K3 Business Technology Group Regulatory News (KBT)

AIM: KBT

9 July 2019 

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 supply chain sector

Interim results

for the six months to 31 May 2019

KEY POINTS

Summary

Financial

Operational

Adalsteinn Valdimarsson, Chief Executive Officer of K3, commented:

 "K3's transformation programme continues to make good progress, and while first half results are below the same period last year, the Group remains on track to meet market expectations for the full year and to show good year-on-year earnings progression.

"Delays to certain contract signings affected first half results, however we have now largely caught up on the outstanding delays, and the second half includes significant licence and maintenance contract renewals where renewal rates are very high - around 98%. The near-term pipeline also remains encouraging.

"Our growth strategy - based on selling more of our own IP - has the potential to drive earnings and recurring income significantly. 'K3 I imagine', our new, cutting-edge product, is especially exciting, and is relevant for both new and existing customers. We remain very positive about prospects."

Enquiries:

Notes:

JOINT REPORT OF THE CHAIRMAN AND CHIEF EXECUTIVE OFFICER

Introduction

K3 continues to make encouraging progress with its transformation programme, and while first half results are below the same period last year, the Group remains on track to meet current market expectations for the year and to show good year-on-year earnings progression. This view takes into account the closure of three major new contracts and commitments at the end of the period, additional orders that have come through since then, as well as an encouraging near-term new business pipeline. It should also be noted that the Group's earnings are in any case seasonally weighted towards the second half, with a large number of annual software licence and maintenance contracts falling due in the period; renewals rates are very high.

As previously reported, the first half performance was affected by delays in certain contract signings, some of which related to Brexit. This meant that these large contracts closed later than expected, thereby reducing services utilisation and income. However, we have now largely caught up on the outstanding major Supply Chain contract closures and expect further software licence orders to come through from the new customer signings. Aside from these delays, all units performed in line with or above management expectations in the period.

A major focus this year is on developing sales of our new, cutting-edge, cloud-native product, 'K3 I imagine', which was launched at the end of the last financial year. 'K3 I imagine' and its platform and suite of applications form the cornerstone of our growth plans. The product has great potential across K3's existing extensive customer base as well for new customers, and we expect it to make a meaningful contribution to the Group's revenue in the second half, benefiting margin expansion and recurring income. We have strengthened our sales resource accordingly.

Financial Results

Revenue for the six months to 31 May 2019 decreased by 7.0% to £38.2m (2018: £41.4m). Recurring income, which comprises software maintenance renewals, support contracts, SaaS, and hosting & managed services, increased 2.6%, to £19.2m (2018: £18.7m) or 50.0% of total revenue in the period (2018: 45.2%).

Gross profit was 9.7% lower than the same period last year at £19.5m (2018: £21.6m). This principally reflected delayed contract signings, which severely impacted services activity and consequently utilisation and services gross margin. Services gross profit decreased by £1.4m to £2.7m in the period (2018: £4.1m) and gross margin reduced by 7.1 percentage points to 21.8% (2018: 27.9%). Similarly, software licence gross profit reduced by £0.5m to £3.4m (2018: £3.9m) and gross margin was 68.7% (2018: 71.7%).

Gross profit derived from our Intellectual Property ("IP") is a key metric for us since it generates the Group's highest margins, and own IP licence sales are at the core of our growth strategy. Our own IP contributed £6.3m or 32.5% to total gross profit (2018: £6.8m or 31.5%) in the period.

Administrative expenses reduced by 7.1% to £20.5m (2018: £22.1m) as a result of a continuing process of improving efficiencies and cost-saving initiatives.

Adjusted profit from operations was £0.8m (2018: £1.7m), mostly the result of reduced services gross margins.

After taking into account £0.3m of exceptional costs (2018: £0.7m), which related to the reorganisation programme, an amortisation charge of £1.2m for acquired intangibles (2018: £1.3m) and a share-based payment charge of £0.3m (2018: 0.2m), the loss from operations was £1.0m (2018: loss of £0.5m).

Finance expenses were £0.4m (2018: £0.5m), resulting in an adjusted profit before tax*2 for the period of £0.4m (2018: adjusted profit before tax*2 of £1.2m). The reported loss before tax for the period was £1.5m (2018: loss of £1.0m).

Adjusted earnings per share*3 was 0.0p (2018: adjusted earnings per share*3 of 1.4p). Basic loss per share was 3.0p (2018: basic loss per share 2.8p). 

Balance sheet and cash flows

Net debt at 31 May 2019 stood at £5.7m (31 May 2018: £8.5m), a 33% reduction. We continue to focus on improving cash generation and this is being supported by better internal processes, improved deal and resource allocation evaluation, as well as incentivisation.

