Big Air; Initial Public Offerings in the US

Open on the table next to me I have the preliminary and actual prospectus for, respectively, Morrow and Ride Snowboards initial public offerings. As of December 13th, 1995, my broker assures me, Morrow is not public yet.  Ride’s prospectus is dated May 6, 1994 and those of you who bought their stock at the time of the offering are patting yourselves on the back. Those of you who didn’t, aren’t.

Ride’s prospectus estimates expenses of the offering at $361,500. Morrow’s estimate is $900,000. They pay these expenses for the privilege of filing quarterly and annual statements with the Security and Exchange Commission (SEC), dealing with shareholders, revealing information they’d rather keep confidential, paying for audited financial statements and legal fees and holding annual meetings.
I can tell you from experience that to prepare their company to do all this, they went through a process which, besides being expensive, distracted senior management from running the business, was stressful and involved a high level of uncertainty. Why would they do it?
For the money, dude. But it’s not quite that simple. Basically, there are five financial benefits to going public.
First, the company receives cash from the sale of shares. In the case of Ride, the net proceeds were $4,138,500. Morrow hopes to raise something like $19,000,000. The company has great flexibility in how it uses the money. The Use of Proceeds section of the Ride prospectus says they expect to use $175,000 for office and warehouse equipment and the remainder for “working capital and general corporate purposes.” As non specific as that is, they then go on to reserve the right to use it differently “…if market conditions or unexpected changes in operating conditions or results occur.”
Basically, they can use it for any reasonable business purpose.
Second, it’s typical that the value of a public company is higher than a private company. As recently as April of 1995, Morrow sold convertible debentures with a conversion price of $3.67 per share. Remember they are hoping to go public at “between $11.00 and $13.00 per share.” If the offering price was $12.00, the company’s apparent valuation would have increased over 225% since April. Going public creates wealth.
Third, the company gains liquidity, and this in part explains the higher valuation. Shares in the company can now be bought or sold easily and efficiently.  The price is determined daily by the actions of (hopefully) objective third parties.
Fourth, the owners reduce their risk and can diversify their portfolios. Also, they make a lot of money. Morrow expects to sell 1,600,000 shares to the public but current shareholders will sell an additional 530,000 shares personally. The net proceeds from sale of those shares (around $6 million) will go directly to those individuals.
Finally, the company creates an asset that doesn’t show up on its balance sheet; the ability to sell stock. There are restrictions to how much you can sell, when, and at what price.  Some restrictions are legal one, and some the result of how the financial markets view the sale of new shares. But in general the public company has easier access to capital.
In August of this year, Ride did a secondary stock offering. The company sold an additional 1,165,400 shares and existing shareholders (directors and officers of the company) sold 834,600 shares they held at a price of $17.00 a share, succinctly demonstrating the value to the owners of a public offering and a successful company’s ability to raise cash after it is public.
The process of doing a public offering starts when a company goes into registration, submitting a registration statement and a draft of the prospectus (known as a “red herring”) to the SEC. Depending on how recently the company has done an offering, and how well known the company may be, the SEC may decide to have no review, limited review, or full review. A review will typically take about a month. It results in the company receiving comments from the SEC that require changes and/or additions to the registration statement and prospectus.
If there is no review, or when it is complete, the road show can begin. The road show is a series of meetings and presentations with interested investors and institutions in different cities. These meetings allow the company and its investment bankers to create interest in the offering and to evaluate how it should be priced.
Following the road show, the stock is priced in one or more meetings between the company and its investment bankers. The price depends on a variety of factors including market conditions and the reception during the road show. Once the deal is priced, the prospectus can be printed with complete information and become effective. The prospectus and stock are distributed to interested institutions for sale to investors and the stock begins to trade.
The draft I have of Morrow’s prospectus runs to 66 pages. Ride’s was 48. Both have sections entitled “Additional Information” which makes the reader aware that the prospectus does not contain all the information in the Registration Statement filed with the SEC. It notes that “Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete…” and informs the reader that they can get copies of these documents (which, including exhibits, can run to hundreds of additional pages) from the SEC.
