Finance Director's Report

SCISYS ANNUAL REPORT AND FINANCIAL STATEMENTS 2017

 

Finance Director’s Report

 

I am pleased to report that the rally in trading that we predicted in our Interim Report came to fruition in the second half of 2017, lifting the first-half figures to produce an admirable full-year result.

Both revenues and underlying operating profits reached historic highs and strong cash flows have made a significant dent in the net-debt position that peaked in December 2016 with the injection of additional borrowings to fund the ANNOVA Systems GmbH (Annova) acquisition.

 

REVENUES

Total revenues for the year were 25% higher at £57.2m (2016: £45.7m), of which the component relating to professional fees was £48.0m (2016: £37.6m). 48% of total revenue was from Eurozone customers (2016: 49%).

Following a welcome gain in value against the pound in 2016, the euro strengthened again in 2017, which boosted the Group’s revenue figures.

 

PROFITS

Since 2007 the Board has gauged the underlying performance of business using an adjusted operating profit measure that excludes the costs of the Group’s long-term share incentive schemes, exceptional items and any amortisation of intangible assets arising on business acquisition. Internal reporting is exclusively based on adjusted performance measures to facilitate comparison between financial years and publicly available research notes on SCISYS published by financial analysts focuses on these same measures. Adjusted operating profit was up 44% on 2016 at £4.6m (2016: £3.2m), while statutory operating profit was £4.7m (2016: £2.8m). The adjusted and statutory operating profit measures reconcile as follows:

2017 exceptional items totalled £2.1m and reflect the combination of a credit arising from the reassessment of contingent consideration payable under the Annova earnout arrangement and accrued UK Research & Development (R&D) tax credits. These exceptional items are explained in further detail later in this report. By contrast, 2016 exceptional items represented charges of £0.4m for non-capitalisable legal and professional fees relating to the Annova acquisition. 

On the acquisition of Annova on 31 December 2016, IFRS 3 required SCISYS to make fair-value consolidation adjustments to the Annova balance sheet. Intangible assets for fair-value recognition comprised the 2016 year-end order book and the internally developed intellectual property rights in Annova’s OpenMedia product. Recognition of these assets in the 2016 consolidated Group balance sheet resulted in non-cash amortisation charges to the 2017 income statement of £2.0m (2016: £nil).

Share-based payment charges were immaterial following the lapse of option awards granted in 2015, owing to the failure to achieve the associated three-year performance criteria.

The Group’s results were less adversely impacted by variations in the euro–pound exchange rate than in previous years for two reasons. First, the funding structure for the Annova acquisition and the sterling-based cash flows of its contract with the BBC served to bring the Group’s overall currency requirements more into balance, whereas in previous years the Group generated substantial surplus euro income from its German operations and UK-based space market activities. Second, although the currency-hedging contracts taken out in 2016 to convert anticipated surplus euros in 2017 into pounds went significantly out of the money following the EU referendum vote in June 2016, the devaluation was largely reflected in the 2016 accounts.

The Group has not entered into any external currency-hedging contracts for 2018 and beyond. Intra-Group hedging contracts will be used to balance the Group’s currency exposures across its subsidiary companies.

While revenues benefited from a stronger euro, the same foreign-exchange rate movement increased the sterling value of our euro-denominated costs in Germany. However, on a constant-currency basis, and excluding exceptional items, Group overheads – representing the costs for provision of shared business services to the divisions – were 4% lower than in 2016 at £8.0m (2016: £8.2m).

 

EPS

Adjusted basic EPS, calculated on the profit for the year before post-tax exceptional items, share-based payments and amortisation of acquisition-related intangible assets, were 9% higher at 10.0p (2016: 9.2p). Basic EPS were 11.5p (2016: 7.6p).

 

CASH AND DEBT

The Group closed the year with bank deposits (net of overdrafts) of £8.0m (2016: £6.7m), while Group borrowings amounted to £13.9m (2016: £16.9m). This resulted in net debt of £5.9m (2016: £10.2m).

Cash flow in 2017 was particularly strong for two reasons. First, anomalies in timing of two 2016 year-end receipts reversed in the first half of 2017 and did not recur, boosting bank balances by £1.9m. Second, the first earnout payment to Annova’s former owners of £1.7m in September was more than covered by receipt from the BBC of a significant milestone payment in August.

Unutilised working capital facilities at the year-end totalled £4.3m (2016: £4.4m).

