ShareScope agers Cat) STV ektoidl sl) ON el a Cake Box Holdings has some accounting issues | Small-Cap Spotlight Report (LSE: a Posted on | By Cake Box's shares have tripled as its franchisees sell more egg- free cakes and open more shops. But Maynard Paton discovers the accounts contain some unusual financial disclosures and alarming remarks from the auditor.Oh dear. | had expected this article to celebrate a dynamic growth company that had commendably prospered during the pandemic. | find myself instead relaying some unusual financial reporting after digging deep into a few annual reports. Read on to discover: = Anerroneous £2 million entry within the cash flow statement; = The inconsistent disclosure of related-party transactions; = The delayed reporting of a website breach to the auditor (and customers); = “Historic errors’ with stock control; = The auditor resigning after becoming “concerned about the robustness of the Company's control and governance frameworks", = The peculiar disclosure of trade payables and receivables, and the level of receivables versus revenue, and; = Bookkeeping curiosities such as overdue tax, R&D tax credits and regular revaluations of distribution centres. Let’s take a closer look.Egg-free cakes sold through 200 Cake Box outlets The small-cap in question is Cake Box, the owner of a popular brand of fresh cream cakes. The business operates as a franchisor. It manufactures a “high end, secret recipe" egg-free sponge that is sold to numerous franchisees who in turn use the sponge to make the cakes. The franchisees presently sell the cakes from 200 outlets.Cake Box floated on AIM during 2018 at 108p and the shares have since tripled to support a market cap of almost £140 million: epienare rice) Cake Box Holdings PLC (CBOX) 450 400 ° ‘Octoder 2018 Apri'2019 October 2019 April 2020 October 2020 April’2021 October 2021 www.sharepad.co.uk Month/Year @SharePad Franchisees opening new shops combined with some impressive like- for-like sales figures have powered revenue and profit higher:move, Cake Box Holdings PLC (CBOX) 2016 2017 2018 2019 2020 2021 www-sharepad.co.uk Year @SharePad anor EST (my Cake Box Holdings PLC (CBOX) 5.0 45 4.0 = 35 30 B25 E20 ais 1.0 05 0.0 2016 www sharepad.co.uk Year The ‘quality’ ratios also look great: Quauiry EBIT margin, FCF conv ROE ROCE 21.6% 116% 37.8% 38.2% 3y avg 23.5% 3y avg 63.3% 3y avg 57.4% 3y avg 50.3% So far, so good. But then | opened the accounts and was not impressed.An extra £2 million and inconsistent related-party transactions The story starts with the 2021 annual report and a small error within the income statement. The entries did not add up, and | discovered the declared £854k tax charge differed to the £842k reported within the earlier results RNS: 4,209,270, 3,763,944 (242,382) (635,249) Annual report showed different tax expense Tncometax 3,128,585, Profit after income tox The cash flow statement contained a larger error: the insertion of a phantom £2 million entry: Increase in inventories (505,936) (486,519) (Increase)/decrease in trade and other receivables, (1,172,047) 119,818 Increase/(decrease) in trade and other payables 1,860,396 (38,537) Share based payment charge 288,000 198,968, Finance income (4,087) (17,872) 5,813,276 4,025,224 Annual report included extra £2,016k entry Gos95 sss Game 988 I ass 198368 Finance income (4,087) (17,872) Cath genertea rom operations sarga76 4025224Such mistakes may seem minor when the original RNS was correct. But double-checking the rest of the report felt in order, just in case. | found inconsistencies within the reporting of related-party transactions. Certain numbers for 2020 were restated lower within the 2021 annual report... 2001 Sales Balance ‘Me Sukh Chamdal? € € Cake Box (Cranley) Listed (0%) a835- 15708 Cake Box CT Limited (0%) 222,752 Cake Box Strood) Limited (0%) 17985 (Gravesend) Limited (0%) 3182 05,726 2020 sales of £833k restated as £498k S&S Cakes Limited (0%) 234337 Cake Box (Gravesend) Limited (0%) 129,143 Cake Box (Maidstone) Led (0%) Cake Box (S004) Limited (0%) (Cake Box (Crawiey) Limited (0%) Cake Box CT Limted (Caring Tow) ©) ..While certain numbers for 2018 were restated higher within the 2019 annual report: ‘Me Sukh Chamdal £ £ £ ‘ S&S Cakes United 20407 E 203495 ‘Cake Box (Gravesend) Limited * 2017 2016 £ £ £ Sales ‘Sales Sales for the forthe Balance forthe ‘Balance ‘at year ended asat year ended asat ‘March ~ 31March 31 March 31 March 31 March ‘S&S Cakes Limited 191,482 = _ 171,163 -Cake Box’s related-party transactions reflect the sale of goods to the franchisee companies controlled by members of the directors’ families. Taking the 2020 restatement, S & S Cakes and Cake Box (Maidstone) were included in the 2020 annual report but then excluded in the 2021 report. Companies House shows S & S Cakes changing ownership during March 2020 but does not show any similar ownership change for Cake Box (Maidstone). (Note: The 2020 numbers for Cake Box (Gravesend) and Cake Box (Strood) were swapped within