AppScatter Group – Another Case of Very Dubious Accounts

Last night I gave a presentation on my new book and explained why accounts are not to be trusted. I said that there were several new examples revealed every month of dubious accounts and today we have another one. In this case the company is AppScatter Group (APPS). This is an AIM listed company whose shares are currently suspended because of a proposed acquisition. I do not hold the shares but have been monitoring it as it operates in a sector that is of interest to me.

Today they published their interim results for the period to the end of June. To quote from it: “appScatter is a scalable B2B SaaS platform that allows paying users to distribute their apps to, and manage their apps on, multiple app stores. Additionally, the centralised platform enables app developers and publishers to manage and track performance of their own and competing apps across all of the app stores on the platform”.

Launch of the platform is behind schedule putting pressure on working capital so they have issued equity to raise £1.6 million and entered into a loan facility for £5 million on which they are paying 11% interest to cover that and the acquisition costs.

Revenue was up on the 2018 figure at £710k but the half year loss was £5.1 million. But this is the really surprising statement: “The revenue for the first six months of 2018 included accrued revenue of £576,573. This related to work carried out for corporate customers where invoicing was anticipated to occur after the reporting date.  Only £38,000 of this work had been invoiced as at 31 December 2018 and given timing uncertainties under when the balance will be invoiced the accrued revenue was not recognised for the twelve months to 31 December 2019. On a consistent basis the comparable revenue figure for the first six months of 2018 would be £365,596”.

So in simple words, they recognised future revenue when there was no certainty of invoicing or when it could be billed. This is just totally imprudent accounting but the directors signed off on this and their AIM Nomad would have done so also.

This kind of sharp practice hardly inspires confidence in the future of the business. But it’s symptomatic of the lax accounting standards that have crept into public companies of late. The 2018 full year results show the CFO resigned in June 2018 and adoption of IFRS15 reduced revenue by £1 million over the prior year. The accounts were also qualified by their auditors over the valuation of their investment in Priori Data.

Unfortunately although I do not hold the company directly it is held by two of the Venture Capital Trusts I hold. I hope they make representations to the management on this issue.

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

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Eddie Stobart Logistics and Reasons to be Fearful

No sooner had I published a book that says investors cannot trust the accounts of companies when making investment decisions (“Business Perspective Investing”) than we have yet another case of dubious financial reporting. The latest example is that of Eddie Stobart Logistics (ESL) which has announced that “the Board is applying a more prudent approach to revenue recognition, re-assessing the recoverability of certain receivables, as well as considering the appropriateness of certain provisions”. CEO Alex Laffey is leaving with immediate effect, profits seem to now be uncertain, the dividend is being reviewed and the shares have been suspended. In other words, it’s one of those shock announcements that undermines investor confidence in company accounts and in the stock market in general.

That follows on from the case of Burford Capital where revenue recognition has also come into question and I personally doubt the accounts are prudent. We seem to be getting about one case per week recently of accounts that are called into question or where significant restatements are required. I may need to revise my book sooner than expected because it contains a list of examples of dubious and fraudulent accounts in companies which is rapidly becoming out of date!

ESL is of course one of Neil Woodford’s largest investment holdings – he holds 22% of the company. Mr Woodford has also suffered from a write down in the value of his holding via Woodford Patient Capital Trust in Industrial Heat due to slow business progress. This is a company focused on “cold fusion” technology. Mr Woodford seems to be adept at picking risky investments of late which is not how he built his former reputation. Even the Sunday Times is now attacking Neil Woodford with an article today headlined “Neil Woodford’s worthless tech bets” which covers his investments in Precision Biopsy and SciFluor Life Sciences and which are now alleged to be almost worthless. I feel it’s going to be a very long time before his reputation recovers.

As regards more wider issues, there was a very good article by Merryn Somerset Webb in Saturday’s Financial Times under the headline “So many reasons to be fearful”. She points out that due to low interest rates making it seem irrelevant how long it might be before exciting companies actually produce returns, value stocks are trading lower relative to growth stocks than they have for 44 years. The pound is also at a 35-year low against the dollar and US stock prices at a 50-year high relative to US GDP.

