Second Interim Results

27 September 2017

AIM: KBT

K3 BUSINESS TECHNOLOGY GROUP PLC

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

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

Second interim results - 6 months to 30 June 2017

&

12 months to 30 June 2017

KEY POINTS

Summary

· Strong progress in reshaping K3 for a return to profitability and sustainable growth

− focus is on SME marketplace, increasing sales of own IP, and driving recurring income 

− review of K3's resources is progressing well, with results expected before end of 2017 

− core SME business performing well

− reorganisation programme continues - to create more unified, streamlined operations and reduced cost base

− annualised savings of c. £3.7m achieved to date

· Accounting reference date and year end changed to 30 November to reflect the Group's strong seasonal trading patterns

Financial

· As previously reported, financial performance was significantly impacted by certain high value contract tenders in Enterprise activities not closing as expected

· Revenues of £84.6m for the 12 months to 30 June 2017 (2016: £89.2m)

− recurring revenues remained high at £40.8m (2016: £41.6m) - c.48.2% of total

− K3 own IP and related revenues rose by 27% to £27.1m (2016: £21.3m) - 32.0% of total (2016: 23.8%) 

· Gross margin decreased to 50.4% (2016: 54.4%) - affected by weakness in Enterprise activities

− margin on recurring revenues increased to 69.0% (2016: 67.4%)

· Adjusted loss from operations1 of £1.81m for the 12 months to 30 June 2017 (2016: adjusted profit from operations1 of £9.50m) / Reported loss from operations of £9.75m (2016: profit of £5.23m) 

· Adjusted loss before tax1 for the 12 months to 30 June 2017 of £2.63m (2016: adjusted profit before tax1 of £8.80m) / Reported loss before tax of £10.56m (2016: profit before tax of £4.53m) 

· Adjusted loss per share2 for the 12 months to 30 June 2017 of 7.4p (2016: adjusted earnings per share2 of 23.5p). Basic loss per share of 24.5p (2016: basic earnings per share*4 of 12.6p)  

· Pro-forma net debt3 of £6.6m at 30 June 2017

− taking into account the equity placing and warrants exercised (yielding a total of £8.4m together), and debt-to-equity conversion (of £0.6m) completed on 5 July 2017 

Operational

· Good level of contract wins from SME-related activities across all supply chain verticals 

· NextGen, the new, in-house developed multi-platform solution, seeing first successes

− pilot project with major European retailer, Hunkemoller, has resulted in roll-out of NextGen across its stores

− a number of other customers are engaged in the pre-sales process for the solution 

· Global Accounts activities set to benefit from ongoing expansion of IKEA franchisee network

· New business pipeline has been refined and is encouraging at £70.3m

· Board views prospects positively

Stuart Darling, Chairman, said:

"As previously reported, the Group's financial performance for the 12 months to 30 June 2017 was adversely affected by the difficulties experienced in the Group's Enterprise activities. In particular, a number of high value contract tenders did not close as expected. However, we have also made strong progress in reshaping the business over the last twelve months to create a more unified and streamlined Group, refocused on our core SME marketplace, which generates the majority of K3's recurring revenues.

"We are now reviewing the Group's resources - having completed our fund raising in July, and have the full flexibility to consider all strategic options. We have a core of profitable, cash generative businesses, and we look forward to providing a further update on our plans before the end of the year.

"Our business reorganisation programme, which has been a major focus, has already achieved £3.7m in sustainable annualised cost savings, and we are continuing to look for further efficiencies, and believe we can achieve additional material savings.

"In the SME marketplace, we signed a good level of new contracts in the six months to June across all our supply chain verticals. We have also been successful in growing revenues from our own IP products, with sales rising by 27% to £27.1m over the 12 months.

"Increasing own IP revenues remains a key part of our growth strategy and it is therefore especially pleasing to report that our NextGen platform is gaining traction. It readily integrates agnostically with existing IT architecture and simplifies the implementation of our software.

