IPOs: Process and Pricing

1. IPOs: Process and Pricing Presented to: The Taiwan Stock Exchange Gretai Securities Markets The China Intangible Asset Valuation Association by Daniel L. McConaughy, PhD Partner, Grobstein, Horwath and Company LLP Associate Professor of Finance, California State University Northridge Dmcconaughy@horwathcal.com 818-501-5200 March 21, 2005 Grobstein, Horwath & Company LLP

2. IPO IS • an Initial Public Offering of a company’s stock to the public • an orderly sale of shares to the public following rules outlined in the Securities Act of 1933 and enforced by the SEC • A mechanism for private companies to sell ownership stakes to investors who believe in the companies’ futures • Purposes: • Growth • Recapitalization • Original shareholders diversify Grobstein, Horwath & Company LLP

3. BENEFITS of being a Public Company • Expand and diversify equity base: • Lower cost of capital • Public exposure and prestige • Equity-based compensation opportunities for attracting and retaining key management and employees • Creation of ‘Currency’ for acquisitions • Facilitates other financing opportunities: equity, convertible debt, cheaper bank loans, etc. Individuals Management & Venture Capital Funds Mutual Funds Pension Funds Other Institutions Grobstein, Horwath & Company LLP

4. COSTS of being a Public Company • Disclosure requirements • Scrutiny by and pressure from shareholders and security analysts • Shareholder Relations • Vulnerability to hostile takeovers • Corporate governance • Cultural considerations Grobstein, Horwath & Company LLP

5. Public Company Disclosure - Public quarterly SEC filings - Detailed review of operating results - Quarterly investor calls, easier for competition to asses strengths and weaknesses Accountability - External shareholders - Research Analysts - Management - Board of Directors Forecasting - Thorough - Precise - Conservative - Must meet or exceed Street expectations – missing a forecast can result in stock price drop Private vs. Public Company Private Company • Disclosure • - Private summary results to shareholders • - Management accounting • - Hard for competition to monitor • Accountability • - Management • - Shareholders • - Board of Directors • Forecasting • - Primarily for budgeting • - Missing budgeted numbers may impact bonus payments but does not necessarily weaken a company’s competitive position or value Grobstein, Horwath & Company LLP

6. Preparation for IPO • Understand and fulfill due diligence requirements • Develop budgeting and reporting processes • Develop timely reporting of key metrics • Develop investor relations and communication methods to disclose performance changes • Identify key persons to provide communications to investors • Train investor relations staff for - responses to outsider inquiries - information disclosures Grobstein, Horwath & Company LLP

7. Follow up after IPO Manage investors’ expectations • Investor relations activities - Conference calls - Press releases - SEC requirements - Ongoing discussions with investors and analysts • Create management credibility • Ensure responsiveness to changing marketplace Grobstein, Horwath & Company LLP

8. Getting Started Preliminaries • Put together Strategic working group • Devise structure of offering • Schedule and assign tasks • Put together Legal Team • Publicity • Make sure Accounting Team has credibility and expertise Grobstein, Horwath & Company LLP

9. Getting Started Duties Hire the Outside Team • Lead Manager • Co-mangers • Issuer’s counsel • Underwriters’ counsel • Accountants Prepare the Internal Team • Structure • Strategy • Due diligence • Disclosure • Must be able to work effectively with Outside Team Grobstein, Horwath & Company LLP

10. Getting Started Structuring the Offering • Size • Number of shares authorized • Follow-on issues • Status of mezzanine financing - pay in cash - give shares • Review existing shareholders • Determine lock-up agreements with company, principal shareholders, officers, directors • Underwriter distribution objectives/syndication • Selection of listing exchange • Selection of stock symbol • Use of proceeds Grobstein, Horwath & Company LLP

11. Getting Started To Do List • Due diligence – making sure things are OK • Drafting legal documents and regulatory filings • Audited financials • Shareholder communications • Board meetings • Filing with SEC • SEC review period • Roadshow • Pricing and offering size • IPO follow up details Grobstein, Horwath & Company LLP

