NETSOL TECHNOLOGIES INC quarterly report, Q3 FY2018

NetSol Technologies, Inc. — Form 10-Q Summary

Reporting period: Fiscal quarter and nine months ended March 31, 2018, filed May 14, 2018. The filing is unaudited. Although the request identifies “2017 Q3,” the filing covers the third quarter of fiscal 2018. NetSol provides software licenses, maintenance, implementation, consulting, and IT services for automobile finance, leasing, banking, and financial-services customers worldwide.

Financial highlights

Metric	Three months ended March 31, 2018	Three months ended March 31, 2017	Nine months ended March 31, 2018	Nine months ended March 31, 2017
Revenue	$17.0 million	$17.9 million	$44.3 million	$50.9 million
Gross profit	$9.2 million	$9.0 million	$20.7 million	$23.8 million
Gross margin	53.94%	50.12%	46.70%	46.82%
Income from operations	$2.8 million	$1.8 million	$2.0 million	$2.3 million
Net income attributable to NetSol	$2.9 million	$0.7 million	$3.1 million	$(1.9) million
Basic diluted EPS	$0.26 / $0.25	$0.06 / $0.06	$0.28 / $0.28	$(0.17) / $(0.17)
Adjusted EBITDA, net	$4.3 million	$2.0 million	$7.4 million	$3.0 million

Revenue mix and profitability

Quarterly revenue declined 5.0%, while nine-month revenue declined 12.9% year over year.
Quarterly license revenue fell to $2.6 million from $5.7 million, primarily because less revenue was recognized from the 12-country NFS Ascent contract. This was partly offset by approximately $1.4 million of legacy-product licenses and $1.2 million of mobility-product licenses.
Quarterly services revenue increased 40.1% to $9.3 million, supported by new implementations and customer change requests. Maintenance revenue increased modestly to $3.7 million.
Nine-month services revenue increased 35.1% to $25.5 million, but the improvement did not offset the $11.7 million decline in license revenue and the $1.6 million decline in related-party services revenue.
Quarterly operating margin improved to 16.15% from 10.25%, reflecting lower cost of revenues and operating expenses. Nine-month operating margin decreased slightly to 4.41% from 4.58%.
Net income benefited materially from foreign-currency gains of $2.6 million in the quarter and $5.3 million year to date, compared with $0.4 million of gains and a $0.6 million loss, respectively, in the prior-year periods.

Cash flow, liquidity, and debt

Cash and cash equivalents were $12.7 million at March 31, 2018, compared with $14.2 million at June 30, 2017. Approximately $11.6 million was held by foreign subsidiaries.
Current assets were $58.3 million and current liabilities were $24.8 million, implying substantial reported short-term coverage; however, liquidity is concentrated outside the United States.
Net cash provided by operating activities was $2.3 million for the first nine months of fiscal 2018, compared with $2.0 million used in the prior-year period.
Accounts receivable increased to $26.3 million from $8.2 million, and total accounts receivable plus revenues in excess of billings increased to $43.5 million from $32.6 million. Average days sales outstanding increased to 274 days from 165 days.
Capital expenditures were $1.1 million. Investing cash outflows also included a $550,000 convertible note receivable and a $50,000 investment in WRLD3D.
Total loans and capital lease obligations were $9.4 million, including $9.1 million current and $0.3 million long term, compared with $10.6 million at June 30, 2017.
Management stated that subsidiaries were in compliance with financial covenants and expected to repay obligations from internal sources. Planned capital requirements for the next 12 months were approximately $2.0 million for business development and infrastructure.

Material changes versus prior comparable periods

Quarterly revenue declined despite stronger services and maintenance activity, primarily because of lower license-fee recognition.
Nine-month revenue and gross profit declined, while cost reductions limited the impact on operating income.
The company moved from a nine-month NetSol-attributable loss of $1.9 million to income of $3.1 million, largely because of foreign-exchange gains and lower operating expenses.
Foreign-currency translation losses increased substantially: the NetSol-attributable translation loss was $1.7 million for the quarter and $3.9 million year to date, compared with $0.2 million and $0.1 million, respectively, in the prior-year periods.
The company repurchased 171,074 shares for $750,714 during the nine months and had 205,853 treasury shares at March 31, 2018.
A September 2017 amendment to the Daimler Financial Services contract added approximately €7.7 million, or approximately $9.5 million, of future revenue over the remaining contract term. The contract included approximately €71.0 million of original license and maintenance fees and services billed separately.

Outlook, commentary, risks, and unusual items

Management described the outlook as optimistic and cited continued demand for NFS Ascent, NFS legacy products, mobility applications, customer upgrades, and implementation services.
Reported successes included implementations in Thailand and Korea, a major NFS Ascent release in China, a new mobility deployment agreement valued at approximately $3 million, and approximately $1 million of additional licenses purchased by a Chinese customer.
Management expects maintenance revenue to increase as additional NFS and NFS Ascent customers go live and stated that customization activity may support future revenue.
Key risks include foreign-exchange volatility, global political and security conditions, customer liquidity and delayed receivables, dependence on major customers, technology obsolescence, competition, recruitment and retention of technical personnel, and possible disruption from industry changes such as autonomous vehicles.
Daimler Financial Services represented approximately 36.65% of nine-month revenue and had accounts receivable of $17.4 million at March 31, 2018. The customer may withdraw from certain modules or terminate coverage for certain countries under specified conditions.
The company held approximately $750,000 of a related-party convertible note receivable from WRLD3D, plus related-party investment and receivable balances. The note bears interest at 5% and was payable upon request on or after February 1, 2018.
A legal proceeding involving subsidiary Virtual Lease Services was settled and dismissed on March 19, 2018, for approximately $421,000; insurance covered approximately $293,000.
Management concluded that disclosure controls and procedures were ineffective because of a material weakness involving insufficient qualified internal-audit resources for legacy accounting systems and corporate functions. Remediation included implementation of a cloud-based ERP system and engagement of an internal-audit consulting firm.
The company had not completed its assessment of certain tax effects under the Tax Cuts and Jobs Act and expected to finalize adjustments by June 30, 2018.

Most important facts for investors to verify

Whether the elevated $43.5 million combined receivable and unbilled balance, including 274 days sales outstanding, converts to cash without material collection losses or delays.
The timing and collectability of revenue from the amended Daimler contract and the customer’s rights to withdraw from modules or countries.
How much of reported earnings depends on foreign-currency gains and whether future currency movements could reverse that benefit.
Progress in remediating the material weakness in internal control over financial reporting and completion of the ERP implementation.
The recoverability and terms of the WRLD3D convertible note, related-party investment, and service-based investment arrangements.
Whether license revenue rebounds as NFS Ascent implementations progress and whether services-led growth can offset lower license recognition.
Foreign-subsidiary cash availability, potential tax or repatriation costs, debt covenant compliance, and the ability to fund approximately $2 million of planned capital needs internally.