Progressing the Recovery Story: Interview with Mike Love and Chris Cheetham of Scisys Plc

IT systems specialist, Scisys Plc (LON:SSY) , is an AIM listed developer of ICT services, e-Business and advanced technology solutions primarily to the Space, Government, Defence, Environment and Media/Broadcast sectors. Its customers are mostly blue chip companies, government and quasi-government organisations like the European Space Agency, the BBC and the Coal Authority. Headquarted in Wiltshire, the group also has offices in Bochum, Darmstadt and Oberpfaffenhofen in Germany. 

Currently trading at 40p per share, Scisys has a market capitalisation of £12m. The company has been something of a recovery story for a while now - the shares were above a pound back in 2007. Perhaps reflecting the mood of pessimism over public sector facing business at a time of austerity measures, though, the shares have traded down in recent months.

Keen to find out more about how the business was holding up, we met recently with the CEO of Mike Love and his Finance Director, Chris Cheetham.  

Mike and Chris, thanks for speaking to us today. Mike, can you tell us a bit more about the history of Scisys?

SciSys was set up in 1980 and I’ve been involved with the business since the beginning.  We came to the AIM market in 1997.  At that point we were called Science Systems. In 2000, we acquired the activities of a financial accounting product, which was called CODA.  We acquired the customer base, the IP, quite a lot of staff but not the company.  Based around the CODA accounting package, we created a subsidiary, which we called CODA, and changed the name of the plc group to CODASciSys. For four or five years, we were then running as CODASciSys, integrating the CODA product into the activities of our commercial division. We demerged back in 2006, when we basically split CODASciSys into two companies, CODA and SciSys.  SciSys is what we’re talking to you about today. CODA was subsequently acquired by Unit4 Agresso. It was purchased for £160m so it was quite a good return, but we had a clear reason to separate the companies.  Following the demerger, SciSys then acquired a new company in Germany, VCS, and the past three years has been all about integrating VCS into SciSys and rebuilding the business under the SciSys brand, with SciSys management.  We are now a business modelled on the old SciSys business but with the addition of VCS.

Scisys has been something of a recovery story, hasn’t it?

Yes, it made unexpected and significant losses three years ago and as a consequence we had to introduce quite a lot of management change.  I came back out of retirement, others came back into the Board and we restructured the senior team.  This is now the third year we’ll be delivering year on year improvement in revenues and profits, very much in line with the long term plan we spelt out to investors and the guidance given to investors.

And the losses, were they from the German acquisition?

No, it was losses within the core SciSys business.  If you really look back with the benefit of hindsight it was clear management had defocused.  CODA had become a dominant part of the CODASciSys group so, as it split, the fragility in the SciSys team was exposed quite quickly. Problems were identified which are taking time to sort out. We are very pleased with the new management team we have built, and it’s a good team to build around going forward.

Can you describe what the business does?

Our business develops the large and complex computer systems which other organisations, typically large blue chips, government bodies or quasi government organisations need to operate their businesses or transact on their franchise.  So, for example, a very large slice of our activities are in the Space sector; Space is our biggest division. People who operate and run satellites need complex computer systems to run their businesses. We design and develop the systems which are used to control satellites in orbit, control the equipment on the satellites, process the data from the satellites and distribute the data to the end users.  Our customers are people like European Space Agency, EUMETSAT, which runs the European metrological satellites, Inmarsat, which runs the marine navigational satellites, Eutelsat, which runs communication satellites and the UK Ministry of Defence. 

Was that the case from the start, back in 1980?

Yes, our very first business in 1980 was in the Space sector and the business, in fact, has diversified and grown from that footing. Another area we’re very pleased with these days is our Media Broadcast Division, which was acquired through the VCS acquisition.  It’s a division which provides what’s called ‘audio edit playout facilities’.  Essentially if you are a public sector radio broadcaster who runs current affairs programmes, you need facilities in the modern digital world where you can quickly collect information on a breaking news story; prepare programmes and play adverts into the programme, weave in interviews, all of that has to be done; researching the internet, researching of the broadcasters, what they’re announcing, digging up background information, archives, finding pictures, finding clips, recording and  capturing everything, putting it through an editorial process and, of course, the playout.  If you look at, say, BBC News 24 and see Fiona Bruce in a soundproof cubicle presenting the programme, you’ll see behind that soundproof cubicle utter mayhem; computer screens, people rushing around creating a story, feeding it through to editorial and eventually feeding it through to the presenter.  So you can imagine what’s been going on with e.g. the Chilean miners’ story in order to source the information, get the story together and present it.  Our biggest customer is the BBC; we have a large contract to reequip the entire BBC estate, as sole supplier, with modern AEP equipment.  That contract was won recently.

