SYSTEM1: Bumper Q4 Supports Stronger H2 2023 But New Marketing Course Raises Fresh Management Doubts And Leaves Disgruntled Shareholders Hoping For Trade-Sale Exit

14 thoughts on “SYSTEM1: Bumper Q4 Supports Stronger H2 2023 But New Marketing Course Raises Fresh Management Doubts And Leaves Disgruntled Shareholders Hoping For Trade-Sale Exit”

1. Thanks for the very thorough review Maynard, very informative. By my reckoning John Kearon is at least 58 (based on him leaving University at 21, Thank you LinkedIn), so whilst not exactly ancient he’s old enough to want to potentially leave the corporate world (and perhaps do more of the dancing that he seems to be more passionate about than anything else!) and maybe that explains why the System1 management seem content to plod along? So maybe a buy out isn’t so far fetched, though it might just be wishful thinking from a frustrated holder.

   • Thanks Paul. Companies House says Mr Kearon is indeed 58 (this month). The general meeting suggested Mr Kearon was not keen on leaving just yet, although I do think he is better suited in his present sales role than his previous CEO role that required more involvement with practical business matters. Stefan Barden reckoned he could re-focus the business and then sell it, although as you say a buyout now may well be wishful thinking!
     Maynard

2. Pretty decent results announced this morning.
   Hitting Canacord’s FY Pbt forecasts in H1 suggests upgrades should be on their way (perhaps accompanying the Interims when some Q3 visibility is apparent). Cash inflow also welcome.

   Especially good to see the link between increased revenue and improved pbt which does reinforce the view the business could be nicely profitable if the current revenue trends continue.

3. Hi Maynard
   IMHO – Overall a pretty decent set of interim results today. But the management outlook is still uncertain. I guess that new advertising campaigns are naturally ‘lumpy’ and so their income isn’t much like a real SAAS model. i.e. their ‘platform’ might be excellent, but it does not guarantee any particular level of income.
   Given the downside risks, I wouldn’t be surprised if the SP did drop back again but I do feel that the team and especially John Kearon deserve some credit for the success so far.
   As always, thank you for all your hard work.
   Charles
   NB – I am very sad that Charlie Munger died. He was a wonderful man.

4. Hi Maynard
   I thought that the SYS1 H1 InvestorMeet presentation was excellent. It might even be the cause of the subsequent price rise. As you might have seen, I put my question about lumpiness and the reply implied that it was not a big problem and that it would also get less of a problem as they grew. Do you have any thoughts on their answer?
   I definitely wish you well with this investment as it is your biggest investment. For me it is just a 1% long term holding but at this rate it could grow quite fast!!! (although I expect that it will be very lumpy).
   Thanks as always – especially for all the massive work that you continue to do on analysing this company.
   Charles

   • Hi Charles,
     Management referred to the non-platform bespoke lumpiness, and such lumpiness should indeed have less impact if the platform side grows significantly. Mind you, platform revenue can fluctuate between quarters (e.g. Q4 2022->Q1 2023) but management noted platform income from the top 20 customers should be less volatile. I think quarter-to-quarter fluctuations will continue to occur, though, which could cause some anxiety for anyone who does not believe the long-term transition story.
     Maynard

5. Hi Maynard –

   Previously Mr Barden seemed to think that a buyout price of £4.40 was a good deal for shareholders. But he also said: “I think this business is worth £100m at least, £8 a share, if not £125m, £10 a share.”

   Kearon himself suggested £1bn a while back (i.e. £80 a share)

   I know that you normally buy and hold, but this is becoming a huge holding for you and I imagine that you are thinking about the long term value. I’m looking forward to your next update!

   Well done.

   Charles

   PS – I was buying a few more at c£4.20 in February.

   • Hi Charles

     Yes, Mr Barden said he was happy to sell a year ago at 440p when the shares were c200p. He also talked of selling SYS1 to a trade buyer after 3 years at £8-10 a share had he become executive chairman at last year’s EGM.

     The £1b value was touted jointly by Mr Kearon, Mr Barden and the FD a few years ago, and was watered down when Mr Barden left the company. The £1b value was cited with SYS1 becoming part of a larger marketing business -> “You can get System1 to a billion if it is owned by a major multinational.” (More here)

     Mr Barden said during his EGM statement:

     “6) Valuation: As a result, and you might want to pass this to Chris, if successful, how much could System1 be worth in say 2 to 3 years time?

     a) If you can’t give a valuation what would the shape of the P&L be? For example, your 25% CAGR sales growth aspiration is a doubling in sales every 3 years. What is the associated cost structure?”

     The Capital Markets Day in February provided an illustration of what could happen to profit (or at least Ebitda) if sales did double. If that illustration proves reasonably accurate, then maybe the shares still offer good upside. Steadily clearing my backlog of updates from other portfolio companies (ASY+MTVW) then I will be onto SYS1.

     Maynard

6. System1 (SYS1)

   Publication of 2023 annual report

   Here are the points of interest beyond those noted in the blog post above:

   ——————————————————————————————————————

   1) GROUP OVERVIEW

   Some changes here for 2023:

   a) Who we are

   The 2022 report contained encouraging text such as “best in the world“, “scalable players” and “laser focussed:

   “We believe we are the best in the world at what we do. The “Test Your…” platform leverages data and production economics, rather than service economics. Data and production economics point to industry value accruing disproportionately to a small number of scalable players. We are laser focussed on becoming one of them.”

   But that encouraging text was sadly replaced for 2023 by this more functional introduction:

   “System1 is a marketing decision-making platform business. Our target customers are the world’s largest advertisers. These businesses understand that creativity is the most powerful tool for growth within their control. System1 helps them make confident creative decisions that lead to transformational business results.”

   b) What we do

   A new line for 2023 that reminds shareholders that SYS1’s products measure emotion:

   “System1 predicts and improves marketing effectiveness. Our advertising and idea tests measure emotion to give our customers the most accurate predictions of the business impact of creativity. We ‘predict’ (provide research results) and ‘improve’ (provide insight and consultancy on those results) on arguably three of the most critical marketing questions for our customers: advertising effectiveness, innovation effectiveness and brand effectiveness. We aspire to do these three things better than anyone else at a value that makes System1 our customers’ choice.”

   c) Our products

   The graphic below now includes Bespoke Consultancy that implies such work is done only on an ‘Enterprise’ scale:

   

   KDA stands for Key Drivers Analysis, while DAT stands for Distinctive Assets Testing. I am not quite sure what the ‘Audit’ service is for Test Your Ad and Test Your Innovation. It is not listed on SYS1’s website (TYA and TYI). Although the website does list Distinctive Asset testing for both TYA and TYI, which might be ‘Audit’.

   d) The size of the prize

   All this text from 2022 was sadly omitted for 2023:

   “The size of the prize

   ‘Predictions’ currently represent less than 10% of the global research market. We estimate that our target markets of predicting and improving advertising, brand and innovation effectiveness represent about $10bn of the $89bn research market. Currently at less than 1% share, we believe that System1 can gain 10% global market share in the next decade—a lower share than the current market leaders. Whether we can achieve that scale is the management challenge. But a necessary, if not sufficient, pre-condition to success is having the vision and a plan.”

   e) Investment case

   This remains unchanged from 2022:

   

   But the explanatory text accompanying the investment case, such as this below…

   “ Unique and step-change improvement in product value for customers 

   Today many of our Advertising predictions are automated, and we have challenged ourselves to deliver them at 1/20th the cost and 20x faster than traditional methods. We believe we are far ahead of traditional competitors in automated predictions and indeed that some of our competitors’ legacy economics will make it difficult for them to catch up with us. In addition, our pioneering framework for how advertising works at its best also enables our experts to provide the very best improvement advice for increasing our customers’ return on their annual advertising investment.”

   …was omitted for 2023. Perhaps the explanatory text had become outdated and/or a little too detailed. The “1/20th the cost and 20x faster” for instance from 2022 was originally “1/100th the cost and 100x faster” within the 2021 report and I mentioned this change at the 2022 AGM. I wonder if that question may have prompted SYS1 to remove all the accompanying text and just leave the ‘big picture’ ambitions.

   f) Progress towards our goals

   SYS1 commendably kept to its four goals within the CEO’s 2023 review:

   “This year, alongside our shift of culture towards relentless execution, we made significant progress towards delivering the four goals we set out 5 years ago, namely: Build defensible assets; Generate fame; Win new customers; and Generate new revenues.”

