Introduction

Today's Business Page reviews the annual report and accounts of J.P. Santos & Company Limited (JPS) for the year ended December 31, 2003. The report, austere both in appearance and content, is characteristic of the lean and unostentatious style which has been a hallmark of its well-run and some would say almost reclusive parent - John Fernandes Limited, one of the oldest surviving businesses in Guyana. It presents the consolidated financial statements of the company and Bryden & Fernandes, its subsidiary in which it has 51% shareholding but whose business activities cannot be deduced from a review of the report.

The Directors' Report, except for a section on proposed capital expenditure continues in the tradition of many other public companies in Guyana barely providing the minimum that is statutorily required even though the trend in properly regulated and functioning capital markets is for more not less information.

Profitability

During the eighties and nineties the company almost went out of business because of the rampant smuggling and pavement vending, both of which created an unfair competitive environment and which had eroded its share of the retail market. The company was on the brink of liquidation and was advised to consider financial restructuring and the introduction of new capital. Chris Fernandes, Chairman of John Fernandes readily saw the synergies that could be achieved with the adjacent business with its strong but underperforming asset base and took up the challenge buying control of the company.

It has been a success story since with continuing gains in each year. The financial statements report a 32% increase in revenue excluding other income (rental, interest, dividend and miscellaneous income), while the group's revenues increased by 25%. The Company cut its 2002 operating loss of $6.5Mn.by 93% to $441k.while the Group had a 36% increase in its operating profit. However the company's operating losses may be distorted as a consequence of the significant volume of inter-company transactions which will be dealt with later.

This improvement is achieved solely through revenue growth because operating costs of the company and the group increased by 23% and 31% respectively. Before-tax profit for both company and group showed a 19% improvement over 2002 boosted by other income of $69Mn.and $57Mn.respectively and the returns on equity and assets are a healthy 15% and 19% respectively. The company has no long-term debt, assets of $390Mn and shareholders' equity of $301Mn.

The taxable profit would in fact have been much higher but for a management fee of $30Mn. (4.69% of turnover from retail activities) paid to Bounty Farm, a subsidiary of the parent.

The accounts suggest however that the fee covers staffing but one has to wonder about the structure of the management fee when the company is making a loss on its core retail operations. While the average overdraft is $20+ million dollars, interest paid is less than half a million dollars, suggesting that the overdraft may be a year-end phenomenon.

Earnings per share have increased significantly from $2.32 in 2002 to $3.26 in 2003. However in what is both confusing and unfortunate, the motion to be put to the shareholders is for a dividend of $1.00 per share while the accounts show a dividend of $2.00 per share, each of which has a book value of $16. The payout of $2.00 per share represents 61% of the profits available for the year, compared with 23% in the preceding year.

The subsidiary which has made post-tax profits of $40Mn. proposes to pay no dividends.

Taxation

According to the tax note to the financial statements, the applicable tax rate for the year is 45% which on a pre-tax profit of $68.7Mn.would be equivalent to approximately $31Mn. Yet, the corporation tax charge is shown at $13.9Mn. which is even less than 2% of turnover, the minimum corporation tax the company should pay. In fact, the net tax charge after taking account of prior -year adjustment and deferred tax is $6.6Mn.which is an effective rate of less than 10%. One can speculate that this may be partly explained by the utilization of tax losses from earlier years although this is not apparent from a review of the financial statements.

By comparison, the subsidiary which made pre-tax profits of $38Mn. has an effective tax charge equivalent to 44%.

Balance Sheet

The balance sheet of the company is much stronger than that of the subsidiary with the former having a ratio of current assets over current liabilities of 2.19:1 while in the case of the subsidiary the ratio is 0.56:1. While JPS has just about fifteen days worth of inventory in stock, the subsidiary has well in excess of three months but appears to have made no provision for obsolescence. Similarly, while JPS has a net worth of $301Mn. and total liabilities of $94Mn., the subsidiary has net worth of $23Mn. and total liabilities of $193Mn!

Related Party Transactions

John Fernandes Limited owns in excess of 90% of the shares of JPS and the parent company or its shareholders have a controlling interest in Bounty Farm Limited to whom J.P. Santos paid management fees of $30,000,000 in 2003. JPS also made purchases valued at $265Mn.in 2003 from Bounty Farm Limited while loaning it $71m.(2002 - $2Mn). JPS is also shown as having advanced Bryden & Fernandes Limited some $20Mn. during the year to bring the total owed by the subsidiary to JPS to $70Mn. In neither case are the terms of repayment of these advances disclosed in the financial statements although the notes indicate that interest of $3m.was charged for the year - clearly at subsidised rates. The disclosure requirement for related party transactions includes pricing policy but this is not stated.

The inadequate disclosures in the financial statements do not allow the reader to make an informed determination, but unless the interest charged on the loan to Bounty Farm exceeds the interest charged on the company's secured overdraft of $45Mn, then minority shareholders have good reason to question whether this "investment" is in their interest if the overdraft situation persists. Neither the assets pledged as security nor the interest rate are disclosed as required by International Financial Reporting Standards (IFRS). The same holds true for the company's $70Mn.investment in its subsidiary Bryden & Fernandes Inc, a company, which based on the financial statements is valued at G$1Mn. and which itself is running an overdraft of $89Mn.

Neither the Directors' Report nor the accounts provides any insight into the operations of Bryden & Fernandes and it is therefore not possible to determine the rationale for such a sizable investment. Similar absence of disclosure, except for the amount of income received, also surrounds the company's lease of its investment properties with its parent John Fernandes Limited and again the reader is unable to assess the benefits or otherwise of the arrangements.

Statutory Compliance

The absence of a reconciliation of the effective tax rate; information on general and other reserves; details of lease arrangements with all parties; statement as to number of employees; information on investment properties; segment information, the date of and authority for approval of the financial statements are among the omissions that render the financial statements non-compliant with International Financial Reporting Standards contrary to the assertion in the audit report.

It should also be worth noting the notice of the Annual General Meeting is undated and the AGM should have been held by June 30, 2004 failing which special permission has to be obtained from the Registrar of Companies. There is nothing in the Directors' Report to suggest that this has been done. This omission is not only surprising after the recent publicity surrounding this issue but in effect renders the meeting unlawful.

Conclusion

All of the company's directors are non-executive though several are connected with the parent company. The directors include Mr. Winston Tyrrel, a well-known advocate of shareholders' rights who is also a director of another public company and who recently criticized DDL for short-changing shareholders and Mr. Chris Fernandes who is also a director of Banks DIH, a major public company. One would have therefore expected more transparency in the financial statements disclosure rather than the private-company approach to its transactions with related entities.