K3 Business Technology Group — Update 10 January 2017

K3 Business Technology Group — Update 10 January 2017

K3 Business Technology Group

Katherine Thompson

Written by

Katherine Thompson

Director

K3 Business Technology

Order slippage drives earnings downgrade

Trading update

Software & comp services

10 January 2017

Price

238.0p

Market cap

£86m

€1.15:£1

Net debt (£m) at end FY16

8.9

Shares in issue

36.0m

Free float

80%

Code

KBT

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(1.5)

(14.0)

(16.3)

Rel (local)

(5.3)

(16.3)

(30.2)

52-week high/low

365.50p

306.00p

Business description

K3 Business Technology provides Microsoft-, SYSPRO- and Sage-based ERP solutions and managed services to the retail, distribution and manufacturing sectors.

Next events

H117 results

March 2017

Analysts

Katherine Thompson

+44 (0)20 3077 5730

Dan Ridsdale

+44 (0)20 3077 5729

K3 Business Technology is a research client of Edison Investment Research Limited

K3 had a tough end to H117, with lengthening sales cycles for enterprise customers causing a shortfall in new business. More positively, recent restructuring is starting to drive more cross-divisional sales and is reducing the cost base. We have revised our revenue and EPS forecasts to reflect the slower pace of order wins as well as the restructuring, reducing FY17 EPS by 34% and FY18 by 11%. Evidence of improving order flow, growth in channel sales and growth in recurring revenues will be the triggers for share price recovery, in our view.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

06/15

83.4

7.2

19.1

1.50

12.5

0.6

06/16

89.2

8.8

23.0

1.75

10.3

0.7

06/17e

89.1

7.7

16.7

1.93

14.3

0.8

06/18e

90.2

11.0

24.4

2.12

9.8

0.9

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Order slippage at the end of H117

In the crucial last few weeks of December, K3 failed to close as much business as budgeted, with order slippage in both divisions. Enterprise customers are delaying decisions, particularly when choosing between cloud-based and on-premise solutions, although SME business (which typically is less cloud-focused) remains strong. In management’s view, these deals have not been lost, merely delayed, with the company remaining firm on pricing. The new management team is in the process of restructuring the business in order to streamline the operational structure and create a broader offering across the group. This strategy is already starting to pay off with a growing pipeline of cross-divisional opportunities.

Restructuring reduces impact of shortfall

Management expects the shortfall to reduce EBITDA by £3.5m in FY17 (before exceptionals). We have revised down our forecasts to reflect slower order intake in H117, as well as a higher proportion of cloud-based deals (where revenue is recognised over a longer period of time). The restructuring programme is expected to cost c £3m this year, and should result in annualised cost savings of £3m (with some benefit in FY17 and the full effect in FY18). We reduce our revenue forecasts by 8.4% in FY17 and 10.6% in FY18, and normalised EPS by 34% in FY17 and 11% in FY18. We increase our end-FY17 net debt forecast from £4.4m to £10.0m.

Valuation: Cloud reshaping the business model

On our revised forecasts, K3 is trading on 14.3x FY17e normalised EPS and 9.8x FY18e compared to small-cap UK software and IT services stocks trading on an average 16.5x current year and 15.2x next year EPS. K3’s continued investment in developing and supporting its own-IP solutions and building out its partner channel should provide opportunities to grow higher-margin revenues. At the same time, the increasing proportion of cloud-based deals, while reducing upfront revenue recognition, will help the company build a higher level of recurring revenues.

Exhibit 1: Financial summary

£'000s

2012

2013

2014

2015

2016

2017e

2018e

Year end 30 June

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

67,961

63,513

71,950

83,427

89,175

89,050

90,240

Cost of Sales

(28,491)

(30,375)

(32,990)

(40,446)

(40,636)

(41,043)

(40,454)

Gross Profit

39,470

33,138

38,960

42,981

48,539

48,008

49,786

EBITDA

 

 

12,942

7,261

9,861

10,975

12,843

12,318

15,856

Operating Profit (before am of acq. Intang. and except.)

