NetSol Technologies, Inc. (NTWK) Q1 2020 Earnings Report, Transcript and Summary

Good morning. Welcome to NetSol Technologies' First Quarter 2020 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, and CEO, OTOZ; 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 the call for questions. Please note that all the information discussed on 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 could differ materially from those stated or implied. These forward-looking statements are qualified by the cautionary statements contained in NetSol's press releases 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 a link available in today's press release. Now I would like to turn the call over to Najeeb. Najeeb?

Thank you, Patti, and good morning, everyone. I am so delighted to be calling you from the NetSol, Beijing office, our biggest market in China, and I am fortunate enough to be here today because NetSol senior management has been invited to meet with one of our largest clients, BMW Financials. We are celebrating the first Go-Live event within our larger Ascent agreement as well as exploring additional opportunities for collaboration going forward. On a broader level, I’d like to say how proud I am of our team in China and our other markets for their tireless efforts in making NetSol, a leading company in our sector and for making this huge project a success so far. We began the fiscal year where we left off at the end. In the middle of a decisive transition as we work to build our business for its next phase of growth. The fiscal first quarter has historically been affected by a degree of seasonality. And in Q1 2020, this was the rule, not the exception. While our results reflected the effects of this transition phase as well as the typical seasonality we experienced during this period, we are very encouraged with the initial progress we have made to-date as well as the line of sight we have within our current pipeline and through our overall company roadmap. I have mentioned it many times before, but I believe the message wants repeating. At NetSol, we are managing our business with an eye for the long-term. This has always been our approach. In more recent years, we have experienced a great deal of success, but this success is also the result of some hard decisions we had to make at other points in the past. One of those difficult choices with our major cost reduction initiative we put in place in fiscal 2018 period, which has enabled us to streamline our operation and recognize more from every dollar we earn. Looking even further back, another decisive move we made was a major infrastructure spend we incurred while building out our next generation NFS Ascent back in 2014. In total that $25 million investment has already yielded an estimated value of $200 million for our company's revenue, another example of a hard decision leading to a long-term benefit. Furthermore, for NetSol, we view it as SOP, or Standard Operating Practice, to remain focused on global cost optimization with an eye on increased efficiencies wherever we can realize them. Today, we find ourselves in a similar situation to the previous instances I just described. As I also mentioned on our last call, while we continue to believe in the quality of our products and our value proposition to customers, the reality for us has been that the sales process is long, slow and unpredictable. Furthermore, as it stands right now, we are essentially a one-product company. In recognition of this fact, we've been hard at work to develop a new strategy that will future-proof our own business in the way that we aim to do so for our customers. More specifically, thanks to the success of Ascent. We are now in a position to be able to explore new opportunities for growth and also more consistent revenue streams. As you have seen from a recent press release, I am pleased to announce the first major step in that direction. NetSol will now be offering subscription-based pricing as an alternative to the traditional license model. With this new pricing option, we have now effectively removed what was previously a barrier for certain potential customers due to the significant upfront cost associated with traditional license agreements. The reality is that the global markets are shifting. We know that we must respond quickly and decisively to these changing paradigms by offering alternative pricing options. Our new SaaS monthly subscription model with cloud-based solution, is just one such way. To be clear, we will continue offering license model pricing structures as we have been for years now. That said, this new pricing options represents the start of our new growth strategy and I am excited to talk more about this and some of the developments in just a moment. But before I do that, I'm going to ask our CFO, Roger Almond, who will walk us through our results for the quarter. Roger?

