Sunday, June  5th, 2005

Introduction:

In contrast with its half-year results for 2004 that were regarded very favourably by the company and the market, Sterling Products Limited's full-year profit for the year has been met with a generous mixture of surprise and doubt. The directors of the company, a subsidiary of Secure International Finance Company Inc., part of the Beharry Group of Companies can find themselves challenged by tough questions from shareholders about the results and governance of the company when they present the company's Annual Report for the year ended December 31, 2004 at the company's 50th AGM on June 16, 2005.

The results for the second half of 2004, extrapolated from the 2004 audited financial statements, have caused much public discussion about the quality and reliability of unaudited financial statements published by public companies generally and questions about the possibility of fraud within the company. While strongly denying that any frauds took place, the company has failed to offer sufficiently convincing explanations for the sudden decline in major elements of the company's business resulting in after-tax profits for the entire year of $58Mn. being less than the $60Mn. reported for the first half!

Non-executive Chairman Dr. Leslie Chin in his report gave no indication of how the Board felt abut the results preferring to deal only with the generally favourable comparisons with full-year 2003 and completely overlooking the less than flattering performance of the second- half of 2004. A 28% increase in revenue in second half 2004 over the first half appears to have come at a great cost. Gross profit percentage, the mark-up on cost, fell from 27. 4 % to 23.7%, so that an increase in sales of $180Mn. over the first half-year produced only $19Mn more in gross profit or an even less attractive 11%.

Deceptive comparison:

But that is only part of the problem. 'Administrative and general expenses had a dramatic 60% increase in the second half of the year even though at half-year 2004 the increase over the same period in 2003 was only 5%. Because the major increases are recorded in the second half of 2004, the Chairman's comparison of full-year 2004 with 2003 masks some strange developments which might have escaped him. Had the figures for first-half 2004 held for the full year the charge for 'Administrative and general expenses would have been $70Mn.less than the $310Mn. reported in the audited financial statements, all of which would have gone to the bottom line.

Instead, those statements indicate that employment costs have increased by 100% over the year and administrative expenses which is believed to include selling and distribution costs by 50%. The company entered into a two-year agreement beginning Jan.1, 2004 with the Clerical and Commercial Workers' Union which was commended by the Chairman for negotiating in good faith. That agreement provided for across-the-board increases of 6% in 2004 and 51/2% in 2005 coupled with some adjustment to the minimum scales. Given that the increase took effect from January 1, the increase in employment costs defy logic and even the Chairman of the Audit Committee was quoted as saying that the doubling of the wage bill 'appeared ridiculous'. There is no obvious reason why the increase in Administrative expense is not similarly difficult to justify.

Beautiful but not good:

In January 2004, i.e. five months before the 2003 Annual General Meeting, there was a thorough overhaul of the Board of directors with the 'resignations' of former Chairman Mr. John Carpenter, and directors Messrs. Clarence Hughes, P.E. Fredericks and Charles Quintin. Comprising two of the younger members of the Beharry family, an employee of that group and Dr. Leslie Chin, non-executive Chairman as directors, the Board of four is one of, if not the smallest, of public companies in the region. While a small Board has some benefits it is hard to see how the usual Committees now considered necessary for good corporate governance can operate with as small a Board as Sterling's. Who for example supports Mr. Paul Cheong, Chairman of the Audit Committee whose responsibility includes looking into the issues of both internal and external auditing and financial matters?

At the management level too the company has suffered major losses over the years. Last year this column reported on the departure of two managers in 2003 following the loss of four senior managers including the Chief Executive Officer in 2002. In 2004 the company lost its Engineering Services Manager and its Finance Controller so that the incumbent is the third person to hold the Finance Controller's position in three years. Such rapid change at the most senior level of the Finance Department often signals a more serious problem and a weakening of an important function in the company.

Business Page last year questioned whether the auditors were right to state that the financial results reported by the company and reported on by Deloitte & Touche were in conformity with the Companies Act, 1991 and International Financial Reporting Standards. The company has addressed the more obvious and major concern in relation to Pension Scheme accounting and disclosure but the more common non-compliance issues with the Companies Act 1991 and IAS remain to be properly addressed.

