“Carpe Diem”: Oilfield Services Companies Eye the IPO Market

 

 

By Tyler Chase, Managing Director
Energy and Utilities Industry Leader

and Steve Hobbs, Managing Director
Public Company Transformation

 

Despite the recent downward trend in oil prices, the oil and gas industry overall is feeling optimistic, as evidenced by increased rig counts and production levels. Both are signs that the industry is on the rebound after a downturn that has persisted for well over two years. Renewed confidence and optimism about future growth have many companies in the sector thinking about pursuing an initial public offering (IPO). Among them: fast-growing and capital-hungry oilfield services providers.

These service businesses play an important role in supporting the oil and gas industry. They provide innovative technology, manufacturing of critical equipment, and services that allow oil and gas companies to enhance their existing infrastructure and processes so they can produce more at less cost.

The recent volatility in the oil and gas market hit oilfield services providers hard. In 2015 and 2016, many were burdened with significant debt and selling their services at a discount just to survive; several companies ended up filing for bankruptcy.

Now, less than a year after that dark period, oilfield services providers are driving IPO activity in the energy sector — outpacing exploration and production companies. Many of these private equity-backed companies have been waiting for conditions in the industry and capital markets to improve so they can execute an IPO as their forward strategy. Others are looking to an IPO as a way to raise much needed capital fast, to fuel growth and innovation.

What many oilfield services providers learn in exploring the IPO idea is that they simply aren’t prepared to make the leap. One reason is that these firms lack maturity in their business processes, and have limited alignment with GAAP accounting and insufficient infrastructure and personnel to support expansion. They are, essentially, startups. And like any startup or other fast-growing private company in any other sector, oilfield services providers must achieve a certain level of “readiness” before attempting to go public.

These firms are also at risk of making a mistake common among other businesses with IPO aspirations: underestimating the amount of time and personnel required to address the demands of a public company transformation. These pre-public companies must address six primary infrastructure elements on their journey to IPO readiness, including:

  • Corporate policies: These include governance, financial reporting and company policies, such as human resource and marketing policies. Like most startups, oilfield services providers are so focused on delivering their technology and services and trying to grow their market that they don’t spend enough time on essential back-office infrastructure for the business, such as creating formal policies. Structure and documentation are needed not only for compliance purposes, but also to help the company communicate to everyone, from investors to current employees and potential hires, how it operates, what its values are, and more — a basic expectation from an IPO candidate.
  • Corporate processes: Financial reporting processes are just one example of corporate processes that many oilfield services providers will need to upgrade substantially and standardize before going public. For instance, documentation about business agreements is likely inadequate because of the informality with which these service companies often approach deals — confirming terms with perhaps little more than a handshake. So, firms preparing to go public need to start moving now to formalize their agreements with business partners and create an appropriate paper trail. Many accounting and financial planning and analysis forecasting processes will also need to be augmented and automated because manual practices are error-prone and time-consuming.
  • People and organization: Any company that wants to go public needs a well-structured and experienced leadership team. The IPO process places huge demands on senior executives — especially the CEO and CFO, who will need to spend much of their time on the road meeting with analysts and potential investors. Once the IPO ball starts rolling, these executives won’t be able to focus much on everyday business needs. There needs to be a strong team in place, especially in the accounting/finance organization, to help guide the company in their absence, address external auditor considerations, and meet SEC filing deadlines on time.
  • Systems and data: Pre-IPO companies frequently report that their IT departments are a major area of focus during their readiness effort. IT general controls that pertain to Sarbanes-Oxley Act compliance and data security and privacy strategies and policies are just two key areas within IT that oilfield services providers will need to pay special attention to as they lay the groundwork for a public offering. A critical risk within the realm of IT system compliance is addressing the organization’s lack of segregation of duties (SoD) and the need for comprehensive monitoring of access for all critical business IT systems. It’s imperative for management to be directly involved in the SoD design process to clearly shape the roles and duties of personnel within the company prior to an IPO. Data security and privacy can be particularly wide in scope, including everything from cybersecurity policies to business continuity management planning.
  • Management reports (e.g., on internal control over financial reporting) and methodologies (e.g., for the offering price, for financial controls, significant accounting estimates) round out the six primary elements. Oilfield services providers must ensure they have them covered — and implement a sustainable infrastructure and strong organizational capabilities as well — before pursuing an IPO.

Addressing all the above is a complex and resource-intensive endeavor, and likely will require expert assistance on many fronts. This fact is not to dissuade oilfield services companies from seizing opportunities in the current oil and gas market.  But seizing the opportunity is one thing; managing the newly public company in the weeks and months following the IPO in a manner that is consistent with the expectations of regulators and shareholders and the company’s own executives’ vision is quite another. At issue here is sustaining confidence with regulators and shareholders. According to our experience across a wide variety of sectors, covering the six elements of infrastructure above in a thoughtful, proactive manner is a vital process in moving to the next stage successfully.