   Within the table below, the stats for TYA (c80,000 ads) and TYI (c60,000 ideas) are oddly the same for 2023 as for 2022:

   

   TYB now has c7,000 brands versus c6,000 the year before.

   2) PRINCIPAL RISKS AND UNCERTAINTIES

   The 2023 report introduced a new ‘Strategic’ risk about AI and competing ineffectively with the following potential impacts and mitigations:

   “Potential impact: Technological advances including artificial intelligence reduce the commercial viability of the group’s methodology:

   Mitigation: The group positions itself as “the most predictive” provider of information to support creative and marketing decisions. Currently a combination of real-life panel respondents and System1’s methodology achieves this goal. The group acknowledges that this may change over time and continuously reviews the application of AI and other tools in predictive market research and more generally.”

   “Potential impact: Participation. The group does not compete effectively in the largest and faster-growing markets:
   Mitigation: The group formally reviews product and geographic markets as part of its annual strategy review. We upweighted our presence in the US to reflect the significant opportunity in that market and launched digital and audio versions of Test Your Ad.”

   The Operational risk now includes the potential impact of lower-quality panel data:

   “Potential impact: A reduction in panel data quality affects the company’s reputation with key customers:
   Mitigation: We conduct both operational and strategic reviews of respondent quality in close collaboration with our approved panel suppliers and can switch provider where required.”

   The Environmental and political risk now includes the potential impact of unhappy shareholders:


   “Potential impact: Shareholder relations: the company’s plans could be opposed by significant shareholders:
   Mitigation: The company holds comprehensive investor one-on-one and group meetings in roadshows after the full-year and interim results are announced. In addition, quarterly trading updates provide an opportunity to engage with shareholders who follow the company closely.”

   The other risks remain the same, namely:
   
* Loss of a significant customer/key personnel/critical supplier/assets, data & IP;
   
* Litigation

   * Operational
   
* Financial
   
* Environmental and political

   3) SECTION 172 REPORT

   SYS1’s ‘cultural pyramid’ remains unchanged:

   

   a) Customers

   A text refresh for 2023:

   “Customers
   
Our target customers are the world’s largest advertisers. The board understands the importance of forming and retaining good working relationships with its existing and target customers. These customers understand that creativity is the most powerful tool for growth within their control…
   System1 helps these companies make confident creative decisions that lead to transformational business results. Our advertising and idea tests measure emotion to give our customers the most accurate predictions of the business impact of creativity. We also provide expert guidance to our customers to help them improve the effectiveness of their ad or innovation. Enabling our customers to Create with Confidence“.

   The case studies of LinkedIn and adidas — used both for 2022 and 2021! — were thankfully replaced by a new example for 2023 (Sam Adams/Boston Beer).

   b) Talent

   A good sign: drinks with John Kearon cited within the 2022 report…

   “There is a comprehensive programme of employee communication and engagement sessions, monthly Town Hall meetings with all staff, to fortnightly senior management forums, through to “birthday cheers” with the CEO.”

   …have been curtailed and replaced with monthly workshops:

   “We hold follow up discussions with each team across the business, chaired by the team leaders and the HR team to agree improvements, actions and owners. In addition to monthly Town Hall meetings with all staff, we also hold monthly senior management forums and run monthly workshops with managers.”

   New text for 2023 about ‘flexible holiday and benefits’ and a November all-company meeting:

   In April 2023 we introduced a Flexible Holiday pilot, to build on our Flexible Working approach and additionally launched a Flexible Benefits platform. This provides our employees with increased autonomy when it comes to choosing how they work and rest and we have received very positive feedback on all of these initiatives. We find it very important to regularly bring people together in person, to share updates and build relationships, to complement the time spent working remotely. For example, we run 1derful Wednesday events to encourage employees to socialise together in the office and in November 2023 we plan to gather all staff in the UK for an all-company Strategy update meeting.”

   c) Investors

   The line “They have no cash bonus scheme” was removed for 2023 as cash bonuses were introduced (see point 7a).

   New text for 2023 referred to IMC:

   “In the past year we began using InvestorMeetCompany, an investor engagement platform which we use for capital markets days, group meetings of investors and the annual general meeting.”

   The general meeting held during April 2023 that considered the board reshuffle was not broadcast on IMC.

   d) Suppliers

   Some new text for 2023:

   “As outlined in the Principal Risks and Uncertainties section on page 20, the loss of a critical supplier could leave the Group unable to meet customer demand, therefore the Board has regard to the importance of fostering good relationships with our suppliers to promote the success of the Group.”

   The text below has not changed, but worth reiterating how SYS1 commendably discloses its main suppliers:

   “Our key delivery suppliers include:

   • MAP Marketing Research provides us with survey programming and project management services
   
• Toluna, Prodege and NetQuest provide us with market research panel respondents to complete our surveys
   
• Datawise provides us with bespoke data processing and charting services on our non-standard deliverables
   
• Intonation provides us with translation services (forward translation of questionnaires and back translation of respondent verbatim)”

   e) Community

   SYS1 is developing an ESG strategy:

   “We are currently in the process of developing a comprehensive ESG Strategy with the support of expert consultants, to create an appropriate plan that includes achievable goals and timelines that are in line with science-based targets. In the meantime, we have outlined below some of the things that we are currently doing under each heading.”

   All the emission stats that follow in the 2023 report are in fact copied from the 2022 annual report! However, the 2023 report did add this text:

   “This year, we are partnering with ITV on Sustainability initiatives in two ways:

   1. We are working together to produce and publish research on Sustainability in Advertising – this will seek to 
understand the most effective ways to talk about sustainability in advertising with a view to behaviour change. We will launch this at the Festival of Marketing in October

   2. We are committing to assist ITV in achieving its emissions reduction targets, in alignment with the Science-Based Targets initiative (“SBTi”) Corporate Net-Zero Standard Framework (sciencebasedtargets.org) and to achieve at least a 5% reduction of Greenhouse Gas Emissions year on year”

   Plus lots of new text under the Social sub-heading:

   
”We launched Look Out volunteering this year. Under this initiative, employees are invited to participate in local events that support the community. So far these have included delivering meals to vulnerable people in Singapore, preparing clothing packages for homeless people in Brazil and working with Breakthrough in the UK, to prepare ex- o enders to re-enter the workplace. 
In addition, we are supporting the ESOMAR Foundation (esomarfoundation.org) and Women In Research (www.womeninresearch.org/). John Kearon has been President of the Foundation for the last four years. Its purpose is, ‘using Market Research to build a better world’ and it is run on a purely voluntary basis. With a team of System1 volunteers, together with five volunteer research industry Board members, the Foundation provides research training, inspirational case studies, and support, to help charities anywhere in the world in making a difference to the communities they serve. The Foundation raises over £100,000 a year, through annual donations from the research community, to fund these activities. Emma Cooper (Chief People Officer) organises WIRexec (Women in Research) annual summits and System1 is sponsoring the European event this year. WIRe believes in the positive impact of women in business and works to advance the contributions and voice of women in research, both for themselves and for the greater good of the industry. System1 is also putting 10 employees through the WIRe Accelerate program, a multi-module, virtual program delivering professional development concepts.
   System1 increases its sphere of influence by partnering on initiatives that impact the community. In addition to the Sustainability example outlined in the previous section, other examples include the Feeling Seen and Wise Up reports we have produced with ITV. These provide guidance on diversity in advertising, and we have conducted events and run panels to help socialise our findings within the industry.”

   4) GROUP DIRECTORS’ REPORT

   No significant changes to this section for 2023.

   a) Credit risk

   SYS1 reiterating a lack of bad debts and that HSBC is the bank that does not pay the group interest (see blog post above):

   “Since the majority of the Group’s customers are large blue-chip organisations, the Group rarely suffers a bad debt. The Group’s cash balances are held, in the main, at HSBC Bank.

   b) Foreign-Exchange risk

   SYS1 reiterating its sensible approach to foreign currencies:

   “In addition to the United Kingdom, the Group operated in the United States, Rest of Europe, Brazil, Singapore, and Australia during the period and was exposed to currency movements impacting commercial transactions and net investments in those countries. Management endeavours to match the currencies in which revenues are earned with the currencies in which costs are incurred. So, for example, its US operation generates most of its revenue in US dollars and incurs most of its costs in US dollars also. Management does not believe that there would be any long- term benefit in endeavouring to manage currency risk further, and to avoid the cost and complexity does not deal in hedging instruments.”

   c) Subsequent events

   New text for 2023. I understand the payment is recorded within ‘other income’:

   “On 30 June 2023, the Group reached a mutually agreeable resolution of the lawsuit filed by System1 Group PLC against System1 OpCo, LLC in the Southern District of New York for trademark infringement. The parties have signed a global agreement which governs the co-existence of their respective use of the “System1” trademark in connection with their operations. As part of this agreement, the Group will receive a fixed amount, payable in instalments, in the years ending 31 March 2024 and 2025. The parties have agreed to keep further detail of their agreement confidential.”

   d) Disclosure of information to auditors

   New boilerplate text for 2023:

   “The directors are responsible for the maintenance and integrity of the corporate and financial information included on the System1 Group PLC website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.

