NetSol Technologies, Inc. (NTWK) Q2 2020 Earnings Report, Transcript and Summary

Good morning. Welcome to NETSOL Technologies Fiscal Second 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 the 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 would like to turn the call over to Najeeb. Najeeb?

Thank you, Patti, and good morning, everyone, and thank you all for joining us today. I'm really excited to be calling this time from London office, where I'm visiting with members of our U.K. team and our business affiliates and getting updates, a number of the initiatives we've been going on in this key growth region for NETSOL. We are in the midst of some exciting times at our company. Just a few weeks ago, we were fortunate enough to be invited at the NASDAQ MarketSite in New York City for their formal closing bells ceremony. While NETSOL has presided over many closing bells and opening bells in the past since we went public, this particular event held special meeting for us as it commemorated the 20th year of our official listing on NASDAQ. And while a lot has changed in these 2 decades, I'm very proud of the fact that we have been able to remain true to our founding mission all these years later, NETSOL is an organization focused on innovation and people. Through the confluence of these 2 areas, we've been able to build an adaptable, technology organization and built-to-last. And while the past 2 decades have provided their fair share of thrills, I am even more excited about what's to come. Also during the ceremony, we officially announced NETSOL's Cloud Readiness campaign, which represents our new marketing campaign focused on highlighting our expanded cloud-based offering, which now includes our flagship Ascent platform and will also apply to some of the new offerings from our Innovation Lab. NETSOL is a cloud-ready organization capable of effectively serving the digital economy and our clients' enterprise needs worldwide. We are also working on expanding our addressable market and tackling a number of other exciting projects, which I plan to detail in just a minute. However, before I do, I will now dive into our results for the second quarter. The fiscal second quarter was a positive step forward for our business as we continue to position NETSOL for its next phase of growth in the years ahead. We drove a 16% sequential improvement in our top line which was the result of ongoing and significant implementation work within our core business. Our incrementally improved revenues also reflected an additional $2 million in change requests, yet another favorable data point that underlies the ongoing industry shift to more complex deployments. While our year-to-date results reflect our ongoing efforts to transition NETSOL towards the more diversified revenue mix, in Q2 we maintained our commitment to financial prudence most notably evidenced in our return to profitability during the period, during which we generated $0.05 per earnings share -- earnings per share. Operationally, we began the initial application of our three-pronged growth strategy, which has yielded already favorable results. More specifically, in November, we closed our first official sale of NFS Ascent in North America, which has represented the first SaaS-based agreement for Ascent in this region. Additionally, our mobility focus work within our Otoz Innovation Lab has garnered serious attention from potential and existing customers alike, which we expect to materialize and increase demos, more advanced development discussions and additional pilot projects in the coming months. With that overview completed and before I get into greater detail, 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 second quarter 2020 financial results for the period ended December 31, our total net revenues for the second quarter were $15.7 million compared to $17 million in the prior year period. The decrease in total net revenues was primarily due to a decrease in total license fees of $4.4 million, which was offset by an increase in services revenue of $1.8 million and an increase in total maintenance fees of $1.3 million. Total license fees in Q2 were $384,000 compared to $4.8 million in the prior year