Provisions in M&A Deals

Structuring Terms to Minimize Transaction Risks and Post-Closing Disputes

 December 5, 2013

14730531.1

Today's Presenters

6

 John C. Partigan Nixon Peabody LLP jpartigan@nixonpeabody.com  Jeff Litvak FTI Consulting jeff.litvak@fticonsulting.com

 Agenda  Negotiating MAC Clauses  Negotiating Indemnification Provisions  Reassessing Common Provisions Favorable to Sellers  Overview of Merger and Acquisition Transactions and Disputes  The CPA’s Role in Pricing MAC and Benefit of the Bargain Claims

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MAC Clauses and Indemnification provisions in M&A Deals

MAC CLAUSES AND INDEMNIFICATION PROVISIONS IN M&A DEALS

NEGOTIATING MAC CLAUSES

9 9

NEGOTIATING MAC CLAUSES WHAT IS A MAC?

Means of allocating risks between signing and closing MACs used in different parts of the acquisition agreement: Representations, Warranties and Covenants – used to establish a threshold for determining the scope of disclosure or compliance relating to risks associated with changes in the target’s business — A representation may provide that the target has complied with ERISA except as would not have a Material Adverse Effect. — The agreement may include a separate representation regarding non-occurrence of MAC since a given date

NEGOTIATING MAC CLAUSES WHAT IS A MAC?

Closing Condition - used to delineate the circumstances under which a bidder would be permitted to abandon the transaction without liability: Frequently referred to as a “MAC out” – appears in the conditions precedent to the bidder’s obligation to close 98% of the publicly filed deals surveyed included a MAC closing condition*

*Nixon Peabody’s 2013 MAC Survey, analyzing 195 publicly filed acquisition agreements, including asset purchase, stock purchase and merger agreements for transactions with values ranging from $100 million to $54 billion that were dated between June 1, 2012 and May 31, 2013 (“2013 NP MAC Survey”).

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NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D.)

Sample standalone rep provision: “During the period from the Balance Sheet Date to the date hereof…there has been no Material Adverse Effect and, to the Knowledge of the Company, no fact or condition exists

• r is contemplated or threatened which might reasonably

be expected to cause a Material Adverse Effect.”

NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D)

Sample closing condition provisions: — “Buyer’s obligation to consummate the transactions contemplated by this Agreement is subject to the satisfaction of the following conditions. . . — The representations and warranties of Seller contained in this Agreement were accurate as of the date of this Agreement and are accurate as of the Closing Date, except for any inaccuracy that would not, individually or in the aggregate, reasonably be expected to result in a [MAC].” or — “There shall not have occurred a [MAC] in the Company.”

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NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D.)

— Simple “MAC” definition: “Material Adverse Change” means any material adverse change in the business, results of operations, assets, liabilities or financial condition of Seller, taken as a whole — Drafting Issues to Consider

• Inclusion of forward-looking standard in MAC definition?

 Forward-looking standard was included in MAC definition 53% of the time*  Example: “any event, change or effect that could reasonably be expected to be materially adverse to the business…”

*Source: 2013 NP MAC Survey.

14 14

NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D.)

• Inclusion of “prospects” in MAC definition?

 According to the 2012 SRS Study, “prospects” included 13%

• f the time, down from 25% in 2009**

 Less prevalent in public deals where walk away right for MAC – none of the top 100 publicly filed deals surveyed recently included “prospects”*

• Quantify materiality?

 According to a 2011 ABA Study, stated dollar amount included in MAC only 8% of the time***

** Source: 2012 SRS M&A Deal Terms Study, analyzing private target deals between 2009 and the end of Q3 2012 (“2012 SRS Study”). ***Source: 2011 Private Target Mergers & Acquisitions Deal Points Study (“2011 ABA Study”)

NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D.)

Inclusions and Carve-outs — On average, 13 carve-outs per agreement* — Disproportionate affects qualifier included in MAC definition 89% of the time* — Changes in general economic conditions (95%)* — Changes affecting industry as a whole (91%)* — Changes in GAAP (84%)* — Announcement of Agreement (88%)* — Actions contemplated by the Agreement (73%)* — Employee attrition (40%)*

*Source: 2013 NP MAC Survey.

