K3 Business Technology Group Regulatory News (KBT)

9 July 2018

AIM: KBT

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

Interim Results

Six months to 31 May 2018

KEY POINTS

Summary

Financial

Operational

Adalsteinn Valdimarsson, Chief Executive Officer of K3, said:

"These results are very encouraging with the Group returning to underlying profitability. They reflect the benefits of our restructuring to create a more streamlined and integrated business, as well as the refocused growth strategy.

"Increasing revenues from software products that we have developed in-house remains a core part of the Group's growth strategy, and we remain positive about sales prospects both for our existing products and our newer offering, Imagine, which we formally launched in the first half. Imagine offers customers the opportunity to adopt latest technology easily and at low cost, without changing existing IT infrastructure. We also see it as a ready-made upgrade path for existing customers, especially those using older systems.

"The second half is our stronger earnings period, reflecting the volume of software licence and support renewals in the final quarter of the financial year. It has started very encouragingly, with a healthy pipeline in place, and this, together with expected high renewals, gives us confidence that the Group will make further progress over the remainder of the year."

Enquiries:

Notes:

JOINT REPORT OF THE CHAIRMAN AND CHIEF EXECUTIVE OFFICER

Introduction

We are pleased with the progress K3 has made over the first half, following a period of significant restructuring and internal change as the new management team implemented initiatives to place the Group on a better footing for long-term revenue and profit growth. Results for the first six months of the financial year show the benefits of a tighter, more integrated organisational structure, and our refocused sales and own Intellectual Property ("IP") strategy. In particular, we are pleased to see the Group return to underlying profitability, helped by a marked improvement in gross margins, particularly services and own IP. Operational cash generation continues to improve and, with the seasonally stronger weighting in software licence and support contract renewals in the second half, the Group's cash generation should show further progress by the financial year end.

Overall, the business is in substantially better shape, financially, operationally and strategically, and we view prospects for continuing recovery and growth over the remainder of the financial year positively, supported by a healthy new business pipeline and expected high levels of renewals, with Syspro renewals typically at c. 98%.

Financial Results

Revenue for the six months to 31 May 2018 increased by 2.6% to £41.4m (2017: £40.3m), with recurring income, from software maintenance renewals, support contracts and hosting & managed services, continuing to make up a high percentage of the total, at £18.7m (2017: £18.8m).

Gross profit rose by 14.3% to £21.6m (2017: £18.9m), with significant increases in contribution from services, and software licences. The proportion of gross profit derived from own IP improved and accounted for 31.5% of the total (2017: 30.7%).

The Group's gross margin shows a substantial recovery, increasing by 5.4 percentage points to 52.2% (2017: 46.8%). This improvement principally reflects the lower cost base, recovery in productivity, and growth in own IP software licences.

Gross margin was higher in software licences and services, and also across recurring and hardware income streams. Gross margin in software licences increased by 12.2 percentage points to 71.7% (2017: 59.5%) and in services rose by 11.1 percentage points to 27.9% (2017: 16.8%). Recurring revenue gross margin improved by 2.3 percentage points to 68.3% (2017: 66.0%).

The recovery in gross margin helped to drive the Group's turnaround in underlying profitability, with K3 moving from losses to an adjusted profit from operations*1 of £1.7m (2017: adjusted loss from operations*1 of £3.1m), a £4.8m improvement.

After taking into account £0.7m of exceptional costs (2017: £0.8m), which related to the reorganisation programme, an amortisation charge of £1.3m for acquired intangibles (2017: £1.4m) and a share-based payment charge of £0.2m (2017: nil), the loss from operations was £0.5m (2017: loss of £5.4m), which is a year-on-year reduction of £4.9m.

Finance expenses were £0.5m (2017: £0.5m), resulting in an adjusted profit before tax*2 for the period of £1.2m (2017: adjusted loss before tax*2 of £3.6m). The reported loss before tax for the period was £1.0m (2017: loss of £5.8m).

