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Securities Commission's inquiry into aspects of initial public offering (IPO) of Vertex Group Holdings Limited (Vertex) [2003] NZSecCom 1 (14 March 2003)

Last Updated: 8 November 2014

Report on aspects of the initial public offering of Vertex Group Holdings Limited in 2002

14 March 2003

TABLE OF CONTENTS

SUMMARY OF CONCLUSIONS

  1. The Securities Commission's inquiry into aspects of the initial public offering (IPO) of Vertex Group Holdings Limited (Vertex) considered three broad questions:
    1. whether the offer document for Vertex's IPO adequately described the risks associated with the share offer;

  1. whether the prospective financial information in the offer document properly identified and set out the principal assumptions on which it was based; and

  1. whether the process followed by the directors of Vertex in preparing for the IPO was appropriate.

  1. The Commission is of the opinion that the offer document was likely to mislead investors because it did not adequately disclose the risks associated with the offer. The offer document emphasised certain business units of Vertex as being the most significant source of potential growth, but did not give sufficient information about risks associated with those business units. When particular emphasis is given to part of a business as a selling point for the investment, equal emphasis should be placed on material risks associated with that part of the business. In this case, the difference in emphasis given to the potential growth of certain business units of Vertex and to the risks associated with those business units, was such that the document was likely to mislead investors.

  1. The Commission considers that although not misleading, certain assumptions underlying the prospective financial information for the Technical Injection and Securefresh business units were not sufficiently supportable for the information relating to those two business units to be presented as forecasts.

  1. The Commission is of the view that the assumptions for the other business units were sufficiently supportable to produce forecasts. In such circumstances, the Commission believes that businesses should distinguish between those business units for which they can forecast, and those for which only projections can be given. The Commission recognises that the Financial Reporting Standards do not provide clear guidance on this point and refers this matter to the Institute of Chartered Accountants of New Zealand (ICANZ).

  1. Several corporate governance issues arose during the inquiry, which warrant comment by the Commission:

  1. The evidence suggests that there was some confusion as to the role of PricewaterhouseCoopers (PwC) as financial adviser to Vertex, concerning PwC's responsibilities in relation to the prospective financial information. Clear lines of communication at the appropriate levels were not apparent on this issue.

  1. There was also a lack of understanding by several Vertex directors about the options for presenting the prospective financial information required in offer documents. In particular, some directors did not appear to know that prospective financial information in a prospectus can be presented as either a forecast or a projection.

  1. In addition, there were deficiencies in communication of information about the performance of the individual business units from management to the Vertex Board.

  1. The Commission notes that there is currently no professional guidance for auditors concerning their role in engagements that involve an examination of prospective financial information. The Commission refers to ICANZ the question of whether such guidance is desirable.

  1. The Commission has not found evidence to suggest that the directors of Vertex believed the offer document was misleading. Nor has it found evidence to suggest that at the date of allotment the directors knew the offer document was misleading.

BACKGROUND TO THIS REPORT

  1. Vertex made an offer of shares to the public in a combined investment statement and registered prospectus dated 7 June 2002 (the offer document). Following the IPO, the shares were allotted on 1 July 2002 and Vertex listed on the New Zealand Stock Exchange (NZSE) on 1 July 2002.

  1. Just over two months later, on 4 September 2002, Vertex made an announcement to the NZSE that it expected its earnings before interest and tax (EBIT) for the six months to 30 September 2002 to fall short of the amount forecast in the offer document for that period. Vertex said it expected EBIT for the six months to be down by 15% on its forecast, and its full-year EBIT to 31 March 2003 to be down by 10%. The announcement also stated that Vertex expected revenues for the six months to 30 September 2002 to be down by 10% on the amount forecast in the offer document, but that full year revenues to 31 March 2003 were expected to be in line with the forecasts contained in the offer document.

  1. The company attributed these anticipated shortfalls to a "poor second quarter", expanding on this as follows: "The major component in this shortfall is the performance of the Technical Injection business. Weak export sales for animal health applicators (primarily due to reduced US demand for 'over the counter' products) and unanticipated delays in customers' planned new product introductions have affected sales and production efficiencies in the business unit...

    Securefresh packaging sales have also been under plan due to the recent substantial reduction in Australian chilled lamb exports related to drought and market changes. The business has also experienced delays in customer take-up of new technology...

    The final stages of the 18 month restructuring program, Project New Age, have resulted in higher than anticipated costs in recent months in the Dairy and Industrial businesses."

  1. On 5 September 2002 the NZSE announced that it had referred the matter of Vertex's compliance with the continuous disclosure obligations of the NZSE Listing Rules to the Market Surveillance Panel for investigation. The Market Surveillance Panel's investigation considered the period between the release of the offer document on 7 June 2002 and the announcement made by Vertex on 4 September 2002. The Market Surveillance Panel announced its findings on 4 March 2003.

  1. In its statement of 5 September 2002, the NZSE said:

    "[A]s yesterday's announcement by Vertex may cast doubt upon the accuracy of the forecast financial information presented in the Investment Statement and Prospectus dated 7 June 2002, the Exchange has referred this matter to the Securities Commission for its further consideration."

  1. The matter was referred by the NZSE to the Commission on 5 September 2002.

  1. The Commission notes that on 20 February 2003 Vertex made a announcement to the NZSE that it had further revised its expected earnings before interest and tax (EBIT) for the full year to 31 March 2003, and expected EBIT to fall short of the amount forecast in the offer document by between 14 and 18% for that period. The Commission has reviewed that announcement and does not consider that it raises any further issues for the Commission.

THE COMMISSION'S INQUIRY

  1. After a preliminary review of the referral, on 11 September 2002, the Commission announced an inquiry into aspects of Vertex's public share offer and offer document. This inquiry has been carried out under section 10(c) of the Securities Act 1978, which provides that it is a function of the Commission to "keep under review practices relating to securities, and to comment thereon to any appropriate body".

  1. The quorum considering this matter comprised Jane Diplock (Chairman of the Commission), Colin Beyer, Falcon Clouston, and Elizabeth Hickey (Members of the Commission).

  1. Terms of reference for this inquiry were settled on 11 September 2002. The Terms of Reference are set out in Appendix A. This report does not cover issues relating to trading in the shares of Vertex.

  1. The Commission's inquiry focused on the matters set out in paragraph 1 of this report. The inquiry did not address the historical financial information contained in the offer document. The Commission's inquiry also did not consider any questions in relation to Vertex's public announcement on 4 September 2002. That announcement was being considered contemporaneously by the Market Surveillance Panel in its investigation into Vertex's compliance with the Listing Rules of the NZSE.

  1. The Commission recognises that it is considering this matter with the benefit of hindsight. Nevertheless, the Commission has focused its attention on the circumstances and risks that should have been known to the directors at the time of the IPO, and has reached its conclusions on that basis.

  1. The Commission considers that the matters under review raise issues of securities law and practice relevant to participants in New Zealand markets, and upon which it is appropriate for the Commission to comment. The Commission has decided to comment by way of this report.

Procedure

  1. The Commission determined the procedures for this review. The Commission heard evidence on matters relating to the IPO from the following:

  1. The Commission received affidavit evidence from Lloyd Edwards, a Partner at PwC.

  1. In addition the Commission received documents and information from:

  1. The Commission during its inquiry received over 3,500 individual documents. The Commission committed significant time and resources to a careful analysis of those documents.

  1. Confidentiality orders were in place throughout the inquiry. Hearings were held over four days. Vertex was represented by counsel throughout the hearing of evidence. PwC was represented by counsel during presentation of its evidence. Counsel were advised that they could put questions to witnesses through the Chairman of the Commission. Documentary evidence considered by the Commission was provided to Vertex. Oral evidence was recorded, and transcripts provided to Vertex.

  1. After receiving evidence the Commission prepared a confidential consultative report and invited comment from affected parties These parties were given the opportunity to respond with submissions and to provide further evidence to the Commission. An appropriate consultation period was afforded to those parties. Once submissions had been received, it was necessary in the interests of natural justice to then seek further submissions from some witnesses.

  1. The Commission has carefully considered all evidence and submissions before publishing this report.

VERTEX'S SHAREHOLDERS AND MANAGEMENT

  1. Vertex had its origins in the Carter Holt Harvey Group of companies. Vertex was formed from Carter Holt Harvey Plastic Products. This was an established business, having effectively been in existence since 1941. This business (excluding a plant in Australia) was purchased in October 2000 by two private equity investment funds, the PEP Funds and the Bain Funds. The business was purchased by a company incorporated in New Zealand for the purpose, Vertex Group Holdings Limited, and renamed Vertex Pacific Limited ("Vertex").

  1. At the time of the IPO the Board of Vertex comprised:

  1. Sarah Roberts of Buddle Findlay and Rickard Gardell (a director of PEP) were directors immediately prior to the registration of the registered prospectus. They both resigned as directors with effect from 6 June 2002.

  1. Vertex's senior management at the time of the IPO was as follows:

THE BUSINESS OF VERTEX GROUP HOLDINGS LIMITED

Nature of Vertex's Business

  1. Vertex is primarily a plastics packaging company, with four well-established "core" businesses: Food Trays, Dairy Packaging, Industrial Containers and Household Products. It also has two "growth" businesses: Technical Injection (an injection moulding business that evolved from Industrial Containers) and Securefresh (a business utilising technology acquired in 2001, selling meat packaging machinery and trays).

  1. The separate business units were identified and separated out as part of the restructuring of the business following its acquisition in October 2000 from Carter Holt Harvey Plastics and incorporation as a new company. The restructuring involved significant capital expenditure with the aim of increasing efficiency and maximising the potential of the business. The name given to the restructuring programme was "Project New Age". This project was ongoing at the time of the IPO.

  1. As a result of the restructuring, internal management reporting systems were put in place from April 2002 to record the monthly financial and operating performance of the business units, for communication to Vertex's executive management and to the Board.

