Business Context and Reporting Period
NetSol Technologies, Inc. provides enterprise software, licensing, maintenance, implementation, consulting, business-process outsourcing and IT services primarily to the global automobile financing and leasing, banking and financial-services industries. The unaudited Form 10-Q covers the quarter and six months ended December 31, 2019, representing fiscal 2020 second-quarter and year-to-date results. The prior comparable periods ended December 31, 2018.
Key Financial Metrics
| Metric | Three Months Ended Dec. 31, 2019 | Three Months Ended Dec. 31, 2018 | Six Months Ended Dec. 31, 2019 | Six Months Ended Dec. 31, 2018 |
|---|---|---|---|---|
| Net revenue | $15.7 million | $17.0 million | $29.3 million | $33.4 million |
| Gross profit | $7.8 million | $8.9 million | $13.9 million | $17.1 million |
| Gross margin | 49.7% | 52.1% | 47.5% | 51.2% |
| Operating income | $0.7 million | $2.2 million | $0.3 million | $3.8 million |
| Net income attributable to NetSol | $0.6 million | $2.9 million | $(1.2) million | $3.8 million |
| Diluted earnings per share | $0.05 | $0.25 | $(0.11) | $0.33 |
| Adjusted EBITDA, net | $1.6 million | $4.1 million | $0.5 million | $6.3 million |
Quarterly revenue comprised $0.4 million of license fees, $5.0 million of maintenance fees, $10.3 million of services and $0.1 million of related-party services. For the six-month period, license fees were $3.1 million, maintenance fees were $9.4 million, services were $16.7 million and related-party services were $0.1 million.
For the six months ended December 31, 2019, operating cash flow was $3.8 million versus $3.2 million in the prior year. Investing cash flow used $1.3 million, including $0.8 million of capital expenditures and $0.5 million funded to a related-party convertible note. Financing activities provided $0.1 million after $1.9 million of dividends paid by subsidiaries to non-controlling interests.
Cash and cash equivalents were $22.1 million at December 31, 2019, compared with $17.4 million at June 30, 2019. Current assets were $55.2 million and current liabilities were $21.8 million, implying reported current resources substantially exceeded current obligations. Approximately $20.3 million of cash was held by foreign subsidiaries and foreign deposits were largely uninsured.
Total debt and finance-lease obligations were $9.9 million, including $9.4 million current and $0.4 million long-term. Operating lease liabilities totaled $3.1 million following adoption of the new lease standard. Total stockholders’ equity was $66.8 million.
Material Changes Versus the Prior Comparable Period
- Quarterly revenue declined 7.7%, while six-month revenue declined 12.4%, primarily because the prior-year periods included significant license revenue from large China-related NFS Ascent implementations.
- Maintenance revenue increased 35.6% for the quarter and 26.4% for the six-month period, reflecting additional customers reaching go-live status.
- Services revenue increased 23.2% for the quarter and 12.7% year to date, driven by new implementations and customer change requests.
- Gross margin declined to 49.7% from 52.1% for the quarter and to 47.5% from 51.2% year to date. Cost of revenue increased as a percentage of sales.
- Operating margin fell to 4.5% from 12.9% for the quarter and to approximately 0.9% from 11.3% year to date. General and administrative expense increased, including higher withholding taxes, travel and rent expenses.
- Six-month results were further affected by a $1.7 million foreign-currency loss, compared with a $2.5 million gain in the prior year. Quarterly foreign-currency gain was $0.1 million versus $2.5 million previously.
- The company reported a six-month net loss attributable to NetSol of $1.2 million, compared with net income of $3.8 million in the prior-year period.
- Asia-Pacific remained the dominant region, representing approximately 73.7% of consolidated revenue for both the quarter and six-month period, although its revenue declined year over year. North America and Europe increased their revenue contributions.
- NetSol adopted ASC 842, Leases, on July 1, 2019, recording approximately $3.0 million of right-of-use assets and $3.1 million of lease liabilities. Management stated that adoption did not materially affect operating results or cash flows.
Guidance, Outlook, Risks and Unusual Items
Management described its outlook as optimistic and highlighted progress with cloud-enabled NFS Ascent deployments, SaaS pricing, customer go-lives and innovation initiatives. The company signed SCI Lease Corp for a cloud-enabled NFS Ascent contract-management deployment in North America and reported major customer go-lives in China, Hong Kong, Japan and New Zealand.
Management expects maintenance revenue to increase as additional NFS and NFS Ascent customers go live. It also identified growing interest in SaaS, NFS Ascent upgrades, digital products and emerging markets. The company expects approximately $2.5 million of capital expenditures over the next 12 months for business development and infrastructure, to be funded from operations.
Key risks include foreign-currency volatility, dependence on major customers, geopolitical and economic instability, potential recessionary conditions, Brexit and U.S.-China trade uncertainty, terrorism and regional conflict, and the potential effect of the coronavirus on China-related growth and implementations. DFS and BMW represented 29.7% and 16.4%, respectively, of six-month revenue.
The company held $4.2 million of related-party convertible notes receivable from WRLD3D, including notes due on demand and notes maturing March 31, 2020. It also held a $2.4 million equity-method investment in related entities and recognized a $0.4 million share of equity-method losses for the six-month period.
Contracted but unsatisfied performance obligations were approximately $65.3 million at December 31, 2019; management expects to recognize approximately $13.5 million over the next 12 months and the remainder over an estimated five years. Revenue timing depends partly on the timing of software-module installations at customer sites.
The company reported compliance with its borrowing covenants and no defaults. Legal proceedings and risk factors were reported as none in Part II of the filing. Management concluded that disclosure controls were effective and that there was no material weakness in internal control over financial reporting.
Investor Verification Checklist
- Verify the sustainability and timing of license revenue versus recurring maintenance, services and SaaS revenue.
- Monitor gross-margin recovery and operating-expense discipline, particularly general and administrative costs.
- Assess the effect of foreign-exchange movements on NetSol PK and consolidated earnings.
- Evaluate customer concentration, especially DFS and BMW, and the timing of major Asia-Pacific implementations.
- Review collectability and timing of the $17.2 million of revenues in excess of billings and the $65.3 million of remaining performance obligations.
- Assess liquidity considering that most cash is held by foreign subsidiaries, foreign deposits are largely uninsured, and approximately $9.4 million of debt and finance-lease obligations is current.
- Track repayment or conversion of the $4.2 million WRLD3D convertible-note receivable and related-party investment performance.
- Confirm execution of management’s planned $2.5 million of capital expenditures and continued compliance with subsidiary debt covenants.