NetSol Technologies, Inc. (NTWK) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to NetSol Technologies Fiscal Third Quarter 2018 Earnings Conference Call. On the call today are Najeeb Ghauri, Chairman and Chief Executive Officer; Roger Almond, Chief Financial Officer; Naeem Ghauri, President, Global Sales; Jeff Bilbrey, President, North America; and Patti McGlasson, General Counsel. I would now like to turn the call over to Patti McGlasson, who will provide the necessary cautions regarding the forward-looking statements made by management during this call. Please proceed.

Good morning, everyone, and thank you for joining us. Following a review of the company’s business highlights and financial results, we will open up the call for questions. Please note that all of the information discussed in today’s call is covered under the safe harbor provisions of the Private Securities Litigation Reform Act. The company’s discussion may include forward-looking statements reflecting management’s current forecast of certain aspects of the company’s future, and our actual results may differ materially from those stated or implied. These forward-looking statements are qualified by the cautionary statements contained in NetSol’s press release and SEC filings, including our annual report on Form 10-K and quarterly reports on Form 10-Q. I would also like to point out that we will be discussing certain non-GAAP measures. The press release issued earlier today contains a reconciliation of these non-GAAP financial results to their most comparable GAAP measures. Finally, I would like to remind everyone that this call will be recorded and made available for replay on our website at www.netsoltech.com and via link available in today’s press release. Now I’d like to turn the call over to Najeeb. Najeeb?

Thank you, Patti, and good morning, everyone. Before the market opened today, we issued a press release announcing our results for the fiscal third quarter ended March 31, 2018 and a copy of which is available in the Investor Relations section of our website. The first third quarter – the fiscal third quarter represented yet another step in the right direction for NetSol. As we have for the past few quarters now, we improved on our bottom line results, thanks in major part to the success of our cost reduction initiative, which we recently announced in December of 2016. And while our top line in fiscal 2018 has not experienced the significant growth, we know it’s capable of – over the long term. It’s worth pointing out that since the beginning of fiscal 2015, we have actually been increasing revenues at a double-digit compounded annual growth rate in our core business. And to be sure, this does not include any M&A activities, which further highlights the strong organic growth we have generated, driven primarily by our next-generation NFS Ascent platform. As it relates to this quarter, our positive results were also generated through new wins as well as increased customization and change requests from long-standing customers. In this quarter alone, we generated close to $2 million through successful implementation of these requests, and are expecting up to 15% year-over-year growth in license and services revenue in fiscal 2018. More broadly, these change requests allow us to generate incremental revenues, while we work diligently to advance some of the most significant deals within our expanded pipeline. The increased complexity requirements from our existing customers also provides further evidence of the greater overall shift our industry is experiencing. And it’s with this shift in mind, and we’ve also recognized the need to accelerate our digital and mobility sales and marketing efforts. In other words, our mobile and digital offerings need to not only complement every new NFS Ascent contract, but also a biz ad standalone offering. Simply put, it’s apparent that innovation is not only aspirational anymore, it is required to compete effectively in our business. Now before I go any further into our operations for the quarter as well as our outlook, I’m going to turn the call over to CFO, Roger Almond, who will review our financial performance for the fiscal third quarter in more detail, and then I’ll come back in a few minutes to discuss all of these items in greater detail. Roger, please.

