Rs. 1300 Crore Write-Off: Stakeholders Taken for a Ride

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While analyzing a company engaged in a pharmaceuticals industry, we came across some important points concerning some notable issues on quality of earnings and corporate governance. The below note explains our findings on the same.

About the Company and Transaction:

The company is engaged in manufacturing and marketing of pharmaceuticals products. In recent past, on 29th June 2014 the company had completed slump sale transaction of its “branded domestic formulation business in India and Nepal” for Rs.20,040 million. According to company and as stated in their 2014 Annual Report, the proceeds of sale and transfer were primarily utilized to repay financial obligations to banks/Institutions.

Exceptional item note in 2014 Annual Report details the transaction and its accounting as follows:

Particulars INR Million
Purchase Consideration 20,040
Working Capital Adjustments (422)
Net Purchase Consideration 19,618
Slump sale advisory expense (275)
Tax (2,000)
Net Consideration after taxes 17,343
Loss on sale of advances (10,316)
Sundry debtors written off (3,227)
Exchange Loss (88)
Net Exceptional Profit 3,713

Note: Company follows year ending date as June 30. It can also be seen that this transaction was completed in June 2014 Quarter and the above note pertains to the said quarter.

The above observations made it important to have a detailed look into following heads;

  1. Loans & Advances
  2. Trade Receivables
  3. Debt
  4. Cash & Cash Equivalents

These have been analyzed in detail below.

Loan & Advances

(INR Million)
Particulars June 30, 2013 June 30, 2014 Change
Loans and Advances to related parties 112 797 685
Trade Advances 2,568 441 (2,127)
Others 3,756 1,898 (1,858)
Advances to sundry creditors 733 174 (559)
Total 7,169 3,310  (3,859)

We were able to trace reduction in Loans & Advances to the extent of Rs.3,859 million as against Rs. 10,316 million write off reported by company in exceptional item. It is also important to note that the above working is based on year end balances. Thus does not consider any advances made during the year/June 2014 quarter and then written off during the June 2014 quarter.

Question to ponder- Is it possible that the company made some advances and wrote off in the very same quarter?

Trade Receivables:

Particulars June 30, 2014 June 30, 2014 Change
Total trade receivables 3,981 1,657 (2,324)

We can observe reduction in trade receivables to the extent of Rs.2,324 million as against Rs.3,227 million Sundry Debtors write off reported by company in exceptional item. However, the note compares year end balances and thus debtors arising on account of sales made during the year/June 2014 quarter and then written off during the June 2014 quarter would not be reflected here.

Question to ponder – Is it possible that the company recorded some sales and wrote off the debtors in the very same quarter?

Debt:

Particulars June 30, 2013 June 30, 2014 Change
Short term borrowings 4,435 2,647 (1,788)
Current maturities of LT debt, unpaid mature debentures, temporary overdraft & Interest accrued & due. 2,333 1,931 (402)
Unpaid mature deposits and accrued interest 111 111
Fixed Deposits 1,677 1,323 (354)
Other long term borrowings 5,363 3,566 (1797)
Total Debt (ST +LT) 13,808 9,578  (4,230)

Cash Balance:

Particulars June 30, 2014 June 30, 2014 Change
Cash and Cash Equivalents 1,173 5,593 4,420

Thus, we can observe that against Rs.17,343 million post tax receipts from the slump sale transaction, Rs.4,230 million was used for debt repayment and there was increase in cash & cash equivalent to the extent of Rs.4,420 million. We were not able to understand other such broad heads where the allocation of remaining Rs.8,693 million would have been made.

To understand this in detail we looked into the Cash Flow Statement of the company. We found that the transaction was done on net basis and the slump sale amount of Rs.19,618 million or say Rs.17,343 million post-tax never came into CFS.  The company reported net cash inflow of Rs.3,713 million in operating cash flows.

Questionnaire to Management:

Since we were not able to exactly understand the whole transaction in terms of its accounting and also the flow & usage of cash pertaining to this slump sale, we had written to the company in 1st week of August this year asking for further clarity on the above. Despite several follow-ups thereafter (on email/phone), we have not received any response from the company in question as yet.

Also noteworthy here are auditor’s comments/qualifications from the AR 2014 with respect to the above mentioned transactions:

  1. Writing off Trade Advances and Other Advances: Company has written off trade advances amounting to Rs.1,762 million and other advances of Rs.8,553 million, made to various parties on current account either during the year or in earlier financial years. The reasons for writing off, details to ascertain financial capability of these parties and confirmation/details of these accounts were not made available to Auditor.
  1. Trade Receivables : Company has written off during the year trade receivables aggregating to Rs.3,227 million since the same has not been acquired by Acquirer of Slump Sale. The company has stated that trade receivables pertaining to products transferred to Acquirer cannot be recovered. The Auditors have neither been provided confirmation to verify the balance of such accounts nor actions initiated by the company for recovery of such trade receivables.
  2. Balance Confirmations: Balances under trade receivables, Inter-division balances, loans & advances in several cases as also in case of a few bank accounts have not been reconciled / confirmed and consequently reconciliation / adjustments, if any, required upon such confirmation are not ascertainable.

Some other observations from the annual report for the year ending June 30, 2014:

  1. The company is irregular in repayment of principal and payment of interest on Deposits and has defaulted therein. The Company has made application to the Company Law Board for the extension of time in repayment of deposits and approval is yet to be received. As at 30th June 2014 the fixed deposits outstanding under the public deposit schemes were Rs.1,434 million.
  2. Seven out of Twelve Directors have resigned in the calendar year 2014.
Conclusion:

In absence of details/disclosures/clarity from company management available, one can’t get satisfactory understanding of:

  1. Where and how slump sale proceeds have been utilized?
  2. Will the minority shareholders be able to get their hands on the slump sale proceeds?
  3. Will the lenders/depositors get their outstanding dues paid from such proceeds?

 

Notes:

  1. The amounts have been rounded off to nearest whole number in Millions.
  2. Company followed year ending March 31 up to 2012, however the same was changed to June 30 from 2013 onwards.

We have compared June 30, 2014 numbers with June 30, 2013 numbers considering that the detailed income statement and balance sheet is not available in interim results.

Statutory Details:-

Multi-Act Equity Consultancy Private Limited 

(SEBI Registered Portfolio ManagerRegistration No. INP000002965)

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