Latest Results

Keystone Law (AIM: KEYS), the fast growing, UK Top 100, challenger law firm, today announces its final results for the year ended 31 January 2020 (‘FY2020’).

Chief Executive’s Review

Operational Review

Introduction and Highlights

2020 has been another exciting year for Keystone.  In spite of the uncertainty in the UK economy, caused predominantly by Brexit and the General Election, we have once again achieved strong results as the business has continued to grow and deliver on our strategy.

Revenue has grown 16%, this figure being lower than the underlying growth as last year’s revenue benefitted from £2.2m which was one off in nature (being a particularly substantial and unusual piece of litigation) excluding this the revenue growth would have been 23%.  The strength of our balance sheet, together with our confidence in the future, were both reflected in the Board’s decision to pay a special dividend in the year of 8 pence per share (£2.5m).

From an operational perspective, against a challenging background, especially in the third quarter, we have had another good year in recruitment with the number of Principals* growing from 277 to 328.  Furthermore, as the Pod concept continues to demonstrate its appeal and flexibility, we have seen the number of Pod members increase from 33 to 54 and ongoing demand for junior support through our central office employed lawyers has also remained strong.

Keystone’s strategy and delivery against it

Our strategy, as previously communicated, is clear and simple; organic growth through recruiting high calibre lawyers in the UK legal services market.  Over the last twelve months the market landscape has remained essentially unchanged.  Our market remains substantial, at over £9billion, and continues to suffer from the same structural problems which have been inherent to it for some time.  As such a large number of lawyers are seeking a different way to continue to develop their practice.

Accordingly we have remained constant in our efforts to take advantage of this opportunity.  Our focus has remained on driving growth through recruitment and delivering “best in class” service to our lawyers once on board, thereby enabling them fully to exploit the potential of their practices. The year started well, with first half qualified new applicant numbers being 7.5% higher than the same period of the prior year (114 v 106).  However, the uncertainty in the broader UK economy triggered by concerns over Brexit and subsequently the General Election caused a temporary slow-down in the third quarter, and whilst we saw a bounce back in the final quarter, overall qualified new applicants ended the year just 4% up at 239 (2019: 230).  This slow down had more of an effect in the number of accepted offers in the year, which ended the first half of the year 24% up (36 v 29) but only reached 56 for the full year (2019: 63), as the bounce back in qualified new applicants in Q4 did not have time to feed through to accepted offers by the year end and the COVID-19 pandemic has subsequently impacted on market conditions in Q1 2020.

This year, we have continued to witness how the full potential of the model has yet to be reached.  In 2019 we started to see lawyers adopting the flexibility of the model to build Pods, enabling them to increase the size of the practice they were able to develop.  This year we have seen the continued evolution of this theme, with 35 new Pod members being recruited by our Principals* (2019: 26).  Of these, 13 were recruited by Principals who themselves joined during the year, 9 were recruited by existing Principals who have taken on their first Pod member with the rest joining an existing Pod.  The establishment and proliferation of these Pods has, not only provided a means by which new and existing lawyers are able to develop larger practices, but also further enhances and extends the appeal of the Keystone model in the market place as a whole.

As we continue to attract more high calibre lawyers, so the overall strength of the Keystone brand continues to grow and our position in the market increases.  This is all part of a virtuous circle as the best lawyers want to work where other good lawyers work. 

*     Principal lawyers are the senior lawyers who own the service company (“Pod”) which contracts with Keystone. The relationship between Keystone and its lawyers is governed by two agreements; a service agreement (which governs the commercial terms and is between the Pod company and Keystone) and a compliance agreement (which governs the behaviour of lawyers and is between each lawyer and Keystone). Pods can employ more than one fee earner. Such juniors/colleagues are employed by or contract with the Principal lawyer’s service company but are, to all other intents and purposes a Keystone lawyer. As such, they are fully vetted by the Central Office to ensure that the quality of the services received by the clients remains of the highest calibre. As is the case for the Principal lawyers, these juniors sign a compliance agreement with Keystone and are required to comply with all rules and regulations governing Keystone’s lawyers’ professional conduct. This development further demonstrates the flexible and scalable nature of our model; the Principal lawyers are able to scale their practice and benefit from the additional fees that their service companies receive, whilst Keystone benefits from the increasing size of the practices which these lawyers are able to build.

