K3 Business Technology Group Regulatory News (KBT)

KBT

K3 BUSINESS TECHNOLOGY GROUP PLC

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

Unaudited Half-yearly Report

For the

Six months to 31 December 2011

KEY POINTS

Financial Key Points

·; Revenue up 35% to £33.36m (2010: £24.67m) − includes £3.73m from acquisitions in H1 and benefit of acquisitions made in 2010

- recurring income up 36% to £17.1m (2010: £12.6m)

·; Adjusted profit from operations*1 up 11% to £6.91m (2010: £6.24m)

Profit from operations unchanged at £4.66m (2010: £4.66m)

·; Investment of c.£0.5m made in managed services and retail software (AX), continuing in H2

·; Adjusted profit before tax*2 up 7% to £6.23m (2010: £5.81m)

Profit before tax of £3.98m (2010: £4.23m)

·; Adjusted basic earnings per share*3 up 7% to 18.1p (2010: 16.9p)

Basic earnings per share of 12.3p (2010: 12.7p)

·; Underlying operating cash generation*4 of £7.29m - represents 105% of adjusted profit from operations*1 (2010: £5.97m, 96% of adjusted profit from operations*1 )

·; Placing raised £5.02m (net) in July 2011 and further banking facility of £1.05m agreed

·; Net debt at 31 December 2011 of £13.35m (2010: £11.48m, 30 June 2011: £15.49m)

·; No interim dividend (in line with dividend policy) but final dividend expected

·; Commencement of formal sale process, announced on 1 March 2012

Operational Key Points

·; Increased revenues across all four divisions (Microsoft UK, SYSPRO and Sage, International and Managed Services)

·; Five significant acquisitions completed. Total initial payment on acquisitions of £6.36m - all complementary, readily integrated

·; Major new order wins totalled £8.6m, up 72% (2010: £5.0m)

·; Significant investment in Microsoft AX capability - flagship new order win with Eason

·; Significant investment in Managed Services Division - hosting platforms now in place for SYSPRO, Microsoft Dynamics NAV and Sage 200

·; Board views prospects for the remainder of the year positively

Commenting on the results, Tom Milne, Chairman of K3, said,

"We are pleased with K3's performance over the six months to 31 December 2011. A number of major new orders were closed in the period and our International Division in particular is showing encouraging growth. Results were supported by the high levels of recurring income the Group enjoys from annual software licence and support renewals across our growing customer base. Cash flows were also strong as expected.

We have continued our acquisition strategy to accelerate the growth of the business. The acquisitions in the period have added further customers, additional intellectual property and increased the reach of the business. The new divisional structure is a good platform for generating synergies from the existing business and the acquisitions.

The expansion of our hosting capability in the Managed Services Division remains a major focus. We have recruited additional skilled resource and invested in capacity and will continue to do so.

As announced on 1 March 2012, we have commenced a formal sales process and will be making further announcements in due course. With the growth opportunities available and our strong financial position and supportive bankers, we expect K3 to make good progress over the remainder of the financial year and beyond."

Notes:

*¹ Adjusted profit from operations for the six months ended 31 December 2011 is calculated before amortisation of acquired intangibles of £1.75m (2010: £1.43m) and acquisition and reorganisation costs of £0.50m (2010: £0.15m).

*2 Adjusted profit before tax for the six months ended 31 December 2011 is calculated before amortisation of acquired intangibles of £1.75m (2010: £1.43m) and acquisition and reorganisation costs of £0.50m (2010: £0.15m).

*3 Adjusted basic EPS for the six months ended 31 December 2011 is calculated before amortisation of acquired intangibles (net of tax) of £1.19m (2010: £0.93m) and acquisition and reorganisation costs (net of tax) of £0.46m (2010: £0.15m).

*4 Underlying operating cash is calculated before the cost of regularising liabilities in acquired entities of £1.18m (2010: £0.91m) and acquisition and reorganisation costs of £0.30m (2010: £0.15)

Enquiries:

OVERVIEW

In tough market conditions, results for the six months to 31 December 2011 are encouraging and continue to illustrate the robustness of K3's earnings, which are underpinned by high levels of recurring income. The Group's revenues increased by 35% year-on-year to £33.36m, helped by the acquisitions we have made. Adjusted profit before tax*1 increased to £6.23m, which is a 7% rise on the same period last year. The level of profitability was held back, as expected, by the significant investment that we made in our Managed Services and Microsoft UK Divisions in the period.

