Business Context and Reporting Period
NetSol Technologies, Inc. designs, develops, markets and exports enterprise software and provides systems integration, consulting, implementation and IT services, primarily for automotive finance and leasing, banking, healthcare and financial-services customers worldwide. Its principal product is the NetSol Financial Suite, supplemented by managed services and Vroozi’s smartOCI e-procurement technology.
This unaudited Form 10-Q covers the quarter and six months ended December 31, 2011, the second quarter of fiscal 2012. Comparative periods are the quarter and six months ended December 31, 2010. The company reported 56,948,855 common shares outstanding at December 31, 2011 and 57,226,355 shares outstanding as of January 31, 2012.
Financial Highlights
| Metric | Three months ended Dec. 31, 2011 | Three months ended Dec. 31, 2010 | Six months ended Dec. 31, 2011 | Six months ended Dec. 31, 2010 |
|---|---|---|---|---|
| Revenue | $8.606 million | $10.425 million | $14.835 million | $18.828 million |
| Gross profit | $4.702 million | $6.929 million | $6.846 million | $12.151 million |
| Gross margin | 54.64% | 66.46% | 46.15% | 64.54% |
| Operating income | $1.217 million | $3.896 million | $0.390 million | $5.922 million |
| Net income attributable to NetSol | $0.320 million | $1.936 million | $(1.139) million | $3.503 million |
| Basic and diluted EPS | $0.01 | $0.04 | $(0.02) | $0.08 |
| Net EBITDA | $1.580 million | $3.168 million | $1.354 million | $5.872 million |
| EBITDA margin | 18.36% | 30.38% | 9.13% | 31.19% |
Six-month revenue consisted of license fees of $3.124 million, maintenance fees of $4.158 million and services revenue of $7.553 million. Asia-Pacific generated $10.579 million, or 71.31%, of consolidated revenue; Europe generated $2.506 million and North America generated $1.749 million.
For the six months, net cash provided by operating activities was $3.957 million, compared with $5.307 million in the prior-year period. Investing activities used $6.845 million, including $2.832 million for property and equipment, $3.713 million for intangible assets and $0.253 million for the UK acquisition. Financing activities provided $3.349 million.
Cash and cash equivalents were $4.723 million at December 31, 2011, compared with $5.856 million at December 31, 2010 and $4.173 million at June 30, 2011. Restricted cash was $2.704 million. Accounts receivable were $12.210 million, with reported days sales outstanding of 151 days versus 144 days in the prior-year period.
Total assets were $85.978 million and total liabilities were $20.775 million at December 31, 2011. Reported debt components included $6.457 million of loans and capitalized lease obligations, $2.217 million of bank loans and $3.640 million of long-term convertible notes. The company stated that it was in compliance with applicable debt covenants and that no borrowing defaults existed.
Material Changes Versus the Prior Comparable Period
- Six-month revenue declined 21.21%, primarily because license revenue fell 52.72% to $3.124 million and services revenue fell 11.43% to $7.553 million. Management attributed delays in new contracts to geopolitical conditions, including U.S.-Pakistan tensions and broader South Asian uncertainty.
- Six-month gross margin fell to 46.15% from 64.54%, as revenue declined while delivery salaries, consultants and depreciation and amortization increased.
- Six-month operating income fell to $0.390 million from $5.922 million, and NetSol reported a six-month loss attributable to NetSol of $1.139 million versus income of $3.503 million.
- Quarterly revenue declined 17.45%, while quarterly gross margin decreased to 54.64% from 66.46% and quarterly NetSol-attributable income declined 83.49% to $0.320 million.
- Foreign-currency results shifted from a $0.673 million gain in the prior-year six-month period to a $0.039 million gain in the current period. The quarter included a $0.160 million gain versus a $0.401 million loss in the prior-year quarter.
- On October 4, 2011, the company acquired a 51% controlling interest in Virtual Lease Services Holdings Limited, which acquired Virtual Lease Services Limited in the United Kingdom, for $1.009 million in cash. The transaction generated $0.214 million of goodwill and added $0.248 million of customer-list assets and $0.243 million of technology assets.
- The company issued $4.0 million of two-year convertible notes in September 2011, convertible initially at $0.895 per share, together with warrants for 1,408,451 shares. The proceeds were used in part to retire the remaining 2008 convertible notes.
- The company authorized a six-month repurchase program for up to 2.5 million shares and repurchased 44,300 shares for $19,417 through December 31, 2011.
Guidance, Outlook, Risks and Unusual Items
Management described its outlook as optimistic but stated that near-term performance depends on restoring revenue growth, improving profitability, securing capital for expansion and strengthening North American and other regional operations. Its three-to-five-year plan anticipates a return to annual top-line growth, double-digit growth from 2013 onward, improved net margins and continued investment in next-generation NFS solutions, SaaS, e-commerce and strategic acquisitions. These statements are management objectives rather than firm financial guidance.
Management expects working-capital needs of approximately $5.0 million to $7.0 million over the next 12 months for business development and infrastructure enhancements. It identified the company’s weak cash position as a major constraint on winning larger projects and stated that additional capital could be obtained through operating cash flow, option exercises, debt, private equity offerings or a public offering. The filing does not provide a committed financing source.
- NASDAQ notified the company of noncompliance with the minimum bid-price requirement under Listing Rule 5550(a)(2). The company had a 180-day grace period beginning September 2, 2011, but stated that delisting remained possible if compliance was not restored.
- Management disclosed a material weakness in internal control over financial reporting because accounting personnel lacked sufficient technical expertise in complex U.S. GAAP matters. Disclosure controls and procedures were deemed ineffective as of December 31, 2011. Proposed remediation included hiring a U.S.-based CPA, adding U.S. GAAP personnel and engaging a SOX 404 consultant.
- Customer purchasing and payment decisions may be affected by the sluggish North American and European economies, the Japanese earthquake and tsunami, geopolitical unrest, Pakistan-related risks, tighter IT budgets and longer collection cycles.
- The company is exposed to foreign-currency movements across Pakistan, the United Kingdom, Europe, Thailand, Australia and other regions. Accumulated translation losses were $9.965 million at December 31, 2011.
- Non-controlling interests reduced six-month net income attributable to NetSol by $0.964 million. The company also recorded $0.100 million of equity-method investment loss, $0.074 million of beneficial-conversion-feature expense and $0.419 million of interest expense during the six months.
- The financial statements are unaudited, and management cautioned that interim results are not necessarily indicative of annual results.
Facts Investors Should Verify
- Whether delayed license and services contracts convert into revenue and whether the company can restore gross margins toward management’s stated historical target above 60%.
- Whether the company can fund the stated $5.0 million to $7.0 million working-capital requirement without materially increasing leverage or diluting shareholders.
- The repayment, conversion and potential dilution terms of the $4.0 million 2011 convertible notes and the associated 1,408,451 warrants.
- Whether the company regains and maintains NASDAQ’s minimum bid-price compliance.
- Progress in remediating the material weakness in U.S. GAAP and financial-reporting controls.
- Accounts-receivable collections, including the 151-day DSO, and the adequacy of bad-debt reserves.
- Operating performance and integration costs associated with the 51%-owned VLS acquisition, including the effect of non-controlling interests.