From Private To Public: How To Read An S-1

IPO stories abound in the financial press. However, coverage may be cursory or lack information about the company you’d like to know.

Maybe coverage of a hot IPO contains excellent information on how much money the CEO stands to make when her company debuts, but zero details on its customer cohorts. Or maybe you want to learn more about a company’s quarterly performance, but the piece you find covers the numbers without context.

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If you could do your own research, you’d be in business. You wouldn’t be dependent on the media (hello!) to tell you what matters and what doesn’t. In order to get started, let’s define what an S-1 will tell you about a company aiming to go public.

Meet The S-1 Filing

A Form S-1, commonly referred to as an S-1, is a form that private companies file with the U.S. Securities and Exchange Commission (SEC) when they intend to go public.

The form includes a wealth of information about the company:

• How much a company intends to raise in its offering.
• A summary of its business.
• Notes concerning its competitors.
• How the firm intends to spend the money it raises.
• And the most critical parts of an S-1: its financial performance.

What you need to know is that when a company is going public, it files an S-1 with oodles of details on its business. The filing provides information that the company uses to sell shares in its IPO, and provides much of the information that regular folks will use to decide whether to buy shares in the company.

The better-known the filing company is, the bigger splash its S-1 can make. You can imagine, for example, how big of a deal it was when Google and Facebook originally filed, and how big of deal it will be when Uber eventually releases its own S-1 as well. And unlike a lot of government documents, these filings are fairly accessible to the general public.

Where To Find S-1 Filings

Now that we know we want to read S-1 filings, where do we get them? It’s time you get familiar with our friend Edgar.

Edgar isn’t a grumpy accountant down the hallway. Instead, it’s an SEC service you can access for free. What we want is this particular Edgar search function1 that lets us hunt for company-specific filings.

Let’s get you accustomed to how it works. Tenable, a cybersecurity company, recently went public. So click on the above link, type in “Tenable,” and click search.

Welcome to the Edgar search results page, which isn’t very user-friendly. But let’s forgive the government’s lack of digital polish and get to work. You will note there are two Tenable entries. This will often happen when you search for a company.

Go ahead and click the top result called “Tenable Holdings, Inc” under the column named Central Index Key (CIK). If you ever have to guess at which company you need to click on, remember you are looking for a company that intends to go public; therefore, there will likely be fewer, more recent filings under the entity you want.

Once you clicked on the right company, you will land on a page with a list of filings. The filing you’re looking for will be listed as “S-1.”2

For Tenable, you will also note that there are also two S-1/A filings. An S-1/A is an amended S-1 filing. A company going public may file an S-1/A if it needs to include more information. For instance, an S-1/A could include an additional quarter of financial details. But what we want is the first S-1.

Give it a click. Now repeat the exercise with another company that recently went public for practice. Here are a few to get you sleuthing: Sonos, Dropbox, and MuleSoft.

The further back a company’s offering was, the more buried its S-1 may be. To find an S-1 in these situations, learn to use the Edgar’s “Filing Type” form:

Now that we know where an S-1 filing can be found, what’s next? The good stuff, of course. We’ll start with the financial bits, talk about how to size an offering, peek at how companies describe themselves, and chat risks. This will be fun!

Financial Nuts and Bolts

If we wanted to go over every detail and nuance of an S-1, this post would be a book. Much of your S-1 learnings will be self-directed. We’re here to teach you to stand; it’s up to you to learn how to run. Your curiosity, and using Google for financial jargon, will carry you further.

To get to that point, here is what we’re going to help you answer from reviewing an S-1:

• How much money comes in the door (revenue).
• How much the money coming through the door costs (cost of revenue).
• How much the company spends to run (operating costs).
• How much or how little money is left after we subtract costs (profit).

To get this information, you will need to take a look at a company’s income statement. Think of this statement as a filter. Up top, revenue. From there, we’ll begin to take costs into account. If any revenue makes it all the way to the bottom of the filter after each cost is taken into account, what’s left over is profit. If the company runs out of revenue while paying costs, the deficit it reports is its loss.

We’ll use Tenable’s S-1-sourced income statement today to make our point. Note that everything is in thousands, so if a line says $1,000 it means $1,000,000!

In an income statement, each column corresponds to a different time period. The first column is the year ending December 31, 2015, the column to its right is the same period in 2016, and the next is the same period in 2017. Finally, on the far right, we have two columns that describe a three month period (one quarter) in both 2017 and 2018.

