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Date: Thursday 21 Aug 2008

LONDON (ShareCast) - Xaar has experienced trading problems in China but it is still generating profits and cash.

The fully listed inkjet printing head technology group issued a profit warning in July which sent its share price diving.

Xaar dominates the Chinese market for inkjet heads which are predominantly used for wide format printing of outdoor posters. Xaar’s customers are printing equipment manufacturers who supply this market. Chief executive Ian Dinwoodie reckons its market share is around 90%.

Licensees of Xaar’s technology are starting to attack the Chinese market. They licence the technology and develop their own print heads.

That means that, although Xaar’s overall share of the market hasn’t really changed, less print heads are being supplied directly by the company. This comes at a time when the rate of growth is slowing.

This can be seen by the fact that, although overall revenues fell 4% to £22.5m, licence fees and royalties nearly doubled to £1.56m.

Xaar hopes that introducing newer products will help it to win more business directly.

Demand has also been hit by the Sichuan earthquake and a lack of activity around the time of the Olympic Games. That had some effect on the second quarter and will continue to hamper progress in the third quarter.

The first half figures weren’t bad with Europe and the Americas trading strongly. Pre-tax profits increased from £3.12m to £3.75m. European sales rose 15% and Americas revenues grew by 26%.

Higher stock levels meant that cash generated from operations was lower in the first half of 2008 despite the profit rise. Xaar capitalised £468,000 of third party development work in the first half, compared with £1.08m in the first half of 2007.

A maiden interim dividend of 1p a share was declared. Last year’s final dividend was 2.5p a share.

Xaar has an up and down record but it has always managed to sort out its problems and prosper over the long-term. The high rating of the shares does mean that any disappointment can cause a sharp fall in the share price.

Full year profits are expected to fall from £7.3m to £6.4m yet the year end net cash position is still forecast to improve from £12.4m to £15.2m.

It is right for management to be cautious about the second half and next year. Europe and the Americas have been growing strongly and there are no signs that this is changing, yet. However, the printing sector is tough at the moment and this is likely to show through in capital spending.

Xaar is becoming less reliant on the original printing sector customer base. Packaging and industrial accounted for nearly one-third of first half revenues. Flat panel displays, digital label printing and franking are newer uses of the technology. Future users could include fuel cell manufacturers.

This diversification of revenues will, hopefully, help to make Xaar’s results less volatile. However, in a business like this where the technology is always evolving there is likely to be slips along the way.

What Xaar has in its favour is a strong balance sheet and cash generative business. Many medium-sized technology businesses don’t have that luxury because they are still struggling to consistently make money.

The shares have nearly halved in recent weeks and fell a further 14.5p to 107p following the interim results. That puts the shares on less than 15 times prospective earnings for 2008.

One-fifth of Xaar’s market value is covered by cash. The fall in the share price could make Danaher, which was interested in bidding 200p-220p a share in 2006-07, reconsider its position. It may also attract other bidders.

Xaar’s newer technologies are helping it move into additional markets and their potential has hardly been tapped. The longer-term outlook for the business is positive.

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