Analysis: Quick Heal Technologies Ltd

Modified: 27-Oct-20

The current section of “Analysis” series covers Quick Heal Technologies Ltd, an Indian company providing security software solutions like antivirus, antispyware, antimalware etc. to retail consumers under brand Quick Heal and to enterprise & govt. segment under brand Seqrite.

“Analysis” series is an attempt to share with all the readers, our inputs to the company analysis submitted by readers on the “Ask Your Queries” section of our website.

In order to benefit the maximum from this article, an investor should focus on the process of analysis instead of looking for good or bad aspects of the company. She should learn the interpretation of different types of data and transactions and pay attention to the parts of annual reports etc. used to get the information. This will help her in improving her stock analysis skills.

(Please note that in this article we have used the term “antivirus” to include all security solutions like antivirus, antispyware, antimalware, anti-rootkit, anti-ransomware etc.).

 

Quick Heal Technologies Ltd Research Report by Reader

 

Hello Sir,

I have tried to analyze the business of Quick Heal Technologies Ltd (QH). Please help me with improvements. I have tried to do a systematic approach in this direction.

Thanks,

Gurjeev

 

What the Business is about:

Quick Heal Technologies Ltd (QH) is one of the leading IT security solutions company. They design products to simplify IT security management across the length and depth of devices and on multiple platforms. They have a concentrated focus on R&D to continuously innovate and develop products to provide security services to growing needs in today’s times. The current portfolio of cloud-based security and advanced machine learning-enabled solutions to stop threats, attacks, and malicious traffic before it strikes. Their security products are developed in India. The company is also a certified partner of Microsoft since 2008.

 

Financial Analysis of Quick Heal Technologies Ltd:

QH came out with their IPO in 2016 which was not very successful. Until date, they have not been able to attain their IPO price in the open market.

Data available for Quick Heal Technologies Ltd is of 9 years. They started reporting their consolidated numbers from 2012 onwards. Thereby seeing the full company, I am trying to analyze QH the standalone not for 2010 and 2011 thereby fallowed by consolidated numbers from 2012.

Quick Heal Technologies Ltd has been growing its sales at a moderate pace of 16-17% in last 9 years. It has seen its revenue grow from 89 cr to 339 cr further the revenue is up to 339 cr in last four quaters. The growth has been achieved by fluctuating operating margins, which currently stand at good metrics. OPM has fluctuated from 55% to 29% and is now at 30% plus after 2016, (2016 demonetization hit them in a big way). Their PAT has grown at 11-12 % for the last 9 years, which is lower than the revenue growth.

Since they are an IT services company, which have employee cost and R&D, expenses as their main expenses. The fluctuating margins show that they are quite able to pass on the increase in these costs to their customers. While I have tried to find out the reasons for the same.

Their Net profit margins have seen somewhat similar trends. Now stabilizing near 19 – 25% mark. Which is impressive.

 

a) Tax Structure:

Quick Heal Technologies Ltd has paid taxes as per the normal tax rates as in India. Their tax payment rates are contumely above 30%.

 

b) Interest:

Quick Heal Technologies Ltd is a debt-free company (debt to equity =0). They carry 400cr + (which includes their IPO money also) on their balance, which is currently in fixed deposits (FDs) for two more years until it goes to some use.

Why they have still kept it in FDs that is a concern and a good point is that they are not rushing upon acquisitions.

IT Services firms are an asset-light business model. Current Ratio > 5.

 

c) Cash Flow Analysis of Quick Heal Technologies Ltd:

cCFO of Quick Heal Technologies Ltd is 90%, which is quite likely for a growing company. This is mainly because of delayed payments. This gives a sense of competition that persists in this industry.

Rather than Indian unorganized segment competition, they face challenges from Kasper Sky, Avast the top foreign players.

 

d) Revenue Breakup of Quick Heal Technologies Ltd:

  • Retail: 80% (Where the need to make Cd/DVD ROMs and pack in boxes)
  • Government / Enterprises: 15% (No CD/DVD/Boxes required. Directly Downloaded from the server)
  • Mobile Security: 5% (Always download model)

This tells something about the incremental costs involved in distribution. Management has stated in conference calls (concalls) that they want to scale up the enterprises/government and mobile division (B2B) to 30% of their pie. Usually, a company like them would have less bargaining power in the B2B segment due to the presence of international competition.

Quick Heal Technologies Ltd had a revenue dip in FY2017.

Their retail (B2C) which is the major contributor of revenue works on the stock and sell model. During the demonetization period, they faced resistance from channel partners to stock their product, which affected their sales. They also had to give higher credit terms. That lowered their receivable days dropped by 20 days from 95 to 115 days.

Quick Heal Technologies Ltd has developed a BOT tool with Government (CERT), which they are offering without any revenue consideration. This is the step by the company to increase their penetration and get more people to subscribe to their products.

The rate at which attacks/threats are rising is astonishing. Recently the world was affected by a Ransomware attack, which forced the user to pay if he wanted to access his computer and the data stored in it.

The government wants to push the cybersecurity market with a focus on the products made in India.

Our government can control and direct Indian companies but they will have no trust/control over foreign competitors. The scope of negligence is least as the outcomes could be catastrophic. The government cannot trust sensitive issues like securities to foreign players who might not have the least regard for backdoor breach and harm the nation whose outcomes could be bad.

Quick Heal Technologies Ltd has already joined India-Cert for and developed BOT removal tool. This will give them good business visibility as their government/enterprise segment is concerned.

 

Concerns with Operating Efficiency of Quick Heal Technologies Ltd:

The NFAT turn is continuously on a downtrend from last 7 years dropping from 10.65 now down to 1.77. Why is this so I tried finding the reasons for this but was unable to do so.

Receivable days of Quick Heal Technologies Ltd are extended, and as mentioned by the management they had to give loose credit terms in times of demonetization. Their receivable days had improved from 127 down to 89 days but again that has gone up to 117 days. This signifies the presence of competition and low bargaining power of the business.

The inventory turns have come down from 0ver 100 times to +50 times. This shows the product is fast selling and is of small ticket size. As the management has stated that their major revenue contribution is from retail. In addition, the ticket size of their product is from Rs 500 – 2000 in retail. These guidelines from the management are evident from their inventory turns.

 

Business and Industry Analysis of Quick Heal Technologies Ltd:

The market size of security/antivirus/ cloud security in India (SaaS Software as a service) is estimated at $120 billion this year, more than 30 times its size just over a decade ago. This is growing at 10-12% going forward.

 

a) Cyber Insurance (which QH offers with JV partners):

This market is currently small globally. The global Cyber Insurance market is $4 billion (28000 Cr Rs) Dollars, which is expected to be $20 billion (140000 Cr Rs) dollars. Indian cyber insurance market is only about 50 cr, which should see growth ahead due to credit/debit card hacks, frauds. Currently, this segment is not counted as a business vertical.

 

b) Security / Antivirus players in India (a like for like comparison):

Quick Heal / K7 /E-Scan/ Tech Guard Antivirus

Only Quick Heal Technologies Ltd is listed in this space thereby could not find financial data for the others. Also stated by the management in concalls they hold 30% market share in the retail (the major contributor) to their business.

 

c) Penetration levels / Development over the years:

From a single retail product (Antivirus) company they have evolved to a total security company, which is not moving to mobile and cloud security going ahead. The rise in R&D cost and Employee Costs (to retain talent) has shown from the trend in the annual reports.

 

d) Conversion of Profits into Cash:

The cCFO is 90% of cPAT mainly because of loose credit terms the company offers to sell its inventory.

 

e) Value Creation by Quick Heal Technologies Ltd:

The Company has cumulative retained earnings of 376 for the same they have been able to increase its market capitalization by 1831 crores. That is the company has created four Rs for every 1 Rs they have held and not paid as a dividend.