Why do companies include single-quarter results in addition to yearly results? It helps investors zoom in on the firm’s most recent performance. And by providing the March 31 quarter’s results from both 2018 and 2017, we can see how much Tenable grew from the first quarter of 2017 to the first quarter of 2018. As a result, you can make year-over-year comparisons of the company’s first quarters from the last two years.

Take a minute and read through the numbers above. You don’t have to understand many of them. But get a feel for the income statement. Always remember that numbers are your friends, and an audited income statement is the fifth gospel.

Recall our filter analogy. Now look after at the far right column. We are going to peek at Tenable’s March 31, 2018 quarter. Here’s what I see:

Revenue: $59.1 million

Comparing this figure to the number directly to its left (the March 31, 2017 quarter’s revenue), we can see that Tenable grew from the year-ago quarter. That’s good. Companies want to grow fast. And the faster a company grows, the more valuable it tends to be.

Cost of revenue: $8.7 million

This is the first cost that we’ll use to begin filtering revenue to see if the company made any money. Cost of revenue, also called Cost of Goods Sold (COGS), deals with direct costs relating to revenue. For a cloud company, this is the Amazon Web Services bill generated by hosting their service. For GM, it would be the steel that goes into making a car.

Gross profit: $50.4 million

Here we have the loosest of profit metrics. Revenue minus cost of revenue equals gross profit. This is not the sort of profitability that most people mean when they discuss the concept. Instead, gross tells us how much revenue the firm in question has left after paying for revenue inputs to run its business. In overly simplified terms, if a company has operating expenses lower than its gross profit, the firm will generate profit in the sense that most people mean it.

Operating expenses: $65.8 million

Tenable next lists its various operating expenses, including sales and marketing costs, research costs, general and administrative expenses, and the like. These add together to create the “Operating expenses” line item. Think of these costs as the expenses that run the company. This is salaries, catered lunches, sending the CEO to Davos, paying sales commissions, and share-based compensation costs.

Loss from operations: $15.4 million

Recall when we said that if a firm’s operating costs are smaller than is gross profit, it will (generally) make money? Well, look at our numbers from the preceding two paragraphs, and what do we see? The opposite. So when we subtract operating expenses ($65.828 million) from gross profit ($50.379 million), we find that our filter has already run out of revenue and has created a hole of $15.4 million.

Other expense, net: $8,000

Every business is distinct, and companies often have some other costs that don’t fit into their operating results. Those costs could end up on this line. What this figure lets us do is understand the difference between a company’s operating results (its operating profit or loss) and its net profit or loss.

Net loss: $15.9 million

This is the number that we’re looking for. Net loss is what we get after all the company’s costs have been removed from revenue. In this case, as we expected, Tenable lost money as its gross profit wasn’t enough to cover its operating expenses, let alone its other lists costs.

What About The “Accretion” Line Item?

This is tricky. To get a solid explanation of this bit of financial arcana, Crunchbase News reached out to IPO expert and Deloitte & Touche partner Barrett Daniels to explain it in detail:

“Sometimes investors negotiate terms which provide for potential redemption of preferred stock, and in those instances, a company can find itself recognizing a charge, in a form similar to that of a dividend, as accretion below its net loss in the income statement.”

We care more about the net loss as it’s more closely tied to the company’s operating results instead of this somewhat arcane financial item. But that’s what it means in case you were curious!

You have now gone through an income statement’s most basic pieces, giving you the start of an understanding of what it means. The good news for you is that it will never be harder than that. The first run is the worst, as it seems that there is a blizzard of numbers in front of you that you’ll never see through.

As an exercise, read the other columns in the income statement. Get a feeling for how the company did in 2016 and how it did in 2017, and ask yourself these questions:

• How much did its revenue grow between the two years?
• Was Tenable less profitable in the first half of 2017 or the first half of 2018?
• And finally, did Tenable have more cash on hand at the end of 2017 or the end of 2016?

Don’t worry; we won’t leave you hanging. The answers are here.

After a few more S-1s, income statements will be nothing to you. And even better, the same income statement notes from above will apply to any earnings report you need to read. That’s great!

Finding Quarterly Results

Search for “quarterly results” in the S-1. The third result is what we want. As you can see on pages 68 and 69 of the Tenable S-1, we have the company’s results broken down by quarter. This lets us see how the firm did during the periods it summarized elsewhere in its filing. You can think of quarterly results as a high form of truth, as the company can’t stuff a bad quarter into a year’s results to smooth it out.

In Tenable’s case, we can see how heavily the firm has spent on sales and marketing in the last two quarters. It also posts strong revenue growth during those periods. What does that tell us? Email me what you think here.