Technical Injection

  1. Technical Injection grew out of the Industrial Containers business unit of Vertex, and was established as a separate business unit in 2001. It makes injection-moulded products to order and specialises in agri-tech and human health products. At the time of the IPO it relied on four main customers for its business: Prima, Zee Tags, Fisher & Paykel Healthcare and Fernz Health & Science. The largest proportion of its business came from Prima.

  1. Prima develops and markets animal health applicators, such as vaccinators and drench guns. It is primarily an export business with operations in Hamilton and agents in the USA. Vertex has had a close relationship with Prima since 2000, when Prima commenced business. Vertex manufactures the animal health applicators and shares intellectual property with Prima. Vertex has also financed $1.3 million of Prima's tooling. This is amortised over three years. Vertex and Prima have a supply agreement in place, although in common with Vertex's other supply agreements, no particular volume or frequency of order is required. Vertex and Prima are in regular contact, both at an informal discussion level and on a more formal basis with Prima providing Vertex with regular updates of forecast orders.

Securefresh

  1. The Securefresh business unit of Vertex was created as a result of the purchase of assets, including patents and supply contracts, from Securefresh Pacific Limited. Vertex has the right to use the technology and the name in New Zealand, Australia and the Asia-Pacific region. The Securefresh system is a meat packaging system that involves the use of patented machinery to remove oxygen from bags that contain primal cuts (i.e. large cuts of meat) or from wrapped meat trays (case ready). Carbon dioxide is then flushed into the bag, and the meat is held in an effective "suspended animation" to remain fresh until it is re-opened by the meat packer (for primal cuts) or supermarket (for case-ready meat). The technology was purchased in response to the increasing trend towards case-ready meat (i.e. supermarkets purchasing meat that is already packed in trays, rather than preparing the meat and packing it into trays themselves).

  1. The case-ready section of the business involves the sale of Securefresh machinery, accompanied by a packaging supply agreement. That section of the business is the growth part of the Securefresh business unit, and involves the sale of machinery and packaging materials. The primal cuts packaging segment of the business involves the sale of packaging materials only. The primal cuts packaging business is established and has a sales history, whereas the history of the case-ready section of the business consisted of customer trials and a very limited number of machine sales.

THE IPO PROCESS

  1. Immediately before the IPO, there were 31,559,306 shares on issue in Vertex. The shareholdings were as follows:
Bain Funds:
24,530,444
PEP Funds:
4,734,806
Vertex Management:
2,212,054
Budfin Nominees:
82,002

  1. Of these holdings, only shares belonging to the Bain Funds and the PEP Funds were offered for sale in the IPO. A further 490,694 new shares were issued for subscription and included in the share offer. The shares offered for sale by the PEP Funds included 1,726,536 shares acquired by PEP Fund I from Vertex management. As vendors, the PEP and Bain Funds are issuers, sharing responsibility with Vertex and its directors under the Securities Act 1978.

  1. PEP Pty Limited, the manager of the PEP Funds, was the promoter of the IPO. The Commission was advised by lawyers for the Bain Funds that PEP Pty Limited has a co-investment arrangement with Bain Capital Inc., the manager of the Bain Funds, under which PEP Pty Limited seeks out suitable investments in the Australasian region in which it invites Bain Capital Inc. to invest. Lawyers for PEP advised the Commission that the PEP Funds and the Bain Funds often co-invest alongside each other.

  1. The vendors had always considered an IPO as a possible option for exiting their investment. Formal discussions regarding a possible IPO took place at a meeting of the Vertex Board in February 2002.

  1. Five investment banks were approached in February 2002. Of those, four were invited to submit proposals for the IPO. All the investment banks recommended that the IPO should take place in mid-2002.

  1. The Commission notes that the IPO took place at a time when the business was undergoing significant structural change and, particularly in the growth business units of the business, settled patterns were yet to emerge. However, the Commission recognises that the timing was ultimately a business decision for the directors, requiring a balancing of all relevant considerations prevailing at the time.

  1. In March 2002, the Vertex Board decided to proceed with an IPO. JBWere was appointed as lead manager and underwriter, and UBS Warburg as co-lead manager.

  1. In March 2002, PwC was appointed as the independent financial adviser to Vertex for the IPO. PwC had been involved in the due diligence when Vertex was purchased from Carter Holt Harvey. PwC was also Vertex's auditor. For the purpose of the IPO, PwC was engaged in a dual capacity:

  1. to carry out financial, information technology and tax due diligence and prepare a due diligence report on these matters; and

  1. to perform its statutory role as auditor in respect of the financial information to appear in the offer document (including the prospective financial information).

  1. Also in March 2002, Vertex appointed Buddle Findlay as solicitors for the offer, and to carry out legal due diligence. Buddle Findlay had been Vertex's legal adviser since the business had been acquired from Carter Holt Harvey.

  1. A Due Diligence Committee (DDC) was established in April 2002.

  1. In April 2002, JBWere prepared a timetable for the IPO. This contemplated an offer document being ready at the end of May 2002, and the offer being made in June 2002. Regular IPO planning meetings took place.

  1. The final form of the offer document was approved by the Board at its meeting on 7 June 2002. The offer document was registered on 7 June 2002, and the offer opened on 10 June 2002. The new shares were allotted on 1 July 2002.

THE DUE DILIGENCE PROCESS

  1. The DDC comprised the following people:

  1. Observers to the DDC were:

  1. A Due Diligence Planning Memorandum prepared by Buddle Findlay and adopted by the DDC on 12 April 2002 set out the objectives of the due diligence process as being to ensure that:
    1. the [offer documents] make full and fair disclosure of all facts which are material to enable investors to make a properly informed decision in relation to the offer contained in those documents;

  1. the [offer documents] do not contain any material statement that is false or misleading;

  1. there are no material omissions from the [offer documents];

  1. there is evidence to show that those involved in the preparation and issue of the [offer documents] made reasonable enquiries to ensure that all material statements included in those documents were true and not misleading and that there were no material omissions from those documents;

  1. there is evidence to verify the accuracy and completeness of all material statements contained in the [offer documents] such as to provide reasonable grounds for the belief that all material statements in those documents were true and not misleading and that there were no material omissions; and

  1. the [offer documents] comply with the information disclosure requirements of the Securities Act, Securities Regulations and Listing Rules."

  1. DDC meetings were held weekly between 8 April and 27 May 2002. On 3 April 2002, before the first DDC meeting, Vertex management gave a presentation to the DDC to provide an understanding of the activities and main issues within each business unit, to demonstrate the basis of the proposed forecasts and to provide an explanation of the key assumptions underlying the budgets of each business unit.

  1. Initial issues were identified from that session, and a "due diligence information request list" was created. This was a running list of material issues to be considered in the due diligence. The list was reviewed and updated at each DDC meeting.

  1. The Commission was told that the DDC reviewed the 2002/2003 budget prepared by Vertex. This included details of the assumptions underlying the budgets for each business unit. The budget was the starting point for the forecasts in the offer document.

  1. A key issues log was created to record the issues raised by the DDC and the responses to those issues. Some issues were dealt with by way of further presentations and reports provided to the DDC. Much of that information was packaged together in a "drill-down pack" and provided to the DDC members.

  1. All of the due diligence information was kept in a "data room" at Buddle Findlay's offices, which was accessible by Vertex management, directors, prospective directors and advisers. The Commission understands that the room was used regularly, particularly by incoming independent directors Jon Hartley and Doug McKay. Vertex's solicitors, Buddle Findlay, have also advised the Commission that Board members and advisers carried out plant visits and that substantial interrogation of the due diligence information was undertaken.

  1. In their evidence before the Commission Vertex's directors expressed the view that the due diligence procedure adopted was of a very high standard relative to others they had known.

  1. Instead of the regular DDC meeting on 20 May 2002, a lengthy questions and answers session was held, which was open to the DDC, other interested parties and management. That session was used as a forum to test the reasonableness of the information provided throughout the due diligence, and any other information available at that time.

  1. The DDC required the preparation of due diligence reports by its independent advisers, Buddle Findlay (legal), PwC (financial, information technology and tax) and Kingett Mitchell (environmental). These reports were based on the due diligence information request list.

  1. As noted above, PwC was appointed to carry out a due diligence role and to perform its statutory role as auditor in respect of the financial information to appear in the offer document. PwC's engagement letters to Vertex clearly separated the two functions, and defined the scope of the work to be undertaken by PwC in respect of each. Copies of these letters are attached as Appendices B and C. In its engagement letter of 20 March 2002 relating to the due diligence, PwC listed the sections of the due diligence information request list that it was engaged to report on. This did not include questions relating to the prospective financial information.

  1. Vertex's solicitors advised the Commission that the questions in the due diligence information request list relating to the prospective financial information were not contained in a due diligence report as such, but were addressed by the DDC and recorded in the key issues log where relevant.

  1. The Commission is of the view that the scope of the activities undertaken by the DDC was appropriate. However, there was a confusion about the role of PwC and the directors in relation to the prospective financial information. This is commented on later.

Budget process

  1. On the evidence presented to the Commission, it appears that Vertex has a comprehensive budget process that is followed each year. The process commences in December, at which time a high level review of targeted sales, EBIT and capital expenditure is carried out. Detailed sales plans are then prepared for each business unit, based on historical data, trends, and anticipated new product development projects.

  1. Assumptions are made in relation to raw material costs, including associated foreign exchange rates. Overheads are budgeted on the basis of historical data, known changes and latest wage and salary costs.

  1. When the business unit budgets were complete for the 2002/2003 financial year, George Clark (Chief Financial Officer), Jim Bini (Chief Operating Officer) and Paddy Boyle (Managing Director) and the business unit managers reviewed the budgets, and checked whether all the assumptions underlying the budgets were reasonable. They also checked the alignment of the business unit plans to the strategic plans for the company. Mr Bini took primary responsibility for the review of the core business unit budgets, while Mr Boyle took primary responsibility for the review of the Securefresh and Technical Injection budgets. This review took place in February 2002, following which changes were incorporated into the business unit plans and the first draft of the consolidated 2002/2003 budget prepared.