   
In the case of each Director in office at the date the Directors’ report is approved:

   
• so far as the director is aware, there is no relevant audit information of which the group’s and company’s auditors are unaware; and
   
• they have taken all the steps that they ought to have taken as a director in order to make themselves aware of any relevant audit information and to establish that the group’s and company’s auditors are aware of that information.”

   e) Substantial shareholders

   A number of alterations to the major shareholdings since 2022, despite only one TR1 RNS (from Langfristige) during the period between when the shareholdings were taken (1 August 2022 to 1 August 2023):

   

   
• Langfristige now owns 10.4% versus 7.7% for 2022.

   
• Stefan Barden now owns 5.2% versus 6.2% for 2022.
   

• Lombard Odier now owns 4.8% versus 4.7% for 2022.

   
• Motley Fool now owns 4.1% versus 4.5% for 2022.

   
• Ennismore now owns 3.5% versus 4.5% for 2022.

   I think any trading by Stefan Barden and Ennismore ought to have been reported through the RNS as their holdings both crossed through a percentage threshold. Shareholding sizes are important given the unhappiness expressed at the April 2023 general meeting. I therefore wonder if the changes actually reflect a double-check for the 2023 shareholdings ahead of the general meeting, which corrected possible shareholding errors reported for 2022. Indeed, I understand the Langfristige change was due to a consolidation of smaller, affiliated shareholdings under one name, rather than actual share buying.

   5) CORPORATE GOVERNANCE

   a) Introduction and QCA code

   A whole new section of introductory text for 2023:

   “System1 understands how vital good governance is for achieving our business goals and sustainability targets. We will share more about our approach to governance in later sections of this report. 

We know that good governance is key for our company’s success. It benefits everyone involved with our group – not just our shareholders, but our employees, clients, and partners too. That is why we have built a governance structure that makes sure our decisions are transparent, responsible, and uphold the highest ethical standards.

This past year, we have been busy improving our governance policies and processes. We have been aligning them with the latest industry standards, legal requirements, and ESG principles. We are committed to ongoing review and refinement to make sure we manage risks effectively and stay compliant with laws and regulations.

Our Board of Directors is central to our governance structure. It consists of individuals with a wide range of skills and experiences. They provide critical oversight, strategic counsel, and informed decision-making, ensuring our commitment to the highest ethical standards is never compromised.

   
Employee engagement and development form a crucial part of our governance strategy. Our significant investment in ongoing professional development ensures our team is equipped with the latest industry knowledge, skills, and best practices to deliver exceptional market research and insights to our clients.

   As we move forward, we are committed to maintaining and improving our governance standards and to promoting a culture of responsibility, integrity, and excellence throughout System1.

   As an AIM-listed company, System1 adheres to the ten principles of the Quoted Companies Alliance (QCA) Corporate Governance Code. The QCA Code identifies ten principles that underpin growth in long-term shareholder value, encompassing an efficient, effective and dynamic management framework accompanied by good communication to promote confidence and trust.”

   The ten QCA principles were unchanged from 2022 and referred to other sections of the annual report.

   b) Board of directors

   This new line for 2023 might reflect enquiries about re-introducing cash bonuses for senior management (point 7a):

   “During the year, the Remuneration Committee sought advice from external consultants on board and senior management remuneration.“.

   The text below is unchanged from 2022, but perhaps gives a reminder why some non-execs had their positions challenged at the April 2023 general meeting (i.e. they had not invested significant sums and therefore had not suffered financially through SYS1’s underperformance) (point 7d):

   “The Board considers each of the Non-Executive Directors to be independent, for the following principal reasons:

   
• they all have served on the Board for less than ten years;
   
• their remuneration is not material in the context of their financial circumstances;

   • they have no executive role;
   
• they each own an immaterial number of shares in the Company in the context of their financial circumstances
   
• they are not related to any of the Executive Directors; and
   
• they have no material conflict of interest given their other roles and business activities.

   c) Meeting attendance

   Looks like every director attended every meeting they could:

   

   The finance director was invited to all three audit meetings and both remuneration meetings, which might suggest the non-execs find his input particularly valuable.

   d) Board effectiveness

   The text below was introduced for 2023, suggesting the chairman’s performance was reviewed for the first time:

   “In line with best practice governance, the Group’s Senior Independent Director recently concluded the annual review of the Chair. This involved confidential discussions with the independent Directors, to act as a sounding board for any concerns, and to ensure that the Board is functioning optimally. The review concluded that the Board meetings were being run well, with all Directors given full opportunity to express views and ask questions of the Executive, and with clear goal setting and follow up of action points.”

   The bold text below is new for 2023, which notably assesses the relationship between the CEO and chairman (i.e. perhaps debating whether former CEO John Kearon enjoyed too much board power? This FY 2023 period saw Mr Kearon step down as CEO and a new chairman appointed):

   “Additionally, this year’s Board Evaluation included a number of key topics including:
   • the effectiveness of the Board in setting strategy and assessing risk;
   • the relationship between the CEO and Chair;
   • that decision making was balanced and objective and took active account of relevant stakeholder issues;
   • areas for improvement in shareholder communications, including use of the annual AGM;
   • that the Board was effective and responsive to new information and events; and
   • that the Board had the appropriate composition and skills to discharge its duties, and had sufficient process in place for regular self assessment.”

   Succession planning is (once again) not quite up to standard:

   “Overall, the Board Evaluations have indicated that Board processes have been robust, although certain areas have been flagged as needing improvement. In particular, succession planning has been identified as needing greater focus, and these processes have been enhanced in response.”

   6) AUDIT COMMITTEE REPORT

   The text below is all new for 2023, explaining how the committee evaluated the auditor:

   “The Committee has adopted a broad framework to review the effectiveness of the Group’s external audit process and audit quality which includes: assessment of the audit partner and team with particular focus on the lead audit engagement partner; planning and scope of the audit, with identification of particular areas of audit risk; the planned approach and execution of the audit; management of an effective audit process; communications by the auditors with the Committee; how the audit contributes insights and adds value; a review of independence and objectivity of the audit firm; and the quality of the formal audit report to shareholders. The Audit Committee recommends that RSM be re-appointed as the Group’s auditor at the next AGM.

   Areas of key significance in the preparation of the financial statements

   Prior to publication of this Annual Report and Accounts, the Committee reviewed the accounting policies and significant judgements and estimates underpinning the financial statements as disclosed in notes to the consolidated financial statements.

   Significant focus is placed on key accounting policies, including any judgements and estimates, which underpin the financial statements, which include:

   • revenue recognition;

   • capitalisation and valuation of intangibles;
   • valuation of share-based payments.”

   SYS1’s audit committee chair was also the audit committee chair for Hotel Chocolat, which is not ideal as the chocolate retailer was quizzed by the FRC the other year (article here) about its accounts before its purchase by Mars.

   7) REMUNERATION COMMITTEE REPORT

   a) Short-term bonus

   The main change for 2023 is the introduction of annual bonuses for senior management:

   “The balance of variable elements, between short-term and long-term awards, is designed to focus decision making on delivering shareholder value. In the period to March 2023 the Committee judged that delivery of the Group’s long-term growth strategy was the primary objective and no short-term awards were granted. For the period to March 2024, the Committee considered that, in light of the recent strategic review, short-term incentives (bonuses) matched to the near-term goals of the strategic review would be applicable to retain and reward Executives.”

   “Year ended 31 March 2024: Executives have the opportunity to earn cash bonuses for exceeding annual targets. Targets are set such that no bonus accrues until Adjusted Profit before Taxation (= Profit before Taxation and Share-Based Payments) exceeds the budgeted performance for that measure. The level of bonus payable increases progressively from zero for meeting target to a maximum potential payment of 50% of salary for Executive Directors. Payment is dependent upon a share price accretion underpin.”

