Lyka Labs is a nugget by any yardstick and appears to be a classic example of the doctor shooting itself in the foot, as it appears to be unclear on what palliative medicines it needs to imbibe to revive its irregular heartbeat. In reality the company appears to have deliberatively chosen the wrong turn at the cross road. At some point in its tepid life the management lost the plot and since then the company is being steered firmly on the road less travelled. And if the management does not engineer a turnaround in its fortunes soon enough, the company may well be operating on borrowed time. The accumulated losses of the standalone entity as at end September 2010 was Rs 271 m, against a marginally higher Rs 289 m in the preceding year. The auditor's report has its fair share of notes on the company's working on which they are 'unable to express any opinion'. Including these qualifications the losses would be appreciably higher. Further, the objective of the management appears to be to confuse and obfuscate.
Take for example the wording of the paragraph under the heading 'operations' in the directors' report and I quote. "During the year under review the total operating income of the company was Rs 1.2 bn as against Rs 1 bn of the previous year on an annualised basis. The net profit after tax was Rs 18 m as against a loss of Rs 64 m in the previous period." There is a slight catch here please. The point is that the loss of the preceding year has not been annualised as was the case with the top-line. The loss recorded for the preceding year on an annualised basis would be Rs 43 m. The preceding year results were for an operational period of 18 months you see. By not annualising the bottom-line, the turnaround was made to look more dramatic. This error cannot be accidental.
Emphasis on bought out sales
The company as the name suggests makes and sells bulk drugs and formulations and other bits and ends connected with the industry. (It also boasts a very weak kneed subsidiary going by the name of Lyka BDR International Ltd which does the honours on the 'out of India' story). The company also outsources and then sells the very products that it manufactures and sells. Income from formulation sales accounted for 85% (94% previously) of all sales income. Not surprisingly, the company as is the norm in the pharma industry depends largely on outsourced materials to earn its living. At least this is the inference one draws from an analysis of the volume sales. It is only in the case of ointments and injectables that the company depends on in-house capacity to generate the bulk of the volume sales. However the production levels of bulk drugs, capsules, tablets, ointments and injectables still hover at abysmal levels relative to the installed capacity. This also implies quite some un-utilisation of its productive assets. But let that be.
Somehow the management just does not know how to make ends meet. The cost of manufacturing and other operational expenses eat up all the margins. This includes 'miscellaneous expenses' of Rs 52 m. What little is left of the black ink is unfortunately swallowed up by interest and depreciation charges. The result is that there is no cheer at the end of it all. Though sales have increased in the latest financial year the company has to extend large dollops of credit to generate the turnover. There are several other aspects too to its functioning, which are very revealing.
Borrowed to the hilt
The company is borrowed to the hilt relative to its ability to service the debt. Borrowings at year end amounted to Rs 789 m against Rs 652 m previously. (The borrowings include fixed deposits and inter-corporate deposits amounting to Rs 245 m). The company is unable to generate enough credit from trade and other creditors and is thus forced to finance a high level of net current assets. Its investments of the book value of Rs 202 m are a millstone round its neck and this is entirely of its own making. It has also advanced large dollops of shaky credit to group companies which are featured in the loan and advances schedule. Such loans and advances have their own vicarious story to tell. Quite naturally therefore, the only way out is to resort to more borrowings, and discounting of bills, to raise cash to meet its enhanced working capital requirements. The interest payout debited to the profit & loss account amounted to Rs 111 m against Rs 145 m previously. How the company managed to get by on a lower interest payout in a year when the borrowings were substantially larger is not known. And as a smokescreen to cover up its inefficiencies, the company resorts to revaluing its gross block at periodic intervals to present a 'picture perfect' balance sheet.
The revaluation enigma
In reality the revaluation of the gross block has a seamier side to it and is a tell all of what the company is all about. In 2007, the company revaluated its gross block for a rather asinine reason. The gross block was re-valued by Rs 362 m to arrive at its 'net replacement value'. But the catch here is that the increased value credited to reserves was used to set off irrecoverable trade debtors to the tune of Rs 342 m. So there was really very little left in the reserves schedule after this book adjustment. As a matter of fact the revaluation was resorted to purely to engineer this transaction. Book entry shenanigans or not, it also severely dented its cash flow. In 2010, the company again resorted to another bout of revaluation. (The remarkable point here is that given the manner in which this company is being run, the re-valuers actually found assets which are worth revaluing upwards).
