The interim financial statements published by RS2 Software plc on August 14 may have caught investors and financial analysts by surprise. Few would have possibly expected such a strong increase in revenue and profitability during the first half of 2015, given the lack of any major contracts announced by the company.

RS2 reported a 48.5 per cent increase in revenue to €11.5 million, and pre-tax profits surged by 121 per cent to €6.6 million (June 2014: €2.9 million).

The only new contract announced by the company in the first half of the year was the licence agreement with Viet Capital Bank, a bank in Vietnam, for an undisclosed amount.

Shareholders and market participants who attended the annual general meeting on June 9, 2015 ought to have been less surprised at the revenue and profitability growth in the first half of the year. In his speech during the AGM, CEO Radi El Haj indicated that the results for H1 2015 are positive and exceeding expectations. The CEO also commented that the second half of 2015 should be very successful for the company.

Unfortunately, the interim financial statements do not provide a breakdown of the various revenue sources split up into licence fees, service fees, income from mainten-ance agreements and processing services. This makes it difficult to analyse the exact changes that took place in the first half-year.

RS2 indicated that the growth in revenue was mainly attributable to the recognition of new licence fees and an increase in service fees. Moreover, the company reported that maintenance fees for new and existing clients also contributed to the increased revenue figure while processing fees grew by 16 per cent.

During the 2014 financial year RS2 registered a surge in service fee income to almost €8 million (+84 per cent), largely due to the implementation and consultancy services provided to the two new major clients, namely Barclays Bank plc and the unnamed global processing company signed up in 2014.

At the time of the publication of the 2014 annual financial statements, Mr El Haj had confirmed that service fee income should continue to grow in 2015 and future years. As such, this strong trend ought to have continued during the first half of the year, largely contributing to the 48.5 per cent overall revenue growth.

The 2015 interim financial statements provide further confirm-ation of the profitable business model of RS2. The gross profit margin improved to 59 per cent (June 2014: 50 per cent) and likewise, the Ebitda margin surged to 62.7 per cent from 49.3 per cent in the first half of 2014. Additionally, the net profit margin increased to 41 per cent compared to 29 per cent in the first half of last year.

The growth in revenue was attributable mainly to the recognition of new licence fees and an increase in service fees

Another very important ratio for financial analysts is the return on equity, measuring the profit achieved by a company from the amount of money invested by shareholders. Since this ratio is calculated by dividing profits by the amount of average shareholders’ funds, it is not always a good measure to use at the interim reporting stage because one cannot annualise the interim profit due to fluctuations in profits from one accounting period to the next.

This is very relevant in the case of RS2 Software. In fact, in recent years revenue and profits from one accounting period to the next fluctuated remarkably and were very much dependent on the timing of licensing contracts.

RS2’s directors again cautioned investors about this likelihood in the recent company announcement by stating that since the performance for a specific accounting period is influenced by revenue recognition criteria, the performance between accounting periods may not be linear.

This may start to smoothen out given the surge in service fee income as well as the growth in processing fees. However, RS2’s financial performance is still somewhat dependent on the timing of new licence agreements, and one cannot simply assume that the profits achieved in H1 2015 will double during the second half of the year.

As such, although the interim ROE is very strong indeed, it would not be prudent to assume that this ratio will be similar at year-end. Notwithstanding any fluctuations in the second half of the year, the 2014 ROE of RS2 at 12.5 per cent was still relatively attractive but somewhat lower than the top achievers, namely Malta International Airport plc and Medserv plc which are both above 20 per cent. It would be interesting to see whether RS2 can achieve this ratio once the 2015 full-year financial statements are published.

So what could one expect from RS2 during the second half of its financial year? It is worth recalling that in the interim directors’ statement published on November 19, 2014, the directors stated that the group is in the process of negotiating a new licence deal with a client in Europe and this was expected to be concluded during the first quarter of 2015. No news of this has so far emerged.

Last November RS2 confirmed that in the area of transaction processing (i) negotiations on a second letter of intent were ongoing and were at an advanced stage, while in the interim directors’ statement published on May 13, 2015, the directors indicated that contract negotiations are taking place with a UK company; (ii) negotiations on new letters of intent were ongoing with potential clients across Europe and North America. In both instances, no further updates were provided in the recent announcement.

Presumably, RS2 will be updating on the progress achieved in each of these cases as they occur.

In addition to all the foregoing, during the AGM held on June 9, 2015, Mr El Haj confirmed that the licence agreement with the Vietnamese bank was an important step to achieve further penetration across the Asian market, and RS2 was also targeting other potential clients in Asia.

RS2’s immediate strategy also involves penetrating the market in the US, and during 2014 it increased its equity stake in the US company Transworks from 25 per cent to 64 per cent. This vehicle is being used to expand the group’s business in the US.

At the AGM, the CEO hinted that some positive developments could materialise in the months ahead. Furthermore, last week’s announcement revealing the appointment of John Elkins to the board of directors of RS2 could also be linked to the company’s expansion strategy in the US.

Although the interim ROE is very strong indeed, it would not be prudent to assume a similar ratio at year-end

Mr Elkins has extensive experience in the industry, having served as executive vice president and chief marketing officer for Visa International and more recently as president and executive management committee member (International Regions) of First Data, a global electronic payment processing enterprise, with operations in 35 countries. Additionally, the news release published by RS2 on this new appointment reveals that the company has worked with Mr Elkins at First Data since 2011 and believes that Mr Elkins’s tremendous knowledge of the payments industry should enable RS2 to continue its global expansion strategy.

RS2’s share price has by far been the strongest performer in recent years. After the 2-for-1 share split in mid-June the equity traded up to a new record and touched €2.26 on July 20 before easing to €2.05 last week.

Following the publication of the interim financial statements, the share price rebounded sharply and traded up to a new record high of €2.30. The strong rally over the past three years increased the market capitalisation of RS2 from €20 million to over €200 million.

RS2 is now the seventh largest company on the Malta Stock Exchange and its market capitalis-ation exceeds many of the longer-established companies’. RS2 now needs to conclude a number of the international contracts referred to in recent months and communicate these to the market accordingly to justify the significant increase in its market capitalisation.

Edward Rizzo is a director at Rizzo, Farrugia & Co. (Stockbrokers) Ltd.

www.rizzofarrugia.com

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