Bond yields are so low that even in nominal terms they are negative in many parts of Europe. What should investors do? She comes up with some suggestions such as investing in commodities such as gold or silver, or even oil because there is a risk that with Governments running out of options to stimulate their economies, they may start printing money which will drive up inflation.

She also comments on a likely new “cold war” to be fought by the USA and China over trade which will may profoundly affect many of our investments. She argues that the next 30 years may be very different to the last 30.

Altogether an interesting article well worth reading if just to remind ourselves that the world is rapidly changing and that we live in very unusual times.

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

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Renold Accounts, Audit Quality and Abnormal Price Movements

Chain maker Renold (RNO) has provided the latest example of sloppy accounting work. On the 9th July it reported that it had identified accounting issues in the three years ending March 2017, 2018 and 2019. Assets and profits were overstated and liabilities were understated in the Torque Transmission division. In total adjusted operating profits were overstated by £1.8 million. As a result the AGM is being postponed to give time for revising the Annual Accounts. Their auditors are Deloitte.

The Financial Reporting Council (FRC) have reported on their latest assessment of audit quality and it makes for dismal reading. Their target for assessed audits is 90% being “good or requiring limited improvements” but only 75% of FTSE 350 audits met that target. Overall there has been no improvement on last year.

Grant Thornton and PwC came in for particular criticism. Scrutiny of Grant Thornton has been increased and PwC is required to take “prompt and targeted action” to address their decline in performance. KPMG also continues to be subject to increased FRC scrutiny. The FRC suggests that all audit firms suffer from failing to challenge management sufficiently on judgmental issues, and need to work harder to solve this problem.

Comment: this has certainly been a long-standing issue that is driven by the desire of audit firms to reduce their prices to win business and reluctance to challenge management. Renewal of audit contracts with the same firm over many years contributes to the problem. The only way to break this system is to change how auditors are hired. At least that’s my personal opinion.

But the good news for investors is that the Financial Conduct Authority (FCA) have reported that abnormal price movements before deals are announced were down last year. In other words, market abuse has fallen by 12% and is now at its lowest level since 2006.

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

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PwC Fined over Audit at Redcentric

Audit firm PwC have been fined £4.5 million by the Financial Reporting Council (FRC) for the defective audits of Redcentric (RCN) in 2015/2016. Two audit partners at the firm were also fined £140,000 each.

Redcentric is an IT services company which had to restate its accounts when a £20 million hole was discovered. Assets were written down and the profit of £5.3 million in 2016 was restated to be a loss of £4.2 million. Professional scepticism by the auditors was apparently missing so that management were able to present fictitious figures and get them through the audits.

The current Chairman of Redcentric appears to be reluctant to pursue legal action on behalf of shareholders against PwC which is surely unfortunate. Shareholders would have difficulty in pursuing an action for their losses directly because of the Caparo legal judgement, but a “Derivative” action can be pursued I suggest.

But this is yet another case where the audit profession has failed to pick up serious defects in the accounts of a company. It’s yet another example of why the audit profession needs to improve its game to meet the reasonable needs of investors and other stakeholders.

I have never held shares in this company but I feel for those who were duped by the company and its management into investing in it.

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

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Paying Illegal Dividends, Burford Capital, Woodford Patient Capital Trust and Zero Carbon Objective

A group of investors including Sarasin, Legal & General, Hermes and the UK Shareholders Association (UKSA) has written to Sir Donald Brydon who is undertaking a review of the audit market. They have yet again raised the question of whether the International Financial Accounting Standards (IFRS) are consistent with UK company law. In particular they question whether profits are sometimes being recognised, thus allowing the payment of illegal dividends. The particular issue is whether profits can arise on certain transactions under IFRS from transactions between parent and subsidiary companies or by the use of “mark to market” accounting. The problem is “unrealised profits” that might turn into cash in the future, but may not.

This may appear a somewhat technical question, but it can in practice lead to over-optimistic reporting of profits, leading to excessive bonus payments to managers, and the general misleading of investors. Actually calculating when a dividend can be paid as dividends are not supposed to be paid out of capital is not easy and is not self-evident to investors. The published accounts do not make it obvious. Regular mistakes are made by companies requiring later “whitewash” resolutions to be passed by shareholders. The ICAEW has previously rejected complaints on this issue but it is surely an area that requires more examination.

