NetSol Technologies, Inc. — Form 10-Q Summary
Reporting period: Quarterly period ended December 31, 2013; fiscal-year-to-date results cover the six months ended December 31, 2013. The interim financial statements are unaudited. NetSol develops and markets enterprise software, primarily for automobile finance, leasing, banking, healthcare and financial-services customers, and provides implementation, consulting, systems-integration and managed services.
Financial Results and Position
| Metric | Three months ended Dec. 31, 2013 | Three months ended Dec. 31, 2012 | Six months ended Dec. 31, 2013 | Six months ended Dec. 31, 2012 |
|---|---|---|---|---|
| Revenue | $8.71 million | $11.81 million | $17.77 million | $22.88 million |
| Gross profit | $2.74 million | $6.73 million | $6.14 million | $12.04 million |
| Gross margin | 31.47% | 56.96% | 34.55% | 52.63% |
| Operating income (loss) | $(1.60) million | $2.92 million | $(3.13) million | $4.42 million |
| Net income (loss) attributable to NetSol | $(1.63) million | $2.22 million | $(2.72) million | $3.15 million |
| Basic EPS | $(0.18) | $0.28 | $(0.30) | $0.41 |
| Cash flow from operations | Not separately provided | Not separately provided | $12.66 million | $9.43 million |
Revenue declined 26.25% year over year in the quarter and 22.35% for the six-month period. Quarterly license revenue fell to $455,616 from $3.51 million, while maintenance revenue increased to $2.87 million from $2.66 million and services revenue declined to $5.39 million from $5.64 million.
For the six months, license revenue was $2.71 million versus $6.75 million, maintenance revenue was $5.25 million versus $4.71 million, and services revenue was $9.81 million versus $11.42 million. Asia-Pacific remained the largest region, contributing $12.77 million, or 71.87%, of six-month revenue.
Quarterly EBITDA, a non-GAAP measure disclosed by management, was $79,129, or 1.46% of revenue, compared with $3.73 million, or 31.56%, in the prior-year quarter. Six-month EBITDA was $502,794, or 3.10% of revenue, compared with $6.24 million, or 27.26%.
Liquidity, Cash Flow and Debt
- Cash and cash equivalents were $11.58 million at December 31, 2013, up from $7.87 million at June 30, 2013. Restricted cash was $2.54 million.
- Current assets were $39.28 million and current liabilities were $16.05 million, implying reported current assets substantially exceeded current liabilities.
- Accounts receivable were $16.68 million, and revenues in excess of billings were $6.27 million.
- Operating cash flow of $12.66 million was offset partly by $8.31 million of investing cash outflows, including $6.06 million of property and equipment purchases and $2.31 million of additions to intangible assets.
- Total loans and capitalized lease obligations were $7.14 million, consisting of $5.54 million current and $1.60 million long term, compared with $6.72 million at June 30, 2013.
- Management stated that the company was in compliance with borrowing covenants and expected to repay obligations from internal sources. It anticipated $2.5 million to $3.5 million of working-capital needs over the next 12 months for business development and infrastructure.
Material Changes Versus the Prior Comparable Period
- The launch of the next-generation NFS Ascent platform delayed certain legacy-product transactions as customers evaluated the new platform. Management expected legacy license sales to remain under pressure for at least two to three quarters until NFS Ascent revenue recognition began.
- Gross margin contracted sharply because revenue declined while delivery salaries, consultants and depreciation and amortization remained elevated. Quarterly cost of revenues rose to 68.53% of revenue from 43.04%.
- Operating expenses increased 14.13% in the quarter and 21.59% for the six months, driven principally by higher salaries, general and administrative costs, and depreciation and amortization.
- Interest expense decreased to $45,036 in the quarter and $114,253 for the six months, primarily because convertible notes had been converted into equity.
- Foreign-currency gains were $96,039 for the quarter and $1.21 million for the six months; translation losses recorded in other comprehensive loss were $2.58 million for the six months.
- Property and equipment increased to $23.58 million from $20.98 million, while intangible assets were $29.18 million. Goodwill remained $9.65 million, with no impairment recorded.
- Shares outstanding increased during the period through employee, director and consultant compensation, related-party settlement and option or warrant exercises. The company reported 9,085,299 common shares outstanding as of February 12, 2014.
Guidance, Outlook, Risks and Unusual Items
Management described its outlook as optimistic and cited implementation wins, NFS Ascent development, mobility products, expansion in China and other markets, and new European business-process-outsourcing opportunities. Its three-to-five-year strategy targeted double-digit annual revenue growth, gross margins of 50% to 55% in 2015, and margins of at least 60% for the following three years. These are management targets rather than guarantees.
The company planned to expand its NFS delivery and sales organization, including hiring and training more personnel and increasing infrastructure capacity in Lahore and Bangkok. Execution of the NFS Ascent transition, customer adoption, sales timing and the ability to convert the pipeline into recognized revenue are material uncertainties.
- Key operating risks include geopolitical and security conditions in Pakistan and surrounding regions, strained U.S.-Pakistan relations, regulatory delays in China, increased competition and pricing pressure, constrained customer IT budgets, longer sales cycles, foreign-currency volatility and low trading volume in the company’s shares.
- Management disclosed a material weakness in internal control over financial reporting relating to insufficient technical accounting training for some accounting staff. Management expected the appointment of a new CFO with complex U.S. GAAP expertise to help remediate the weakness, but the filing states that controls were not effective as of December 31, 2013.
- The SEC was investigating matters involving director and subsidiary officer Salim Ghauri, including Section 16 reporting and securities-holdings disclosures. The company engaged outside counsel and cooperated with the investigation. Mr. Ghauri paid $33,197 of short-swing profits, including interest, under a February 2014 settlement agreement.
- The company stated that no material litigation was pending or threatened and reported no defaults under senior securities.
- The filing contains an apparent MD&A drafting inconsistency referring in one place to the quarter ending September 30, 2013, although the financial statements and most analysis address the quarter ended December 31, 2013.
Important Facts for Investors to Verify
- Whether NFS Ascent customer adoption produces the expected license revenue and reverses the temporary decline in legacy-product sales.
- Whether the company can restore gross margins while maintaining elevated staffing, infrastructure investment and development spending.
- The quality and collectability of the $16.68 million accounts receivable balance and the timing of conversion of $6.27 million of revenues in excess of billings into billed receivables.
- Cash availability after restricted cash, capital expenditures, debt maturities and anticipated $2.5 million to $3.5 million working-capital requirements.
- Remediation and independent validation of the disclosed material weakness in internal controls.
- The status and potential financial, governance or disclosure consequences of the SEC investigation.
- Foreign-exchange exposure, regional concentration in Asia-Pacific, non-controlling interests and the company’s ability to comply with subsidiary-level debt covenants.