the 2021 report) Again, this inconsistent reporting could be seen as a minor administrative issue. But my concerns over sloppy disclosure were mounting up. | now wondered how diligent the auditor had been when checking these entries within the 2021 report. | discovered the auditor had been pre- occupied with other matters. Website hack went undisclosed for more than a year The audit report within Cake Box's 2021 annual report contains some remarkable text. Cake Box's website was hacked during March 2020, but management only told the auditor about the data breach during the full-year audit process more than one year later:De eee aay Refer to page 60 (Accounting policies - Significant judgements and estimates) page 64 (Accounting polices ~ 2.18 Provisions) and page 76 (Ns rovsions) inFel was to be levied. Atoul povsionf f4ee4 20r0-e4 Management failed to soomtooe inform us...” the group wasnatified by the payment platform lamers that a = No wonder the auditor had to “complete additional work to determine whether all material matters had been notified". The audit report noted “the final compromise window’ relating to the breach occurred during August 2020, although Cake Box’s payments processor informed the company of the problem on 27 April 2020. Those dates suggest Cake Box took at least three months to rectify the website. (Note: Customers (and shareholders) were informed of the data breach during June 2021 — fifteen months after the hackers first struck!) Nor was the auditor enamoured by Cake Box's stock-keeping. “Historic errors" and “control weaknesses" were unearthed: Refer to page 63 (Accounting polcies~ 2.11 ~ Inventories) and page 72 (Note 15 ~Inventories) 396K) and as such a material balance s including sponges, food products but be ay act mat vesusested “Control weaknesses” EER sessment men riscn a Interestingly enough, Cake Box restated the amount of stock recorded as an expense for 2020...6. Operating profit The operating profits stated after charging/(crediting) 2021 € Depreciation of tangible Fixed assets 670,333 Stock recognised as an expense 9,768,319, 08,972) 2020 stock expense of £9,979k] 25s restated as £8,840k Depreciation of tangible fixed assets Stock recognised as an expense Profit on disposal of property, plant & equipment ..and for 2018: 6 Operating profit ‘The operating proficis stated after charging: 2018 stock expense of £5,390k' restated as £7,063k Finished goods and goods for resale Inventories recognised in cost of sales during the year as an expense 17 - £3,559,595, 2016 - £2,386,444), The audit report also contained this line: “Transactions posted to nominal ledger codes outside of the normal revenue cycle were identified using a data analytic tool and investigated.”The areas that we identified as being susceptible to material misstatement due to fraud were: ‘Audit procedures performed by the audit engagement team: Obtaining an understanding ofthe processes and controls around revenue recognitio’ Transactions posted to nominal ledger codes outside of the normal revenue cycle were identified usinga data analytic tool and investigated nts; timates are indicative Jt are unusual My earlier concerns of sloppy disclosure had now shifted to wider doubts about the company’s financial controls. And then | realised the auditor had resigned. heme § HazelnuThe auditor’s letter of resignation Relations with the auditor were severed completely last September. An RNS at the time said: “Cake Box, the specialist retailer of fresh cream cakes, is pleased to announce that following a competitive and comprehensive tender process, overseen by the Audit Committee, it has appointed Macintyre Hudson LLP (“Macintyre Hudson") as the Company's auditor with immediate effect. The Company intends to put the appointment to a vote of shareholders at the Company's next Annual General Meeting. The Company's previous auditor, RSM UK Audit LLP, submitted its letter of resignation to the Board of Directors on 16 September 2021. In accordance with the relevant Companies Act 2006 requirements, a copy of the resignation letter and statement of reasons will be sent to shareholders of the Company." The statement seemed innocuous enough, until | read the copy of the auditor's resignation letter: Statement of reasons relating to the resignation of RSM UK Audit LLP as auditors to Cake Box Holdings Pic - Company Number 08777765 ("the Company”) In accordance with section 519 of the Companies Act 2006, we consider that the following matter connected with our ceasing to hold office should be brought to the attention of the company's members and creditors: Sarg Seon famed orn osucn wenden delays did not, however, prevent us from issuing an unqualified audit opinion on the Company's financial statements for the year ended 31 March 2024 RSM uk Ak WPAn auditor becoming “concerned about the robustness of the Company's control and governance frameworks" seems very alarming to me. Note that the RNS announcing the change of auditor referred to a “competitive and