The form and content of a prospectus is clearly defined by the SEC. It is a carefully choreographed document that results from a certain level of creative tension between the company executives, the lawyers and the investment bankers. They all share the goal of getting the company public. The executives and investment bankers want the prospectus to be as positive a document as possible to improve the prospects of selling the shares at the best price. The lawyers are more cautious. Their job is to make sure that all the relevant information is disclosed completely and accurately, whether it is negative or positive. Lawsuits by investors claiming inadequate or inaccurate disclosure in the prospectus are not unusual.
My favorite example of how language gets crafted is in the Morrow prospectus when they talk about manufacturing risks. When discussing the company’s ability to get the materials it requires for manufacturing, they say “In addition, the Company has experienced limited delays in the delivery of certain raw materials due to delay in payment for such materials.” Those of us who are less eloquent than attorneys might have said “Their suppliers wouldn’t ship any more until they paid for what they’d already received.”
Obviously Morrow is far from the only snowboard company to have a tight cash flow, and one purpose of the offering is to prevent that from happening again, but you can see how it can pay to read some of the fine print carefully.
The Table of Contents to Ride’s prospectus dated May 6, 1994 is reproduced in the box below. Morrow’s is the same except for a few words and the order of presentation. We’ll talk briefly about some of the sections.
Table of Contents                                  Page
Prospectus Summary                            3
Risk Factors                                         6
Use of Proceeds                                   12
Dividend Policy                                     12
Dilution                                                 13
Capitalization                                        14
Selected Financial Data                         15
Management’s Discussion and Analysis
  of Financial Condition and Results of
  Operations                                          16
Business                                               18
Management                                         22
Executive Compensation                       24
Principal Shareholders                           27
Certain Transactions                              28
Description of Securities                       31
Underwriting                                          33
Shares Eligible for Future Sale               36
Legal Matters                                        36
Experts                                                 36
Additional Information                           37
Index to Financial Statements                F-1
The prospectus begin with a summary and moves on to “Risk Factors.” Morrow and Ride take six pages to talk about what could go wrong; foreign exchange, seasonality, ability to sustain growth, weather, dependence on key individuals, product liability. The list goes on. It gives the potential investor insight into the business risks, but is also important in protecting the company from lawsuits for inadequate disclosure.
“Selected Financial Data” is summarized historical income statement and balance sheet data. I always ignore this and proceed directly to the detailed, audited financial statements. The “Management Discussion” puts into words the financial relationships you’ll note yourself in reviewing the financial statements and explains the conditions that led to those results. The “Business” section talks about the industry, the company’s strategy, and its basis for competing.
Now it starts to get really interesting. “Management” describes the age, position and background of the company’s executives and directors. “Executive Compensation” tells you who is paid how much in salary, bonus and “other.” “Principal Shareholders” lets you know who owns how many shares, and what percent they own before and after the offering.
Now comes my favorite section: “Certain Transactions.”   This is where you can hope to  learn how the company really got financed before its public offering. You learn about stock issued for services, loans from family members of officers, private placements to officers and directors and their families and other interesting transactions. I always smile when I read about them, but it’s partly in admiration for people who figured out how to get the job done.
“Shares Eligible For Future Sale” gives you some idea what the “float” (number of shares actively available to trade) will be. Morrow’s prospectus indicates that after completion of the offering, but assuming no exercise of outstanding options or warrants, there will be 5,061,045 shares of common stock outstanding, but that only 2,130,000 will be eligible for sale to the public without restriction. The others are restricted either for legal reasons or be agreement with the investment bankers doing the public offering. They will become eligible to be sold as described in this section of the prospectus. As and if they appear on the market, the supply of Morrow common stock will increase. All other things being equal, increased supply reduces demand and, therefore, price.
Now you know a little about what it means to go public in the US and what’s to be found in a prospectus. Only the substantial financial rewards to the company and the shareholders can justify the expenses, distractions and continuing obligations the process inflicts.