So You’ve Gone Public – What’s Next?

Steve HobbsBy Steve Hobbs, Managing Director
Public Company Transformation

 

 

Once a company is public, the event is often celebrated and the organization emits a collective sigh of relief. But then the next daunting question looms: “What’s next?” Recently, I had the opportunity to discuss this very topic on a podcast with my colleague Andrea Spinelli, a director in our Business Performance Improvement practice. The key aspects of a post-IPO environment, which we discuss in more detail during the podcast, include:

  • Transition from “project” to “process.” Now that the pre-IPO scramble is in the past, companies need to focus on designing, operating or enhancing processes within the organization to meet the financial reporting and other requirements for public companies.
  • Forecast the business. Forecasting can be a fairly complicated and difficult process that is often overlooked when a company is considering its IPO readiness – but it is something public companies are expected to do competently.
  • Invest in technology. There is a higher expectation for increased capability maturity from a public company. This expectation runs throughout the organization and includes the technology automation required to manage the business. Manual processes, for example, are more prone to error and create data and other integrity risks, and technology is key to minimizing those risks.

The podcast discussion provides insight on these points and more, and is of interest to both pre- and post-IPO companies. I urge you to listen at the link below when you have time, and send us a comment if you like.

Podcast: So You’ve Gone Public – What’s Next?

 

It’s That Time of Year: The 2016 Audit Committee Agenda

It was a good kickoff of the new year, with more than 1,500 forward-looking directors and executives logging on to our January 7th webinar, Setting the 2016 Audit Committee Agenda. Hosted by Protiviti’s Brian Christensen and David Brand and me, the webinar was based on our latest issue of The Bulletin, which I’ve tweeted about, but have not previously addressed here.

Given the high attendance and rapid-fire Q&A (we will be covering some of these questions on this blog soon), I want to recap Protiviti’s ten Mandates for Audit Committees in 2016 that shaped the discussion. These mandates are intended to augment the normal, ongoing operations of the committee. The first five address issues pertaining to enterprise, process and technology risk issues. The rest focus on financial reporting issues.

  1. Ensure the risk profile reflects current business realities. Historically, boards have looked at their risk profiles annually. That was the case for more than half of webinar participants (51.5 percent). Given the increasing economic, political and global risk volatility, it is critical that boards ensure that the risk profile remains current and that emerging risks are identified timely as the risk landscape changes. The audit committee has either a direct or indirect interest in having a current view of the organization’s risks, depending on the risks’ impact on public and financial reporting.
  2. Understand the technology-related risks that present threats to the business model. Whether your company is creating the disruption or reacting to it, audit committees need to stay abreast of these changes. For example, the United States Securities and Exchange Commission (SEC) requires listed companies to disclose significant cybersecurity breaches and other related matters.
  3. Pay attention to risk culture and the tone of the organization. Recent catastrophic risk management failures have one thing in common: The tone at the top was not as strong as it could have been. A resounding majority of webinar participants (86.5 percent) said maintaining a robust risk culture is important to leaders in their organization. I hope this is true for your organization, as well.
  4. Consider the need for expanded capabilities of the finance organization. Big data, business intelligence, reporting enhancements – all of these changes, along with the increasing regulatory/compliance burden, are increasing demands on the finance organization, particularly in the areas of automation and information technology. Make sure your organization has allocated adequate resources to this critical and growing area.
  5. Consider the need for expanded capabilities of the internal audit function. As risk management matures, internal audit’s role as the third line of defense changes. Every year, technology-enabled auditing and data analytics rank as top challenges in our Internal Audit Capabilities and Needs Survey – which means we’re not making the progress that needs to be made. And the list of internal audit priorities continues to grow. The audit committee needs to ensure that internal audit is sufficiently resourced to execute its risk-based audit plan.
  6. Make the necessary process adjustments to enable the new revenue recognition standard. It’s common knowledge that public companies must comply with new Financial Accounting Standards Board (FASB) revenue recognition standards beginning with calendar year 2018. The task here is to make sure that your company gets started. There’s a lot of work entailed, even if it’s just in determining how the new rules affect your organization – and yet, less than 40 percent of organizations have even started.
  7. Review the Public Company Accounting Oversight Board (PCAOB) inspection report on the audit firm and understand how it impacts the audit process. As the PCAOB increasingly holds audit firms accountable for the quality of their audits, it could affect what auditors are looking for when they audit your organization. Audit committee members should review the PCAOB inspection report on the company’s audit firm and determine whether there are any implications for the organization. Also, the PCAOB is seeking public comment on a draft of 28 audit quality indicators, and audit committees need to keep an eye on that development.
  8. Consider the PCAOB-audit committee dialogue. Both the PCAOB and the SEC have increased their outreach to audit committees. We encourage audit committee members to obtain an understanding of what these organizations expect in a quality audit.
  9. Pay attention to developments on the lease accounting front. There’s a new standard on leases coming out in early 2016 that will have a significant effect on so-called “off balance sheet” financing. Going forward, both operating and capital leases will have to be accounted for on balance sheets. If this impact is significant, the company may need to start thinking about the related implications to contractual agreements, loan covenants and capital ratios, among other things.
  10. Ascertain the implications of the SEC’s concept release on audit committee disclosures. The SEC wants more transparency into audit committee activities. In 2015, the agency issued a concept draft of new audit committee disclosures. If you haven’t reviewed these already, you need to.

