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Browns offer to buy back Afco Steel: new owners claim financial projections were overstated.

NEARLY 20 MONTHS AFTER SELLing Afco Steel Inc. of Little Rock for $81 million, Fred I. Brown III and his family are willing to buy it back from W&W Steel Co. of Oklahoma City.

The offer surfaced in March as the Browns are in the early stages of a lawsuit brought on by W&W Steel's holding company, WWSC Acquisition Corp. of West Reno, Okla. W&W is seeking at least $19 million from the Browns, whom the company accuses of fraudulently misrepresenting Afco's future financial health during negotiations in 2002.

Meanwhile, the Browns are planning on filing a countersuit alleging W&W breached a contract during negotiations by concealing accounting information it discovered about Afco. The Browns also will ask that they be given permission to buy the company back, said their attorney John Tull III of Little Rock.

"The Brown family believes that Afco was and is a very strong company," Tull said. "And if W&W is for some reason unsatisfied with it, the Browns feel it is and will be a very strong company. The Browns feel that W&W got a good deal on the business."

W&W, through its attorney, John Lile of Little Rock, declined to comment on the case.

In papers filed in U.S. District Court in Little Rock, W&W said Brown, Afco's former president and one of the lead family negotiators, knew or should have known that the financial projections he released were overstated. Brown's brother Robert S. "Bobby" Brown also was involved in the negotiations.

"We've reviewed those claims, and when the day comes for proof rather than allegations, we believe that the proof will clearly show that the lawsuit has no merit," Tull said.

In the meantime, "The Browns stand ready, willing and able to take the company back through rescission," be said.

The Browns

Fredrick Isaac Brown founded Afco in 1909. Later, his two sons, Fred I. Brown Jr. and Joseph Brown operated the company. They then handed the company over to the next generation, Fred I. Brown III and Willis Brown.

By the turn of the 21st century, Afco had grown to be one of the country's largest and most successful steel fabrication businesses.

In 2001, Afco had "by far the most profitable year in its history," according to its counterclaim.

For Afco's fiscal 2001, which ended Oct. 31, it had earnings before interest, taxes, depreciation and amortization (EBITDA) of $22 million, which exceeded the previous four-year average of Afco's EBITDA by about $10 million. It also had $126.42 million in sales, according to a report filed in the case.

It was at that time the family decided to sell.

In the fall of 2001, the Browns hired investment bankers Cobblestone Capital Advisors LLC of Rochester, N.Y., to market and sell the company. Cobblestone prepared a report that showed Afco's EBITDA for FY 2002 would be $13.1 million.

In the fall of 2001, W&W Steel expressed interest in buying Afco. It hired the accounting firm of Davidson & Golden EC. of Brentwood, Tenn., to review Afco's financial books and records.

W&W liked what it saw and signed a letter of intent to buy Afco for $81 million on Jan. 10, 2002.

But then some financial questions began surfacing.

D&G said in a report on Jan. 31, 2002, that several of Afco's accounting practices and procedures would justify a reduction of the purchase price, according to the Browns' counterclaim. (The

Browns have asked permission from the judge to file an amended answer which includes the counterclaim. That ruling is pending.)

But W&W didn't disclose D&G's report to the Browns, which the Browns said it should have under their agreement, nor did W&W request an adjustment to the purchase price, the counterclaim said.

W&W received other financial figures, including projections from Grady Harvell, Afco's current president who was then executive vice president. The Browns said W&W shouldn't have been tailing with Harvell without their permission.

Still, the numbers Harvell projected for Afco's EBITDA for 2002 ranged from $16.27 million to $18 million. He also had future financial projections at $10.73 million to $12.28 million.

May 2002

On May 1, 2002, the Browns provided W&W with revised upward projections for the company's EBITDA for 2002 and 2003, listing $15.12 million for 2002 and $17.26 million for 2003.

In June 2002, before the closing date, W&W met with Cobblestone, Brown and other Afco officials.

At that June 7 meeting, W&W questioned the May financial projections and asked the Browns to prepare updated numbers, W&W said in its lawsuit.

After the meeting, Harvell and Afco's controller Victor Cobb started preparing the new numbers.

"Although Fred I. Brown III knew these revised financial projections requested by (W&W) had been substantially prepared, he instructed the company's executive vice president and the company's controller to cease working on any revised financial projections," W&W said. "Fred I. Brown III told them that he had 'hired people' to do the financial projections and that any revised financial projections by the company's executive vice president and the controller would not be given to (W&W)."

Brown then told W&W the May numbers were still good and didn't need to be revised, W&W said.