Quick Heal Technologies Ltd has flagship product SEQRITE that has given brand visibility in the market.

 

Management Analysis of Quick Heal Technologies Ltd:

A google check shows there have been instances for fraud relating to the company. However, on further reading, it is that at one instance their old general manager (GM) was found guilty of selling their products through the firms in his own capacity.

Where we can see that this was done by the employee for his personal benefits and the promoters were not involved in any misconduct of deeds.

Secondly, two men were arrested on the allegations that Quick Heal Technologies Ltd failed to disclose their names as shareholders when they were allotted shares in the company. The company clarified that they had never allotted any shares to such bogus entities.

 

a) Management Succession Planning:

Current management of Quick Heal Technologies Ltd is the 1st generation management of the company. I could not find any info on management succession planning.

Kailash Katkar and Sanjay Katkar look to be family members in the promoter category. Currently, they are MD&CEO and chief technology officer in the company. Thereby signifying they have significant important roles in the functioning of the business.

 

b) Promoters’ Salary:

The executive directors are entitled to a salary of 1.2 cr (inclusive of commissions) each (+ a car to each has been provided by the company). The Non-executive director salary is 44 lakhs (inclusive of commissions). The net combined salaries are well below 2% of the net profits of the company, which looks decent.

 

c) Project Execution Skills of Quick Heal Technologies Ltd:

Increase/addition of several innovative products, which are needed by everyone. Security is a service, which cannot be compensated. With rising awareness and rising dependence upon data/computers, security is necessary. Nowadays a thief does not have to rob you in physical. They can hack into your unsecured bank accounts / critical data and harm you sitting thousands of kilometers away.

Quick Heal Technologies Ltd from a single product (retail) now to several verticals shows good project execution skills.

 

d) Dividends:

The rate of payout of dividends has been 20-30% of profits for Quick Heal Technologies Ltd. That gives them a dividend yield of 1%. For growing companies’ moderate dividends payout is quite likely. However, a key concern I find here is the return on equity, which is 12%. If the management feels that they can create more value for the shareholders by retaining the amount of the dividend, then they should be earning better returns on their equity.

 

e) Skin in the Game:

The promoters hold 72% holding in Quick Heal Technologies Ltd. That shows their confidence and skin in the game for the business

 

Government Influence / Diversification for Quick Heal Technologies Ltd:

Government has no influence to put any restrictions on the business. Rather they are themselves trying to develop this market. The Make in India initiative would be big for companies like Quick Heal Technologies Ltd.

From a retail single-product company, they are now a Total Security company. They are in retail/enterprises/ government services / mobile security. Going in for cloud security. Security of Data would play a key role in electronic self-driven cars in the future.

 

Valuation Analysis of Quick Heal Technologies Ltd:

At current market price, QH has a trailing PE of 19, which does not offer any margin of safety. EY is 5.2% which is lower that is been offered by Government Bonds currently.

 

Self Sustainable Growth Rate (SSGR):

The self-sustainable growth rate of Quick Heal Technologies Ltd has been 14% but the company sales growth is slightly higher at 17% so. Still, the company is debt-free because of its inventory turns. The company gets 80% revenue from retail where the ticket size of their customer is Rs 500 – Rs 2000. With rising awareness of security due to the rising speed of threats and full computing moving to online (cloud) after IoT (5g) technologies. This implies the reason for their high and inventory turnover.

 

Free Cash Flow (FCF) generation:

Quick Heal Technologies Ltd has invested 308 cr to increase its sales over the years mainly in trading of security software, acquiring technical know-how, R&D, retaining talent. Thus, they were able to generate a 35% FCF to their CFO. Since they are a net debt-free and cash positive company the major proportionate of their FCF has been used to pay dividends (reward the shareholders).

 

Credit Rating for Quick Heal Technologies Ltd:

Since they do not have debt that is why they are not credit rated.

 

Dr Vijay Malik’s Response

 

Hi Gurjeev,

Thanks for sharing the analysis of Quick Heal Technologies Ltd (QH) with us! We appreciate the time & effort put in by you in the analysis.

While analyzing the past financial performance data of the company, an investor would notice that until FY2011, Quick Heal Technologies Ltd used to disclose only standalone financials. However, since FY2012, the company started reporting both standalone as well as consolidated financials. This is because, in FY2012, Quick Heal Technologies Ltd formed its first subsidiary, Quick Heal Technologies Africa Limited on Dec 2, 2011. As a result, it started reporting consolidated financials, which included the business performance of QH, its African subsidiary as well as the other subsidiaries that it formed subsequently.

FY2019 annual report, page 66:

Quick Heal Technologies Date Of Subsidiaries Formation

We believe that while analysing any company, the investor should always look at the company as a whole and focus on financials, which represent the business picture of the entire group. Therefore, while analysing Quick Heal Technologies Ltd, we have analysed standalone financials from FY2010-FY2011 and consolidated financials from FY2012-FY2019.

Further advised reading: Standalone vs Consolidated Financials: A Complete Guide

Quick Heal Technologies FY2010 2019 Financials

Financial and business analysis of Quick Heal Technologies Ltd:

While analyzing the financials of Quick Heal Technologies Ltd, an investor would note that in the past, the company has been able to grow its sales at a rate of 10-15% year on year; however, the growth has nearly stagnated in the recent years. Sales of the company increased from ₹89 cr. in FY2010 to ₹315 cr in FY2019.

While analysing the performance of the company in the past, an investor would notice that in the past, the operating profit margin (OPM) of the company had declined consistently from 55% in FY2010 to 30% in FY2017. In recent years, the OPM has recovered to 41% in FY2019. However, it is still below the level of operating profits enjoyed by the company in the past.

While analysing the reasons for such a decline in the OPM, an investor gets to know that Quick Heal Technologies Ltd operates in an industry, which is highly competitive. Many players offer software security solutions, which seem to provide similar protection levels. Almost all the players claim to have won multiple awards for their antivirus solutions. Therefore, in the end, the purchase decision turns out to be based on the pricing of the product.

Quick Heal Technologies Ltd had elaborated on the tough competitive nature of its industry in its red herring prospectus (RHP) before the initial public offer (IPO) in FY2016.

RHP, Jan 2016, page 18:

Some of our competitors are global companies that have larger technical and financial resources and the broad customer bases needed to bring competitive solutions to the market. Such companies may use these advantages to offer solutions that are perceived to be as effective as ours at a lower price or for free as part of a larger product package or solely in consideration for maintenance and services fees.

The company highlighted that many of its competitors are large global companies, which have a lot of resources. These companies can price their software security products to their customers at a lower price and even free of cost as a package. Moreover, the consumers perceive that all branded antivirus solutions including Quick Heal provide a similar acceptable level of service.

Quick Heal Technologies Ltd highlighted that for the retail segment, it faces competition from companies like AVAST and AVG, which offer basic antivirus free of cost and then offer to provide additional services as a premium add-on.

RHP, Jan 2016, page 18:

Low-priced or free competitive products. Security protection is increasingly being offered by third parties at significant discounts to our prices or, in some cases is bundled for free. The widespread inclusion of lower-priced or free products that are perceived to perform the same or similar functions as our products within computer hardware or other companies’ software products could potentially reduce the need for our products or render our products unmarketable – even if these incorporated products are inferior or more limited than our products. It is possible that a major competitor may offer a free anti-virus or anti-malware enterprise product. For instance, software companies may partner with manufacturing companies to provide pre-loaded anti-virus on smartphones and other mobile devices. Thus, we face competition from competitors like AVAST and AVG which provide several freemium products and with whom we compete to acquire users, especially those users who are sensitive to pricing.

The company acknowledges that the retail consumer market for antivirus products faces very intense competition from companies willing to provide a low priced or free solution. As a result, the competition may even lead to the antivirus solution of Quick Heal Technologies Ltd as unmarketable.