As 2016 builds a full head of steam, it promises to be a wild ride. As always, we’ll be here at The Protiviti View to help you find the signal amid the noise. If your audit committee has other priorities that aren’t on this list, I’d love to hear them. Feel free to weigh in, in the comment section below.

Jim

Revenue Recognition Webinar Series: Industry Considerations and Cross-Functional Implications

Chris WrightChris Wright, Managing Director
Leader of Protiviti’s Finance Remediation and Reporting Compliance practice

 

 

By now, regular readers of this blog should be well-aware that new Financial Accounting Standards Board (FASB) revenue recognition rules will apply to reporting periods beginning after December 15, 2018 — and will be allowed a year earlier for those who are ready. Now is the time for companies to be considering the potential effects of this change and running diagnostic exercises to determine how much work will be required to adapt their policies, procedures and controls to the new rules in time to be ready for their chosen or mandated due date.

Protiviti launched the Revenue Recognition webinar series in November of last year, working through the six elements of infrastructure, delineating the probable impacts of the transition process in each. The final installment — Industry Considerations and Cross-Functional Implications —  was held on July 23.

Chris Wright, Managing Director and leader of our Finance Remediation and Reporting Compliance practice, wraps up our post-blog Q&A series by answering some of the top questions posed during the live session.

Q: How will the new revenue recognition standards affect internal controls and how will that affect Sarbanes-Oxley (SOX) audits?

A: Internal and SOX audits, which test controls, will be impacted in a downstream manner through changes in accounting policy, which is likely to be affected by the new rules, and more so in some industries than others. Industries that rely on long-term and percentage-of-completion contracts — construction and aerospace, for example, and anyone who is manufacturing for the defense industry — are particularly likely to see substantial changes. If the company has to recognize revenue sooner, or based on different indicators, that will have to be baked into a new accounting policy. If that policy changes, then what people do at their desktops — in the accounting organization, the operations and logistics areas, in treasury and tax, and in HR, where they compute the commissions, etc. — may also change. And of course, whenever you change processes, you have to assess whether the controls you had in place before address any additional risks that come from that change. This is where the flow-through effect of the new rules could move all the way into the domains of internal and SOX audits.

Q: Does this new standard do away with percentage-of-completion accounting for long-term contracts?

A: As an academic matter, yes. As a practical matter, however, its effects may not go away completely. All generally accepted accounting principles regarding revenue recognition are replaced by the new standard. The rules on percentage-of-completion accounting have been around for 35 years. Companies have gotten used to them. What’s really going to be a challenge is to separate and account for multiple margins and deliverables – the delivery of one plane, one tank, or one building — within a single contract. One contract might have separate streams with different margins from quarter to quarter, or year to year.

Down the road, it’s not inconceivable that companies may not only change accounting policies as a result of the new standard, but also change their pricing and their approach to accounting. That’s why we recommend a cross-functional view of the new rules. If the initial diagnostic has determined a need for substantial change, it is important to assemble a team with a full view of all upstream and downstream impacts. Without assessing the gap between the new rules and the current rules, there is a potential to overestimate the simplicity or complexity of the changes — we need to get past guessing. The diagnostic assessment needs to start at the treetops and get to a granular level, and happen sooner rather than later.

Q: What are the biggest issues facing manufacturers whose standard “free-on-board” (FOB) terms are FOB shipping point, but do have some FOB destination customers?

A: As a practical matter, the new rules shouldn’t affect a company’s policy regarding the point at which ownership of goods transfers to the recipient. What needs to be clear is the terms, and that there are no further performance obligations — policies, procedures and controls. From a cross-functional perspective, it is important to test this process all the way through, and the sales force needs to be educated to make sure that what they are telling customers matches the terms in the company’s contract — terms which are the basis for the company’s new accounting policy.

