K3 Business Technology Group Regulatory News (KBT)

AIM: KBT

21 March 2016

K3 BUSINESS TECHNOLOGY GROUP PLC

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

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

Interim results for the six months to 31 December 2015

KEY POINTS

Financial

· Results in line with management expectations - and profitability substantially ahead of prior year

· Adj. PBT1 up 33% to £4.72m (2014: £3.56m) (up 36% with constant currency)

- benefiting from strong performance from retail activities, increase in own IP and cloud hosting revenues as well as efficiency initiatives

Reported PBT up 27% to £2.28m (2014: £1.79m)

· Adj. EPS2 up 43% to 12.0p (2014: 8.4p) / Reported EPS up 51% to 5.9p (2014: 3.9p)

· Revenues up 1% to £42.29m (up 4% with constant currency) (2014: £41.67m)

- recurring revenue margin up to 70% (2014: 64%) and account for c.47% of total

- higher margin own IP revenues represented 23% of total sales (2014: 22%)

· Net debt reduced by 13% to £10.45m (2014: £12.07m)

· Adj. cash generated from operations3 rose to 114% (2014: 109%) with higher rate of cash conversion

Operational

· Continued encouraging progress as business transitions to increase own IP content

- strong growth in chosen focus areas of own IP, channel sales and hosting

· Major new orders remained buoyant at £11.3m (2014: £12.3m)

· Channel partner sales - a key to accelerating growth - progressing very well, with first major contracts with Global Systems Integrators ("GSIs")

· Major endorsement from Microsoft - membership of elite Microsoft Dynamics 'Inner Circle' - supports channel partner sales strategy and relationships with GSIs

· Hosting and managed services activities growing well and bolstered by the acquisition of Starcom in April 2015

· Board remains confident regarding future prospects

Lars-Olof Norell, Chairman, said:

"We are encouraged by these results, which show a significant increase in profits, driven by a strong performance from our retail activities, own IP sales and cloud hosting as well as cost reduction initiatives.

A key part of our growth plans for K3 is to drive sales of our own IP software products, particularly our retail product on Microsoft Dynamics AX. As part of this strategy, we are focused on growing sales through channel partners as well as through our own direct sales teams. We made encouraging progress here in the period and received our first orders through a Global Systems Integrator for our ax I is fashion" product. Microsoft's endorsement of K3 in July 2015 as member of its elite Microsoft Dynamics 'Inner Circle' supports growing channel partner interest in our solutions and we are also engaging with Microsoft on potential opportunities.

Looking forward, we remain confident about the potential to exploit our own IP and expect to see continuing progress in our growth strategy together with rising channel partner sales and hosting. As we have previously noted, cloud-based subscription models are becoming increasingly important to us as customers move towards consumption-based licensing. This means that whilst income from contracts is recognised over longer periods rather than upfront, the lifetime value has the potential to be significantly higher.

As we seek to further develop the business, we also intend to consider acquisitions which enhance our existing product offering."

Enquiries:

Notes:

CHAIRMAN'S STATEMENT

OVERVIEW

K3's half year trading results are in line with management expectations, and show a significant improvement in profitability with adjusted profit before tax*1 up 33% to £4.72m (2014: £3.56m) (36% with constant currency). This reflects a strong performance from our retail activities and cloud hosting as well as the benefits of reorganisation changes, which helped lift the Group's gross margin percentage to 55.6% from 50.7% in the same period last year. As expected, Group revenues at £42.29m (2014: £41.67m) were affected by the shift towards cloud-based consumption licensing and the weaker Euro.

We continue to be very encouraged by the progress we are making in driving sales in areas we have chosen to focus on, which are our own IP software products, channel sales and hosting. We are particularly pleased with the major orders for our fashion retail product on Microsoft Dynamics AX. As a result of this strong sales performance, our own IP product software licence revenue of £4.89m accounted for 25% (2014: 23%) of all product software licence revenue sold in the period. Total revenues derived from our own IP amounted to £9.56m which represents approximately 23% of the Group's total sales and importantly, the gross margin percentage on this income also improved to 65.5% from 63.9%.

A key part of our growth plans for K3 is to drive sales of our own IP software products through channel partners as well as through our own direct sales teams. We are making excellent progress here and, as we previously reported, in September 2015, we received our first order through a Global Systems Integrator ("GSI") for our "ax I is fashion" product. The order was our largest so far through our channel partner network and our first in Germany, Europe's largest market for fashion. Over the period, we signed three major contracts through GSIs and new channel partners, and continue to remain very confident of the significant opportunity that the channel represents. Microsoft's endorsement of K3 in July 2015 as member of its elite Microsoft Dynamics 'Inner Circle' supports the growing channel partner interest in our solutions and we are also engaging with Microsoft on potential opportunities.

