Retail software company K3 Business Technology (KBT:150p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services, is raising £8.5m in a placing and open offer of shares at 140p to strengthen its balance sheet, and provide working capital.
I last advised holding the shares for recovery at 157p ('Small-cap trading updates', 24 May 2017), and I have to admit the deterioration in trading, announced in the fundraise document, is far worse than I anticipated. The board is guiding investors to expect an operating loss of between £400,000 and £2.4m for the 12 months to the end of June 2017, and that excludes £3.5m of one-off costs announced in January, £1.8m of write-downs, and a goodwill impairment charge of £2m. The company would have breached its banking covenants if its lenders had not agreed to defer the test until November.
House broker finnCap now only expects a pre-tax profit of £4m in the 2018 financial year, less than half the £8.8m reported in the 2016 financial year, and given the far greater scale of turnaround needed, a forward rating of 19 times net profits, based on the enlarged share count, is too rich for me. So, although the shares are well down on my 220p entry point ('Tapping into retail growth', 16 Sep 2014), and were showing a 66 per cent paper profit last autumn, I am cutting the loss. Sell.
I can't blame the company for raising funds via a placing, otherwise there might have been serious cashflow problems & related covenant issues with the bank.
The Chairman has gone so the old guard is being cleared out. That's no bad thing, as he was too invested in the old acquire and build model which gradually destroyed the original cash generative business.
The transparency of what the CEO means by focussing on cash producing parts of the business is lacking at this stage. But you can't really knock the principle.
We are talking a couple of years to turn this ship around, I believe. They have built a top-heavy development business largely funded by their annual recurring revenues, and they need to slash that back IMO, or 're-structure' as management parlance would have it.
Stockopedia have them operating at a 6.3 x PE. I suspect that is generous in the current hiatus, but may prove to be a bargain at some distant point in time. For the time being its goodbye to dividends (I suspect), building up cash and paying down debt.
The vast majority of the announcements from companies on my watchlist have been positive, but this is not the case with retail software company K3 Business Technology
(KBT:157p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services.
At the start of the year the company warned of weak trading in the key selling month of December due to a softening in market conditions, lengthening of sales cycles around larger deals, and an accelerating shift to cloud-based solutions among customers. Although K3's management team insisted that these deals had merely been delayed, and the company remains firm on pricing, the directors downgraded their cash profit guidance for the financial year to end of June 2017 by £3.5m, prompting analysts at both Edison Investment Research and finnCap to rein back their cash profit estimates from £16m to £12.4m based on flat revenue of £89m. This implied a 12 per cent fall in pre-tax profit to £7.7m, to produce EPS in the range between 16.7p and 17.7p, a hefty shortfall on Edison's previous estimate of 26p, and way below last year's reported figure of 23p even though the company has made a number of acquisitions that have boosted the bottom line.
That news wiped 20 per cent off the company's share price, but having reviewed the investment case I felt the shares were worth holding on to for recovery at 255p ('Funded for growth', 15 Feb 2017), having first advised buying at 220p a few years ago ('Tapping into retail growth', 16 Sep 2014). Unfortunately, the company warned last week that it has failed to secure some large contracts in its enterprise software division with the result that full-year results will be significantly below even those heavily downgraded profit estimates. The news wiped a further 40 per cent off K3's share price and analysts at both broking houses have suspended their forecasts pending greater clarity either in the pre-close trading update or in the final results.
The results will also include exceptional costs resulting from a senior management reorganisation that has streamlined the operating structure with the aim of boosting sales and delivering cost savings. It's come at a price as K3 will book a one-off cost of £3m. Analysts had been predicting year-end net debt close to £10m, up from £8.9m in June 2016, but I can see this being revised upwards given the profit shortfall.
All is not lost
There are positives although as the directors point out that operations elsewhere have been making encouraging progress and generating healthy cash flows, and it has secured pilot customers for its new cloud-based modular technologies which is promising as this highlights the opportunities for its high-margin own IP. The board are also starting a review with the aim of refocusing the growth strategy around its cash generating businesses and installed 3,700 strong customer base.
The bottom line is that although selling out in January would have been the right call in hindsight, I see little point exiting now. That's because the company's market value has halved to £55m, so its enterprise value is little over five times the level of cash profit in the 2016 financial year. Clearly, profit will be sharply down in the year to June 2017, so that multiple will expand - it could even double in the worst-case scenario - but with banking facilities refinanced last autumn to take advantage of favourable interest rates, and the directors now aiming to focus the business on the most highly cash-generative segments, then the bad news looks priced in.
