K3 reported group revenue growth of 6.9%, 1.9% ahead of our forecast. On a divisional basis, Retail revenues came in 6.2% ahead of our forecast whereas Manufacturing & Distribution was 2.1% below. The company had to write off revenues relating to a major customer, My Local, which went into administration at the end of FY16. We understand this comprised mainly hosting and maintenance revenues, with the greatest impact on the Retail division and a smaller effect on Manufacturing & Distribution. Recurring revenues grew 4% y-o-y to make up 46.7% of total revenues, slightly down from 47.8% in FY15.
Group gross profit of £48.5m was 2.5% ahead of our forecast whereas normalised operating profit was 6.7% below. The My Local bad debt, incurred at the end of H216, made up a large percentage of the operating expense overrun. In addition, the company bolstered its legal team and other senior management, resulting in higher than expected head office costs. The net interest expense of £701k was lower than our £780k forecast, and the tax rate came in below our forecast (13.3% versus 18.0% on a normalised basis), resulting in normalised EPS only 1.1% below our forecast. As previously flagged in the July trading update, net debt was higher than our forecast due to a combination of currency (c £0.6m impact), the My Local write-off and licence deals signed at the end of the period. In addition, total capex (tangibles plus capitalised development costs) came in at £5.6m compared to our £4.7m forecast.
The company announced a final dividend of 1.75p, +16.7% y-o-y and ahead of our 1.65p forecast.
Exhibit 1: Summary financials
£m |
FY15 |
FY16 |
FY16 |
% difference |
% y-o-y |
Retail revenues |
39.7 |
42.3 |
44.9 |
6.2 |
13.0 |
Manufacturing & distribution revenues |
43.7 |
45.2 |
44.3 |
-2.1 |
1.3 |
Total revenues |
83.43 |
87.50 |
89.18 |
1.9 |
6.9 |
Retail |
3.51 |
5.25 |
6.05 |
15.1 |
72.4 |
Manufacturing & distribution |
5.12 |
5.50 |
4.28 |
-22.2 |
(16.4) |
Head office costs |
(0.46) |
(0.54) |
(0.80) |
48.5 |
73.9 |
Normalised* operating profit |
8.17 |
10.22 |
9.53 |
-6.7 |
16.6 |
Operating margin |
9.8% |
11.7% |
10.7% |
-1.0 |
0.9 |
Normalised PBT |
7.24 |
9.44 |
8.83 |
-6.4 |
23.9 |
Normalised net income |
6.16 |
7.74 |
7.65 |
-1.1 |
24.1 |
Reported EPS (p) |
10.9 |
14.0 |
12.6 |
-9.4 |
15.6 |
Normalised EPS (p) |
19.1 |
23.3 |
23.0 |
-1.3 |
20.4 |
Net debt |
12.08 |
5.77 |
8.88 |
54.0 |
(26.5) |
Source: K3 Business Technology Group, Edison Investment Research. Note: *Normalised profitability measures exclude exceptionals, share-based payments and amortisation of acquired intangibles.
Exhibit 2: Own-IP related revenues
£m |
|
H115 |
H215 |
H116 |
H216 |
% y-o-y |
% h-o-h |
Product licence revenues |
|
4.54 |
4.20 |
4.89 |
5.87 |
39.8 |
20.0 |
Retail |
|
2.62 |
2.88 |
3.13 |
4.21 |
46.2 |
34.5 |
Manufacturing & distribution |
|
1.92 |
1.32 |
1.76 |
1.66 |
25.8 |
-5.7 |
Product-related revenues |
|
4.53 |
4.62 |
4.67 |
5.84 |
26.4 |
25.1 |
Retail |
|
4.32 |
4.08 |
4.49 |
5.64 |
38.2 |
25.6 |
Manufacturing & distribution |
|
0.21 |
0.54 |
0.18 |
0.20 |
-63.0 |
11.1 |
Gross profit |
|
5.8 |
5.92 |
6.27 |
7.81 |
31.9 |
24.6 |
Retail |
|
3.84 |
4.18 |
4.47 |
6.10 |
45.9 |
36.5 |
Manufacturing & distribution |
|
1.96 |
1.74 |
1.80 |
1.71 |
-1.7 |
-5.0 |
|
|
|
|
|
|
|
|
Gross margin (%) |
|
63.9 |
67.1 |
65.6 |
66.7 |
-0.4 |
1.1 |
Retail |
|
55.3 |
60.1 |
58.7 |
61.9 |
1.9 |
3.3 |
Manufacturing & distribution |
|
92.0 |
93.5 |
92.8 |
91.9 |
-1.6 |
-0.8 |
K3 IP-related revenues/total revenues (%) |
|
21.8 |
21.1 |
22.6 |
25.0 |
3.9 |
2.4 |
Source: K3 Business Technology
The company is gradually increasing the proportion of own-IP related sales (ie the combination of sales of licences based on K3’s IP plus related revenues). As this is higher margin, this should help drive the group gross margin up over time. Efforts to reduce the cost of implementation in the Retail division are also helping to bring up the Retail own-IP gross margins.