Major new orders in the period remained encouraging, totalling £11.3m against a strong prior period (2014: £12.3m) and we have closed the half year with a pipeline of potential new deals valued at £56.5m (2014: £56.7m). This pipeline includes the remaining part of an initial order with a global fashion retailer which has the potential to grow significantly.

The business continues to deliver high levels of recurring revenues, which made up 47% of the Group's total revenues in the first half. At £19.72m (2014: £19.84m), they are mainly derived from annual software licence renewals, support contracts and hosting. I am also pleased to highlight the increase in gross margin percentage on this income which has risen to 70.0% from 63.9% in the comparative period.

We also focused on driving the growth of our cloud hosting and managed services activities. These operations are growing well and annualised subscription income is now at £8.2m, of which over £6.4m is from our cloud hosting operations. Our cloud hosting business has since won its largest ever order, and has a number of other contracts for implementation in the coming months.

Looking forward, we remain confident about the potential to exploit our own IP and expect to see continuing progress in our growth strategy. We also expect cloud-based consumption licensing to be an increasing feature of the Group's revenue mix, together with rising channel partner sales and hosting. As we seek to further develop the business, we also intend to consider acquisitions which enhance our existing product offering.

FINANCIAL RESULTS

*Recurring revenue: software maintenance renewals, support contracts, and hosting & managed services

K3 Intellectual Property

We highlight the revenue generated by K3's own IP below, which is included in the revenues above.

i) K3 Product Licence includes initial and annual software licences.

ii) K3 Product Related represents the additional identifiable revenues which flow directly from our K3 Product sales.

iii) adjusted to reflect reclassification of £0.35m from product licence to product related.

For the six months to 31 December 2015, total revenues rose by 1% to £42.29m (2014: £41.67m) affected by consumption licencing and a weakening Euro. Recurring revenues, from software maintenance renewals, support contracts, hosting and managed services, accounted for 47% of the Group's income and totalled £19.72m (2014: £19.84m). Services revenue was up 11% to £13.19m (2014: £11.93m) and reflected strong activity levels following the excellent close to the last financial year. Software licence sales at £6.88m (2014: £7.63m) represented a good performance against a record result in the prior year and as expected, the current year has seen an increase in consumption-based licencing.

Results show a significant year-on-year improvement in gross margin which increased by 11% to £23.52m (2014: £21.11m) with the gross percentage margin rising to 56% (2014: 51%). This improvement reflects the benefits of the initiatives we implemented to reduce resourcing costs for implementations through in-house training and near-shore resourcing. The gross margin on recurring income also benefitted from the higher margin on our hosting and managed services businesses and a reduced impact of Microsoft embed partner margin Overhead costs*2 increased to £18.4m (2014: £17.0m) and includes an additional £1.0m of personnel cost, £0.2m of additional premises costs and £0.1m of additional development cost amortisation.

Adjusted profit from operations*3 increased by 24% to £5.11m (2014: £4.11m). Key drivers in this improvement were the reorganisations and management changes we announced in September 2015 at a cost of £0.85m (2014: £0.16m). These costs are reported as exceptional in these results and have contributed to a step change in the performance of our retail operation. The charge for amortisation of acquired intangibles was £1.60m, in line with the prior year.

Net finance expenses decreased to £0.39m (2014: £0.55m) as a result of reduced debt and the impact of currency.

Adjusted profit before tax*3 rose by 33% to £4.72m (2014: £3.56m) and adjusted earnings per share*4 increased by 43% to 12.0p (2014: 8.4p).

Reported profit before tax increased by 27% to £2.28m (2014: £1.79m) with basic earnings per share rising by 51% to 5.9p (2014: 3.9p). There was a net tax charge for the period of £0.41m (2014: £0.57m) after the benefit of a £0.14m deferred tax credit (2014: £0.12m).

Cash flow and banking

Net debt at 31 December 2015 decreased by 13% to £10.45m (2014: £12.07m). Cash flow from operations was up 16% at £4.97m (2014: £4.30m) reflecting the higher profit in the period and management of working capital. In what is traditionally our stronger half year for cash generation due to SYSPRO annual licence billings, the adjusted cash flow generated from operations*5 increased to 114% (2014: 109%) of adjusted operating profit*3. Net cash absorbed by financing in the period was £1.36m (2014: £3.06m net generated from refinancing).

The expenditure on capitalised development increased to £2.17m (2014: £1.75m) as we continued to execute our strategy of building our own product IP. Expenditure on fixed assets was £0.57m (2014: £0.33m) and deferred consideration on acquisitions cost a further £0.03m (2014: £nil).

