Revenue Recognition, Patisserie Valerie, Utilitywise and Cryptocurrencies

Revenue recognition is a hot topic at present as folks have come to realise that this is a frequent cause of company accounts misrepresenting the true state of the business. Quindell and Blancco are two examples and I cover Utilitywise below. But first let me report on the Annual General Meeting of Patisserie Valerie (TIDM:CAKE) which I attended this morning (as a shareholder of course).

The company operates a chain of cake+coffee shops under the company name but they also have several other brands. However they seem to be concentrating on the Patisserie Valerie one in terms of new openings. This is a typical “retail roll-out” story where they just open more outlets – fixed costs do not increase in proportion so profits grow rapidly. They plan to open about another 20 stores per year at present. The company is run by Executive Chairman Luke Johnson who owns 38% of the company.

Having read the Annual Report I asked a question on revenue recognition because on page 16 it says “revenue recognition has been identified by the audit team as a significant risk”. Perhaps the auditors are now hedging their bets by putting that in all company reports but I found it rather surprising bearing in mind that I expected most customers would be paying cash in the cafes. Indeed the CFO indicated 80% of revenue is in cash. They do issue promotional vouchers but these are not recognised as revenue until used. However they do have some wholesale customers and franchise deals with companies such as Sainsbury where payments are delayed. This explains why they have significant trade accounts receivable at £12.3 million on revenue of £114 million. So I don’t think revenue recognition is likely to be an issue in this company.

Otherwise the AGM was fairly routine and we did get some cake at the end. There were about a dozen shareholders present in the City at one of their outlets. Luke Johnson is not a greatly impressive figure physically (first time I had met him) but answered questions openly. He noted profits were up 19% at £16.4 million. He said they opened 20 new stores and all were immediately profitable. Net cash was £25 million at the year end so they are well positioned for acquisitions if they arise, he noted. A couple of interesting questions from shareholders were:

1. Is there any difficulty in attracting staff, particularly in London and the South-East. Answer: probably as hard as it has ever been, but they expect a lot of foreign staff to stay in the UK after Brexit and many are non-EU citizens anyway.
2. Media have reported a possible acquisition of Gails, a similar chain (and partly owned by Luke Johnson I believe). Answer: cannot comment.

In summary, Patisserie Valerie is riding on the popularity of cake and coffee of late, but they are differentiated slightly from common coffee shops. They are also vertically integrated which keeps costs of the cakes low and as a result have good profit margins. Defending that position could be tricky but the business seems to be well managed.

Utilitywise (UTW), a reseller of utility power contracts, has had its shares suspended after failing to file accounts within the timescale required by the AIM market rules. To quote from the company’s announcement: “This delay is due to the volume of work still required to be completed by the Company and its auditor to cater for the proposed change in the Company’s revenue recognition policy, as announced on 17 January 2018. This work includes amendments to the Company’s financial reporting systems in order to analyse energy contract data in accordance with that new policy, alongside associated work by the Company’s auditor, for the audit of its results for FY17 to be completed.”

Now I don’t currently hold this company’s shares but I did briefly from December 2013 to July 2014. The more I learned about the way revenue and profits from contracts entered into that covered future periods were recognised, the more concerned I became. Revenue was still reportedly growing rapidly in 2014 but I sold at about 260p. The share price recently was near 40p.

In my book, revenue and the associated profits from long-term contracts should not be recognised until the cash comes in. But that’s not the way accountants like to handle matters at present. Part of the difficulty lies in costs expended in the short term to obtain or develop the contracts so matching costs with revenue, a basic accounting principle, is a problem.

Lastly I think it is worth mentioning cryptocurrencies, initial coin offerings, bitcoin and blockchain technology. These are all hot subjects that I do not think I have covered before which is probably a gross omission.

Blockchain technology is interesting. It’s basically an “open ledger” which might have many applications, although whether it is really any good for really high volume transaction processing seems to be in doubt. Many banks and other financial institutions seem to be looking at it but it is not altogether clear why they need it (are not existing systems and software adequate enough? Perhaps they are just a bit archaic?). It may be lower cost and simplify development but it potentially has great weaknesses.

For example, Coincheck, the “Leading Bitcoin and Cryptocurrency Exchange in Asia” as they style themselves, recently suffered a hack that meant $500 million has disappeared into the hands of the perpetrators. They have promised to reimburse affected customers but it seems highly unlikely that they have the financial backing to do so.

This is not the first such time this has happened. Another case was that of MtGox which became bankrupt after a similar fraud. So it seems bitcoin systems are not as secure as one might have hoped.

One reason internet fraudsters like payments in Bitcoins is allegedly because they cannot be traced. So does that mean there is no audit trail so one cannot trace where the funds come from and where they go to? This is a major defect in any transaction system which suggests to me that Bitcoins and other similar currencies based on blockchain technology should be promptly regulated by all countries as soon as possible. There may be a need to have a “virtual” currency not controlled by any one Government, but unless it is secure with proper audit trails on its movement, it is not fit for purpose.

The Financial Conduct Authority (FCA) should be looking at this area and pronto before the wide boys of the financial world exploit gullible folks and fraudsters take advantage of its defects.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )