BEST World International is hiring an independent reviewer to scrutinise its business and accounting practices, after The Business Times raised concerns last week over the challenges in tracking sales of its DR's Secret line of premium skincare products in China.
In a statement on Saturday, the company said that it has conducted its business ethically and in compliance with applicable laws, but "is not responsible for the accounting and sales records of the franchisees, who are independent third parties".
Up until a week ago, Best World shares were on a multi-year rally, driven by strong growth in China. The group derives 66 per cent of total revenue from sales of the DR's Secret line of premium skincare products in China under its franchise model.
Revenue is booked when the franchisees in China purchase inventory from Best World. At least one analyst has pointed to challenges reconciling between upfront sales figures and underlying consumer demand in China.
Best World said the findings from the independent review will be published and reported to its audit committee, as well as to the Singapore Exchange RegCo. The exact timeline and scope of the review was not specified, but updates will be made in due course.
Separately, the company's auditors, Ernst & Young, have laid out an audit plan for the group's financial statements for the year ended Dec 31, 2018, which will include reviewing samples of revenue contracts and reviewing relationships with customers for evidence of related party sales.
In China, where the franchise model has been adopted since the second quarter of 2018, "EY will also consider conducting site visits at BWL Lifestyle Centers operated by franchisees on a sample basis, and will request confirmations from franchisees on sales transactions with the group", the group said.
These procedures are "appropriate to ensure the occurrence, completeness and measurement of revenue recognised by the group", Best World's directors believe.
Auditors typically sign off on Best World's audited group financial results in early April, ahead of its annual shareholder meeting.
Both the audit report and independent review will be watched closely by investors.
This is because Best World's unique distribution model for DR's Secret in China gives outsiders limited visibility over how its franchisees operate and record sales. In the past, Best World has used the term "social selling" to describe how its franchisees operate.
Best World clarified on Saturday: "The group does not directly conduct any sales transactions in China through online stores or social media, including Taobao. The products are primarily distributed in China by franchisees directly to consumers through BWL Lifestyle Centres in China...
"Franchisees may also use online and social media platforms as communication tools, which, for example, enables customers to send messages through platforms like WeChat to franchisees to place orders informally, make payments separately by bank transfer or online money transfer platforms, and arrange for delivery or pick-up of such products at BWL Lifestyle Centres."
Last week, BT wrote that not a single one of Best World's franchisees is listed on the company website. Generally, its retail locations in China are exceptionally hard for consumers to track down.
Since the BT article on the company was published, Best World has listed the addresses of 33 BWL Lifestyle Centres on its website. It has 33 franchisees now, up from 28 at the end of 2018.
However, the registered names of the franchisees were not disclosed, and Best World's management did not immediately respond to a request for disclosure sent by BT last Thursday.
In the weekend's announcement, Best World clarified the payment terms and accounting treatment for its franchisees: "Generally, franchisees pay the group for the products in cash before delivery, though the group may consider extending credit terms to franchisees on a case by case basis."
It added: "The group is not responsible for the accounting and sales records of the franchisees, who are independent third parties."
Even so, Best World's management "periodically visits the franchisees to understand their operating conditions and the market demands for the products", it said.
"As at Dec 31, 2018, the group had worked with each of the 28 franchisees signed in 2018 for an average period of five years," it added.
To ensure reliable financial reporting when it switched to a franchise model, Best World also hired a third party internal controls consultant firm to review the group's internal controls policies with respect to entity-level controls, including accounting and cash management procedures, it said.
It did not identify the firm. This firm conducted physical inspections of 10 BWL Lifestyle Centres operated by franchisees and performed background and qualification checks, reviews of sales and promotions records, inspection of inventory and compliance management systems, and licence reviews, Best World said.
Best World also confirmed on Saturday that the direct selling licence it obtained in 2016 covers only "certain health supplement products over a limited geographical space in China", and does not cover the DR's Secret skincare line.
Direct selling, in which companies recruit sales promoters to sell products directly to end consumers outside the companies' fixed outlets, is a regulated activity in China, as part of a broader crackdown on illegal pyramid schemes.
"Since obtaining the direct selling licence in 2016, the group has not conducted any sales in reliance of the direct selling licence," Best World clarified.
Although it had considered adopting a direct selling model in China, Best World said it dropped the idea as it would require the expansion of the coverage of the group's direct selling licences, and the establishment of service outlets in every district of every city in which the products are distributed due to legal requirements, which would have been "inefficient" and "costly".
The group added that it had obtained legal advice from its legal counsel that the operation of its franchise model is lawful. It did not identify its legal counsel, except to say that it was one of the largest law firms in China.
Best World has also used data from Euromonitor to show that it was the 13th largest company in China's premium skincare market in 2017. Last week, BT reported that it was told by the market research firm that Best World was "not significant enough to be tracked" according to its 2017 research methodology.
Best World clarified on Saturday that it had commissioned Euromonitor to perform "customised research" late last year, and obtained the ranking directly from Euromonitor.
It explained: "Euromonitor was not able to ascertain Best World's ranking prior to conducting the 'customised research', as the company was an emerging player operating in the fragmented premium skin care market in China. The company's ranking was ascertained based on the additional market information and industry data obtained by Euromonitor through 'customised research'."
Best World did not elaborate on the exact nature of "customised research", except to say that it is of a narrower scope and "more company and category focused than the research methodology used in producing 'published research'".
Since its listing in 2004, Best World had been audited by RSM Chio Lim, until it was replaced by EY in 2017. EY partner Ang Chuen Beng is lead engagement partner. At the time, Best World's audit committee explained that a periodic rotation of auditors would enable the company to benefit from fresh perspectives and enhance the value of the audit.
Trading in shares of Best World will resume on Monday. Best World had requested a trading halt last Monday after its shares fell 16.6 per cent following a BT report published that day, titled Sales of DR's Secret in China: Best World's best-kept secret?