"As we look forward, we are encouraged by the substantial work completed to position the Group for a return to profitability and growth. Net debt has been significantly reduced and we expect underlying cash generation to benefit from our ongoing initiatives. The Group's new business pipeline is healthy and, while our review of K3's resources is still ongoing, we believe that the Group is now in better shape for recovery and remain confident of K3's prospects."

Enquiries:

Notes:

JOINT REPORT OF THE CHAIRMAN AND CHIEF EXECUTIVE OFFICER

Introduction

This is my first statement as Chairman since assuming the role in early July 2017, and we are pleased to report on the progress being made to reshape the Company and position it for sustainable growth and a return to profitability.

Background

As we have previously reported, K3's recent financial performance in Enterprise-related activities has been disappointing and, in mid-May, the new management team commenced a review of K3's resources, with the intention of refocusing the Group's growth strategy around the existing profitable, cash generative business units and our large SME customer base.

In early July, we completed an equity placing to support this process, and to enable us to operate with full flexibility as we make and implement strategic decisions to benefit the Company's future.

Resources Review and Refocused Operations

Our review of K3's resources is progressing well. Our objectives are to increase focus on the development and sale of the Group's own intellectual property, and develop multiple "niche" software solutions capable of deployment in an agnostic way across a wide range of Enterprise Resource Planning ("ERP") solutions. This will improve the quality of the Group's earnings and will help to drive contracted, recurring revenues. The industry's increasing shift towards the subscription/consumption-based model, and away from 'on-premise' solutions with large, upfront licence payments, will help to increase the visibility of the Group's revenues.

We expect our review process to be completed before the end of the year, and will provide a further update in due course.

Together with our initiatives to refocus the Group's activities, we commenced a programme to simplify and more closely integrate the Group's operations. This centralisation strategy will promote better cross-selling of products and improve operational efficiencies. Over the past 12 months, we have materially reduced our cost base, delivering cost savings of approximately £3.7m on an annualised basis. This programme is ongoing and we anticipate making further cost savings as we complete the streamlining of the Group's operations.

Focus on Cash Generation

We continue to focus on cash generation and are making good progress in improving working capital, primarily by reducing debtor days and accrued income.

Pro-forma net debt as at 30 June 2017 was £6.6m. This takes into account the equity placing and open offer of shares completed in early July 2017, which raised a net of £7.76m, as well as an exercise of warrants of £0.66m and debt-to-equity conversion of £0.64m. Excluding this, reported net debt at 30 June 2017 was £15.6m (30 June 2016: £8.9m; 31 December 2016: £12.51m).

Performance

As previously reported, financial results for both the six and 12 month periods were significantly impacted by a number of high value contract tenders not closing as expected. This deterioration in large contract wins in the Enterprise space was due to softening end-markets, particularly for large retailers, as well as lengthening decision-making process for large deals, driven by the shift towards cloud delivery and away from 'on-premise' solutions. As a result, there was a marked year-on-year reduction in software licence revenues, with gross margin also affected by excess resource capacity in services and implementation.

By contrast, the Group's SME-related activities performed well across all of our supply chain verticals, and we secured a continuing good level of contract wins in the six months to 30 June 2017. The SME-focused Retail business performed very strongly, with RSG, Merac and DdD all contributing to the growth.

In addition, we achieved very encouraging sales of our own IP, with new customers including Jack Wolfskin, the Royal Horticultural Society and F-Engel. Sales of Pebblestone in particular were strong. K3 Product and Product-related revenues represented approximately 32.0% of the Group's total in the 12 months to 30 June 2017 (2016: 23.8%) and 35.0% in the six months to 30 June 2017 (six months to 30 June 2016: 25.0%).

The development of NextGen, our 'next generation', multi-platform solution, has been an important step for us as we drive own IP sales. The platform will deploy a range of products, including our high value applications such as mobile Retail solutions. Importantly, it gives us the ability to easily integrate our solutions with a wide range of ERP systems. Our pilot project, for a mobile Retail solution with a large European fashion retailer, Hunkemoller, has progressed very well, and Hunkemoller is now committed to rolling out NextGen across its business over the coming months. A number of other potential customers are engaged in a pre-sales process for NextGen.