period. The decrease in license fees for the quarter was primarily due to the prior year's quarter's inclusion of approximately $1.1 million in license fees related to our $12 million -- $110 million contract as well as $1.9 million in license fees related to the 5-year contract that was signed with a Tier 1 auto captive finance company to implement our NFS Ascent platform in China. And approximately $1.3 million in license fees related to the contract signed in China with a major American multinational automaker to implement our NFS Ascent retail platform, without a corresponding contribution in the current year period. Total maintenance fees in Q2 were $5 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 agreements from customers who went live with our products during the latter stages of fiscal year 2019 and into fiscal year 2020. We anticipate maintenance fees to gradually increase as we implement both our NFS legacy products and NFS Ascent across a broader, long-term customer base. Total services revenue for the quarter were $10.3 million compared to $8.5 million in the prior year period. The increase in services revenue was due to an increase in new implementations and change requests. Total cost of revenues was $7.9 million for the second quarter, a decrease of $256,000 from $8.1 million in the second quarter of fiscal 2019. The decrease in cost of revenues was predominantly driven by decreases in travel, depreciation and amortization and other expenses, which were offset by an increase in salaries and consultants' costs. Gross profit for the second quarter of fiscal 2020 was $7.8 million or 49.7% of net revenues, down from $8.9 million or 52.1% of net revenues in the second quarter of fiscal 2019. The decreases in gross profit and gross profit as a percentage of revenue were primarily due to decreases in revenue by an amount that was greater than the related decreases in cost of revenues. Operating expenses for the second quarter increased 6.4% to $7.1 million or 45.2% of net revenues from $6.7 million or 39.2% of net revenues in the same period last year. The increase in operating expenses was primarily due to increases in general and administrative expenses, which were offset by decreases in sales and marketing expenses, salaries and wages and professional services. Turning to our profitability metrics. Net income from operations was $705,000 for the second quarter, a decrease from the net income from operations of $2.2 million in Q2 last year. Our GAAP net income attributable to NETSOL for the second quarter of fiscal 2020 totaled $586,000 or $0.05 per diluted share. This compares with GAAP net income of $2.9 million or $0.25 per diluted share in the second quarter of last year. The decrease in GAAP net income attributable to NETSOL was primarily due to the decrease in license fees previously mentioned without a related decrease in expenses or commensurate revenues to offset the year-to-year discrepancy. As I mentioned on previous calls, it is important to point out that included in our net income this quarter was a gain of $61,000 on foreign currency exchange transactions compared to a gain of $2.5 million in Q2 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 rate, generally has an 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 gained strength relative to foreign currency exchange rate, 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 uncertainty of our target markets. Moving to our non-GAAP metrics. Non-GAAP adjusted EBITDA for the second quarter of fiscal 2020 totaled $1.6 million or $0.13 per diluted share compared with non-GAAP adjusted EBITDA of $4.1 million or $0.35 per diluted share in the second quarter of last year. Please see the reconciliation schedules contained in today's release for our calculations of adjusted EBITDA for the fiscal quarter ended December 31, 2019. Turning to our balance sheet. At quarter end, we had cash and cash equivalents of approximately $22.1 million or approximately $1.88 per diluted common share, which was up from $20.3 million or approximately $1.75 per diluted common share at December 31, 2018. That concludes my prepared remarks. I'll now turn the time back over to Najeeb. Najeeb?