In line with our growth plan, we continued to make acquisitions, completing five significant purchases in the period. Initial payments on acquisitions were £6.36m. All the acquisitions are complementary to our existing operations and can be readily integrated. A major strand of our acquisition strategy is to add complementary customer bases which are suitable for introduction to our hosting model. In this way, we will accelerate the growth of our recurring income stream.

I am particularly encouraged by the growth in our International Division which has seen revenues rise by 29% to £4.84m and adjusted profit from operations*2 rise by 25% to £1.4m in the first half. These excellent results have been driven by a combination of steady order wins in our fashion/wholesale market and a high level of activity with Inter IKEA Systems B.V. (the owner and franchisor of The IKEA Concept), the largest customer in the International Division. We anticipate further good growth in this division.

The UK market remained challenging and our Microsoft UK Division and SYSPRO and Sage Division are highly focused on minimising costs whilst delivering sales targets. We have however invested heavily in the development of our Retail AX Multi Channel solution as we believe there are significant opportunities to drive growth as Microsoft takes this product to market. This decision bore fruit at the end of the period with a number of very significant order wins, including Eason and Son Ltd ("Eason"), the largest supplier of books, magazines and newspapers in Ireland.

The development of our Managed Services Division has huge potential to drive K3's long-term growth and we have invested heavily in this in the current financial year and will continue to do so. Revenues at the Division are growing well, however the required investment and increase in costs together with the phased recognition of income (which is recognised over the life of the hosting contract) means that profitability is being impacted. The exploitation of the hosting proposition is the key focus of our growth plans.

On 1 December 2011, we announced that we had received an approach from K3's largest shareholder, Mr P J Claesson, regarding a possible offer for the Company. At the same time, we also began a strategic review of the options available to the Group. Since then, on 26 January 2012, we announced that the Board of K3 did not wish to take Mr Claesson's proposal forward. On 1 March 2012, we announced that the Company had received a number of indicative proposals at levels materially higher than the current share price at that date. Whilst the Board firmly believes that the Company has a secure future as an independent business, it recognises that further investment will enable it to more fully exploit the potential of its managed services business. The strategic review has therefore completed and the Company is holding ongoing discussions with these potential offerors. We will make any further announcements as appropriate.

K3 continues to generate good cash flows and our bankers are highly supportive of both our acquisition strategy and our working capital needs. K3 is financially and operationally well-placed. Our strong product offering and good cash flows will help to support our growth and we view prospects for the remainder of the year positively.

FINANCIAL RESULTS

For the six months to 31 December 2011, the Group generated revenues of £33.36m, representing an increase of 35% over the prior period (2010: £24.67m). The five acquisitions completed in the period made a revenue contribution totalling £3.73m. Recurring revenues from maintenance and support in the half year totalled £17.1m (2010: £12.6m), representing 51% of Group income in the first half, and it continues to underpin profitability.

Adjusted profit from operations*2 for the six month period rose by 11% to £6.91m against the same period last year (2010: £6.24m). It should be noted that this was after significant investment in our Managed Services Division and Retail AX software suite in the period, of which we have expensed £0.5m. Additionally,we have capitalised £0.45m in respect of platforms and intellectual property that will benefit future periods and spent £0.25m on equipment. Acquisitions contributed £0.51m of the adjusted profit*3. Acquisition and reorganisation costs included write-off of investments of £0.10m (2010: £nil). Profit from operations remained flat at £4.66m (2010: £4.66m) reflecting higher acquisition and exceptional costs together with an increased charge for the amortisation of intangibles.

Adjusted profit before tax*1 rose by 7% to £6.23m (2010: £5.81m). Profit before tax was 6% lower at £3.98m (2010: £4.23m). This is after a £0.35m increase in acquisition and reorganisation costs, a £0.26m increase in finance costs and a £0.32m increase in goodwill amortisation. Adjusted earnings per share*4 increased by 7% to 18.1p (2010: 16.9p). Basic earnings per share was 3% lower at 12.3p (2010: 12.7p). This is stated after amortisation of acquired intangibles (net of tax) of £1.19m (2010: £0.93m) and acquisition and reorganisation costs of £0.46m (2010: £0.15m). The tax charge for the period was £0.52m (2010: £0.98m) and includes the benefit of a £0.57m credit to deferred tax on acquired intangibles (2010: £0.51m) and a £0.20m current tax credit primarily in respect of research and development from prior years.

