NetSol Technologies, Inc. — Form 10-Q Summary
Reporting period: Three and six months ended December 31, 2017; fiscal year ending June 30. The interim financial statements are unaudited. NetSol provides enterprise software, licensing, maintenance, implementation, consulting, and IT services primarily to the global automobile financing and leasing, banking, and financial-services industries. Operations are reported across North America, Europe, and Asia-Pacific.
Financial Performance and Position
| Metric | Three months ended December 31, 2017 | Three months ended December 31, 2016 | Six months ended December 31, 2017 | Six months ended December 31, 2016 |
|---|---|---|---|---|
| Net revenues | $14.45 million | $15.86 million | $27.27 million | $32.94 million |
| Gross profit | $6.69 million | $6.66 million | $11.50 million | $14.83 million |
| Gross margin | 46.30% | 41.98% | 42.18% | 45.02% |
| Operating income (loss) | $0.32 million | $(0.35) million | $(0.80) million | $0.49 million |
| Net income (loss) attributable to NetSol | $0.63 million | $(2.17) million | $0.26 million | $(2.55) million |
| Basic and diluted EPS | $0.06 | $(0.20) | $0.02 | $(0.24) |
- Revenue mix: Six-month revenue consisted principally of services of $16.10 million, maintenance fees of $7.04 million, and license fees of $0.56 million. Asia-Pacific represented 76.94% of six-month revenue.
- Cash flow: Net cash used in operating activities was $2.05 million for the six months, compared with $0.07 million of cash provided in the prior-year period. Investing cash outflow was $0.90 million and financing cash outflow was $0.45 million.
- Liquidity: Cash and cash equivalents were $10.00 million at December 31, 2017, down from $14.17 million at June 30, 2017. Current assets were $51.46 million versus current liabilities of $27.86 million.
- Working capital: Accounts receivable totaled $21.69 million, and revenues in excess of billings totaled $22.87 million, including $6.67 million classified as long term. Combined accounts receivable and unbilled revenue increased to $44.56 million from $32.61 million at June 30, 2017. Reported average days sales outstanding increased to 260 days from 145 days.
- Debt: Loans and capitalized lease obligations totaled $10.38 million, including $10.13 million current and $0.25 million long term. Borrowings are primarily at subsidiaries in Pakistan and the United Kingdom. Management reported compliance with all financial covenants.
- Adjusted EBITDA: Net adjusted EBITDA, a non-GAAP measure, was $2.09 million for the quarter and $3.06 million for the six months, compared with $(0.30) million and $1.00 million, respectively, in the restated prior-year periods.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue declined 8.9%, while six-month revenue declined 17.2%, principally because license revenue from the 12-country NFS Ascent contract was recognized at a lower level. Services revenue increased 37.3% for the quarter and 32.3% for the six months.
- Quarterly gross margin improved to 46.30% from 41.98%, reflecting lower cost of revenues and technical workforce reductions. Six-month gross margin declined to 42.18% from 45.02% because revenue declined more rapidly than costs.
- Quarterly operating results improved to income of $0.32 million from a loss of $0.35 million. Six-month operating results deteriorated to a loss of $0.80 million from income of $0.49 million.
- Net income attributable to NetSol improved in both periods, primarily because of foreign-exchange gains. The company recorded foreign-exchange gains of $1.74 million for the quarter and $2.75 million for the six months, compared with prior-year losses of $0.62 million and $1.04 million.
- Operating expenses declined 9.1% for the quarter and 14.2% for the six months, mainly from lower selling and marketing costs, staffing reductions, and lower depreciation and amortization.
- Prior-year comparative amounts were restated for revenue-recognition errors involving the NFS Ascent contract and maintenance revenue. The restatement reduced reported six-month 2016 revenue by $0.30 million and changed six-month 2016 net loss attributable to NetSol to $2.55 million.
Guidance, Outlook, Risks, and Unusual Items
- Management described the outlook as optimistic and expects maintenance revenue to gradually increase as legacy and NFS Ascent implementations go live. It also expects continued services demand from implementations, customization, and change requests.
- The company amended its Daimler Financial Services agreement to secure approximately €7.7 million, or approximately $9.3 million, of additional future revenue over the remaining contract term. Approximately €7.0 million was expected to be paid in the current fiscal year, with the remainder payable over subsequent years.
- Management expects approximately $2 million of capital expenditures and business-development spending during the next 12 months, to be funded from current operations.
- Daimler Financial Services represented approximately 35.90% of six-month revenue, and related accounts receivable were $12.76 million. The contract permits withdrawal from certain modules or countries under specified conditions.
- Foreign-exchange results were unusually significant. The reported gains primarily reflected the decline of the Pakistani rupee against the U.S. dollar and euro and may not recur.
- The company held approximately $8.46 million of foreign cash deposits that were uninsured as of December 31, 2017. Foreign operations expose the company to political, economic, legal, currency, and repatriation risks.
- The company recorded a $0.27 million claim against subsidiary Virtual Lease Services relating to alleged contractual defaults. VLS denies the claims and intends to defend the action; related expenses were covered by available insurance.
- Management concluded that disclosure controls and procedures were ineffective because of a material weakness involving insufficient qualified internal-audit resources for documenting and testing legacy accounting systems and corporate functions. Remediation includes implementation of a global ERP system and use of an internal-audit consulting firm.
- The company issued a $0.75 million, 5% convertible note to related party WRLD3D, with principal and accrued interest payable upon request on or after February 1, 2018, subject to conversion provisions.
- The Tax Cuts and Jobs Act created provisional tax effects, including a potential one-time repatriation tax on approximately $22.8 million of undistributed foreign earnings. Management expected to offset the amount with net operating loss carryforwards but had not finalized the accounting.
Key Facts for Investors to Verify
- Whether the Daimler contract amendment converts the substantial unbilled and receivable balances into cash as expected, including the reported $4.22 million collection in January 2018.
- The sustainability of profitability excluding the $1.74 million quarterly and $2.75 million six-month foreign-exchange gains.
- Progress in remediating the material weakness and completing the global ERP implementation by June 30, 2018.
- Customer concentration, contract termination rights, and the timing of license, implementation, and maintenance revenue under the Daimler arrangement.
- Collection risk associated with the 260-day average sales outstanding and $44.56 million combined receivable and unbilled-revenue balance.
- Availability and repatriation of foreign cash, compliance with subsidiary debt covenants, and the ability to fund approximately $2 million of planned capital and business-development spending from operations.
- Final accounting for the Tax Cuts and Jobs Act, future accounting-standard adoptions, and the outcome of the Conister Bank litigation.