Thank you, Roger. I'll begin my remarks, as we always do by recapping some of the major operational highlights from the period. Now starting in Asia Pacific, we -- with our previously announced 12 countries, $110 million contract with Daimler Financial Services in Germany, we continue to make considerable progress along our multiyear multi-country implementations road map. More specifically, during the period, we achieved a successful Go-Live in Hong Kong, with NFS Ascent retail platform, which consists of our Omni-Point of Sale and contract management system. Moving forward, the most near-term Go-Live events to come, which we expect to announce in the coming months will be in Singapore, Malaysia and Thailand, for again, Daimler Financial Services. We have additional deployment schedule for new territories beyond these, and we also have more Go-Live events further on the horizon for areas, we are currently partially operational, but we expect those announcements to be made in subsequent calendar years. In all, we are continuing to proceed under budget and ahead of schedule. Switching to our ongoing rollout with BMW Financials in China. As I mentioned on our previous call, in October, we announced the successful implementation and Go-Live with our NFS Ascent wholesale platform in China. It's worth noting that this implementation is the first BMW group project in last 9 years in the finance and leasing phase that has been delivered on time and within the assigned or allocated budget. Our customer has been thrilled with the rollout, and we are looking forward to delivering the next phase, our retail platform sometime later in this calendar year 2020. During the quarter, we also announced the official Go-Live with our mCollector application for a top-tier multi-finance company in Indonesia, which was part of a larger contract that will be signed in 2018. Finishing up in APAC, we also continued to make significant progress towards the deployment of our NFS Ascent retail platform for a New Zealand-based captive equipment finance company, our current project projected Go-Live time frame for this project will be early fiscal 2021. Now moving on to our European operations or NPE for short. As I have made -- mentioned on previous calls, in July, we signed a roughly $4 million contract with a large independent vehicle finance company called BCA in the U.K. for the implementation of our NFS Ascent wholesale finance platform. We continue to believe that this first rollout of NFS Ascent in the European market will serve as an invaluable calling card for future business in the region. In recognition of the importance of this project, we are working on providing a flawless first implementation. While we have a ways to go, our team has been working diligently, and we'll look to provide updates as the project gets nearer to completion. Additionally, we are currently in the final stages with another customer in the U.K. for a Go-Live with our LeaseSoft product. While we expect to continue to generate future business of this regional offering, we remain focused on building our future growth in Europe and the U.S. through the expansion of our flagship Ascent platform offering. With that in mind, I'll switch gears to spend a minute talking about perhaps our most exciting updates from the quarter. As many of you are aware from our recent press release and commentary on the last call, NETSOL recently reduced the global availability of subscription-based pricing for new and existing customers on all cloud based products. At the time of the announcement, we stated, our thesis was that this new go-to-market approach would have a material positive impact to our business over the long term. While we still believe that the multinational blue chip organizations that we work with will want to continue with the legacy licensing model, given that they are less price conscious. However, we think this new offering will be a game changer for new deals with SMBs and smaller enterprises, who might be more budget driven. In typical licensing contracts, customers are required to pay a large sum upfront, before any work is actually performed, which has 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 require complex and lengthy procurement cycles. As you heard from Roger, while our services revenues and maintenance fees continue to grow as we bring new customers onto our platform, we remain susceptible to the inherent lumpiness that come with licensing contract. Over time, it is our goal to mitigate these effects as well as build a stronger revenue base through smaller but more consistent SaaS contracts. Representing a great first step in this long-term plan during fiscal Q2, we secured our first ever NFS Ascent win in North America through an agreement with SCI Lease Corp, a Canadian-based national automotive leasing company for our contract management system on the cloud. This contract represents the first SaaS-based agreement for Ascent in this region. And like our inaugural deal in the U.K., we feel the value it will ultimately provide is greater than the face value dollar amount. We are laser-focused on ensuring a smooth rollout here as well with a more immediate target Go-Live date later this fiscal year. We continue to believe that a strong first deployment will serve as a valuable calling card for NETSOL in North America, just like it should be in Europe. We look forward to announcing more deals like this one in the coming months. For the remainder of our call, I will now provide some brief updates on our progress within our 3 strong growth strategy. As a reminder, these are the 3 key areas where NETSOL is focusing in calendar 2020, where we believe we can generate outsized results and propel our business to its next phase of growth: The first one, continued to focus on the organic growth of our current core business; second, innovation in new areas and looking to create partnerships where our technology and personnel can be a major benefit to other organizations as well as our own; and third, exploring inorganic growth opportunities where it makes sense. Beginning with the first prong, our core business. As you just heard from the numerous operational highlights I just mentioned, remains healthy with an encouraging regional and product mix. As I mentioned