Cash flow and banking

Net debt at the period end increased to £13.35m (2010: £11.48m) but has reduced from the 30 June 2011 position of £15.49m. We completed a share placing of £5.02m (net of costs) in July 2011 and in the same month agreed £1.05m of additional revolving credit facility, which was used for an acquisition. The acquisitions we made in the first half were also funded by cash in the business and the share placing completed in July 2011. The initial net cash cost of acquisitions (i.e. net of amounts paid/deducted for cash balances and overdrafts in the acquired businesses) was £6.36m with a further £1.27m payable on a contingent basis and up to £1.48m of potential earn out subject to the achievement of performance criteria. A further £1.18m was utilised to fund the working capital requirements and loan repayments of the acquired businesses, together with acquisition costs of £0.26m. Additional facilities of up to £5.00m are available to match the net receipts of the share placing though we have not utilised these to date. Operating cash flow in the first half was £5.81m, representing 84% of adjusted profit from operations*2 (2010: £4.91m, representing 79%). After adding back overdue liabilities, together with acquisition and reorganisation costs relating to the acquisitions, the underlying operating cash for the period is £7.29m, representing 105% of adjusted operating profit*2. Finance costs at £0.69m (2010: £0.43m) reflect higher average borrowings and facility fees.

Dividend

In line with the Group's dividend policy, no interim dividend is proposed but the Directors intend to propose a final dividend with results for the full financial year.

Operational Review

As indicated in the annual report and financial statements for the year ended 30 June 2011, from 1 July 2011, the reporting of results reflects four trading divisions: Microsoft UK, International, SYSPRO and Sage, and Managed Services together with central costs. The comparatives for the six months ended 31 December 2010 have been restated accordingly.

The financial results by operating division are summarised in the table below:

Microsoft UK Division

Revenues at the Microsoft UK Division increased by 13% to £12.10m (2010: £10.67m), with recurring income delivering £4.37m (2010: £3.41m). However adjusted profit from operations*5 at £1.52m was unchanged year-on-year (2010: £1.58m) partly reflecting the major investment we are making in our retail software offering, in particular bringing the Microsoft AX product in line with our Microsoft Dynamics NAV portfolio. We also invested in our sales and delivery resource in advance of sales of this product offering. The cost of our investment was £0.30m with a further £0.25m capitalised as development costs.

After a slow start to the financial year in our UK retail markets, the Division closed three major new deals in November and December worth a combined £5.7m (2010: eight major contracts, £3.4m). This included our first major order for Microsoft's new AX for Retail solution in a substantial contract we won with Eason, which was secured against some tier one competitors. We are very encouraged by the increasing demand for this new solution and are well placed to exploit it. A large element of our own IP is included in these sales, which supports good margins.

In the course of our Group reorganisation to create the Microsoft UK Division, we have integrated our other smaller Microsoft based software units under a single management team. This is allowing cost savings to be achieved and we are also seeing efficiencies arising from the use of common resources.

The addition of Retail Systems Group Ltd ("RSG") in December 2011, one of the leading providers of Microsoft Dynamics 'RMS' to retailers in the UK and Ireland, brings us a software suite more suitable for smaller retailers and therefore widens our marketplace. RSG also has a managed service offering which will further expand K3's own growing Managed Services Division.

The prospects pipeline for the Division stands at approximately £24.0m (2010: £18.0m), with nearly half the opportunities focused on our Microsoft AX Multi Channel retail solution.

International Division

The International Division, based in The Netherlands, performed very strongly in the first half. Revenues increased by 29% year-on-year to £4.84m (2010: £3.75m), with recurring income at £1.90m (2010: £1.76m), and adjusted profit from operations*6 rose by 25% to £1.40m (2010: £1.12m). These results are in part due to the strengthening of our relationship with Inter IKEA Systems B.V. (the owner and franchisor of The IKEA Concept), the largest customer in the Division. They also reflect the growth of the Pebblestone acquisitions, made in 2010, which established K3 as a major supplier of ERP systems in the Dutch fashion market and added a 30 country international partner channel for K3's IP. Sales into this reseller channel have increased by 58% to £0.75m as a result of investment in the Pebblestone solution that was made over the last 18 months.