Exhibit 3: K3 divisional performance
£m |
FY16a |
FY16e |
% difference |
Revenues |
|
|
|
Software |
16.23 |
14.99 |
8.3 |
Retail |
10.34 |
8.90 |
16.2 |
Manufacturing & distribution |
5.89 |
6.09 |
-3.3 |
Services |
25.74 |
26.23 |
-1.9 |
Retail |
14.52 |
15.43 |
-5.9 |
Manufacturing & distribution |
11.22 |
10.80 |
3.9 |
Recurring revenues |
41.62 |
40.47 |
2.8 |
Retail |
16.74 |
14.40 |
16.3 |
Manufacturing & distribution |
24.88 |
26.07 |
-4.6 |
Hardware & other revenues |
5.59 |
4.85 |
15.3 |
Retail |
3.32 |
2.59 |
28.2 |
Manufacturing & distribution |
2.27 |
2.26 |
0.4 |
|
|
|
|
Total revenues |
89.18 |
87.50 |
1.9 |
Retail |
44.92 |
42.29 |
6.2 |
Manufacturing & distribution |
44.26 |
45.22 |
-2.1 |
|
|
|
|
Gross profit |
48.54 |
47.38 |
2.5 |
Retail |
23.36 |
21.20 |
10.2 |
Manufacturing & distribution |
25.18 |
26.17 |
-3.8 |
|
|
|
|
Gross margin (%) |
54.4 |
54.1 |
0.3 |
Retail |
52.0 |
50.1 |
1.9 |
Manufacturing & distribution |
56.9 |
57.9 |
-1.0 |
|
|
|
|
Operating costs |
39.04 |
37.19 |
5.0 |
Retail |
17.31 |
15.95 |
8.5 |
Manufacturing & distribution |
20.90 |
20.67 |
1.1 |
Head office |
0.83 |
0.57 |
45.6 |
|
|
|
|
Adjusted operating profit* |
9.50 |
10.19 |
-6.7 |
Retail |
6.05 |
5.25 |
15.1 |
Manufacturing & distribution |
4.28 |
5.50 |
-22.2 |
Head office |
-0.83 |
-0.57 |
45.6 |
|
|
|
|
Adjusted operating margin (%) |
10.7 |
11.6 |
-1.0 |
Retail |
13.5 |
12.4 |
1.0 |
Manufacturing & distribution |
9.7 |
12.2 |
-2.5 |
Source: K3 Business Technology. Note: *Adjusted operating profit excludes exceptionals and amortisation of acquired intangibles.
The division saw strong growth of 13.0% in FY16. Excluding the £0.8m contribution from DdD (two months’ worth), revenues grew 11.0%. This is after writing off revenues from the failure of My Local. Software licence sales were particularly strong, up 44.8% y-o-y. H216 licence sales were up 90.8% y-o-y and 29.8% h-o-h, with several major deals signed in the period. The division also continues to see a steady flow of work from the Ikea franchisees as they roll-out and upgrade stores.
Recurring revenues increased 13% to make up 37% of revenues (flat versus FY15). Several customers have signed extended software licence enhancements ahead of Microsoft’s planned licensing structure changes.
Services revenues decreased 4% after the completion of several contracts that used high levels of contractors. The company has worked to bring the cost of implementation down and has built more automation into the process, resulting in improved gross margins of 27% for this part of the business (up from 24%).
The division received orders worth £21.0m in FY16, compared to £11.3m in FY15. Larger contracts included orders from Bonmarché, Sue Ryder, Fortnum & Mason and Ann Summers. The channel partner network generated orders from 27 customers (eight for ax│is Fashion), including the contracts with TriStyle, KLiNGEL and Lacoste that were previously announced. Orders through the channel totalled £2.43m, compared to £1.60m in FY15.
Adjusted operating profit of £6.05m (13.5% margin) came in 15% ahead of our forecast despite the loss generated from the My Local write-off.
The new deal pipeline has expanded by 40% y-o-y and 70% h-o-h to £44.9m, including £4.6m via channel partners. Management continues to see North America as a good opportunity for new orders and is building a team with sales and pre-sales capability in addition to developing its channel partner strategy there.
Manufacturing & Distribution
This division saw mixed performance, with revenues increasing by only 1.3% to £44.3m (2.1% below our forecast) and adjusted operating profit coming in 22% below our forecast to generate a margin of 9.7% compared to 11.7% the prior year. We note that the Starcom acquisition added revenues of £2.5m and adjusted operating profit of £0.25m y-o-y. The SYSPRO business saw good levels of renewals and upgrades to new customers but saw disappointing levels of new business in H2. The expected improvement in the Sage business did not materialise in H216, resulting in a £1m negative impact on profitability y-o-y. The cloud hosting and managed services business has made good progress in the year, ending the year with a contracted subscription run rate of £8.5m (£6.5m from hosting), up from £8.0m (£6.0m from hosting) at the end of FY15 despite losing the My Local business.
Software licence revenues declined 12% y-o-y, mainly due to lower sales of Sage and CRM solutions. This conversely had a positive impact on licence gross margins, increasing to 58.4% from 54.9% a year ago. Services revenues rose 15% y-o-y reflecting implementation activity for Microsoft Dynamics, CRM and hosting. New orders increased 43% y-o-y to £14.3m, as the Microsoft Dynamics AX and NAV had a strong H2.
At the end of H216, action was taken to refresh the SYSPRO new business sales team and changes made to the Sage sales team to improve closure rates, which should result in improved levels of new business in FY17. The new business pipeline stood at £31.2m at the end of FY16, up 4.7% y-o-y and 3.3% h-o-h.