DIVIDEND

In line with the Group's dividend policy, no interim dividend will be declared but the Directors intend to propose a progressive final dividend.

BOARD CHANGE

In December 2015, we were delighted to welcome Jonathan Manley to the Board as a Non-executive Director. He has over 35 years' experience in IT, both in the UK and US including at Harrods Ltd, where he is currently leading an IT change program, John Lewis and Estee Lauder. He replaces Peter Cookson who retired from the Board with our grateful thanks for all his hard work and contribution to K3.

OUTLOOK

We are starting to see the benefits of our focus on own IP come through in increased Group profitability, channel partner sales and hosting, and remain very excited about ongoing opportunities.

As part of our growth strategy we will continue to invest significantly in developing our product offerings and also intend to consider acquisitions which complement our existing activities. As we have previously noted, cloud-based subscription models are becoming increasingly important to us as customers move towards consumption-based licensing. While this shift away from traditional on-premise models means that income from contracts is recognised over longer periods rather than upfront, the lifetime value has the potential to be significantly higher. The estimate of this lifetime value will be a key metric for monitoring the development of the business going forward.

The pipelines across both our retail and manufacturing and distribution activities remain very healthy and we are confident that K3 will continue to make good progress with its growth plans.

Lars-Olof Norell

Chairman

21 March 2016

Operational Review

RESULTS OVERVIEW BY INDUSTRY SECTOR

The operational results for the Group are summarised by industry sector as follows:

RETAIL ACTIVITIES

Results Overview

*Recurring revenue: from software maintenance renewals, support contracts, and hosting and managed services.

Intellectual Property

Retail Performance

Our retail operations performed strongly overall, with adjusted profit from operations*6 more than doubling to £2.51m (2014: £1.06m) on revenues of £19.72m (2014: £19.63m). Encouragingly, revenue attributable to our own IP has risen by 10% to £7.62m from £6.94m in 2014.

The significant improvement in profitability was driven by both higher software licence sales and the initiatives we put in place to reduce the cost of software implementations. While trading conditions in the Dutch fashion and retail market and the weaker Euro hampered results, the cost base reductions we made in Holland at the beginning of the period helped to offset this effect.

Software sales at £4.50m were up 10% year on year with the 70% gross margin on these sales reflecting the own IP content of the deals. Services revenues at £7.68m were in line with the prior year with gross margin significantly increased to 30.5% (2014: 20.6%) as implementation costs reduced. While recurring revenues decreased to £6.2m (2014: £6.78m) because of the lower number of multi-year enhancement deals, the gross margin percentage increased significantly to 70.8% from 56.6%. This reflected the increase in own IP in the revenue mix, a reduced impact from the low margin Microsoft Embed (OEM) programme and higher margin on support renewals.

Major new orders in the period totalled £6.6m (2014: £6.8m).

We continued to drive sales across all our retail solutions, however a key focus remains on our own IP and, in particular, delivering the full potential of our "ax l is" product, which we consider is significant. An important element of our growth strategy is to expand sales through channel partners as well as through our own direct sales teams. We were therefore delighted to sign our first contract for "ax l is" through a Global Systems Integrator ("GSI") in the period. The deal secured with TriStyle, a leading European mail order fashion retailer, via a GSI in Germany was the largest order secured to date through our channel partner network. It was also K3's first win in Germany, the largest market for fashion in Europe. We subsequently signed two further major channel partner contracts for "ax|is fashion" in the period. This included a second win in Germany with one of Germany's largest online fashion retailers, KLiNGEL. We are also now well advanced with initial work on a contract for a large global fashion retailer which has potential to deliver significant annual revenue in future years.

In the second quarter, we signed a major deal with a new customer, to provide our Microsoft Dynamics NAV retail software suite on a hosted consumption basis. The contract is notable because it was our first major cloud-based subscription model win. As we have previously indicated, we expect to see an increasing shift in the way we sell our solutions, away from traditional 'on-premise' sales to the 'consumption' model as customers move towards adopting cloud hosted systems. This move towards more consumption based delivery is underscored by Microsoft's move to launch its new version of AX for a six month period via the cloud on its Azure platform.

Our business with IKEA was also strong in the period, with a good mix of licence, support and services from Inter IKEA and the concept franchisees following the extension of our strategic partnership in 2014 through to 2020, which included a multi-year enhancement licence commitment. At the lower end of the Retail market we were also encouraged by the excellent performance of our Retail Essential Solutions, which focuses on "events and venues" and is a flourishing section of the UK retail market, as well as our Unisoft Dutch business which focuses on smaller retailers in Benelux.