The intense price-based competition of antivirus products leaves very low pricing power in the hands of solution providers like Quick Heal Technologies Ltd. Investors could witness the lack of pricing power of Quick Heal Technologies Ltd in FY2018 when the indirect tax on antivirus solutions was increased on commencement of goods & services tax (GST).

Before GST, the products of Quick Heal Technologies Ltd used to come under value-added tax (VAT) at 6%. However, after the start of GST, its products came under 18% tax bracket. Quick Heal Technologies Ltd had to bear the impact of higher indirect tax (GST) itself, as it could not increase the price of its products. As a result, the profitability of the company took a hit.

Feb 2018 conference call, page 14:

Rajesh Ghonasgi: You also need to consider one thing that before GST it was VAT, so we used to pay 6% and now with GST we are paying 18% GST on retail products so again that cost is being absorbed by the company because we cannot increase the MRP price, there is a lot of pressure on MRP actually as well as market driven price that MOP also there is a big pressure on that.

An investor would also notice that such intense competition limiting the pricing power of the company is not limited to the retail consumer segment of the antivirus industry. In the RHP, Quick Heal Technologies Ltd clearly highlighted the extent of competition faced by it in the enterprise segment.

RHP, Jan 2016, page 18:

We face competition from both international and Indian companies such as Symantec, Trend Micro, Kaspersky, McAfee, Sophos, Fortinet, Watchguard, Apps Daily, Syska and K7. Large vendors of hardware or operating system software, such as Microsoft, Cisco Systems and International Business Machines Corp. (IBM), HP and Lenovo increasingly incorporate the system and network security functionality into their products, and enhance that functionality either through internal development or through strategic alliances or acquisitions. Some of our competitors are global companies that have larger technical and financial resources and the broad customer bases needed to bring competitive solutions to the market. Such companies may use these advantages to offer solutions that are perceived to be as effective as ours at a lower price or for free as part of a larger product package or solely in consideration for maintenance and services fees.

Further advised reading: How to do Business Analysis of a Company?

Quick Heal Technologies Ltd mentioned that it competes with large global security solution players like Symantec (Norton), McAfee etc. as well as other players like Microsoft and IBM, which have large resources and can provide their solutions at a much lower price and even free of cost to the customer as a part of service & maintenance and other packages.

Recently Airtel, one of the leading telecom service providers in India, has started offering a one-year subscription of Norton antivirus (by Symantec) free of cost to its prepaid subscribers. (Source: Financial Express: Airtel reportedly offering 1-year free Norton antivirus to subscribers)

In addition, the customer perceives the effectiveness of antivirus of these companies at a similar level as Quick Heal. Therefore, the propensity of consumers to pay for paid antivirus products like Quick Heal reduces in light of such competitive offers.

The company acknowledged that these large global players have many competitive advantages over Quick Heal like better-known brands, large budgets; higher research & development (R&D) capabilities, already established relationships with key customers and distributors as well as a large number of patented technologies.

RHP, Jan 2016, page 18:

Our competitors may enjoy potential competitive advantages over us, such as:
greater name recognition, a longer operating history, a larger customer base and extensive international operations;
larger sales and marketing budgets and resources;
– larger technical teams, research and product development budgets and resources;
– broader distribution and established relationships with channel partners and hardware vendors;
– greater customer support resources;
resources to make acquisitions; and
larger intellectual property portfolios.

After three years, in FY2019, the competitive intensity of the antivirus industry has increased further. An investor gets a glimpse into the extent of competition in the conference call of the company in May 2019. In the conference call, the management of Quick Heal Technologies Ltd intimates the analysts that the prices of the products (licenses) are going down due to the competition.

May 2019 conference call, page 4:

The second factor is obviously the competition in the market, which is driving down the price for license throughout the segment, so that had impact on our ARPU and finally the cross sell and up sell effort, we still need to do a lot more to ensure that we sell our younger products to our existing customer base and that actually would help us to increase the ARPUs.

The company intimated the investors that the antivirus industry is witnessing so much competition that the players are willing to offer solutions at any price to gain business. The company confirms there is no limit/floor to which the antivirus prices can decline.

May 2019 conference call, page 11:

Saurabh Jain: Okay and just last question from my side, generally we are seeing that there is a lot of pressure on pricing including on the enterprise side, in this kind of scenario, do you think there is a floor ever to the pricing or it does not really exist?

Vijay Mhaskar: I did not get you, can you repeat the question?

Saurabh Jain: There is a certain price below which people will not go in the industry or that does not really work through?

Vijay Mhaskar: That does not really work through because in this enterprise world there are the MNC players, Tier-1 players and also there are local players and there are entrants, startups and so on who do not mind to get the business at whatever cost it is, so that is the ground reality.

In the FY2019, the company reported a decline in sales despite selling to a higher number of customers. This is because the prices of the products of the company declined.

FY2019 annual report, page 9:

The customer acquisition has moved up, but average realisation per unit is lower so the translation of customer acquisition to the revenue has not moved up as much.

FY2019 annual report, page 47:

The numbers show an upward movement in customer acquisition. However, the average realisation per unit was on the lower side which has impacted the overall revenue growth Various factors can be attributed to this:

a) Our lower price variant products (from a basket of multiple product variants) had higher contribution in Q4

b) The market competitive pressures pulled the price down

Further advised reading: Understanding the Annual Report of a Company

Therefore, an investor would appreciate that whether it is a retail consumer segment or the enterprise segment, the antivirus industry faces intense competition. There is hardly any pricing power in the hands of the players. The competitors are willing to offer their products at very low prices, even free of cost. As a result, we witnessed that Quick Heal Technologies Ltd could not increase the prices of its products when it faced a higher indirect tax under GST.

Quick Heal Technologies Ltd has highlighted its large distribution network in different public disclosures. As per the May 2019 results presentation, page 11, the company has more than 25,000 retail partners, 457 corporate partners, and 105 government partners.

Quick Heal Technologies 2019 Number Of Distributors

However, when an investor analyses further, then she gets to know that these distribution partners are not exclusive to the company and can easily sell any other competitive antivirus or their own solutions to the customers. As a result, the distribution channel of the company is also the distribution channel of its competitors. In addition, distributors can also turn competitors. FY2019 annual report, page 50:

Our agreements with channel partners are non-exclusive, meaning our partners may offer customers software security products from other companies, including products that compete with our solutions. If our channel partners do not effectively market and sell our solutions or choose to use greater efforts to market and sell their own solutions or the solutions of our competitors, our business operations will be adversely affected. Adverse changes in our channel partner network or relationships with channel partners could adversely affect the quantity and pricing of the solutions offered by us which may in turn materially and adversely affect our business prospects

An investor would appreciate that in such a situation, in order to grow its sales, Quick Heal Technologies Ltd would have to spend a lot of money on advertisements and research & development so that the customers get to know about the company and its products and perceive them to be of a higher quality.

Therefore, it does not come as a surprise to the investor that Quick Heal spends a lot of money on sales & promotion and advertisement expenditure. Moreover, the company proposed to use the largest portion of the money raised by the company in the IPO for advertisement & sales promotions.

RHP Jan 2016, page 103:

After deducting the Offer related expenses in relation to the Fresh Issue, we estimate the proceeds of the Fresh Issue to be ₹[*] million (“Net Proceeds”). The objects for which our Company intends to use the Net Proceeds are:
1. Advertising and sales promotion;
2. Capital expenditure for research and development;
3. Purchase, development and renovation of office premises in Kolkata, Pune and New Delhi; and
4. General corporate purposes.

FY2019 annual report, page 138:

Quick Heal Technologies Breakup Of IPO Funds Utilization

Advertisement, sales & promotion, as well as most of the research & development expenditures, are a part of the operating expenses of the company. As a result, the higher spending on these aspects increases the operating expenses of the company. This leads to lower profit margins of the company.