Thanks, Najeeb. Turning to our fiscal first quarter 2020 financial results for the period ended September 30, our total net revenues for the first quarter were $13.6 million compared to $16.4 million in the prior year period. The decrease in total net revenues was primarily due to a decrease in total license fees of $3.3 million and a decrease in services revenues of $199,000, which was offset by an increase in total maintenance fees of $652,000. Total license fees in Q1 were $2.7 million compared to $6 million in the prior year period. The decrease in license fees for the quarter was primarily due to the prior year's quarters' inclusion of approximately $4.9 million in license fees related to the five-year contract that was signed with a Tier 1 auto captive finance company to implement our NFS Ascent platform in China without a corresponding contribution in the current fiscal year’s Q1. Total maintenance fees in Q1 were $4.4 million compared to $3.7 million in the prior year period. The increase in total maintenance fees for the quarter was due to the start of new maintenance agreement from customers who went live with our products during the latter stages of fiscal year 2018 and into fiscal year 2019. We anticipate maintenance fees to gradually increase as we implement both our NFS legacy product and NFS Ascent across a broader long-term customer base. Total services revenue for the quarter was $6.5 million compared to $6.7 million in the prior year period. Removing related party revenues, total services revenue for the year was essentially flat. Total cost of revenues was $7.5 million for the first quarter, a decrease of $697,000 from $8.2 million in the first quarter of fiscal 2019. The decrease in cost of revenues was predominantly driven by decreases in salaries and consultant costs, lower depreciation and amortization and other expenses, which were offset by increases in travel expenses. Gross profit for the first quarter of fiscal 2020 was $6.1 million or 45% of net revenues, down from $8.2 million or 50.2% in net revenues in the first quarter of fiscal 2019. The decreases in gross profit and margin were primarily due to decreases in revenue by an amount that was greater than the related decreases in cost of revenues, respectively. Operating expenses for the first quarter decreased 1.5% to $6.5 million or 48.2% of net revenues, from $6.6 million or 40.5% of net revenues in the same period last year. The decrease in operating expenses was primarily due to a decrease in general and administrative expenses, which was offset by an increase in sales and marketing, and research and development expenses. Moving forward, we plan on continuing to judiciously allocate additional resources to our R&D budget as we focus increasingly on our innovation-related initiatives. Turning to our profitability metrics. Our net loss from operations was $427,000 for the first quarter, a decrease from net income from operations of $1.6 million in Q1 last year. Our GAAP net loss attributable to NetSol for the first quarter of fiscal 2020 totaled $1.8 million or $0.16 per diluted share. This compares with GAAP net income of $963,000 or $0.08 per diluted share in the first quarter of last year. The decrease in GAAP net income attributable to NetSol was primarily due to decrease in license fees previously mentioned without a related decrease in expenses or commencement revenues can offset the year-to-year discrepancy. As I have mentioned on previous calls, it's important to point out that included in our net loss this quarter was a loss of $1.8 million on foreign currency exchange transactions compared to a gain of $11,000 in Q1 of last year. Because we operate in several geographical regions, a significant portion of our business is conducted in currencies other than the U.S. dollar. A decrease in the value of the U.S. dollar compared to foreign currency exchange rates generally has the effect of increasing our revenues, but it also increases our expenses denominated in currencies other than the U.S. dollar. Similarly, as the U.S. dollar gains strength relative to foreign currency exchange rates, it tends to reduce our revenues, but it also reduces our expenses denominated in currencies other than the U.S. dollar. We plan our business accordingly by deploying additional resources to areas of expansion while continuing to monitor our overall expenditures given the economic uncertainties of our target market. Moving to our non-GAAP metrics. Our non-GAAP adjusted EBITDA loss for the first quarter fiscal 2020 totaled $1.1 million or $0.09 per diluted share compared with non-GAAP adjusted EBITDA of $2.2 million or $0.19 per diluted share in the first quarter of last year. Please see the reconciliation schedules contained in today's release for our revised calculations of adjusted EBITDA for the fiscal quarter ended September 30, 2019. Turning to our balance sheet. At quarter end, we had cash and cash equivalents of approximately $17.6 million or approximately $1.51 per diluted common share, which is up from $17.4 million or approximately $1.49 per diluted common share at June 30, 2019. That concludes my prepared remarks. I'll now turn the call back over to Najeeb. Najeeb?