K3's cash flow is now following normal seasonality and, as previously indicated, the second half of the financial year will benefit from annual software licence and support renewals, which are heavily weighted towards this period, with SYSPRO renewal rates typically around 98%.

Capitalised development expenditure for the six months was £1.7m (2018: £1.0m), in line with the Group's refocused IP development roadmap, and 50% of expenditure was on the 'K3 I imagine' product.

Cash utilised in operating activities amounted to £3.0m (2018: £2.9m), and reflects a more normal annual seasonality to cash generation.

Depreciation was similar to the prior six months at £0.4m (2018: £0.5m) and amortisation £2.6m (2018: £2.4m).

The Group's current banking facilities are due for renewal in October 2019. This process is at an advanced stage and we expect the renewal to be successfully concluded in the second half, with terms agreed through to March 2021.

Dividend

As in prior years, the Board expects to propose only a final (and total) dividend for the financial year. This is anticipated to show a year-on year uplift in line with the Board's confidence in K3's future prospects.

Overview of Performance 

A key area of focus for the Company is increasing sales from our own IP. 'K3 I imagine', our class-leading platform and solution sets have very exciting potential to drive own IP sales. This is in addition to our more established add-on solutions for Microsoft Dynamics, 'K3 I fashion' and 'K3 I pebblestone' and our ERP agnostic integration platform 'K3 I dataswitch'. These products have been sold to around 500 customers both direct and through our global partner channel.

The 'K3Iimagine' platform and applications are provided on a Platform-as-a-Service ("PaaS") and Software-as-a-Solution ("SaaS") basis. The technology can be deployed agnostically via cloud or via our 'K3 I Cloud' Infrastructure-as-a-Service unit ("IaaS"). We have developed solutions for multiple business processes, including inventory management, Point of Sale ("POS"), pricing & promotion, tax compliance, and bespoke customer solutions, and believe that the ease with which our technology can be integrated and the innovation it supports makes our offering an attractive option for businesses across the supply chain sector.

As well as selling to new customers, 'K3 I imagine' is relevant to our existing installed base of approximately 3,700 customers. We see opportunities to deepen our engagement with customers that use our existing ERP and POS solutions. Almost half of the Group's customer base deploys a K3 authored/supported POS solutions, with many customers using legacy systems. In addition, well over 40% of the total base are ERP customers using SYSPRO, Microsoft or Sage products. The 'K3 I imagine' Retail Suite provides a ready upgrade for POS customers, and over time, we intend to broaden the offering to enhance our overall proposition across the broader customer base.

We are also working on extending our Managed Services and IaaS offerings, including 'K3 I Cloud', across the customer base.

During the first half, we significantly expanded the sales team in order to support these and other initiatives. The early response to the launch of 'K3 I imagine' has been encouraging, with a pilot now in place with a major food and beverage group and our Mobile Goods Flow solution in use in a number of Inter IKEA Concept franchisee stores.

'K3 I fashion' added three more customers in the period, with Brexit causing some disruption. We expect two of these newly-signed customers to ramp-up software licence orders over the remainder of 2019.

In line with the market shift to subscription, customers are tending to purchase software licences in line with their roll-out plans on Microsoft Dynamics 365F&O subscription deployment, and we are seeing a new pattern emerging whereby newly-contracted customers initially purchase a small number of software licences, subsequently stepping up licence order further down the project timeline. This differs from previous large upfront purchases under the traditional model.

Our relationship with Microsoft continues to be very strong, especially in relation to 'K3 I fashion', which is increasingly viewed as a market-leading product for the fashion industry. Our close engagement with Microsoft helps both direct sales and indirect sales through channel partners. In the period, we launched a channel partner model in the UK for 'K3 I fashion', which has extended our IP footprint. A high profile Microsoft Dynamics 365F&O implementation for Fortnum & Mason also went live in the period.

The Global Accounts operation saw good growth and the new office in Kuala Lumpur is working well, and will support continuing growth in the Far East. We have commenced global resource pooling of Dynamics resource especially to facilitate Global Accounts growth.

The Group's SME-related activities performed steadily across all of our supply chain verticals and we are especially pleased at progress within Sage and Managed Services activities.

Outlook

We believe the initiatives put in place during the last two years will continue to underpin K3's performance and growth prospects. We will also look for additional opportunities to increase operational efficiency.

The second half of the financial year has started well, with three 'K3 I fashion' deals expected to close. We are encouraged by customer reaction to 'K3 I imagine' and expect the offering to contribute meaningfully to the Group's results during this financial year. The wider new business pipeline, including for 'K3 I fashion' and Global Accounts remains strong and we expect services utilisation to show a marked improvement in the second half following recent deal closures.