Thanks, Najeeb. Turning to our fiscal third quarter 2018 financial results for the period ended March 31, 2018. Our total net revenues for the third quarter were $17 million compared to $17.9 million in the prior year period. The decrease in total net revenues was primarily due to a decrease in license fees at $3.1 million, which was offset by an increase in services revenue of $2 million. Total license fees in Q3 were $2.6 million compared to $5.7 million in the prior year period. The decrease in total license fees was primarily due to the decrease in license revenue from Daimler Financial Services, offset by new license sales of approximately $1.4 million and $1.2 million for our legacy products and our mobility products, respectively. Total maintenance fees in Q3 were $3.8 million compared to $3.6 million in the prior year period. The increase in total maintenance fees was primarily due to the fluctuation and usage of active users. We anticipate maintenance fees to gradually increase as we implement both our legacy NFS product and our next-generation NFS Ascent. Total services revenue for the quarter were $10.6 million, an increase of 23% from $8.6 million in the prior year period. The increase in total services revenue for the quarter was primarily due to an increase in services revenue associated with new implementations and change requests. Total cost of revenues was $7.9 million for the third quarter, a decrease of 12% from $9 million in Q3 last year. The decrease in cost of revenues was primarily due to a decrease in salaries and consultants, travel and depreciation. Gross profit for the third quarter fiscal 2018 was $9.2 million or 54% of net revenues which is up from $9 million or 50% of net revenues in Q3 last year. The increase in gross profit and gross profit as a percentage of net revenues was primarily due to a $1.1 million decrease in cost of revenues for the quarter. Operating expenses for the third quarter decreased 10% to $6.4 million or 38% of net revenues from $7.2 million or 40% of net revenues in the same period last year. The decrease in operating expenses was primarily due to decreases in selling and marketing expenses, professional services, G&A expenses and depreciation. Moving forward, we plan on judiciously allocating additional resources to our R&D budget as we focus increasingly on our innovation-related initiatives. Net income from operations was $2.8 million for the third quarter, an increase of 50% from $1.8 million in Q3 last year. The increase in net income from operations was primarily due to a reduction in selling and marketing expenses, professional services, G&A expenses and depreciation, offset by an increase in R&D expense. Turning to our other profitability metrics. Our GAAP net income attributable to NetSol for the third quarter fiscal 2018 totaled $2.9 million or $0.25 per diluted share. This compares with net income of $700,000 or 6% per diluted share in the third quarter of fiscal 2017. It’s important to point out that included in our net income this quarter was a $2.6 million gain on foreign currency exchange transactions compared to a gain of $391,000 in Q3 of last year. The increase was primarily due to the fluctuation and foreign currency exchange transactions during the period due to the fact that NetSol PK has many of its contracts denominated in euros and U.S. dollars. As Najeeb mentioned earlier, during fiscal 2017, we implemented a cost reduction plan as well as other organizational transformation initiatives. At NetSol, we are bottom line-focused as much as we are top line growth-driven. To that end, we are pleased to have reported our second consecutive quarter of GAAP profitability, and remain focused on continuing these same results for the remainder of fiscal year 2018. As I’ve stated previously, these outcomes are predicated on the execution of new Ascent deals this fiscal year, which are currently in the negotiation phase with various new and existing customers. Moving to our non-GAAP metrics. Non-GAAP adjusted EBITDA for the third quarter fiscal 2018 totaled $4.3 million or $0.39 per diluted share compared with a non-GAAP adjusted EBITDA of $2 million or $0.18 per diluted share in the third quarter of last year. As we disclosed in our earnings release, beginning with the fourth quarter fiscal year 2016, we revised our calculation of adjusted EBITDA to exclude the portion of adjusted EBITDA that is attributable to the non-controlling interest in our subsidiaries. We believe the supplemental disclosure provides additional insights into the true operational performance of our business. Please see the reconciliation schedules contained in our earnings release for our revised calculations of adjusted EBITDA for the fiscal third quarter ended March 31, 2017 and 2018. Now turning to our balance sheet. At quarter-end, we had cash and cash equivalents of approximately $12.7 million or approximately $1.13 per diluted common share. This was up from $10 million or approximately $0.90 per diluted common share at the end of the prior quarter. Turning to our renewed stock repurchase program. On February 27, 2018, our Board of Directors approved a stock repurchase program that authorized potential repurchases of up to 500,000 shares of our common stock through June 30 of this year. Under the program, we may repurchase our common stock in the open market from time-to-time in amounts at prices and at such time we deem appropriate. Of course, these are subject to market conditions and federal and state laws governing such transactions. We expect to fund this repurchase of our common stock with existing cash on hand and cash generated from operations. During the quarter, we have repurchased 31,799 shares of our common stock at an aggregate value of $149,694. That concludes my prepared remarks. I’ll now turn the call over to Najeeb, who will provide an update on our sales progress and key initiatives as well as the outlook from our respective regions. Najeeb?