Thank you, Roger. I'll now provide some brief updates related to our major ongoing implementations, across the globe before discussing our updated growth strategy. With respect to our multi-year international deployment associated with previously announced 12-country, $110 million contract with Daimler Financial Services in Germany. We are continuing to make progress with our ongoing deployments and look forward to making additional Go-Live announcements early on in the next calendar year. Next, on our development roadmap, we have Singapore, Malaysia, Hong Kong, India, and Thailand. Moving to another major implementation project with BMW Financial Services in China. As I mentioned on our previous call, we are continuing to make solid strides here. In October, we announced the successful implementation and Go-Live with our NFS Ascent Wholesale Platform with another on time delivery and a smooth rollout with 100% data migration verification, we are continuing to set a higher bar in China and the industry overall. Next on the roadmap, we expect to finish up with the retail component sometime in late calendar 2020 with BMW. Finishing up in APAC, last week we announced the official Go-Live with our mCollector application for a top tier multi-finance company in Indonesia. This mCollector Go-Live is part of a larger contract recently signed in 2018. For those of you who do not know, mCollector is built on NetSol's flagship NFS Ascent framework and uses its smart workflow engine throughout the assignments and tests to relevant collection agents, empowering collections teams to do more, with an easy-to-use interface and intelligent architecture. With our second successful mCollector Go-Live in Indonesia, our implementation team has made considerable progress, having delivered the latest application within two months. The Indonesian market continues to be a strong point for our business, and we are looking forward to build on this initial traction going forward. Moving to major highlights in our other regions. I mentioned on our previous call, back in July, we signed roughly $4 million contract with the large independent used-vehicle finance company in the United Kingdom for the implementation of our Ascent Wholesale Finance Platform. The total contract includes additional revenue opportunities based on the usage and contracts under management. This deployment marks the first rollout of our NFS Ascent in not only in the UK, but the entire European market. Going forward, we feel this signing represents a beachhead for us as you work to build a solid baseline for further implementation of our core solution in the European market. The North American market is now also seeing encouraging progress to-date for our ongoing Ascent rollout, as well as OTOZ. We currently have begun, what we are calling soft marketing efforts with our U.S. based sales team, and our global Ascent team, and are already resuming initial interest and upgrades to Ascent from a few existing clients. The main response we are hitting that Ascent's successful launch in Asia Pacific over the past four years and it has been the best possible calling card, which is exactly what we have envisioned as a benefit for being the global organization that we are. We are also seeing similar responses for the few of our newly launched auto initiatives. In fact, a couple of existing tier one auto captive have shown a desire to collaborate on new proposed concepts which we expect to translate to some exciting announcements in the near future. With that overview now completed, I like to spend the rest of my time on the call discussing the progress being made in our new growth strategy. As I mentioned in our last call, in the new fiscal year NetSol plan for growth would take a three-pronged approach. One, we would continue to focus on the organic growth of our current core business; two, we would continue to innovate in new areas and look to create partnerships where our technology and personnel can be a major benefit to other organizations as well as our own; and three, we will also be exploring inorganic growth opportunities where it makes sense. Beginning with the first, the state of our organic business remains strong. As Roger mentioned, fiscal Q1 was impacted mostly by our outperformance last year, resulting from a major new contract signing with BMW Financial which was reflected in our license fees line. Overall, the structure remains intact. We are continuing to implement some of the most difficult projects now in our industry with the 100% success rate, which has been great for both winning additional business with current customers and as a referenced for potential new customers. As you also just heard me say, we have a number of significant Go-Live events on the horizon, which gives us added confidence in our ability to achieve strong operating results throughout the course of fiscal 2020. All that said, you must acknowledge that the state of our industry is changing. We are in the middle of a major paradigm shift. We just prompted our need to take action. Furthermore, while our core business remains one viable growth opportunity among others, we have become increasingly susceptible to a sales process that is long, slow, and unpredictable. This does not allow us to run our business in the way that we need to. In recognition of the changing business environment in which we have found ourselves, we have responded as you always have with decisive action. One of the ways we are combating this issue is through a new go-to-market approach. As I mentioned in my opening remarks, NetSol is offering Software-as-a-Service or SaaS-based pricing for all cloud-based product offerings. What is also important to keep in mind is that we are also making this new model available to our existing customers as well. With our substantial scale and global footprint, we feel confident that over time we can become a market leader in this domain. Our new SaaS offering provides for faster decision-making, thanks to a lower pricing barrier to entry and typical license contract. Customers are required to pay a large sum upfront before any work is actually performed, which had historically caused some hesitation. By removing upfront license fees, NetSol is enabling organizations to more effectively spread software usage and maintenance expenses over time rather than through legacy processes which required complex and lengthy procurement cycles. While we believe this new pricing strategy to be customer friendly, we also expect NetSol will be positively impacted in a number of ways, namely through improved recurring revenues, customer retention, and ultimately lifetime values. While this global program is still in its early days, we are looking forward to the potentially transformative effect our new strategy can have over the long-term. As a final note, we do anticipate initial impact in licensing fees as a result of this new pricing structure. Fortunately, we already have a healthy pipeline of prospects who are interested in this new pricing option and we look forward to announcing new deals in the coming weeks and months. On the marketing side, we are continuing to make our presence felt across the industry conference circuit. We believe attendance and sponsorship at major events increases our profile and credibility in the market. These events serve as a great opportunity to generate new business for NetSol. For the remainder of this year and the coming calendar year, our marketing team has shortlisted several industry conferences to attend across Asia Pacific, Europe, and North America regions. Most importantly, NetSol was a sole diamond sponsor at the Auto Finance Summit, one of the premier events in our industry. Our team on the ground did a wonderful job and is spreading the NetSol message to new potential customers and partners and further supported our position as one of the leading providers in the industry. Moving to our second key growth area, which is innovation and partnerships. Beginning with our OTOZ Innovation Lab, the team continues to make strong progress on a number of proof-of-concepts and other beta projects, which are expected to be announced this fiscal year. We remain in quite active discussions with many current and potential new customers, and many of whom are blue-chip automotive brands, and I believe we should start to see some deals come through the pipeline this fiscal year as well. As an additional data point that OTOZ team recently won an industry award at a Nation ICT Competition for its fleet owner application, which speaks to the initial validation we are seeing for our R&D efforts here. Well, the more immediate exciting items on the roadmap is our anticipated Go-Live for Drivemate. As some of you may recall, back in March, we announced a strategic partnership and investment with Drivemate, the leading car and ride sharing business in Thailand. Since that time, the OTOZ team has been focused on strengthening the current Drivemate platform with a specific emphasis on efficiency, security and scalability. We have made tremendous progress these past eight months and are almost ready to show the world what we have been working on. Another facet of our second growth vector involves strategic partnerships. But I can't share any specific details in that area. On today's call, I'll just say that we'll have some exciting announcements to make in the near future for this area. Our third and final growth area, we are continuing to evaluate opportunities in the marketplace that makes sense and being highly accretive and complimentary to our business, and we will report accordingly when we have a material updates on this area. In summary, while our results for the quarter one where we would like them to be. We are already well on our way to addressing the underlying causes and are optimistic that our go-forward results will reflect this incremental progress. We are continuing to execute in our core business. We are innovating by bringing that product to new markets and in new more customers' friendly formats, and we are investing in areas both internally and externally, that have the potential to generate asymmetric returns and propel NetSol to its next phase of growth. NetSol remains in a strong position today, and we are building to be in an even better, more diversified position for tomorrow. And with that, I'd like to open the call for questions. Operator?