Reflecting the importance of our IP and channel partner strategy, during the period, we established a core IP team. This team is solely focused on developing our innovative core solutions for sale through our channel partner network. We see the expansion of this activity as a key part of our strategy to improve profitability and replace lower margin services income. As indicated in our last annual report, we took steps to tackle performance issues in our services centric Dutch fashion and retail business and rationalised our retail management structure at a cost of £0.66m.

Retail Prospects

We remain very positive about the global sales potential of our "ax l is" offering and our new elevated status as a member of the Microsoft Dynamics Inner Circle will greatly assist our strategy to drive global sales, both directly and indirectly through an international network of channel partners.

Our pipeline as we entered the second half of the financial year stands at a healthy £26.3m (2014: £28.7m) and with potential deals across both "ax|is fashion" and our more established solutions, we believe that our retail operations will continue to make encouraging progress.

MANUFACTURING AND DISTRIBUTION ACTIVITIES

Results Overview

*Recurring revenue from software maintenance renewals, support contracts, and hosting and managed services

Intellectual Property

Manufacturing and Distribution Performance

Our manufacturing and distribution activities performed robustly in the period, with revenues up by 2.4% to £22.57m. While adjusted profit from operations at £2.99m*7 (2014: £3.40m) was impacted by order delays in some units, gross margins improved to 58.8% (2014: 56.9%). This reflected growth in hosting and efficiency improvements in the delivery of services.

Nearly 60% of this segment's revenue comprises recurring income which provides significant cash flow for the investment activities for the whole Group. (It also accounts for approximately 69% of the Group's total recurring income.) Recurring income increased by 4% to £13.52m in the period, with SYSPRO maintenance and support renewals continuing to account for the major part. SYSPRO renewal rates remained high at 98% (2014: 98%) and, as annual renewals are billed in October, revenues and cash flows from this segment are significantly weighted to the first half of the financial year.

Overheads increased by £1.03m following the investment in resources noted at the prior year end and the addition of Starcom.

Our SYSPRO business performed in line with expectations as we updated our core own IP products (Dataswitch Connectivity, Equator Payroll and Orchard Warehouse Management) and achieved initial sales through our channel partners. We expect to see continuing progress in these areas in the second half. Our hosting and managed services businesses continued to grow well, benefiting from the merger with Starcom, acquired in April 2015. The combined business has enabled us to provide hosting to different service level requirements and also to merge a number of on-premise support businesses under common management. The hosting operations now trade solely under the Starcom name.

New orders were encouraging at £4.7m (2014: £5.5m) although a number of larger software deals, which include own IP related revenues, moved into the second half.

Services revenues rose 28% to £5.5m (2014: £4.3m) reflecting delivery of contracts signed in the prior year in SYSPRO, our NAV and AX manufacturing business, and in our hosting operation where Starcom has a small level of chargeable services. The NAV and AX business closed the half year with a strong pipeline, which we are now starting to see converting into orders since the period end. The Sage business delivered lower levels of services revenues reflecting the relatively low numbers of deal closures in the first four months of the period with margins also reduced as a result. In recent months though, we have seen an increase in the Sage prospects pipeline which provides encouragement for the second half year.

Our hosting and managed services operation is performing well with the addition of Starcom boosting our delivery capabilities. Now part of a merged hosting operation, we estimate that it added approximately £1.5m to sales and £0.2m to adjusted operating profit*9 in the period. Hosting and managed services contributed £3.79m of recurring revenues in the period (2014: £2.73m) and the closing contracted run rate of subscription income has increased by 29% to £8.22m (2014: £6.36m). This run rate now includes the major hosting contract referred to in our retail activities, running for an initial period of five years. The range of cloud hosting activities that we offer across a variety of products and price points is proving attractive to customers and we remain very optimistic about continuing growth prospects for our hosting and managed services business.

Manufacturing and Distribution Prospects

The outlook for our manufacturing and distribution activities is encouraging, supported by a very robust recurring income and a pipeline of prospects worth £30.2m at the period end (2014: £28.0m). In addition, we are continuing to focus strongly on the growth potential of our cloud hosting business. 

CENTRAL COSTS

Head office

Head office costs for the period were £0.49m (2014: £0.35m) with the increase reflecting investment in legal staff and consultancy as the business has expanded. Costs are stated net of recovery of elements recharged to the operating units.

OUTLOOK

We continue to be optimistic about the performance of the Group as we transition to an increased product focus. We are encouraged by the progress we have made in the current period and will continue to seek ways to accelerate this process.

David Bolton

Chief Executive Officer