  1. The budget was considered by the Vertex Board in February 2002. Mr Pillar told the Commission that the board undertook a "risk assessment" based on the relative volatility of each business. He also commented that changes were made as a result of this assessment, "on the basis of conservatism". The most significant change was a reduction in budgeted operating earnings before interest, tax, depreciation, and amortisation (EBITDA) from $18,056,000 to $17,627,000.

  1. A copy of the final budget adopted by the Vertex Board, including the business unit budgets, was given to the Commission.

Technical Injection budget

  1. The budget for Technical Injection anticipated significant growth in revenues over previous years, with a large proportion of budgeted sales coming from new product development (targeted at existing customers), and large increases in revenues from existing customers. The majority of budgeted sales revenues were expected to be derived from Technical Injection's four main customers. Because Technical Injection was anticipating significant growth compared to the previous year, the budget was not based on the prior year's figures, but on Technical Injection's business plan prepared in September 2001.

  1. Vertex used information provided by customers about their intentions to budget sales revenues. However, for the purpose of its budget Technical Injection discounted Prima's own forecasts by 50 to 60%, as it considered that Prima was over-optimistic about the sales it expected to achieve. Vertex's directors told the Commission that overall, and particularly in relation to the growth businesses, Vertex adopted a conservative approach to its budgeted revenues.

  1. The Commission heard evidence from the directors and from a Technical Injection customer that, as part of the due diligence and budget processes, Vertex tested the sales projections provided by customers. This included a visit to Prima in the USA.

  1. The budget identified risks faced by Technical Injection, and indicated that there were some production quality and capacity issues within the business unit. It also identified the possibility of Prima losing over the counter volumes and of Fisher & Paykel not achieving market share. Reliance was placed on Fisher & Paykel Healthcare's sleep apnoea product launch in the USA occurring on time and growing rapidly.

  1. The capacity issue was addressed by the purchase of additional machinery, which was approved in May 2002. The approval of the purchase of the machinery at that time indicates to the Commission that no significant drop-off in orders was expected in the near future, rather that business was expected to increase. The internal quality issues were addressed with the introduction of a new member of staff responsible for production planning.

Securefresh budget

  1. The budget for Securefresh anticipated significantly higher revenues and EBIT from the previous year, based on planned growth in sales of Securefresh machinery and packaging to Australia, and tray sales both domestically and to the USA. Planned sales for case-ready were based on the assumption that the machine trials would be successful, and that certain key contracts would be signed with customers. No issues in relation to the primal cuts segment of the business were identified at the time of the budget. Post-budget events

  1. In early May 2002 Technical Injection lost the contract to manufacture one of Fisher & Paykel's sleep apnoea products, representing around 25% of its business from Fisher & Paykel. At that time, new business was being acquired from Zee Tags, which offset the lost revenue. The launch in the USA of Oracle, another Fisher & Paykel sleep apnoea product referred to in the Technical Injection budget, was also deferred in May for three months, and deferred again after that. Prima also continually deferred orders from May, but information provided by Prima indicated that the orders would eventuate.

  1. Prima did not indicate to Vertex until August that there would actually be a significant reduction in volumes ordered. Until that time, Vertex was confident that the orders would be received, and that revenues would simply be deferred until later in the year. Vertex witnesses indicated to the Commission in December 2002 that more orders were starting to come through by late 2002, and that the situation might be one of deferral rather than cancellation.

  1. Securefresh began to experience problems in its established primals business in May, as a result of a shortage of lambs for export due to the drought in Australia and an increase in the use of live exports into the Middle East. Miles Patterson, Securefresh's business manager, gave evidence that Progressive Enterprises and Woolworths had told Securefresh that they would be implementing case-ready operations in 2002. Those sales were included in Securefresh's budget, but in May, deferrals of orders for case-ready machinery and packaging began to occur. However, communications from customers prior to the IPO indicated that these were short-term deferrals only. Securefresh was not advised until September that the orders would not be made at all.

  1. Evidence provided to the Commission indicated that there were difficulties with Richmond's early trials of the Securefresh system, which resulted in additional delays of planned sales.

  1. Mr Patterson stated in his evidence that the delays with the case ready business were very important in relation to the budget, because of the impact on sales revenue, and the impact on EBIT. He noted that although there is not a large profit made on the machines themselves, the lost profit on the accompanying packaging sales is significant.

  1. Mr Patterson advised that in July, Securefresh reviewed its sales plan and it was evident to Securefresh management at that time that budgeted sales would not be achieved.

  1. The evidence provided to the Commission indicates that the directors were first made aware of the extent of the issues facing Technical Injection and Securefresh at a board meeting held on 25 June 2002. That meeting focused particularly on the problems in Technical Injection, revenues for which were $377,000 below plan at that time, and for which the EBITDA was $456,000 below plan on a year to date basis.

  1. Vertex made adjustments to its internal sales forecasts on 28 June 2002 to defer sales revenues in Technical Injection and Securefresh from the first half of the year to the second. The Vertex board held a telephone meeting to discuss the impact of these revised sales forecasts, in light of the forthcoming allotment. The board determined that Vertex's forecast EBIT was still on track.

Adjustments from budget

  1. The Commission heard that an important factor for the Vertex board in reaching this conclusion was a "margin of safety" that had been built into the forecast EBIT when it was developed from the budget.

  1. The starting point for preparing the prospective financial information in the offer document was the Vertex board-approved budget. Forecast EBITDA for the year ended 31 March 2003 in the offer document was the same as in the Vertex budget. The forecast EBIT figure in the prospectus for the year was $800,000 lower than in the budget. That $800,000 was included in the prospective financial statements on the basis of an assumption stated in the notes to the prospective financial statements that "Vertex Group will incur an additional NZ$0.8 million in project management costs in the six months ending 30 September 2002 associated with the completion of Project New Age." Effectively this represented a reduction of budgeted earnings to provide, as seen by Vertex's directors, a "margin of safety" between the EBIT of $12,008,000 in the budget and the EBIT of $11,208,000 forecast in the offer document.

  1. A further adjustment was made for the forecast EBIT for the first six-month period. Forecast EBIT for the period April to September 2002 in the offer document was reduced by a further $800,000 against the corresponding amount in the budget. Forecast EBIT for the period October 2002 to March 2003 increased by $800,000 against the corresponding amount in the budget. The change was effected by transferring $800,000 of budgeted operating expenditure from the second six-month period into the first six-month period.

Final testing of the figures

  1. Jim Bini prepared a memorandum to the Vertex directors on 2 June 2002, for consideration at the 3 June 2002 board meeting. Jim Bini included in his memorandum actual results for April and a forecast for May based on the preliminary sales for May, and extrapolated from that a forecast for FY 2003. He noted shortfalls in Technical Injection, Securefresh and Hastings Food Trays. However, he also noted that these shortfalls were partially offset by strong performances in other business units. Jim Bini's memo concluded that the prospectus revenues were achievable and that there was still a significant "EBIT buffer" available. This buffer existed on account of lower actual Project New Age project management costs against the amount included in the prospective financial statements ($800,000) and the existence, at the time, of a further "EBIT buffer" from expected and actual positive variances against various budgeted provisions and foreign exchange items, and also unbudgeted sales price increases.

  1. On 25 June 2002, after the offer document was registered, but before the shares were allotted on 1 July 2002, changes were made to Vertex's internally reported sales forecasts. These changes took account of deferred sales in the Technical Injection business that had come to light at the Vertex board meeting on 25 June 2002. It was apparent at that time that Technical Injection and Securefresh were not going to reach their revenue forecasts for the first six months. The Vertex board met by telephone on 28 June 2002 to discuss the possible implications of the changes, and confirmed the forecasts appearing in the offer document, as there was a strong "EBIT buffer" between the internal forecasts and the forecast EBIT figure in the offer document, and results were still ahead of plan for the company as a whole.

THE OFFER DOCUMENT

Disclosure Requirements

  1. Offers of securities to the public must be made in compliance with the Securities Act 1978. This requires issuers to register a prospectus and to produce an investment statement. Each of these documents must contain certain information that is relevant to investors' decisions whether or not to invest in the securities being offered.

  1. The purpose of these documents is to allow prospective investors to make an informed decision about their investment.

  1. A registered prospectus contains detailed historical and prospective financial information, and information about the issuer, its directors, promoters, and substantial security holders, and the terms of the offer of securities.

  1. An investment statement is designed to provide key information to assist the "prudent but non-expert" person to make an investment decision, and to draw to that person's attention the fact that more information is available in other documents. The investment statement must contain prescribed information answering eleven important questions about the offer of securities.

  1. The prospectus and investment statement disclosure requirements are set out in the Securities Act 1978 and the Securities Regulations 1983. Both the registered prospectus and investment statement must disclose risks associated with the offer of securities.

  1. The purpose of risk disclosure in a prospectus or an investment statement is to inform prospective investors about matters that may impact adversely on their investment. In the course of operating a business it is ordinarily the responsibility of the management and directors of a company to consider risk factors and to take decisions based on assessment of those risks. However, where a company decides to raise money from the public the securities laws require these material risk factors to be publicly disclosed so that prospective investors and their advisers can assess the desirability of investment in the company.

  1. Whether or not a risk or a fact must be disclosed in a prospectus or an investment statement depends on whether it is "material". When this term is used in securities law it means that a matter is one that would be likely to influence a reasonable person in making a decision whether or not to subscribe for the securities, without necessarily being determinative of the decision.

  1. Information is material if it is needed to enable a reader of the prospectus or investment statement to properly assess the risk of an investment. Because of this the disclosure of risk factors in a prospectus and an investment statement is particularly important. The investment statement

  1. One of the questions to be answered in the investment statement is: "What are my risks?" Under this heading the investment statement must set out:
    1. "A brief description of the principal risks of-
      1. The money paid by a subscriber not being recovered in full by the subscriber:
      2. A subscriber not receiving the returns referred to in the investment statement:
      1. A subscriber being required to pay more money in respect of a security than is disclosed as the subscription cost or any amount payable in insolvency.