FY2016 annual report, page 30:

We have  a profitable business model supporting strong cash generation. Investment in research and development in enterprise and mobile device segment and establishing distribution network for these two segments pulled down our EBITDA margins in past three years. Earnings also fell due to investments incurred on our foray into new product lines and sales and distribution. Our capital expenditure increased to ₹599.6 million.

Therefore, an investor would note that the antivirus industry has a highly challenging business environment. It is an intensely competitive industry where most of the products are supposed to provide a similar level of service and therefore, the players compete on pricing. Many players are willing to offer their products at a very low price, even free of cost, which limits the pricing ability of other players.

As a result, Quick Heal Technologies Ltd has to bear the impact of the increase in taxes on its own, as it could not increase the prices of its products when GST was implemented. The company had to spend a lot of money on advertisement and sales promotions, which has significantly reduced its profit margins over the years.

In light of such intense competition, an investor may keep a close watch on the profit margins of the company going ahead. It is also advised that investors should keep the intensely competitive nature of the antivirus industry in mind when extrapolating the recent improvement of profit margins in the future.

The net profit margin (NPM) of Quick Heal Technologies Ltd has followed the trend of OPM over the years.

Over the years, Quick Heal Technologies Ltd had a tax payout ratio in line with the standard corporate tax rate prevalent in India.

Further advised reading: How to do Financial Analysis of Companies

 

Operating Efficiency Analysis of Quick Heal Technologies Ltd:

a) Net fixed asset turnover (NFAT) of Quick Heal Technologies Ltd:

When an investor analyses the net fixed asset turnover (NFAT) of Quick Heal Technologies Ltd in the past years (FY2010-18), then she notices that the NFAT of the company has consistently declined from 10 in FY2010-FY2011 to 1.8 in FY2019.

Upon analysis, an investor notices that the primary reason for decline in the NFAT of the company is the investment in fixed assets by the company. The net fixed assets of the company have increased from ₹13 cr in FY2010 to ₹165 cr in FY2019. The company did major additions to its fixed assets during FY2014 (₹80 cr), FY2015 (₹68 cr), FY2016 (₹36 cr), FY2017 (₹33 cr).

An analysis of the fixed assets schedule in the available annual reports (FY2016 onwards) indicates that the company has invested most of the money in buildings and some money on computers and office equipment etc.

FY2016 annual report, page 111:

Quick Heal Technologies Investment In Buildings In FY2015 And FY2016

FY2018 annual report, page 110:

Quick Heal Technologies Investment In Buildings In FY2017

Therefore, an investor would notice that in FY2014-FY2017, Quick Heal Technologies Ltd has invested a lot of money on creating the infrastructure like building, computer systems etc. However, the sales growth of the company moderated as the company could increase its sales from ₹302 cr in FY2016 to only ₹315 cr in FY2019. As a result, the NFAT of the company witnessed a significant decline.

This illustrates the tough competitive business environment of the antivirus industry.

Further advised reading: Asset Turnover Ratio: A Complete Guide for Investors

 

b) Inventory turnover ratio of Quick Heal Technologies Ltd:

Quick Heal Technologies Ltd carries a minimal amount of inventory. As per the RHP, Jan 2016, the inventory and raw material consumption primarily consist of the hardware equipment for unified threat management, which is not a large contributor to the revenue.

RHP Jan 2016, page 315:

Raw materials consumed refers to our purchase of hardware equipment required for UTM solutions.

As most of the other products sold by the company are software, therefore, the company needs to carry very low inventory. As a result, Quick Heal Technologies Ltd has very high inventory turnover ratios in the range of 40 to 100 over the years.

Read on: How to Assess Operating Efficiency of Companies

 

c) Analysis of receivables days of Quick Heal Technologies Ltd:

An investor notices that the receivables days of Quick Heal Technologies Ltd have frequently stayed at about 110 days and above. The receivables days declined to 86 days in FY2015. However, since then, receivables days have again increased to 132 days in FY2019.

The actual level of receivables days observed by an investor is quite different from the normal credit period the company claims to provide to its distributors, which is at 30-60 days.

FY2019 annual report, page 119:

Trade receivables are non interest bearing and generally on credit terms of 30 to 60 days.

FY2019 annual report, page 52:

We typically offer our channel partners around 60 days of credit.

The actual receivables days of 110 days and above when compared to normal credit period of 30-60 days indicates that most of the buyers of antivirus products from Quick Heal Technologies Ltd delay their payments beyond the agreed-upon credit terms.

To understand such behavior of buyers of Quick Heal Technologies Ltd, an investor needs to understand the nature of these buyers.

As per the discussion in the May 2019 conference call, page 9, the management highlighted that the sales revenue reported by the company is not the actual purchase by the end-users/consumers. Quick Heal Technologies Ltd mentioned that the reported sales revenue is actually the sales to the distributor.

Vijay Mhaskar: So the numbers that we talk about here is actually the billing numbers as we are in a stock and sell model, so it does not reflect actually on the product being actually consumed in the market that is activation numbers. Activation we are seeing pretty good numbers at this point. I do not think it is actually about the product that we are getting billed into the primary distributor or T1 distributor right, so that is where we have seen a drop and I mentioned earlier we had some disruption into the distribution channels primarily because the laptop and desktop OEMs they had some practices, which caused the cash rotation problem with the distributors, so number of them had their cash locked-in which impacted their investment that they could do into other businesses and because we have overlap between the distribution channel for the hardware products and the consumer security products, we had to suffer that and essentially it actually impacted our ability to recover the outstanding and in a way impacted our billing for Q4.

Saurabh Jain: But the distributor will actually buy the product if there is a demand for it in the retail end even though he might sell it after say a month or two months?

Vijay Mhaskar: The distribution channel is three tiers, so by the time he bills the product, by the time it flows to Tier-3, it takes almost two to three months. So there is usually enough stock in the market, so there is no need to do.

Further advised reading: How to do Business Analysis of a Company?

Therefore, the sales of Quick Heal Technologies Ltd reflect sale to distributors and may not represent the final sale to the consumer. An investor would also recollect from the above discussion that the distributors of the company are not exclusive distributors to the company and have the ability to sell antivirus of competing companies as well as their own antivirus products.

In such a situation, when the distributor can easily sell an alternative antivirus product to the consumer, it is difficult to assume that Quick Heal Technologies Ltd would have the power to force strict receivable collection from the distributors. In case of excessive follow up by the company for the collection of receivables, a distributor can threaten to remove the products of Quick Heal Technologies Ltd from its shelf/catalog.

In addition, the distributors do not buy antivirus products of Quick Heal Technologies Ltd for their own consumption. The distributors are traders who earn revenue by selling these antivirus products to next tier of distributors or consumers. Therefore, an investor can anticipate that the distributor who has bought antivirus products from Quick Heal Technologies Ltd will normally hesitate to pay money to the company unless it has sold the products to consumers/next tier of distributors. In case, the distributor is not able to sell the products of Quick Heal Technologies Ltd to other consumers, then in most likely cases, it will delay payments to the company.

This aspect of nature of sales of Quick Heal Technologies Ltd coupled with the negotiation power wielded by the distributors exposes the company to high credit risk. In the case of lower sales, the distributors may delay payments to the company or in some case may refuse to pay the money.

An investor may think of a situation where a distributor has many compact discs (CDs) of Quick Heal antivirus on its shelf, which it has taken from the company on credit. In case, the distributor finds that these CDs are not selling despite being on the shelf from many months, then the investor may try to imagine the willingness of the distributor to pay money to Quick Heal Technologies Ltd for these unsold CDs at the end of credit period of 30-60 days. It is very likely that if Quick Heal Technologies Ltd puts pressure for collection of receivables from the distributor for these unsold CDs on its shelf, then the distributor may ask the company to wait until these CDs are sold, or take back the CDs. In any case, the distributor has the option to sell other competing antivirus products to its consumers.

