K3 Business Technology Group Regulatory News (KBT)

AIM: KBT

27 March 2018

This announcement is inside information for the purposes of Article 7 of Regulation 596/2014.

K3 BUSINESS TECHNOLOGY GROUP PLC

("K3" or "the Group" or "the Company")

Provider of mission-critical software (owned and third party), cloud solutions and managed services to the retail, manufacturing and distribution sectors

Final results for the 17 months to 30 November 2017

REPOSITIONED FOR PROFITABLE GROWTH

All comparative figures for 2016 refer to the 12 months to 30 June 2016

Adalsteinn Valdimarsson, Chief Executive Officer of K3, said:

"We have implemented significant changes at K3 over the last 18 months, aimed at placing the Group on a better footing for long-term revenue and profit growth and improved cash generation. The Group's operations are now more streamlined and integrated, and we have refocused our IP development roadmap. While the process has involved cultural change and substantial one-off costs, we are seeing the benefits come through.

"We have strong offerings in our chosen markets across the supply chain, including our new cloud-native IP. Since the period end, trading has been encouraging, especially for own IP sales. While there is still work to be done, we remain confident about prospects for continuing progress."

Enquiries:

Notes:

CHAIRMAN'S AND CHIEF EXECUTIVE'S STATEMENT

Overview

K3 has undergone significant change over the last 18 months. We have reshaped the Group including the leadership team, creating a simpler, more integrated and streamlined structure, and have removed substantial costs. We have also redefined our growth strategy, IP development roadmap, and are improving our customer delivery capability. In addition, we completed a share placing and open offer to qualifying shareholders. While these initiatives have involved substantial one-off costs, as well as internal cultural change, we are encouraged by the progress made to date and the opportunities ahead.

We see scope for further operational improvements but believe that K3 is now substantially better positioned for long-term revenue growth, higher quality earnings and improved cash generation.

Market Positioning

K3 is a leading provider of mission-critical Enterprise Resource Planning ("ERP") and other business solutions to customers across the supply chain, including retailers, manufacturers and distributors. We support c.3,700 customers predominantly based in the UK, but also in Europe, the Far East and the USA. We deploy our business solutions, which are mainly built on Microsoft, Sage and SYSPRO solutions, both directly to customers and through channel partners. Once installed, our solutions generate high levels of recurring revenues through annual software maintenance renewals, support contracts and hosting.

Strategic Refocusing and Organisational Changes

Building upon these foundations, during the period under review, we began to implement significant organisational changes to the business, and strategically refocused K3's growth plans.

A core element of our growth strategy is to increase revenues from own intellectual property ("IP"). Our IP is embedded within specific third party ERP solutions, including Microsoft and SYSPRO's, to provide sector specific functionality. It differentiates our solutions, underpins stronger customer relationships, and generates higher margins and recurring revenues. While we will continue to build on this model, an important part of extending our software roadmap is the growth of our own stand-alone 'point' solutions, and in particular, our cloud-native delivery platform, 'Imagine', and our cloud-native applications, which have been specifically developed to perform in the cloud.

As we previously reported, 'Imagine' is an exciting 'next generation' delivery platform, which enables us to embrace fully the opportunities that the increasing shift to the cloud brings, and places us at the forefront of cloud-native development. What is especially relevant is that it is system agnostic, capable of swift integration with any IT infrastructure a customer may already have. Customers therefore do not need to replace core systems, unlike traditional models. We have developed a cloud-native suite of solutions that is built for our platform and provides highly advanced functionality. The whole offering therefore enables customers to adopt innovative solutions and applications rapidly and flexibly. It also offers them a faster return-on-investment and extends the life of their previous IT investments. We intend to develop additional applications for Imagine in order to broaden the scope and target market of our existing solutions set, and view its growth potential very positively.

In reviewing our market approach for our Enterprise-related software offering, ax l is fashion, (a K3 own IP add-on to a Microsoft core ERP product), we are renewing our focus on building strategic relationships with System Integrators ("SI"). These relationships enable us to capture more efficiently the sales potential of this market-leading product. SI's will provide implementation and support services while we retain IP-related income streams and provide industry specific expertise. Helped by this increased focus on SIs, we are pleased to report that we saw significantly improved sales momentum for ax I is fashion towards the end of the reporting period and an encouraging number of contracts have closed since then.

As previously reported, we undertook a review of the Group's resources as part of our process of simplifying and integrating the Group's operations. This review was completed in December 2017, and we have subsequently combined our Microsoft Dynamics businesses (AX, NAV and CRM) into a single practice. This should also enhance our customer service capability.

Other changes that resulted from our review included the integration of all software development and own IP management functions into a single Group-level IP unit. We also created a single team to support sales of our Software-as-a-Service ("SaaS") offering, as well as a single support team for SaaS.

We are confident that these initiatives will improve both the sales process and operational efficiencies.

We have materially reduced our cost base over the period, delivering savings in excess of £5.0m on an annualised basis. Over 2018, we plan to add resource selectively to support sales demand.

