Solution Dynamics Limited (“SDL” or “Company”) produced an unaudited net profit after tax of $587,000 for the half year. This represents 7.7% year-on-year growth on an after-tax basis although the prior financial interim result had no tax expense as the Company was still utilising tax losses. On a net profit before tax basis, SDL’s result was $804,000 and this represented 47.3% year-on-year growth. The result and underlying growth was mainly generated from Software & Technology and contained no unusual items or material one-off software licensing revenue. The Directors have declared an interim dividend of 3.0 cents per share, fully imputed.

Operating revenue grew 15.8%, however, much of this was from gains in low margin postage revenue, with Outsourced Services revenue increasing 45.0%. The consequence of this was a decline in the Company’s gross margin percentage (although dollar gross margin continued to grow and was up 11.6% to $3,301,000). More pleasingly, Software & Technology revenues increased 14.2% assisted by a modest contribution from a new product development being undertaken for a large print equipment supply company.

Revenue was largely flat year-on-year in the traditional digital print and document handling services market, a market which otherwise remains in overall decline. Opportunities for SDL in this sector come from both new business wins and incremental business from existing clients, offset by migration of some client volumes to electronic distribution. New business wins partly stem from the Company’s software technology offerings coupled with a commitment to maintaining high service levels and, where possible, integrating SDL’s technology into its customers’ internal processes to help drive customer efficiencies. SDL gained a couple of reasonably sized new digital print accounts during 1H and these will begin contributing during the second half.

High asset utilisation of SDL’s print imaging and document handling equipment coupled with ongoing cost efficiency gains saw modest improvement in imaging gross margin. The major change to the mail and print operation during the six months was finalising installation of a high-speed, continuous-sheet laser printer. This was a requirement for SDL being appointed as an accredited DMS (Document Management Services) partner for Fuji Xerox. The DMS arrangement is unlikely to show much near term financial benefit but has medium term potential to add meaningfully to print revenues and SDL believes that, in conjunction with Fuji Xerox, it now provides a very competitive offering for large print customers.

The key first half development for Software & Technology has been the acceleration in rollout of DéjarMail into health practices in the UK. This is through embedding DéjarMail into the health practice management system provided by a third party software developer. The rate of take up by practices improved significantly late in the first half and we expect this rate of increase to continue during the second half. There was little first half revenue generated from this activity and there are up-front costs in the second half which will mute any profitability gains for FY2016, however, we expect FY2017 to see a strong positive effect from this contract.

The first half also included some capitalised software development costs as SDL acquired the IP for a print procurement package the Company is having developed by a third party. This
software development was undertaken on the basis that a customer has already signed up to utilise the package on a SaaS basis, and revenues should commence during the second half with the likelihood of additional users (and revenues) in FY2017.

The Company’s balance sheet remains very strong with half year net cash on hand (i.e. cash less interest bearing debt) of $1,350,000. Major cash outflows occurred during the half year for finalising the specialised print room to house the DMS contract print equipment, for the software IP development referred to above, as well as for the payment of SDL’s maiden dividend of 1.5 cents per share for the FY15 year.

The first half saw SDL conclude a market development agreement with NZ Trade and Enterprise (“NZTE”). NZTE will assist in funding 40% of certain market development costs in relation to expanding the Company’s software revenue in the UK (over a three year period, to a maximum reimbursement of $428,000). SDL believes the UK will prove to be an important growth market over the coming years. A degree of growth is already assured as the rollout of DéjarMail into health practices is unlikely to fully mature for several years and that contract has already opened discussions with other parties which have potentially significant revenue opportunities.

Financial Performance
Earnings before interest, tax, depreciation and amortisation (EBITDA) improved by $235,000 (+33.8%) on sales volumes that rose 15.8%.

Summary Financial Performance Yr-on-Yr Yr-on-Yr
(all figures $000) 1H FY16 1H FY15 $ Change % Change
Total Revenue 7,760 6,702 1,058 15.8%
Cost of Goods Sold 4,411 3,701 710 19.2%
Gross Margin 3,349 3,001 348 11.6%
Gross Margin (%) 43.2% 44.8%
Selling, General & Admin Costs 2,418 2,305 113 4.9%
EBITDA 931 696 235 33.8%
EBITDA Margin (%) 12.0% 10.4%
Depreciation 128 103 25 24.3%
Amortisation 5 48 -43 -89.6%
EBIT 798 545 253 46.4%
Net Interest -6 -1 -5 500%
Net Profit before Tax 804 546 258 47.3%
Taxation 217 1 216 n.a.
Net Profit after Tax 587 545 42 7.7%

 

Note that prior year FY15 profit figure has been adjusted and differs from that shown in the FY15 interim report. This is due to the incorrect classification of $14,000 ESOP expense into Comprehensive Income in FY15. It is now included in Selling, General & Admin Costs for both years (FY16 ESOP charge was $18,000.

The EBITDA gain is partly the benefit of higher gross margin in both digital print and software & technology, coupled with holding selling, general and administration (SG&A) costs to a modest year-on-year increase. Underlying SG&A costs remain well managed; the SG&A increase is partly accruing for higher staff incentive payments as a result of improved operating results and partly from higher costs in relation to new business initiatives.