NEGOTIATING MAC CLAUSES WHAT IS A MAC? (CONT’D)

Inclusions and Carve-outs (each carve-out has the effect of diluting the definition from the perspective of the Buyer): — Acts of war or major hostilities (88%)* — Acts of terrorism (87%)* — Acts of God (67%)* — Change in political conditions (72%)* — Reduction of customers or decline in business (35%)* — Litigation resulting from any law relating to the agreement or the transactions contemplated (41%)* — Failure to meet revenue or earnings projections (80%)* — Changes in securities markets (62%)* — Changes in interest rates (37%)*

*Source: 2013 NP MAC Survey.

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NEGOTIATING MAC CLAUSES WHAT DOES CASE LAW TEACH US?

Case Law — In re IBP, Inc. Shareholder Litigation (Del. Ch. 2001) (“Tyson Foods”)

• Delaware court interpreting New York law
• Tyson sought to terminate deal based upon sharp earnings

decline of IBP

• Court granted specific performance to IBP
• In absence of specific language, earnings volatility does not

constitute a MAC — Frontier Oil Corp. v. Holly Corp. (Del. Ch. 2005)

• Buyer sought to terminate for MAC based upon threatened toxic

tort litigation

• Court found that requisite likelihood of “catastrophic” result not

established to constitute a MAC

• Potential litigation costs of $15 million to $20 million relative to a

deal size of approximately $340 million

18 18

NEGOTIATING MAC CLAUSES WHAT DOES CASE LAW TEACH US?

— United Rentals, Inc. v. Ram Holdings, Inc. (Del. Ch. 2007)

• MAC clause excluded the condition of the credit markets in the United

States

• However, specific performance not granted – the merger agreement

was ambiguous on the subject and evidence established an understanding between the parties that the merger agreement barred the remedy of specific performance

• Cerberus acquisition subsidiary required to pay $100 million

termination fee

19 19

NEGOTIATING MAC CLAUSES WHAT DOES CASE LAW TEACH US?

— Hexion Specialty Chemicals, Inc. v. Huntsman Corp. (Del. Ch. 2008)

• No financing out
• Fairly typical MAC out (with limited carve-outs)
• Reverse break-up fee if buyer breached (no cap, if intentional breach)
• “Heavy” burden rests on party seeking to excuse performance and

“poor earnings must be expected to persist significantly into the future” for decline in target’s earnings to constitute MAC

• Court found no MAC; Buyer liable for all damages

NEGOTIATING MAC CLAUSES EXAMPLE OF DISPUTE NOT LITIGATED

HD Supply – Bain Capital/Carlyle/CD&R Transaction: June 2007: Home Depot agreed to sell HD Supply, its wholesale distribution business, to an affiliate of several PE firms, for $10.325B. Break-up fee of $310M, 3% of the merger consideration. MAE definition: excluded “(i) changes affecting any or all of the wholesale distribution industries for construction, infrastructure, maintenance, or repair or remodel products generally; (ii) changes affecting the U.S. or Canadian housing or remodeling markets generally; (iii) seasonal fluctuations in HD Supply; ..(v) general financial or capital market conditions…except to the extent such event, change, circumstance or effect materially disproportionately impacts HD Supply (taken as a whole) relative to other companies in the industries in which HD Supply operates.”

20

NEGOTIATING MAC CLAUSES EXAMPLE OF DISPUTE NOT LITIGATED (CONT’D)

Alleged basis for MAE Claim: Home Depot’s 2Q 2007 results reflected a 22% reduction in operating profit at HD Supply. Litigation: no litigation was filed. Resolution: (i) Home Depot and buyers reduced the purchase price to $8.5B pursuant to an amended agreement; (ii) Home Depot agreed to purchase a 12.5% equity interest in the buyer of HD Supply for $325 million; and (iii) Home Depot agreed to guarantee a $1B senior secured loan to HD Supply. The transaction closed on August 30, 2007. Would the result be different if the matter was resolved after the Hexion case had been decided?

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22 22

NEGOTIATING MAC CLAUSES WHAT DOES CASE LAW TEACH US?

