A private company or subsidiary may use the proceeds of an IPO to pay a dividend to its promoters/owners or parent company. In some situations, the dividend may exceed earnings in the most recent year. In such a case, the reporting entity should include unaudited pro forma per share data (for the latest year and interim period only) on the face of the income statement, giving effect to the number of shares whose proceeds would be necessary to pay the portion of the dividend that exceeds the current year’s earnings.

The pro forma EPS requirement also applies to both of the following situations:

SEC FRM 3420.2 addresses the application of ASC 855-10-S99-1 (SAB Topic 1.B.3) when the dividend to be paid exceeds both the last twelve months’ earnings and the proceeds from the equity offering. In that instance, the pro forma EPS computation should not reflect more shares than will be outstanding after the offering.

To present a transparent picture for the investor in this case, reporting entities should also adjust the numerator of the pro forma EPS computation to reflect the incremental interest expense (net of tax) relating to the portion of the dividend that exceeds both the gross proceeds from the equity offering and the previous 12 months’ earnings, which would be assumed to be funded by debt.

SAB Topic 3.A reminds registrants of the pro forma requirements of S-X Article 11 in a registration statement of convertible preferred stock or debt when the proceeds will be used to extinguish existing preferred stock or debt and the extinguishments will have a material effect on EPS.

We believe that registrants should also consider the guidance in SAB Topic 3.A when there is an issuance of common stock with similar use of the related proceeds to retire preferred stock or debt. In this situation, the pro forma EPS calculations would be based on the shares outstanding prior to sale plus the shares required to be sold to raise the cash necessary to extinguish the preferred stock or debt (i.e., not necessarily the entire proposed issuance), calculated using the offering price per share to the public. Net income would be adjusted to eliminate the interest expense, net of related tax effect (or, in the case of preferred stock, net income attributable to common stockholders would be adjusted to eliminate the dividends on the preferred stock). The additional shares should be included for the elapsed time from the beginning of the period or the date of issuance of the preferred stock or debt, if later. If the proceeds of the offering exceed the preferred stock or debt to be extinguished, only the number of shares necessary to raise the proceeds to extinguish the preferred stock or debt would be included in the denominator. The amount of dividends or interest expense eliminated should be the amount actually attributable to the preferred stock or debt extinguished.

Another situation generally requiring pro forma EPS involves a newly formed corporate entity (e.g., a recently incorporated carve-out or leveraged buyout). The capital structure of such an entity often includes temporary or bridge financing. For example, for tax purposes a company may use preferred stock rather than debt as the bridge financing vehicle, which will be extinguished with the proceeds of a public equity offering.

Example FSP 7-21 illustrates the calculation of pro forma EPS when a registrant uses the proceeds from an offering to extinguish existing debt.

EXAMPLE FSP 7-21
Calculation of pro forma EPS - proceeds of common share offering used to extinguish debt

FSP Corp will offer 10,000 common shares at $10 per share for total proceeds of $100,000. At December 31 20X1, FSP Corp has net income of $100,000, weighted average shares outstanding of 20,000, and a reported basic EPS of $5.00. The tax rate is 30%.

With a portion of the proceeds from the offering, FSP Corp will extinguish $50,000 of its existing debt, of which $25,000 was issued on January 1, 20X1 and $25,000 was issued on July 1, 20X1. The interest rate is 10%, and interest expense for the year is $3,750.

How should FSP Corp calculate pro forma basic EPS?

FSP Corp should calculate pro forma basic EPS as follows:

As illustrated above, the pro forma basic EPS calculation only includes the number of shares associated with the actual amount of debt being extinguished ($50,000) and not the entire share offering proceeds ($100,000).

Pro forma earnings per share amounts generally should not be presented in the financial statements in subsequent Exchange Act filings (e.g. annual and interim filings on Forms 10-K and 10-Q), even if such amounts were included in the financial statements in the IPO registration statements.

See FSP 7.6.1 for guidance when presenting EPS in Exchange Act filings that gives effect to stock splits, reverse stock splits, stock dividends, and recapitalizations that were declared and effective in different reporting periods.

If the issuer was formerly a Sub-Chapter S corporation, partnership, or similar tax exempt enterprise, and voluntarily provided pro forma data (reflecting adjustments for taxes only) for all periods presented, the issuer should continue to present that pro forma data for periods prior to becoming a taxable entity (including the period of change) in subsequent Exchange Act filings, consistent with FSP 32.4.2.1. Such pro forma presentations should continue to calculate the pro forma tax expense based on statutory rates in effect for the earlier period. See SEC FRM 3410.1 and SEC FRM 3410.2.