SDL held its digital print and document handling revenues steady despite the ongoing erosion of mail volumes. This has resulted in market share gains and we expect this trend to continue as a result of:

✔ SDL’s ownership of intellectual property (IP) relating to document creation, handling and archival, enabling technology-based solutions to clients’ communications needs. This also provides an ability to quickly meet changing client requirements;
✔ a strong service-oriented and customer-focused culture; and
✔ new products such as DéjarMail driving growth in variable print-on-demand volumes.

New digital print business wins should begin to generate modest revenue growth during the second half although this is partly dependent on the timing of when the print work handover occurs.

Revenue Analysis Yr-on-Yr Yr-on-Yr
(all figures $000) 1H FY16 1H FY15 $ Change % Change
Software & Technology 2,038 1,784 254 14.2%
Digital Print & Document Handling 3,088 3,101 -13 -0.4%
Outsourced Services 2,634 1,817 817 45.0%
Total Revenue 7,760 6,702 1,058 15.8%

 

While SDL’s market share gains are covering general mail volumes erosion, the development of non-mailing revenue is key to the Company’s successful longer term growth. SDL continues to develop its core software products and is building distribution channels, although channel development progress remains slow and the Company is still too reliant on direct sales efforts and a small number of key customers. The 14.2% revenue growth rate for the first half was slightly ahead of our internal target and our efforts in the UK market are likely to ensure Software & Technology has a number of years of solid revenue growth ahead.

 

Balance Sheet, Liquidity and Debt

SDL closed the half year with net cash on hand of $1,350,000. A $200,000 bank overdraft facility remains in place but is presently unused.

Selected Balance Sheet and Cashflow Figures Yr-on-Yr Yr-on-Yr
(all figures $000) 1H FY16 1H FY15 $ Change % Change
Net Cash on Hand (net of debt) 1,350 1,108 242 21.8%
Non-current Assets 1,993 1,480 513 34.7%
Net Other Liabilities -412 -307 -105 34.2%
Net Assets 2,931 2,281 650 28.5%
Cashflow from Trading 743 708 35 4.9%
Movement in Working Capital -49 -126 77 -61.1%
Cash Inflow from Operations 694 582 112 19.2%

 

As a result of the above items, book value (net assets) has increased by 28.5% to $2.93 million. This increase is largely the result of SDL’s investment in fixed assets related to the DMS contract and software IP development. Working capital continues to be well managed.
SDL made capital expenditure additions during the half of $482,000, the majority of which, as noted above, was to house the DMS-related print equipment. Additionally, and also previously noted, SDL has acquired the IP to a software product it is having externally developed and most of the capital expenditure related to this was incurred in the first half (approximately $200,000 was spent and some modest remaining spend will be required in the second half). We believe the Company’s current print and print-related equipment configuration means there is little obvious requirement for anything other than minor capital expenditure in the near-to-medium term.
In reviewing the above cash flow figures, a degree of seasonality should be noted. Historically, sales and earnings are higher in 1H compared to 2H and accordingly the movement in working capital is negative in 1H, and positive in 2H. As SDL’s software revenues increase over time, the extent of the seasonality should reduce.
We have noted in the past, but it bears reiterating, that the Company has a cautious stance in relation to acquisitions and retains a strong preference for organic growth. The directors are conscious that acquisitions often fail to add value to shareholders. Acquisitions would typically either need to be “bolt ons” where removal of duplicated costs means the effective acquisition multiple is very low, or product extensions where the acquisition fills a gap in SDL’s software portfolio plus SDL has the opportunity to sell its software into the acquired company’s customer base.

 

Dividend

SDL is pleased to announce the payment of an interim dividend of 3.0 cents per share. This is SDL’s maiden interim dividend and follows the Company’s maiden final dividend for FY15.

Earnings and Dividend per Share Yr-on-Yr Yr-on-Yr
1H FY16 1H FY15 $ Change % Change
Earnings per share (cents) 4.18 3.88 0.30 7.7%
Dividend per share (cents) 3.00 n.a. n.a. n.a.
Dividend proportion Imputed 100.0% n.a. n.a. n.a.
Payout ratio 71.9% n.a. n.a. n.a.

 

The dividend is fully imputed and the amount represents a payout ratio of 72% of earnings per share. The arrangement with NZTE in relation to funding UK market development requires the Company to cap the payout ratio at less than 75% for the duration of the agreement.

As first half profitability is normally seasonally stronger than the second half, the interim dividend is likely to also be correspondingly stronger.

FY 2016 Outlook

The interim result was slightly better than expectations at the start of the year and is in line with SDL’s earnings upgrade issued on 17 December 2015. The Company’s forecast for the full financial year remains for a net profit after tax in excess of $850,000. SDL also notes that a number of digital print and software contracts are only partly contributing to the expected FY16 full year result and furthermore, that some of these initiatives have one-off start-up costs. Subject to the usual risk caveats, this augurs well for potentially robust earnings growth in FY17.

 

For further information, please contact:

John McMahon Nelson Siva
Chairman Director & Chief Executive Officer
+61-410-411 806 +64-21-415027

 

Appendix 1, Preliminary Report 1H 2016

Appendix 4, Interim Dividend 2016