Fran O'Sullivan: Bad time for Fonterra to play coy

When dairy co-operative Fonterra released its interim financial report for the six months to January 31, there was a surprising omission.

For the first time since the company's inception, New Zealand's largest exporter had issued interim financial statements without also including an independent accountant's review of the interim results.

Let's be clear, Fonterra is not required by law to get its auditor to issue a review at the six-monthly period.

It only has to issue an audit opinion of the company's full-year accounts certifying the company's financial statements present a fair and true view of its financial position at annual close-off time.

But it has always gone one step further than meeting purely legal compliance issues.

To take the 2008 interim financial statements as an example, the PricewaterhouseCoopers' review acknowledged it had reviewed the financial performance and cash flows of the group for the six months period ended November 30, 2007 and its financial position as to that date.

"Based on our review nothing has come to our attention that causes us to believe the interim financial statements do not present fairly the financial position of the group at 30 November 2007," said PWC.

Such a statement was also included by KPMG (for the first Fonterra interim report in 2002) and then PWC at the back of all the succeeding interim reports until this year's interim statements.

Fonterra's new chief financial officer, Jonathan Mason, says the omission is not a mystery.

The company hasn't fired its long-time auditor PricewaterhouseCoopers. Neither has PWC resigned the prize audit mandate due to a difference of view with Fonterra's on material issues. These are two theories that have been doing the rounds among dairy-sector observers in the absence of any explanation for the change of course.

PricewaterhouseCoopers is still very much in the audit chair.

PWC boss Warwick Hunt is no longer the lead partner on the Fonterra audit - that has been rotated internally. But Hunt remains a prime adviser. Fonterra simply isn't required to get an auditor review at this stage - so it is saving on what otherwise could loosely be termed compliance costs.

Mason says PWC is across all the major decisions the company has taken. Ratings agencies have run their ruler over the company's balance sheet and ability to pay its debt.

What's the problem?

The problem is timing and attitudes.

Why choose a time to depart from established procedures when Fonterra is sporting a balance sheet that shows the company is clearly afflicted by high indebtedness and compromised cash flows due to depressed commodity prices?

Critics such as accounting professor Alan Robb had already raised questions over the company's failure to fully restate its results after the change in its balance date last year. That change meant the six month's result to January 31 was boosted by two prime summer production periods in comparison to the previous November 30, 2007 interim figures.

Initial headline reports by New Zealand media on March 24 followed the line in the company's press statement that Fonterra's revenue was up 9.6 per cent to $8 billion.

"The higher revenue was driven by the inclusion of two high sales months due to the change in balance date, stronger contributions from Fonterra's regional consumer businesses, and the lower Kiwi dollar - offset by lower global dairy prices," said Fonterra at the time.

Most initial reports neglected the qualifying statement that adjusting for timing factors and including exchange hedging, total revenues would have been down by 7.6 per cent, reflecting the lower international dairy commodity prices.

When Robb raised the need for fuller appropriate comparisons with the NZX he got the brush-off from its legal department.

NZX boss Mark Weldon was relatively polite when the Business Herald queried whether the exchange should have asked Fonterra to make appropriate comparisons with earlier periods.

Weldon had spoken with Fonterra and accepted its rationale. Asking for a full restatement would add an unnecessary compliance burden for the company. It didn't need to do so legally - period.

After all, Weldon said, investment firm Goldman Sachs had buried its "missing month" and the United States Securities and Exchanges Commission had not required it to restate its accounts in a more transparent fashion.

For those that missed this drama, Goldman Sachs' quarter one profits were reported at US$1.81 billion ($3 billion) which Bloomberg noted were due to a "surge in trading revenue outweighing asset write-downs".

What Bloomberg initially neglected to say (note the similarity to the initial reporting on Fonterra's interim results) was that the Goldman Sachs' results were boosted when it changed its reporting period to a January-December calendar year, away from its previous reporting period in which the 2008 year ended on November 30.

This made December an orphan month as the first-quarter results were for January-March 2009. What was not immediately apparent - as it was filed separately - was that Goldman had also taken a US$1.3 billion write-off in the orphan period.

So the good news got reported and the bad news swept under the carpet just as Goldman was launching a new stock offering.

The New York Times' Floyd Norris queried: "Would the firm have had a profit if it had stuck to its old calendar, and had to include December and exclude March?"

Clearly Goldman is not directly analogous with Fonterra, but there have to be questions as to whether both companies have presented a realistic picture of their financial health.

In my view, when balance dates change during times of utmost volatility this is when a prime blue chip should seek to keep the confidence in its company high by not deviating from established patterns.

A PWC statement would have been helpful here.

It's also worth noting that Fonterra decided to go to the market this year with a retail bonds issue which drew in $800 million on the basis of annual financial statements that were already well out-of-date. It did not wait until the release of next interim statements to proceed.

As has been noted elsewhere in industry reports, Fonterra added $4 billion of liabilities to its balance sheet without reporting anything. It got an A+ credit rating from Fitch in February which noted the agency's rating took into account Fonterra's ability to reduce payout to suppliers.

But with conditions sharpening within the dairy industry, questions are being asked whether Fitch may have overlooked the fact that Fonterra's shareholders are feeling the pinch. Many of them are finding it difficult to service debt levels due to lower payouts from the co-op. It is a vicious circle.

Fonterra - with the aid of the NZX boss - is stymying valid debate on what should be the appropriate level of transparency for NZ's largest company.

When it started operations it made a decision to "over-report" by going further than mere NZX listing rules requirements to build confidence in the company.

When the going gets tough it abandons its established methods. Yet later this year Fonterra's board will launch another capital restructuring exercise.

Fonterra's job would have been made easier in the longer-term if Weldon was thinking more holistically about how to retain and grow confidence in the New Zealand stock market.