In any event the second revaluation exercise led to another accretion in the value of tangible assets by Rs 490 m. This exercise too led to only momentary bliss. The management this time around set this reserve off against slow moving inventories, trade debtors, loans and advances and to deferred revenue expenditure to the tune of Rs 243 m. Thus the balance sum remaining on revaluation account from this second exercise is now watered down to Rs 247 m. As was with the previous exercise the cash flow took a hit to the extent of the provision. Then there is the non provision for diminution in the book value of the cost of investments - all in group companies. What is more, balances relating to trade debtors, trade creditors, and loans and advances are pending confirmation from the respective parties. This is a cardinal requirement in any audit.
Just does not add up
This is all adding up to incredulous nonsense. In a space of four calendar years the company has had to make provisions for overdue trade debtors twice over. Does not this company exercise any due diligence before it registers credit sales? It has been in business for 35 years and still appears to be on an unlearning curve in the very basics of conducting business. Quite some amounts are also sold to its subsidiary which then exports the products across the seven seas. There are bad debts on this count too. The provision for doubtful advances can also be traced to the doorstep of the group companies. The advances include a deposit of Rs 50 m placed with the managing director as deposit for a residential accommodation taken on leave and license which has been given by the company to him in accordance with the terms of his appointment.
Is one to understand from this transaction that the company has leased a house from its own CEO and then placed a deposit for it with him? In which event the promoters are helping to suck the company dry. In this unfolding 'tamasha' the auditors are playing it safe by merely stating that they have no opinion to offer as regards the accounting treatment of setting off of certain expenses, doubtful receivables and advances, and non provision for diminution of value of investments - in their report to the shareholders. How can this be? The auditors quite definitely know more about the company's innards than meets the eye. They should definitely have an opinion in the matter and state it upfront. Why then have the accounts audited at all?
The group companies
This brings us to the group companies - including its subsidiary, Lyka BDR International, which is in association with its joint venture partner BDR Pharma International. It also has two associate companies, Lyka Exports and Lyka Securities and Investments. (It makes do with two companies for the purpose of exports). Lyka BDR like the parent is also oscillating in a black hole and is a mirror image of parent in every aspect of its functioning. It is heavily geared, has bountiful revaluation reserves, boasts of auditor's qualifications, and has to give large dollops of credit to affect sales. Is BDR Pharma also contributing to the mess?
This company too is barely breaking even, and the accumulated losses at year end were an impressive Rs 163 m. It merely outsources myriad pharma items, including from the parent and then exports the wares to emerging markets. The list of companies that it exports to is impressive but given the overall turnover of Rs 474 m, the sales generated per country cannot really amount to anything of note. For the 18 month period ended September 2009 it reported a loss before tax, but it was able to report a bottom-line in black ink for the 12 months ended September 2010 with the a little bit of magic mantra. In the latter year it was able to book 'other operational income' of Rs 5.3 m (Rs 1.7 m previously).There is no separate schedule explaining this source of income. But for this manna from heaven, the results of the latter year would have also been splashed in red ink.
No fixed assets worth its name
This company by virtue of its operations has no fixed assets worth its name, but it has still engineered a revaluation of its gross block through its intangible assets. This revaluation has been facilitated through a bizarre creation called 'Registration Rights'. The Registration Rights after revaluation amounts to Rs 698 m, and accounts for a humungous 98% of its gross block. It has registration rights in various markets. It currently boasts 591 registered products and intends to add another 200 products in the markets. The gross revaluation reserve totes up to Rs 200 m of which Rs 67 m was reduced to set off other expenses. The other expenses so set off include a claim from the parent for Rs 26 m and trade debtors' dues gone sour to the extent of Rs 28 m. Now this is getting to be truly nuts! The directors' in their report to the shareholders state that it has not been able to reach its stated potential due to factors beyond its control, but it expects to grow the turnover by 30% in the current year. This in turn will lead to improved bottom-lines the report adds!
Its equity investment of Rs 55 m in its associate Lyka Exports is also on shaky grounds, or put differently it is in the 'sub-prime' category. But the parent has not made any provision for the diminution in the value of this investment. No details are proffered on why this company too like the subsidiary is an underperformer. But its performance is well in keeping with the happenings in other companies within the group.
Companies like this should be avoided like the plague.
Disclosure: I do not hold any shares in this company, either directly, or under any non discretionary portfolio management scheme
This column Cool Hand Luke is written by Luke Verghese. Luke has been a business journalist, financial analyst and knowledge management head with a professional experience of more than 20 years. An avid watcher of the stock market, he has written extensively on stock market trends. His articles have featured in Business Standard, Financial Express and Fortune India amongst others. He has also been the Deputy Editor, Fortune India and the Financial Editor of The Business and Political Observer.