The other shoe drops

It took Reebok India five years to wake up to financial irregularities of nearly ₹900 crore. What happens now?

He’s the quintessential salesman who will do “almost anything” to close a deal. Friends and rivals alike describe Subhinder Singh Prem as determined and a go-getter. The 43-year-old former managing director of Adidas India is known for following his pursuits passionately, be it working out or running a business. From the time he joined Reebok India in 1995 as a footwear manager, Prem was a regular at the company’s fitness centre, reaching there at least an hour before work started.

The workouts continued as he climbed up the ranks to become managing director of Reebok India in 2003 and last year, Adidas India after the two companies integrated operations in India. Meanwhile, he was also acting as a de facto entrepreneur: a couple of years ago, Prem told Outlook Business how Reebok India gave him the opportunity to run the business as his own. “Within the ambit of global norms, we have full liberty to make things work here without awaiting approval from headquarters,” he said.

Those words are probably haunting him now. In March 2012, Adidas India curtly announced that Prem and Vishnu Bhagat, the company’s chief operating officer, were leaving with immediate effect and were being replaced with people from the parent company. Less than two months later, on May 21, Reebok India filed a First Information Report (FIR) accusing the two of commercial irregularities that had cost the company over Rs.870 crore.

Overall, the FIR charges Prem and Bhagat on several counts  — theft of stock and moving them to their own warehouses, generating fictitious sales, working in a suspicious manner with franchisees, inflating sales figures and maintaining parallel books of accounts (see: How it was done). While Prem refused to comment for this story, Bhagat did not respond to calls and messages on his mobile. As things stand, the anticipatory bail plea of the duo has been denied and the case has been referred to the Serious Frauds Investigation Office (SFIO). Meanwhile, Prem has filed a countersuit against Reebok India, citing defamation and abrupt termination of services, and is demanding Rs.15 crore as compensation. 

Clearly, it is going to be years before this issue is settled. But just how deep is the rot at Reebok India? Such “irregularities” in a conglomerate that clocks a combined turnover of over Rs.1,000 crore in India could not have been possible without the collusion of almost all stakeholders, from company management and franchisees to suppliers and auditors. The FIR says Reebok India will need to incur a restructuring cost of Rs.487 crore to “remedy the consequences of the criminal conspiracy” on its business. For Reebok India, the other shoe has already dropped.

The man in the middle

Prem joined Reebok some four years after B-school and stints with Ranbaxy and the infamous Mesco. At Reebok, the “lanky, cocky guy” met Bhagat, who moved from Ernst & Young in 1996. The duo rose almost simultaneously within the system: in just over seven years, Bhagat went from finance manager to CFO, and then to COO in mid-2009. Around the same time, Prem became managing director, first of Reebok and then of Adidas. “The company was run like their fiefdom and they were bosom buddies. They took all the decisions without asking for approval from anyone,” says a Reebok insider.

Prem’s success did not go unnoticed and in 2008, his alma mater, IMT, Ghaziabad, conferred a distinguished alumnus award on him. Rajeev Karwal, founder of Milagrow Business and Knowledge Solutions, who graduated from the same institute in 1984, remembers Prem from various IMT and retail industry events. “He was always very ambitious,” he recalls, saying he was impressed with Prem’s multi-faceted personality. “In an environment that had executives in expensive suits, Prem was the casually dressed maverick. He would crack a joke or even start humming right in the middle of a serious discussion,” he says. 

To several people, there was always something odd about Prem and Reebok’s brass. A former official of the Royal Challengers of Bangalore (RCB), who was closely involved in discussing sponsorship details with Reebok during the first edition of Indian Premier League (IPL) in 2008, remembers the company lavishly doling out freebies like expensive shoes and apparel. “Even the sponsorship deal with RCB was concluded over a couple of drinks with the guys at Reebok agreeing to whatever we asked for,” he says. Some of those excesses now seem to be showing up in Reebok’s books. 

What really happened

In August 2005, Adidas acquired Reebok globally, although the integration of the Indian operations did not happen until last year. In those six years, Reebok went on a retail overdrive, growing from 200 stores in 2005 to over 1,000 in 2011. Competitors were left staring — and with good reason. “Reebok, at one point, had five stores on Mumbai’s Linking Road [a prominent shopping area]. We were stunned, since real estate prices were soaring and there was not that much business anyway,” recalls a rival. In stark contrast, both Puma and Nike had about 200 stores. It was only when Reebok filed the FIR that the real picture about the franchisee overdrive emerged.