Therefore, an investor would appreciate that Quick Heal Technologies Ltd seems to have low power to collect receivables from its buyers who are distributors. The company has highlighted this risk in its FY2019 annual report, page 52.

Exposure to high credit risk: AV retail industry predominantly work on Stock and Sales model. This being a hypercompetitive industry, heavy stocking at all levels plays a pivotal role in driving market share. We rely significantly on our channel partners to sell and support our solutions and we expect that sales through our channel partners will continue to account for a significant percentage of our revenues. Weakness in the end user market could negatively affect the cash flow of our channel partners or distributors and resellers, who could, in turn, delay making payments to us and impact our working capital. We typically offer our channel partners around 60 days of credit. Furthermore, a change in the credit quality at one of our channel partners or other counterparties can increase the risk that such counterparty is unable or unwilling to pay amounts owed to us, which could directly or indirectly have a material adverse effect on our results of operations.

An investor should keep in mind that the high credit risk in the collection of receivables by the company has affected it in the past. The company disclosed in the red herring prospectus (RHP) in January 2016 before its IPO that one of its distributors refused to pay money to the company in FY2014 and it has to bear a loss of ₹16.4 cr due to the same.

RHP, January 2019, page 327:

During the year ended March 31, 2014, one of our distributors (which we refer to as our channel partners) defaulted in making payments and we initiated legal proceedings against him. We made a provision for ₹ 163.79 million for fiscal year 2014.

Moreover, the auditor of the company has also highlighted the high amount of trade receivables of the company as a key audit matter in FY2019 annual report, page 92:

Further, with respect to the trade receivables, the appropriateness of the provision for doubtful debts is subjective due to high degree of judgement applied by management in determining the impairment provision.

Trade receivables as at March 31, 2019 amounts to INR 1,250.52 million and comprise 15% of total assets in the Balance Sheet.

Due to the significance of revenue, judgments relating to identification of separate performance obligations, as well as the complexity associated with the timing and related estimation uncertainty in valuation of trade receivables, this is considered as a key audit matter.

Further advised reading: Understanding the Annual Report of a Company

In light of the above discussion, an investor would appreciate that Quick Heal Technologies Ltd is not in a very strong position to collect money from its distributors for the sales reported by it in the financial statements. The distributors tend to delay the payment due to the higher negotiating power enjoyed by them. As a result, the company has continuously reported higher actual receivables days of more than 110 days than the normal credit period of 30-60 days.

An investor may appreciate that the temporary improvement in receivables days to below 100 in FY2015 and FY2016 might be a result of the impending IPO of the company in February 2016. Many times, investors notice that the company disclose good financial performance for the periods preceding IPOs. In many cases, financial performance declines after the IPO is completed.

In FY2016 annual report, page 44, Quick Heal Technologies Ltd mentioned that it takes an advance payment from its buyers who are large revenue contributors (largest distributors).

We maintain strict control on credit exposure to our channel partners. While our sales team continuously works with them to ensure faster sales turnaround, they also keep a close tab on collections from partner. Our overall partner network has also been growing, with revenue contribution from top 20 dealers reducing from 52% in FY15 to 45% in FY16. In case of dealers who are larger revenue contributors, we work on advances to keep our credit exposure within control.

However, an investor would appreciate from the above discussion that in the case of distributors with strong negotiating power who can easily replace your product with the product of competitors, it is very difficult to collect money as per credit terms. It is even more difficult to get full advance payments. Therefore, it does not come as a surprise that the receivables days of the company have steadily increased after IPO from 95 days in FY2016 to 132 days in FY2019.

An investor would appreciate that delay in the payments by the distributors will influence the working capital position of the company. The company will find incremental money being stuck in the working capital.

This aspect of the business of Quick Heal Technologies Ltd gets established when an investor compares the cumulative net profit after tax (cPAT) of the company with the cumulative cash flow from operations (cCFO) for FY2010-19. She notices that the company has been able to convert its profits into cash flow from operations.

Over FY2010-19, Quick Heal Technologies Ltd has reported a total cumulative net profit after tax (cPAT) of ₹615 cr. whereas during the same period, it reported cumulative cash flow from operations (cCFO) of ₹543 cr.

It is advised that investors should read the article on CFO calculation mentioned below, which would help them understand the situations in which companies tend to have the CFO lower than their PAT and the situations when the companies tend to have CFO higher than their PAT.

Further advised reading: Understanding Cash Flow from Operations (CFO)

 

Margin of Safety in the Business of Quick Heal Technologies Ltd:

a) Self-Sustainable Growth Rate (SSGR):

Further advised reading: Self Sustainable Growth Rate: a measure of Inherent Growth Potential of a Company

Upon reading the SSGR article, an investor would appreciate that if a company is growing at a rate equal to or less than the SSGR and it is able to convert its profits into cash flow from operations, then it would be able to fund its growth from its internal resources without the need of external sources of funds.

Conversely, if any company attempts to grow its sales at a rate higher than its SSGR, then its internal resources would not be sufficient to fund its growth aspirations. As a result, the company would have to rely on additional sources of funds like debt or equity dilution to meet the cash requirements to generate its target growth.

While studying the formula for calculation of SSGR, an investor would understand that the SSGR directly depends on the following factors.

SSGR = NFAT * NPM * (1-DPR) – Dep

Where,

  • SSGR = Self Sustainable Growth Rate in %
  • Dep = Depreciation rate as a % of net fixed assets
  • NFAT = Net fixed asset turnover (Sales/average net fixed assets over the year)
  • NPM = Net profit margin as % of sales
  • DPR = Dividend paid as % of net profit after tax

(For systematic algebraic calculation of SSGR formula: Click Here)

While analysing the SSGR of Quick Heal Technologies Ltd, an investor would notice that the company has an SSGR of about 18-19%. However, the company has been growing at a rate of 10-15% over the years. As a result, investors would appreciate that Quick Heal Technologies Ltd seems to be able to fund its growth from its business profits without any need to raise money from additional sources like debt or equity.

Therefore, it does not come as a surprise to the investor that the company has consistently stayed debt-free over the last decade.

An investor is able to observe this aspect of the company’s business when she analyses the cumulative cash flow position including free cash flow for the company over the last 10 years (FY2010-19).

 

b) Free Cash Flow Analysis of Quick Heal Technologies Ltd:

While looking at the cash flow performance of Quick Heal Technologies Ltd, an investor notices that during FY2010-19, the company had a cumulative cash flow from operations of ₹543 cr. However, during this period it did a capital expenditure (capex) of ₹289 cr. As a result, it had a free cash flow of ₹254 cr. (543 – 289), which it has utilized to pay dividends of about ₹130 cr to its shareholder and has kept the remaining funds as cash & investments.

Further advised reading: Free Cash Flow: A Complete Guide to Understanding FCF

The presence of free cash flow indicates that Quick Heal Technologies Ltd has been able to meet all its capital expenditure requirements from its cash flow from operations. As a result, the company could expand its business and make investments in the advertisement, research & development, subsidiaries as well as other companies and still stayed debt-free.

At March 31, 2019, the company had a cash & investments balance of about ₹525 cr, which includes surplus cash left after dividends payment and unutilized IPO proceeds.

Free cash flow (FCF) is one of the main pillars of assessing the margin of safety in the business model of any company.

Further advised reading: 3 Simple Ways to Assess “Margin of Safety”: The Cornerstone of Stock Investing

 

Additional aspects of Quick Heal Technologies Ltd:

On analysing Quick Heal Technologies Ltd, an investor comes across certain other aspects of the company:

 

1) The curious case of declining focus on research and development by Quick Heal Technologies Ltd:

While an investor reads the public disclosures by Quick Heal Technologies Ltd, then she notices that the company has highlighted its strong focus on research & development as one of the key competitive strengths of the company.