Sharing the surplus:

Those investors who follow the financial statements on an annual basis would note a significant by favourable, prior-year adjustment of about $26Mn. before tax and $17Mn. after tax which the directors paid out in dividends. The Chairman explained in his report that the adjustment was a result of an actuarial surplus in the pension scheme for employees. Where the scheme is a contributory scheme, the company would normally have three options including the enhancement of benefits, reduction of contributions and returning the surplus to the company which assumes responsibility for any actuarial deficit. The decision to pay the surplus in additional dividends represents the option most favourable to the controlling directors since the payment was made as an interim dividend not requiring any reference to the shareholders.

Profit and loss account:

2004 2003 2002 % change

(restated) 2004/2003

G$ 'Mn G$ 'Mn G$ 'Mn

Net sales 1,456 1,283 1,097 13.48

Gross profit 369 325 319 13.54

Other income 35 21 33 66.67

Profit before tax 93 136 109 (31.62)

Taxation 35 59 60 (40.68)

Profit after tax 58 77 49 (24,68)

Dividends 61 46 46 32.61

Net sales showed an increase of 13.5% over 2003 which the Chairman attributed to expansion into export markets, increased advertising and promotion of branded products and growth in all four of its product ranges locally.

In 2002, the company reported that it was 'working assiduously' to increase regional sales, but while exports in 2004 went up by 78%, they still account for less than 3% of total sales. With Guyana's static population, the company needs to increase exports sales substantially to enhance its prospects and the small growth of exports sales must be troubling the directors and main shareholders.

Moving overseas:

After the second half developments, the gross profit margin for the year was identical at 25.3% to the preceding year so that in absolute terms gross profit increased by 13.5% from $325Mn to $369Mn. Higher productivity from the investments in a new margarine plant and increased ice cream production capacity off-set higher production costs and allowed the company to maintain the selling price for its products. Other income recorded a significant increase of 66.67% from $21Mn to $35Mn resulting primarily from the sale of drums ($7Mn.) and income from new investments ($11Mn.) The investment income arises from what are described as 'Caricom Sovereign Bonds' purchased for $149Mn. through a fellow subsidiary. The issuing countries, the terms of the investments and the currency are not stated and it is therefore impossible for the reader and shareholder to assess the level of risks associated with these investments.

Sterling now joins the growing list of mainly financial businesses which have opted to invest off-shore to take advantage of exchange rate stability, generous rates of interest offered by Governments in the region and the favourable provisions of the Caricom Double Taxation Treaty. In its selection of investment destinations, the company would no doubt have taken note of the difficulties which faced Dominica, Grenada and Belize in certain of their securities issued.

As a result of what appears to have been out of control expenditure, pre-tax profits declined sharply from $136Mn. to $93Mn. but due to available capital allowances, the company has no Corporation Tax liability for the year. The tax charge of $35Mn. is made up of Property Tax ($12Mn.) and Deferred Tax ($23Mn.)

Balance sheet

2004 2003 2002 % change

2004/2003

G$ 'Mn G$ 'Mn G$ 'Mn

Current assets 584 692 722(15.61)

Current liabilities 97 77 88 25.97

Working capital 487 615 634 (20.81)

Fixed assets 820 820 759 -

Equity 1387 1412 1,368 (1.77)

The balance sheet remains sound and despite the significant investment in securities the company holds about $100Mn. in cash which makes the overdraft balance of $24Mn. unnecessary and costly. Over the past two years inventory has increased by more than $110Mn. which in the absence of sound inventory and financial control could signal an underlying problem.

Conclusion:

The shareholders must be particularly concerned about the decline in earnings per share and the slow returns on the investment in new plant and machinery. The investment policy of the Beharry Group which owns 58% of the company's shares has been for the long haul but the drastic overhaul of the Board in 2004 must have signalled concerns about the performance of the company. It was the first year in which members of the Beharry clan represent 50% of the Board and the results and rumours surrounding their first year would no doubt jolt them out of any complacency.

Ironically, if the escalation of expenditure arose not from unusual circumstances but as the Chairman's report suggests, are the recurrent costs associated with the business, then the problems are deeper than they may appear from the audited financial statements. On the other hand, if it turns out that something might have gone amiss, then observers would consider their incredulity with the 2004 numbers and the explanations from the company quite justified.

Once again the Chairman has failed to offer shareholders any indication of the prospects for the company. It would be too early for the majority shareholders to expand the company's Board but that is not something they should ignore.