   Oh dear. Substantial backtracking here from SYS1 as the LTIP (point 7b) was approved by shareholders on the understanding that the LTIP participants would not be eligible for annual bonuses. Indeed, the 2022 annual report said:

   “The Executive Directors and other senior executives who participate in an LTIP forgo annual bonus and profit share.”

   As I remarked during the 2023 AGM, the introduction of short-term bonuses does imply i) the LTIP targets (as agreed by the LTIP participants just two years prior!) have proven unattainable, and; ii) the board was quite happy to undermine the LTIP approval from shareholders.

   A more pragmatic view is that the prospect of annual bonuses helped motivate the senior managers and supported the group’s improved progress during FY 2024.

   The forthcoming FY 2024 annual report ought to outline the bonuses paid to the executives, the targets that were met and whether any short-term bonus scheme will operate for FY 2025.

   b) LTIP

   No changes to the LTIP, which was introduced during 2017 and was modified during 2019 and modified again during 2021.

   Basic conditions for vesting for one third of the LTIP remain as follows:



   • Share price of at least 400p

   • Adjusted profit after tax greater than zero
   • Revenue of £45m

   All the LTIP vests if revenue hits £88m, with pro-rata vesting between £45m and £88m. The LTIP still has FY 2025 to run.


   The RNS published on 16 April 2024 indicated FY 2024 revenue of £30m, so no vesting for FY 2024 and unlikely to be any vesting for FY 2025. But if the LTIP is extended with the same conditions, then FY 2026 could see revenue top £45m (assuming 25% revenue growth in FYs 2025 and 2026) and the first tranche of the LTIP vest.

   But will the LTIP be extended with the same conditions? The LTIP will I am sure require shareholder approval again and the unhappy shareholders voting for the board changes at the 2023 general meeting may want to tighten up the wording and/or alter the vesting conditions given the introduction of short-term bonuses for the LTIP participants (point 7a).

   The LTIP granted options to new CEO James Gregory during the year:

   

   I calculate Mr Gregory was awarded 44,089 options that vest if revenue reaches £45m (Threshold) and 88,178 options that vest if revenue reaches £88m (Stretch). John Kearon still has 198,400 options and the finance director still has 132,267 options. A further 66,134 options were granted to a sixth senior manager.

   Add in some residual options from older schemes and 46,995 ‘non-employee’ options still held by former director Stefan Barden, and the potential dilution is 9.4%:

   “The maximum aggregate dilution under these schemes is 9.4% of the Company’s voting shares.

   c) Salaries

   Mr Kearon’s salary was thankfully unchanged during 2023:

   

   Mr Kearon had enjoyed a salary increase from £200k to £232.5k to £265k during 2021 and 2022 — despite during those years relinquishing his CEO duties to Stefan Barden. The FD enjoyed a 5% pay rise for 2023 while new CEO Mr Gregory was appointed on 6 Dec 2022 and his £58k for four months implies a c£175k annual salary (which I am sure has since been raised to match the FD’s £210k for FY 2024).

   Executive salaries of £265k + £210k + £210k(?) = £685k = up to a further £342.5k paid through short-term bonuses if the (unspecified) targets are met (point 7a).

   d) Shareholdings

   The “immaterial number of shares… in the context of their financial circumstances” owned by the non-execs (and dare I say the FD and new CEO as well) (point 5b):

   

   8) INDEPENDENT AUDITORS’ REPORT

   Various changes here for 2023:

   a) Key audit matters

   This annual report introduced revenue recognition and the capitalisation and valuation of intangibles as key audit matters:

   

   The key audit matter details did not seem as comprehensive as 2022, although the same auditor (RSM) was employed for both years.

   In particular, the auditor’s ‘key observations’ (example from 2022 below)…

   

   … were missing for 2023. Any adverse commentary from the auditor generally sits within such ‘key observations’. Typically such ‘key observations’ conclude with the auditor stating the accounting in question was acceptable.

   The new key audit matters for 2023 are shown below:

   

   

   The sabbatical provision and share-based payment key audit matters were carried over from 2022 to 2023.

   b) Materiality

   Overall materiality was unusually derived from the 5-year average of profit before tax:

   

   Usually overall materiality is simply 5% of that year’s profit before tax.

   Statutory profit before tax was £719k, of which 5% is £36k. So using £73k as overall materiality could mean the auditor is not looking as deep as it could to assess untoward accounting.

   For 2022, the £80.8k overall materiality was equivalent to 8.6% of the £945k pre-tax profit, so again higher than the industry-standard 5% and implying perhaps the auditor not looking as deep as it should.

   c) Scope

   This text does not seem ideal — a full-scope audit was applied only on a UK subsidiary:

   “The group consists of 13 components, located in:

   • United Kingdom;
   • Netherlands;
   • United States of America (“USA”);
   • Switzerland;
   • Germany;
   • China;
   • Brazil;
   • France;
   • Singapore; and
   • Australia.
   

   A full scope audit was performed on one of the components in the United Kingdom and specified audit procedures were applied to the other components, achieving 100% coverage by our audit procedures.”

   I presume the UK subsidiary in question is System1 Research Limited, which reported revenue of £8.9m for 2023.

   £8.9m is 38% of total £23.4m group revenue, so very small in terms of full-scope audit coverage.

   The limited full-scope coverage appears related to the appointment of RSM during 2020. The previous auditor (Grant Thornton) stated in the 2019:

   “We performed a full scope audit of the parent company and the group financial statements covering 100% of global revenue and net assets.”

   RSM has undertaken its current full-scope approach since appointment, and nothing sinister has occurred bookkeeping wise. But exactly what “specified audit procedures” are being undertaken in, say, Brazil and China, are not clear.

   Arguably the auditor could/should have also taken a tougher line of some of SYS1’s adjustments (e.g. repeat ‘compensation for loss of office payments’ — see blog post above) and capitalising IT spend (when past capitalised IT was written off entirely).

   Audit costs jumped considerably for 2023, despite revenue reducing 3%:

   

   Grant Thornton’s audit fee for 2019 was £64k, so SYS1 was then obtaining 100% full-scope coverage at what seemed to be a very reasonable price. And the annual report (with the same March year-end) used to be published during June and not late August as last year.

   But Grant Thornton’s non-audit fees were then £121k, which SYS1 has since done away with (at least such non-audit fees are not paid to current auditor RSM).

   d) Conclusions relating to going concern

   A rewrite for this section of the 2023 audit report. No references this time to HSBC’s bank loan, covenants and worst-case scenarios, but more standard going-concern text instead:


   “• obtaining an understanding of relevant controls over the going concern models prepared by management, 
including the review of the inputs and assumptions used in those models.
   
• testing the accuracy of management’s models, including agreement to the most recent Board approved budgets 
and forecasts.
   
• auditing the forecasts prepared by management from 1 April 2023 to 31 March 2025 by challenging the key assumptions of these forecasts by:

   • comparing forecast revenue with the Group’s historical performance;

   • evaluating the historical accuracy of forecasts prepared by management;

   • assessing the sensitivity of the available headroom on the liquidity of the Group;
   • review of post year end trading of the group and comparison to the forecasts supplied by management.
   • auditing the sufficiency of going concern disclosures in the financial statements, including whether commentary regarding the new facility entered into by the Group is appropriate.”

   e) The extent to which the audit was considered capable of detecting irregularities, including fraud

   A new check introduced for 2023:

   “Existence of employees: Testing was completed on a sample basis to review photographic identification, employer background checks and to meet with employees of the group.”

   With employees the largest expense in a lot of businesses today, this check makes sense… although I can’t recall seeing such a check in other annual reports.