  1. If it is reasonably foreseeable that, on termination of any security at any time, a subscriber will have received, in total, less than the amount paid to the issuer or an associated person for the security, a statement to this effect and a brief description of the circumstances that may produce this result."

  1. All the information that is required to answer this question must be set out together in the investment statement under the "What are my risks?" heading.

The registered prospectus

  1. A registered prospectus for shares must contain certain information that is prescribed in regulations. These regulations include a catch-all obligation requiring the registered prospectus to contain "particulars of any material matters relating to the offer of securities".

  1. One of the specific disclosure requirements relates to prospects and forecasts. The relevant provision says the registered prospectus must contain:
    1. "A statement as to the trading prospects of the issuing group, together with any material information that may be relevant thereto.

  1. The statement required by subclause (1) of this clause shall include a description of all special trade factors and risks that-
    1. are not mentioned elsewhere in the registered prospectus; and

  1. are not likely to be known or anticipated by the general public; and

  1. could materially affect the prospects of the issuing group."

  1. The disclosure requirements of the Securities Regulations 1983 do not limit the information that an issuer can put in a registered prospectus. These Regulations provide that if any statement that is required to be in a registered prospectus would be misleading if additional information were not also included, then the prospectus must also contain that additional information.

Risk disclosure in Vertex's offer document

  1. Vertex combined the registered prospectus and investment statement into one document. This is allowed under the Securities Act 1978, although the Commission has warned in the past that care must be taken in doing this to ensure that neither document is concealed by the other. Each must remain clearly distinguishable and prospective investors must be able to easily find the important information they require.

  1. The offer document discussed risks in several places. The principal discussion about risks material to the offer of securities was set out in a section entitled "Risks and Risk Management".

  1. The Risks and Risk Management section began on page 32 of the offer document. This section detailed risks and special trade factors and also referred readers to the general risks set out in the investment statement part of the offer document. The investment statement part of the document, under the question "What are my Risks?" on page 77 of the offer document discussed general risks and also referred readers to the Risk and Risk Management section of the offer document.

  1. The risk factors described in the Risk and Risk Management section were:

  1. Under the heading "Loss of Major Customers" on page 32, the offer document states:

    "[T]he Group has a number of major customers, the loss of whose business would be likely to adversely affect the future short to medium term performance of the Group. Moreover, it is typical of the industry that supply contracts with customers are relatively short term in nature with no certainty of rollover".

  1. The Commission is of the view that this risk disclosure accurately describes the risk associated with potential loss of business for the company as a whole. However, there is no mention of specific business risks relating to uncertainties regarding Technical Injection and Securefresh.

Disclosure of business risks facing Technical Injection and Securefresh

  1. The Commission is of the view that the prospectus should have contained specific risk disclosure about Technical Injection and Securefresh. There are two reasons for this:
    1. These growth business units received special attention in the marketing of the IPO, as the main contributors to future company growth; and
    2. Directors recognised uncertainties about the future prospects of Technical Injection and Securefresh.

Proportionality

  1. A prospectus must disclose "material" information about a share offer. Something is material if it is likely to influence a reasonable investor. The Commission is of the view that the likelihood of information about a specific section of a company influencing a reasonable investor will be determined in part by the emphasis given to that section of the business in marketing the offer.

  1. In the Commission's opinion, where an offer document for securities places particular emphasis on any specific feature of a business as being attractive to investors, for instance because it offers very good growth prospects, then the offer document must also emphasise the risks associated with that part of the business. Often a high growth venture carries particular risks that differ from those facing an established business. If an investment is promoted on the basis of its high growth potential (or any other special feature) then it is important that risks associated with the growth business are given equal prominence in order to allow investors to make an informed decision. Where an offer document does not clearly set out such risks the offer document is likely to mislead investors.

  1. The established history of Vertex's core business was emphasised in the offer document, in particular as a likely source of dividend returns for shareholders. However, Vertex's offer document also made frequent reference to the growth prospects for the company resulting from new innovation and technology, referring to Technical Injection and Securefresh in particular. Examples include:

    "Vertex believes its differentiated product range offers opportunities to expand outside New Zealand. Furthermore, recent innovations in the areas of fresh meat packaging and technical componentry offer significant growth opportunities" (p 1)

    "Our [Technical Injection] design and tooling centre team plays a vital role and their skills are contributing to our rapid growth. Revenues doubled from FY01 to FY02 and are expected to increase by over 50% from FY02 to FY03. This exciting business will relocate to a new, GMP-compliant facility later this year to better serve its growing export customer base." (p 20)

    "The Technical Injection business unit utilises the skills of the Group's design and tooling centre. It is the fastest growing Vertex Group business (revenues having doubled from FY01 to FY02 and being forecast to increase by over 65% from FY02 to FY03) and is also the most export-focused (80% of its sales are exported by its customers). Six additional machines have been installed or are on order for the period FY01 to FY03 at a total cost of $0.8 million to meet expected growth" (p 23)

    "When the Group sells Securefresh machines, a packaging supply contract is offered for the supply of trays and pouches for any goods packed with the Securefresh machinery. Margins are earned on the machines, trays and pouches that are supplied through the Securefresh business unit. Sales are forecast to double from FY02 to FY03. The Securefresh business unit also offers significant growth potential to the Vertex Group with expressions of interest for packaging and trays coming from international meat processors...Sales of specialised trays into the United States have grown from zero to well over $1 million from FY01 to FY02." (p 24)

  1. The importance of the growth business units to the potential attractiveness of Vertex as an investment was reinforced by director Barry Watts in his evidence to the Commission, in which he stated:

    "The growth [in the plastics industry] comes through pretty much from new products, and changes in technology. There aren't dramatic new plastics becoming available for detergents or for soft drinks. The last big introduction of a new package was PET, for soft drink and since then there's been nothing really dramatic and unless you have that, growth becomes fairly stable in the market...

    The interesting thing about technology in the Technical Injection business is that it is very unique. It's not like making a PET bottle which a dozen people can make. Technical Injection's pretty much revolving around the very clear skills of the people that are in that business, and there are few in the world that do that sort of business. So, it's a rather unique part of the plastics business and if you've got good technology and good people you can get good growth, so it's quite a large market."

  1. Vertex directors told the Commission that they focused on the "portfolio" effect of the business. They expressed the view that, in the context of the company as a whole, problems in the two growth business units were not material. For that reason, the Commission was invited to conclude that it was not necessary to single out the two growth business units in the risk sections of the offer document.

  1. The practice of adopting a portfolio approach to managing a company is a matter for directors. As a matter of disclosure, the Commission is of the opinion that where an offer document singles out particular business units of a business, highlighting their growth potential, those business units become more material to an investor's decision to invest. As a corollary to that, in the Commission's opinion, a corresponding emphasis is required in the offer document on any risks specific to the growth elements of the business.

Uncertainties regarding Technical Injection

  1. The forecast growth prospects for Technical Injection were based on information from customers. The evidence heard by the Commission indicates that this customer information, in particular the information from Prima, was not regarded as being entirely reliable.

  1. Vertex management made a business decision regarding the extent to which Prima's anticipated orders should be discounted. The discounting was significant, in the region of 50 to 60% overall. In his evidence to the Commission, Mr Starnes stated that he applied a 10% discount to the value of Prima's November 2001 anticipated orders. The question was put to Mr Starnes:

    Q: "Was there any science about 10%? I mean, why was it not just 5, or why was it not 20? Just a matter of judgment?"

    A: "Yeah, it is a matter of judgment; you look at the type of products, who the customer is."

  1. The absence of established sales patterns and the surrounding uncertainty was a risk, as Mr Pillar's evidence demonstrates:

    "In both instances [referring to Technical Injection and Securefresh] there was a very high degree of rigour applied to really understanding what the customers were likely to do, because they are - - there is less of a track record. Is there necessarily a lower certainty of those sales coming through? I think definitely yes, but what we tried to do in the case of Technical Injection was then discount where we felt that there was a degree of uncertainty in order that the final numbers that came out were as hard as the core business numbers."

  1. Although the discounting was not based on a scientific analysis, in view of Prima's relatively short history, and an absence of established sales patterns, it appears that the figures were not capable of such analysis. The discounting was, in the opinion of the Commission, a reasonable attempt to exercise caution. The Commission accepts that Vertex could not have predicted the extent of Prima's orders, given the information Prima was providing to it at the time.

  1. Securefresh's business manager, Miles Patterson, was asked how the budget projections for the case-ready part of the Securefresh business were calculated. He replied:

    "That was probably more difficult in the sense that we were reliant totally upon the expectations of our customers, and they were saying to us, yes, we plan to do Case-ready by such and such a date, we will need the equipment installed by here, and this is their packaging requirement, whether it be a commercial trial or whether it be fully-you know, a full commercial operation, and that's-as I say, it's all emerging, it's all new and there's no sales history, obviously, against that".

  1. He later went on to say:

    "Case-ready is an emerging new market and this system probably constitutes about 20% of the investment that a customer would have to make in going Case Ready, and there are a huge number of drivers that impact on that decision. And whilst the customer might say to us, I'm definitely going to do it by this date, because of a whole raft of other factors that can impinge on the decision and because it's a very large capital investment, often what they commit to verbally they can't actually follow through with in actual practice, and that's something that we-you know, it has been a surprise to us, to be honest".

  1. Business necessarily involves uncertainty, and business judgments must be made by directors. In the context of a public offer of securities the Commission is of the view that, where directors have identified a specific risk relating to a part of the business that is material to the offer and have made a specific judgment about this, then that risk and material factors relating to the judgment should be fully disclosed in the offer document. In this way, investors are given the opportunity to assess for themselves the soundness of the business judgment and the possible effects of that judgment on the investment. Vertex's offer document did not disclose the specific risks around the business judgments made in respect of expected future Technical Injection and Securefresh sales.

Conclusion as to risks

  1. Vertex has submitted to the Commission that in its view, the risk of the growth business units' customer orders not being placed was adequately disclosed by the general risk statement on page 32 of the offer document (quoted at paragraph 105 of this report). The Commission does not agree with this assertion. The risk statement relating to loss of major customers is of a very general nature, and does not reflect the actual uncertainty surrounding the orders for the growth business units.