 

 

SIA Member Services; Run Your Business Better: No Charge

I think the first time I heard about SIA it was when somebody asked me to write a check for membership. “What are we going to get out of this membership?” I asked. “We have to be a member to go to the show,” was the less than enthusiastic endorsement. So I signed the check.

Turns out there’s more to it than that. SIA offers its members no charge services that, if utilized correctly, will add to your bottom line. The mystery is why so few members utilize them. Maybe a little publicity will help.
 
The Credit Services Program gives companies a picture of the payment status and credit quality of retailers they are doing business with. Produced seven times a year (January through May, August and October), this report shows the amount and status of all reported debt more than 60 days past due. It includes not only information supplied by SIA members, but by the credit associations of other action sports trade groups.
 
The report I received in August was about an inch and half thick. The only cost to participate is the time it takes to complete a form which shows the name and address of the account and the amount 60 days or more past due. There’s room for a short comment on the account status.
 
The information is reported by a member number. The name of the reporting company is not disclosed except to Riemer Reporting Service, which assembles the data.
 
Let’s say you’re doing about $2,000,000 in business annually (an estimate of the mean revenue of SIA members). Your business continues to be highly seasonal, and your customers are demanding better payment terms. SIA reports that overdue accounts represented 4.8% of sales at wholesale, or $96,000 for your typical SIA member.
 
Not all of that will ultimately be uncollectable. But after taxes, a lot of businesses are lucky to drop 4.8% to the bottom line. Better management of your bad debt expense can easily be the difference between a profit and a loss.
 
The in season cash flow affects are harder to illustrate, but may be more important. As I’ve said in this space before, companies pay their bills with cash, not with profit. A lot of snowboard industry companies live hand to mouth during the period between the arrival of product and collection of receivables.
 
What happens if, on average, your collection period goes from 60 to 90 days? How much more money will you have to invest in the business? Where will you get it? What will it cost?
 
Just for fun, let’s say you can borrow money at 10% annually.  To carry $2,000,000 in receivables an extra 30 days costs you about $16,700. The calculation is oversimplified, but you get the picture.
 
SIA’s Credit Services Program is part of an effective program to reduce your bad debt exposure. Checking credit references is important, as is your history with the account. But nobody ever handed out bad credit references, and conditions change from year to year. If by participating you can sell more product to accounts that pay, and pay on time, isn’t it worth the few minutes it takes to fill out and send in the form? You bet.
 
Often, public relations doesn’t make it on our radar screens, though when somebody says “advertising and promotion” we perk up and get out our check books. To paraphrase Clauswitz, public relations is advertising and promotion carried on by other means. Working with SIA, you can do some good public relations work that’s inexpensive to free.
 
Sort of my accident I got my hands on SIA’s New Products, Best Values publication. This annual publication, distributed to hundreds of media people and anybody else who wants it, gives each company a chance to briefly describe its latest products. Having a listing is free, but only 30 board companies participated this year. Since the show, SIA has distributed about 1,200 hundred copies.
 
We spend six or seven thousand dollars on a Transworld ad that we wonder if anybody is going to notice, but we won’t take the time to get some information in the hands of people who are specifically requesting it.
 
Call SIA and get their free booklet on press relations. Tell them you want to participate in New Products, Best Values. Then call them again and ask what you should be doing about public relations and how you can do it. The information and advice you can get for free would cost you thousands of bucks from a public relations firm.
 
Finally, there’s the Cost of Doing Business and Compensation and Benefits Survey. It’s just as expensive as all these other SIA services; you got to participate.
 
Inaugurated only in 1994, this survey is focused on developing accurate financial information on the snow sports industry. Only participants receive the report. The submitting company is known only to an outside accounting firm that receives the information. The tabulated data is released only in composite form. It shows expenses as a percentage of sales, not in hard dollar terms. In other words, participants are well protected from disclosure of proprietary information.
 
The data is broken down by small and large companies (with $5 million being the cut off) and by hard and soft goods. Right now, limited participation is making the information less valuable than it will ultimately be. Only 82 companies (out of an SIA membership of 850) are participating, but less than 20 are snowboard or snowboard related. SIA is prepared to run the data for snowboard companies separately as soon as there’s enough participation to make the numbers meaningful. 
 
There are two basic reasons to participate. First, it will let you know how you’re doing compared to other companies, highlighting what you’re doing right and where you can look to improve. Second, it can be very valuable in dealing with your bank or other financing sources.
 
For most industries, banks have “common sized” financial data that allows them to compare your company to others in its industry. Not so with snowboarding; until now. This kind of data is something of a security blanket for bankers unfamiliar with an industry. It will allow you to explain how your company is doing compared to similar businesses. The fact that you even have this data and have considered its implications will improve your credibility, giving you and your banker a common point of reference.
 
Using SIA’s services and information correctly will improve the way you manage and finance your business. Do yourself and the industry a favor; participate. Fill out the forms and send them back.