   9) PRINCIPAL ACCOUNTING POLICIES

   a) Amortisation

   Clarification this year about the amortisation timescale for capitalised IT costs:

   “Intangible assets are amortised on a straight-line basis over their expected useful economic lives, which are as follows:

   • Computer software licenses 2 years
   • Capitalised development costs 3 years”

   b) Revenue recognition

   Additional text for 2023 clarifying revenue recognition in certain circumstances:

   “Revenue is recognised only after the results or final written debrief has been delivered to the customer, except on the rare occasion that a large project straddles a financial period end, and that project can be sub-divided into separate discrete deliverables; in such circumstances revenue is recognised on delivery of each separate deliverable, and the transaction price is allocated across the discrete performance obligations by reference to the standalone price for the separate services. Where a contract with a customer requires a purchase order, signed schedule of work or similar document to evidence the right to consideration, revenue is not recognised until the Group receives these documents.”

   c) Accrued income and contract liabilities

   Not a great snippet:

   “The Group is generally paid in arrears for its services and invoices are typically payable within 120 days”

   The figure was 60 days within the 2022 report. I presume the doubling of time to receive payments is the trade-off to capturing much larger customers. Trade receivables therefore need to be monitored (point 12).

   d) Significant accounting estimates and judgements: Share-based payments – judgement and estimate

   Extra text this year about the LTIP accounting charge:

   “The 2021 LTIP is subject to Revenue, Profit After Tax and the Company’s share price exceeding certain targets; the full details of which are given in the Company’s Remuneration Report. The measure of the share-based payment charge is dependent on the estimates made in respect of the probability of those targets being achieved over the vesting period of the options. The key inputs into those estimates are the Company’s forecasts, revenue volatility and inflation. Revenue volatility is determined by reference to the share price volatility used to determine the fair value of the options (with an assumption that the two will have a high level of correlation). Inflation is determined by reference to the Bank of England data for the UK in March and April 2023. The non-market probability factor utilised in the share-based payment model for the year ended 31 March 2023 is between 13% and 17% (31 March 2022: 62% to 65%). The cumulative charge recognised in respect of share options is £126,000 at 31 March 2023. If the non-market probability factor was reduced by 33% to between 9% and 11%, the cumulative charge would reduce to £84,000.”

   The LTIP accounting is very academic, as the true cost to shareholders is through dilution (should it occur — see point 7b).

   e) Significant accounting estimates and judgements: Employee benefits – estimate

   A good way to start improving employee productivity (point 16) — tightening up the staff sabbatical leave scheme:

   “The Group has a sabbatical leave scheme, which provides 20 days paid leave for each six years of service. During the year ended 31 March 2023, the Group modified the terms of the scheme such that rather than being open to all employees, the scheme is now only available to those individuals who have accrued three or more years of unbroken service as at 30 September 2022. The provision for liabilities under the scheme is measured using the projected unit credit method. This model requires several estimates and assumptions. The significant inputs into the model are rate of salary growth and average staff turnover as explained in Note 11.”

   10) PROPERTY, PLANT AND EQUIPMENT

   A reminder of the tiny book value of SYS1’s conventional tangible assets (just £36k):

   

   11) FINANCIAL RISK MANAGEMENT

   Confirmation that HSBC is the bank that pays no interest on SYS1’s cash (point 4a):

   

   12) TRADE AND OTHER RECEIVABLES

   A reference to customers paying their invoices within 120 days (versus 60 days for 2022) (point 9c) prompts a look at SYS1’s trade receivables:

   

   

   Trade receivables of £5,694k is equivalent to 24.3% of revenue, the highest level since FY 2015 (24.4%). The blog post above shows the percentage exceeding this FY’s 24.3% between FYs 2006 and 2015.

   So trade receivables have become slower to collect versus recent years, but have not become outrageously slow compared to SYS1’s entire quoted history.

   Of the £5,694k trade receivables, £3,961k (£4,007k less £46k provision) is not overdue = 70%, which is in the middle of the 64%-77% range witnessed during the previous 6 years. The £1,733k net overdue may well be double the £862k overdue for FY 2022, but does not compare unfavourably to the £1.8m, £1.7m, £2.1m, £1.4m and £1.7m net overdue for FYs 2017 to 2021 respectively.

   Overall then, trade receivables are showing nothing obviously untoward versus what may be an exceptional FY 2022 (which suffered a weak Q4, which means year-end trade receivables could have been unusually low for the prior year). But let’s see how the figures are for FY 2024.

   The net provision for bad debts increased by £67k from £109k to £176k, which does not seem huge.

   13) SHARE CAPITAL

   Shows 13,227k allotted shares, 548k shares held in treasury and 1,261k options. Share count is therefore 13,227k less 548k = 12,679k

   If all the options are converted into shares and assuming the treasury shares are all issued to satisfy such conversions, then the share count should increase to 12,679k plus 1,261k = 13,940k, which is 9.9% greater than the present 12,679k.

   Text elsewhere in the annual report (point 7b) states the maximum dilution is 9.4%, which seems to be calculated by dividing options of 1,261k by the full 13,227k allotted share count.

   I think if all the options were converted — i.e. revenue did indeed reach the Stretch target of £88m (point 7b) — then dilution of 9.9% would be a pragmatic price to pay for shareholders for such a positive operational performance.

   14) TRADE AND OTHER PAYABLES and CONTRACT LIABILITIES

   Nothing of obvious concern here:

   

   

   Total trade and other payables were equivalent to 15.8% of revenue, the highest since FY 2019 (16.8%).

   The small-print says:

   “The contractual terms for the payment of trade payables are generally 30-45 days from receipt of invoice.”

   So, SYS1 pays its suppliers 30-45 days after invoice, but the group’s customers pay SYS1 within 120 days after invoice (point 12).

   SYS1’s working-capital position is also aided also by contract liabilities (£764k), which reflect upfront payments by customers for work yet to be recognised as revenue (aka deferred income).

   Total working capital (receivables, payables, contract liabilities and stock) came to £2.0m for 2023, or 8.5% of revenue. Not as high as the 9.9% for 2021, but higher than for all other years after FY 2016.

   All told, SYS1 does not enjoy ideal working-capital management, but at least the accounts have to date never suffered a major cash crunch due to late customer payments mixed with early supplier demands. And the net work-cap investment at less than 10% of revenue does not seem onerous.

   15) EXPENSES

   Not quite the detailed breakdown of expenses given by other quoted companies:

   

   Other expenses of £8.4m less cost of sales of £3.7m (panel costs and translations etc) gives undefined indirect costs of £4.7m, which absorbed a notable 20% of revenue. Third-party IT costs are probably among the more likely explanations. (I recall quizzing the FD on this subject, so will try to dig out my notes!)

   16) EMPLOYEES

   Not the greatest FY employee ratio performance:

   

   

   Total revenue per employee was £155k, the lowest since FY 2012 (£141k) but was £171k for H2 (see blog post above).

   Employee cost last year was almost £86k per employee with the average wage at £71k. Total employee costs absorbed 55% of revenue while wages absorbed 46% — both percentages were by some distance record proportions. For SYS1 to emerge as a proper ‘scalable’ platform, revenues must grow faster than employee costs.

   One explanation for the lack of greater employee productivity perhaps lies with the extra sales and marketing employees. Revenue per sales and marketing employee was £488k, down from £560k and £737k for FYs 2022 and 2021 respectively. The implication is the (costly) new sales staff have yet to get up to speed with capturing new clients.

   17) RELATED PARTY TRANSACTIONS

   I don’t know why SYS1’s Brazilian and Chinese subsidiaries show zero overhead charges and royalties. The other overseas ventures all seem to incur PLC charges and pay PLC royalties:

   

   One of the non-execs at risk of losing his board seat at the 2023 general meeting is the chief exec of Merit Group (MRIT):

   “During the year, purchases of £141,181 (2022: £nil) were made from Merit Data & Technology Limited, a related party by virtue of the common directorship of Mr Philip Machray. At the year end, an amount of £nil was owed (2022: £nil).”

   Merit is some sort of data/code/AI business, which sounds relevant to SYS1’s ‘platform’ ambitions. MRIT websites here and here.

   Maynard

7. System1 (SYS1)

   Trading Update for the Annual General Meeting published 27 September 2023

   A positive H1 trading update that lifted revenue and profit expectations for FY 2024. Here is the full text:

   ——————————————————————————————————————
   “ System1, the marketing decision-making platform http://www.system1group.com is today providing a Trading Update to coincide with the Company’s AGM.

   With three trading days left in FY24 H1, it is pleasing to report Platform revenue is approximately 40% above the comparable period in FY23, albeit 2022 was affected by customers’ budgetary response to the Ukraine invasion and associated economic shocks.

   Total revenue for FY24 H1 is expected to be approximately 25% higher than the comparable period in FY23. Second quarter revenue is set to surpass the recent FY23 Q4 peak and deliver double-digit growth on Q1 FY24.

   Overall, FY24 H1 Platform revenue is expected to show low double-digit growth on the second half of FY23, and total revenue is projected to rise modestly despite a reduction in bespoke consultancy revenues.

   The improved gross profit margins achieved in H2 FY23 have been sustained in the current year to date, providing a strong base for a profitable year.