Moreover, the share price is as oversold as it was in the dark days of the last bear market with the 14-day relative strength indicator (RSI) on the floor. In the circumstances, it makes sense to hold onto your shares ahead of the pre-close trading update. Hold.
I feel sorry for the new CEO. Since he has arrived he has been faced with trying to fix the hole in the bucket problems that K3 seems to have.
This business years back was pretty cash generative. Ever since the rapid expansion by acquisition its cash generation qualities have weakened, and unfortunately its bank borrowings have not been significantly reduced in the intervening period.
Now with some significant projects stalling its forward cash generation must look pretty worrying.
The push to acquire AX businesses was a big bet, and I would argue it has struggled from day one, as the development side of that sucked in cash but not generated the sales.
This is a tale as old as time in the IT world. Developing software is hugely expensive and brave ideas of developing in-house own software has sunk many a company. Maybe K3 thought it was big enough to do it, but the AX market has always been a difficult one.
The Retail market is also suffering in the new inflation environment, and with online sales eroding market share.
Some drastic decisions may have to be made in the near future.
I note that amongst the poor results K3 talk about changing the year end again.
This seems to me a classic way of disrupting any comparative analysis, and also a way of fudging headline figures.
This was last done when Bolton was FD (now Chairman) so I am assuming it is from his initiative? The last time it was done seem to me to cover up having to make a profit warning in the full year results of that time.
I think if they follow this through this habit will put K3 into the bargepole arena.
While I was carrying out extensive research on my 2017 Bargain Shares Portfolio, retail software company K3 Business Technology
(KBT:255p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services, issued a profit warning.
I have followed the company for some time, having first advised buying at 220p a couple of years ago ('Tapping into retail growth', 16 Sep 2014), and last reiterated that advice at 350p ('The inside track', 14 Sep 2016), so the 20 per cent share price slump post the profit warning has eroded a chunk of those paper gains.
The main issues concerns trading in the key selling month of December, which was impacted by a softening in market conditions, lengthening of sales cycles around larger deals, and an accelerating shift to cloud-based solutions among customers. Although K3's management team insist that these deals have merely been delayed, not lost, and the company remains firm on pricing, the fact remains that cash profit is expected to come in £3.5m below prior guidance for the financial year to the end of June 2017, prompting analysts at both Edison Investment Research and finnCap to rein back their cash profit estimates from around £16m to £12.4m based on flat revenue of £89m. This implies a 12 per cent fall in pre-tax profit to £7.7m, to produce EPS in the range between 16.7p and 17.7p, a significant shortfall on Edison's previous estimate of 26p, and way below last year's reported figure of 23p even though the company has made a number of acquisitions that have boosted the bottom line.
Moreover, those forecasts are before accounting for exceptional costs resulting from a senior management reorganisation that has streamlined the operating structure with the aim of enhancing sales opportunities and delivering cost savings. It's come at a price, though, as K3 will book a one-off cost of £3m in the full-year results, and analysts now think that year-end net debt is likely to be nearer £10m or double the level they had previously forecast, albeit management guidance is to expect £3m of annual savings from the restructuring.
The good news is that the pipeline of prospects across the company's business segments is growing, while the increasing proportion of cloud-based deals will help it build a higher and more stable level of recurring revenue, although in the short term the transition to subscription revenue streams and away from licences will depress revenue.
The company is due to report half-year results next month and the one-off costs and weaker trading in December mean that the figures are not going to make for a pleasant read. However, ahead of the next trading update alongside those results, I am going to give the management team the benefit of the doubt for now. What I need to see is evidence of conversion of the pipeline and cross-selling opportunities into firm sales, some of the deferred orders coming through, and improvements in working capital management to lower debt levels.
Trading on 15 times depressed earnings estimates - representing a 25 per cent discount to the small-cap UK software and IT services average - I would hold the shares for their recovery potential if you followed my earlier advice. Hold.
Not quite sure what picture the RNS is painting, It talks about sales being soft in Dec and exceptional costs of £3.5m.
Exceptional costs usually arise from restructuring (firing people!) or disposing of premises etc. whereas a revenue line miss is not usually described as an exceptional item.
Anyway, it looks like it has at the halfway stage (December is their 6 mth period) and they may have knocked out most of their free cash generation. The December break was a relatively long break, so would probably also have given rise to soft consultancy sales as well.