Adjusted earnings per share*3 was 1.4p (2017: adjusted loss per share*3 of 7.8p). Basic loss per share was 2.8p (2017: basic loss per share 12.4p). 

Balance sheet and cash flows

The Group has been focused on improving cash generation and continues to work on reducing working capital balances especially accrued income. K3's cash flow is now in line with management expectations, and the second half of the year is expected to benefit from annual software licence and support renewals, which are heavily weighted towards this period, with Syspro renewal rates typically around 98%.

At 31 May 2018, net debt stood at £8.5m (31 May 2017: £18.5m), with this reduction mainly reflecting the equity placing, warrants exercised and debt-to-equity conversion (which together reduced net debt by £9.0m in July 2017). However, we are also pleased to highlight £1.1m of operational cash generation during a 12 month period of restructuring and exceptional costs, as note 5 highlights.

Capitalised development expenditure for the six months was £1.0m (2017: £2.1m), in line with the Group's refocused IP development roadmap. Approximately half of this expenditure was on the Group's Imagine product offering, which was launched in the period.

Cash utilised in operating activities amounted to £2.9m (2017: £1.1m), and reflects a more normal annual seasonality to the cash generation. The comparative results for 2017 were impacted by reorganisation costs, one-offs relating to working capital optimisation, and operating losses.

Depreciation was similar to the prior six months at £0.5m (2017: £0.5m) and amortisation decreased to £2.5m (2017: £3.1m), following the write-downs in the 17 month period ended 30 November 2017.

Dividend

The Board intends to maintain a progressive dividend policy, and expects to propose a final (and total) dividend for the year to 30 November 2018.

Overview of Performance 

A key area of focus for the Company is increasing the proportion of sales from our own IP. Sales of own IP software licences lifted to £2.4m (2017: £1.3m), with gross profit from software licences doubling to £2.2m (2017: £1.1m) in the first half against the same period in 2017.

These very encouraging results reflected the benefits of our redefined 'go-to-market' strategies, and in particular our reinvigorated channel partner sales strategy. The trading backdrop in the Enterprise market, which is especially relevant for our "ax l is fashion" product, was also better. The uncertainty around cloud-adoption versus traditional 'on-premise' solutions has cleared, and is no longer causing major decision delays. A total of seven deals were closed for "ax l is fashion" in the period, mostly through channel partners, which compares with seven deals over the 17 months to 30 November 2017.

We were pleased to formally launch our Imagine platform and the first set of Imagine modules in the first half. The Imagine product is an in-house developed 'cloud-native' offering that enables us to offer cutting- edge applications to customers on a SaaS model. Compellingly, it also allows companies to adopt these new technologies easily and cost effectively, without the need to change existing legacy systems, so providing them with a fast return on their investment. We are mobilising resource from across K3 to leverage technical, market and domain expertise to support the ongoing development of Imagine, and will be launching further modules. We also secured a large customer win for Imagine, signing Ossur, the global leader in non-invasive orthopaedics, including prosthetic limbs. We remain very excited about Imagine's growth potential, both as an upgrade path for existing customers, with older systems, and a growth engine for new customer wins.

The Group's SME-related activities performed steadily across all of our supply chain verticals. As previously announced, we are bringing together our Microsoft Dynamics practices (CRM, AX and NAV) and this process, which started in the first half, is well-advanced.

Our Global Accounts business, which includes our relationship with Inter IKEA Systems B.V. (the owner and franchisor of the IKEA concept, and the largest customer in the Group) and the Inter IKEA Concept franchisees, continued to perform well, contributing to the increase in services income. There is very good visibility in further activity and we have increased our resource in this area to support this growth. We also see significant opportunities for own IP sales, with certain franchisees.

Outlook

We believe that the changes and initiatives put in place under the new leadership team will continue to underpin the turnaround in K3's performance and growth prospects. The material reduction in the cost base of the business and more streamlined structure supports both profitability and our refocused growth plans. We will also be continuing to look for additional opportunities to increase efficiency.