comprehensive tender process". But Cake Box did not mention an audit tender process within its 2021 annual report. Cake Box was in fact happy to recommend the re- appointment of the auditor at the AGM just six weeks before the resignation: Subject to the passing of this resolution, the final dividend willbe paid on 13th August 2021 to those Shareholders on the register at the close of business on 16th July 2021. The ex-dividend date is therefore 15th July 2021. RESOLUTIONS 4 AND'S: RE-APPOINTMENT OF AUDITORS AND AUDITOR REMUNERATION Resolution 4 relates to the Jas the Company's auditors to hold office until the next Annual General Meeting and Resolution 5 authorises the Directors to set their remuneration, RESOLUTIONS 6-11: RE-ELECTION OF DIRECTORS ‘The Board have decided that at the AGM, and at each subsequent annual general meeting all directors will be put forward for re- election, Resolutions 6-11 therefore concern the re-election of each of Neil Sachdey, Sukh Chamdal, Pardip Dass, Dr Jaswir Singh, Martin Blair and Adam Batty as Directors of the Company. The wording of the auditor's resignation letter — in particular, “we consider that the following matter connected with our ceasing to hold office should be brought to the attention of the company’s members and creditors" — does not suggest (at least to me) the departure was due entirely to a tender process.The peculiar disclosure of trade payables and receivables The auditor's departure prompted me to look closer at the 2021 annual report. The following accounting note is perhaps the most peculiar. | cannot recall ever seeing another company provide the ageing profile of its trade and other payables: Taran otegzae geing of| =e 010300 01000 payables rsa 45509 010900 ans8 a5 40300 19278 a76s9 15500 Bias 1295016 9010120094 Tou The reporting standard is to disclose the ageing profile of trade receivables, as demonstrated by fellow high-street franchisor Domino’s Pizza below: ‘1, Trade and other receivables continued ‘Trade receivables “Trade receivables are denominated nthe folowing currencies: Ageing of 1 re generaly on seven t0 28 day terms. As at 27 December 2020, there was # (2019: €0.6m), iss of trade rocsvable is 8 follone: Fir December 2020 a8 20 CT Domino's says its trade receivables — i.e. money owed to the group by the franchisees — are “generally on seven to 28 day terms’. A comparison between Domino's trade receivables and revenue bears this payment arrangement out. Trade receivables of £12 million represented 2.5% — or 9 days’ worth — of its revenue of £505 million. In contrast, Cake Box's trade receivables of £2 million represented 9.3% — or 34 days’ worth — of its £21 million revenue for 2021 That level of receivables does seem large given Cake Box’s annual report says franchisees have a “defined seven day payment term16. Tradeand other receivables Franchise Suppor Fund mentioned Trade receivables of reece tecieasrenoe £2m appear large given a 7-day payment term Cake Box strangely does not include an ageing profile of its trade receivables within its annual reports. But the company did confirm bad debt write-offs were zero for 2021 (albeit using the wrong date): el Overdue tax, R&D and property revaluations My studying of Cake Box's annual reports revealed these interesting snippets. Having to pay interest on overdue tax (during 2021 and 2019) does not suggest timely bookkeeping: 7. Netfinance costs Overdue tax| a me Franeergeses Berta, 577 m8 rsrest avowed 5615 Bankers read omy Gar) oul 37209 36357 The company’s “cake innovations" have attracted R&D tax credits that have reduced the tax charge every year since at least 2016: Profit on erry cies before sresp cee ee eterna |cake innovations} wm nisi ech despre actin Oeretene ta Cory enicintmentintimtre arAnd freehold properties have been revalued upwards three times during the last five years, including this £1.4 million — or 43% — uplift for 31 March 2020: 14. Property, plant and equipment Assets under £1.4m revaluation |= ALT April2019 1,570,793 2,500,000 1,103,652 306,927 120348 392,310 253,837 1,002,4 585,130 6,569,177 1,266,242 Additions Disposals Transfer between lasses (639,543) 724851 | BALANCE SHEET (Cake ox hs a srong bance shet with a cash bance at he yeasendol 217m The Goug ony debts amorigage ol £6 Hieenataes secured by is freehold properties in Enid and Covert ‘A351 March 2020 1,038,177 4,624,851 Cake Box carries its warehouses, distribution centres and bakeries at fair value, which is entirely legitimate but does require regular revaluations. Assets written off é All | can say is | cannot recall looking at another non-property company with the same regular revaluation policy. And ensuring warehouses are valued properly does seem odd when the auditor has highlighted various reporting deficiencies.Cake Box’s actions to improve and enhance I should stress that Cake Box’s 2021 annual report was signed off by the auditor with an unqualified audit opinion What's more, the company has taken steps to improve its