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BW Businessworld

The Fall Guys

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On 2 May, employees of Reebok's India headquarters in Gurgaon, near New Delhi, were in for a surprise as they found themselves being quizzed by a team of income tax (IT) sleuths. The IT investigation, which went on late into the night, was the second shock for them that week as Reebok's parent entity — German sports maker Adidas Group — had announced the discovery of commercial irregularities in Reebok India just two days earlier.

Adidas's announcement of a possible restatement of Reebok India's account books was the reason for the IT raid too, as Reebok India had been showing growth and profits until 2010, the year in which the company announced a sudden plunge into losses.

While the company had registered a profit of Rs 12.8 crore in 2009 on total revenue of Rs 775.9 crore, it made a loss of Rs 40.1 crore the next year despite improving its annual earnings marginally to Rs 786 crore.  Further, the company had recorded a 525 per cent increase in its provision for doubtful debts. Its inventory stocking was 83 per cent higher. Unrealised cheques in hand in 2010 were worth Rs 29.1 crore.

The losses were seen as one of the reasons for Adidas going for a management overhaul of its India business a month ago. It saw Reebok India's long-time managing director Subhinder Singh Prem and chief operating officer Vishnu Bhagat getting replaced by Claus Heckerott, an Adidas Group nominee.

On 30 April, Adidas Group had announced that the commercial irregularities discovered at Reebok India may result in an estimated financial loss (due to restatement of the previous years' financial statements) of nearly €125 million (Rs 870 crore) and a one-time loss of €70 million (Rs 480 crore) in the current year. It also announced that it would bring about significant changes to its commercial business practices in the country.

Following the Adidas announcement, Prem filed a suit against the company, questioning his  ouster. When contacted, Prem declined to go into the details, saying that his "lawyers have advised against making any comments".

As Reebok MD, Prem had maintained that the reason for losses — increasing debts, closure of some unprofitable franchises and return of unsold stocks — were known to Adidas Group.

Today, the future of over 200 employees of Reebok India looks uncertain as the company is planning a massive restructuring of its operations. A Reebok India employee who did not wish to be identified says, "We are yet to be informed about the future plans of the management. Over a dozen of us have been asked to take one month leave. We fear retrenchment in phases." He adds, "Following the resignation of our bosses, at least half a dozen senior colleagues have either left or are in the process of leaving the organisation."

Rejig Troubles

It is not just the employees who are facing an uncertain future. Over 600 Adidas franchises all over the country are also troubled by the company's decision to review the existing business model. "Currently we follow a minimum guarantee model. We have the right to retain up to a particular amount of sales revenues irrespective of the volume of business. The extra revenues, if any, are settled on an annual basis," says Vikas Gupta, a Delhi-based franchise owner and Reebok distributor.

According to Gupta, there has been no official communication about any change in the business model. But specualtion is rife that Adidas, which had shut down over 30 Reebok franchises last year, is planning another massive reduction. Reebok Junior stores are one such specialised franchise brand that could face closure. Over a dozen franchises may be affected.

A former Reebok employee says that the unsold stocks lying with the franchises were at times considered sold for accounting purposes, thereby increasing the top line or sales figures each year. "Revenues were increasing, but profits did not match them. That is what Adidas now calls commercial irregularity," he says.

Franchises are expecting Adidas to move from the minimum guarantee model to a cash- and-carry model that will take away the financial protection they enjoyed until now.

The internal auditor of Reebok India, N. Narasimhan & Co, had found no such "irregularity" in the books of the company. The auditor's report for the year 2010 makes no such remarks on the company's accounting practices.

Narasimhan, who signed the audit report, declined to comment. Accounting experts, however, say that the auditor cannot be held responsible for every irregularity in the company as Adidas has announced "commercial irregularity" and not financial misappropriation.

"The auditor should ensure that the company has not done anything to camouflage debts. Provision for doubtful debts need not be seen as a problem. It's just that the auditor should be satisfied with the extent of provision," says Amarjit Chopra, former president of the Institute of Chartered Accountants of India.

2006 JANUARY Adidas completes global acquisition of Reebok; Indian subsidiaries of both entities remain separate

2011 APRIL Integration of Adidas and Reebok businesses in India; Reebok India managing director Subhinder Singh Prem takes charge of the combined entity

2012 MARCH Adidas Group India managing director Subhinder Singh Prem and chief operating officer Vishnu Bhagat resign; Canadian national Claus Heckerott takes charge as new MD with immediate effect

2012 APRIL Adidas Group announces commercial irregularities at Reebok India, with estimated financial loss of Rs 1,350 crore

2012 MAY Subhinder Singh Prem sues Adidas, challenges his ouster

Meanwhile, Adidas, which has initiated an investigation into the financial and commercial dealings of Reebok India, said that it will not disclose specific details considering the sensitivity of the probe. "As these irregularities have been deemed to have occurred prior to the 2012 financial year, the Adidas Group might have to restate prior-year consolidated financial statements in line with the requirements of IAS 8 (accounting standard)...Management assures its stakeholders that it has, and will continue to, vigorously pursue a course of action to protect the group's interests, which has already resulted in the appointment of a new local leadership team in India at the end of March," Adidas Group states. At the time of going to press Addidas had not responded to a detailed questionnaire sent by BW.

Even though Adidas Group had acquired Reebok globally in 2006, its Indian subsidiaries of Adidas and Reebok remained independent until 2011, with Reebok India being led by Prem. Last year, as part of an integration exercise, Prem was appointed the head of Adidas Group in India, a move that was aimed at replicating Reebok's growth story — as the country's leading sports goods brand with a national franchise network of 900 — in Adidas.

According to industry estimates, Adidas and Reebok account for nearly 70 per cent of the Rs 4,000 crore domestic sports goods market. With so much at stake,  developments at Adidas India will be closely watched.


(This story was published in Businessworld Issue Dated 21-05-2012)