We expect good growth across the Group, with the ongoing development of channel partner sales, opportunities in Global Accounts and renewed sales momentum. Our IP strategy is showing encouraging results, and growth in own IP software licences should further accelerate, helped by channel partner sales and the commercialisation of Imagine. Opportunities for Imagine are opening as K3 engages with its large installed customer base across many sectors.

There is a traditional weighting of cash flows and profitability towards the fourth quarter of the calendar year, and we expect this to be a feature of this year, driven by software licence and support renewals that are traditionally very high, with Syspro renewals typically at c.98%. More broadly, we believe that K3 is very well-positioned to make further progress over the second half of the year, and view growth prospects with confidence.

9 July 2018

Operational Review

Overview

The Group's results for the six months to 31 May 2018, together with comparatives for the same period in 2017, 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 slight reduction in recurring revenues reflected the revenue mix, with services accounting for a larger proportion of overall sales, largely driven by growth in Global Accounts.

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 the Microsoft Dynamics suite of software as well as Syspro and Sage solutions.

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

These results show a marked improvement profitability, helped by the benefits of restructuring and the efficiency drives implemented over the prior periods, as well as growth and better resource utilisation. Gross profit increased by 13.0% to £14.8m (2017: £13.1m) on revenue up by 3.8% to £32.4m (2017: £31.2m) as we focused on better execution of fewer projects.

Overall gross margins improved by 3.8 percentage points to 45.7% (2017: 41.9%), with services margins showing the most substantial increase, rising by 12.1 percentage points to 26.7% (2017: 14.6%).

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, reflecting the ongoing expansion of the IKEA franchisee network and helping to drive services income. We believe that there are some new exciting prospects emerging with certain franchisees, which, if successful, will take the current model into new geographical markets, as well as drive opportunities for own IP product sales. We have opened an office in Kuala Lumpur in order to service more efficiently the Far Eastern growth opportunities we have identified.

Our SME-related activities performed steadily across all our supply chain verticals with good performances in the visitor attraction and hosting and managed services. The Syspro business continued to perform well, and the Sage practice signed Manx Telecom Plc as a new Sage X3 customer.

We are well-advanced with the combination of our Microsoft Dynamics practices (CRM, AX and NAV), which started in the period. As previously indicated, combining the different practices will enable us to optimise our resources and service our customers more effectively.

Own IP

K3's IP portfolio comprises two parts, first, K3-authored software that enriches our established offering mentioned above, based on Microsoft, Syspro and Sage. For example, our "ax l is fashion" and Pebblestone products are both based on Microsoft Dynamics's Enterprise Resource Planning ("ERP") solutions, but have been functionally enriched by K3 IP for specific industry segments. Secondly, our own IP portfolio comprises stand-alone solutions. These include DdD Point of Sales, Dataswitch, and the new Imagine platform and modules. These higher margin products can be sold with our other solutions or individually, including into K3's existing large customer base.

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

Total revenue from own IP over the first half of the financial year amounted to £9.0m (2017: £9.1m), however the revenue mix altered significantly, with revenues from software licences up by 84.6%, and services revenues reducing by 46.7%. This change in the mix drove a 17.2% increase in gross profit to £6.8m (2017: £5.8m) and a 12.5 percentage point improvement in gross margin to 75.9% (2017: 63.4%).

Sales of "ax l is fashion" (which is largely targeted at the Enterprise market) and Pebblestone, (our leading business software for the mid-market fashion industry) were particularly strong, especially at the half year end for "ax l is fashion". We are also very pleased to highlight the volume of sales achieved through our channel partners.

The strong sales of "ax l is fashion" in the period were in stark contrast to the Enterprise market confusion in 2017, and there is now greater sector acceptance of cloud-based models, away from traditional 'on-premise' solutions. Seven "ax l is fashion" deals were closed in the first half, with new customers including Mole Valley Farmers Ltd, the UK-based rural retailer, Engbers, Germany's largest shirt manufacturer, Van Bommel, the Dutch shoemaker and SanMar, the US fashion wholesaler. Eton Shirts, an existing K3 customer, also proceeded with a major roll-out of "ax l is fashion" across its business. Most of the deployment was cloud-based, and these new sales were predominantly achieved through channel partners.

