Buoyed by the improving performance of the company’s Microsoft-based activities, revenue growth accelerated from 9 per cent in the first six months of the fiscal year to 17 per cent in the second half to the end of June 2014. Recurring revenue accounted for half of total revenues of £72m and underpinned by a hefty gross margin of 54 per cent, reflecting higher services revenues and improved software margin, this translated to a sharp increase in profits. In fact, add back the £3m charge for amortisation of intangibles and the company's underlying pre-tax profits soared by half to £6.6m to produce adjusted EPS of 18.6p. It also meant the board was able to declare a 25 per cent hike in the dividend to 1.25p a share.
Headquartered in Didcot, Oxfordshire, and with offices in Ireland and mainland Europe, K3′s core business offers customers a Microsoft Dynamics based range of retail software to provide a single platform for the entire business. There benefits for retailers is two-fold: not only does the technology remove the need for customers to purchase different software solutions for head office, store and EPOS till systems, but it also avoids the requirement of having to integrate multiple databases. This means one integrated software solution and one integrated database, resulting in faster delivering of meaningful data, and fewer integration challenges. Retail customers include Agent Provocateur, Charles Tyrwhitt, Evans Cycles, Gieves & Hawkes, M&Co, SpaceNK and The White Company.
It’s a major income stream for K3 as the company is now Microsoft’s largest Dynamics Retail reseller in the UK and these specific activities generated revenues of £25.2m in the 12-month trading period, up a third on the prior year. In addition, overseas sales of the software giant’s products brought in a further £12.5m of turnover. Prospects look good too because of the £15.4m of new orders secured for the UK division, around 40 per cent closed in the second half including another two pilot projects for its new Microsoft Dynamics AX solution, known as axHTMLPIPESYMBOLis (ax | is). This could lead to “further large orders”.
The pipeline of new business for the international business is equally promising with new orders up almost 30 per cent to £6.7m year-on-year. It’s worth noting that the business posted strong growth across the wholesale, manufacturing and distribution sectors, so it wasn’t all just retail driven although this segment does account for the vast majority of sales. In fact, across the group, order intake of £25m exceeded that for the whole of the 2012 and 2013 fiscal years combined. Of these orders, around half relate to ‘ax | is’ alone, highlighting the importance of the new Microsoft solutions to K3’s future growth.
Hosting a turnaround
It’s also worth pointing out that the top-line growth was not just confined to Microsoft-focused activities as the company’s managed service business moved back into profits, helped in part by a 27 per cent hike in revenues to £8.1m. With the benefit of lower operating costs too, the unit’s adjusted operating profit of £430,000 equated to a £1m profit turnaround on the prior year. K3 hosting offers tailored outsourced IT services to help improve customer’s IT cloud services such as infrastructure as a service (IaaS) and platform as a service (PaaS). These services are fast becoming a preferred option for businesses looking to support business critical systems, make cost savings and enhance productivity.
True, revenues were relatively flat at K3’s SYSPRO and Sage manufacturing focused business. The core offering here is a Microsoft based business solution aimed specifically at small- and medium-sized manufacturers, and one developed by SYSPRO, one of one of the longest standing independent, international vendors of ERP business software solutions and services.
K3 primarily sells SYSPRO solutions to manufacturing customers and is the exclusive distributor of SYSPRO in the UK. The company has also designed a variety of add-on modules for functions such as advanced planning and scheduling, warehouse management, delivery route planning, recipe management, personnel, and time and attendance systems. It’s a solid business generating operating profit of £5m and one underpinned by high renewal rates with recurring revenue accounting for almost 60 per cent of the division’s turnover of £26m.
Robust earnings growth
But it is growth in the Microsoft activities that is set to drive K3’s sales and profits in the coming year as the investment in widening sales channels and territories pays off. In fact, the head of equity research Andrew Darley at broker finnCap predicts that K3’s revenues will increase from £72m to £80m in the current financial year to end June 2014 to drive adjusted pre-tax profits up 21 per cent to £8m. And with the restructuring over – K3 incurred £1.7m of one-off charges last year – finnCap predicts annual free cash flow is set to ramp up to £3.8m in the current financial year to drive net debt down by a quarter to £10.3m by June 2015. In turn, this should enable the board to raise the dividend again to 1.4p a share as finnCap predict.
In my opinion, for a company set to deliver 20 per cent plus profit growth, and one where the sales momentum is well supported by a strong pipeline of orders, K3's shares look attractively priced on only 11 times historic earnings and rated on 1.3 times book value of £52.6m.
If that was not attractive enough K3's shares also appear to have completed their consolidation period making a move back to the April all-time high of 240p, and beyond, firmly on the cards in my view. So with the technical set-up encouraging, and the fundamental case for investing strong, I feel K3's shares could be about to start a multi-month re-rating. Offering 25 per cent upside to my six-month target price of 275p, I rate K3's shares a strong buy on a bid-offer spread of 216p to 220p. Please note that the next trading update will be in 10 weeks' time at the annual meeting on 26 November.
Please note that Thalassa (THAL), IQE (IQE), Flowtech Fluidpower (FLO) and Global Energy Development (GED) have all reported half year results today. I will update my view all of these companies shortly. I have also published another two columns today, both of which are available on my IC homepage...
■ Simon Thompson's new book Stock Picking for Profit can be purchased online at www.ypdbooks.com, or by telephoning YPDBooks on 01904 431 213 and is being sold through no other source. It is priced at £14.99, plus £2.75 postage and packaging. Simon has published an article outlining the content: 'Secrets to successful stock-picking'