K3's seasonal weighting of cash flows and profitability towards the second half of the financial year will be more exaggerated this year mainly due to anticipated growth in services gross margins. More broadly, we believe that K3 is well-positioned to make further progress with its transformation strategy and we view our growth prospects with confidence.

9 July 2019

Operational Review

Overview

The Group's results for the six months to 31 May 2019, together with comparatives for the same period in 2018, are summarised in the table below.

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

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

The increase in recurring revenues reflected growth in Managed Services and 'K3 I imagine'. The increase in the revenue mix of recurring revenue was driven by growth in recurring revenue and decline in services activity. Own IP revenue was down to £8.1m (2018: £9.0m).

Supply Chain Solutions & Managed Services

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

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

Software licenses revenue grew slightly to £3.2m (2018: 3.1m) and gross margin improved to 56.0% (2018: 54.8%). Services revenues were down, the result of delays in the closure of new Microsoft Dynamics deals, and this also resulted in lower services utilisation, with services gross margin decreasing to 19.0% (2018: 26.7%). Several major contracts closed towards the end of H1, including Regatta, the UK-based outdoor clothing supplier, and CreditSafe, the credit agency. We had a notable success with the 'go live' of the Fortnum & Mason Microsoft Dynamics365F&O project, which is a high profile implementation. We also opened up the selling of 'K3 I fashion' in the UK to channel partners in order to expand our IP footprint. We expect services gross margin to increase in the second half as the deals signed at the end of the first half flow into chargeable project work and as we support new 'K3 I fashion' channel partners in the UK. Recurring revenues remained stable on 2018. Gross profit was £13.2m (2018: £14.8m) driven by the services chargeability. Gross margin on hardware increased as a result of the start of a group sourcing initiative.

Global Accounts, which includes our relationship with Inter IKEA Systems B.V. (the owner and franchisor of the IKEA concept) and the Inter IKEA Concept franchisees, continued to grow. This reflected the ongoing expansion of the IKEA franchisee network into new geographies and the increased activity mainly contributed to services income. The Kuala Lumpur office opened in the second half of 2018, and we have added further resource. Encouragingly, the office generated earlier levels of chargeability than expected. Our initiative to start to increase own IP sales in Global Accounts is bearing fruit, with further sales of 'K3 I dataswitch' and first sales of 'K3 I imagine' warehouse solutions. There is also still more opportunity to deepen relationships within the IKEA ecosystem.

Own IP

K3's IP portfolio comprises two parts, first, K3-authored software that enriches our established third party offerings, specifically Microsoft, SYSPRO and Sage technology. For example, our 'K3 l fashion' and 'K3 I Pebblestone' products are both based on Microsoft Dynamics's Enterprise Resource Planning ("ERP") solutions, and are enriched by K3 IP to suit the needs of specific industry segments. Secondly, we provide solely-authored, stand-alone solutions. These include DdD Point of Sales, Dataswitch, and 'K3 I imagine'. These products can be sold with our other solutions or individually.

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

While recurring revenues from own IP increased to £5.1m (2018: £4.6m), which reflected the growth of our stand-alone agnostics IP solutions including 'K3 I dataswitch', DdD and 'K3 I imagine', total revenue from own IP reduced to £8.1m (2018: £9.0m). Revenues from software licence sales decreased to £1.8m (2018: £2.4m) with delays to expected deals and follow-on orders as highlighted above. As mentioned, three new customers for 'K3 I fashion' were added in the first half, including Regatta and we expect licence revenue to increase as further orders as roll-outs proceed. The number of customers expanded by 12% in H1 and the pipeline is good and of a high quality. Gross profit trends in software mirrored the revenue due to high margins. Services gross margins increased to revenue from our integrations team.

We expect recurring revenue to continue to grow as we commercialise 'K3 I imagine'. This will also benefit sales of 'K3 I dataswitch', our integration product. 'K3 I imagine' revenue in H1 was £0.3m (2018: nil).

Support Costs

Support costs*6 include the global costs of the Group's finance, IT, legal and human resource functions, as well as Board and PLC costs. There was a net increase in cost in the period, which arose from investment in IT security only partially set off by further internal efficiencies.

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED INCOME STATEMENT

For the six months ended 31 May 2019

All of the loss for the period is attributable to equity holders of the parent.

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME

For the six months ended 31 May 2019

All of the total comprehensive expense for the period is attributable to equity holders of the parent. All of the other comprehensive (expense)/income will be reclassified subsequently to profit or loss when specific conditions are met. None of the items within other comprehensive (expense)/income had a tax impact.