11,405

5,164

7,328

8,169

9,529

8,118

11,256

Amortisation of acquired intangibles

(3,586)

(3,182)

(2,989)

(2,800)

(2,734)

(2,900)

(2,900)

Share-based payments

(72)

(70)

(27)

(18)

(28)

(30)

(30)

Other

(395)

(727)

(1,722)

(546)

(1,538)

(3,000)

0

Operating Profit

7,352

1,185

2,590

4,805

5,229

2,188

8,326

Net Interest

(1,309)

(723)

(705)

(926)

(701)

(400)

(250)

Profit Before Tax (norm)

 

 

10,096

4,441

6,623

7,243

8,828

7,718

11,006

Profit Before Tax (FRS 3)

 

 

6,043

462

1,885

3,879

4,528

1,788

8,076

Tax

(319)

780

675

(436)

(425)

(965)

(1,508)

Profit After Tax (norm)

8,591

4,165

5,874

6,162

7,650

6,133

8,973

Profit After Tax (FRS 3)

5,724

1,242

2,560

3,443

4,103

823

6,568

Average Number of Shares Outstanding (m)

28.2

29.2

31.4

31.6

32.4

36.0

36.0

EPS - normalised (p)

 

 

30.4

14.3

18.7

19.5

23.6

17.0

24.9

EPS - normalised fully diluted (p)

 

 

29.7

14.1

18.5

19.1

23.0

16.7

24.4

EPS - FRS 3 (p)

 

 

20.3

4.3

8.1

10.9

12.6

2.3

18.2

Dividend per share (p)

1.00

1.00

1.25

1.50

1.75

1.93

2.12

Gross Margin (%)

58.1

52.2

54.1

51.5

54.4

53.9

55.2

EBITDA Margin (%)

19.0

11.4

13.7

13.2

14.4

13.8

17.6

Operating Margin (before GW and except.) (%)

16.8

8.1

10.2

9.8

10.7

9.1

12.5

BALANCE SHEET

Fixed Assets

 

 

68,325

69,398

67,067

67,497

78,072

77,242

74,792

Intangible Assets

21,255

21,040

20,040

20,806

26,369

25,739

23,439

Tangible Assets

2,722

2,927

2,439

2,316

2,389

2,189

2,039

Goodwill

43,540

44,610

43,952

43,541

48,793

48,793

48,793

Other

808

821

636

834

521

521

521

Current Assets

 

 

32,418

25,523

29,535

33,734

43,695

41,454

44,066

Stocks

0

0

0

0

0

0

0

Debtors

30,322

25,251

28,888

31,839

40,923

40,987

41,535

Cash

2,096

272

647

1,895

2,772

467

2,531

Current Liabilities

 

 

(48,043)

(39,272)

(40,278)

(32,886)

(36,332)

(41,893)

(36,674)

Creditors

(8,797)

(5,842)

(7,218)

(7,640)

(8,324)

(8,313)

(8,422)

Other Creditors

(21,468)

(19,379)

(18,799)

(21,803)

(24,632)

(23,132)

(20,732)

Short term borrowings

(17,778)

(14,051)

(14,261)

(3,443)

(3,376)

(10,448)

(7,520)

Long Term Liabilities

 

 

(5,797)

(4,524)

(3,719)

(14,850)

(12,025)

(3,171)

(2,646)

Long term borrowings

0

(32)

(14)

(10,531)

(8,272)

(38)

(38)

Other long term liabilities

(5,797)

(4,492)

(3,705)

(4,319)

(3,753)

(3,133)

(2,608)

Net Assets

 

 

46,903

51,125

52,605

53,495

73,410

73,633

79,538

CASH FLOW

Operating Cash Flow

 

 

7,284

8,022

5,352

9,600

5,498

7,742

13,018

Net Interest

(839)

(820)

(848)

(950)

(783)

(400)

(250)

Tax

(1,312)

(1,217)

290

(264)

(688)

(1,585)

(2,033)

Capex

(3,160)

(4,613)

(4,487)

(4,564)

(5,573)

(5,000)

(5,050)

Acquisitions/disposals

(7,132)

(1,917)

(129)

(1,998)

(7,386)

(1,270)

0

Financing

5,026

2,677

277

69

13,175

0

0

Dividends

(214)

(286)

(316)

(397)

(477)

(630)

(693)

Net Cash Flow

(347)

1,846

139

1,496

3,766

(1,143)

4,992

Opening net debt/(cash)

 

 

15,486

15,682

13,811

13,628

12,079

8,876

10,019

HP finance leases initiated

0

0

0

0

0

0

0

Other

151

25

44

53

(563)

0

0

Closing net debt/(cash)

 

 

15,682

13,811

13,628

12,079

8,876

10,019

5,027

Source: K3 Business Technology, Edison Investment Research

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt and Sydney. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by K3 Business Technology and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt and Sydney. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2017 Edison Investment Research Limited. All rights reserved. This report has been commissioned by K3 Business Technology and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2017. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

ChimpChange — Update 10 January 2017

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