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Anja Soderstrom with Sidoti & Company. Please proceed with your question.

Hey gentlemen. Thank you for taking my question. So business subscription pricing model, how did that come about? And how do you see that evolving, especially as maybe transitioning from the current licensees, are you more seeing new contracts coming in with this?

Yes. Thank you, Anja for the question, and I have Naeem to jump in.

Yes. Hi. So we've been working very closely with our existing clients as well as gauging the market in general with our prospects as well. We've been finding that the sales cycles on our classical license model have been very slow and long. And there's been some demand from some existing clients also to offer subscription pricing for both on-prem and on-cloud deployment for Ascent. So as a result, we did a major exercise in building some financial models on how we will transition from – if you like historically, from a pure license-based pricing to gradually transition to SaaS. So as a result, we've decided to know the go-to-market with this strategy and we have already signed some interesting new clients. Some announcements will be coming forward in the foreseeable future. But we see that this is going to help us in shortening the sales cycles and also making the barrier to entry for new clients a lot lower with pricing and subscription spread over several years. And as a company, it gives us some more visibility in terms of revenues going forward because typically a subscription contract is signed for a five-year period, and then you know what will be the revenue stream over that time. Most of our peer group companies are now moving to subscription. And we find also companies not in our space, but also in other ERP solutions have already transitioned with very good results. There is this period in which – while we transition, license income will drop, but eventually there's an inflection point. At this stage, we don't know exactly when that would be, but that will then start to show growth. On the subscription side, it will track higher than what we've been doing on licensing. I hope that kind of explains.