Who are your other customers? 

Other customers in the Media Broadcast Division are people like Deutsche Welle and the Belgian TV and radio broadcaster, Iceland radio, Voice of Vietnam. In our Environment Division our biggest customer is the Environment Agency. Other customers include the Irish Environment Protection Agency, the Scottish Environment Protection Agency, the Coal Authority, the Met Office An awful lot of what companies and organisations want to do is subject to rafts of regulation, much of which flows out of Europe. This includes things like carbon emissions, carbon trading, environmental emissions, waste management, all of which is subject to EA regulation. We develop the systems that the EA or other agencies use for regulation. These are large complex computer systems with big databases and very specialist software to encapsulate the regulation work flow process. 

This kind of mission critical software would presumably make it hard for another operator to come along and take on those contracts.  Is that what you find?

Yes that’s right.  Our customers are all pretty well recognised household names and big organisations like the BBC, the RNLI lifeboats, the Coal Authority and so on.  If you look at the characteristics of these organisations, they are large bodies with a very complex business model to support using modern information flow technologies. They require a lot of specialist application software and need to work with an organisation which truly understands their business model and can design the systems which will give them the robust systems which will give them the information flows they need to run and manage their businesses.  Generally they have a lot of repeat business and they’re very dependent on their supplier, to provide continuity around those systems.

Why do these accounts generate a lot of repeat business?  Well, their own business model changes all the time; driven by regulatory changes, competitive pressures and  technology.  For example all the current wave of work to roll out modern AEP systems, audio edit playout systems, for broadcasters, is because the market has now become multimedia digital driven and the pace of change accelerates, it doesn’t decelerate.  Consequently all of our clients have large repeat requirements for systems and that generates repeat revenue for us.  Something like 85% of our revenue stream comes from our established base year in, year out.  As we cast budgets going forward, of course, that’s where we look for the bulk of our revenues to come.

In terms of new customers, you tend to find our client base changes very slowly. We’ve had most of our customers for 20 plus years.  It’s an expensive process winning a new customer, with a high cost of sales, because inevitably you’re displacing an incumbent.  In terms of customers we’ve won business from over the recent period, some are actually established customers where we’ve increased the level of business we are winning from them.  So Invensys, for example, it’s the old Westinghouse Brake and Signals Company, where we get involved in helping develop all the complex software they need for trackside management of rail networks.  They were on a journey where they were outsourcing a lot of their development work to the Far East.  They’ve reversed that, they’re now bringing it back into Europe, back into the UK, hence we’re now doing a lot more work for them and that’s a local customer that’s currently building up; equally it represents a long established customer where we’re currently seeing quite a lot of growth in demand.  Raytheon (NYSE:RTN), likewise, is a customer we worked with in the past, we’re now seeing the level of business picking up there as well. BAE Systems (LON:BA.) is a customer we’ve worked with in the past and where we are now picking up additional work. There is a pattern here. We have seen, over the recent past, quite a lot more work coming to SciSys, from large, prime contractors, whereas probably the bulk of our work, if we went back 18 months, was very much with end customers. Other examples include work from Westlands and Lockheed Martin.

Who do you see as your competitors? Who do you win the contracts from, who do you lose contracts to?

It’s one of these things, some days you’re business partners, you’re collaborating and bidding for things together; a week later you’re in competition against each other.  So there is quite a lot of the ‘all is fair in love and war’ type messages. In the Space sector the kind of competitors we face are people like Vega Group, an Italian based company, [it used to be in the UK, it’s now Italian based], GMV, a Spanish company, Logica’s the obvious UK challenger. In the Environment sector, Capgemini we collaborate with and compete against, Fujitsu (PINK:FJTSY), IBM (NYSE:IBM), Deloittes are also in the mix. In the Media Broadcast sector, Dalet (EPA:DLT), a French company, is probably our main challenger. So we’ve got quite a mix of competitors but generally the solutions that we are proposing do the selling for us.

And in terms of listed players, there’s obviously Logicacmg (LON:LOG) – who else?

Logica, yes.  IBM, we work with IBM and we compete against IBM, Fujitsu and a list of players, Capgemini. Again, we’ve seen a shift in the market place. Probably four or five years ago you tended to find there was a propensity to place business with bigger players. Talking to customers, they were much more inclined to say ‘let’s use a big player, use a recognised name for the work’, and it was relatively hard for a smaller market cap company to win the contracts.   These days there’s much more of a demand for value for money, so people like the Environment Agency and MoD are far more likely to recognise that, with a big name and a big ticket, it doesn’t mean value for money.  As a smaller, provincial systems house we’re able to do jobs more effectively and more efficiently. Our productivity is probably higher, hence we can make reasonable margins doing work at prices which are still quite competitive. Hence, we’re finding far more opportunity as people are forced to look for value for money. With a revenue base of £50m we’re quite well equipped to deal with contracts of £5m to £10m, in value over a couple of years. That’s comfortable territory for us but it would be a bit of a challenge to win a £100m contract.  So our size is quite attractive in the market space for the £5-10m type contracts.  The catch phrase is ‘Big enough to count, small enough to care’.