 

ANNOVA SYSTEMS

Annova contributed to Group earnings for the first time in 2017 following completion of its acquisition at the end of 2016. Strategically the acquisition remains highly favourable. The order book is building as sales success expands Annova’s geographical footprint and cross-fertilisation of the customer base with our Media & Broadcast division continues to gain momentum.

Pre-acquisition due diligence identified that governance and management controls procedures were not as mature as those in the wider SCISYS Group, so during 2017 the Board conducted a thorough review of Annova’s financial disciplines and reporting processes. Annova management’s financial forecasts for 2017 proved over-optimistic as we had anticipated because they were flagged as a specific risk area during due diligence. This prompted SCISYS to adopt a purchase consideration structure that placed significant emphasis on performance during the three-year earnout period, 2016 to 2018.

The total purchase price payable for the Annova acquisition is linked both to average profitability and achievement of key commercial milestones in its flagship contract with the BBC. Annova successfully obtained customer acceptance for a critical phase of this project in August, three months earlier than had been provided for in the acquisition balance sheet. This triggered payment of a first earnout instalment of €2.0m in September 2017, of which 10% was satisfied in new SCISYS PLC shares, with the balance paid in cash from existing Group resources.

Annova’s over-performance in the first earnout year of 2016 raised expectations in the 2017 Interim Report for the level of contingent consideration that would eventually be payable by SCISYS to Annova’s former owners. Since publication of the first half-year results, Annova management has been included in the detailed Group business planning process for 2018–21. Application of planning and forecasting policies consistent with those across the rest of the Group has resulted in scaled-back expectations for Annova in 2018. This led to a reduction in the Group’s anticipated liabilities for earnout payments and resulted in an exceptional credit to 2017’s Income Statement of £1.6m.

The fair value of remaining contingent consideration for earnout payments included in the consolidated financial statements is £nil (2016: £3.3m). This compares with a contractual cap of £12.9m (2016: £14.6m).

 

TAX

The effective Group tax rate for the year was 15% (2016: 15%).

SCISYS continues to benefit from the tax-credit system for UK expenditure on R&D in SMEs, receiving credits in the form of cash rebates from HM Revenue & Customs. Up to and including 2016, these were incorporated into the net tax charge. An accounting standard change requires R&D tax credits from 2017 to be treated as deductions from operating expenses. SCISYS anticipates that it will no longer qualify under the SME tax credit scheme in 2018 as it expects to exceed the headcount-eligibility threshold, lifting SCISYS into the scheme for Large Enterprises, where credits are significantly less generous. Accordingly, the above-the-line tax credit of £0.5m in 2017 is treated as an exceptional item.

The 2017 tax charge reflected the benefit of an adjustment to prior-year credits in respect of UK tax. A conservative estimate of £0.5m for receipt of R&D tax credits was included in the 2016 accounts, whereas the amount actually received was £0.7m.

 

ACCOUNTING STANDARDS

No material changes in accounting standards have impacted the Group accounts for 2017. The next significant change affecting SCISYS will be in 2018, when IFRS 15: Revenue from contracts with customers will be adopted. Detailed analysis by the SCISYS Board has established that implementation of the new standard will have a negligible impact on the phasing of anticipated operating profits, although reported revenues will be depressed compared with previously applied treatment. The reduction reflects provisions in the standard whereby only the mark-up on third-party costs can be recognised as revenue in situations where SCISYS acts in the capacity of an Agent, simply passing the third-party’s goods and services to customers through its books. If IFRS 15 had been applied in 2017, revenues would have been £5.5m lower than reported and operating profits would have been unaffected.

 

SHARE OPTIONS

During the year a total of 0.4m share options were exercised, of which 0.3m were granted in 2008 under the Enterprise Management Incentive scheme for which the exercise window closed at the end of 2017. All 0.3m outstanding options under the 2015 CSOP award lapsed during the year due to the failure to achieve the three-year performance criteria as a consequence of the disappointing results in 2015. Option awards in 2016 and 2017 remain in the money and on track to vest in full.

 

ORDER BOOK

Boosted by the October contract award from OHB Systems for the Heinrich Hertz satellite-communications mission ground segment infrastructure, the year-end order book was at a record level, 41% ahead of the prior-year at £91.3m (2016: £64.6m). Of this total, £36.5m (2016: £31.2m) is invoiceable within one year and £51.8m (2016: £38.4m) within two years. The longer-term balance principally reflects Annova’s contract with the BBC, which runs to at least 2027. 57% (2016: 34%) of the total order book value was denominated in euros. l

 

Chris Cheetham

Finance Director