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. We are supporting the ongoing expansion of the IKEA franchisee network and expect to see a substantial increase in their service delivery requirements.

The SYSPRO business also delivered good results and remains a strong contributor to the Group's cash flows. SYSPRO customer renewals continue to be high, at 98% for the 12 month period (2016: 98%). The Sage business gained traction in the higher end X3 product offering and won some notable deals. Business Solutions restructured its cost base to focus on the Microsoft Dynamics/Navision SME space and is now seeing an improvement in its profitability.

The performance of our hosting and managed services operation, Starcom, was affected by the softness in the Enterprise activities, as well as the loss of MyLocal in June 2016. Going forward, it will benefit from the Group's simplified organisational structure and tighter focus on driving cross-selling across its various products.

As we have previously reported, the move towards cloud-based consumption licensing will drive a change in the rate of reported revenue growth and have a beneficial long-term impact. Income from contracts will be recognised over longer periods, rather than upfront as with the traditional model of perpetual software licences. The lifetime value of customer relationships under this new model has the potential to be significantly higher than before. The pace of uptake of consumption-based ERP has increased this year, with K3 successfully completing first sales of Microsoft Dynamics and "ax I is Fashion" on this basis. As the rate of growth of consumption-based agreements increases, the Group will start to monitor and report on new KPI's to quantify their importance.

Dividend

The Board intends to maintain a progressive dividend policy and expects to propose a dividend for the 17 month period to 30 November 2017, subject to trading.

Board Changes

A number of Board changes took place in the twelve months to 30 June 2017. David Bolton, previously Chairman, and Lars-Olof Norell, previously Non-Executive Director, both retired from the Company.

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.

Outlook

We believe that the changes and initiatives from the new management team over the last year have put K3 on a sustainable track for improvement in the quality of its earnings and cash flow generation.

Our investment in the NextGen 'born-in-the-cloud' platform is an important step forward. It opens up further opportunities for the Group to sell its own IP as the platform readily integrates with a wide range of ERP systems. NextGen also makes us more flexible and fleet of foot in addressing customers' changing needs, and corresponds with customers' increasing interest in consumption-based products and services. This cloud-based approach promotes closer customer relationships and supports our objective of further increasing our large recurring income streams.

We have materially reduced the cost base of the business and created a more streamlined structure that supports cross-selling opportunities. We will be continuing with our cost efficiency programme and our strategic review should be substantially completed before the end of 2017, at which point we will provide a further update.

Looking ahead, we are encouraged by our new business pipeline. We have taken the opportunity to refine our reporting of new business prospects, and while this has meant removing certain prospects from the pipeline, it makes for an overall stronger picture of the potential order book. Currently, the pipeline stands at £70.3m.

We remain confident of K3's prospects.

27 September 2017

FINANCIAL RESULTS FOR THE 12 MONTHS TO 30 JUNE 2017

Change of Accounting Reference Date and Financial Year End

Following the Board's decision to change the Company's accounting reference date and financial year end to 30 November, from 30 June, this report covers both the six month period to 30 June 2017 and the twelve month period to the same date.

The change in the accounting reference date has been made, as previously highlighted, in order to place shareholders in a better position to assess the Company's trading prospects when full year and interim results are published, given the Company's strong seasonal trading patterns, with December and June both historically key selling months.

We have also taken the decision to change the way we report on the Group's activities to better reflect the operational structure of the business. We have therefore moved away from an analysis by industry vertical to reporting the financial performance of the Group as a whole. We will continue to highlight certain key performance indicators, including revenue generated by K3's own intellectual property.

Overview

K3 Intellectual Property

We highlight the revenues generated by K3's own IP below. They are included in the figures above.

The percentage of K3 product-related revenues over the 12 months to 30 June 2017 has increased significantly to 32.0% (2016: 23.8%). This largely reflected the benefit of the acquisitions of DdD and Merac, in April and July 2016 respectively.