Your size and the attractiveness to the clients, that would seem attractive to a predator, have you ever been in talks with some of those larger names?

We had an indicative offer from Microgen (LON:MCGN) which turned out not to be that real. It was clear, as we looked at it; the synergies weren’t there so they quietly backed off.  We’ll wait and see. As a public company you have to take any enquiry of interest seriously but equally we’ve got our own track record of acquisitions over the years, Science Systems took over CODA and now we’re back to SciSys.  I think VCS is proving to be of the same calibre as the CODA acquisition, it’s an extremely good acquisition, it’s bedding in well.

That’s the German acquisition - is that what gave you the media system business?

Yes, we had a small amount of work ourselves already in Media Broadcast but nothing like the quality or volume and breadth of customer base that VCS had got. Having put the media businesses together it has given us a much stronger footing.

The margins look quite low, although I appreciate that it's been a turnaround story. Are these margins now typical of the sector?

No and this is where there’s still some growth left in the business.  In 2009, our bottom line margin to revenue was 4%.  Someone like Logica is currently doing 7 to 8%. In 2008, we were at 2.5%, 2007 we were loss making, so we’re gradually getting ourselves up that path and the margin focus is quite crucial to what we’re doing.

We’ve got a couple of stratagems we’re building into the budgets for the next couple of years to drive margins, but you have to focus fundamentally in our business on quality of delivery.  That’s the most important thing, because it’s quality of delivery which generates repeat business, so that’s one crucial thing to get right and to then get into the nuts and bolts to drive the margins beneath that. 

So increasing margins, are you able to do that through price or through cutting costs or both? 

It’s primarily all about productivity on the job; better management of the projects themselves. Because most of the work we do is on long term fixed price contracts, we’ve got to bid it right then execute and deliver; making sure we’re on the ball when it comes to raising change notes against the original scope if the requirements or the specifications change during the course of the project.  So it’s getting things like that right which will deliver the better margins as we complete work within or even underneath the anticipated costs.

How’s current trading generally in this environment?

Six months ago, going into our AGM, we had had a good year; we were well on track with the recovery story.  We had reported an opening order book at the beginning of the year well north of £30m. We nevertheless also put out cautionary messages; as there were strong signs of storms on the horizon.  All the turbulence we’re sitting in today in the public sector and the spending squeeze, was well highlighted. With quite a lot of revenues effectively from the public sector we were alert to the fact that we would be under some pressure as well.

The message we put out though was ‘that we thought we were reasonably resilient and as a business we would navigate our way through the complexities’. We judged at that juncture that with our business base; the level of order book we had; and the nature of the work we did for customers, we should be able to work our way  through the challenge.  Six months on, right in the heart of that battleground, I think we can say that was a good judgement. This year we will have a good year; we’ll make progress on last year; it won’t be a stompingly spectacular year because of all the turbulence around but we will make progress. We are having to be flexible, changing the way we do things to react to the pressures. Picking up work from prime contractors is one good example of how our Government and Defence Division, which is the division you’d expect to be most vulnerable to the pressures, has actually managed to manoeuvre itself to have a quite strong position at this point in time.

By flexible you mean you’ve got to be taking on more of these contracts but also flexible in terms of pricing?

More flexible in terms of being responsive.  For the work we’re doing at Raytheon we’ve had to travel Monday to Friday to their site to do it, though we are now looking to pull that work back into an office in the West Country. So the mixture of the business is switching but by being flexible and responsive we’ve basically got to the stage where we can see our way substantially through the turbulence in a pretty intact state. 

We had a good first half, which was on the back of a good year last year and a good opening order book position. We’re cautioning people though to recognise that it’s going to be a year of two halves; with all the turbulence from the public sector squeeze around us at the moment. Fundamentally the business will have a good year this year and we’ll hopefully make further progress next year. 

Cash has also held up very well. One of our biggest customers, the European Space Agency, put in a new financial accounting system and customer payment system in early January, and has had significant issues with it. We ended up, at the half year point, with something like £5m cash owed to us by the Space Agency against the £1m to £1.5m of money we’d normally expect to be owed, so it was a very, very substantial cash strain.  Despite this, our own cash position moved upwards, which is a good measure of the underlying performance of the business.

Thanks for speaking to Stockopedia.

Thank you.