Financial Results

These results cover the 17-month trading period to 30 November 2017. This extended period reflects the transition to the new accounting reference date of 30 November from 30 June. As we previously reported, given K3's key selling periods of December and June, the change of date will enable the Board to provide shareholders with a more informed view of the Company's trading outlook when reporting full year and half year results.

K3's results for the period are an adjusted loss from operations*1 of £1.67m (2016: adjusted profit from operations*1 of £9.50m). We incurred significant charges in the period, which related to our comprehensive review and reorganisation programme, and they included: £4.73m of exceptional reorganisation costs (2016: £1.05m), £4.54m of exceptional impairment of development costs (2016: £nil), and £3.93m of amortisation of acquired intangibles (2016: £2.73m). After these and other charges, the loss from operations was £14.78m (2016: profit from operations of £5.23m). The exceptional reorganisation costs will deliver savings of £5.0m on an annualised basis and the impairment of development costs was taken against products that are no longer core to the Group's strategy. The adjusted loss per share*2 was 7.7p (2016: adjusted earnings per share*2 of 23.5p), and the basic loss per share was 35.3p (2016: earnings per share of 12.6p).

The major factors influencing the outcome for the period are discussed in the Operational Review and include market disruption, caused by the industry's shift away from 'on-premise' technology to cloud-based delivery, and a softening in end-markets. Gross margins were adversely impacted by both the significant reduction in software licence sales, which are typically higher margin, and excess resource capacity in services and implementation.  

Balance Sheet and Focus on Cash Generation

Cash generation is a major focus and we are making good progress in improving working capital, primarily by reducing debtor days and accrued income. Reflecting our initiatives to improve cash generation, as well as the July 2017 fund raising, net debt has been significantly reduced and stood at £4.3m at 30 November 2017. This compared to net debt of £15.6m at 30 June 2017 (30 June 2016: £8.9m).

Our placing and open offer to qualifying shareholders, completed in July 2017, raised a total of £7.75m net, with an additional £0.66m invested in K3 through an exercise of warrants and a debt-to-equity conversion of £0.64m.

Dividend

The Board is pleased to propose a final (and total) dividend for the financial period of 1.4p per share. This dividend will become payable, subject to shareholder approval, on the 15 June 2018 to shareholders on the register on 18 May 2018.

K3's Annual General Meeting will be held on 30 May 2018 at 10.30am at the Group's offices at Baltimore House, 50 Kansas Avenue, Manchester, M50 2GL.

Board Changes

There have been a number of Board over the 17 months to 30 November 2017. In October 2016, Adalsteinn Valdimarsson assumed the role of Chief Executive Officer, having joined K3 as a Non-Executive Director in July 2016. Robert Price, who joined K3 as Chief Financial Officer in October 2016 (in a non-Board capacity), was appointed to the Board as Finance Director in July 2017. David Bolton, previously Chairman, and Lars-Olof Norell, previously Non-Executive Director, both retired from the Company. I was appointed to the Board in April 2017 and became interim Chairman in July 2017, becoming permanent Chairman in December 2017.

Staff

On behalf of the Board, I would like to thank all K3's employees for their hard work and commitment during this period of change. It has been tremendous and our skilled teams remain the foundation on which the Company will continue to develop and grow.

Outlook

K3 has undergone significant change and is focused on continuing to improve its performance. While there is still work to be done in implementing our growth initiatives, we believe that the Group is now better positioned to drive own IP sales and recurring income, which currently stands at nearly half the Group's total revenues.

The Group's revenue profile is changing as the move away from 'on-premise' solutions accelerates and customers increasingly adopt consumption-based models. In the short term, this will decrease the Group's rate of revenue growth but the long term effect is highly beneficial, with revenue flows becoming more predictable and the customer relationship expected to deepen and broaden.

Trading since the period end has been encouraging, especially with our own IP product sales. In particular, three ax I is deals were signed in the first quarter of the new financial year compared to seven in the 17 months to November 2017, and our cloud-native Imagine offering is seeing encouraging traction. More widely, we view prospects for our solutions offerings positively, underpinned by the steps we have taken to improve the Group's operational performance.

We remain confident about prospects for continuing progress over the year ahead. We also highlight the bias in the Group's earnings, which is now weighted to the second half of the financial year. This corresponds to the timing of annual software licence and support renewals in our SYSPRO operations.

S Darling

Chairman

26 March 2018

Notes:

Operational Review

Reflecting our decision to create a simpler, more integrated approach to sales and support, as well as our objective to drive own IP sales, K3's operational results are now presented under the following two segments:

*Own IP revenues includes initial and annual software licences and those additional revenues which flow directly from K3 IP.

Recurring revenue comprises software maintenance renewals, support contracts, and hosting & managed services.

Recurring revenue as a percentage of the Group's total revenues over the 17 months to 30 November 2017 increased to 48.7% (2016: 46.7%). Encouragingly, revenue from our own IP accounted for 19.8% of K3's total revenues and rose sharply from 13.9% in 2016. Own IP gross margin accounted for 24.6% of the Group's total gross margin, up by 7.4 percentage points from 17.2% in 2016.