   OUTLOOK

   The Company expects to release its Q2 revenue numbers on 24 October 2023 and publish interim results on 6 December 2023.

   The Board is encouraged by trading in FY24 H1 and believes that the Group is well set to outperform the current consensus(1) numbers for Revenue and Adjusted Profit Before Taxation(2) for the current financial year.

   Chairman Rupert Howell commented: “The sustained improvement in performance over the past 9 months reflects the clarity on strategy achieved in last year’s review of strategic options and the executive team’s focus on delivering the plan.”

   (1)Current consensus for FY24: Revenue £25.7m, Adjusted Profit Before Taxation £0.9m (2)Statutory Profit Before Taxation excluding share-based payment charges/credits.”
   ——————————————————————————————————————

   Total H1 2024 revenue up 25% implies total H1 2024 revenue was £10.5m*1.25 = £13.1m.

   Total Q1 2024 revenue was £6.2m, which implies total Q2 2024 revenue was £13.1m less £6.2m = £6.9m.

   Platform H1 2024 revenue up 40% implies platform H1 2024 revenue was £7.6m*1.4 = £10.7m.

   Platform Q1 2024 revenue was £4.9m, so platform Q2 2024 was £10.7m less £4.9m = £5.8m. As per the statement, £5.8m does indeed surpass the platform Q4 2023 peak (£5.5m) and shows double-digit growth on Q1 (+18% on £4.9m). Also, platform H1 2024 revenue of £10.7m just about shows low double-digit growth on H2 2023 (+10% on £9.75m).

   Total Q2 2024 revenue of £6.9m less platform Q2 2024 revenue of £5.8m leaves bespoke consultancy Q2 2024 revenue of £1.1m — the lowest ever for a quarter:

   

   Revenue forecasts for FY 2024 before this update were £25.7m, and the lifted guidance therefore means H2 2024 will deliver revenue of at least £12.6m — versus £12.9m for the comparable H2 2023.

   Annualise this Q2, and total revenue comes to £27.6m with platform revenue at £23.2m. So very understandable SYS1 has raised its revenue expectations for FY 2024 beyond £25.7m.

   News about sustaining the H2 2023 gross margin — a record 86% — into H1 2024 is very welcome and underpins the profit upgrade… although December’s H1 results will clarify the actual profit recorded and any adjustments made (adjustments have complicated the group’s profit reporting during recent years).

   Maynard

8. System1 (SYS1)

   AGM attendance and Result of AGM hosted/published 27 September 2023

   I attended SYS1’s AGM last September(!) and the formal meeting was broadcast via the InvestorMeetCompany platform. I was the only shareholder to attend the physical meeting and I asked questions mostly about bonuses and marketing courses. Other shareholders submitted questions via IMC:

   

   Unlike the 2022 AGM, this AGM did not reveal significant protest votes against the directors and all the directors were re-elected with 99%-plus approval. The only protest votes of significance (c17% of votes cast) concerned the disapplication of pre-emption rights:

   
   
   

   The voting suggests a truce between the unhappy shareholders (the German investors and Stefan Barden) and SYS1 after the April 2023 general meeting that considered the election, removal and demotion of various directors. Votes cast at this AGM came to 7.92 million versus 9.65 million for 2022. So 1.73 million votes less this year. Total shares in issue was 12.68 million.

   Watching the IMC video back, what is now striking is that SYS1 founder/executive John Kearon did not say anything during the meeting and his arms-folded body language did not suggest he found the meeting of great interest.

   Let’s not forget that, just five months before in the very same room, SYS1 shareholders gave Mr Kearon the benefit of the doubt and voted for him to remain an executive at the general meeting. I would have thought Mr Kearon would have become more vocal in these shareholder meetings to reassure investors about the group’s progress and his executive involvement.

   What follows is my lightly edited transcript of the AGM:

   (MP = Maynard Paton, RH = Rupert Howell (Chairman), CW = Chris Willford (CFO), JG = James Gregory (CEO), PM = Philip Machray (non-exec), ST = Sophie Tomkins (non-exec), Q = remote question, TYA/TYI/TYB = Test Your Ad/Idea/Brand)

   ——————————————————————————————————————

   MP: Last year the chairman read out the votes, and there were significant protest votes. What are you not reading out the votes this year?

   RH: The advice is we can read out the votes at the end of the meeting. I can advise you there has been no protest vote. We are talking about votes in the 90%s in favour.

   MP: You have introduced a short-term executive bonus scheme. Why have you introduced that when the LTIP is still running?

   RH: We felt that as we had a new refocused strategy with very strong demands on the sales performance, and in the absence of any pay rises, because we have frozen pay unlike most companies in our sector, to keep our costs under control, that the alternative way of motivating people, rather than giving them pay rises in advance, was to give them bonuses when they achieve results. This has proven to be extraordinarily effective.

   MP: The LTIP was introduced on the understanding that the executives were forgoing their bonuses.

   RH: My view is that you need both in any dynamic organisation. You need an LTIP which is for long-term retention of key executives and rewards for long-term performance. You also need to drive short-term performance, something this company has not always delivered. We are determined we shall deliver, month-on-month, quarter-on-quarter, which is exactly what we are doing. The bonus scheme is a key part of that.

   MP: I think the spirit of the LTIP introduction has been broken.

   RH: Noted.

   MP: Why is short-term bonus targeting profit and not the KPIs from the strategic review such as the rule of 40.

   CW: We have tried to ensure the executive scheme is aligned with the profit that shareholders see. So that is why it is profit and not revenue gain or gross profit for example. I am sure you would be less happy if we achieved some non-financial strategic goals, paid cash out of the company and yet the company was not reporting the earnings you would expect to see.

   MP: There seems to be a conflict, where you are telling shareholders one thing with the rule of 40 and financial metrics for the strategic review, and then your own incentive is something different. So there is no clear alignment there.

   JG: The implicit alignment is that before any incentive is paid out, the rule of 40 will be the driver behind that [required performance]. You need to hit that for the revenue growth and the profit underneath it before anything is paid.

   MP: That needs to be made clear in the annual report.

   RH: Noted.

   CW: When we launched the rule of 40, we said it was a strategic measure and said in some years we would beat it and some years we might fall just short of it, just because of the way the maths works. We are not walking away from the rule of 40. The rule of 40 was not designed as an annual-compensation driving measure. It was more a strategic light that we drive towards.

   RH: We are a business in growth. And long may it continue. And we need to drive month-on-month, quarter-on-quarter growth. We believe we will achieve the rule of 40 each year, but we said very explicitly as part of the strategic review that it was a long-term goal and not a quarterly or annual goal. But we hope to beat both.

   MP: Is the LTIP now done?


   PM: The policy remains that remuneration should be a combination of fixed elements, variable short-term elements and variable long-term elements. The last variable long-term element that was put in place is the LTIP scheme, which is intended to continue in its current form.

   But following the strategic review and as the policy outlines, we reviewed the mixture of fixed and variable elements, and determined following the strategic review there will be a short-term focus on month-on-month growth, quarter-on-quarter growth, needed to hit the long-term objectives. So the long-term LTIP remains in place, and if the business is successful, the LTIP could be the most significant element of remuneration.

   It’s important to say there are no short-term bonuses paid in respect of the accounts being tabled in the meeting today. But for FY 2024, we have layered in some short-term objectives. I don’t consider them to be soft objectives. They are for over-performance of the board’s expectation for the business, and we will review them on the completion of FY 2024 against the targets and we will review again going forward whether the business should revert to solely an LTIP or a combination of short-term and long-term variable. So the LTIP is not done, it remains part of the remuneration mix.

   MP: Does seem like some senior employees have given up on the LTIP. The targets were stretching and it was really clear to shareholders what the targets were.

   PM: And I hope it is clear to shareholders what any of the remuneration targets are.

   MP: What are the targets for the short-term bonus as they are not specified in the annual report.

   PM: I take on your observation, but I don’t think it is right to think that anybody, certainly in the executive team or indeed the management team, has given up on the LTIP or the long-term strategy.

   MP: We have two years to find out whether the bonuses are paid out and the LTIP isn’t.

   PM: The only way we will get there in two years is to hit the quarterly targets and the half-yearly targets…

   RH:… which we are currently doing.

   MP: Reading the statement this morning, you may not need the short-term bonuses as you will easily hit the LTIP.