Looking at their cashflow statement (year end '16) they wouldn't have generated any net cash except for their raising of £13m, of which £7-8m went to acquisitions and £3m went to reduce long term debt. The rest of operational cash was absorbed in other costs,
It maybe that the new CEO is looking to clear some of the organisational cost out of the door to restore net margins, but it is not helpful to that process to have a sales slump,
Real net profit margins.(ignoring statements of EBITDA) are looking at around 5%. Software development is absorbing nearly £4-5m a year, but is not being charged to the P&L as it is being capitalised,
Maybe this is a temporary phenomena, and the second half will see an improvement? But its a bit squeaky for cash generation. So maybe the dividend will be suspended, though this is not exactly a big deal for shareholders as it absorbed circa £0,5m in 2016.?
Tom Winnifrith has been a cheerleader of K3 for quite a few years.
He has made some useful insights into dodgy stocks in the past. I can't speak about his share tipping abilities.
However, I do recall he completely overlooked the great mystery of the change of accounting year change peformed by K3 about 4-5 years ago, and never questioned the then CEO about it when interviewing him.
It strikes me that in the various manuals he has written regarding red flags of various manouvres by companies to obfuscate poor results, he missed a trick in failng to hightlight the possibility of a change of accounting year as a means of burying reporting a performance drop in the p&l.
It was difficult not to be impressed by the full-year results performance from retail software company K3 Business Technology
(KBT:350p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services. The fact that its share price is making headway back towards last autumn's 19-year high of 377p tells a story in itself. It's a company I know well, having advised buying at 220p a couple of years ago ('Tapping into retail growth', 16 Sep 2014), and last reiterated that advice at 337p ('On the acquisition trail', 5 Jul 2016).
The key takes for me were growth in sales of K3's higher margin own intellectual property software which now accounts for 25 per cent of the mix and generates a gross margin of 66 per cent; a channel partner network that is clearly gaining traction; and a pipeline of new business which is up 23 per cent to £76m year-on-year. New orders hit a record of £35.3m and helped drive revenues ahead by 7 per cent to £89m in the 12 months to end June 2016. But it's the nature of the new business being won which resulted in both adjusted pre-tax profit and EPS shooting up by more than a fifth to £8.8m and 23.5p, respectively. The fact that K3 hit forecasts even though it was hit by an £830,000 write-down after a client went into administration says much about the resilience of the business too.
In the 12-month period, K3's software license sales increased by 17 per cent to £16.2m, helped by a contribution from the retail segment and its "ax I is fashion" offering. Leading European mail order fashion retailer, TriStyle Mode GmbH was a notable client win as were Lacoste and KLiNGEL, just two of 27 customers signed up through K3's channel partner network.
Acquisitions will contribute to another year of growth too. For instance, K3 recently acquired Merac, the author of an electronic point-of-sale and management system for the visitor attractions and leisure sector. It was an earnings accretive deal as K3 has acquired a business that makes annual pre-tax profits of £330,000 on revenue of £1.27m for a cash consideration of £1.4m. It also adds substance to analyst forecasts that K3 can lift EPS by 11 per cent to 26p in the 12 months to end June 2017, a performance that would easily justify another hike in the payout per share to 2p. The payout was lifted by 16 per cent to 1.75p in the year just ended, a reflection of the cash generative nature of the business.
Analysts believe K3 should be able to report free cash flow of £6m in the current financial year after factoring in capital expenditure north of £5m. This means that even after raising the dividend again the company should be able to cut net debt in half to £4.6m by June 2017. Gearing is only 12 per cent of shareholders funds, so there is scope for more acquisitions too.
So, with the outlook positive, and K3 well funded, I have no hesitation reiterating my buy advice. On 13.5 times forward earnings, and offering decent upside to my 425p target price, K3's shares are a decent buy at 350p.
Transition has slowed near-term sales growth
Order delays in manufacturing division
Shares in companies with a strong track record of landing big contracts and making savvy acquisitions rarely come cheap. K3 Business Technology (KBT) may be an exception. The software and IT services provider is growing quickly and polishing its business, yet its shares look too cheap given its rich prospects.
Retailers, manufacturers and distributors use K3's software to run everything from shop tills and tablets to payroll systems and marketing campaigns. The group is shifting its focus towards proprietary rather than third-party products - sold both directly and via partners - and subscription and hosting services in order to boost profit and improve the predictability of its revenue. Its efforts drove up first-half sales of proprietary products by 5 per cent, widening its gross profit margin by nearly 5 percentage points to 55.6 per cent. Moreover, K3 signed its first major contract for cloud-based subscription software and its improved product range and sales network helped it add 111 customers, up from 81 in the comparative period.