1 K3 Product Licence includes initial and annual software licences.

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

Group revenues for the 12 months to 30 June 2017 totalled £84.6m (2016: £89.2m). The year-on-year decrease was mainly accounted for by reduced software licence sales in the Enterprise space. Software licence gross margins were also lower at 62.7% (2016: 67.8%), driven by lower "ax I is" sales in the Enterprise space.

We currently recognise revenues from all multi-year deals on a traditional licence basis, where the majority of revenues are recognised upfront. Going forward revenue will be recognised over the licence period as dictated by contracts and as deployment becomes mostly consumption. For illustrative purposes, the table below shows previously reported revenues and what those revenues would have been had the revenue been recognised on a consumption basis over the licence period rather than upfront.

Reported recurring revenues remain high as a proportion of the Group's total, comprising almost half of all income. Gross margins on recurring revenues increased to 69.0% (67.4%), reflecting the growth in income generated by K3 Product sales, including DdD and Merac.

Services revenues increased, helped by greater activity within Global Accounts. However, the gross margin percentage contracted significantly. This was due to margin pressures in the six months to December 2016, when we experienced an increase in the number of contractors needed to deliver the high level of contract wins from June 2016, followed by excess contractor capacity in the six months to June 2017 as a result of reduced deal flow, especially in the Enterprise space.

Revenues, gross profit and gross margin generated by Hardware and other activity all showed positive gains. This largely reflected buoyant sales of DdD's own point-of-sale hardware, sold alongside cloud-based software.

Adjusted loss from operations*1 for the 12 months to 30 June 2017 was £1.8m (2016: adjusted profit from operations*1 of £9.5m), with the adjusted loss from operations*2 in the six months to 30 June 2017 being £2.2m (2016: adjusted profit from operations*2 of £4.4m).

We incurred £5.4m (2016: £1.0m) of exceptional costs over the year. These related to our re-organisation programme and included a £2.0m non-cash write-off of capitalised development costs.

The amortisation charge for acquired intangibles was £2.93m (2016: £2.73m). Finance expenses were £0.82m (2016: £0.70m).

Adjusted loss before tax*3 for the 12 months to 30 June 2017 was £2.63m (2016: adjusted profit before tax*3 £8.80m) and reported loss before tax was £10.56m (2016: profit before tax £4.53m).

Adjusted loss per share*4 was 7.4p (2016: adjusted earnings per share*4 23.5p). Basic loss per share was 24.5p (2016: adjusted earnings per share*4 12.6p). There was a net tax credit for the year of £1.77m (2016: net tax expense £0.43m), after the benefit of a £1.46m deferred tax credit (2016: £0.42m).

Cash flow and banking

Net debt at 30 June 2017 was £15.6m (30 June 2016: £8.9m; 31 December 2016: £12.51m) and, taking into account the equity placing, warrants exercised and debt-to-equity conversion completed on 5 July 2017, pro forma net debt on that date is calculated at £6.6m.

Cashflow from operating activities was £0.9m for the 12 months (2016: £4.0m), following exceptional restructuring costs of £3.4m (2016: £1.0m). There was a material inflow of £2.2m (2016: £5.8m outflow) into working capital, a reflection of a tighter approach to working capital management that we intend to build on in the future.

Depreciation was similar to the prior 12 months at £1.0m (2016: £1.0m) and amortisation increased to £8.2m (2016: £5.1m), following a £2.0m exceptional write-off of previously capitalised development costs.

Software development costs in the 12 months to 30 June 2017 increased marginally to £4.9m (2016: £4.6m) and capital expenditure reduced to £0.8m (2016: £0.9m). Over the 12 month period, we made one acquisition, purchasing Merac in July 2016, and received a refund of deferred consideration of £0.4m for DdD, which had been paid into escrow in April 2016, in the 6 months to 30 June 2017.

CENTRAL COSTS

Head office costs include directors' costs, human resources, accounting and legal personnel, and costs associated with the Plc. Costs are stated net of recovery of elements recharged to the operating units. Costs for the year*5 increased to £1.25m (2016: £0.83m), which primarily reflected the centralisation of functions.