Key Takeaways — Party seeking to invoke MAC to avoid closing bears a “heavy burden” to show MAC has occurred — Parties may reallocate burden of proof in agreement — MAC ordinarily will be measured in years, not months (i.e., “consequential” change to long-term earnings rather than “short-term hiccup”) — Reliance on general MAC provision to terminate will be difficult — If possible, include important events as specifically targeted closing conditions (e.g., no material deterioration in target’s relationship with a key customer or supplier) [more difficult to do in a public deal] — MAC will be viewed in context of entire agreement, not in isolation

23 23

NEGOTIATING MAC CLAUSES DRAFTING CONSIDERATIONS

Case law is fact specific and does not provide uniform benchmarks or

• definitions. However, materiality standard almost certainly higher than

securities law materiality threshold. Caveat: No Delaware court has found a MAC to have occurred in the context of a merger agreement. Exclusions/carve-outs are critical and must be carefully crafted Buyer typically should insist on appropriate forward-looking component Self-assess: who is the buyer, what is the purpose of the transaction, and what does the buyer know? Coordinate representations and warranties (and other agreement provisions) with MAC Language is key! In the world of MACs, one size does not fit all

MAC CLAUSES AND INDEMNIFICATION PROVISIONS IN M&A DEALS

NEGOTIATING INDEMNIFICATION CLAUSES

25

NEGOTIATING INDEMNIFICATION PROVISIONS

An indemnity clause, if indemnification is the exclusive remedy for breaches of the acquisition agreement, limits or customizes the damages and remedies that would

• therwise be available to the parties for a breach of a

representation, warranty or covenant. As a practical matter, the indemnity clause will be most important to the Seller because the Seller has the most exposure on its representations, warranties and covenants and is the party most often required to pay an indemnity claim.

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26

NEGOTIATING INDEMNIFICATION PROVISIONS MATERIALITY SCRAPES

Definition of “Materiality Scrape” — Materiality qualifications in the representations and warranties are disregarded to determine whether a breach of the agreement has occurred, provided that no such breach or breaches, individually or in the aggregate, constitute a MAC.

• the MAC exception may not apply to certain representations and

warranties.

• this “materiality scrape” is included in the Conditions to Closing Section.

— Materiality qualifications in the representations and warranties are disregarded for all indemnification purposes

• Buyer’s will argue the “materiality scrape” is necessary to avoid double

materiality when the indemnification obligations are subject to a basket or deductible amount.

• this “materiality scrape” is included in the Indemnification Section.

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27

NEGOTIATING INDEMNIFICATION PROVISIONS MATERIALITY SCRAPES (CONT’D.)

An increase in materiality scrapes was a product of an increasingly buyer-friendly environment, and their use has increased — In 2011 and 2012, materiality scrapes were used in about 82% of deals, up from about 69% between 2007 and 2010* — In 2012, about 32% of materiality scrapes were used to both determine breach and damages while about 56% were used only to determine damages* Sellers could use the presence of materiality scrapes to negotiate for

• ther provisions, including higher baskets and deductibles

Materiality scrapes provide an incentive for sellers to list all items in the disclosure schedules

*2012 SRS M&A Deal Terms Study, analyzing private target deals in Q1 to Q3 of 2012 (“2012 SRS Study”)

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NEGOTIATING INDEMNIFICATION PROVISIONS SURVIVAL PERIODS

Survival Periods have remained relatively steady — In 2012 and 2011, the average survival period was 18 months* — In 2006 through 2010, the median survival period was also 18 months*** However, the median environmental survival period in 2012 was 36 months** In addition to longer survival periods for breaches of certain reps, a claim for breach of the Seller’s covenants survived for a longer period in 77% of the deals in 2010***

* 2012 SRS Study (private target deals) ** 2012 Houlihan Lokey Purchase Agreement Study *** 2011 ABA Study

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NEGOTIATING INDEMNIFICATION PROVISIONS SURVIVAL PERIODS (CONT’D)

The most common carve-outs from a General Survival Period in 2012 were for:* — Capitalization (87%) — Due Authority (86%) — Taxes (76%) — Brokers/Finders Fees (52%) — Intellectual Property (36%) — Employee Benefits/ERISA (30%)

* 2012 SRS Study (private target deals)

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30

NEGOTIATING INDEMNIFICATION PROVISIONS “SANDBAGGING”

“Anti-sandbagging” provision limits the Seller’s liability for losses resulting from breaches of representations or warranties if the Buyer had knowledge of the breach before the closing “Pro-sandbagging” provisions (knowledge savings clauses) expressly provide that the Buyer’s indemnification or other remedy is not affected by any knowledge of the Buyer

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NEGOTIATING INDEMNIFICATION PROVISIONS “SANDBAGGING” (CONT’D)