We signed nine major new contracts in the period, worth a total of £0.50m (2010: six contracts, £0.64m). The Division also generated excellent levels of services income and we are currently recruiting additional personnel to add extra resource.

In December 2011, we acquired certain assets of Unisoft BV, a leading provider of retail point of sale solutions in Holland and Scandinavia. The solutions complement our existing offering and should create cross-selling opportunities.

The prospects pipeline, excluding potential business anticipated in a long term plan with Inter IKEA Systems B.V., currently amounts to approximately £3.3m of orders. It also includes a number of AX opportunities, a market that is now becoming increasingly important to us.

SYSPRO and Sage Division

In the first half, the SYSPRO and Sage Division (which comprises four business units) saw revenues increase by 61% to £13.81m (2010: £8.57m), with recurring income at £8.79m (2010: £6.15m). Adjusted profit from operations*7 rose by 15% to £4.07m (2010: £3.53m). Acquisitions contributed £3.09m of revenue and £0.31m of adjusted operating profit*8. The majority of the revenue increase relates to Sage acquisitions that generally deliver lower operating margins. The pipeline of prospects is holding up well with a value of £9.20m, split relatively evenly between Sage and SYSPRO opportunities.

Our key business unit in this Division, K3 SYSPRO (formerly Supply Chain Solutions) which supplies SYSPRO ERP solutions, performed robustly. It closed six new deals with a combined value of £0.60m in the period (2010 full year: 13 deals; £0.93m) and generated significant additional work from the customer base. Annual software licence fee renewals for SYSPRO were collected between October and December and licence renewals were in excess of 98% as is usual. The SYSPRO maintenance licence and support income is worth approximately £5.90m per annum and we recognise some 85% of this figure in this half of our financial year.

Having entered the Sage marketplace in November 2010, we are now a leading Sage supplier and provide the full range of Sage products, from Sage 50 up to enterprise level Sage 1000. Our Sage customer base now stands at 900 customers (2010: 400 customers) and generates recurring income of around £6.00m (2010: £2.4m) per annum, approximately half of which falls in the first half of our financial year. In July 2011, we acquired Fifth Dimension Systems Ltd and, in October 2011, the business secured the Sage Enterprise Partner of the Year award, which entitles it to higher margins in the next year. Our Sage operations secured 39 new deals worth £1.3m (2010: 16 deals worth £0.3m). While the Sage support market is highly price competitive, we continue to attract customers from other Sage partners. Mirroring the model we are deploying for our Microsoft and SYSPRO customers, we will be cross-selling our Cloud Computing solutions to our new Sage customer base and have a deployment model already operational for the Sage 200 product.

The other two business units comprise customers running smaller ERP systems who can be offered upgrade opportunities to our SYSPRO or AX solutions and hosting. These businesses contributed £1.02m (2010: £1.15m) of sales in the period, substantially all of which is recurring.

Managed Services Division

Revenue rose by 55% to £2.61m (2010: £1.68m), with recurring income delivering £2.04m (2010: £1.09m). However, as expected, profits lagged revenue growth as we invested £0.2m in additional resource. Divisional overheads have increased to £1.36m (2010: £0.7m), capitalised development was £0.22m and capital expenditure was £0.25m. Adjusted profit from operations*9 was £0.09m (2010: £0.15m). We now have platforms in place for the hosting of SYSPRO, Microsoft Dynamics NAV and Sage 200 software and are seeing a good demand for these and the other complementary services we can offer from "the Cloud". Our deployment now ranges from on-site managed services to fully hosted services provided on a multi-tenanted solution in the Cloud.

As this Division grows, it will increase our annualised recurring income, which at 31 December 2011 had increased to c.£4.2m (2010: £3.28m), with a delivery pipeline of £0.77m awaiting deployment. Currently, the prospects pipeline stands at £2.38m of potential income.

Head Office

Central costs*10 for the first half were £0.17m (2010: £0.14m). Underlying costs remain unchanged but subject to the operational performance of the Group.

Outlook

The increase in K3's underlying profitability and cash flow is highly encouraging. We have an excellent record of acquiring complementary businesses and delivering synergies. We also have a number of exciting growth opportunities to leverage our large customer base and build on our key customer and supplier relationships. A formal sale process is now in place and we will be making further announcements in due course.

With the growth opportunities available and the strong financial platform in place, we remain excited about the future prospects for the Group.

Tom Milne

Chairman