  1. The Securities Act 1978 provides that a statement included in a registered prospectus is deemed to be untrue if it is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included.

  1. The evidence shows that Vertex recognised specific risks regarding the future prospects of Technical Injection and Securefresh, as a result of the lack of sales history and the lack of certainty around customer sales plans.

  1. Generally, the risk section of Vertex's offer document gave the impression that the risk was at the same level across all business units. Except for one matter relating to potential litigation there was no mention of any specific risk in relation to Technical Injection or Securefresh.

  1. The Commission is of the opinion that in view of the emphasis given to the growth prospects of Technical Injection and Securefresh in the offer document, the risk factors associated with these business units would have been likely to influence a reasonable investor in deciding whether or not to buy shares.

  1. The Commission considers that by omitting to disclose specific material risks relating to Technical Injection and Securefresh, the offer document was likely to mislead.

PROSPECTIVE FINANCIAL INFORMATION

Legal Requirements

  1. Under the Securities Act 1978 and the Securities Regulations 1983 a registered prospectus for an offer of shares to the public must contain certain financial information. The registered prospectus for a company making its first offer of shares to the public must also contain certain prospective financial information.

  1. Prospective financial information presented in a registered prospectus falls within the meaning of "general purpose prospective financial information" contained in Financial Reporting Standard 29 Prospective Financial Information (FRS-29), issued by ICANZ. Financial reporting standards are the primary indicators of generally accepted accounting practice (GAAP) in New Zealand.

  1. The Securities Regulations 1983 do not expressly require that prospective financial information in a registered prospectus be prepared in accordance with GAAP. However, the professional standards of ICANZ require accountants and auditors to ensure that general purpose prospective financial information is prepared in accordance with GAAP (i.e. FRS-29). The Commission is of the opinion that information prepared other than in accordance with FRS-29 is likely to be misleading. As with other information in a registered prospectus or investment statement, prospective financial information must not be false or misleading. Prospective financial information will not be false or misleading simply because the results projected or forecast do not eventuate. It may be false or misleading if it is based on demonstrably incorrect, unreasonable, or incompletely stated assumptions.

  1. The Securities Regulations 1983 require that where an issuer includes prospective financial information in a registered prospectus then the prospectus must also disclose the principal assumptions on which the prospective financial information is based. FRS-29 sets out the requirements for assumptions underlying prospective financial information.

Forecasts and projections

  1. Prospective financial information can be presented in the form of a forecast or a projection. FRS-29 defines the two terms in the following way:

    "'A forecast' means prospective financial information prepared on the basis of assumptions as to future events that the governing body reasonably expects to occur associated with the actions the governing body reasonably expects to take as at the date that the information is prepared (best-estimate assumptions).
    'A projection' means prospective financial information prepared on the basis of one of more hypothetical but realistic assumptions, (or 'what-if' scenarios), that reflect possible courses of action for the reporting periods concerned as at the date that the information is prepared."

  1. FRS-29 states that "forecasts" mean prospective financial information that is prepared "on the basis of assumptions as to future events that the governing body reasonably expects to occur as at the date the information is prepared". Investors are thus more likely, and should be able, to derive more confidence from the presentation of forecasts, rather than projections, in an offer document. For this reason FRS-29 requires that all disclosed prospective financial information shall be labelled clearly as either a forecast or a projection and "the distinction between a forecast and a projection...shall be made clear in any prospective financial information being presented".

  1. FRS-29 also requires that assumptions used in preparing forecasts "shall be reasonable, supportable, consistent among themselves and with the strategic plans of the entity, and be applied consistently". To be supportable, best-estimate assumptions for a forecast need to be based on certain underlying fundamental indicators, namely:



FRS-29 states further that "the extent of detailed information supporting the assumptions, and an assessment of the reasonableness of each assumption will vary according to circumstances" and "be influenced by factors such as the significance of the assumption and the availability and quality of the supporting information".

  1. Issuers should be aware that the preparation of prospective financial information includes a decision to present that information as projections or forecasts. Accordingly, the decision to present prospective financial information as a forecast carries a responsibility for the board to check, on an ongoing basis, that the assumptions underlying the forecasts are reasonable and supportable, and based on information reflecting future events that the board reasonably expects to occur, and associated with actions the board reasonably expects to take.

  1. This test should be contrasted with the lower standard required in respect of projections, for which the underlying assumptions are required to be reasonable, but not necessarily supportable. Assumptions for projections may be hypothetical, reflecting possible courses of action as at the date the prospective information is prepared. However, the assumptions must be realistic.

Vertex's Prospective Financial Information

  1. The share offer made in June 2002 was Vertex's first public offer of shares. The registered prospectus for the offer was required by law to contain a prospective statement of cash flows of Vertex and any subsidiaries which the directors expected to occur in the year commencing on the date the prospectus was delivered for registration (i.e., a prospective statement of cash flows for the year ending 7 June 2003).

  1. Vertex's financial year runs from 1 April to 31 March. Vertex sought from the Commission, and was granted, an exemption to align the prospective financial information in the prospectus with Vertex's financial year, to aid comparison between that information and Vertex's historical financial information. As a result, the offer document contained a prospective statement of cash flows for the six months ended 30 September 2002, for the year ended 31 March 2003, and for the 6 months ended 30 September 2003. In addition, Vertex included prospective statements of financial performance and financial position for the six months ended 30 September 2002, for the year ended 31 March 2003, and for the 6 months ended 30 September 2003.

  1. The Vertex offer document stated that the prospective financial information it contained for the period to 31 March 2003 was forecast financial information, while the prospective financial information it contained for the period to 30 September 2003 was a projection.

  1. Vertex's forecast statement of financial performance in the offer document predicted a net surplus of $5,814,000 for the year ended 31 March 2003, from revenues of $90,680,000. This represented an overall increase of 2% in total revenues and a 52.5% increase in net surplus compared with the reported financial results for the year ended 31 March 2002.



Assumptions

  1. The prospective financial statements were presented along with the directors' general assumptions and trading assumptions for Vertex, which appear on pages 60 to 62 of the offer document under the heading "Prospective Financial Information Assumptions".

  1. The revenue assumptions underlying the prospective statement of financial performance were that the core businesses would reflect a small decline over the previously reported revenues, but that the Technical Injection and Securefresh units would, on a combined basis, achieve revenue growth of 88% for the first six month period to 30 September 2002, 55% for the second six month period to 31 March 2003, and 77% for the further six month period ending 30 September 2003.

  1. The prospective combined revenues for the core business activities for the year ended 31 March 2003 were disclosed as $74,520,000, while the prospective combined revenues for Technical Injection and Securefresh for the same period were disclosed as $16,160,000.

Technical Injection and Securefresh

  1. The prospective financial information in the offer document separated out the revenues anticipated from the combined core businesses on the one hand, and the two growth businesses, Technical Injection and Securefresh, on the other. Those figures indicated that the revenues for the core businesses were expected to decline slightly, but that significant growth was anticipated in the Technical Injection and Securefresh revenues. The offer document recorded that:

    "[Technical Injection] is the fastest growing Vertex Group business (revenues having doubled from FY01 to FY02 and being forecast to increase by over 65% from FY02 to FY03)"

    and, in relation to Securefresh:

    "Sales are forecast to double from FY02 to FY03".

  1. As mentioned above, the prospective financial information for the period to 31 March 2003 was presented in Vertex's offer document as a forecast, while the information for the period to 30 September 2003 was presented as a projection. FRS-29 requires that the assumptions used as the basis for forecasts be both reasonable and supportable. FRS-29 also notes that projections might be used by an entity in its start-up phase, when certain key assumptions cannot be supported.

Stage of development of growth businesses

  1. The Technical Injection business unit, in particular, was a relatively new component of the overall Vertex business. Mr Starnes characterised Technical Injection as being of a start-up nature:
    "Our business in particular, given our start-up stage, is about 40% of our business products that are less than a year old."

  1. Mr Hartley expressed the view that Technical Injection was not a greenfields start-up business. He stated that Technical Injection was not new in the sense that it had been supplying Vertex customers for three years, and that "it was more a case of bringing it together as a business unit for the first time, but the actual underpinning business I was informed had been there for three years".

  1. Technical Injection was established as a separate business unit with effect from 1 April 2002. This meant that the period leading up to the IPO was the first time that actual data on the costs associated with Technical Injection's operations was available. Prior to that, standard costs were assumed for the business unit. Mr Clark's evidence showed that the separation had revealed higher than anticipated costs. These manifested themselves as significant negative variances in Technical Injection's actual operating results against plan in April and May 2002:

    Q: Was the recent trading history of Technical Injection a cause of concern to you at all?

    A: Yes. In the first two months we had suffered, obviously from a sales perspective, and we had suffered from a production variance point of view. Our labour costs were much higher than we had anticipated, and what was happening was, because it was the first -April was the first month we had split Technical Injection out on its own from what was...the injection department within the Hamilton facility, the labour costs that were coming through were higher than we had expected.

    ...Prior to that we had been putting into our Board pack an assumed result for Technical Injection, but it was based on the standard cost of sales...we could not calculate the actual because it [Technical Injection] wasn't split separately.

    ...we had obviously made assumptions based on the standards we had and allocations of some of the other costs that you had to get you down to actual gross margin between the non-Technical Injection and the true Technical Injection.

    Q: ...the actual cost of sales...were mingled in with the other businesses--?

    A: They were mingled in...We had to make assumptions on what the profitability was, on what the extra costs were beyond the standard."

  1. The Securefresh business was acquired during 2001, and the major part of its business activity during its first year within Vertex comprised of customer trials and a small number of machine sales.

Basis for assumptions

  1. The Commission received evidence that, to a significant extent, the assumed revenue growth for the Technical Injection business unit was based on customer information about their projected sales.

  1. Mr Hartley stated that:

    "the customer sales had been built up from what I would call hard numbers, in other words they weren't guesstimates... They seem to have been built up from discussions with customers. I was told that in some cases the customer forecasts were reduced by 60 to 70% relative to the customer's forecast.