Yes. Thank you. And are there any specific regions where there sort of demand or requests for this has been strong you see? Like, are they more prone to do this in the U.S. and Europe rather than Asia Pacific or…?

Yes, it's not regional, but type of client. Typically the very, very large clients prefer licensing, but the medium to small clients prefer subscription. So it's not so much regional, it's more on the type of client you're offering the product too.

I want to add one more thing – Anja sorry. To further repeat what I said in the prepared remarks that this option gave us and the customers who’re not large inside like Naeem just said have the ability to make rather quick decisions. They can budget their monthly payments to the vendor. And then they can acquire the system they need to acquire whether they are conversions from the existing customers or even the new, so we’re basically broadening our marketability in both sectors, both with the license, sales and also through SaaS on the monthly model. So I think – and for us, it is a win-win and a very friendly opportunity for our customers also.

I don't know if you're aware that currently are – quite a big percentage of our current revenue has a subscription component and we do have lot of recurring revenue on maintenance. So we already have 20%, 30% of revenue coming from subscription and other types of recurring revenue like maintenance. But please also note that this is a very proven model, right. This is not something groundbreaking. Subscription is a very much a proven model. SAP and Microsoft, a lot of those big players are already in this space and that's where the biggest growth is coming from. On-cloud, SaaS deployment is the fastest growing, fastest emerging segment within the ERP solution space.

Yes. Including salesforce of the…

Okay, thank you. And then can you give some color on the pipeline? How is it trending? And is there any quantification you can give us around that?

Yes. Go ahead, Naeem.

Yes. So from a pipeline perspective, we've stated in the previous quarter that it is strong, but the sales cycles are taking longer. So the deals we expected to complete in this quarter reporting have not materialized, have been deferred to the current quarter. So the pipeline remains strong. It’s a question of how much of the pipeline do we convert into actual contracts? And that first quarter traditionally has always been slow anyway, but we expected at least one or two contracts to fall into this quarter, but they've been deferred to the coming this quarter that we are in now.

Okay. And then also as a follow-up for the subscription, do you foresee that helping that pipeline further materialize quicker because it's shortening the sales cycle or how do you see that affecting the pipelines converting?

So what's happening now is that currently we have at least three very mature prospects all on SaaS. That is the first time it's ever happened. We have back-to-back SaaS deals ready to mature. Obviously, we can’t be 100% sure on the timing, but these are definitely lot shorter sales cycles than these very large license deals. So we expect once this stock to get more traction with additional marketing, we will have more frequent deal closure for each quarter.

Okay. Thank you for that additional color. And then how correlated are you to the auto industry? And what are you seeing there in terms of the slow down and how is that trending?

Yes. And that is a question which is generally for the auto industry. In our segment, whenever the auto industry hit some headwinds, they go into very creative mode in terms of financing. So on the financing side, when they come out with the products, they become more creative and they find ways to sell more cars. System investment typically is time lag. So we have found that even in difficult situations when sales are down, a lot of the finance companies start to invest in technology to scale for the time when the market gets better. So we are not so cyclical really as the general auto industry is, our pipeline remains still very active, we haven't seen any major drop.

Okay. Thank you. That was awesome. Thank you, guys.

Okay. Thank you, Anja.

[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's Investor Relations team by e-mailing them at ntwk@gatewayir.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 for joining us today. I especially want to thank our investors for their continued support, our loyal customers, and dedicated employees for their ongoing contribution. We look forward to updating you on our next call. Thank you and have a good day. Operator?

Thank you for joining us today for NetSol’s fiscal first quarter 2020 earnings call. You may now disconnect.