Thank you, Roger. As I alluded in my opening remarks, in Q1, we continue to improve our financial performance, leading to our second consecutive quarter of profitability as well as our second consecutive quarter of improving top line results. Most impressively, on a per share basis, we increased our net earnings by more than 300% compared to the prior year. Most of this is thanks greatly to the outperformance of our ongoing cost reduction initiatives. In fact, in the third quarter alone, we achieved another roughly $1.8 million in cost savings related to these efforts. These savings were generated through a $1 million reduction in our cost of revenues and a greater than $700,000 decrease in our operating expenses. Put together, our total cost reduction to date now amounts to $6.2 million over the course of nine months. The massive success of this program has actually led us to revise our initial estimates of total cost savings through fiscal 2018 from our previously stated $6 million to now at least $7 million in the full fiscal year. But these initiatives have not only optimized our cost structure, but also created more headroom and capability to scale our business, which we believe can support a significant more amount of revenue without requiring meaningful incremental investment to support it. In addition, we have also created greater stability in the near term as we navigate the longer sales cycle processes that inherently come with a larger potential contract opportunity that we are pursuing. And as I mentioned earlier, while we continue to manage those things that are directly within our control, we are also still running new and errands business at a promising rate. To further illustrate this point, I would now like to make – take a minute and provide some highlights from the quarter related to our key wins, deployments and overall pipeline. First, the key wins. In April, we announced the signing of a roughly $3 million contract with a top tier multi-finance company in Indonesia to implement NFS Ascent’s suite of digital applications. This company is actually part of the large financial services group based in Japan, and also an existing customer. Next, we successfully generated over $1 million from an existing capital finance company customer in China to help facilitate an increase in the size of the customer’s business. Also of note, this quarter, we signed a letter of intent with a capital finance company on the heavy industrial and agricultural equipment manufacturer in New Zealand for the implementation of its NFS Ascent retail and digital solutions. And finally, as I also mentioned briefly on our last call, one of the larger projects we’ve been pursuing out of this region is now in the final stages of commercial negotiation, and we look forward to come into terms in the not-too-distant future. Moving on to implementations and deployments. We recently kicked off an asset-backed securitization, or ABS projects, for a captive auto finance company based out of Korea, which is estimated to result in roughly $0.5 million in additional revenues. Additionally, a captive auto finance company of a leading German auto manufacturer successfully went live with our dealer touch point solution from NetSol in Malaysia this quarter. In North America, we see continued interest in our new digital and Ascent solutions with increasing sales activity and several opportunities near the end of the sales cycle. We’re also seeing a reinvigorated interest in our legacy North America platform that is now available only at a cloud SaaS solution for the SMB tier. We have converted two legacy clients on to new cloud SaaS contracts in the last year and added one client in the quarter on to the cloud SaaS platform. As a percentage of revenue, we have seen a marked increase in SaaS revenue in the North American operation, with almost 20% of all revenue being recurring and reliable SaaS income. In summary, our overall pipeline has remained strong, and we are now slowly converting some of these discussions into new and add-on business. And while many of these larger deals have required much patience, an ultimate reward will be invested pricing and in lucrative margins. Moving on, I spoke earlier about the requirement of innovation in our business. Innovation has always been at the core of what we do at NetSol, and we also believe that it is important to look at that tenant of our business in many ways. Sure, innovation can mean creating disruptive technologies that have the power to transform businesses and industries, but innovation can be represented in many different ways. We believe this focus on innovation is also applies to the people who are enacting those changes. This is why I’m very proud of our recent addition to the management team. Well, first, as you may have seen in our recently filed proxy, we are looking forward to strengthening and expanding our Board of Directors with the appointment of two professionals with relative experience in our space, Mr. Henry Tolentino and Ms. Malea Farsai. Henry brings more than 30 years of experience in the auto finance industry working with global manufacturers, such as Toyota and General Motors. As we have already seen his involvement in the advisory board, Henry has a deep global network, and has greatly helped to drive innovation, focus, efforts across our business. Maria has been with NetSol for nearly two decades, and was on the team that took the company public. Maria has served as our corporate counsel for a number of those years, and also responsible for some of NetSol’s corporate governance, SEC reporting and NASDAQ compliance. Prior to joining NetSol, Maria practiced law with the law firm of Horwitz and Beam in California, representing both domestic and international private and public companies, and also worked on the formation of business start-ups and IPOs. And although Maria is certainly not new to NetSol, she will undoubtedly bring great energy, a fresh perspective and a recipe of opinion to our corporate governance. At NetSol, our Board of Directors function as a key strategic and governing body that continually challenges our leadership team to be better and more innovative, while also playing an integral role in our governance and growth. Our second announcement is that we have hired Mr. Murad Baig as our new Global Chief Innovation Officer to lead our innovation lab initiative, which will allow us to place more emphasis on R&D initiatives and areas where we can continue to stay ahead on the technology curve. Murad joined NetSol from Deloitte in UK, where he led innovation, blockchain and disruptive technologies across some banking and security sectors. He brings a wealth of experience, passion and ability to NetSol, and we look forward to benefiting from his proven leadership and forward thinking. In his new role, Murad will work closely with our clients and partners to develop a new innovation ecosystem that will leverage emerging platforms within blockchain and artificial intelligence to consolidate and future-proof the company’s Ascent platforms, dominance and market-leading position. As I said in my opening remarks, we are entering a paradigm shift in our industry, with digital and mobile solutions being desired and required by our existing and new partners. And no other company in our industry is more well equipped than NetSol to meet these changing demands. With our leading technological offering and our leaner organization structure, we are in an ideal position – positioning to reap the rewards of our patience and planning. We have taken the necessary steps to position ourselves to add decisively when new opportunities arise, and are increasingly motivated to capitalize on the greater opportunities in front of us. And despite the extended sales cycle our industry now faces, we will continue to devote the rest of our efforts in areas where we have abilities to directly impact and control our results. The renewal of our stock repurchase program is one such example that not only reflects the sustained confidence and belief our leadership has in NetSol’s future, but also shows that our focus remains as ever on generating long-term sustainable value for our shareholders. As of our call today, I can say confidently and with great excitement that we are now coming out of our slow growth period and hitting a true inflection point. And we may still be dependent upon certain contracts that are now in deep discussions with the customers, I could not feel better about the future for our business. Our offices across the globe are singularly focused on converting our existing pipeline into meaningful growth, both on the top and bottom lines. In doing so, we believe that we will be able to unlock the extreme level of value that is currently waiting to be realized. The demand for our innovative solutions is on the rise. In the past, we have been known as a regional leader in our various markets, but our goal is to one day become a global leading information technology company in our sector. And with that, I’d like to open the call for questions. Operator?