The new plan paid off in both divisions. First-half sales of lucrative intellectual property (IP) leapt a tenth in the retail business, which accounts for over 40 per cent of group sales and profit. Coupled with restructuring, that served to widen the segment's gross margin by 8.4 percentage points to 52 per cent. Sales also rose 2 per cent in the manufacturing and distribution segment, as a 4 per cent rise in recurring sales and higher services turnover offset lower software revenue. Moreover, strong demand for hosting and greater efficiency meant the division's gross margin widened by 1.9 percentage points to 58.8 per cent. K3 also updated key IP products such as Equator Payroll and Orchard Warehouse Management, but development spending and underperforming third-party products weighed on profit.
K3 has made other gains. Microsoft has endorsed it as an elite supplier of enterprise software, and it recently landed big contracts through its partner network with TriStyle and KLiNGEL, two European fashion groups. Moreover, an initial order with a global fashion retailer has the potential to grow significantly. K3 has also made a trio of recent acquisitions: Starcom, bolstering its hosting and managed services offerings; DdD, a Danish software business that sells proprietary, cloud-based products to retailers; and Merac, which provides electronic point-of-sale and management systems - powered by its own IP - to Stonehenge, Alnwick Castle and other leisure customers. And last month K3 said it expected to meet the City's forecasts for the year to the end of June, highlighting strong trading in its core business, as well as further contract wins and renewals.
Analysts at broker finnCap, for whom K3 is a corporate client, estimate that K3's adjusted cash profit rose a quarter in 2015-16 and expect 17 per cent growth in 2016-17. Yet the shares trade on an unassuming rating of 12 times forecast EPS, well below software peers. That rating undervalues K3's continued contract wins and the likelihood of further acquisitions. True, the transition to proprietary products promises to boost profit and the quality of earnings at the expense of short-term sales growth and a delay in manufacturing orders in the first half may be just a blip; the upside should be a strong second-half performance. Buy.
Retail software company K3 Business Technology (KBT:337p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services, has made its second acquisition in the past 10 weeks.
The company is acquiring Merac, the author of an electronic point-of-sale and management system for the visitor attractions and leisure sector. Merac's customers comprise many of the UK's leading historic houses, zoos, and theme parks, including Stonehenge, Longleat Safari Park, Castle Howard, Adventure Island, and Wookey Hole Caves.
Its a well structured deal as K3 is paying an initial cash consideration of £1.27m, and an earn-out up to £175,000 is payable next year depending on performance. In the last financial year, Merac made an adjusted pre-tax profit of £0.33m on revenue of £1.27m, so the bolt-on deal will be earnings accretive. It also adds further substance to analyst forecasts that K3 can lift EPS by 10 per cent to almost 27p in the 12 months to end June 2017.
On 12.5 times forward earnings, and offering 25 per cent upside to my 425p target price, I rate K3's shares a decent buy at 337p. Please note that I first advised buying the shares at 220p ('Tapping into retail growth', 16 Sep 2014), and recently published a detailed analysis of the company for online subscribers (Plug in and play with K3, 20 June 2016).
When markets are jittery it pays to screen for shares that are showing relative strength. That's because the lack of selling pressure in a company's share price is a sign that shareholders are sufficiently comfortable with trading prospects and the valuation of their holdings to ride out the general market sell-off. It also indicates an absence of speculative holders who are all too ready to press the sell button. This resilience appeals because when investor sentiment improves, and the risk premium embedded in equity valuations returns to a more normal level when market volatility subsides, then shares that failed to join the sell-off in the down phase are more likely than not to make headway.
Of course, shares in companies that have been sold off heavily are likely to bounce back strongly if the concerns expressed by investors that led to the share price decline prove unfounded. But as is always the case, any investment decision is all about balancing risk and reward. Personally, I would rather recommend buying shares in a quality small-cap company with a solid and loyal shareholder base and where the share price is unlikely to take a hit if investor risk-aversion rises any further.
High margin, and high growth software play
Bearing this in mind, I have noticed that Aim-traded shares in retail software company K3 Business Technology (KBT:358p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web-hosting services, have held up remarkably well since the share price hit a 19-year high of 377p last November. The sideways consolidation move, and lack of selling since then, is usually a good sign that the next move will be to the upside. It's a company I know well, having spotted the investment potential when the shares were priced at 220p ('Tapping into retail growth', 16 Sep 2014). I last recommended running profits back in April at the current price ('Hitting target prices', 21 Apr 2016).