Investment in Chancery Lane Offices

Our main offices at Chancery Lane serves as both where the central office team work and, probably more importantly, the “face of the firm”.  This is the principal location where lawyers wishing to meet with their clients at Keystone offices do so.  At the start of the 2020 financial year, we occupied the first floor in Chancery Lane for both client meeting rooms and the central office as well as a small premises near the main offices which provided hot desking facilities to our lawyers whilst they were in London as well as enabling a small number to rent space from us on a commercial basis (“the lawyer centre”).

Keystone’s growth in recent years had seen an increasing pressure on the availability of meeting rooms; this was further highlighted through the responses to our annual lawyer survey which identified this as an area which could be improved upon. Furthermore, the lease on the lawyer centre only ran until December 2019.

We were, therefore, very happy to be able to take advantage of the opportunity which presented itself to co-locate both our lawyer centre, client meeting rooms and central office in the one building by taking a second floor in Chancery Lane. At the same time we were also able to align the old lease with the new lease such that we now hold two conterminous five year leases.  Furthermore, taking the new floor not only increased the number of meeting rooms available (more than doubling it) to our lawyers but presented the opportunity to fit out the offices to a higher spec than the existing floor, thereby realigning the “face of the firm” with the current and future positioning of Keystone in the market place.

Although we took the new leases from the end of Q1, the new floor became available for use from the start of the second half of the year and has been exceedingly well received by both lawyers and clients.

Ongoing Investment in IT

For Keystone, IT is a key enabler of the model and so we work tirelessly to deliver ongoing improvements and enhancements across the IT estate to ensure that our offering remains “best in class” and a clear differentiator.  This year has been another busy year for the IT team, delivering the ongoing enhancements needed to ensure that the systems provide the best user experience, driving operational efficiency and ensuring continued compliance to the constantly developing rules and regulations under which a law firm operates. 

Over and above the day to day enhancements and developments, we have also rolled out a number of projects which, this year have again focused on improving the security of our IT estate.  We successfully migrated all users from Exchange on site (albeit on site at our outsourced provider Naastar) to Exchange on-line.  The most significant advantage of this change is that all data is now encrypted at rest (ie: the point at which the email leaves the local machine). As part of this roll out, and to further enhance security of the local devices, we also introduced multi-factor authentication for all users’ machines.  Finally, in a separate project focusing on mobile devices, we rolled out a product which ensures that any device with access to Keystone emails has an up to date operating system with all the patches up to date, is password encrypted and satisfies a determined level of security criteria.  The product also has the additional advantage of enabling the central office team to delete all Keystone data from the app should the mobile device be lost or stolen.

Ongoing Investment in the Central office team

Whilst the key driver of growth in the business is recruitment of lawyers and their clients, the role of the Central office team is equally key to the growth and development of the business.  The work done in delivering services of the highest quality to our lawyers by all areas of the Central office team is a fundamental aspect of what makes Keystone so special.  Within the business we believe that we have two groups of clients;  those to whom we deliver legal services and the lawyers themselves.  This customer services approach treating our lawyers as clients, is an aspect of the model which is often overlooked but which goes to the heart of the business’ culture, significantly enhancing Keystone’s offering. As such, the ongoing investment in and evolution of the Central office team is essential if we are to continue to meet and exceed the expectations of our lawyers and their clients.  This is a continual process of improvement and something that we are mindful of with each new hire and / or promotion.  I would like to take this opportunity to thank all those involved in the Central office for the excellent attitude that they have brought to their work over the course of the last year and look forward to continuing on this journey of excellence with them in the year ahead.

Looking ahead

Once again, this year, Keystone’s business model has continued to flourish and evolve, extending its appeal to an ever wider audience within the legal community.  It has continued to demonstrate its ability to attract and retain high quality lawyers, working with them to develop and exploit their practices to maximum effect.

The current year started well with trading for the first six weeks being strong and in line with our expectations.  Whilst we, like most businesses around the world, have been impacted by the effects of the COVID-19 pandemic and the resultant impact on the broader economy, Keystone is in a strong position to deal with both the operational and financial impacts.

Keystone is highly liquid, being debt free and with a net cash position of £4.4 million as at 31 January 2020.  Furthermore, the Group has been cash generative in the period since year end.  The Keystone model itself is highly resilient to economic volatility due to the ‘capital light’ nature of the business and the high proportion of its cost base which is fully variable; most notably the lawyer fees which represent approximately 75% of revenue. These are not only fully variable but also on a paid when paid basis, thus underpinning the cash-generative nature of the Keystone model.