administration. June's annual results mentioned “strengthening our internal audit function“ “This includes the recruitment of an IT Director, a Commercial/Managing Director with responsibility for Group marketing and supply chain management, a Financial Analyst and strengthening our internal audit function to ensure that stronger ongoing controls are operated across the group particularly in light of the data breach and increased online sales." September's letter to shareholders then referred to “actions to enhance the Company's control and governance framework”. “In order to support the growth of the business, in recent months we have taken a number of actions to enhance the Company's control and governance framework. These include appointing an additional new Non-Executive Director, Alison Green, the appointment of BDO LLP to fulfil an internal audit function and hiring additional senior staff." And the latest interim results stated “improved internal audit practices’ “We have strengthened our internal IT capabilities by appointing an experienced IT Director and further invested in our IT systems. We have also appointed BDO to assist with implementing improved internal audit practices.’ The recruitment of extra senior staff was also touched upon during three results webinars (here, here and here) during November. Perhaps the company’s actions alongside a fresh auditor will now combine to prevent any further reporting mishaps. Judging by the share price, the market certainly believes the growth story will continue, A lot of the webinar talk was of expanding the franchisee estate from 200 locations to beyond 400 during the years ahead, Such projections have fed through to the positive forecasts below:FORECASTS ~—~—_ £ millionsunlessstated Year 2022 2023 2024 Turnover 906 307% 345 127% «985 HTH EBITOA 780 +444% 868 “119% 9.86. 196% eer 694 +455% 797 +49% 898 +123% Presiax profit 696 489% 7.86 128% «= 898 149% Posttax profit E E 2 EPS(p) 443 149.1% 162 +129% 183 +196% Dividend (9) 712 +282% 7.90 +10% 903 143% Capex - - Free cash ow 400 474% 6.28 900% 7.14 H13.7%, Net borrowing 662 10.28 “14382 NAV. E e 2 Like for tke sales growth % = Financial risks and unusual disclosures Maybe the market is right. Cake Box has after all exhibited very respectable growth during recent years, which continued with November's impressive half-year performance: Half year ended 30 | Half year ended 30 ‘September 2021, September 2020 (en Fv2a) (uaa)? £16.47 859m £7.61m £4.16 416m £1.98 370m 1.6m £4.15 £3.80 557m 534m 7.469 3.459 I therefore admit | could be acting far too sceptically here, and | may be missing out on an exceptional growth stock if my worries prove unfounded. But I have learnt over time not to take financial risks with shares where | have any doubts about unusual disclosures. Inspecting annual reports and raising awkward points (¢.g. LoopUp and Purplebricks) have helped protect my portfolio from rash investments, and | intend to keep things that way. While Cake Box does not convince me, you can of course download the-eccounts, double-check what | have written and then make up your own mind. Until next time, | wish you safe and healthy investing with SharePad. Maynard Paton Maynard writes about his portfolio at maynardpaton.com and hosts an investment discussion forum at quidisq.com. He does not own shares in Cake Box. Additional UPDATE note: Cake Box issued a statement on 24/01/22 following the publication of this article, The full statement is below:“Cake Box notes the movement in its share price this morning and also notes recent commentary from a retail investor blogger. “The Company acknowledges some transcription errors between its 2021 Full Year Results announcement published on 30 June 2021 (the “Results Announcement’) and the 2021 Annual Report and Accounts (the “Annual Report’). It also notes inconsistencies in prior period inventory reporting and comparative period disclosures relating to director interests in franchise stores. Where such discrepancies exist between the Annual Report and the Results Announcement, investors should refer to the Results Announcement. “The errors noted have no impact on the Group's reported profits, cash flows or balance sheet and the Company received a clean audit opinion for the year. “As previously announced and as we continue to grow the business, a key priority for the Board remains underpinning growth with the appropriate level of experience and expertise for the Group's central functions, internal controls and processes. BDO has also been appointed to assist with implementing improved internal audit practices. “The Board confirms that, since the Company updated the market with its half year results in November, trading in H2 has continued strongly and in line with expectations for the full year.” This article is for educational purposes only. It is not a recommendation to buy or sell shares or other investments. Do your own research before buying or selling any investment or seek professional financial advice.