On Wednesday, December 1, WeWork Inc. [WE] announced they discovered a material weakness in their internal controls and would restate their financial statements to reflect the correct classification of redeemable shares. The company’s share price fell by 5.2% in after-hours trading on the news of the restatement and material weakness.
While all financial restatements should be taken seriously, there are a few reasons the dramatic reaction might be overstated.
The restatement had been disclosed two weeks earlier
WeWork first disclosed the accounting error on November 15. The initial disclosure, as seen below, had no impact on WeWork’s share price.
“Revision to Previously Reported Financial Statements
In preparation of the Company’s unaudited condensed consolidated financial statements as of and for quarterly period ended September 30, 2021, the Company concluded it should revise its financial statements to classify all Class A common stock subject to possible redemption in temporary equity. In accordance with the SEC and its staff’s guidance on redeemable equity instruments, ASC 480, paragraph 10-S99, redemption provisions not solely within the control of the Company require common stock subject to redemption to be classified outside of permanent equity. The Company had previously classified a portion of its Class A common stock in permanent equity, or total stockholders’ equity. Although the Company did not specify a maximum redemption threshold, its charter currently provides that the Company will not redeem its public shares in an amount that would cause its net tangible assets to be less than $5,000,001. Previously the Company did not consider redeemable stock classified as temporary equity as part of net tangible assets. Effective with these financial statements, the Company revised this interpretation to include temporary equity in net intangible assets. Accordingly, effective with this filing, the Company presents all redeemable Class A common stock as temporary equity and recognizes accretion from the initial book value to redemption value at the time of its Initial Public Offering (including exercise of the over-allotment option) and in accordance with ASC 480. The change in the carrying value of the redeemable shares of Class A common stock at the Initial Public Offering and over-allotment resulted in a decrease of approximately $5.1 million in additional paid-in capital and an increase of approximately $20.9 million to accumulated deficit, as well as a reclassification of 2,597,621 shares of Class A common stock from permanent equity to temporary equity. The Company will present this revision in a prospective manner in all future filings. Under this approach, the previously issued financial statement included as an exhibit to the Company’s Form 8-K filed with the SEC on August 13, 2020, and Form 10-Qs will not be amended, but historical amounts presented in the current and future filings will be recast to be consistent with the current presentation.
The impact of the revision to the balance sheet as of December 31, 2020, and the unaudited condensed consolidated balance sheets as of September 30, 2020, March 31, 2021, and June 30, 2021, is a reclassification of $33.9 million, $30.4 million, $39.5 million and $50.7 million, respectively, from total stockholders’ equity to Class A common stock subject to possible redemption. There is no impact to the reported amounts for total assets, total liabilities, cash flows or net income (loss). In connection with the change in presentation for the Class A common stock subject to possible redemption, the Company has revised its earnings per share calculation to allocate income and losses shared pro rata between the two classes of shares. This presentation contemplates a Business Combination as the most likely outcome, in which case, both classes of shares share pro rata in the income and losses of the Company.”
The restatement was initially disclosed as a revision or “little r” restatement rather than as a reissuance or “Big R” restatement. These restatement methods can usually be distinguished in two ways.
Reissuance restatements are seen as more serious. The use of a Form 8-K, Item 4.02 is required for the correction of material errors and the reissuance process is more costly.
As Nicola White of Bloomberg Tax pointed out, “most audit firms considered the errors small enough to be fixable with a revision.” But, as the article states, the SEC clarified that they expected these restatements to be corrected with a Form 8-K, Item 4.02.
So, the initial use of the revision method – which resulted in no market reaction – was widely accepted among reporting professionals. It was only when the reissuance notification was released that the market cared about the error.
Most SPACs are disclosing the same restatement
Another interesting aspect of the market reaction to the WeWork restatement is that there has been little reaction to other companies issuing the same restatement. Since November 1, over 250 other companies have disclosed the same redeemable share reclassification restatement through the reissuance process. However, WeWork, which had a failed IPO two years ago, was the only company to see a harsh market reaction to the news.
The restatement impacts BowX not WeWork
Most importantly, WeWork – the company that owns and rents office space – did not restate their financial statements. WeWork – the shell company that changed its name from BowX Acquisition Corp. – did. This is a confusing and complicated aspect of corporate reporting when mergers and acquisitions occur, particularly for special purpose acquisition companies (SPACs).
To find the financial statements of the operating WeWork company, one would have to look at the exhibit 99.3 in the amended Form 8-K issued on November 15, 2021. These financial statements show that the operating WeWork company accounted for their redeemable shares correctly as a noncontrolling interest in the mezzanine section of the balance sheet.
It was the shell WeWork company that misclassified their separate redeemable shares as permanent equity.
The reason for the two sets of financial statements is because the acquisition was not completed before the September 30th period end. This means BowX – which changed its name to WeWork on October 20th – was required to issue their financial statements as the SEC registrant for the period ending September 30th. These financial statements included a note about the operating WeWork company acquisition as a subsequent event.
Going forward, we should expect to see the reissuance of BowX’s FY 2020 10-K, and Q1, Q2, and Q3 2021 10-Qs. These will include the restatement and material weakness disclosures.
But don’t expect to see these disclosures in the next 10-K (FY 2021), as the new combined WeWork will issue financial statements for the combined WeWork company and the misclassified redeemable share will no longer exist. However, WeWork included a risk factor in their November 10th registration statement that warned a material weakness may exist in internal controls due to the company’s growth.
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