The 2012 SRS Study showed pro-sandbagging in 68% of deals* — Up from 62% in 2011, and still up from 2009 (54%)* Only 1% of deals in 2012 had anti-sandbagging language* — Down from 3% in 2011, 2% in 2010 and 8% in 2009* The compromise position is to remain silent; note that in some jurisdictions, silence can be interpreted to result in an imputed anti- sandbag — 30% of deals were silent in 2012** — 54% of deals were silent in 2010***

*2012 SRS Study (private target deals) **2011 SRS Study (private target deals) ***2011 ABA Study

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NEGOTIATING INDEMNIFICATION PROVISIONS BASKETS

Basket amounts have been stable — In 2012, the mean basket for breaches of representations and warranties was approximately .56% of the Purchase Price* Expected studies would show more first-dollar baskets instead of deductible baskets, but studies have some conflicting information — 2012 SRS Study - 37% deductible baskets, 58% first dollar baskets, 3% combination baskets and 2% no baskets in 2012* — 2012 Houlihan Lokey Study – 88% deductible baskets in 2012**

*2012 SRS Study (private target deals) **2012 Houlihan Lokey Study (private and public deals)

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NEGOTIATING INDEMNIFICATION PROVISIONS BASKETS (CONT’D)

Buyers may also request: — Buyer may argue that the existence of the basket justifies a “materiality scrape” with respect to the indemnity because the Buyer considers breaches which cause damages greater than the basket to be material. — Seller may seek a higher basket amount if there is a “materiality scrape” with respect to the indemnity. — The inclusion of carve-outs in the basket

33

NEGOTIATING INDEMNIFICATION PROVISIONS BASKETS (CONT’D)

About 93% of deals in the 2012 SRS Study had one or more carve-outs* — For Seller’s breach of covenant or fraud

• Last year, about 75% of deals included a carve-out for

fraud; 67% for non-willful breach of covenant; 42% for intentional breach of rep*

— For specific indemnity provisions

• The most common carve-outs are for the following

representations: capitalization (75%); due authority (75%); share ownership (70%); taxes (61%); due organization (62%); and intellectual property (41%)*

*2012 SRS Study (private target deals)

NEGOTIATING INDEMNIFICATION PROVISIONS CAPS AS A PERCENTAGE OF TRANSACTION VALUE

Caps on indemnity claims for breaches of representations and warranties have remained relatively steady — The 2012 Houlihan Lokey study found the average cap was 13.5% in 2012 and 13.3% over the last 10 years* — The 2012 SRS Study reflected an average cap of 12.97% in 2012 through Q3

* Source: 2012 Houlihan Lokey Study ** Source: 2012 SRS Study

36

NEGOTIATING INDEMNIFICATION PROVISIONS CAPS AS A PERCENTAGE OF TRANSACTION VALUE (CONT’D.)

If cap is less than 100% of purchase price, Buyer may push to include carve-outs: — For Seller’s breach of covenant or fraud

• Through Q3 in 2012, about 91% of deals included a carve-out for

fraud; 40% for non-willful breach of covenant; 49% for intentional breach of rep* — For specific indemnity provisions

• Capitalization, taxes, due authority, and share ownership are

popular carve-outs — For certain reps and warranties

• The most common carve-outs are for the following

representations: capitalization (79%); due authority (77%); share

• wnership (74%) and taxes (63%)*

* Source: 2012 SRS Study

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NEGOTIATING INDEMNIFICATION PROVISIONS ESCROW

Importance of Escrow or Set-off Rights — Buyer’s indemnification claims are unsecured claims

• This has heightened relevance if Seller files for bankruptcy post

closing — Escrow

• Portion of purchase price may be placed in escrow
• Term of escrow account

— Set-off Rights

• Allow buyer to deduct indemnification amounts against future

transaction payments or earn-out payments

• Procedures for identifying setoff payments are critical

 Time period of payments v. time of allowable indemnification claims

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NEGOTIATING INDEMNIFICATION PROVISIONS ESCROW (CONT’D)

Escrow periods have remained steady — In 2012, the escrow period average was 20 months, and the average for the last 10 years was 19 months** Escrow amounts have also remained steadily high — For 2012 through Q3, the SRS Study showed an average escrow of 11.2%, similar to the average from 2009 through 2011* — In the Houlihan Lokey Study, the average escrow amount was 7.6% of the purchase price in 2012**