Operationally, Keystone’s service delivery model, whereby lawyers operate on a remote basis accessing central services through its bespoke technology platform, has been substantially unaffected by the restrictions on movement implemented by the UK Government.   In the interests of staff wellbeing the Board acted quickly to move all office-based support staff to remote working with effect from 13 March 2020.  This change was achieved with no impact to the business and Keystone’s service delivery capability is as robust as it was before the COVID-19 outbreak.  We are well diversified, delivering legal services across a wide range of sectors and specialisms such that we have no dependency on any single area of the economy or client.

The current situation is unprecedented and the wider economic impact on our clients, together with the timing of this within our financial year and unknown duration for which it may apply, mean that the impact on the Group for the year ending 31 January 2021 cannot yet be assessed.  In the month since the pandemic broke in the UK, whilst billing and cash generation have remained strong, we have seen a meaningful decline in the number of new instructions received.  We have modelled a range of scenarios, including some which are more negative than what we currently consider the most likely outcome for the Group, and under all of these scenarios the business remains profitable and cash generative for this financial year. However, we will provide a further update once the full effects of the pandemic become clear.

As a Board we are monitoring the situation closely and will take all necessary actions to ensure the good health of the business through these challenging times.  We remain confident of the Group’s ability to continue to deliver on its strategy for growth, taking advantage of the sizeable market opportunity which exists, once the current situation has passed.

Financial Review and Strategic Report

Key Performance Indicators (KPI’s)

The following KPI’s are used by the management to monitor the financial performance of the Group.

• Revenue growth: 16.3% increase (2019: 35.1%)
• Adjusted PBT growth: 12.0% increase (2019: 56.8%)
• Adjusted PBT margin: 11.6% (2019 (restated for one off litigation: 11.0%)
• PBT growth: 10.1% increase (2019: 145.5%)
• PBT margin: 10.5% (2019: 11.1%)
• Operating cash conversion %:81% (2019: 92%)
• Trade debtor days: 36 (2019: 40)
• Net Assets: £14.1m (2019: £15.4m)

The calculation of adjusted PBT is shown below.

Income Statement

I am pleased to report revenue for the year of £49.6m, an increase of 16.3% on the prior year.  This growth rate is somewhat downplayed by the fact that last year’s revenue had benefited from £2.2m litigation revenue which was one off in nature (this case was one-off in nature predominantly due to the source of work; being a conflict case from a magic circle firm); excluding the distortion caused by this revenue growth would have been c. 23%.  Revenue growth has been driven by the lawyers recruited last year contributing a full year of productivity as well as contributions from the lawyers who have been recruited during this year, with principal lawyer numbers increasing from 277 to 328.

Gross Profit

The gross profit margin of the business has fallen slightly this year to 26.7% (2019: 27.1%). The majority of this decline is again due to the impact of the one off litigation work last year which generated an enhanced gross profit margin (32.4%) due to the level of fees billed by central office employed lawyers on the case.  Excluding the one off litigation case last year, the gross profit margin would have been 26.8% and gross profit year on year would have been broadly flat.

Administrative Expenses

Administrative expenses have increased by 14.3% to £7.2m (2019: £6.3m).  The largest single component of this is staff costs which increased by 16.7% to £2.9m (2019: £2.5m), with support staff increasing from an average of 37 in 2019 to 44 in 2020.  Other administrative costs increased by 12.9%% to £4.4m (2019: £3.9m).  These increases compare to the 23% increase in underlying revenue (ie. excluding one off litigation revenue from 2019) and continue to demonstrate the operational gearing effect within the business.

Other costs

This year’s application of IFRS16 has meant that the treatment of leases has changed such that the largest element of the cost is now treated as amortisation, whilst the element arising from discounting the liability is treated as interest. As such, in spite of the business not having any third party debt, we now have a reasonable charge for interest.

Amortisation costs in the business now comprise both the amortisation of the goodwill which arose from the structuring of Root Capital’s investment in the business in October 2014, together with the amortisation of the discounted cost associated with our property leases.  Last year, we held a lease for our lawyer centre in Staple Inn and our principal office on the first floor of 48 Chancery Lane.  In April this year, we took a new lease of the second floor of Chancery Lane, and resigned a new lease on the first floor so that both leases co-terminate in 5 years’ time.  The lease in Staple Inn came to an end during this year. 

