NetSol Technologies, Inc. — Form 10-Q Summary
Reporting period: The filing covers the three and nine months ended March 31, 2017, NetSol’s fiscal third quarter. The request metadata identifies “2016 Q3,” but the filing’s stated period is March 31, 2017. Financial statements are unaudited.
Business Context
NetSol provides enterprise software, licensing, maintenance, implementation, consulting, and IT services primarily to automobile financing, leasing, banking, and financial-services customers. Its principal products include NFS, NFS Ascent, NFS Mobility, LeasePak, LeaseSoft, and LoanSoft. Operations span North America, Europe, and Asia-Pacific, with Asia-Pacific representing approximately 84% of consolidated revenue in the quarter.
Key Financial Metrics
| Metric | Three months ended Mar. 31, 2017 | Three months ended Mar. 31, 2016 | Nine months ended Mar. 31, 2017 | Nine months ended Mar. 31, 2016 |
|---|---|---|---|---|
| Revenue | $17.95 million | $15.97 million | $50.88 million | $45.47 million |
| Gross profit | $9.00 million | $7.39 million | $23.82 million | $20.51 million |
| Gross margin | 50.12% | 46.29% | 46.82% | 45.11% |
| Operating income | $1.84 million | $1.24 million | $2.33 million | $3.26 million |
| Operating margin | 10.25% | 7.74% | 4.58% | 7.18% |
| Net income | $2.14 million | $1.16 million | $1.14 million | $2.70 million |
| Net income attributable to NetSol | $0.70 million | $0.85 million | $(1.85) million | $1.31 million |
| Basic EPS attributable to NetSol | $0.06 | $0.08 | $(0.17) | $0.13 |
| Adjusted EBITDA, net | $2.29 million | $2.28 million | $3.66 million | $5.50 million |
Quarterly revenue growth was driven primarily by license sales, including NFS Ascent and regional offerings. Services revenue declined, while maintenance revenue increased as additional customers went live. The quarterly results included a $390,897 foreign-currency gain; the nine-month results included a $645,886 foreign-currency loss.
Cash Flow, Liquidity, Debt, and Balance Sheet
- Cash and cash equivalents were $8.45 million at March 31, 2017, down from $11.56 million at June 30, 2016. Approximately $6.79 million was held by foreign subsidiaries and was intended to be permanently reinvested outside the United States.
- Operating cash flow was negative $2.02 million for the nine months, compared with positive $1.13 million in the prior-year period. The principal working-capital use was a $10.39 million increase in revenues in excess of billings.
- Investing cash flow was negative $2.11 million, including $1.32 million of capital expenditures and investment-related payments involving eeGeo.
- Financing cash flow was positive $1.10 million, including $1.48 million of bank-loan proceeds, $785,479 from option and warrant exercises, and a $968,657 dividend paid by a subsidiary to non-controlling interests.
- Current assets were $47.20 million versus current liabilities of $17.17 million. Accounts receivable and revenues in excess of billings totaled $35.71 million, up from $26.68 million at June 30, 2016. Reported average days sales outstanding remained 165 days.
- Total loans and capitalized-lease obligations were $6.15 million, including $5.65 million current and $0.50 million long term. The company reported compliance with its borrowing covenants and no defaults.
- Management expects approximately $3 million of capital expenditures over the next 12 months for Asia-Pacific, U.S., and European business development and infrastructure, to be funded from current operations.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue increased 12.4%, while nine-month revenue increased 11.9%. License revenue rose substantially, but services revenue declined by approximately $2.09 million in the quarter and $7.07 million for the nine-month period.
- Quarterly gross margin expanded by 383 basis points to 50.12%; nine-month gross margin improved by 171 basis points to 46.82%.
- Operating expenses increased 16.2% in the quarter and 24.6% for the nine-month period, primarily from higher selling and marketing and general and administrative costs, including hiring, compensation, commissions, travel, professional services, and stock-based compensation.
- Quarterly income attributable to NetSol decreased to $699,968 from $849,479 despite higher operating income, primarily reflecting a substantially larger allocation of income to non-controlling interests.
- Nine-month results shifted from $1.31 million of attributable net income to a $1.85 million attributable loss, reflecting higher operating expenses, foreign-exchange losses, and increased non-controlling interest.
- The company invested in eeGeo through cash payments and services. The investment balance was $2.46 million at March 31, 2017 and included a potential forfeiture risk if contracted future services are not provided.
- NetSol repurchased 7,500 shares at an average price of $5.18 under a newly authorized program allowing repurchases of up to 500,000 shares over six months.
Restatement, Controls, Outlook, and Risks
Restatement and internal controls: The company determined that previously issued quarterly financial statements for the quarters ended September 30, 2015, December 31, 2015, September 30, 2016, and December 31, 2016 should no longer be relied upon because of revenue-recognition errors. The errors involved improper timing of revenue for long-term, multi-country NFS Ascent arrangements and related maintenance revenue. Management identified a material weakness in revenue-recognition controls and concluded that disclosure controls and procedures were ineffective as of March 31, 2017.
Outlook: Management remained optimistic about continuing operations and stated that a restructuring initiated in December 2016 was expected to generate approximately $4 million of savings over the following year. Management expects maintenance revenue to increase as NFS legacy and NFS Ascent implementations go live. Reported guidance does not provide a clear revenue or earnings forecast.
Business developments: The company completed an initial NFS Ascent implementation in Australia and New Zealand, continued implementations in China, Korea, and South Africa, sold a $500,000 LeasePak license to a Korean automotive captive, and reported go-live activity in Thailand and China.
Risks and contingencies: Key risks include revenue-recognition judgments and control remediation, long collection cycles and high unbilled revenue, foreign-currency volatility, political and economic conditions in international markets, Brexit-related uncertainty, geopolitical and security risks, technology obsolescence, dependence on qualified personnel, customer implementation and acceptance risk, and potential funding constraints. A shareholder derivative settlement remained subject to final court approval; related legal fees were expected to be covered by insurers. The previously disclosed securities class-action settlement was approved and covered by insurance.
Investor Verification Checklist
- Verify the restated historical revenue, earnings, balance-sheet, and cash-flow figures before relying on prior quarterly comparisons.
- Assess management’s remediation of the material weakness in revenue recognition and the effectiveness of subsequent controls.
- Monitor the large increase in revenues in excess of billings, 165-day days sales outstanding, and conversion of reported earnings into operating cash flow.
- Evaluate the sustainability of license-driven growth versus declining services revenue and the effect of higher selling, marketing, and administrative costs.
- Review the allocation of earnings to non-controlling interests, particularly NetSol PK and NetSol Innovation.
- Confirm the status and valuation of the eeGeo investment, including required future services and potential forfeiture provisions.
- Confirm debt covenant compliance, repayment timing, foreign-subsidiary cash availability, and the funding plan for expected capital expenditures.
- Check the final status and financial impact of the shareholder derivative settlement and any related insurance coverage.