In the fi fth year of our intangible asset allocation study, we noted some interesting trends in the allocation of the “Intangible Gap” (defi ned as total assets over the net of the amounts assigned to tangible assets). Our current look focused on transactions that closed during the calendar year ended December 31, 2006. Transactions in the Financial Institutional market (i.e., banking, insurance, etc.) were excluded from our analysis as the economics and typical assets within this market are unique (e.g., a large percentage of fi nancial instruments and a low percentage of identifi able intangible assets) and therefore are not necessarily comparable to transactions in other industries. Further, the statistics discussed in this article are based on an equally-weighted analysis as opposed to dollar-weighted results. The equally-weighted results of our 2006 study are summarized in the following chart.

Goodwill As illustrated in the chart, goodwill still represents the largest percentage of the Intangible Gap (61.0% in 2006). There is an evident downward trend in this percentage, albeit at a relatively slow pace, as the amount allocated to goodwill has declined from 69.7% in

2002 to 61.0% in 2006. The downward trend is consistent with our expectations given the general “push” for an increase in the allocation of purchase price to identifi able intangible assets since the release of SFAS 141, Business Combinations in June 2001.

Marketing-Related Intangibles Relatively unchanged from 2005, marketing-related intangibles (e.g., trademarks, trade names, etc.) accounted for 6.2% of the Intangible Gap in 2006. The most notable change in the capitalization of marketing-related intangibles was in the Computer Software, Supplies and Services industry, which accounted for 5.4% of the Intangible Gap, more than double 2005 levels. The Communications and the Drugs, Medical Supplies and Equipment industries showed downward trends in marketing-related intangibles over the past three years.

Technology-Based Intangibles

After goodwill, technology-based intangibles accounted for the largest portion of the Intangible Gap in 2006, representing 13.5% on average. The Drugs, Medical Supplies and Equipment industry exhibited the largest increase in the allocation of technology-based intangibles over the past three years, with recognition increasing from 23.9% to 53.0% of all transactions. The upward trend in technology-based intangibles within this industry is primarily attributable to in-process research and development assets, which accounted for 60.7% of total technology-based intangibles in 2006 (up from 42.9% in 2004). Overall, in-process research and development was the second most common technology-based asset recognized across all industries in 2006, following patented and unpatented technology. Patented and unpatented technology was recognized in 78 of the 215 transactions analyzed (or 36%).

Customer-Related Intangibles

The largest year-over-year change in booked intangible assets over the fi ve-year history of our study was recorded in customer-related intangibles. Customer-related intangible assets include customer relationships, customer contracts, customer lists, customer orders,

Trends in the Allocation of Intangible Assets for Purchase AccountingBy Jason M. Muraco, CFA – jmuraco@srr.com

Valuation & Financial Opinions

2006 2005 2004 2003 2002

Number of Transactions 215 557 274 353 398

GoodwillPercentage of Intangible Gap 61.0% 62.4% 67.3% 61.0% 69.7%

Marketing-Related IntangiblesPercentage of Intangible Gap 6.2% 6.3% 5.0% 6.0% 4.4%

Technology-Based IntangiblesPercentage of Intangible Gap 13.5% 11.3% 11.8% 18.0% 13.8%

Customer-Related IntangiblesPercentage of Intangible Gap 12.7% 14.4% 9.9% 8.9% 5.7%

Contract-Based IntangiblesPercentage of Intangible Gap 4.6% 4.6% 3.5% 3.7% 5.1%

Miscellaneous IntangiblesPercentage of Intangible Gap 2.0% 1.0% 2.5% 2.3% 1.4%

[a]

Total (Excluding Financial Institutions) [a]

All percentage calculations are based on a straight average.Excludes the following industries: banking and finance; insurance; and brokerage,investment & management consulting.

Source: SEC filings of companies identified in Mergerstat Review .

Patrick A. BrownDirector216.373.2993pbrown@srr.com

Gregory A. O’HaraManaging Director216.373.2992gohara@srr.com www.srr.com

and customer backlogs. These intangibles comprised 12.7% of the Intangible Gap in 2006, which is materially higher than the 5.7% average in our 2002 study. The Manufacturing and the Communi-cations industries exhibited the highest increases of the top fi ve industries in customer-related intangibles over the past three years.

Customer relationships were by far the most commonly-recorded customer-based intangible in the 2006 study, as they were booked in 130 of the 215 transactions analyzed. The FASB’s dissemination of Emerging Issues Task Force (“EITF”) Issue No. 02-17 “Recognition of Customer Relationship Intangible Assets Acquired in a Business Combination” was referenced in a previous study as a potential reason for the trend towards an increase in the recording of customer relationships. EITF Issue No. 02-17 (which was released in 2002) attempted to clarify the defi nition of customer relationships in the context of recognizing this asset in a business combination. It certainly appears that the EITF had an impact on the recognition of customer relationships, as the average percentage of the total Intangible Gap allocated to customer relationships increased from 1.6% in 2002 to 11.0% in 2006.