* 2012 SRS Study; 2011 SRS Study ** Source: 2012 Houlihan Lokey Study

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MAC CLAUSES AND INDEMNIFICATION PROVISIONS IN M&A DEALS

REASSESSING PROVISIONS REGARDED AS SELLER-FRIENDLY

40

REASSESSING COMMON PROVISIONS CONSEQUENTIAL DAMAGES

Boilerplate provisions commonly exclude more than consequential damages — Often exclude: Consequential, Incidental, Indirect, Special, Punitive Damages, Loss of Revenue/Income/Profits

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REASSESSING COMMON PROVISIONS CONSEQUENTIAL DAMAGES (CONT'D.)

Consequential damages: — Compensate the Buyer for real losses resulting from seller’s breach of a representation or warranty Incidental damages: — Include expenses incurred by non-breaching party to avoid other losses caused by the breach

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REASSESSING COMMON PROVISIONS CONSEQUENTIAL DAMAGES (CONT'D.)

Incidental damages likely include out-of-pocket expenses incurred by buyers to remedy problems resulting from seller’s breach Thus, buyers should seek to exclude incidental damages from waiver provisions, although they are commonly excluded in boilerplate provisions

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REASSESSING COMMON PROVISIONS SURVIVAL CLAUSES

GRT, Inc. v. Marathon GTF Tech. Ltd. (Del. Ch. July 11, 2011): Survival Clause: provided that Design Reps would “survive for 12 months after the Closing Date, and will thereafter terminate together with any associated right of indemnification….” Indemnification was also the sole remedy for breach under the securities purchase agreement. Plaintiff argued: the survival clause simply described the period during which a breach could occur, rather than the time period during which a claim had to be filed.

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REASSESSING COMMON PROVISIONS SURVIVAL CLAUSES (CONT’D)

Delaware Chancery Court in GRT held: The Design Reps and the associated remedies would terminate one year after closing. In other words, the Survival Clause in this agreement, when viewed in the context of the entire agreement, would operate as a contractual statute of limitations. Unlike the case law in some other jurisdictions (notably New York and California), there is no public policy in Delaware that would construe narrowly a contract clause which seeks to shorten the statute of limitations. The GRT court concluded that practitioners generally intend a survival clause to create a contractual statute of limitations.

44

REASSESSING COMMON PROVISIONS SURVIVAL CLAUSES (CONT’D)

What if the agreement had provided that the Design reps would “survive indefinitely” or “without time limit” ? The GRT court suggested that such a provision would be treated as running with the otherwise applicable statute of limitations. There is a public policy in Delaware against lengthening the applicable statute of limitations by contract. Such a provision is generally viewed as being unenforceable in Delaware as a violation of public policy. (See Shaw v. Aetna Life Insurance Co., 395 A.2d 384, 386 (Del. Super.

• Ct. 1978).

45

REASSESSING COMMON PROVISIONS SURVIVAL CLAUSES (CONT’D)

What is the applicable Survival Period in Delaware? The applicable statute of limitations for a contract claim under an acquisition agreement appears to be three years from the accrual of the cause of action. (See 10 Del. Code Section 8106; Certainteed Corp. v. Celotex Corp., 2005 Del. Ch. Lexis 11, 16 (January 24, 2005)(discussing the three year statute of limitations in the context of an asset purchase agreement). Thus, if a longer survival period for certain representations is an important part of the transaction, the parties should consider having the law of another jurisdiction apply to the transaction since Delaware appears to favor the public policy of protecting the court from having to decide stale claims, over the policy of freedom of contract.

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Overview of Mergers and Acquisition Transactions and Disputes Determining the Purchase Price

The Purchase Price

Reflection of investment value specific to transacting parties Reflects “bargained for”: ■ Anticipated stream of future earnings or cash flows ■ Measure of capital necessary to support operation in the normal course Often incorporates synergistic considerations

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Purchase Price: Valuation Approaches Market approach (financial element x multiple) ■Earnings measurement (e.g., EBITDA) or balance sheet measure (e.g., assets) depending on business ■Multiple – Based on multiples used by guideline comparable companies or transactions Income approaches ■Discounted cash flow (DCF) valuation ■Required internal rate of return (IRR) based on DCF projection Cost approach ■Not applicable in most deals

49

Overview of Mergers and Acquisition Transactions and Disputes Post Closing Purchase Price Adjustments

