NetSol Technologies, Inc. — Fiscal Q1 2019 Form 10-Q
Reporting period: Three months ended September 30, 2019, compared with the three months ended September 30, 2018. The interim financial statements are unaudited. NetSol provides enterprise software, licensing, maintenance, implementation, consulting, IT, business-process outsourcing, and internet services primarily to the automobile financing and leasing, banking, and financial-services industries.
Financial Performance and Position
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Total revenue | $13.57 million | $16.40 million | Down $2.82 million |
| Gross profit | $6.11 million | $8.24 million | Down $2.13 million |
| Gross margin | 45.0% | 50.2% | Down 5.2 percentage points |
| Operating income (loss) | $(0.43) million | $1.60 million | Decline of $2.03 million |
| Net income (loss) | $(2.26) million | $1.28 million | Decline of $3.54 million |
| Net income (loss) attributable to NetSol | $(1.83) million | $0.96 million | Decline of $2.79 million |
| Basic and diluted EPS | $(0.16) | $0.08 | Declined $0.24 |
| Adjusted EBITDA, net | $(1.08) million | $2.20 million | Decline of $3.28 million |
| Operating cash flow | $0.27 million | $(0.34) million | Improved $0.61 million |
- Revenue mix shifted materially: license fees fell to $2.68 million from $5.96 million, while maintenance increased to $4.39 million from $3.74 million and services were broadly stable at $6.42 million.
- Operating expenses were $6.54 million, or 48.2% of revenue, compared with $6.64 million, or 40.5%, in the prior-year quarter. Research and development increased to $0.67 million from $0.32 million.
- A $1.76 million foreign-currency transaction loss, compared with a $0.01 million gain in the prior-year quarter, was the principal driver of the consolidated loss.
- Cash and cash equivalents were $17.62 million at September 30, 2019, versus $17.37 million at June 30, 2019. Approximately $16.70 million was held by foreign subsidiaries and was uninsured.
- Current assets were $52.76 million and current liabilities were $19.91 million, implying reported working capital of approximately $32.85 million.
- Total debt and finance-lease obligations were $7.59 million, including $7.10 million current and $0.49 million long term. Operating lease liabilities totaled $2.83 million following adoption of the new lease standard.
- Capital expenditures were $0.32 million. Investing cash use was $0.76 million, including a $0.44 million investment in a related-party convertible note receivable.
Material Changes Versus the Prior Comparable Period
- Reported revenue declined 17.2%, driven primarily by lower license revenue and unfavorable foreign-currency translation. Management estimated a $0.31 million constant-currency revenue decline versus a $2.51 million currency-related decline.
- Asia-Pacific revenue declined to $10.00 million from $13.63 million and represented 73.7% of consolidated revenue. Europe revenue increased to $2.59 million from $1.92 million, while North America increased to $0.98 million from $0.84 million.
- The gross margin contracted because cost of revenues increased to 55.0% of revenue from 49.8%; management cited salary increases and unfavorable revenue mix.
- The company moved from operating income to an operating loss and from attributable net income to an attributable net loss. The loss was amplified by the foreign-exchange loss and a $0.19 million share of equity-method investment losses.
- Accounts receivable plus revenues in excess of billings decreased to $28.95 million from $31.71 million at June 30, 2019, but average days sales outstanding increased to 205 days from 156 days.
- Net translation adjustment was a gain of $0.90 million, compared with a loss of $0.26 million in the prior-year quarter; accumulated other comprehensive translation loss remained substantial at $32.22 million.
Outlook, Commentary, Risks, and Unusual Items
- Management stated that its outlook remained optimistic and highlighted customer deployments of NFS Ascent, progress on cloud implementations, approximately $1 million of change-request revenue, and a new European statement of work expected to generate more than $250,000.
- Management identified potential growth from NFS Ascent, SaaS offerings, existing customer upgrades, emerging markets, and Latin America. It also cited risks from geopolitical instability, Pakistan-India tensions, Brexit, the China-U.S. trade dispute, recession concerns, terrorism, and potential disruption to global automobile demand.
- The company expects approximately $2.5 million of capital expenditures over the next 12 months for business development and infrastructure, to be funded from current operations.
- NetSol adopted ASC 842, Leases, on July 1, 2019. The adoption recorded approximately $3.01 million of right-of-use assets and $3.09 million of lease liabilities and did not materially affect earnings or cash flows.
- Contracted but unsatisfied performance obligations were approximately $69.20 million at September 30, 2019; management estimated recognition of approximately $14.54 million during the next 12 months and the remainder over approximately five years.
- Two customers generated 37.1% and 7.0% of quarterly revenue, respectively, creating significant customer-concentration risk. The comparable prior-year figures were 28.8% and 29.6%.
- The company reported compliance with applicable borrowing covenants and no defaults. Borrowing maturities could accelerate upon covenant violations or certain changes in control.
- The filing reports no legal proceedings, risk-factor updates, defaults, or material weaknesses in internal control as of September 30, 2019. Management stated that disclosure controls were effective.
Investor Verification Checklist
- Verify whether the substantial license-revenue decline is timing-related or indicates a lasting shift toward lower-margin maintenance and services revenue.
- Monitor foreign-exchange exposure, particularly the Pakistani rupee, and its effect on earnings, cash conversion, and reported revenue.
- Assess collection of the $28.95 million combined accounts-receivable and unbilled-revenue balance and the elevated 205-day sales outstanding.
- Review the concentration and collectability of revenue and contract assets associated with the two largest customers.
- Evaluate the recoverability and terms of the $4.09 million related-party convertible note receivable and the company’s equity-method investments.
- Confirm that operating cash flow can fund the planned $2.5 million of capital expenditures while servicing current debt and lease obligations.
- Track execution of NFS Ascent deployments, cloud and SaaS initiatives, and the reported European and customer change-request opportunities.