According to the FIR, Prem and Bhagat started a franchisee referral program that involved collecting money on the pretext of opening stores. “The said program was started despite instructions in October 2010 from the Adidas group headquarters not to expand the store base further,” it says. A sum of Rs.114.26 crore was collected from various interested parties, although no stores were opened. Reebok is currently paying interest on that money and now needs to repay the entire sum. 

There’s more. Allegedly, Prem and Bhagat created fictitious sales that would boost their sales figures and then diverted the stock to four secret warehouses in New Delhi. “Such fictitious sales were secretly diverted to the warehouses under the instructions of Singh and Prem, which tantamounts to theft of such products. On December 31, 2011, the complainant, Reebok India, had about Rs.147 crore in products invoiced but not yet delivered to customers,” states the FIR. Customer returns over the years have not been accounted for, either. That’s another Rs.62.99 crore (see: It all adds up now). 

But what is really likely to send the retail trade into a tizzy is the increasing talk that the market is flooded with fake Reeboks Prem and Bhagat manufactured. Prem and Bhagat apparently entered into agreements with suppliers to manufacture Reebok-branded shoes that would look like the original, but at less than half the cost. Manufacturing costs account for, at most, 20% of the retail price in sports footwear.

That meant, at the lower end, a pair that sold in the stores for Rs.1,000 would have cost Reebok India about Rs.200; what came from the clandestine operation cost even less, just Rs.100. But both were selling through legitimate outlets at the same price. And to ensure there was enough offtake of the counterfeit shoes, every store was fed stock far in excess of what was required (called ‘channel stuffing’ in tradespeak). Through the FIR, Reebok India has charged Prem and Bhagat with inflating sales figures to get the maximum bonus, increment and incentives.

Warning signs

The skeletons are now bursting out of the closet. A former associate, who has worked with Reebok on several marketing and advertising-related transactions, says insiders warned him at least two months before the FIR was filed to not negotiate fresh deals. “Several people in the company seemed to know something was very wrong, which struck me as odd,” he says.

In February 2009, ratings agency ICRA sent out an innocuous-sounding press release on Reebok India. It referred to the company’s Rs.300 crore bank limit and gave high credit ratings in both the short and long term. Reebok India’s financials were mentioned almost as an aside. For the first nine months of 2008 (the company uses the calendar year for its financial results), it had a turnover of Rs.406 crore — but net profit was just Rs.17 lakh.

The statement did say that ICRA had “taken note of the company’s high working capital intensity and relatively high gearing levels”. But if those numbers were a red flag, why was a high-quality rating being given? “The rating given out in 2008 was based on the unconditional and irrevocable guarantee from Reebok’s parent, Adidas,” says Anjan Ghosh, group head of corporate ratings, Icra. Exactly three years later, ICRA suspended the ratings assigned to Reebok India. According to Ghosh, there was not much cooperation from the company. “The required information was not provided to us by Reebok,” he explains.

Certainly, the numbers in the past couple of years have not been looking good at all. Peek at Reebok India’s balance sheets for 2009 and 2010 and you will see that sundry debtors in 2009 stood at Rs.323.18 crore. The following year, the same number had been restated as Rs.636 crore (nearly double the original figure), while sundry debtors for 2011 stood at Rs.699 crore.

No reason is given for this significant restatement, although it is clear that the receivables situation was getting out of hand with receivables at nearly 90% of annual sales. The pressure on finances was visible. In 2010, the company recorded a loss of Rs.40.11 crore on a turnover of Rs.783 crore, a huge fall from the previous year when it had a net profit of Rs.12.75 crore on a turnover of Rs.772 crore. 

A suspicious parent

Prem’s control over Reebok was challenged once the integration with Adidas began. A senior official at a rival footwear brand says that one of the first big changes was that Adidas India officials began signing off on most transactions involving Reebok. “This was unnerving for Prem,” he adds. 

Then, a former Reebok executive points out that Adidas made it clear that it would be bringing in its own people. “That was bad news for Prem and he resisted all change,” says the executive who has now switched industries. Still, the beginning of the integration of Adidas and Reebok seemed smooth enough. Prem took over as managing director of the new, merged entity in May last year — India was perhaps the only country where someone from outside the Adidas universe was at the helm.