12. Getting Started Legal Considerations • Outstanding claims • Loan agreement restrictions or other consents needed to offer shares • Board meetings • Disclosure of confidential agreements • Request of confidentiality or treatment of confidential information • Possible lawsuits • Possible acquisitions, divestitures, restructuring, management changes Grobstein, Horwath & Company LLP

13. Getting Started Investor Relations • Quiet period • Industry presentations • Press releases/other corporate announcements • Interviews or articles on company to be published Grobstein, Horwath & Company LLP

14. Getting Started Financial and Accounting Matters • Prepare historical and pro forma audited financial statements • Identify unusual items requiring advance discussion with SEC • Auditors comfort letter to the underwriter Grobstein, Horwath & Company LLP

15. Getting Started Time Line 2 months 1 month Continuing… 2 –3 months Marketing the Issue - “Red herrings” – print and distribute - Stock Analysts present to underwriters’ sales forces - Target key investors - Create underwriting syndicate - Presentations to sell-side analyst - Roadshow presentations - Develop the “Book” i.e.,institutional and retail demand Pricing, Trading and Follow-on Support - Analyze pricing issues and investor feedback - Determine allocation to retail & institution - Begin aftermarket trading - Closing details - On-going research - Investor relations begins and continues in earnest • Prior to filing • - Due diligence • Valuation • - Choose co-managers • - Documentation • - Positioning • - File registration statement • SEC Review • - Prepare for roadshow • presentation • - Respond to SEC • Comments Grobstein, Horwath & Company LLP

16. Due Diligence Process • Corporate Level Company • History • Mission statement/vision • SWOT (Strength Weaknesses Opportunity Threats) analysis • Objectives and key challenges • Management team/organizational chart • Key investment highlights • Strategic position in the industry • Industry size/growth rates • Market drivers • Major industry trends(spending, commissions, etc.) • Consolidation • Segmentation/target markets • Cyclicality • Regulatory environment Grobstein, Horwath & Company LLP

17. Due Diligence Process (cont’d)At the Corporate Level • Products/Services - Description of each major product/service category - Market size by category - Sales and margins by product/service category • Customers - Breakdown of total customers/subscribers(business vs. consumer, small vs. large, etc.) - Historical growth in customer/subscribers • Suppliers - List of key suppliers(number, sourcing policy, relationships, price volatility) • Growth Strategy and Projections - Organic growth opportunities - Strategy for growing below-the-line business - Key areas for new development • Acquisitions/Ventures - Any planned or pending acquisitions • Legal • Human resources - Retention of key employees after the IPO • THERE MUST BE A COMPELLING STORY Grobstein, Horwath & Company LLP

18. Due Diligence Process (cont’d)At the Business Unit Level Business Units • Business Unit Strategy • Review Major Business Units - Competitive strengths/points of differentiation/areas of weakness - Growth strategy - Employees (breakdown, hiring, turnover, retention plans) - Pricing trends/margin trends - Significant threats/opportunities • Financial Reviews - Reconciliation of budget vs. actual results - Annual historical/pro forma financial data and key operating statistics - 3-year projected financial results - detailed model including income statement, balance sheet, cashflow - Sales and profitability breakdown between traditional and below the line sales - Financial objectives (revenue growth, operating margin, leverage statistics, etc.) - Major accounting issues (revenue recognition, receivables, write-off policies, reserves, etc.) - Exposure to exchange rates and how foreign currency exposure is managed - Internal auditing procedures - Tax position, current and future Grobstein, Horwath & Company LLP

19. Due Diligence Process (cont’d)At the Business Unit Level • Budgeting and Forecasting • Personnel - Recent and planned management changes - Compensation philosophy (salary vs. bonus, how bonuses are determined, share ownership, etc.) - Employee recruitment and retention strategy - Significant employee agreements • Customer Review - Concentration last 3 yrs and projected - Revenue breakdown (by service, customer, industry, geography) - Recent major wins/losses and reasons - Customers at risk - Summary of contract terms for key customers Grobstein, Horwath & Company LLP