PBT and Adjusted PBT

Adjusted PBT is calculated as follow:

PBT has increased by 10.1% to £5.2m and adjusted PBT has increased by 12.0% to £5.8m (these increases would have been 29.1% and 29.6% respectively had 2019 not benefitted from the one off piece of litigation). The effect of the one off litigation also impacted on the 2019 PBT and adjusted PBT margins which were 11.1% and 12% respectively but which otherwise would have been 10.0% and 11.0%.  As such, although both the PBT and adjusted PBT margin declined this year, this was due to 2019 margin being enhanced.  If we exclude the impact of the one off litigation from 2019 both the PBT and the adjusted margins for this year would have shown an increase reflecting the continued effect of operational gearing in the business.

Taxation

The effective tax rate of 20.3% is higher than the standard rate and that of the prior year (19.8%).  Due to the nature of our business and the investment we make in providing networking opportunities in social environments for our lawyers, the tax rate of the business is always likely to be slightly higher than the standard rate as these costs are disallowable for corporation tax purposes.

Earnings Per Share

Basic earnings per share has increased from 12.2p to 13.3p, with the dilution effect from shares granted under LTIP being negligible. Adjusted earnings per share, (calculated by making the same adjustments to earnings as has been made in calculating adjusted PBT and divided by the average shares in circulation this year) has increased by 33.9% to 15.0p (2019: 11.2p).

Statement of Financial Position

Cash

The Group’s business model is strongly cash generative because its most significant cost, the fees paid to lawyers, is only paid once Keystone has been paid for the work it has delivered. As such, operating cash conversion for the year was 81% (2019: 92%) generating cash from operations of £4.9m (2019 (restated): £4.9m). This decrease in the operating cash conversion in the period, which equates to c £0.5m, is due to an increase in the level of client disbursements which have been paid by the Group and not yet recovered from clients on ongoing matters. 

Capital expenditure was £0.4m (2019: £0.04) reflecting the costs associated with fitting out the new floor of offices taken in Chancery Lane, corporation tax payments were £0.8m (2019: £0.9m), net interest received was £0.06 (2019: £0.06) and lease payments were £0.15m (2019: £0.27m); lower this year than last, in spite of the additional space taken, due to the rent free periods on both of the new leases signed.   As such, cash generated by the business in the year was £3.6m (2019: £3.8m).

The Group paid dividends of £5.5m (2019: £1.0m), which included ordinary dividends of £3.0m and a special dividend of £2.5m, the prior year had been much lower because it only reflected the previous interim and a small dividend in respect of the post admission period.  This left closing cash of £4.4m (2019: £6.3m) and no debt.

Net Assets

Although the net assets of the Group have decreased from £15.4m to £14.1m, this is the result of the payment of a special dividend of £2.5m.  This still leaves the business with a strong balance sheet.

Section 172 Companies Act Statement

The statements below address the reporting requirements of the Board under Section 172 of the Companies Act and the Companies (Miscellaneous Reporting) Regulations 2018.

Keystone’s has a clearly stated long term organic growth strategy and as such all significant business decisions consider both the short and long term impact in the process.  Key to delivering this strategy is to continue to recruit and retain high calibre lawyers.  In order to be an attractive place for high calibre lawyers to work, it is essential that Keystone maintains its reputation for delivering work to the highest professional standards. 

Keystone’s primary asset is its people, be it the central office staff, the lawyers, the clients or third party suppliers with whom we work (such as counsel, experts and other professionals).  As a business, we dedicate substantial time, effort and resources in working to develop and maintain strong relationships from which all parties benefit.  As a people business, the impact of business decisions on our principal stakeholders is always central to the decision making process.

The nature of the Group’s business is fundamentally low impact to the environment.  Furthermore, the Keystone model which enables lawyers to deliver their services using technology further reduces the environmental impact as our lawyers have no need to commute to work.

The Directors treat all members of the Company fairly and consistently, as required by both professional standards and in compliance with various pieces of legislation.  We provide information to all shareholders and other third parties on an equal basis.

Dividend

Due to the Covid-19 pandemic and the resultant uncertainty of the effects on the UK economy the Board has decided that it would not be prudent to propose a final dividend at this time.  As such the total dividend for the period will be the amount paid as an interim dividend, that being 3.2p per share (2019: total ordinary dividend 9.0p (interim 2.5p)).

On behalf of the Board.

Ashley Miller
Finance Director
27 April 2020