    Q: ... when you say they had been downgraded, the starting point was what customers were telling Technical Injection they were going to buy?

    A: They were indicating that that was their order level, yes."

  1. In relation to the preparation of the budget, which was used as the basis for the anticipated sales for Technical Injection included in the prospective financial information, Mr Starnes stated the following:

    "Q: ... what information did you seek from your customers about the level of business they're likely to generate for you?

    A: ... it depends on the customers... We looked at their numbers and then put a discount on that for the first year, which is F03. The business plan was heavily discounted because they were blue sky at that stage. Once we got closer to our budget we had a look at their numbers and then discounted by a further 10%."

  1. Mr Starnes noted that Technical Injection's small customer base differed in terms of the length of customer relationships with Technical Injection. He noted that among the customer base Prima was relatively new start up company; Zee Tags had come on board just six months prior to the budget period; and Fisher and Paykel Healthcare's custom was around 18 months to two years old.

  1. The evidence indicated that the quality of customer information was often highly variable and inherently unreliable. Mr Berney, of Prima ( a Technical Injection customer) was asked:

    Q: "In terms of the volumes of business you did, coming back to the period up to March 2002, had your business with Vertex been consistent or were there lumps in it in the financial year?"

    A: "No, it hadn't been consistent at all. It was very lumpy. We - probably the most consistent thing about it was that we tended to miss our forecasts".

  1. Mr Berney did go on to say that Prima had frank and regular ongoing discussions with Vertex in relation to Prima's planned volumes of sales, and whether it was on target to achieve them.

  1. Mr Watts gave evidence as follows:

    "[Technical Injection] was struggling because some of their customers had decided to introduce their new products more slowly...we're very dependent on that customer saying to us 'yes I'm going to take this quantity'...but in the end if he doesn't it's very hard for management to deal with it...

    ...even if they get a new contract today with a new customer, it's got to be tested and proven and it will take months to get through."

    ...customers are very difficult at times about giving you 'forecasts' because they want to maintain a position in your delivery queue, so, they hold back giving you reality checks and that's what happened here. The reality has set in and they have reduced their orders significantly.

    ...I think at times, you know our customers like many others, particularly in plastics, are very vulnerable to having good 'forecasts' but not always getting them in reality."

    Mr Watts told the Commission that at the time of preparation of the prospectus he had a concern about the level of growth forecast for Technical Injection:

    "... the one that worried me was TI and where it was heading because it had shown 100% growth in sales the year before, and this prospectus was saying it's going to get another large piece of growth. Not usual in the plastics business."

    "I was particularly comforted though... that they did know their products and their markets very well, they knew their customers very well, and they had down cast the customers forecast by half or 60%, significant reduction... it looked reasonably conservative to me..."

Conclusions about forecasts and projections

  1. The evidence given to the Commission suggests that the two growth units were at an early stage of their anticipated growth phases. In the case of Technical Injection the business was established as a separate business unit just prior to Vertex's IPO. It was undergoing a significant restructuring phase to grow its business operations; and its true operating costs and profitability on a 'stand-alone' had not been clearly established at the time its 2003 budget was approved and incorporated into the prospective financial information for the offer documents.

  1. The Commission is of the view that the revenue growth assumptions for Technical Injection and Securefresh were not misleading, as there was nothing in the evidence provided to indicate that it was unreasonable to expect the stated growth to occur. However, it considers that the assumptions underlying that forecast revenue growth were based mainly on customer information that was inherently highly uncertain.

  1. The Commission's view is that the underlying bases for the revenue growth assumptions for Technical Injection and Securefresh rendered them of type that should be viewed as "hypothetical possibilities" rather than "supportable best-estimate assumptions" as defined in FRS-29.

  1. The fact that the customer-based estimates supporting the growth assumptions were heavily discounted did nothing to remove the inherent uncertainty and lack of reliability which characterised that information. It merely reduced the potential financial impact of that uncertainty.

  1. The Commission considers that, taken together, the circumstances surrounding the assumptions used for the growth business units suggest that they should not have been used to provide the basis for revenue growth assumptions for a forecast.

  1. The Commission is of the opinion that the prospective financial information for the growth business units at the EBIT level would ideally have been described as a projection rather than a forecast.

  1. However, the Commission also recognises that Vertex did produce prospective financial information in relation to the core business units that had a basis in assumptions which appeared to be supportable for the presentation of forecasts.

Presentation of components of prospective financial information: forecasts and projections

  1. The Commission recognises that where an established business is seeking to raise funds from the public it is important, as a matter of credibility, that the business is able to demonstrate a degree of confidence about its prospects, and that this ability may not be reflected if the business presents projections rather than forecasts. However, the Commission is of the view that, where an offer document separates out prospective financial information for identifiable business units or parts of a business, issuers should be able to present the information for some business units as forecasts, and for others as projections. It may be desirable and appropriate to do this where the quality of the information underlying the assumptions is lower for some business units than others. It is likely that the business unit with the lower quality information will have a larger deviation in actual outcomes from predicted outcomes.

  1. If this were permitted, forecasts could be made for the separately identifiable components of the business where the assumptions underlying the prospective financial information are reasonably expected to occur and are supportable. Projections could be presented for those identifiable components of the business where the underlying assumptions are hypothetical and realistic only.

  1. PwC submitted to the Commission that it was not aware of any case in which one reporting entity, for one financial period, has reported prospective financial information comprising both forecasts and projections.

  1. The Commission recognises that FRS-29 draws a clear distinction between forecasts and projections in terms of presentation and disclosure requirements, but is silent on whether any particular set of prospective financial information can be made up of both forecasts and projections.

  1. The Commission is of the view that this should be permitted and that the Financial Reporting Standards should provide clear guidance on this matter. The Commission refers this question to ICANZ.

CORPORATE GOVERNANCE MATTERS

  1. Several corporate governance issues arose during the inquiry. These are discussed below.

Information available to the Vertex Board for IPO Planning

  1. During the period under review, Vertex management prepared financial information for inclusion in the monthly board meeting papers. The board papers included a monthly management pack containing the following financial information:

  1. The information sets included in the monthly management pack for Vertex board meetings at which Vertex's financial and operating performance and position were discussed, varied somewhat in content between April and June 2002. Mr Clark informed the Commission that as a consequence of the restructuring of the business, the form and content of management reports changed for Vertex board meetings held from June onwards.

  1. Detailed financial information concerning business unit operating profitability (as distinct from levels of customer sales) was not included in the management report presented at board meetings in the period before the offer document was registered. For board meetings held up until 28 May 2002 (including the April 2002 results) management reports included business unit level information in a sales and marketing report, which showed sales by customer for each business unit. For board meetings held from June onwards (including the May 2002 results) the management report to the Board included detailed financial information at the individual business unit level, and in particular the actual sales and EBIT/EBITDA of each business unit against plan on a monthly and year to date basis, with an analysis of variance.

  1. The minutes of the May board meeting (at which results were presented for April 2002) recorded that discussions were held about the profitability (EBITDA) of individual business units. The Commission's view is that, given the lack of documented figures showing all of the revenue, expenditure and earnings figures of each business unit against plan in the May management reporting pack, the directors may not have had a full opportunity to properly understand the earnings performance of each business unit in terms of both revenues and operating costs and earnings. The documented figures presented at that board meeting only covered the April sales, by customer.

  1. Mr Clark confirmed to the Commission that the first time the full Vertex Board saw the detailed business unit performance, analysed by sales and operating earnings, was on 25 June, when the May Vertex results were presented to the board.

  1. The May management report presented to the board on 25 June 2002 indicated a significant cumulative negative variance in the Technical Injection unit's EBITDA against plan (i.e. negative 25% on the full year budgeted operating EBITDA and negative 148% on the unit's cumulative budgeted operating EBITDA for the months of April and May 2002).

  1. It is apparent that the quality of business unit level information communicated to the board improved from the June board meeting (at which the May results were presented). The Commission is, however, of the view that the information about the actual financial performance of the individual Vertex business units was critical to the board's understanding and knowledge of Vertex's actual underlying operating profitability, at the commencement of the 2002/2003 financial year and before the prospectus was registered and the shares allotted.

  1. In the Commission's view, the business unit level information would have been relevant to the board's assessment of the prospective financial information included in the offer document. The sales information by itself (which was all that was made available to the board prior to June) was not sufficient to provide directors with an indication of the performance of the individual business units, as it took no account of costs.

  1. It appears that the directors were aware of the negative variance in operating profitability in some of the business units during the months prior to registration of the offer document. After the June board meeting, when the extent of the problems in Technical Injection became apparent, the board did call for an in-depth review of Technical Injection's operations and financial performance to be presented at the July board meeting.

  1. The Commission considers that the fact that the information provided to the board in the period leading up to the IPO was incomplete is a matter of concern from a corporate governance perspective. This was an IPO of a company with diverse business units, where the IPO was promoted on the strengths of some of those units. In these circumstances, the Commission considers it is important that the board has complete information about the performance of individual units in the period leading up to the registration of a prospectus. If such information is not available, and the decision is taken to proceed with an IPO, directors need to satisfy themselves that the content of the prospectus accurately reflects of the amount of information that is available. For example, if the information available to the Board is not sufficient to support the inclusion of forecasts in the prospectus, then forecasts should not be used.

Understanding of forecasts and projections

  1. The evidence provided to the Commission demonstrated that some of the directors were not aware of the difference between forecasts and projections, and did not understand what form the prospective financial information in the offer document was required to take. Some thought that securities law required the prospective financial information for the period to 31 March 2003 (i.e. to the end of Vertex's financial year) to take the form of a forecast.

  1. When asked to describe the material differences between a projection and a forecast, Mr McKay replied as follows:

    "I'm not sure which way round legally we're talking, from projection versus forecast, but what goes into a prospectus has to be the very best estimate of what we believe is achievable, and based on a rigorous due diligence process."