   RH: The short-term bonuses are part of why we were able to put out a statement like this morning… because they have been very targeted and brilliant targeted I may say by James [Gregory] with the approval of the remuneration committee and the board to make sure key people are absolutely 100% focused on hitting targets rather than allowing anything even to drift for a minute. That’s the plan.

   PM: They are there to motivate as well as remunerate.

   RH: We are also dealing here with some very high-calibre people and who are in demand elsewhere and we took a business decision not to give any pay rises. The average pay rises in our sector are double digit, and we did not do that. What we did instead is say we will put in place some short-term bonus schemes if you deliver the numbers and they have. And we are delighted by that and we think shareholders should be delighted about that.

   MP: Will the bonuses be classified as an adjusting item next year?

   CW: Currently SYS1 treats bonuses and commission payments as what we call a non-trading cost. That goes back to 2019, 2020, 2021, when the bonus targets were set very, very high, and partly because of the pandemic the business performance was very low and so bonuses were either very high or nothing. And so potentially that could hide the underlying performance.

   So we decided we would take those bonuses out of what we call our ongoing profit figure. With our new bonus structure, both for the sales team and the short-term incentive for the executive team, we are actively considering taking variable compensation out of non-trading and putting it into the operational cost. That decision has not been taken yet. And we would restate any prior periods to give that clarity. The reason for it being non-trading because it was very confusing and understanding what was going on in the business.

   MP: The worry is that the bonuses are paid as another adjusting item, the board may get another £300k or so and the senior managers some more, and we are back to breakeven.

   CW: I understand why you are asking that question. I would highlight the statement we put out this morning where we indicated the board was confident we are going to beat the consensus profit figure, so we are signalling very clearly we are going to be very profitable. We have set a gross margin percentage base that gives us a great start towards that. We have obviously not disclosed the costs, it is not even the end of the half year yet. But read that as it is intended.

   MP: I think it’s just a bit sad that shareholders have approved an LTIP two years ago on the understanding that you are forgoing annual bonuses and driving for this LTIP, and you are changing the rules half way through.

   RH: We conducted an exhaustive strategic review and reset the business on a path I would argue 99.9% of our shareholders are very happy with. Because it has started to move in the right direction. And it is all part and parcel of it. But your comments are understood and noted.

   [MP note: 42% of shareholders who voted in the 2023 general meeting essentially voted for a different path for the business]

   MP: The LTIP has going for six years and has not paid out. Do you need other people to drive the business forward?

   RH: We are going to get there. It is a difficult talent market and we have got some great talent and we have got to motivate and remunerate them.

   MP: The talent so far has not matched your LTIP targets.

   RH: It is a re-energised talent following the strategic review and getting the right people doing the right jobs.

   CW: Can I just point out that four of the seven participants in the LTIP have joined the company or joined the LTIP since 2021, and so for that group in particular, with the LTIP having been designed in 2017 and I know it has been adjusted slightly, we need to make sure those individuals are properly motivated as well as rewarded for their performance.

   MP: Why is Orlando Wood spending time developing a marketing course and not selling the platform services?



   RH: He is doing both. I am delighted what Orlando is up to and I will tell you why. The way of marketing our new business is to build fame for SYS1, but we also need to spread the gospel to senior marketers as widely as we can and at some depth. Because one of the reasons I wanted to show the case studies is this is not a product you buy off Google. This is a product that has to be developed and sold into big companies. It’s a key part of them spending millions and millions of dollars, and to do that requires quite a lot of education. One of the things that John [Kearon] has found himself doing in New York quite a lot is running masterclasses at the request of client companies, to teach them how to think differently about advertising, how you measure it, how you make it more performant.

   What Orlando is doing here in partnership with us and WARC, which is an incredibly high-profile organisation, is building a course that is going to educate a whole generation of marketers around the SYS1 protocols. So suddenly we will have, instead of just one person going out proselytising SYS1, hopefully thousands of people will do that. There are thousands of people who have pre-registered interest in the course we are building with Orlando.

   So it’s a joint thing, it will be co-branded with SYS1, it will raise the fame and he will still be working four days a week, not five, four days a week with us meeting clients, and running new business pitches. By the way this is not like a classroom course. What happens is he produces video modules that are served online, so it is an online e-education course. This is not Orlando university, so he can do it in a day a week. And he is going down to four days a week in terms of his pay.

   [MP note: so the chief innovation office is reducing his SYS1 workload to four days a week, with the extra day spent on his own course project (sign up here for £1,895)]

   JG: Orlando is our chief innovation officer and the key thing he does is building out our methodology and IP, and promoting that, whether that is on stage or whether it is directly with customers to win or retain them. If you look at where he was yesterday, he was on stage promoting our new publication ‘Listen Up’, which is all about radio and audio advertising. We talked about in our strategic pillars about doing more than just TV testing, so that helps for that. But again, he is still there promoting SYS1 and our methodology. The great thing about the course is the scalability and that it is modular. It is pre-recorded and essentially can be scaled to multiple people, versus having people in one room with one customer at a time which is much less scalable.

   RH: That’s why we are very pleased about it. It is a very good evolution of his role.

   JG: The attendees are customers or potential customers. It helps with new wins and retention.

   Q: As a very long-term shareholder, I hate dilution in principal. I like execs to buy shares themselves and hold them. Can you give me any reaction to this in your long-term thinking.

   PM: On the dilution point, I think we are clear in the remuneration policy that we are very cognisant that nobody likes dilution. And that the shareholder accretion we expect to be delivered in order to fulfil the LTIP goes beyond the point at which the plan itself will be diluted.

   So I echo the sentiment in that question, and I think that will continue to be reflected in part of the remuneration policy going forward.

   The second part of the question about executives holding shares, I think I am right in saying every member of the board at the moment has shareholdings, and since joining I certainly have and Conrad [Bona, non-executive], the most recent joiner of the board, have both purchased shares. I think we don’t have a specific requirement for executives to hold shares at this point in time but continue to encourage it.

   ST: I am not aware of a formal policy but we could certainly look at a policy because it is becoming more and more common in the market to have a formal exec holding policy where you hold a proportion or a multiple of salary in shares going forward. So we can certainly look at it.

   MP: Surely Orlando should be selling the predictions, speed and value of the service?

   JG: I don’t want to reveal all of the content, but it will come out very soon and within there you will see SYS1 and its methodology and for example, having people accessing the database so they can understand the breadth of what Robin [De Cesare, chief research manager] talked about earlier, those 100,000 ads, which will be there. So it is inherently linked in everything SYS1 stands for and does.

   MP: Are there mentions of 17th century Italian art in these films?



   JG: If Orlando brings to light the methodology through his unique way, he will choose to do so and we will never limit him on that.

   MP: That’s quite a System2 approach.

   RH: The other thing is when you are doing a module approach — I have never personally had a business that does e-learning but I have friends who have founded e-learning businesses including the current chancellor of the exchequer, who did one of the first e-learning businesses — is that the absolute critical point is that you keep it interesting not dry. One of the things that Orlando is brilliant at is making what could be quite a dry topic, fruity, and that is why we think it is going to be incredibly successful.

   MP: From what I can see it is the opposite way round.

   RH: What he does is bring it to life in a very engaging and compelling way for the marketing community, which is the target audience. With all due respect, our target market is not with professional investors. It’s the marketeers.

   Q: What is the long-term future of the original non-platform business?

   JG: I think something we have tried to restate since we did the strategic review is there is always likely to be an element of bespoke work required. When we talk about the make-up of the business, we talk about 75%-80% is our Data, our pure ‘predictual’ offering; about 15-20% is our Data-led consultancy, our ‘Improve Your’ offering; and 5% on Bespoke.

   What we have considered is the historic enterprise work and its ‘bespokeness’. As we grow the business, the bespoke level where we are at today will decline although we imagine we will retain some going forward. If you look at some of the ways our largest customers buy, sometimes they just have a question to ask which we can’t offer from our standard offer and that will come into the bespoke part of our business.

   Q: From today’s trading statement, it is possible to calculate both H1 and Q2 platform and non-platform revenue but requires transposing growth rates from previous periods. Would it not be simpler just to state the numbers for the current periods.

   CW: Yes it would but the Q2 and H1 have not finished yet, and on 24th October we will publish the numbers in tabular form and you can see exactly that. And they will be hopefully approximately close to what we have trailed today. We felt it would be wrong not to indicate the direction of travel.

   MP: TYI has got off to a slow start. Why isn’t Orlando writing a book about TYI?