Commonly Arising Post-Closing Purchase Price Disputes

Generally accepted accounting principles (“GAAP”) “GAAP” vs. “ Consistency” Subsequent Events

51

Common GAAP Disputes Accounts receivable and related allowances for doubtful accounts Inventories and related reserves for excess and obsolescence Employee accruals (e.g., commissions, bonuses, payroll, vacation) Warranty reserves Contingent loss accruals ■Probable? Reasonably estimable? General disputes about the realizability of assets and existence

• f obligations

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MAC Clauses and Indemnification Provisions in M&A Deals

The Role of the CPA in Proving Material Adverse Change and Benefit of the Bargain Claims

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause Purchase and Sale Agreements typically include a Material Adverse Change (“MAC”) clause containing language similar to the following: Definition ■Material Adverse Change – any event, development, circumstance, change or effect that is or would reasonably be expected to be materially adverse to the business, financial condition or results of the operations of the Acquired Company. Representation of Seller ■Since date XX, there has not been any Material Adverse Change in the business, operations, properties, prospects, assets, or condition of any Acquired Company, and no event has

• ccurred or circumstance exits that may result in such Material

Adverse Change.

54

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued IBP, Inc. v. Tyson Foods, Inc. Based on VC Strine’s ruling in this case, a MAC may have been sustained if:

■Dramatic downturn in earnings from the date of the signing of the SPA and before the closing. ■There is a downturn in the business that is disproportionate to the industry, ■The downturn is durationally-significant (or over a commercially reasonable period), meaning years and not months (is the downturn a blip or a trend?), and ■The change in the business in unknown to the Buyer.

Another point of contention, assuming a MAC has occurred is whether it was known to the Buyer prior to signing the Agreement?

55

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued An assessment of the Buyer’s valuation process will often reveal the facts contemplated by the Buyer at the time and whether or not the causes of the MAC were known. As a related issue in assessing if damages have occurred, did the Buyer receive the benefit of its bargain or did the Seller materially mislead the Buyer as to the quality of its earnings? Valassis and ADVO are in the direct mail advertising business. Each company had sales in excess of $1B. The combined entity will exceed $2.65B in sales. Late in 2005 Valassis commenced merger discussions with ADVO. On July 7, 2006, Valassis and ADVO signed the SPA, whereby, Valassis would pay $37/share in cash.

56

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued Prior to the signing of the SPA, ADVO represented:

■Forecasted operating income for FY2006 of $68 million; ■The integration of their SDR computer system was progressing as planned; ■That the April & May 2006 financial statements were materially correct;

The SPA is signed on July 5, 2006. AFTER the signing of the SPA:

■ADVO disclosed that April and May’s 2006 financial statements were misstated by $2.6M; ■August 10, 2006, ADVO adjusted its $68 million forecasted operating income to $54.8 million, nearly identical to an internal April 2006 forecast of $54.5 million; ■Actual FY results ending 9/30/06 were $37.9 million, some $30 million below expectations.

57

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued Negotiations stalemated. On October 31, 2006 Valassis filed suit to rescind the merger. Investigate the following allegations:

■Were ADVO’s financial statements and financial forecasts misleading? ■Was ADVO’s new computer system operating as represented? ■Financially speaking, did ADVO’s business suffer a financial downturn? More specifically: –Did ADVO suffer a MAC? –Was ADVO performing disproportionately below its peers in the industry? –Was ADVO’s downturn durationally significant? ■Did Valassis significantly overpay for ADVO? ■Critique opposing expert report

58

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

59

5M 10M 25M ($) in Millions 20M 15M

Q1 Q2 Q3

Q4

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

2003 2004 2005 2006

$20.0 $18.7 $21.6 $21.3 $19.8 $19.0 $20.7 $21.6 $14.1 $18.5 $22.4 $14.1 $22.1 $12.6 $11.6 $7.0

Mean = $19.5 ADVO’s Recent Operating Income is Below the Historical Mean

Declined 70% From Q1 2006 to Q4 2006

Source: Quarterly amounts through Q3 2006 from ADVO’s 10-Q and 10-K filings. Q4 2006 from ADVO’s November 16, 2006 press

• release. Q1, Q2, Q3, and Q4 2006 amounts include add-backs of $1.5M, $2.3M, $2.0M, and $2.2M for stock option expense

amounts, respectively. Q3 and Q4 2006 amounts include add-backs of $2.9M and $4.5M of merger and litigation costs, respectively, as well as adjustments for $6M of client credits.

