Weatherford International (WFT) provides equipment and services used in the oil and natural gas industry. Headquartered in Geneva, Switzerland, it operates in over one hundred countries. For nearly two years, Weatherford has been on a roller coaster ride filled with breath-taking hills and head-jerking turns.
On March 1, 2011, Weatherford announced its 2010 annual report would be filed late. The company explained it would need to restate earnings back to 2007 because of income tax accounting errors. It estimated the impact would be in the $500 million range. Weatherford's multinational tax structure is complex. It is subject to numerous tax laws in over one hundred jurisdictions. The taxes are based on income before taxes, deemed profits (uses a percentage of revenues rather than profits), and alternative minimum taxes. The problems Weatherford found were that its "processes and procedures did not provide for adequate and timely identification and review of various income tax calculations, reconciliations and related supporting documentation required to properly account for income taxes in accordance with U.S. GAAP".
On February 21, 2012, during the 2011 fourth quarter conference call, Weatherford's CFO reported:
"...as a result of the continued material weakness over the accounting for income taxes, significant incremental work has been performed by Weatherford employees and external advisors during 2011 and early 2012, which management expects to result in roughly $225 million to $250 million of aggregate net adjustments to previously reported financial results for the years 2010 and prior relating to the correction of errors identified with respect to the company's accounting for income taxes."
In another area, Weatherford found its reporting units did not fail the first step of its goodwill impairment test in 2011. Fair values were in excess of the goodwill values being carried. Goodwill values carried on December 31, 2011 for relevant reporting units were as follows: MENA (Middle East/North Africa) - $508 million, Russia - $283 million, and SSA (Sub-Sahara Africa) - $77 million.
By July 24, 2012, during the 2012 second quarter conference call, Weatherford reported:
We are reporting our results on a pre-tax basis because we have identified additional income tax items during 2012 that are related to prior periods, $36 million in the first quarter and now an additional $56 million in the second quarter, totaling $92 million. Due to the materiality of these income tax items to 2012, we must record them in the prior years, and we will therefore restate our prior year financial statements. We will not issue restated financial statements until we have completed additional procedures and reviews of our accounting for income taxes. In plain terms, we do not intend to reissue financial statements for prior years until we have completed additional procedures related to income tax accounting and performed, at a minimum, our third quarter tax provision review process.
Since the self-diagnosed error spotted in February 2011 by our own internal audit, the scope and scale of historical errors has steadily decreased. The numbers are becoming smaller.
Weatherford hinted about the goodwill impairment in its press release:
This analysis indicated that the Middle East/North Africa, Russia and Sub-Sahara Africa reporting units were potentially impaired. The company expects to finalize its goodwill impairment analysis during the third quarter of 2012 and record an impairment charge if it concludes that the goodwill of any reporting unit is impaired. The total amount of goodwill for these reporting units was $769 million as of June 30, 2012.
In November 2012, erroneous reports surfaced that Weatherford's tax woes were now in excess of $800 million. The original $500 million estimated in March, 2011 was being added to the $225 million to $250 million reported in February, 2012 as well as the $92 million reported in July, 2012. Even though Weatherford management specifically stated in July, 2012 that the numbers were becoming smaller, impatience and distrust surrounded Weatherford. And, the hints of goodwill impairment continued to be overshadowed by the climb toward the looming financial reporting restatements.
Weatherford provided preliminary details about the goodwill impairment November 12, 2012 in its third quarter pre-tax results release:
The company also reports a revised preliminary second quarter 2012 loss before income taxes of $753 million, or earnings of $146 million after excluding pre-tax losses of $899 million. These results had been previously reported on a preliminary basis, and the excluded items include:
- $589 million for non-cash goodwill impairment charges in the Middle East/North Africa and Sub-Sahara Africa regions,
$204 million primarily for the non-cash write down of equity method investments,
On December 7th, 2012, S&P upgraded its opinion from a "hold" to "buy" on Weatherford shares.
When Weatherford issued its restated financial statements December 17th, 2012, the income tax expense was understated for 2011 by $56 million, for 2010 by $57 million and for 2009 by $26 million compared to the previously reported results. Errors attributable to 2008 and prior years totaled $47 million. So, the actual adjustment for income tax restatement is $186 million - far less than the projected $500 million and far, far less than the erroneously fabricated $800 million. The accumulated expenses for income tax restatement and material weakness remediation to date have reached $73 million ($21 million included in previous years, $14 million in first quarter, $11 million in second quarter and $27 million in third quarter). The $259 million of adjustment and expense equates to a per share loss of $0.34.