   JG: We have to keep our powder dry. Watch this space, there will be more focus on TYI going forwards and at the appropriate time we will be able to share what that looks like. Orlando is our chief innovation officer and he was very involved in the ‘Listen Up’ publication. 

The other thing we have been focused on is you have to double down on what is working while you are building for the future. So what we know is that TYA is really flying and really rocketing and so we have to make sure we can drive as much revenue from that for us to reinvest in the business in future things like TYI, TYB etc. So it is not being ignored and it’s on our list.

   MP: Innovation was previously a really big part of SYS1. Seems like it has fallen by the wayside and you are focusing on advertising.

   JG: When I talked in the last Capital Markets Day, we talked about the TYI revenue not growing at the level we want it to and we want to continue to invest and focus on it. We would like to see that grow this year. We would like to ensure we have the supporting methodology, the fame and the new business wins, and retain customers through TYI in the same way in the same way as we have been able to do through TYA.

   MP: I would say TYI is your number one priority instead of Orlando doing a course, because it is such a bigger market than ad-testing.

   JG: If look at the full marketing cycle, and you look at how innovation is interlinked with advertising, once you have innovated a product, you have to advertise it. They are not completely standalone. I know we split our revenues, because we want to, but the idea is that you innovate, you advertise on the back of it, and you improve your brand performance. There is a bit of cyclicality through that piece. We view Orlando’s course will be very positive for the business. We view that TYI is a big opportunity for us to grow in as well and we will be doing both.

   RH: There are many opportunities that we have. TYI, TYB, the move into digital print, these are all quite nascent compared to TYA. TYA is going like a runaway train at the moment, while the other ones still have plenty of potential. We are putting a lot of effort behind them. And I think it just shows you the long-term potential of this business I think is enormous.

   We know what the barriers are. The barriers are the understanding… the fame of SYS1. We are modestly famous in the UK, we are not yet at all famous in the US, which is what John’s been doing. So fame is really important. The reason why it is important is that these are massive [customer] decisions. We are not talking about somebody deciding whether to run an ad or not; we are talking about people making $100 million decisions in some cases. So engaging with us and us being their core adviser is a big decision, and you only do that with people you know and know well and those whose methodology you understand and believe in.

   Everything we are doing is about raising the fame, increasing the understanding of the SYS1 methodology, which is a lot of what Orlando does. And then a sales force that gets in there and educating. People do not buy this off the shelf. You have to get in there to grow and the proof is in the pudding. We are doing it, but the potential, yes, is huge I agree.

   TYI is a harder sell, partly because the cycle is longer. New product cycles tend to be multiple years, so people do not do a new product every year. They might do it in one, three, five or seven year cycles, whereas TYA typically will be annual or bi-annual. Innovation is a longer cycle to get in and start doing stuff with them. But the potential is huge, I am not disagreeing with you.

   With the clients we are working with, we are renowned as the world-leading experts in testing your advertising. We still have a very small market share, so we have to drive that to in turn drive the other, harder-to-sell, tools, and that’s what we are doing. I am not disagreeing with you at all. It is the way you do it.

   When I first joined the board, I was concerned how we had let the consultancy business go. Because all the transformation work I have done in other companies is by using the growth in the established business to fund the innovative side and the new development side of the business. It is not an either or.

   ——————————————————————————————————————

9. Some interesting changes to the shareholder register with the previously disgruntled German consortium leaving at 430p to be replaced by 12 new or increased holdings including Kestrel, Octopus and BGF.

   Stefan Barden though seems to be holding on for more upside ;-)

   • Hi Patrick

     My reading of the trades is that 2.5 million shares were sold in one go and repurchased in 12 batches, although we can now tell Octopus purchased 2 of those batches. German investor Langfristige had 1.3 million shares, so not all of the seller identities have been revealed to date. With Kestrel and BGF declaring, the largest unidentified batch is now 240k shares = c2%, so the other buyers may never be known. The 2023 annual report cited these major holders:

     

     Maynard

     Update: 28 May 2024
     Chapters/Mediqon, another German holder with what was 700k shares, has also exited completely. So the two German holders have sold c2m shares that leaves 500k sold by unidentified sellers. Mr Barden owned 657k shares, so if he has sold, he still retains some shares. Among the list of major shareholders above, the University of Notre Dame du Lac owns 500k so that may well have sold, too, although it does not sound very German.

10. System1 (SYS1)

    Quarter 2 and Half Year Trading Update published 24 October 2023

    News of a slightly better Q2/H1 than previously indicated. Here is the full text:

    ——————————————————————————————————————
    “System1, the marketing decision-making platform http://www.system1group.com today issues an update on trading for the quarter ended 30 September 2023 (Q2) and the half-year ended 30 September 2023 (H1) in advance of its interim results announcement.

    

    Quarter 2 Update

    As highlighted in the Company’s AGM trading progress on 27 September 2023, System1 made further progress towards the strategic objectives that the Board set out following the 2022 strategic review, growing Q2 platform revenue by 55% versus Q2 FY23.

    Predict Your (data) revenue grew by 57% on the comparable prior-year quarter to £5.0m and Improve Your (data-led consultancy) revenue increased by 49% over the comparable prior-year quarter to £1.0m, bringing total platform revenue to £6.0m, up 55%.

    Total Group revenue grew by £1.9m (35%) on Q2 FY23 including a £0.3m reduction in non-platform consultancy, with particularly strong growth in Europe and the UK.

    Half Year Update

    Revenue performance for H1 was slightly ahead of the estimates contained in last month’s AGM trading update, with total revenue expected to be up 27% on H1 FY23 and platform revenue expected to grow by 44%.

    Gross profit for the first half year is expected to reach £11.6m at a margin of 87% (H1 FY23: £8.5m at 81.5% margin), reflecting the management team’s focus on delivering profitable growth and improving shareholder value. Operating costs are expected to increase by £2.2m versus the comparable period, due to increased staff costs – including performance related pay, lower net capitalisation of IT development costs, and enhanced sector and geographic coverage of the TYA Premium database following multiple client wins in the retail, technology and travel sectors.

    The Company expects to report a Statutory Pre-Tax Profit just below £1.0 million for the half-year (H1 FY 23: £0.0m).

    Cash inflow during H1 amounted to £0.6m, resulting in a 30 September 2023 net cash balance of £6.3m (31 March 2023: £5.7m).

    The Company won over 100 new clients in H1, including a global top three advertiser, a leading global breakfast foods company, a leading European car manufacturer, a leading budget airline, a ‘big four’ UK supermarket, and a multinational consumer goods company.

    Commenting on the trading update, CEO James Gregory said: “The sales momentum in the platform business continues, with platform revenue up 55% in Q2, 44% in H1 and all at an improved profit margin“.

    Interim Results
    
The Company intends to release interim results for the half-year ended 30 September 2023 on 6 December 2023.”
    ——————————————————————————————————————

    As per the statement, the Q2 and H1 performance turned out a little better (+£0.2m revenue) than what was announced at the AGM on 27 September 2023.

    Platform Q2 2024 revenue was £6.0m versus my earlier £5.8m estimate.

    Bespoke Q2 2024 revenue was £1.1m and matched my earlier estimate.

    Platform H1 2024 revenue was therefore £10.9m versus my earlier £10.7m estimate.

    Bespoke H1 2024 revenue was therefore £2.4m and matched my earlier estimate.

    Total H1 2024 revenue was therefore £13.3m versus my earlier £13.1m estimate.

    

    The comparable H1 2023 revenue was £10.5m, so this H1 2024 increased revenue by £13.3m less £10.5m = £2.8m.

    Winning more than 100 new clients during H1 suggests i) most of the clients were very small given the incremental £2.8m revenue (<£28k average spend), and/or ii) a lot of existing clients spent a lot less during this H1 than the comparable H1. The H1 gross margin at 87% sets a new record. I am not sure whether increasing H1 operating costs by £2.2m refers to all costs, or just indirect costs (i.e. excluding cost of sales). If the £2.2m refers to all costs, then adding revenue of £2.8m and adding costs of £2.2m gives an incremental £0.6m profit -- which is a 21% margin on the extra revenue. That suggests some scalability is (at last) being demonstrated by the business. A projected H1 statutory pre-tax profit of £1.0m compares with the AGM update signalling something beyond an adjusted pre-tax profit of £0.9m. As before, December’s H1 results will clarify the actual profit recorded and any adjustments made (adjustments have complicated the group’s profit reporting during recent years). The H1 cash inflow of £0.6m might tell us more about 'profit' -- we shall see. Maynard

Comments are closed.