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

60

10M 20M 30M 60M

($) in Millions

40M 80M 50M

7/6/2006 Merger Agreement

$76.1 (Original Budget) 70M $54.5 $65.0 $68.6 $68.0 $54.8 $37.9

4/14/2006 5/4/2006 5/10/2006 6/23/2006 8/10/2006 Actual (unaudited)

ADVOS’s Fiscal Year 2006 Operating Income Forecasts

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

61

2005 2003 2004 2006

Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

5M 10M 15M 25M 20M 30M 35M 40M $38.1 $38.1 $37.4 $32.2 $35.3 $36.3 $37.3 $36.6 $37.4 $35.9 $37.2 $37.1 $35.3 $35.8 $35.1

(4.3)% Change (69.5)% Change

$14.1 $20.6 $10.3 $18.7 $21.6 $21.3 $25.6 $23.1 $23.2 $21.6 $18.5 $25.9 $14.1 $6.32 Industry Average* ADVO

($) in Millions

Time between Q1 & Q4

$9.21

Q1 Q2 Q3 Q4 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4

Source: 10-Q’s and 10-K’s were used for all companies and are adjusted for non-recurring charges.

• 1. Deducted $6M client credit; added $1.6M in merger and litigation costs, added $0.9M in strategic initiatives.
• 2. Added $6M client credit, $4.5M in merger and litigation costs, $1.5M in strategic initiatives

ADVOS’s Fiscal Year 2006 Operating Income Forecasts

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

Change in DCF Analysis Based On Facts Known as of August 2006 62

Historical Valassis Original Forecast (as of July)

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 EBIT $ 97 $ 80 $ 82 $ 80 $ 69 $ 66 $ 74 $ 90 $ 94 $ 98 $ 105 % Margin 8.5% 7.1% 7.1% 6.4% 5.0% 4.5% 4.9% 5.8% 5.8% 5.8% 6.1% % Growth

• 17.5%

2.5%

• 2.4%
• 13.8%
• 4.3%

12.1% 21.6% 4.4% 4.3% 7.1% Free Cash Flow 53 55 48 50 59 Discounted Free Cash Flow $50 $48 $38 $36 $39 Present Value of Terminal Value 868 Present Value of Cash Flows 212 Present Value of Free Cash Flow2 $1,080

Historical Valassis Revised Forecast (as of August)

2001 2002 2003 2004 2005 2006 2007 2008 20091 20101 20111 EBIT $ 97 $ 80 $ 82 $ 80 $ 69 $ 51 $ 50 $ 62 $ 64 $ 66 $ 68 % Margin 8.5% 7.1% 7.1% 6.4% 5.0% 3.5% 3.4% 4.2% 4.2% 4.2% 4.2% % Growth

• 17.5%

2.5%

• 2.4%
• 13.8%
• 25.5%
• 3.7%

25.6% 3.0% 3.0% 3.0% Free Cash Flow 40 39 34 36 42 Discounted Free Cash Flow $38 $34 $26 $26 $28 Present Value of Terminal Value 524 Present Value of Cash Flows 152 Present Value of Free Cash Flow3 $676

• 1. Litvak assumption based on Valassis revised projection trend.
• 2. Using discount rate of 9.5% and terminal growth rate of 4.75%.
• 3. Using discount rate of 10.0% and terminal growth rate of 4.5%.

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued A MAC is very difficult to prove, therefore, the buyer should consider incorporating economic teeth into the MAC clause, for example:

■Downturn defined, in duration and monetary terms ■Projected vs. actual results threshold defined ■Loss of customer base defined ■The combination of these issues would trigger a purchase price adjustment

For example:

■If sales decline more than 15% from the previous quarters financial statements ■If EBITDA (as defined in the Agreement) declines more that $5 million from the previous months EBITDA ■If a customer comprising 10% or more of total sales for the previous twelve months is lost

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CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

“The benefit of the bargain measure awards the plaintiff the difference between the gain had the misrepresentations been true and what the plaintiff actually received.”1

1 Litigation Services Handbook, Fourth Edition, 18.7

64

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued Did the buyer receive the value represented by the seller? Were misstatements of the financial statement known to the buyer? If the seller misstated the financial statements, the buyer may not have received the benefit of its bargain. ADVO was valued based on the financial performance as represented by Valassis in July 2006 (prior to signing) and in August 2006 (after signing). Valassis utilized both the Market and Income approaches in valuing ADVO. Valassis paid a significant control premium in its acquisition of ADVO.

