LRM however continues to capitalize more software development than its amortizes, resulting in management EBIT overstating cash earnings. If one expenses all software development costs then adjusted first half 2015 EBIT or cash earnings remains a disappointing (£1.402 million) loss. The brighter news however is this represents a £1.02 million improvement from the loss (£2.420 million) generated in the 1st half of the 2014 financial year.
The next piece of information to decipher is the degree LRM's earnings are bias towards the second half or the six months to March 31. This bias is highlighted by the 2014 year which saw a first half cash earnings loss of (£2.42) followed by a second half cash profit of £2.8 million.
The reason for the split is higher levels of recurring revenue and fixed term licence renewals fall in the 6 months to 31 March as it encompasses December 31 and March 31 balance dates which are the common reporting dates for global financial institutions (most non-UK financial institutions have 31 December balance dates). The financial year ends often coincide with the signing off capital puchase items like software. The first half to September 30, also includes the European summer holiday months of August and September where fewer sales deals are typically closed.
The company have outlined that £4.3 million in recurring revenue was recognized in the first half 2015 with in-excess of £4.5 million expected in the 2nd half (this excludes revenue from fixed term license renewals).
The purchase and implementation of new risk management and regulatory compliance software is typically arranged to coincide with balance dates, with annual license fee and annual support and maintenance typically paid on the twelve month anniversary of either the successful software implementation or twelve months post the payment of the initial license fee.
LRM typically sells its software for a typical five year fixed term period (some longer, some shorter) and receives an initial license fee. The company then charges both an annual license fee and an annual support and maintenance fee, which are both treated as recurring revenue. After the expiry of a five year fixed term license the company is typically able to renew the contract and charge a fixed term license renewal.
Its fair to say many software models are morphing towards subscription type pricing and away from chunky upfront license fees. This said, large banking institutions will be more reluctant than most to move their business data offsite, so traditional software licensing structures will persist for longer in this space.
The Risk Management products have a recurring element (annual license and support and maintenance) of around 20 percent of the value of the initial license fee, which is pretty standard for enterprise software sales. The Regulatory Compliance business has a higher element of recurring revenue of between 40 and 50 percent, which is explained due to the added complexity of keeping up with the numerous banking regulatory changes.
The order book stood at £5.1 million as at 30 September 2014 down from £5.4 million in the corresponding period in 2013. The company were also quick to comment that early deals in the month of October had added to this order book, so essentially the company is starting on a similar footing as it did the year prior. The company are also guiding they have healthy level of recurring revenues expected in the second half as well as some fixed term license renewals.
In 2014 LRM did 2nd half revenues and cash profits of £13 million and £2.8 million respectively. If one assumes second half 2015 was identical to 2014, investors should expect full year revenues of £22.2 million and an annual cash profit of £1.4 million. This puts the company (using share price of 12.5p) on a reasonable enterprise value to revenue ratio of 1.42 times, with 10 percent revenue growth and a ritzy price to cash earnings ratio of 23.8 times (no tax on earnings).
An optimist would assume a similar £1.02 million improvement seen in the first half of 2015 will be repeated (even exceeded) in the second half of 2015 on the back of continued revenue growth (first half revenue growth was 28 percent). This would see the price to cash earnings ratio fall to 14 times (cash earnings £2.4 million).
LRM is not really about what the company earns in 2015, although it would be nice to see free cashflow generation. Its about leveraging their 300 banking/financial clients with deep pockets through the sale of smart software products which provide efficiency, accuracy while reducing complexity, in an increasingly regulated financial world. The specialism LRM has in the risk management and compliance space, and the aggressive technology spend (35 percent in sales in 2014) in combination with good sales execution surely must allow the company to build a franchise with sales heading towards £50 million and 20 percent cash margins.
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