in my opening remarks, during Q2, we generated an extra $2 million by providing additional services and change requests for various customers across multiple regions. Our ability to satisfy those additional obligations and requests speaks to the adaptability of our team and technology. Going forward, as deployments continue to increase in complexity and customization, we will be ready to benefit from their industry tailwind. In fact, we have already begun the process of making strategic headcount increases at our Lahore campus to address this growing need. These new additions are targeted at addressing key technical areas where we've seen client requests to justify the man-hours. Also within our core business, the introduction of our new subscription pricing model, coupled with our augmented efforts to expand into new geographies is also already producing encouraging results. Beyond the first official NFS Ascent signing in Europe and North America, respectively, we are continuing to see healthy interest from new and existing customers, which has contributed to an increasingly robust pipeline. To further advance our efforts in these key regions, we have made additions to our regional leadership teams as well. Within NTE, we recently announced the appointment of industry veteran, Chris Mobley, as a new head of NFS Ascent wholesale operations in the European market. Chris comes highly pedigreed, and we believe, he will be able to contribute greatly to our expansion efforts in Europe. In the near term, he'll be focused on leading the rollout of our new subscription pricing strategy as well as orchestrating our overall growth plans and also leading presales of our wholesale operations globally. Chris has already been -- already made a meaningful impact on our team here that I have been able to see firsthand. We are grateful to him -- to have him on the team and look forward to the work they will be doing in the months ahead. Within NDA or our Americas division, we are also looking forward to making additional senior leadership related announcement in the near term. Moving to our second key growth area, which is innovation and partnerships. Beginning in our Otoz Innovation lab, we are seeing the list of potential customers and interested parties continue to grow. We are currently engaged with a number of parties from international blue chip companies to cutting-edge hyper growth focused start-ups. The interest in and need for our mobility solution is massive and Otoz is well positioned to take advantage of this macro industry movement. Those conversations, while in early stages, are progressing well. In one situation, we are actually engaged in a pilot program discussion with an existing large customer, and we are optimistic about the potential opportunity this represents. Unfortunately, we can't share any more detail at this time. But what I hope this anecdote illustrates is that there is a real interest here, and it's only a matter of time before the traction starts to pick up. In fact, as of the date of this call, we have now grown our core Otoz team to 30 developers, which includes a number of technical positions for our campus in Lahore as well as another key leadership role for a domain expert to help lead our artificial intelligence efforts. As some of you may recall, back in March of 2019, we announced a strategic partnership and investment with Drivemate in Bangkok, the leading car and riding sharing business in Thailand. Since that time, Otoz team has been focused on strengthening the current Drivemate platform with a specific emphasis on efficiency, security and scalability. And today, I'm excited to announce the first official release that Drivemate has successfully been completed. We also recently headlined in International Asset Finance Network, or IAFN Conference, where our team provided a keynote speech on innovation and Otoz's work in the new mobility economy. At the conference, we also won the P@SHA Innovation Award in the mobility category, providing yet another data point to legitimize our expertise to the outside market. Moving to the other half of our second growth area, strategic partnerships. While I can't give any specific details in that area on today's call, which what I can share currently is that we are working with some of our existing large customers in an effort to align strategically for mobility related offerings. And now our third and final growth area, we are continuing to evaluate opportunities in the marketplace that make sense in being highly accretive and complementary to our business. At this time, we have no updates to report. Looking to the second half of the year, with our current pipeline as well as ongoing major rollouts with existing customers, we have strong visibility to reaffirm our expectations for sequential improvement throughout the balance of fiscal 2020. Before I turn the call over to questions, I'd like to also share some brief remarks about the global events, which have been top of mind for many over the last few weeks. More specifically, given the significant amount of business we can put in the Asia Pacific region, we have naturally received questions about any potential impact we may see from the outbreak of Coronavirus. To date, we have not received any information that leads us to believe, we should expect to incur any negative effect from the disease outbreak with respect to our current business. Although, it is possible to imagine a scenario where we could experience a delay in business development or delivery activities due to a general impact on overall business activities in the region, we have yet to notice that effect take place. In addition to monitoring news updates as well as communication from international health organizations, we are in constant dialogue with our senior management leadership in the region making sure that we are following all the guidelines and best practices to protect our employees. Our chief concern, first and foremost, is for the health and wellbeing of our employees, as the situation currently remains quite fluid, we plan to provide updates to the market should it become relevant. Again, at this time, we do not anticipate any major effect on our current operations. Now with that said, I would like to open the line for questions.