Q: What should internal audit do to prepare for the changes?

A: Chief audit executives (CAE) are in a unique position as liaisons between the audit committee and management. The audit committee will likely want to weigh in on things like prospective versus retroactive reporting and early adoption. CAEs need to make sure that these items are on the audit committee agenda and that they are being addressed. On the management side, internal audit needs to at least attend diagnostic and subsequent project management meetings, and ideally should be represented as a fully participating voice in the project management organization. Although internal auditors should not be writing accounting policy, they play a big role in making sure revenue recognition issues, particularly the cross-functional implications — both upstream and downstream — are considered and addressed. We’re seeing that plans for testing the consistent application of the new rules may require a different skill set than some companies have committed to, and that they need to move from junior internal auditors with checklists to more senior personnel with more developed critical thinking capabilities. Otherwise, how can the CAE expect the internal audit function to be effective in challenging senior accounting officers as they apply a very different accounting approach to such a critical area as revenue recognition?

The new revenue recognition standard is an important and complex issue that could have process, policy and control implications throughout your organization. To help you and your organization navigate this change, we have established the microsite protiviti.com/revenuerecognition, with links to all five of our recorded webinars, and additional thought leadership on this topic.

Effective Date of Revenue Recognition Standard to be Deferred

Yesterday, the Financial Accounting Standards Board (FASB) voted to defer, by one year, the effective date of the board’s new revenue recognition standard. Issued almost a year ago, this new guidance resulted from a collaborative effort by the FASB and International Accounting Standards Board (IASB) to agree on a global standard based on common principles that can be applied across industries and regions. The FASB voted for a one-year deferral of the effective date of the new standard and will issue an exposure draft proposing the deferral, with a 30-day comment period.

With respect to public companies: In the original release, the new standard is expected to be effective for fiscal years, including interim periods within those years, beginning after December 15, 2016. The proposal would now require application of the new standard no later than annual reporting periods beginning after December 15, 2017, including interim reporting periods therein. For example, a calendar year reporting company would now be required to apply the new standard during 2018, including the interim periods therein.

For nonpublic entities: The standard, as originally issued, is expected to be effective for fiscal years beginning after December 15, 2017, and interim periods thereafter. The proposal would now require application of the new standard no later than annual reporting periods beginning after December 15, 2018, including interim reporting periods therein. For example, a calendar year reporting company would be required to apply the new standard during 2019, including the interim periods therein.

Under the proposal, public entities would be permitted to elect to early adopt the new standard as of the original effective date, as described above – in effect, a year earlier than the proposed new effective date. In addition, a nonpublic entity may elect to apply the amendments as of the original effective date for public companies. The originally proposed new standard did not allow early adoption.

The FASB’s proposal is based on its outreach to various stakeholders. The board determined that a deferral is necessary to provide companies adequate time to effectively implement the new standard. Interestingly, the IASB (which also issued this standard) has not provided a specific timeline to make a decision regarding a potential delay in its original effective date, although at least one of its board members has referred to such a delay as “inevitable.”

What does the deferral mean?

This deferral is not a surprise. Not only was it expected, but it has been an assumption baked into the planning and implementation practices among many companies that have started the transition to the new standard in earnest. In effect, a one-year delay still means “full steam ahead” for public companies, especially for those who may not have begun working on the transition process.

A quarter of the current year is now spent, and by the time the exposure draft and comment period are done, it could be half the year. Thus, the only delay is in the effective date of the standard; there should be no delay in management’s efforts to position the organization in a prudent state of readiness.

The introduction of the “early adoption” option presents an opportunity for those who have started, were focused on the new standard and now are, or will be, ready to adopt early. Also, it presents yet another choice (whether to early adopt) to the list of decisions for companies, which already includes deciding whether to adopt prospectively or retrospectively. This added choice is one with which the audit committee and the external auditor will want to be involved. In addition, analysts, regulators, lenders and other stakeholders may have an interest in the organization’s decision. The possibility of early adoption by some, but not all, also allows those who might be more cautious to learn from the triumphs and mistakes of the early adopters.

Whatever management’s take on the available options, the pressure remains on the immediate need for companies to perform diagnostic work to demystify the impact on their financial reporting. Otherwise, absent a determination of the impact of the applicability of this new standard, they risk overestimating either the simplicity or the complexity, and run the risk of doing too little, too late, or too much, too soon.

One other point: Now that early adoption will be available for those who have already moved forward with the transition under the original timeline, it will be interesting to see how companies respond when their peers early adopt.

Jim