Is FreeAgent Holdings plc a hidden gem as profits fly 38%?

Software company FreeAgent Holdings(LSE: FREE) has its head in the clouds after today's interim results which showed gross profits soaring 38% to £3m, up from £2.2m one year ago.

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FreeBird

The Edinburgh-based company, which has a market capitalisation of £33m and only launched on AiM last month, provides cloud-based "software-as-a-service" to small businesses.

Today's six-month interims for the six months ended 30 September also showed a turbo-charged 36% rise in revenues to £3.6m, continuing its recent run of good form. FreeAgent enjoys a gross profit margin of 84%, and strengthened its balance sheet by paying down £5m of net cash immediately after its IPO, which raised £8m of new equity.

Secret Agent

Investors looking for small company growth ideas will prick up their ears at these numbers, so should you liberate a place for FreeAgent in your portfolio? The company's online accounting software is designed to demystify accounting for freelancers, small business owners and their accountants, and customer numbers are growing rapidly.

Accounting practice clients more than doubled from 12,611 to 27,137 year-on-year, with direct client numbers edging up more sedately, from 14,582 to 16,724. Its average customer has less than 10 staff, with monthly fees starting at $10.

Cloud nine

Chief executive Ed Molyneaux said the £8m proceeds raised from its placing have been used to repay the company's loan facility and significantly strengthen its balance sheet. "It provides us with the opportunity to further invest in customer acquisition activities and product development to enhance our product offering," he added.

Simply producing a tech IPO amid current UK uncertainties is impressive, especially given the recent decision by financial software developer Misys to pull out of a planned £750m IPO, blaming adverse market conditions. FreeAgent employs more than 100 full-time staff and incurred a £1.3m loss last year, although Molyneaux says it will be profitable before interest, depreciation, amortization and taxes in 2018.

Software, hard questions

FreeAgent's software allows users to automatically generate and submit self-assessment tax returns and should therefore be given a lift by HM Revenue & Customs' plans to push small businesses into managing their returns digitally and filing quarterly, rather than annually as at present. However, it operates in a crowded field where there's a host of small business accounting tools, including ClearBooks, Kashflow, Kashoo, and LessAccounting to name but a few, so it doesn't exactly have the field to itself.

There's an ongoing surge in self-employment and small business growth in the UK, and this could prove a lucrative growth zone. This fledgling company is undoubtedly at the higher end of the risk scale but could be a flier for braver investors. Molyneaux spent 11 years in the Royal Air Force, including two tours of duty as a Harrier pilot, but he seems to have his feet on the ground.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.