Pro-forma financials for IPO purposes

The pro-forma financial information as the term suggests has for its objective the provision of information to investors about the effect(s) of a transaction or a set of transactions that might have had on the historical operations of a registrant as well as the possible effect(s) on the continuing operations of the registrant. It is considered by investors that pro-forma financial information is the best form to reflect the financial position and results of operations to be included in a newly formed entity as these consider historical information and management assumptions.

The Securities and Exchange Commission (SEC) has released Guidelines on Reporting and Attestation of Pro-Forma Financial Information (SEC Memorandum Circular No. 2, Series of 2008 or circular). This circular applies to pro-forma financial information that should be submitted with the registration statement in the registration of securities for initial public offerings or follow-on offerings. In particular, these guidelines apply in the case of a registrant who was previously a part of another entity and information about that fact is necessary to reflect the operations and financial position of the registrant as an autonomous entity, among other applications.

It should be noted that before this circular came into effect on Feb. 15, 2008, the SEC only accepted registrants for public offerings which have either a track record of profitable operations for three full years; or a market capitalization of P500 million, provided that it has a five-year operating history; or net tangible assets of P500 million, provided that it has a five-year operating history. The just mentioned requirements pertain to those companies applying for IPOs in the first board. Similar guidelines, though, lesser in scope, are required to be met if an entity applies with either the second board or with the Small and Medium Enterprise (SME) Board. In all of these, the applicant-entity must be a separate juridical entity, i.e., it should be a company or a corporation duly registered with the SEC.

With the issuance of the circular, companies can now spin-off a particular division with the intention of offering the shares of the new spun-off company to the public. This of course assumes that the basic guidelines (under the First Board) as regards three year profitable operations while it was operating as a division; or a market capitalization of P500 million upon completion of the spin-off; or has a five- year operating history as a division can be clearly demonstrated by  the new spun-off entity.

To clearly illustrate the matter, let us assume that a particular company plans to register its securities for initial public offerings but the particular securities it wanted to offer to the public are the  shares  of one of its operating divisions once it has been spun-off. In this regard,  a new entity has to be created through the spin-off of that particular division. Once the spin-off is completed, special-purpose financial statements for the last two years have to be carved-out from the parent company. These special purpose financial statements would represent the historical financial information of the newly created entity. After giving effect to the management assumptions and adjustments, the carve-out special purpose financial statements   now become the pro-forma financial statements and show the results as if the spin-off has been completed as of the beginning of the earliest period presented. Both the carve-out special purpose financial statements and pro-forma financial statements need attestation of an external auditor. The circular also enumerates the objective of the external auditor’s examination procedures as applied to pro-forma financial information, the procedures to apply to the assumptions and pro-forma adjustments and the kind of attestation report to be issued by an external auditor accredited by SEC under Group A category.

The pro-forma financial information will enable  the investing public to determine the continuing impact of a particular transaction by showing how it might have affected historical financial statements had the transaction been consummated earlier. Through such information, the investor can analyze the future prospects of a securities registrant because the pro-forma financial information presents the possible scope of the change in the registrant’s historical financial position and operations on account of such transaction.

The Circular invokes paragraph nine of the Securities Regulation Code (SRC) Rule 68.1 to be followed in the preparation and presentation requirements of pro-forma financial information. The pro-forma financial information shall consist of condensed balance sheets, income statements, cash flow statements, statements of changes in equity and the related notes to the financial statements, if applicable. If practicable, the pro-forma financial statements shall be presented in two-year comparative periods. The pro-forma adjustments in historical information should be based on management’s assumptions and should take into account all significant effects directly attributable to the transaction or event. The pro-forma financial information should be clearly labeled as such to distinguish it from historical financial information. The presentation should describe among others the transaction or event, the source of the historical financial information on which it is based, the significant assumptions used in developing the pro-forma adjustments, and any significant uncertainties about those assumptions.

The presentation should also indicate that the pro-forma financial information should be read in conjunction with related historical financial information and that the pro-forma financial information is not necessarily indicative of the results that would have been attained had the transactions or events taken place earlier.

There you go. Companies can now have a “vehicle” for their profitable operations conducted through their divisions to register their securities without disturbing the ownership structure of the parent entity.

(Wilfredo Z. Palad is a Partner for Audit Services of  Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email [email protected] or [email protected]).