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CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued A multiple of EBITDA was utilized based on the comparable companies. Valassis initially priced ADVO:

■Bargained for - 11 times EBITDA ■As received - 9 times EBITDA

The multiple of EBITDA approach included a control premium.

66

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

67

Purchase Price Overpayment Calculation

In Millions (except multiples)

9.0x Multiple

Pre-Signing Forecasted Fiscal '06 Op. Income - Misrepresentation $68.0 Less: Pre-Signing Forecasted Fiscal '06 Op. Income – Realistic (54.5) Operating Income Misrepresentation $13.5 % of Misrepresented Operating Income 19.9% ADVO '06 EBITDA (Valassis/Bear Stearns Projection) $119.0 Less: Misrepresentation (13.5) Corrected ADVO '06 EBITDA $105.8 EV/EBITDA Purchase Price Multiple 9.0x Adjusted Enterprise Value $950 Less: Actual Enterprise Value Purchase Price (1,291.3) Purchase Price Overpayment $(341.8) % of Actual Purchase Price 26.5%

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

Change in DCF Analysis Based On Facts Known as of August 2006 68

Historical Valassis Original Forecast (as of July)

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 EBIT $ 97 $ 80 $ 82 $ 80 $ 69 $ 66 $ 74 $ 90 $ 94 $ 98 $ 105 % Margin 8.5% 7.1% 7.1% 6.4% 5.0% 4.5% 4.9% 5.8% 5.8% 5.8% 6.1% % Growth

• 17.5%

2.5%

• 2.4%
• 13.8%
• 4.3%

12.1% 21.6% 4.4% 4.3% 7.1% Free Cash Flow 53 55 48 50 59 Discounted Free Cash Flow $50 $48 $38 $36 $39 Present Value of Terminal Value 868 Present Value of Cash Flows 212 Present Value of Free Cash Flow2 $1,080

Historical Valassis Revised Forecast (as of August)

2001 2002 2003 2004 2005 2006 2007 2008 20091 20101 20111 EBIT $ 97 $ 80 $ 82 $ 80 $ 69 $ 51 $ 50 $ 62 $ 64 $ 66 $ 68 % Margin 8.5% 7.1% 7.1% 6.4% 5.0% 3.5% 3.4% 4.2% 4.2% 4.2% 4.2% % Growth

• 17.5%

2.5%

• 2.4%
• 13.8%
• 25.5%
• 3.7%

25.6% 3.0% 3.0% 3.0% Free Cash Flow 40 39 34 36 42 Discounted Free Cash Flow $38 $34 $26 $26 $28 Present Value of Terminal Value 524 Present Value of Cash Flows 152 Present Value of Free Cash Flow3 $676

• 1. Litvak assumption based on Valassis revised projection trend.
• 2. Using discount rate of 9.5% and terminal growth rate of 4.75%.
• 3. Using discount rate of 10.0% and terminal growth rate of 4.5%.

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued

($) in Millions

69

Multiple of EBITDA Based on Guideline Companies Value at July 5, 20061 $1,291 FY 2006 EBITDA3 $105.5 Multiple 9.0x Value at August 10, 2006 950 ($342) Income Approach (Free Cash Flow) Value at July 5, 20062 $1,080 Value at August 10, 20062 676 ($404)

Source:

• 1. Bear Stearns Fairness Opinion Supporting Analysis dated July 5, 2006.
• 2. From Litvak’s Change in DCF Analysis on as shown on Slide 9.
• 3. From Litvak’s Corrected ADVO ’06 EBITDA for April as shown on Slide 6.

CPA’s Role in Proving MAC and Benefit of the Bargain Claims Standard Material Adverse Change Clause, Continued Case settled, as it should have, at about a $150 to $200 million discount Material Adverse Change:

■Difficult to rescind a merger ■The duration of ADVO’s downturn was a significant debate ■Durationally-significant is difficult to prove when a new customer could be

• btained immediately or take years

Fraud claims were compelling:

■Alleged non-disclosure of Budget ■Alleged misrepresentation of success of sales promotion ■Alleged misrepresentation of the status of the computer system

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