Incidentally I was reading a book yesterday entitled “White Collar Crime in Modern England” (from 1845-1929) which is most enlightening on common frauds that arose when limited companies became popular – many of the frauds still persist. In the “railway mania” of the 1840s it was common to set up companies and raise the capital to build a railway when the chance of it operating profitably was low. To keep the share price high, and the directors in jobs, dividends were paid out of capital. To quote from the book: “unscrupulous directors could easily pay dividends out of capital undetected – projecting a false image of profitability and enticing further investment in their lines”. That was an era when auditors did not have to be accountants and were often simply the directors’ cronies. Standards and regulations have improved since then, but there are still problems in this area that need solving.

There was an interesting discussion on Twitter recently on Burford Capital (BUR) with regard to their accounting methods. Not that I am an expert on the company as I do not hold shares in it, it but as I understand it they recognise the likely future settlements from the litigation funding cases they take on. In other words, they estimate future cash flows based on projections of likely winning the case and the possible settlements. As I said on Twitter, lawyers will often tell you a case is winnable but they will also tell you the outcome of any legal case is uncertain.

It’s interesting to read what Burford say in their Annual Report under accounting policies where it spells it out: “Owing to the illiquid nature of these investments, the assessment of fair valuation is highly subjective and requires a number of significant and complex judgements to be made by management. The exit value will be determined for each investment by the contractual entitlement, the underlying risk profile of the litigation, a trial or an appellate outcome or other case events, any other agreements in respect of settlement discussions or negotiations as well as the credit risk associated with the investment value and any relevant secondary market activity”.

The auditors no doubt scrutinise the reasonableness of the estimates but any outside investor in the shares of the company will have great difficulty in doing so.

Neil Woodford’s Equity Income Fund has a big holding in Burford Capital. I commented on the Woodford Patient Capital Trust yesterday here: https://roliscon.blog/2019/06/11/woodford-patient-capital-trust-is-it-an-opportunity/ and suggested the Trust made a mistake in naming the Trust after him. It makes it more difficult to fire the manager for example. But the FT reported this morning that the Trust has indeed had conversations about doing just that. Woodford’s firm has a contract that only requires 3 months’ notice which is a good thing. At least they can keep the “Patient Capital” moniker because investors in this trust have already had to wait a long time for much return and it could take even longer to improve its performance under a new manager. But as Lex in the FT said, “patience is now in short supply” so far as investors are concerned.

Another major item of news yesterday was soon to be ex-Prime Minister May’s commitment to enshrine in law a target for net zero carbon emissions in the UK by 2050. This is surely a quite suicidal path for the UK to follow when most other major countries, including all the big polluters, will be very unlikely to follow suit. Even Chancellor Philip Hammond has said it will cost about £1 trillion. It will effectively make the UK completely uncompetitive in many products with production and jobs shifting to other countries. We might become the first really “de-industrialised” country which is not a lead that many will follow, and it will actually be practically very difficult to achieve if you bother to study what is required to achieve zero emissions. It will completely change the way we live with the transport network being a particular problem (trains, planes and road vehicles).

As I have said before, if we really want to cut air pollution and CO2 emissions, then we need to reduce the population as well as rely on such wheezes as electrification of the transport and energy systems. Mrs May’s last act as Prime Minister might be to commit the UK to economic suicide. It might not be a good time to invest in UK manufacturing companies.

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

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Share Plc Offer and Improving Corporate Reporting

There was a surprise announcement this morning of a possible offer for Share Plc (SHRE) who run the Share Centre. That is a very popular platform with private investors because it is low cost and administratively efficient but also because it is one of the few investment platforms that makes it easy to vote your shares held in nominee accounts such as ISAs. Takeovers of investment platforms are never popular with customers because it means having to learn one’s way around a new web/IT system and charges may also change. More consolidation of platforms will also reduce competition in this sector.

The offer is from Interactive Investor but it looks like they may have some difficulty even if founder Gavin Oldham supports it. He, his family and associated trusts held 69% of the share in December 2018 but there was also 18% held by staff and customers.