But slowly, things started changing. The finance portfolio was taken from Bhagat and given to Shahin Padath, who was brought in from Adidas Dubai as finance director last April. In January 2012, Frederic Serrant, who was earlier sales director for Adidas in France, moved in. In 2011, Adidas hired Control Risks, a global company that helps organisations manage political, integrity and security risks, to check out the Indian operations. Media reports say KPMG’s forensics investigation team was also hired as far back as 2010 to look into the suspected fraudulent activities of Prem and Bhagat.

The exercise involved scanning emails and having detailed probing sessions with the duo. A month after Prem was chosen to head Adidas India, KPMG’s report gave him and Bhagat a clean chit. It is learnt that Adidas, however, did not slow down its investigation process and continued to gather information on alleged wrongdoings. When contacted, Control Risks’ spokesperson in Singapore said the company does not discuss clients. KPMG’s spokesperson in India, too, said the firm does not comment on company-specific information.

Now, the parent has trying to restore order at Reebok India. A company insider says there is a complete freeze on big spends, with the only exception being this year’s Indian Premier League. “But even that was on the lower side. Key divisions like warehouse management and sourcing have been taken over by people from Adidas,” he adds.

There has been an impact on stocks, too, with outlets in select cities facing a crunch. A sales clerk at a Reebok outlet in Chennai admits supply has slowed down considerably but believes the situation will correct over the next few weeks. Meanwhile, Adidas has announced that it will shut down a third of all Reebok stores in India as part of Adidas’ Route 2015; it will also take a closer look at the existing franchisee model. 

Whither governance?

If Adidas was so suspicious of the happenings at Reebok India, why didn’t it take action earlier? While the charges against Prem are certainly serious, for its part, Reebok appears to have been a pretty loosely run organisation compared with most multinational subsidiaries in India. Prem’s own remarks to Outlook Business aside, the company had a separate auditor although it is accepted practice among multinational companies to retain the same audit firm for all operations.

“The reasons relate to cost synergies across the globe; a common understanding of accounting and audit practices; and avoiding any inter-firm misunderstanding when it comes to consolidating global accounts for the parent company,” explains Ranjit Shahani, vice-chairman and managing director, Novartis India. 

Even other footwear companies in India accept stringent controls over their operations. Consider Puma India, a direct competitor. Managing director Rajiv Mehta concedes his operation enjoys freedom, but within a certain framework. “We report figures at every monthly closing and this is followed by conference calls. There is no compromise on any of this,” he explains.

Issues relating to suppliers and auditors are far more stringent. According to Mehta, suppliers are appointed by the parent company and any agency whose payment exceeds €1,000 per month is vetted by Puma SE. “We can merely offer suggestions. They appoint the internal and external auditors as well,” he adds.

At Reebok, the role of the auditor has come under the scanner: although KPMG is the footwear company’s auditor across the world, in India, a little-known Delhi-based auditing firm, N Narasimhan & Co, has been signing off the balance sheets since 2007; it is not known whether the firm has been retained by Adidas India after recent developments. In response to a detailed questionnaire from Outlook Business, the Adidas Group merely said, “We cannot provide any further details since the matter now rests with the Indian law enforcement authorities.”

A tortuous search through the website of the Institute of Chartered Accountants of India (ICAI) reveals that N Narasimhan, the eponymous owner of the firm, qualified as an associate of the institute in 1981 and became a fellow in 1986. In the auditors’ report for 2009, the firm has said Reebok India’s “balance sheet, P&L account and the cash flow statement are in agreement with the books of accounts and the company has maintained proper records of inventory.”

Even the board meeting for the following financial year recommended the appointment of the same audit firm, which was accepted. Narasimhan, when contacted, did not respond to an email and his office said he was on leave. What is even more intriguing is that BSR & Co, an affiliate of KPMG in India, did not want to be reappointed as Adidas India’s statutory auditors in FY06. No reason has been specified in the directors’ report for that year. At the Annual General Meeting held in June 2007, Adidas India appointed N Narasimhan & Co as its auditors; this meant both Adidas and Reebok had the same auditor. This was at a time when KPMG was Adidas’ auditor globally, which holds true even today.

ICAI is now independently investigating Narasimhan. “We have sent letters to Reebok India and the auditors asking for information and seeking the right facts,” says ICAI president Jaydeep Shah. “If it is a deep-rooted fraud, there is a good chance the auditor may not be aware of what has taken place.” 

Meanwhile, what about Prem? He has spoken with the media selectively, insisting he is a scapegoat for the German company’s larger, sinister motives. Currently, at least, there aren’t too many takers for that view. The shoe does not fit.