In the investors’ presentation of May 2019 (page 8), Quick Heal Technologies Ltd highlighted that it has significantly increased the strength of its research & development team from 138 employees in FY2012 to 356 employees in FY2019. On similar lines, Quick Heal Technologies Ltd highlighted that it has increased investments in research and development from 8% of sales in FY2012 to 17% of sales in FY2019.

Quick Heal Technologies Strong Spending On Research And Development

Moreover, an investor would also recollect that one of the key usages of the IPO funds by the company was mentioned as an investment in research & development.

2016 RHP, page 103:

After deducting the Offer related expenses in relation to the Fresh Issue, we estimate the proceeds of the Fresh Issue to be ₹[*] million (“Net Proceeds”). The objects for which our Company intends to use the Net Proceeds are:
1. Advertising and sales promotion;
2. Capital expenditure for research and development;
3. Purchase, development and renovation of office premises in Kolkata, Pune and New Delhi; and
4. General corporate purposes.

These disclosures give an impression that Quick Heal Technologies Ltd has a very strong focus on research & development year on year. However, when an investor analyses deeper and studies the status of research & development team of the company year on year, then she observes a different picture.

An investor notices that the total number of employees in the research & development team has been declining consistently over recent years.

While analysing the annual reports of FY2016, FY2017, FY2018 and FY2019, an investor notices that the total number of employees in the research & development team of Quick Heal Technologies Ltd has declined year on year from 555 employees in FY2016 to 356 employees in FY2019.

Quick Heal Technologies Declining Number Of Employees In R D Team

An investor would appreciate that the decline of about 200 employees, which is about 35% of the team in FY2016 seems a significant reduction in the R&D team. However, year after year, Quick Heal Technologies Ltd has presented a picture of the increased size of R&D team by comparing the total number of employees in the R&D team in that year with FY2012 when it had a smaller team of 138 employees in the R&D team. (See the presentation of data for FY2018 and FY2019 in the image).

On the similar lines, an investor notices that year after year, Quick Heal Technologies Ltd has reported its expenditure on R&D in comparison with the money spent on R&D in FY2012, which was low at 8% of total sales.

Quick Heal Technologies Declining Spending On R D Team

An investor notices that the company has portrayed an increase in yearly R&D spending by comparing it with FY2012.

While analysing the FY2017 annual report (page 74), an investor finds that in FY2017, Quick Heal Technologies Ltd has spent 21.1% of total sales on R&D. The similar spending in FY2016 was 19.5%.

During FY16 and FY17, the R&D investments made by the company were around 19.5% and 21.1% of total revenues respectively.

Therefore, an investor notices that the amount of money spent by Quick Heal Technologies Ltd on research & development is in a continuous decline in recent years from 21.1% of total sales in FY2017 to 17% of total sales in FY2019. However, the company has presented a picture of increasing R&D spending by comparing it to FY2012 when its R&D spend was very low.

Even in the terms of spending on R&D in INR (₹), an investor notices that the spending on R&D by Quick Heal Technologies Ltd has declined since the IPO in FY2016. The R&D spending has declined from about ₹64 cr in FY2017 to ₹54 cr in FY2019.

Quick Heal Technologies Declining Spend On R D

In light of the above observations of declining size of the R&D team from 555 employees in FY2016 to 356 employees in FY2019 and the associated consistent decline of money spent by Quick Heal Technologies Ltd on research & development, an investor may seek clarifications from the company about the reducing focus on the R&D activities.

Going ahead, an investor may closely track the developments at Quick Heal Technologies Ltd related to research & development.

Further advised reading: Analysis Framework for IT Services Companies

 

2) Continuously declining number of employees at Quick Heal Technologies Ltd:

While analysing the annual reports of the company, an investor notices that the total number of employees at the company has declined significantly over the years. The total number of employees has declined from 1,394 in FY2016 to 1,037 in FY2019.

Moreover, the decline in the number of employees is consistent with year on year reduction in the total number of employees 1,374 in FY2017 to 1,114 in FY2018 to 1,037 in FY2019.

FY2017 annual report, page 69:

If one looks at the Employee cost on a quarter to quarter basis, from Q4, of FY 2016 to Q4, of FY 2017, it will be seen that the total number of employees was fairly stable: at 1,374 people as at the end of FY 2017, as compared to 1394 people, as at the end of FY 2016.

FY2019 annual report, page 49:

The Company’s Employee benefits expenses declined to ₹ 988.51 Million in FY 2019 from ₹ 1,023.00 Million in FY 2018, a decline of 3.4%. The total number of employees declined to 1,037 as at the end of FY 2019 compared to 1,114 as at the end of FY 2018.

An investor would notice that the consistent significant decline in the number of employees (25% since FY2016) has come at a time when the company had raised additional resources from IPO to increase its business. Such a situation may indicate that Quick Heal Technologies Ltd is not able to grow its business despite its intention and availability of money.

Such a situation may also highlight the intensely competitive scenario in the antivirus industry where it does not seem possible for a company to grow just by raising more money from investors.

Going ahead, the investor may keep a close watch on the total number of employees of Quick Heal Technologies Ltd along with attrition level of employees. Currently, the attrition level at the company is about 22%, which indicates that almost one-fifth of the total employees leave the company every year.

FY2019 annual report, page 191:

Quick Heal Technologies 2018 2019 Employee Turnover Attrition

Further advised reading: Analysis Framework for IT Services Companies

 

3) Losses in almost all the investments done in subsidiaries and other companies by Quick Heal Technologies Ltd in the last 5 years:

Over time, Quick Heal Technologies Ltd has done investments in subsidiaries as well as investments in other companies like start-ups in order to generate value for its shareholders. However, when an investor analyses the current state of these investments, then she notices that almost all of these investments have lost value in recent years. Some of the investments have led to complete loss whereas others have led to a partial loss of the investments.

FY2019 annual report, page 177:

Quick Heal Technologies 2019 Impairment Value Of Investment Subsidiaries

Further advised reading: Understanding the Annual Report of a Company

As per the above data, Quick Heal Technologies Ltd has suffered a complete loss of its investments in startups:

  • Smartalyse Technologies Private Limited and
  • Wegilant Net Solutions Private Limited.

Moreover, it has suffered a significant loss in the value of its investments in almost all of its subsidiaries:

  • Quick Heal Technologies Japan K.K., Japan
  • Quick Heal Technologies America Inc., USA
  • Quick Heal Technologies (MENA) FZE, UAE
  • Quick Heal Technologies Africa Limited, Kenya

Over the years, Quick Heal Technologies Ltd has recognized losses due to these decisions as exceptional items in the profit and loss statement.

FY2018 annual report, page 193:

Exceptional items includes impairment of investment in wholly owned subsidiaries amounting to INR 75.09 Million (March 31, 2017: INR 6.33 Million). It also included INR Nil (March 31, 2017: INR 37.80 Million) towards impairment of financial assets being loan to and interest receivable from Wegilant Net Solutions Private Limited.

In light of such frequent losses in the investment decisions made by the company, an investor should keep a close watch on the future investments to be done by the company. An investor would appreciate that ideally investment decisions/capital allocation decisions should generate positive value for shareholders and not losses on almost all the investment decisions.

Further advised reading: How to Identify if Management is Misallocating Capital

 

4) Dispute for payment of a large sum of service tax:

While reading the annual reports of Quick Heal Technologies Ltd, an investor learns that the company is facing a demand of ₹223 cr from the service tax department for selling antivirus software on compact discs (CDs) without paying service tax on the same.

FY2019 annual report, page 91:

We draw attention to Note 33(c) to the consolidated Ind AS financial statements wherein it is stated that the Company has received statements of demand of service tax under the provisions of the Finance Act, 1994 for INR 1,610.50 Million (excluding penalty of INR 626.97 Million, pre-deposit if any) for the period from March 01, 2011 to June 30, 2017. Our opinion is not qualified in respect of this matter.