Thank you. [Operator Instructions] Our first question comes from the line of Mike Vermut with Newland Capital. Please proceed with your question.

Najeeb, Roger, congrats on a phenomenal job here. Great profitability, and it’s great to see the company really turning the corner here. A couple of quick ones for you. I guess, last time you discussed – just looking at the pipeline on the bidding activity, I know we have longer cycles here. I think last time you said we’re in the procurement stage. Just how have things advanced on some of these contracts? And behind these ones that you say are getting towards the finish line, how does the longer-term pipeline look for you, I guess, over the next year or so? Are there other large contracts that are being initiated here?

Yes, I will address a few points, then Naeem will jump in for the long-term pipeline outlook. So I think we did say that we are almost there in terms of procurement discussion and discussions with the prospective customer. And just recently, we were the preferred vendor. We were selected as a finalist. And I think it’s a matter of a few days or a few weeks to get the final agreement signed out. So we’re pretty confident about it at this stage. So Naeem, why don’t you jump in about the outlook overall in the pipeline?

Yes, so, I mean, overall, what we try to do is replace any of the opportunities that we have, more mature sales we’d like to we replace them with some of the early ones, so that the pipelines remain solid. So that’s been the objective, and that’s working out really well. The sales cycle is taking longer because the process has become better governed from the procurement perspective, as our clients have had lots of bad experiences in the past with other vendors. And they have put in more transparency into the process. They are more demanding in what they want from a vendor. So this process now, what used to take maybe 12 months is taking twice as long in some of the larger deals. So as this one or two of the larger opportunities have taken this time frame, we’ve obviously backfilled the pipeline with other opportunities. So I think we, as we speak now, we’re currently running in at least seven or eight RFPs, which are very promising. But that’s still somewhat early stage, somewhat middle stage and, as Najeeb said earlier, a couple of them are very mature.

Excellent. So I guess, my main question here, let’s say we do get some of these really significant large ones over the finish line. I don’t know, let’s say in the next month or two months, can we assume that over the next year, we are going to see a few other large deals as well, that it’s not going to be the same as last time where you had a deal, then it took this amount of time to get the next deal, but there’s a lot more in the pipeline that’s been moving along for the company? So a lot – my point is a lot more has matured over the past year.

Yes. Would you like to see my – okay, sorry. Najeeb, you want me to answer that? Go ahead, yes, please go ahead.

Okay. So what we – well, we don’t want every opportunity to take two years. This was an exceptional one. I’d rather have some of the smaller ones come through faster. And I think some of the opportunities that we are trying to close now probably won’t be of that scale, but then we have more of them that closed earlier. And so that we keep the momentum going, and we can announce – make more announcements on a more regular basis than to wait for some of these large ones that take much longer. So once we get this one done, I’m hoping that some of the other opportunities, which are not as large, but certainly are more of – so that quantity-wise is quite a few, but each offer a different size. But certainly, I’d like to see them closing faster, I mean, because It does take a lot of bandwidth from our sales and presales teams to make sure we get over the line.