Supply Chain Solutions & Managed Services

K3's business solutions and managed services are tailored to the requirement of the supply chain industry, including retailers, manufacturers and distributors. The Group's core offering is based on Microsoft, SYSPRO and Sage solutions.

K3's financial performance over the period was adversely affected by a number of high value contract tenders in the Enterprise space not closing as expected. Part of the reason for this was the disruption caused by the gear-shift in how technology is being delivered, with the model changing from 'on-premise' technology to cloud-based delivery. Alongside this is the associated move to the consumption/subscription model, away from large up-front software licence payments. This disruption caused a significant lengthening in customers' decision-making processes for large deals. However, we also experienced a general softening in end-markets. The sharp drop in software licence revenues reflects the unexpected shortfall in sales. Gross margins were doubly hit, not only by the effect of a lower proportion of higher margin software licence sales in the mix, but also excess resource capacity in services and implementation. Recurring revenue was adversely impacted by the shortfall in sales. However, recurring revenues as a proportion of total revenues, which provides core stability to the business, improved.

Our Global Accounts business, which includes our relationship with Inter IKEA Systems B.V. (the owner and franchisor of the IKEA concept) and the Inter IKEA Concept franchisees, performed well. With the continuing expansion of the IKEA franchisee network, we anticipate a high level of activity here.

The SYSPRO business generates strong cash flows and delivered good results. Customer renewals of software licences continued to be high, at 98% (2016: 98%). Sage X3 continued to grow and we are now recruiting talent from abroad, given the shortage in the UK for delivery resource. As we previously reported, we restructured Business Solutions to focus on the Microsoft Dynamics/Navision SME space and that unit is now seeing an improvement in its profitability, which will be accelerated with the creation of a single Microsoft Dynamics practice.

We previously highlighted that the move towards cloud-based consumption licensing has positive long-term implications for the Group. This is because the lifetime value of customer relationships under this new model has the potential to be significantly higher, compared to the traditional model of perpetual software licences (typically paid upfront, at the commencement of a relationship). However, this shift will affect the Group's rate of reported revenue growth since income from cloud/consumption-based contracts is recognised over longer periods. The pace of uptake of consumption-based contracts has increased over the period, especially in the Microsoft Dynamics space where we are now seeing the majority of new contracts signed on this basis.

Own IP

K3 has developed in-house, or acquired the IP rights to, software products, which the Company sells on a standalone basis or as part of its integrated suite of solutions. In addition K3's core ERP solutions are typically enhanced and enriched by our own IP for specific industry segments. This gives us our solutions a competitive advantage and differentiation.

Total revenue from own IP over the 17 month period amounted to £23.4m (2016: £12.4m), with the period also benefiting from contributions from two acquisitions, Merac, acquired in July 2016 and DdD Retail, which was added in April 2016. These acquisitions contributed a combined £10.1m to own IP revenues over this period, including £5.2m of recurring revenues. As well as bringing additional valuable, wholly-owned IP, both acquisitions have added new customer bases. Recurring revenues from own IP as a proportion of total revenues increased by 5.7%. Gross margins for own IP were slightly lower than last year due to the lower proportion of revenue coming from software sales on which the gross margin is highest.

Sales of Pebblestone, our leading business software for the mid-market fashion industry, which we also sell through channel partners, were particularly strong. As previously highlighted, sales of ax l is fashion, which are typically large contracts, suffered from the softness in the Enterprise space and customers taking longer to deliberate between cloud or 'on-premise' technology. However ax I is fashion deal closure improved significantly towards the end of the reporting period and a number of large contracts were secured including with Jack Wolfskin, Lifestyle Sports and Eton Shirts. Two of these contracts were delivered through our channel partners. We have continued to see good deal closure since the period end, with three ax|is contracts signed, including SanMar in the USA, and the pipeline for ax I is remains encouraging.

The development of Imagine, our cloud-native, ERP agnostic platform has been an important step for us. The platform enables us to integrate leading-edge 'module' solutions into customers' existing infrastructure swiftly and cost-effectively. In this way, we can bring product innovation and the full power of the cloud to customers in a commercially and operationally attractive way. Our first suite of modules for Imagine are based around our retail offerings and we intend to develop further functionally-rich modules to broaden the scope of our offering. We expect the Imagine platform to become a cornerstone of our IP strategy and, in total, we now have circa 13 customers live on Imagine.

Central Costs

Central costs include directors' costs, human resources, accounting and legal personnel, and the costs associated with running a PLC, including financing. Costs are stated net of recovery of elements recharged to operating units. Central costs*5 for the 17 month period amounted to £1.7m (2016: £0.8m), with the significant rise reflecting our centralisation programme.

Outlook

We remain focused on improving the Group's performance and in particular driving own IP revenues and are confident of continuing progress. We are encouraged by the progress made by own IP business units and the recent deals closed in ax I is fashion. We are now seeing stronger migration by customers to cloud-based solutions from 'on-premise' systems, and, while this represents an adjustment for the business in the near term, it will enhance our customer relationships and contribute high quality revenue streams.

Adalsteinn Valdimarsson

Chief Executive Officer

Notes