An investor would appreciate that the demand of ₹223 cr is significant in relation to the size of the company as it can take away more than 40% of the existing cash & investment balance of the company. Therefore, in order to understand more about the basis of this demand, an investor needs to explore further.

While reading the red herring prospectus (RHP) of January 2016 of the company before IPO, an investor gets to know the argument of the service tax department for this large service tax demand.

RHP January 2016, page 331:

The SCN is in relation to applicability of service tax on anti-virus software in CDs supplied by our Company through distributors. In the SCN, the ADG has alleged, inter alia, that: (i) supplying the anti-virus software replicated CD in retail packs along with the license key amounts to provision of service and accordingly, our Company is liable to pay service tax for such supply; (ii) since our Company has been paying service tax for the anti-virus software sold by it online, our Company ought to have paid service tax for the anti-virus software replicated CDs supplied in retail packs through distributors; (iii) the area based exemption on excise duty available at Baddi in Himachal Pradesh and Rudrapur in Uttaranchal is applicable on the basic cost of manufacturing CD only and hence, service tax would be applicable on the value of the licence key; and (iv) the major component of the price of the software replicated on CD is for the licence key which enables the end user to upgrade the software, which is not covered under excise duty and hence, service tax is payable on the amount charged for the license key.

Our Company has responded to the SCN denying the allegations, through a letter dated June 15, 2015. The matter is currently pending.

By reading the above section of the RHP, an investor gets to know that the dispute is related to applicability of service tax on selling antivirus software on compact discs (CDs). Quick Heal Technologies Ltd had been paid service tax for online antivirus sales. However, the company had not paid service tax for the antivirus sales by CDs.

It seems that the argument of Quick Heal Technologies Ltd is that the service tax is not applicable on the antivirus sold on CDs and instead excise duty is payable on these sales. However, these CDs are produced in factories in Baddi in Himachal Pradesh and Rudrapur in Uttaranchal, which have excise exemptions. Therefore, the company has not paid the indirect tax.

However, the service tax department has contended that the exemption of excise duty is only on the cost of manufacture of the compact disc and not on the software/license key on the disc. An investor would appreciate that when a consumer buys an antivirus product on a CD for about ₹1,000/-, then the cost of the CD is hardly ₹10/- and the remaining ₹990/- is the price paid for the antivirus software.

Therefore, the service tax department is disputing the applicability of excise duty on the software written on the CDs and is demanding service tax on the same.

The company has highlighted the sustainability of excise duty exemption on the sale of antivirus on CDs as a key risk in the RHP at the time of IPO.

RHP, page 24:

We benefit from the tax incentives available to the third party manufacturer of our CDs and DVDs and any loss of this benefit may impact our financial performance, results of operations and cash flows.

A third-party vendor manufactures CDs and DVDs with our security software products at its manufacturing facility located at Rudrapur, in the state of Uttarakhand. This facility is entitled to avail of an excise duty exemption that in effect lowers the cost of manufacturing. This excise duty exemption is valid for a period of 10 years from the date of the government notification or the commencement of commercial production, whichever is later, and the facility is exempt from excise duty on the goods manufactured during this period of time. The loss of this excise duty exemption will effectively increase these manufacturing costs, which will have an adverse impact on our profitability. We understand that the exemption from payment of excise duty at this manufacturing facility is available until June 20, 2018. In addition, in the event of the termination of this agreement, we may not be able to find a suitable replacement third party manufacturing facility on similar terms, or at all.

Going ahead, an investor may closely track the developments related to this dispute of applicability of service tax on the sale of antivirus on CDs. This is because, in case, the decision of the courts/authorities is against Quick Heal Technologies Ltd and it needs to pay the demanded liability, then it will have a significant impact on the cash position of the company.

 

5) History of weaknesses in the internal controls at Quick Heal Technologies Ltd:

While reading the public documents for Quick Heal Technologies Ltd, then she notices that the auditor of the company has repeatedly highlighted various weaknesses in the internal control systems of the company. Such instances of weaknesses before the IPO (FY2016) are presented in the RHP filed by the company in January 2016.

As per the RHP, page 62, in FY2011, the auditor reported that the internal audit system of the company was not proper and its scope needed to be enlarged. The auditor also highlighted that the company had not paid the tax deducted at source (TDS) and value-added tax (VAT) on time.

Annexure to statutory auditor’s report for the Financial Year ended March 31, 2011

The statutory auditor indicated that the Company has an internal audit system, the scope and coverage of which, in their opinion requires to be enlarged to be commensurate with the size and nature of its business.

The statutory auditor indicated that undisputed statutory dues including provident fund, employees’ state insurance, income-tax, sales-tax, wealth-tax, service tax, customs duty, excise duty and cess have generally been regularly deposited with the appropriate authorities except in case of tax deducted at source and VAT where there have been slight delays in a few cases.

The management of the company responded that it has improved the internal audit process by appointing a leading accounting firm as the internal auditor.

RHP, page 62:

Management response: The Company has considered the above qualifications under CARO, 2003, and has taken the following corrective actions:

1. The internal audit process was strengthened by appointing a leading accounting firm to conduct internal audit.

2. In respect of delays in payment of statutory dues, our Company conducted appropriate training for the staff responsible for payment of statutory dues and improving the internal processes for tracking and payment of statutory dues.

However, it seems that even the leading accounting firm was not able to strengthen the internal audit system. This is because, in FY2014, the auditor again highlighted that the internal audit system needs to be improved and such non-improvement of internal audit system is a continued failure to correct a major weakness.

RHP, page 64:

Annexure to statutory auditor’s report for the Financial Year ended March 31, 2014

….In the opinion of the statutory auditor, this is a continuing failure to correct major weakness in the internal control system. Subsequent to the year end, the management had taken adequate steps to strengthen the internal controls and was in the process of further updating the customer and vendor records and strengthening the process of customer purchase orders and delivery acknowledgements with respect to sale of inventory items….

The statutory auditor indicated that undisputed statutory dues including provident fund, employees’ state insurance, income-tax, sales-tax, wealth-tax, service tax, customs duty, excise duty, cess and other material statutory dues had generally been regularly deposited with the appropriate authorities though there had been a slight delay in few cases with respect to tax deducted at source. As informed, the Company did not have any dues towards investor education and protection fund during the year.

In light of such continued weaknesses in the internal controls and processes, an investor notices that the company has faced many frauds and litigations.

One of the biggest instances of the poor internal process is the claim by the company that it is not able to trace the records for issuance of equity shares for a 12 years period (1995-2007).

RHP, page 25:

Some of our corporate records relating to forms filed with the Registrar of Companies are not traceable.

We are unable to trace certain corporate records in relation to our Company. These corporate records include prescribed forms filed with the RoC by our Company relating to certain allotments of Equity Shares made by our Company and increase in authorised share capital of our Company. These documents pertain to the period between 1995 and 2007. Whilst we believe that all filings have been made, there is no assurance that we will not be subject to penalties on this account.

An investor would appreciate that such disappearance of records might be associated with disputes. The publicly available information about Quick Heal Technologies Ltd indicates that the company is fighting a dispute with Manohar Malani, managing director of a firm NCS Computech Ltd, related to his shareholding in the company where the shares were allotted to him in the year 2000. (Source: Livemint: Quick Heal shares slide amid spat over shareholding)

On Wednesday, a day ahead of listing, Manohar Malani, managing director at Kolkata-based firm NCS Computech Ltd, wrote to capital markets regulator Securities and Exchange Board of India (Sebi), complaining about the fraudulent transfer of 20,000 shares of Quick Heal Technologies Ltd, which he claimed belonged to him and his family. Mint has seen a copy of the email complaint sent to Sebi.

Malani claimed that in 2000, he and four members of his family had subscribed to 4,000 shares each of CAT Computer Services Pvt. Ltd (which was later renamed Quick Heal). The red herring prospectus (RHP) filed by Quick Heal on 29 January does not feature either Malani or any of his family members as shareholders in the firm.

