NetSol Technologies, Inc. — Q1 FY2014 Form 10-Q Summary
Business Context and Reporting Period
NetSol designs, develops, markets, and exports enterprise software and related services for the automobile finance and leasing, banking, healthcare, and financial-services industries. Its offerings include the NetSol Financial Suite, managed services, consulting, systems integration, and Vroozi procurement solutions. The filing covers the three months ended September 30, 2013, compared primarily with the three months ended September 30, 2012. The unaudited consolidated results include North America, Europe, and Asia-Pacific operations, with Asia-Pacific representing 73.2% of current-quarter revenue.
Financial Performance and Position
| Metric | Q1 FY2014 | Q1 FY2013 | Change |
|---|---|---|---|
| Revenue | $9.06 million | $11.07 million | Down 18.2% |
| Gross profit | $3.40 million | $5.32 million | Down 36.1% |
| Gross margin | 37.5% | 48.0% | Down 10.5 percentage points |
| Operating income (loss) | $(1.52) million | $1.50 million | Declined $3.02 million |
| Net income (loss) attributable to NetSol | $(1.10) million | $0.93 million | Declined $2.03 million |
| Basic and diluted EPS | $(0.12) | $0.12 | Declined $0.24 |
| Adjusted EBITDA as presented by management | $0.42 million | $2.51 million | Down 83.1% |
License revenue declined 30.5% to $2.25 million, while services revenue declined 23.5% to $4.42 million. Maintenance revenue increased 16.4% to $2.38 million. Cost of revenues fell only 1.7%, causing gross margin compression. Operating expenses increased 29.0% to $4.92 million, including higher selling and marketing costs, salaries, professional services, depreciation and amortization, and $251,673 of bad-debt expense.
A $1.11 million foreign-currency gain and lower interest expense partly offset the operating loss. The foreign-currency gain was substantially larger than the $395,156 gain in the prior-year quarter. Other comprehensive loss attributable to NetSol was $3.30 million, primarily reflecting foreign-currency translation losses; accumulated translation losses were $17.92 million at September 30, 2013.
At September 30, 2013, cash and cash equivalents were $6.76 million, compared with $7.87 million at June 30, 2013 and $8.02 million at September 30, 2012. Restricted cash was $2.30 million. Current assets were $41.87 million versus current liabilities of $14.45 million, implying a current ratio of approximately 2.9x. Accounts receivable were $18.54 million and revenues in excess of billings were $11.44 million.
Cash flow from operating activities was reported as $2.92 million in the consolidated cash-flow statement, compared with $2.90 million in the prior-year quarter. The MD&A section separately reports $2.76 million for the current quarter; investors should reconcile this inconsistency. Investing cash outflow was $3.97 million, including $2.69 million of property and equipment purchases and $1.36 million of capitalized intangible-asset additions. Financing cash inflow was $630,382.
Total debt and capital-lease obligations were approximately $6.95 million, consisting of $3.66 million of current loans and lease obligations, $1.87 million of bank loans, and $1.42 million of long-term loans and lease obligations. Management stated that the company was in compliance with its borrowing covenants and had no defaults.
Material Changes Versus the Prior Comparable Period
- Revenue fell $2.01 million, or 18.2%, primarily because legacy-product license transactions and related services were delayed during the transition to NFS Ascent.
- Asia-Pacific revenue declined 15.6% to $6.63 million, although it remained the dominant region. North America declined 28.9% and Europe declined 19.7%.
- Gross margin declined from 48.0% to 37.5%, while operating expenses increased from 34.4% to approximately 54.3% of revenue.
- The company moved from operating income of $1.50 million to an operating loss of $1.52 million and from NetSol-attributable income of $929,125 to a loss of $1.10 million.
- Interest expense declined to $69,217 from $292,389, principally because convertible notes had been converted into equity.
- Capital expenditures and capitalized development costs increased materially, reflecting investments in infrastructure and new products.
- Share-based compensation and other equity issuances continued, including options, employee shares, consultant shares, and shares to be issued for officer services.
Guidance, Outlook, Commentary, and Risks
Management described its outlook as optimistic and identified a three- to five-year growth strategy. The plan targets double-digit annual revenue growth, gross margins of 55% to 60% in 2014, and gross margins of at least 60% thereafter. Management expects to expand delivery and sales capacity from approximately 600 to more than 1,000 NFS domain experts within 18 months and reported hiring more than 100 personnel during the quarter.
Management expects legacy-product sales to remain under pressure for at least two to three quarters while NFS Ascent gains market traction. The October 24, 2013 launch of NFS Ascent is intended to support future license and services growth, but the company specifically warns that the transition may reduce near-term revenue.
The company anticipates working-capital needs of approximately $5 million to $7 million over the next 12 months for business development and infrastructure enhancements. It intends to rely primarily on internally generated cash but stated that future capital raising may be considered, with potential dilution and unfavorable pricing identified as concerns.
Principal risks include the NFS Ascent transition, delayed customer decisions, foreign-exchange volatility, geopolitical and security conditions in Pakistan and the Middle East, European economic weakness, competition and pricing pressure in China, customer receivable delays, limited trading volume in the company’s stock, and dependence on key personnel and third-party technologies.
Management concluded that disclosure controls and internal control over financial reporting were not effective as of September 30, 2013. A material weakness was identified because core accounting personnel lacked sufficient technical training in complex U.S. GAAP matters. The company appointed a new CFO on September 9, 2013 and expects this appointment to help remediate the weakness in subsequent quarters.
No material litigation was reported, no defaults upon senior securities were reported, and management identified no material recognizable subsequent events through the filing date.
Important Facts for Investors to Verify
- Reconcile the $2.92 million operating-cash-flow figure in the financial statements with the $2.76 million figure in MD&A.
- Track whether NFS Ascent produces sufficient new license revenue to offset the expected decline in legacy-product sales.
- Assess the company’s ability to restore gross margins toward its 55% to 60% target while expanding its workforce and delivery infrastructure.
- Monitor accounts receivable, revenues in excess of billings, bad-debt expense, and the conversion of unbilled amounts to cash.
- Evaluate liquidity after planned $5 million to $7 million working-capital requirements, capital expenditures, restricted cash, and debt maturities.
- Confirm remediation of the material weakness in internal control and whether disclosure controls become effective in subsequent filings.
- Review the effect of foreign-exchange movements on earnings, accumulated other comprehensive loss, and reported equity.
- Verify covenant compliance and repayment capacity for the company’s bank facilities, secured borrowings, and capital leases.