    Mr McKay was then asked:

    Q: "The Vertex prospectus had a forecast for the 12 months to March 03, and then a projection for the following six months. Were you conscious in your input into the prospectus of the difference between the two?"

    A: "Yes, I was"

    Q: "And how did you see that difference?"

    A: "Well, I saw those forecasts as absolutely-you know, that-I was very aware of the importance of getting those forecasts as accurate as possible."

  1. When asked whether he thought the Vertex Board had the option of treating the prospective financial information as all being projections rather than forecasts, Mr McKay replied:

    "Oh no. No, no. No, we were aware of our responsibilities in the prospectus in terms of the forecasts."

  1. Mr McKay was then asked whether he treated those responsibilities as including a mandatory requirement to have a forecast for the next 12 months, to which Mr McKay replied:

    "Yes. We were required to have a forecast for the next 12 months..."

  1. It also appears from Mr McKay's evidence that no discussion took place with Vertex's advisers about the distinction between a forecast and a projection, and whether forecasts or projections should be presented in the offer document.

  1. However, Mr Foliaki's evidence indicates that some informal discussion took place at an early stage between PwC and George Clark, Vertex's CFO, about the characterisation of the prospective financial information. Mr Foliaki was asked:

    Q: "Was there any discussion between you and the CFO on the content of FRS-29 and what the different requirements were for forecasts and projections?"

    A: "No, I pointed out to him where those requirements were and left it to him to consider based on our discussions whether that was appropriate..."

  1. If the prospective financial information is to consist of a forecast, directors must be able to assess whether the assumptions underlying the prospective financial information are sufficiently supportable for the prospective financial information to properly qualify as a forecast in terms of FRS-29, or whether it would be more appropriate to present the information as a projection. To make this assessment, directors need be fully aware of the different requirements of forecasts and projections.

  1. It seems that in practice PwC went some way towards satisfying itself that presenting the prospective financial information as forecasts for all business units for the period to 31 March 2003 was appropriate. However, this judgment was not part of its formal engagement, and PwC did not take any legal responsibility for the quality of the forecasts. In his evidence, Mr Foliaki said:

    "[I] took the view that the forecasts for the 12 months to March 2003 were forecasts, and beyond that they were projections because they were based on high level assumptions."

  1. Mr Foliaki was then asked:

    Q: "And what were the criteria on which you decided that what they were putting in for the 12 months to March 2003 qualified as forecasts?"

    A: "Primarily because it was based on their detailed bottom-up budgetary process which had started some time before the IPO process; and also, because it was the actions that the directors and management were in the process of completing, if you like. They had clearly identified 'this is our plan forward, these are the actions we need to achieve that plan' and they were, you know, moving ahead on that basis."

  1. The Commission is of the view that directors of companies offering shares to the public should obtain advice from professional advisers about obligations under securities law, including the difference between forecasts and projections, and the quality of the information supporting the assumptions underlying the prospective financial information. This does not appear to have happened in Vertex's case.

PwC's Role

  1. PwC and Vertex had two relevant engagement letters. One related to PwC's engagement for the due diligence work. This letter did not extend to due diligence regarding the prospective financial information in the prospectus. The other engagement letter described PwC's statutory role as auditor in respect of the financial information appearing in the offer document. This letter limited the scope of PwC's duties in relation to the prospective financial information. PwC was required to check the numerical accuracy of the calculations and computations included in the prospective financial information, and to express an opinion as to whether the prospective financial information had been properly compiled on the footing of the assumptions in the offer document, and was consistent with the accounting policies normally adopted by Vertex.

  1. It should be noted that an auditor's statutory role in respect of prospective financial information in a prospectus is limited. He or she is not required to verify the information the company used to prepare the prospective information in a prospectus, or to go behind the assumptions used to seek information about their validity.

  1. The Commission notes that there was previously an Auditing Guideline (AG 20, issued in 1990) that provided guidance on the role of an auditor in the examination of prospective financial information. This guidance was subsequently withdrawn. The Commission notes that professional standards and/or guidelines have been issued in other jurisdictions, such as Australia and the US, that deal with an auditor's role in the examination of prospective financial information. The Commission notes, however, that the role of the auditor in those jurisdictions may differ from the auditor's statutory role in New Zealand.

  1. The paragraph headed "Basis of Opinion on the Prospective Financial Information", contained in the Auditors' Report appearing on page 64 of the offer document, reflects the limited nature of PwC's opinion on the prospective financial information as set out in its engagement letters. This limited opinion is consistent with the requirements of the Securities Regulations 1983.

  1. The engagement letters specified that PwC's role did not extend to testing the prospective financial information. However, there appears to have been some confusion between the parties on the scope of PwC's role in the IPO. Mr Clark had signed off the PwC engagement letters on the delegated authority of the board. It appears that the engagement letters were not sighted by the Vertex Board, and at least some directors were of the view that PwC was testing the assumptions underlying the prospective financial information.

  1. In his witness statement, Jon Hartley said:

    "The budget figures and the underlying assumptions were subjected to rigorous review and testing by the DDC, independent advisers, observers and the Board. Specifically, I understand that PwC undertook detailed analysis of the forecasts."

  1. When questioned by the Commission where this understanding derived from, Mr Hartley replied:

    "The amount of time spent by PwC in the offices of Vertex would be an anecdotal indication of the work they were doing. Secondly, the conversations that were had between management and PwC in terms of, for example, the change in revenue number that took place as we came towards the final process. Management specifically met with PwC to make sure that they were satisfied, and management reported back to the Board that they were satisfied with the changes that were being recommended. So, implicit in that is, for PwC to be satisfied about something that is a change, they should be satisfied about what it's changing from in order to be able to form a view about their satisfaction".

  1. PwC asked Vertex management some very detailed questions regarding the basis of the prospective financial information. This may have contributed to Vertex's belief that PwC's engagement was wider in scope than was set out in the engagement letter. Also, it was PwC who suggested to the DDC that the assumptions regarding the exchange rate ought to be reconsidered. The foreign exchange rate used in the prospective financial information was then altered and reflected in the net $1.2 million revenue adjustment made on 28 May 2002.

  1. The following questions were put to Mr Foliaki:

    Q: "In terms of the due diligence work, could you just briefly describe exactly what tasks PwC saw itself undertaking, relative to the prospective financial information?"

    A: "As I say, we didn't do any due diligence work. In terms of their letter, the engagement for due diligence services, we didn't do any work on the prospective information. The prospective information work was covered under our statutory role, so we simply carried out all the tasks we believe we're required to do to fulfil that role."

    Q: "Well did that, for example, extend to testing the validity of the assumptions on which the directors relied in making the projections of revenue in the prospective financial information?"

    A: "No."

    Q: "We've heard evidence that PwC initiated the debate, for example, about the exchange rates that had been used. Do you recall how that came about?"

    A: "Yes, I do. I raised that specific issue because the rate that they had included in the forecast that was represented to us, it started to be different from the spot rate at the time, and I said, that's your assumption but I question-I said that difference, it's materially different. What do the directors want to do about that? And I raised the question."

    Q: "And embarking on that issue, were you not questioning one of the assumptions underlying the prospective financial information?"

    A:"Not in my perspective. I was just saying that there's an assumption here that you've presented to us and we've checked the mathematical accuracy which is, you know, correct but it seems factually flawed if I look at the spot rate today."

  1. It appears to the Commission that by questioning the exchange rate PwC went beyond the stated limited role in respect of the prospective financial information set out in the engagement letter. The Commission does not criticise PwC for asking this question, and notes that PwC may even have had a professional duty to do so under the Code of Ethics that applies to all members of ICANZ. However, the Commission also notes that PwC asking the question may have contributed to a confusion about PwC's role. It appears from the evidence that while PwC did not consider it had any due diligence role in respect of the prospective financial information (and in terms of its engagement letter, at least, in fact had no such role), this was not the view of Vertex's directors.

  1. As already noted, Buddle Findlay advised the Commission that questions in the due diligence information request list relating to the prospective financial information were not contained in a due diligence report. Rather they were addressed by the DDC, which sought further reports from management where necessary, and recorded outcomes in the "key issues log". Buddle Findlay's due diligence report stated that PwC were taking responsibility for reporting on the prospective financial information due diligence. The evidence of the Vertex Board indicated that they were under the impression that PwC had tested the prospective financial information. It appears that the DDC did not communicate to the Vertex Board the fact that the DDC itself, and not an independent adviser, had carried out the due diligence in respect of the prospective financial information.

  1. Evidence from Vertex directors indicated to the Commission that they drew comfort from the due diligence carried out by PwC, which they thought included due diligence on the prospective financial information. This raises the question of whether the board would have drawn the same level of comfort in respect of the prospective financial information due diligence if they had known that the DDC, and not PwC, had taken responsibility for it.

  1. Vertex's legal advisers submitted that there was no misunderstanding or confusion about PwC's role, stating:

    "Although the letters of engagement may have set out a defined role for PwC, the reality of the situation is that they took this role further, thereby assuming shared responsibility for the prospective financial information, which the directors relied upon."

    and

    "PwC was intimately involved in all aspects of the development and finalisation of the forecasts".

  1. Counsel for PwC submitted that:

    "These directors and their legal advisers are sophisticated and experienced. PwC relied on them to understand the engagement letters and the nature and scope of services PwC was providing. Neither market practice nor professional duty expand the scope of work being undertaken by PwC beyond the carefully worded engagement letters."

    and

    "PwC says it was not intimately involved in 'all aspects of the development and finalisation of the forecasts'. It observed them to the extent necessary to give the opinion required by the Securities Regulations 1983. This means that it ensured that it
    1. understood the prospective financial information;
    2. understood the nature and extent of the assumptions on which that. information was based.


However, PwC did not form a view about whether

  1. the assumptions were themselves appropriate;
  1. the risks associated with the assumptions had been accurately described."

  1. It is not for the Commission to reach a conclusion on the scope of the contract between Vertex and PwC, and the Commission makes no comment on that. However, the Commission is of the view that there was confusion surrounding the scope of PwC's role, and is concerned with the potential effects of such confusion.