I think also I would add one more point , migrant to the market. I think these longer cycle contracts as we experienced when we did the Daimler contract over two years ago, it did take longer. But what happened, the advantage we have for the company and the shareholders, that you drive much better margins. And I have said in my prepared remarks, it’s a much more lucrative margin actually. Its long-term effect is much greater for the company as we have benefited from the previous deals we’ve signed two years ago. So yes, we need to be very focused and patient and continue to keep adding some smaller revenues, which we have done there in the last quarter and the ones before. I see the growth. That one is very aggressive in the last three quarters sequentially. And I see that once these deals are inked, then I think it will have an immediate impact or a subsequent quarter impact on a long- term basis like the ones we have for 10 years. So it’s very big, I think, for the company to have situations where you’re dealing with top-tier Fortune 500 companies in the world and to recognize to become the preferred vendor out of the many when we started. And so it shows very well that we are on the right track, and our technology is well received by our bigger customers. So we’re really excited about the outlook in that way.

Excellent. And now I know you mentioned it in the release, but I assume the additional costs as we win these contracts is nominal?

Very nominal because, look, the way I look at it – yes, my view is if we were to add another dollar incremental from this contract, maybe we’ll spend $0.10, $0.15, $0.15 most but we can enjoy any cent that moves our revenue and margin. I believe our cost structure have been much more streamlined. It is not just the one-time cost reduction, but we really optimized efficiencies. The whole operation is in a different mode, and that is we’ve been maturing the last few years, the Ascent implementation. I mean, gaining more efficiency and optimum, I think, cost structure. So more matured development cycle and revenue cycle. And as we add bigger revenue, the margins will be much more steeper. So I’m pretty confident that it’s not like three, four years ago when we were hiring people to go to the bigger projects. Right now, we are in a much better position, and we can manage very effectively all the growth margin, operating margins and net income but not adding too many expense for the new deals.

Excellent. And then I’ll leave another one. On the buyback, I assume as the stock doesn’t move much, that we’ll accelerate the speed of our buyback here, especially after these results and what the current outlook is?

We always have these very sincere efforts when we announce it, and we buy whatever we can based on a given time frame and the pricing and the cash management. I think this is an open program, and we always debate at times between buying shares, NTI or sometimes our Pakistani industry. So it’s always an opportunity here, and we treat it very carefully and then we can make that decision. So we will continue with this program. And as you’ve seen in the past, the pattern of excise buying was also pretty strong. So we will continue to look at them based in the given opportunity, and then liquidity.

Okay. And then I’ll leave you just once I know Roger mentioned here the currency gain that was in there. But just to clarify, the currency gain offsets a margin loss in our currency, right? Because our revenues are lower, and our expenses are a little bit lower. So we have a lower loss because of the currency, and then the currency gain offsets part of that. So it nets itself out somewhat, correct? Am I looking at that correctly?

Yes, absolutely. I mean, you said it rightly. We have about $1 million left, to be exact $900,000, in this quarter from the same quarter last year, and then we showed tremendous cost reductions. So I think currency should be constant – it’s been going on for the last two quarters now. Our results are fundamentally very strong, and I’m very excited about it because you look at the growth you’ve mentioned from the core business, whether the implementation of services, or even legacy U.S. or in Asia Pacific, or UK, we’re doing very well. We’re growing the revenue at a pretty impressive rate, if you just focus on the core business. We are in a healthy position, and currency is something that we are dealing with. EBITDA number is pretty strong. Guidance improved. So I think in every way, we have done very well in this quarter.

Right. Yes, I thought it was fantastic, and the cash build was fantastic, too. My only recommendation would be to use it for the buyback as quickly as you can before these other contracts appear.

Yes. We will keep that in mind, Mike.

Okay, congratulations guys.

Thank you.

Thank you. [Operator Instructions] At this time, this concludes our question-and-answer session. If your question was not addressed during the Q&A session, please contact NETSOL Investor Relations team by e-mailing them at ntwk@liolios.com or by calling them at 949-574-3860. I’d now like to turn the call back over to Mr. Ghauri for his closing remarks.

Thank you, thank you very much for joining us today. I’d especially want to thank our investors and shareholders for their continued support, and our dedicated employees worldwide for their and dedication and their execution. We look forward to updating you on our next call. Thank you. Operator?

Thank you. Thank you for joining us today for NetSol fiscal third quarter earnings call. You may now disconnect your lines and have a wonderful day.