Contract-Based Intangibles

The booking of contract-based intangibles was unchanged from 2005, accounting for 4.6% of the Intangible Gap in 2006. Consistent with past results, non-competition agreements were the most frequently recorded contract-based intangible in the 2006 study, as they were a recognized intangible asset in 40 of the 215 transactions analyzed (or 19%).

Additional Thoughts

In general, goodwill (as a percentage of the Intangible Gap) has declined over the fi ve-year history of our study. However, the decline is modest and the total allocation percentage to goodwill is still relatively high. One potential reason for the discrepancy could be related to the timing of the work performed by valuation fi rms. Generally, valuation fi rms utilize a target company’s preliminary opening balance sheet that does not incorporate all post-transaction accounting adjustments (e.g., deferred tax liabilities). Acquisitions in the form of stock transactions (which tend to be more prevalent than asset transactions) often book a deferred tax liability since the acquired assets are usually written-up for book purposes but not for tax purposes (i.e., an acquirer does not get the full tax deductibility benefi t of acquired assets in a stock transaction, only the carry-over benefi t). The offsetting adjustment to booking a

deferred tax liability is a dollar-for-dollar increase to goodwill. Since this adjustment (which has already been accounted for in the allocations reviewed in this article) is typically made after valuation fi rms perform the purchase price allocation work, the initial allocation percentage to goodwill implied by the valuation fi rm’s work could be lower than the fi nal allocation percentage after any adjustment for deferred tax liabilities (which could be material).

To illustrate this theory, we compared the allocation percentage to goodwill both with and without the inclusion of deferred tax liabilities. The following chart summarizes the results of our study for the top fi ve industries (in terms of number of deals in 2006) over the past three years.

The average allocation to goodwill for the Manufacturing industry was 60.2% in 2006. Removing the impact of deferred tax liabilities (for those deals that disclosed such detail) decreases the average goodwill allocation to 53.9%, nearly a 10% reduction. As such, deferred tax liabilities appear to have a meaningful impact on the allocation of the Intangible Gap to goodwill. Further, removing the deferred tax liability offset (i.e., increased goodwill) from the Intangible Gap calculation would also have the impact of increasing the relative percentages of recognized intangible assets.

Looking Forward

Increases in customer-related intangibles (particularly customer relationships) have accounted for the largest portion of reallocated goodwill amounts over the history of our study. We anticipate this trend to continue for those transactions that closed in calendar year 2007 given the overall push by accounting fi rms and regulators for companies to allocate larger portions of the Intangible Gap to identifi able intangibles (such as customer relationships). For transactions closing in 2008 and beyond, we look forward to analyzing what type of impact more recent regulations (such as the revision of SFAS 141, Business Combinations and the release of SFAS 157, Fair Value Measurements) may have on the allocation of the Intangible Gap.

Valuation & Financial Opinions

2006 2005 2004 2006 2005 2004 2006 2005 2004 2006 2005 2004 2006 2005 2004

Number of Transactions 126 105 128 35 77 31 31 142 75 23 31 9 20 32 25

GoodwillPercentage of Intangible Gap 85.5% 85.0% 85.6% 60.2% 64.8% 66.3% 67.0% 67.0% 68.2% 70.5% 60.7% 80.2% 37.0% 49.0% 62.6%

Marketing-Related IntangiblesPercentage of Intangible Gap 0.2% 0.3% 0.1% 3.0% 5.8% 6.4% 5.4% 1.9% 2.2% 0.5% 3.2% 3.7% 1.9% 3.7% 5.3%

Technology-Based IntangiblesPercentage of Intangible Gap 0.0% 0.1% 0.0% 15.2% 13.4% 15.1% 12.1% 13.7% 12.2% 2.1% 7.5% 0.0% 53.0% 32.0% 23.9%

Customer-Related IntangiblesPercentage of Intangible Gap 14.3% 14.1% 12.9% 18.9% 13.2% 11.2% 10.2% 13.6% 12.5% 19.2% 17.3% 11.8% 2.3% 10.2% 3.8%

Contract-Based IntangiblesPercentage of Intangible Gap 0.1% 0.2% 0.9% 0.7% 1.3% 0.6% 3.1% 3.2% 1.3% 7.6% 11.1% 4.2% 5.7% 5.0% 1.6%

Miscellaneous IntangiblesPercentage of Intangible Gap 0.1% 0.3% 0.5% 2.1% 1.5% 0.4% 2.2% 0.6% 3.6% 0.1% 0.2% 0.1% 0.1% 0.1% 2.9%

[a] The manufacturing industry includes companies classified in the following industries: automotive products & accessories; autos & trucks; electrical equipment; electronics; fabricated metalproducts; industrial farm equipment & machinery; miscellaneous manufacturing; plastics & rubber; primary metal processing; and valves, pumps, & hydraulics.

All percentage calculations are based on a straight average.

Source: SEC filings of companies identified in Mergerstat Review .

Banking and Finance Manufacturing [b]Computer Software, Supplies

and Services CommunicationsDrugs, Medical Supplies and

Equipment

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