NetSol Technologies, Inc. — Form 10-Q Summary
Business Context and Reporting Period
NetSol provides software, implementation, consulting, maintenance, and IT services primarily to the automobile financing, leasing, banking, and financial-services industries. The filing covers the unaudited three months ended September 30, 2017, the first quarter of fiscal 2018, compared with the restated three months ended September 30, 2016.
Operations are reported across North America, Europe, and Asia-Pacific, with Asia-Pacific contributing 77.4% of consolidated revenue in the current quarter. The company had 11,333,129 shares issued and 11,186,570 shares outstanding at September 30, 2017.
Key Financial Metrics
| Metric | Q1 FY2018 | Q1 FY2017 Restated | Change |
|---|---|---|---|
| Total revenue | $12.82 million | $17.08 million | Down 24.9% |
| Gross profit | $4.81 million | $8.17 million | Down 41.1% |
| Gross margin | 37.5% | 47.8% | Down 10.3 percentage points |
| Operating income (loss) | $(1.12) million | $0.84 million | Declined $1.96 million |
| Operating margin | (8.7)% | 4.9% | Down 13.7 percentage points |
| Net income (loss) | $(0.18) million | $0.38 million | Turned to a loss |
| Net loss attributable to NetSol | $(0.37) million | $(0.39) million | Improved $16,613 |
| Basic and diluted loss per share | $(0.03) | $(0.04) | Improved $0.01 |
| Adjusted EBITDA, net | $0.97 million | $1.28 million | Down 24.2% |
Revenue consisted primarily of services of $7.02 million, maintenance fees of $3.47 million, and license fees of $0.33 million. Related-party revenue totaled $2.00 million, including $1.85 million of related-party services.
Net cash used in operating activities was $4.15 million, compared with $0.22 million in the prior-year quarter. Cash used in investing activities was $0.71 million, including a $0.50 million investment in a related-party convertible note and $0.33 million of capital expenditures. Cash used in financing activities was $0.49 million, including $0.50 million of treasury-stock purchases and $0.15 million of net debt and capital-lease payments.
Cash and cash equivalents were $8.55 million at September 30, 2017, down from $14.17 million at June 30, 2017. Current assets were $44.46 million versus current liabilities of $20.88 million. Accounts receivable and revenues in excess of billings totaled $37.49 million, and reported days sales outstanding increased to 251 days from 145 days in the comparable prior-year quarter.
Total debt and capital-lease obligations were $10.32 million, consisting of $10.02 million current and $0.31 million long term. Management stated that the company and its subsidiaries were in compliance with applicable financial covenants.
Material Changes Versus the Prior Comparable Period
- Revenue declined primarily because license revenue from the 12-country NFS Ascent contract fell to $0.33 million from $5.45 million. Services revenue increased $1.46 million, partially offsetting the decline.
- Gross margin decreased to 37.5% from 47.8%, as cost of revenues declined less rapidly than revenue. Management cited a higher cost-of-sales ratio despite reductions in salaries, consultants, travel, and amortization.
- Operating expenses decreased 19.0% to $5.93 million, reflecting lower selling and marketing costs, general and administrative expenses, salaries, professional services, and staffing levels. However, operating expenses increased as a percentage of revenue.
- A $1.02 million foreign-currency gain in the current quarter compared with a $0.41 million loss in the prior-year quarter substantially improved other income, but did not offset the operating loss.
- Operating cash flow deteriorated primarily because of increases in accounts receivable and revenues in excess of billings. The combined balance increased $4.88 million from June 30, 2017.
- The prior-year comparison has been restated for revenue-recognition errors related primarily to the NFS Ascent contract and maintenance fees. Restated Q1 FY2017 revenue increased by $2.07 million, including $1.95 million of license revenue and $0.12 million of maintenance revenue.
- The company repurchased 111,780 shares during the quarter at an average price of $4.48 per share under a program authorizing repurchases of up to 1,000,000 shares through December 15, 2017.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
Management did not provide formal quantitative revenue or earnings guidance. It described the outlook as optimistic and expects growth from NFS Ascent, legacy NFS products, customization requests, new implementations, and activity in emerging markets.
- The company amended its 12-country NFS Ascent contract, securing approximately €7.7 million, or approximately $9.06 million, of additional future revenue to be recognized over the contract term as support services are performed.
- Management expects maintenance revenue to gradually increase as legacy and NFS Ascent implementations go live, although some legacy maintenance agreements were not renewed during the quarter.
- The company anticipates approximately $2 million of capital requirements over the next 12 months for business development and infrastructure enhancements, expected to be funded from current operations.
- Liquidity risk increased because of negative operating cash flow, high days sales outstanding, and substantial unbilled revenue. Approximately $6.77 million of cash was held by foreign subsidiaries and is intended to remain permanently reinvested outside the United States.
- Foreign-exchange exposure is significant because the company operates in multiple currencies. The quarter included a $0.59 million translation loss attributable to NetSol and a $1.02 million transactional foreign-currency gain.
- The company disclosed a material weakness in internal control over financial reporting related to insufficient qualified internal-audit resources for documenting and testing legacy accounting systems and corporate functions. Management is implementing a global ERP system and using an internal-audit consulting firm, with ERP completion expected by June 30, 2018.
- VLS is defending a Conister Bank lawsuit alleging contractual defaults and damages exceeding £200,000, approximately $266,667. VLS denies the claims, and litigation expenses are covered by available insurance.
- The company loaned an additional $50,000 to related party WRLD3D after September 30, 2017. The related-party convertible note balance at quarter-end was $0.70 million and bears interest at 5%.
- Revenue and contract accounting involve significant estimates, including percentage-of-completion judgments, contract costs, collectability, and the valuation of long-term revenues in excess of billings.
Important Facts for Investors to Verify
- Whether the NFS Ascent contract produces the expected implementation, license, maintenance, and services revenue and cash collections.
- The aging, collectability, and eventual billing or conversion to accounts receivable of the $27.41 million of revenues in excess of billings.
- Whether operating cash flow improves from the reported $(4.15) million outflow and whether days sales outstanding declines from 251 days.
- The company’s ability to fund approximately $2 million of planned capital expenditures while meeting current debt and lease obligations.
- Progress in remediating the material weakness in internal controls and completing the global ERP implementation.
- Exposure to customer concentration, particularly Daimler Financial Services, which represented approximately 33.0% of current-quarter revenue, and 1insurer, which represented approximately 8.8%.
- The outcome and potential financial exposure from the Conister Bank litigation and the recoverability of WRLD3D-related investments and receivables.
- The sustainability of reported profitability measures, including adjusted EBITDA, given the decline in revenue, margin compression, foreign-currency gains, and exclusion of stock-based compensation.