The pipeline for both "ax l is fashion" and Pebblestone continues to look very 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 manner. Our first suite of modules for Imagine are based around our existing retail offerings and we intend to develop further functionally-rich modules to broaden the scope of our product range. We formally launched Imagine to the marketplace in the period, and signed a large contract, with Ossur, which designs and manufactures prosthetic limbs. While Imagine sales are currently a relatively small contributor to sales, we expect the Imagine platform and modules to become a cornerstone of our IP strategy, and are planning to spend 50% of capitalised development on Imagine over the year in order to capture the growth opportunities available to us.

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. This classification is different from previous reporting and now reflects the centralised management of these resources and costs.

Costs increased slightly as the Group's infrastructure framework was amended to support a more unified business, including some double-running of costs during this process.

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED INCOME STATEMENT

For the six months ended 31 May 2018

All of the profit/(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 2018

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 2018

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF CASH FLOWS

For the six months ended 31 May 2018

K3 BUSINESS TECHNOLOGY GROUP PLC

CONSOLIDATED STATEMENT OF CHANGES IN EQUITY

For the six months ended 31 May 2018

K3 BUSINESS TECHNOLOGY GROUP PLC

NOTES TO THE UNAUDITED INTERIM STATEMENT

1. Basis of preparation

As announced in May 2017, the Company has changed of its accounting reference date and financial year-end from 30 June to 30 November.

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 2018 which are not expected to be significantly different to those set out in Note 1 of the Group's audited financial statements for the 17 month period ended 30 November 2017. 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 2018 or are expected to be adopted and effective at 30 November 2018. 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 2018 and the six months ended 31 May 2017 has neither been audited nor reviewed pursuant to guidance issued by the Auditing Practices Board. The financial information for the 17 month period ended 30 November 2017 does not constitute the full statutory accounts for that period. The Annual Report and Financial Statements for the 17 month period ended 30 November 2017 have been filed with the Registrar of Companies. The Independent Auditors' Report on the Annual Report and Financial Statement for the 17 month period ended 30 November 2017 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 with early adoption permitted. The Group commenced an initial project to assess the effect of the adoption of IFRS 15 in the latter half of 2017 and good progress is being made. The complexities of IFRS 15 require 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 includes determining whether customers have a right to use or a right to access the software. There are some contracts where revenue may need to be recognised differently under IFRS 15 than under existing IFRS and these areas include the following:

Work is still ongoing to fully quantify the impact on revenue recognition for these contracts. The Group has tentatively 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 new standard will be recorded as an adjustment to the opening balance of equity (retained earnings) at the date of initial application. The Group anticipates that further information on the effect of the adoption of IFRS 15 will be made during the coming year and to consider whether the Group will adopt the standard earlier than is mandatory.

IFRS 9 'Financial instruments' is mandatory for the Group from 1 December 2018 with early adoption permitted. 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. The new requirements will lead to the earlier recognition of larger credit losses. 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 is still developing its model for calculating the ECL and until it has been finalised it is not possible to quantify the effects of this part of the standard.

2. Loss from operations

During the six month period to 31 May 2018, reorganisation costs of £0.73m have been incurred, most of which are redundancy costs. During the six month period to 31 May 2017, reorganisation costs of £0.84m were incurred relating to the reorganisation programme to create more unified, streamlined operations and 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

The movement in net debt (gross debt less cash and cash equivalents) has been computed as the Directors consider it useful to shareholders and investors. As cash flows are seasonal, it is more useful to present the movement for a 12 month period. The movement in net debt during the 12 months to 31 May 2018 is as follows:

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:

Acquisition of subsidiaries and other business units, net of cash acquired comprises:

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.