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF FINANCIAL POSITION

As at 31 May 2019

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF CASH FLOWS

For the six months ended 31 May 2019

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

For the six months ended 31 May 2019

K3 BUSINESS TECHNOLOGY GROUP PLC

NOTES TO THE UNAUDITED INTERIM STATEMENT

1. Basis of preparation

The consolidated interim financial information has been prepared in accordance with the accounting policies that are expected to be adopted in the Group's full financial statements for the year ending 30 November 2019 which are not expected to be significantly different to those set out in Note 1 of the Group's audited financial statements for the 12 month period ended 30 November 2018. These are based on the recognition and measurement principles of IFRS in issue as adopted by the European Union (EU) and are effective at 30 November 2019 or are expected to be adopted and effective at 30 November 2019. The financial information has not been prepared (and is not required to be prepared) in accordance with IAS 34. The accounting policies have been applied consistently throughout the Group for the purposes of preparation of this financial information.

The financial information in this statement relating to the six months ended 31 May 2019 and the six months ended 31 May 2018 has neither been audited nor reviewed pursuant to guidance issued by the Auditing Practices Board. The financial information for the 12 month period ended 30 November 2018 does not constitute the full statutory accounts for that period. The Annual Report and Financial Statements for the 12 month period ended 30 November 2018 have been filed with the Registrar of Companies. The Independent Auditors' Report on the Annual Report and Financial Statement for the 12 month period ended 30 November 2018 was unqualified, did not draw attention to any matters by way of emphasis, and did not contain a statement under 498(2) or 498(3) of the Companies Act 2006.

IFRS 15 'Revenue from Contracts with Customers' is mandatory for the Group from 1 December 2018. The Group has completed an assessment of the impact of IFRS15. The complexities of IFRS 15 required a detailed analysis of the Group's performance obligations under each significant contract in order to assess whether they are distinct and to determine the point in time, or period over which, it is appropriate to recognise revenue. This also included determining whether customers had a right to use or a right to access the software. Some contracts required revenue to be recognised differently under IFRS 15 than under the preceding IFRS and which included the following considerations:

The Group has taken the decision to apply the cumulative effect method as of the date of initial application with no restatement of comparatives. The cumulative effect of applying the standard has been recorded as an adjustment to the opening balance of equity (retained earnings) at the date of 1st December 2018. The adjustment to opening retained earnings with a debit to retained reserves of £0.8m and a credit to accrued income of £0.8m. The adjustment relates to subscription-based cloud hosted software solutions which had been recognised previously at a point in time which is now recognised over time. The impact on the financial results for the 6 months to 31 May 2019 is a credit to revenue and debit to Trade and Other Receivables for £0.2m.

IFRS 9 'Financial instruments' is mandatory for the Group from 1 December 2018. The standard replaces IAS 39 Financial Instruments: Recognition and Measurement. IFRS 9 sets out a new forward looking 'expected credit loss (ECL)' model which replaces the incurred loss model in IAS 39 and applies to, amongst other financial assets and liabilities, trade receivables. Unlike IAS 39, entities will be required to consider forward looking information when measuring ECL. Therefore, a credit event (or impairment 'trigger') no longer has to occur before credit losses are recognised. Therefore, the provision for impairment of trade receivables will take account of the forward looking information. The Group has developed its model for calculating the ECL and the adoption of this standard has not materially impacted the result from the previous standard.

IFRS16 "Leases" is will be applicable to the Group from 1 December 2019 and the Group is in the process of assessing the impact of its adoption. The Group is not yet in a position to quantify the impact of IFRS16 on the Group's reported results or financial position.

2. Loss from operations

During the six month period to 31 May 2019, reorganisation costs of £0.3m have been incurred, most of which are redundancy costs. During the six month period to 31 May 2018, reorganisation costs of £0.7m were incurred relating to the reorganisation programme to create more unified, streamlined operations and a reduced cost base.

3. Tax expense

4. (Loss)/earnings per share

The calculations of (loss)/earnings per share are based on the (loss)/profit for the financial period and the following numbers of shares:

Adjusted earnings per share calculations have been computed because the Directors consider that they are useful to shareholders and investors. These are based on the following profits and the above number of shares:

5. Loans and borrowings

6. Trade and other payables

7. Notes to the cash flow statement

Cash generated from operations is stated after exceptional reorganisation costs and acquisition costs. The adjusted cash generated from operations has been computed because the directors consider it more useful to shareholders and investors in assessing the underlying operating cash flow of the Group. The adjusted cash generated from operations is calculated as follows:

8. The above information is being sent to shareholders and is available from the Company's website, www.k3btg.com, and from its registered office: Baltimore House, 50 Kansas Avenue, Manchester M50 2GL.