NCS Computech was a distributor of Quick Heal products till 2014. Quick Heal has several pending criminal cases against NCS Computech, according to data from its RHP filed with Sebi.

In addition, there have been cases of frauds by employees of the company, which also seem to be a result of weak internal control processes.

Quick Heal ex-GM arrested for fraud (Source: Pune Mirror)

A former general manager of leading anti-virus solution provider Quick Heal has been arrested for allegedly duping the firm to the tune of Rs 1.24 crore over the last 10 years by selling its products through companies owned by him.

In light of such instances and the prolonged period of weak internal control processes, an investor should pray that no other issue/litigation related to the past comes up to haunt the company and its shareholders in future.

An investor should track the developments related to these disputes in the future.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

6) Exceptionally large dividend paid out by Quick Heal Technologies Ltd before the IPO:

While analysing the past financial performance of the company, an investor notices that the company paid an exceptionally large dividend to its shareholders before the IPO in FY2015.

FY2016 annual report, page 18:

Quick Heal Technologies 2015 Large Dividend Payout

An investor would notice that many times such large dividend payouts before the IPO is an attempt by existing shareholders/promoters to take existing cash accumulated by the company over the years. In such cases, the incoming new shareholders (investors in IPO) do not get to benefit from the cash generated by the company before the IPO.

Investors witnessed a similar case of large dividend payout by a company before its IPO in the case of InterGlobe Aviation (IndiGo Airlines). In 2015, InterGlobe paid such a large dividend to its shareholders before IPO that its net worth became negative indicating that the existing shareholders took away all the cash accumulated by the company before the IPO.

IPO-bound profitable IndiGo has negative net worth (Source: Business Today)

Remaining profitable for nearly seven years, InterGlobe, however, saw its net worth slip to a negative Rs 139.39 crore at the end of June 2015.

Such instances remind minority shareholders that the controlling shareholders may prefer their interests to the interests of non-controlling/retail/minority shareholders.

Going ahead, an investor should keep a close watch and in case, she finds that the promoters are taking decisions, which are not in favour of minority shareholders, then she may take a decision accordingly.

Further advised reading: Why Management Assessment is the Most Critical Factor in Stock Investing?

 

7) An error in the annual report of Quick Heal Technologies Ltd:

In FY2019 annual report, on page 49, the company has mentioned that it sold 5,622 million licenses in the retail segment and 1,240 million licenses in the enterprise & govt. segment.

The number of licences sold by the Retail and Enterprises & Government segments, stood at 5,622 Million and 1,240 Million, registering growth over previous year, with a contribution of 82% and 18% respectively.

An investor would appreciate that the number of licenses sold mentioned in the annual report is erroneous as it exceeds the population of India.

In May 2019, investors’ presentation, on page 32, the company has correctly mentioned that the unit of the number of licenses sold by the company is thousands instead of millions.

Quick Heal Technologies Correct Number Of Licenses Sold

Therefore, the correct number of license sold by the company in FY2019 is 5.62 million in the retail segment and 1.24 million in enterprise & govt. segment. The data in the annual report seems to be an inadvertent typographical error.

 

Margin of Safety in the market price of Quick Heal Technologies Ltd:

Currently (July 17, 2019), Quick Heal Technologies Ltd is available at a price to earnings (PE) ratio of about 11 based on earnings of FY2019. The PE ratio of 11 provides a small margin of safety in the purchase price as described by Benjamin Graham in his book The Intelligent Investor.

However, we recommend that an investor may read the following articles to assess the PE ratio to be paid for any stock, takes into account the strength of the business model of the company as well. The strength in the business model of any company is measured by way of its self-sustainable growth rate and the free cash flow generating the ability of the company.

In the absence of any strength in the business model of the company, even a low PE ratio of the company’s stock may be signs of a value trap where instead of being a bargain; the low valuation of the stock price may represent the poor business dynamics of the company.

Investors should note that current market price (July 17, 2019) of Quick Heal Technologies Ltd is ₹153.25 against the IPO price of ₹321/- in February 2016, which indicates a value erosion of more than 50%. In term of money, the value erosion has exceeded ₹1,000 cr whereas the company has retained more than ₹200 cr of earnings from the profits since the IPO (FY2016-FY2019).

 

Analysis Summary

Overall, Quick Heal Technologies Ltd seems like a company, which has been able to grow its sales at a growth rate of 10-15% year on year in the past. The growth path has not been consistent. The sales growth has nearly stagnated in recent years. In addition, the profitability margins of the company have declined over the years from higher than 50% in FY2009-11 to current levels of 30-35%.

The key reason for stagnating growth and declining profit margins seems to be the intensely competitive nature of the antivirus industry. Quick Heal Technologies Ltd charges its customers to use its antivirus whereas many other better-known competitors provide their antivirus solutions of similar effectiveness at a much lower price and in some case even free of cost (AVAST, AVG etc.). As a result, Quick Heal Technologies Ltd has witnessed an average realization of its products decline. The company has to bear the impact of increased in taxes due to GST, as it could not increase the price (MRP) of its products. Therefore, the company has found it difficult to increase its sales despite increasing the number of customers.

Increased spending on advertising and sales promotions to generate sales is another reason for the declining profit margins of the company over the last decade. The company sells its products to distributors who in turn sell it to customers. The distributors hold very high power as they can easily sell antivirus products of other competitors to the customers. Therefore, these distributors seem to delay the payments beyond normal credit terms. As a result, Quick Heal Technologies Ltd has high receivables days of 110 days or more. Therefore, the company has witnessed money being stuck in the working capital. The delays in receivables collections expose the company to credit risk and in the past, there have been cases when a distributor defaulted and the company had a loss of about ₹16 cr.

Quick Heal Technologies Ltd raised money from investors in February 2016 by an IPO to grow its business including investments in research & development. However, an investor notices that the company has consistently reduced the size of its R&D team and the money being spent on R&D has come down year on year. At the one end, the company is investing money on buildings and related infrastructures whereas its total employee count has reduced significantly since the IPO.

Quick Heal Technologies Ltd has invested money in a few overseas subsidiaries and a few start-ups. However, almost all these companies have lost the money invested and as a result, the company has recognized losses/reduced fair value on these investments.

The company is contesting a large service tax demand on the sale of antivirus products on CDs, which if decided against the company, may have a significant impact on the liquidity position of the company.

Quick Heal Technologies Ltd has had a history of weak internal controls, which the auditor pointed out as a continued failure to correct a major weakness. The company has disclosed that it has lost the records for allotment of equity shares for a 12-year period (1995-2007). Some shareholder has claimed that the company allotted him shares in 2000 and is no longer recognizing him as a shareholder. Similarly, weak internal controls seem to have resulted in frauds by employees. The company is fighting in many criminal cases.

Going ahead, investors keep a close watch on the receivable levels of the company, profit margins, utilization of cash, investments in subsidiaries or other companies, developments related to the tax disputes and litigation including the criminal cases, spending on R&D as well as the trend of the total number of employees. If an investor notices that the company has taken any step, which is not in the interests of minority shareholders, then she may take a decision accordingly.

Further advised reading: How to Monitor Stocks in your Portfolio

These are our views on Quick Heal Technologies Ltd. However, investors should do their own analysis before making any investment-related decision about the company.

You may use the following steps to analyse the company: “Selecting Top Stocks to Buy – A Step by Step Process of Finding Multibagger Stocks

Hope it helps!

Regards,

Dr Vijay Malik

P.S:

DISCLAIMER

Registration Status with SEBI:

I am registered with SEBI as an Investment Adviser under SEBI (Investment Advisers) Regulations, 2013

Details of Financial Interest in the Subject Company:

Currently, I do not own stocks of the companies mentioned above in my portfolio.

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