  1. It is important that the role of independent advisers in an IPO is well understood by the company's board and management and the advisers themselves, so that there is no doubt about the responsibilities and expectations of the parties. Directors who sign a prospectus do so in part relying on the due diligence carried out by its advisers. If their reliance is to have a proper basis, the directors must have a clear understanding of the roles of their professional advisers. Any uncertainty about these matters increases the risk of serious flaws in the due diligence process and in the resulting offer document.

  1. The Commission also notes an irregularity in that the directors' representation letter (a standard document prepared by PwC for Vertex to sign on Vertex letterhead confirming the basis on which the company prepared the prospective financial information) was signed by a director who had retired at the time of signing.

  1. Having noted at paragraph 192 the absence of guidance concerning an auditor's examination of prospective financial information, the Commission refers to ICANZ the question of whether such guidance is desirable.

ACTIONS

  1. The Securities Act 1978 imposes criminal and civil liability for breaches of the Act and for use of offer documents containing untrue statements. These are set out in Appendix D of this Report.

  1. Under section 37A(1)(b) of the Securities Act 1978 a security offered to the public must not be allotted if at the time of the allotment the investment statement or registered prospectus relating to the security is known by the issuer of the security, or any director of the issuer, to be false or misleading in a material particular by reason of failing to refer, or give proper emphasis, to adverse circumstances. This applies whether or not the investment statement or registered prospectus becomes false or misleading as a result of a change of circumstances occurring after the date of the investment statement or registered prospectus.

  1. If an allotment of securities is made in contravention of this section then that allotment is voidable if the subscriber gives notice in writing to the issuer. The Commission has not found any evidence to suggest that the issuers or directors of Vertex knew that the offer document was misleading at the time of allotment.

  1. Section 56 of the Act provides shareholders with civil remedies where a registered prospectus contains untrue statements and the shareholder can establish loss or damage caused by the untrue statements. As noted above, the Act deems a statement to be untrue if it is misleading by reason of the omission of a particular which is material to the statement in the form and context in which it is included. In the Commission's opinion, the statement relating to risk in the offer document was likely to mislead.

  1. Section 56 provides defences against liability in certain circumstances. It is not for the Commission to determine liability under this provision - that is the role of the Courts. The Commission refers this report to the shareholders of Vertex who subscribed for shares in the IPO, for them to consider the questions of civil liability. Whether any action should be taken is a matter for those shareholders to determine.

  1. The Commission refers this report to ICANZ.





_______________

Jane Diplock AO
Chairman of the Securities Commission

14 March 2003

Appendix A

Terms of Reference: Vertex Group Holdings Limited

PURSUANT to section 10 of the Securities act 1978 the Securities Commission has decided to undertake an inquiry to review the facts and circumstances of the offer and allotment of the shares of Vertex Group Holdings Limited ("Vertex") for the company's initial public offering as a company listed on the New Zealand Stock Exchange ("NZSE") in June and July 2002, and the company's communications to the share market subsequent to the allotment.

THE Commission wishes to consider any evidence which may be material to :

    1. whether the registered prospectus or the investment statement issued by Vertex and dated 7 June 2002 was false or misleading to any material information, or omitted any material information or did not comply with the Securities Act 1978 or the Securities Regulations 1983;
    2. whether on the date of allotment of the Securities offered in the Vertex registered prospectus and investment statement (1 July 2002), that registered prospectus or investment statement was known by Vertex or any of its directors to be false or misleading in a material particular by reason of failing to refer, or give proper emphasis , to adverse circumstances affecting the entity or any information included in or omitted form the prospectus;
  2. The procedures observed by the directors of Vertex in relation to :
    1. preparation of the registered prospectus dated 7 June 2002;
    2. approval of the allotment of securities under the offer made in that prospectus;
  1. The nature of the information communicated to shareholders and the NZSE about the performance and prospective performance of Vertex after the date of allotment of the securities;
  1. The trading of the shares of Vertex subsequent to the date of their listing on the NZSE;

AND to consider:

  1. Any other matters material to the inquiry;
  2. Whether the Commission should comment on any matters arising in the inquiry to Vertex, its directories, its shareholders, the NZSE or to any other appropriate body under section 10(c) of the securities act
  3. Whether evidence received raises issues under the Securities Act 1978 or the Securities Amendment act 1988
  4. Whether the Commission should publish a report or take any other action.

SUBJECT to the discretion the Commission to amend these terms of reference as it may consider fit.

11 September 2002

Appendix B

PricewaterhouseCoopers

Private & Confidential

The Directors and
Due Diligence Committee
Vertex Group Holdings Limited
Unity Drive
North Harbour Industrial Park
Albany
Auckland
Pacific Equity Partners
Pty Limited
Level 36
The Chifley Tower
2 Chifley Square
Sydney NSW 2000
Australia
Bain Capital, Inc.
Two Copley Place
Boston, MS 02116
United States of America

20 March 2002

Dear Members

Engaged Procedures Relating to Vertex Group Holdings Limited IPO ("the IPO")

We are writing to you in relation to our recent discussions regarding the due diligence procedures you have requested us to perform in relation to the proposed IPO.

The purpose of this letter is to set out the specific procedures to be performed by us in connection with this engagement ("the Engaged Procedures"), our responsibilities, the other terms of our engagement, and acknowledges our willingness to accept this assignment. This Engagement Letter, its appendices and the attached Terms of Business, together form the contract between us ("The Contract").

Please note that a separate letter of engagement has been agreed for our statutory role as Reporting Accountants to the issuer on the IPO.

1. The Services to be provided

Our report
We will prepare an engaged procedures report (the "Report") on the specific procedures to be performed as part of you financial, information technology and tax due diligence on Vertex Group Holdings Limited and its subsidiaries ("Vertex").

The specific scope of the Engaged Procedures you require us to conduct is in accordance with the "Vertex Group Holdings Limited - IPO Due Diligence Information Request List" document date 28 March 2002. We have set out in Appendix 1 to this letter a summary of the Information Request List sections and indicated the areas on which we will perform the engaged procedures.

The engaged procedures are:

The report will follow the format of Appendix 1 to this letter, by repeating in each case the heading and the detailed subsection and then stating, by exception, our findings.

Our report will be addressed to the Due Diligence Committee ("DDC"), for use by the DDC.

We emphasise that our reporting to the DDC will not extend beyond or otherwise enlarge the responsibility or liability of PricewaterhouseCoopers beyond that arising from the reports we prepare.

No procedures will be performed in relation to any of the other files or areas specified in the due diligence checklist.

The work that we shall perform will be in accordance with the Standards and Guidelines for Agreed Upon Procedures Engagements issued by the Institute of Chartered Accountants of New Zealand. The procedures we undertake will be substantially less in scope than an audit examination or a review conducted in accordance with New Zealand auditing standards, the purpose of which is the expression of an opinion on financial statements taken as a whole. Accordingly, we will not express an opinion on the information we examine in the course of the Engaged Procedures.

Sources of Information
In order for us to perform this work, it will be necessary to obtain access to certain original records of Vertex. We understand that this information will be provided via a data room, supplemented by questions of Vertex management and other advisers to Vertex management.

We will have to rely on representations by Vertex management made to us during the course of our work, unless we have reason to believe that those representations are false, or contain irregularities, or do not contain material information. In situations where we are unable to access requisite information support representations by Vertex management we will communicate this to you.

As discussed with you, we will have access to the external auditors' working papers in relation to the financial statements of Vertex for the 31 March 2001 and 2002 audits and discuss with the auditors any matters arising from this work.

Materiality
In accordance with the "Due Diligence Committee Procedures document" we will be applying a materiality exclusion of NZ$150,000. If, in our opinion, a particular item or matter could impact adversely on the profitability or net assets of Vertex by less than NZ$150,000, we propose to exclude this from our Engaged Procedures. We will note the materiality levels applied by the Vertex auditors may be higher than NZ$150,000 and this will place further limitations on our work.

2. Timetable

We expect our report to be completed by 17 May 2002.

3. The team

We currently envisage that our team will be led by, Leo Foliaki, who will be the Engagement Partner responsible for the services we are to provide to you. Further assistance will be provided by Doug Brown acting as Project Manager. Declan Mordaunt is our partner responsible for completing the taxation aspects of our Engaged Procedures.

4. Fees

Our fees will be based upon the time incurred to carry out our procedures at the agreed rates. In the limited time available, it is essential that we utilise experienced and senior resource in order to minimise supervision time. The overall level of fee reflects the degree of skill involved as well as the risks associated with the proposed transaction.

At this stage it is extremely difficult to determine the likely time involved in performing the Engaged Procedures with any degree of accuracy. We will therefore provide you with a regular update of our costs to date and expected costs to complete.

In addition to these fees, our billings will include out of pocket expenses. Significant direct out of pocket expenses (e.g. travel) will be charged at cost. Similar incidental expenses (e.g. local courier, photocopying etc) will be recovered by way of a general charge based on actual time costs (currently 3%). In accordance with our standard terms of engagement we would seek to interim bill on a fortnightly basis. Invoices rendered are due and payable within 14 days of receipt.

5. Terms of business

This letter should be read in conjunction with the enclosed Terms of Business.

Liability
We shall accept liability to pay damages for losses arising as a direct result of breach of contract or negligence on our part in respect of services provided in a connection with, or arising out of, the contract but, to the extent permitted by law, any such liability of PricewaterhouseCoopers, its partners and staff (whether in contract, tort negligence or otherwise) shall in no circumstance exceed 5 times the fees paid in the aggregate of all such services.

In no event shall PricewaterhouseCoopers be liable for any loss, damage, cost or expense arising in any way from fraudulent acts, misrepresentations or wilful default on the part of Vertex or its advisers. Further, PricewaterhouseCoopers accepts no responsibility or liability whatsoever for the accuracy or completeness of any information or documentation provided to us by Vertex or its advisers including, without limitation, the information and material provided by their external auditors.

6. Acknowledgement and acceptance

Please record your agreement to the terms of this contract by signing the enclosed copy of this letter in the space provided and returning it to us.

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