Weatherford detailed the adjustment for goodwill and other intangibles in the restatement of the second quarter for 2012. Weatherford's impairment test is outlined as follows:
We perform an impairment test for goodwill and indefinite-lived intangible assets annually as of October 1, or more frequently if indicators of potential impairment exist. Our goodwill impairment test involves a comparison of the fair value of each of our reporting units with its carrying amount. Fair value is estimated using discounted cash flows and a discount rate based on the weighted average cost of capital of the reporting unit.
This "step one" analysis, indicated that the goodwill attributed to our MENA and SSA reporting units was potentially impaired. Consequently, we performed the "step two" analysis of the goodwill impairment test, comparing the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The "step two" analysis indicated that the goodwill for both reporting units was fully impaired and we recognized an impairment loss of $589 million in the second quarter of which $512 million was attributable to MENA and $77 million to SSA.
In connection with our goodwill impairment test, we prepared an analysis to determine the fair value of our equity investments in less than majority owned entities. Upon completion of this valuation, we determined that the fair value attributable to certain equity investments was significantly below our carrying value for these investments. We assessed these declines in value as other than temporary and recognized an impairment loss of $204 million, with no corresponding tax benefit
These impairment charges equated to a loss of $1.04 per share. That loss tripled the $0.34 loss due to income tax restatement and material weakness remediation.
On December 21st, 2012, just two weeks after upgrading the stock to a "buy", Standard and Poor's Rating Service cut Weatherford's corporate credit rating from BBB to BBB- citing capital spending and working capital investment over the last several quarters. The metric of FFO (funds from operations) to total debt has been in the 20% range for several years. An appropriate range for a BBB rating would be 30-35%.
On December 22nd, 2012, the S&P Capital IQ stock report acknowledged Weatherford's goodwill impairment as the "biggest change" in the financial restatements. Note it was not the income tax restatement and material weakness remediation.
So, which of the roller coaster elements has Weatherford managed to ride out?
Regarding the tax accounting issues, each restated filing contains the admission:
As of the filing date of this report, the material weakness in our internal controls over the accounting for income taxes has not been remediated.
Weatherford even spelled out a step-by-step plan to continue the implementation of its remediation plan. It appears Weatherford may continue to incur income tax restatement and material weakness remediation expenses. However, Weatherford has definitely topped the hill of the tax accounting issue.
Regarding goodwill impairments, it is considered more favorable for the management of a company to take the bullet and take an honest all-encompassing charge than to take a series of recurring charges. By Weatherford's reporting, the Middle East/North Africa and Sub-Sahara Africa units were fully impaired and the related impairment charge was taken in full. Downturns in the oil and gas industry as well as general market factors could impact the fair value of Weatherford's businesses and goodwill values in the future. But, based on current information, Weatherford commanded that turn.
Finally, regarding the most recent concern of the FFO to debt metric raised by Standard and Poor's, the rating agency does believe Weatherford's credit protection measures will improve - just at a slower pace than it had previously expected. For 2013, S&P estimates 6% revenue growth as well as a debt decline of 3.5% which should result in an FFO to debt metric change to a percentage in the mid-to-high twenties. So, as 2013 fast approaches, Weatherford still has this hill to top.
For long-term investors in Weatherford, the income tax accounting issue turned out to be a very, very long climb through a dark tunnel climaxed by a trick hill. The wait built more anticipation than the outcome provided thrill once the restatements were concluded. The share price did not fare well during this leg of the ride giving up more than 50% since the weakness was announced on March 1, 2011. Just as in the best roller coasters, before investors could regain their balance, the S&P rating agency threw in a cutback turn highlighting the credit metrics. The goodwill impairment was a corkscrew turn that happened so quickly, few recognized it even occurred much less processed it. When 2012 annual EPS results are announced at such a curious and considerable loss, investors will likely realize the focus on income tax accounting masked the goodwill impairment twist.
For the investor willing to reopen their closed eyes, the roller coaster ride of Weatherford may offer one more thrill element. If Weatherford can stay on the track and execute to points where credit metrics improve, the share price could improve by 50% and even to early 2011 levels.