20. Preparing the Registration Statement Typical contents • Prospectus summary • Risk Factors • Use of Proceeds • Capitalization • Selected Financial Data • MD&A • Business - Overview - R & D - Environment - Industry - Manufacturing - Properties - Competitive strengths/ - Sales & Marketing - Employees solution - Strategy - Competition - Legal - Products - Customers • Management • Principal Stockholders • Related Party Transactions • Underwriters • Financial Statements Grobstein, Horwath & Company LLP

21. Roadshow Presentation • The company’s opportunity to sell itself to investors - Domestic roadshow - 8 – 10 days (typical in U.S.) - Approximately 100+ face-to-face meetings - International roadshows usually shorter than domestic • Prior to meeting management investors read prospectus, discuss company with research analysts and securities salespeople • Group and individual meetings • “Makes or Breaks” the deal - Investors will ask everything - Demanding and stressful on top management - Distracts from running the company - Must have a compelling story to tell Grobstein, Horwath & Company LLP

22. Roadshow Formats • Group Presentations - company tells its story in detail generally during a meal: can be lunches with hundreds of investors to smaller groups - generally conducted by two teams but sometimes they will combine when necessary • One-on-One Presentations - expected to generate the majority of quality institutional demand - range from meetings with a single portfolio manager/buyside analyst to small group sessions with multiple portfolio managers and buyside analysts - will take place in cities throughout the United States and Europe - will be conducted by the two teams separately with the exception of certain key accounts where the teams will combine for maximum impact • Conference Calls - on as-needed basis with select investors who cannot attend roadshow meeting - maybe group calls as well as one-on-one Grobstein, Horwath & Company LLP

23. Pricing Overview • Teams meet, share feedback and ascertain demand and pricing • When final pricing date has been determined investors are told the deadline for submitting indications of interest and the closing of the book • After closing the book the lead manager and co-managers assess: - Demand - Price sensitivity - Allocation issues - Aftermarket behavior • The lead manager meets the co-management and recommends an offering price that maximizes the offering proceeds to company and favorable aftermarket performance • Company and the underwriter agree on offering price, and sign underwriting and syndicate agreements Grobstein, Horwath & Company LLP

24. Typical Pricing Process Pricing Process Last Days of Roadshow Pricing Day • ‘Book’of Demand • Size • Quality • Price Sensitivity • Likely aftermarket demand Trading begins Analysis Agreement on Price/Size Allocations to investors at agreed initial price Market determines price • External Factors • Recent Developments • - Stock Price levels • - Market in general • - Industry • - Comparables • - New Issues Price Support Activity Green Shoe Option Exercised Grobstein, Horwath & Company LLP

25. After the IPO • Regulation FD – Fair Disclosure - The SEC is adopting new rules to address three issues: the selective disclosure by issuers of material non public information; when insider trading liability arises in connection with a trader’s “use” or “known possession” of material non public information; and when breach of a family or other non-business relationship may give rise to liability under the misappropriation theory of insider trading. The rules are designed to promote the full and fair disclosure of information by issuers, and to clarify and enhance existing prohibitions against insider trading. • Regular filings with the SEC • Earnings announcements • Quarterly and annual financial statements • Material corporate events • Manage expectations • Meet or exceed investors expectations Grobstein, Horwath & Company LLP

26. IPO Dutch Auction: Innovation in IPO Pricing Dutch Auction is an auction method that uses a bidding process to find an optimal market price for the stock, the lowest price at which an issuing company can sell all the available shares. An alternative to the traditional negotiated pricing process used by underwriters to set IPO prices, this auction format was most recently employed by Google and is used for US Treasury auctions. Also called a descending price auction, it was named after the famous auctions of Dutch tulip bulbs in the 17th century. http://www.investorwords.com/1603/Dutch_auction.html Grobstein, Horwath & Company LLP

27. Dutch Auction Case Study: Google • The ABCs of a Unique IPO • IPO Dutch Auctions vs. Traditional Allocation • Case Study: Google IPO Prospectus • Lifting the Google Lid • Another View of the Google IPO Grobstein, Horwath & Company LLP

28. Conclusion • Improved investor feedback into the pricing mechanism. • Will the Dutch Auction gain wider acceptance? • Will this reduce the short-term price increases that often follow the IPO? • What are the implications for underwriters? • What are the implications for investors? Grobstein, Horwath & Company LLP