Yesterday I attended a roundtable at the Financial Reporting Council (FRC) to discuss the “Future of Corporate Reporting”. It was mainly attended by experienced private investors who I won’t name individually. But there was a consensus on many of the issues discussed. I will highlight some of the interesting points that arose:

  • There was widespread concern about the size of Annual Reports and the excessive “padding” and use of “boiler-plate” content. It was clear that most of the investors attending skipped large sections of most Annual Reports.
  • One even went so far to say that he always went to the accounts filed by a company at Companies House which often differed from that in the Annual Report and also contained more information. This is surely an issue that should be looked at by the FRC. It is surely not acceptable that there should be any difference.
  • There was a general view that commentary by the Chairman or CEO tended to be over-optimistic and that risk reporting was full of platitudes while ignoring the really big risks that a company faced. The Macando oil-well disaster at BP and the recent problems at Boeing with the 787Max were mentioned as examples.
  • Other particular issues raised were the valuation of intangibles on the balance sheet, the long-standing complaint that IFRS standards were inconsistent with Company Law (but the FRC has limited input to IFRS standards), the lack of disclosure of long-term debt terms, and the failure to disclose banking covenants.
  • There were also complaints about private investors being excluded from receiving some information disclosed to analysts by companies, and refusal for attendance at company presentation events. The lack of an equivalent rule to that in the USA (Regulation FD on Fair Disclosure) was a major problem.
  • As regards excessive size of Annual Reports, the FRC staff suggested that splitting up the Annual Report into sections might assist although I said that did not really solve the problem of excessive size and irrelevant content.
  • Reporting of ESG factors was discussed but this seemed to be a difficult area due to the lack of standards and the ability of companies to only present positive information.
  • The FRC does undertake quality reviews on large company audits and perhaps a scoring system for Annual Reports could be introduced to raise standards. But it is all too easy at present for company directors to throw masses of superfluous information into the Annual Report to distract investors from the really important facts. I suggested that there be a word or page limit on sections of the Annual Report to ensure that only key information was communicated. For example, do we really need 30+ pages of Remuneration Report as we are now getting at some companies? Where companies wished to provide more detailed information, that could perhaps be given on their web site.

In summary this was a useful meeting to raise the concerns of experienced and knowledgeable investors. Let us hope that the FRC will take up some of these issues.

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

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Horizon Discovery – Defective Accounting Discovered

Horizon Discovery Group (HZD) announced their full year results this morning. Horizon is a biotechnology company focused on cell engineering and CRISPR screening. Revenue was up by 68% to £58.7 million helped by an acquisition. But the “reported loss” increased to £35.8 million due to the exceptional write-off of past investment in “In Vivo”. Although this is a non-cash impairment it suggests that there was past over-optimism in the viability of that business unit and excessive capitalisation of development expenditure. This follows from a strategic review of the company last year by new CEO Terry Pizzie.

They also have a new CFO. There has been a review of revenue recognition policies that has led them to restate 2017 revenue down from £36.5 million to £35.0 million. This is what the company has to say about that: “In 2019, the Group became aware of potential revenue recognition matters in connection with certain license revenue contracts. As a result, the Group undertook a detailed review of all such contracts and determined that the terms and conditions in some of those contracts had been misinterpreted and as a consequence, the accounting periods in which the revenue is recognised have been reassessed, due to license revenues being recognised before they were committed”. Who were their auditors you may ask? Answer: Deloitte. This looks like yet another case of a basic accounting failure that the auditors failed to pick up.

At the last AGM of the company, which I attended as a small shareholder, I questioned why the company was losing money on services. Surely if services were unprofitable, they don’t need to be provided to customers? Good to see that in the latest announcement they are withdrawing from “investment” in parts of the services portfolio. Another interesting comment in the announcement is this: “Our ‘Investing for Growth’ strategy will see the business shift from a scientifically-led life sciences company to a fully commercial tools company, which will mean that Horizon is increasingly well placed to capitalise on its market-leading position to drive sustained top-line growth”.

Apart from the above issues, the company does seem to be moving in the right direction and the comments about future prospects from the CEO are positive. The share price was unmoved at the time of writing.

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

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