But the Browns said W&W had information that should have led them to question the numbers.

"In an undated document titled 'Talking Points Memorandum' prepared at some point after May 17, 2002, and before closing, W&W'S attorneys state that the $17.26 million projected for FY 2003 as presented by Cobblestone was 'questionable--we think the number is closer to $13.5 million,'" the Browns said in their countersuit.

Still, based on the May numbers, W&W agreed to buy the company, W&W said.

"The representations of the financial projections were critical to the assessment of the value of the company and its outstanding shares to be acquired by WWSC," W&W said.

The deal seemed like a marriage made in heaven.

The transaction doubled the size of W&W and made it one of the three largest structural steel fabrication companies in America.

The Afco purchase included two Little Rock plants and two subsidiaries, Van Buren Bridge Co. in Van Buren and Platte River Steel Co. in Greeley, Colo.

W&W kept Afco's name, and the two companies combined for more than 1,000 employees in six plants and five satellite offices. Annual sales were expected to be about $250 million.

"One of the major advantages of this purchase is that about 75 percent of Afco's business involves projects we do not pursue," Bert Cooper, W&W chairman and CEO, said in August 2002. "While we provide structural steel for major commercial buildings, Afco (provides) for bridges and major industrial buildings such as power plants and breweries."

After the Sale

After taking control of Afco in August 2002, W&W "uncovered numerous misrepresentations" the Browns made, it said.

W&W found the condition of Afco's assets in poor shape. And some of the equipment violated the Occupational Safety and Health Act, W&W said.

W&W also accused Afco of failing in maintain the assets between the time it the deal was struck and the closing.

W&W said Afco stopped repairing the parking lot at its south plant, "which was in a significant state of disrepair and which was unusable after the closing date."

Things went from bad to worse for W&W when the financial numbers came in for fiscal year 2002.

On June 30, 2002, Afco had an EBITDA of $11.82 million. But by the end of its fiscal year ended four months later, the EBITDA fell to $11.66 million--"in gross and stark contrast" to the Brown's financial projections of $15.11 million, W&W said.

W&W also saw Afco's revenue drop 9.27 percent from the previous year to $114.7 million. Net income before taxes was $10 million that year.

For the first quarter of 2003, the numbers didn't improve.

The projection for the fiscal year was $17.25 million, an average of $4.31 million per quarter. But the first quarter was $1.18 million, W&W said.

W&W said Brown should have known Afco wasn't going to make the numbers he projected in May 2002.

W&W didn't wait around until the end of its second quarter to see if the numbers improved. It filed suit against the Browns on Marcia 18, 2003, alleging everything from breach of the stock purchase agreement to unjust enrichment.

Court Proceedings

The Browns' attorneys first asked in court documents that the case be dismissed.

"Although the complaint consists of six counts, 134 paragraphs and 25 pages, plaintiff's primary claim boils down to the proposition that certain May 1, 2002 financial projections were not updated before the closing on July 31, 2002, and that, at or shortly before closing, one defendant said that those financial projections were still valid," the Browns said in their response. "We will show the court that plaintiff can prove no set of facts in support of its claims which would entitle it to relief."

While Federal District Judge George Howard Jr. didn't dismiss the lawsuit, he did dismiss the claim for unjust enrichment on Aug. 25. Under the law, unjust enrichment "is a quasi-theory of recovery meant to remedy the absence of a formal contract," he said in his order. Because there was a contract in Afco's case, Howard found W&W couldn't pursue that claim.

On March 16, another one of Brown's attorneys, Charles L. Schlumberger, sent a two-page letter to W&W'S attorneys.

Schlumberger said it had learned that W&W had breached provisions of the confidentiality agreement it signed in 2001 and another agreement in April 2002 by contacting and engaging in discussion with "key personnel" of Afco without the written permission of Afco or Cobblestone.

"Furthermore, your client and its affiliates engaged in bad faith, if not fraud, in concealing accounting information and financial projections developed by your client and its affiliates" while inducing the Browns to sell, Schlumberger said.

Schlumberger said if the Browns had known what was going on, they wouldn't have sold the company.

The Browns, Schhimberger said, demanded they be allowed to buy the company back.

"If your client and its affiliates refuse this demand, we have been instructed to seek appropriate relief against them," Schlumberger said.

Apparently W&W didn't agree to the demands, which led the Browns to ask that the countersuit be filed.

But one of the Browns' burning questions is: What were Afco's final financial numbers for 2003?

"Those documents haven't been provided to us," Tull said, adding, "we have asked for that in discovery."
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Author:Friedman, Mark
Publication:Arkansas Business
Date:May 3, 2004
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