Before we move on, a few more notes on other things you can find in the S-1 that will be helpful:

• Finding Tenable’s current cash position. Run a search on the S-1 page for “cash and,” a query that will bring up the data we need. There are 24 results, which is a lot. The goods news is that the first one is the correct result. (In nearly every S-1, you can find the company’s cash position by executing this search or one very similar.) Keeping in mind that the company’s results are presented in thousands, we can see that the firm has $26.4 million in “cash and cash equivalents.” The combination of the two is generally referred to as simply “cash.” Some companies that are very cash-rich will store some of their cash in short-term investments. That counts as cash, too. And Apple is so wealthy that it stores some of its cash in long-term investments. Mostly, however, cash in the corporate sense means cash and equivalents.
• What about stock-based compensation? After the income statements in this S-1, you’ll often see a second table that is preceded by a comment that reads, “Includes stock-based compensation expense as follows.” Here the company wants you to know that its net loss isn’t as bad as it might appear on a cash basis. As stock-based compensation (paying employees partially in shares) doesn’t cost the firm cash, some investors don’t count it towards a firm’s losses. And companies want you to think that their losses are smaller, so they detail how much of their expenses came from this non-cash cost. Mostly you should view stock-based compensation as a real cost, as it’s mostly a deferred cash cost at best.

Now let’s get our head out of the weeds and talk about some more general concepts you’ll need to know as well. To move forward, it will help to have Tenable’s S-1 on-hand by using Edgar search functions or click here for a direct link to the filing.

Sizing The Offering

You’ve seen the headline: Company X Files For $100 Million IPO. It’s often a big, round, precise number that you see in headlines when it comes to new offerings. That number is mostly crap.

Companies put placeholder figures in their IPO filings until a price range is set. Regardless, you can get blood from this stone.

Do a search in the S-1 for “Proposed maximum aggregate offering price,” which is accountant for “what’s the most money you intend to raise?” Here we see the incredibly common $100 million figure written down. The actual IPO amount will not be $100 million (keep in mind that we’re discussing the amount that Tenable wants to raise, not the amount of money that it is worth), but it will be in the range of $100 million.

Companies that raise $678 million in their IPO don’t put $100 million down as a placeholder. They put down $500 million and so forth. So the clean, round placeholder figure is imprecise, but should prove directionally accurate. Just don’t ever buy that someone is actually raising $100 million or another nicely rounded number. The chances of it being that exact number are quite small.

Company Details

There are always more numbers to read if you are so inclined, but we need to work out how the company thinks about itself and what its risks are. We’ll start with the self-description.

Starting on the formal page one of the S-1, Tenable describes itself in an overview. Starting on page three, the company writes about how it thinks about its market (“Industry Background”). On page five, Tenable dives into how it will grow. Pages six and seven are all about the company’s makeup and its status as an emerging growth company.

Following, there is the company’s to-be-filled-in offering nuts and bolts (shares, how many, how much, from whom, and so forth). Then the S-1 covers the income statement we know so well, and we’re brought straight to page 13: risks.

Risks

It’s always worth reading an S-1’s risk section. It can tell you about who the company thinks of as competition. It will also note where the firm may run into issues regarding technology and the like.

But what should not make you worried are boilerplate warnings. To pick one example, every company that goes public and loses money has to say that it may never make money (“We have a history of losses and may not achieve or maintain profitability in the future.”). Another classic: “Our future quarterly results of operations are likely to fluctuate significantly due to a wide range of factors, which makes our future results difficult to predict.”

This is the company admitting to lacking a crystal ball and the ability to see the future.

But there are often things of worth in the risk section, so do your homework and skim it. If you don’t have that much time, run some searches on the S-1 for keywords that might come up as risks. You’ll often find something great.

Every S-1 Is Special

Remember that line about accretion that we dealt with during our income statement work? It’s a reminder that every S-1 is special, and will require some figuring out. The good news is that Google and the various outcroppings of the Internet (Investopedia, etc.) will help you learn what you don’t know. And if all that fails, you can always ask Twitter or Facebook, wherever you prefer to hang out.

But if you run into something new in an S-1, or something that just plain doesn’t make sense, don’t worry! Just Google the term and go from there. This is stuff you can figure out. Finance is vocabulary and common sense written down. It’s tedious, not difficult; it’s opaque, not impossible.

Just keep the basics in mind: revenue up top, real profit on the bottom, and costs in the middle. And the harder a company works to make you care less about those things in favor of monthly unique active users divided by fourteen cohorts, the more full of beans they probably are. And profit is better than losses in nearly every case.

Now you know enough to be dangerous. Go out and read three more S-1s and email me your questions!

Illustration: Li-Anne Dias