Shortly after I published that article the company raised £13.5m in a placing of 4.09m shares at 330p each, which expanded its share capital by 12.8 per cent. The main purpose of the capital raise was to acquire DdD, a Danish provider of proprietary 'point of sale' software/hardware for retailers primarily for the fashion sector. DdD's core 'retail in a box' product is a fully integrated combined hardware/software proposition that provides and integrates a retailer's point-of-sale, back-office system, and head-office system. The suite is designed as an easy-to-install 'plug and play' solution which is delivered via the cloud and licensed to clients on a monthly 'consumption' basis. Its main attraction to retailers lies in its rich customer interface as well as ease of use and rapid installation.
The benefit for K3 is that DdD enhances the company's overall offering to the retail sector and, in particular, increases the number of its own IP-based solutions. Revenues earned from DdD's consumption-based licensing model and a diverse and well established 750-strong customer base across Denmark, Germany, Sweden and Norway also enhances K3's recurring income. There are cross-selling opportunities, too, while access to DdD's cloud technologies boosts K3's product development activities.
It looks a sensibly priced deal as DdD is a growing, profitable and cash-generative cloud consumption-based business with significant proprietary IP and one that generated cash profit of 1.08m (£850,000) and operating profit of 868,000 on revenue of 6.2m in 2015, so the initial cash consideration of £7m equates to seven times cash profit. There is also an earn-out of £900,000 dependent on performance targets being hit, so management is well incentivised.
Strategically, the acquisition makes sense because it would have taken K3 around 18 months to develop and deliver an equivalent pilot product and at a cost of £2.5m. So the company has not only avoided the executi
Impossible to say whether this is a good acquisition or not. Time will tell.
I note they have stuck on the back of the placing a lump of money will be dedicated to working capital. Probably a sensible move because this company is not generating large amounts of cash as it once was, and so this provided some fall back.
But it has meant a 12% dilution, so not insignificant.
Shares in Aim-traded retail software company K3 Business Technology
(KBT: 341p), the Salford-based supplier of software to the retail, manufacturing and logistics sectors and provider of managed IT and web hosting services, have drifted off slightly off their autumn highs (In the money, 9 November 2015), but I still feel its worth running profits if you followed my earlier advice to buy at 220p ('Tapping into retail growth', 16 Sep 2014).
I have taken a close look at the recent interim results and feel that the company is well on course to deliver the sharp uplift in underlying full-year pre-tax profits from £7.2m to £9.2m as predicted by analyst Katherine Thompson at Edison Investment Research. In the six months to end December 2016, pre-tax profits increased by a third to £4.78m, so more than half that 12 month estimate has been booked already. Moreover, with the benefit of a strong order book, improved margins on the back of a higher proportion of sales of the companys own-IP products, and the company winning major contracts for its "ax|is fashion" solution with major German online retailers, then there are sound reasons to remain positive.
Cash generation is strong, so much so that net debt is expected to fall from £12.1m to £10m in the 12 months to end June 2016, implying balance sheet gearing of only 17 per cent. Part of this cashflow is expected to fund a 10 per cent hike in the dividend per share to 1.65p, following a 20 per cent increase in the previous financial year. Its well covered too by EPS of 23.3p, up from 19.1p a year earlier, and is likely to remain so if K3 grows EPS to somewhere between 25.6p and 26.8p in the financial year to June 2017 as analysts at Edison and finnCap respectively forecast. Given the momentum in the business, I feel comfortable with those estimates.
I also believe that a forward earnings multiple of 12.5 times is an unwarranted 20 per cent discount to the average rating for small cap IT and software companies in K3s space. A valuation closer to 400p is justified to bring the rating into line with peers Edison has fair value of at least 384p and finnCap has a target price of 435p.
So, ahead of a pre-close trading update in early July I would continue to run your 55 per cent gains. Run profits.
Something to be wary of is adjusted earnings. Not entirely sure if development costs of K3 (which are increasing currently) are fully expensed, and written off against the p&l, or are being capitalised and spread (amortised) over their estimated useful lifetime.
If being capitalised, it somewhat flatters the p&l figures. As development costs grow it inevitably flatters even more, earnings.
Something to watch out for
Keep you eye on cash generation. At the moment K3 is sensibly paying down debt incurred for past acquisitions. However, cash generation is not super strong, as it should be for a company of this size in the IT sector they are in. However, moving steadily in the right direction
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