[Operator Instructions] We have a question from the line of Anja Soderstrom, with Sidoti.

Congratulations on a good quarter.

Thank you, Anja.

Can you hear me clearly?

Yes, yes, yes. Go ahead.

Okay, that's good. So first, I wanted to just ask you about this sequential improvement in the second half. What gives you confidence in that? And where do you see that coming from? From the services growing or from the licensing?

I think, as I mentioned in my prepared remarks, we have a very strong pipeline in North America and Europe. And a lot of markets of Asia Pacific, and there's a lot of progress made as a result of our announcement recently going on cloud or a SaaS model, which is actually creating a lot of excitement in the market that they're looking to NETSOL, different demos are going on in different markets. So I feel, given the visibility and the traction we have some deals are about to close, let's say, in the European market, some are good progress in North America and overall Asia. So I'm quite comfortable that the second half, we are cautiously optimistic to be better than H1. Naeem, you want to say something?

Yes. And we traditionally, our second half has always been better for many, many years. A lot of the deals are back-end loaded. A lot of those clients make decisions closer to the end of their fiscal year as well. So where we are positioned in a number of these opportunities, some are very close to being signed off, obviously, until they're signed off they are not signed. But from what we know, they are very close to being signed off. So essentially, they should come in, in the second half.

Okay. So then you're really seeing that the SaaS sales cycle is a lot shorter than it has been for the licensing?

Yes. I think our subscription approach is different because these are normally OpEx type of decisions where they are, including the subscription as part of operational expenses, not of capital expenditure. But it is a shorter buying cycle because it is a smaller amount, which they pay recurring monthly rather than a large upfront license. And that's the -- we've announced earlier, that's the model we are going towards, which is a very proven model now for most of the companies in our space, the Software as a Service as a subscription really is the present and the future. So this is exactly the journey we're on.

Okay. And then in terms of the licensing, I mean, it's normally like larger Tier 1s wants to have the on-premise licensing service. What do you see there in terms of your pipeline and potential interest in something?

Yes, that's never going to be like 0, it will always be -- there are some clients who prefer to purchase their software on license. I think at some point, it will be down to us as a company to design that we absolutely don't do that at all. And we only do one offering, which is subscription. And if we get that disciplined, if our subscription revenue is tracking really strongly, we could probably make those calls at that time. And that actually kind of forces the client to accept subscription as the way to go. And potentially as a long term, this is where I see us going.

Okay. And then the $2 million additional in the services you booked for this quarter, what drove that? Is that additional services that you -- or functions that you've been adding recently? Or was that something that the customer decided before that they maybe didn't need it and realized now that they needed. So they've been adding that? Or...

Services, additional services, what we call change requests. They are always going to be part of our business because business realities change for clients. Sometimes it's regulatory requirements, sometimes it's a business requirement that the change will come in, and they pay a hefty premium for those changes. So those will continue, but very difficult to pick them. But as part of any project, we have never done a project where there has not been additional CR or change request, it always is the case, but you cannot really predict from quarter-to-quarter what that number would be. Yes.

Okay. And it sounds like there will be some exciting announcements, too, in terms of the Otoz Lab. And is that new customers that are looking at that? Or are you -- current customers are -- might be looking to add that on to their already service?

So our target audience is always going to be the large client base we already have. And all of our clients, maybe, I would say, less than 10% would not be but 80% to 90% of the clients that we currently have are looking to enter mobility, smart mobility, on-demand mobility, and they all need solutions. So I recently have been in an event in London, in fact, we did a keynote speech today, and we had a lot of interest from companies around Europe, around the U.S. who came to our stand to talk about mobility. So we are attracting both existing clients for which we have very much a captive audience as well as a new prospect to hear about our Otoz initiatives and they're very interested to know what exactly Otoz is. So really, at this stage, our initial business will come from existing clients because it's a faster route to signing clients. But the new prospects who are getting to know us as a company and what Otoz does. And Otoz is also sold completely on subscription. So that product will never be sold on license. So that's a very exciting part that we never have to change the business model. The business model is a subscription for Otoz. So any new clients that come in, we only present SaaS as the option. So just the short answer is, initially, it will be the existing clients who will use mobility, and that's what we have in the pipeline already. And there will be, obviously, new prospects, so we'll also look at Otoz and potentially sign up as well.

What sort of time line could we expect until something is announced for that, as on your client, like a year? Or is that a couple of months, or...

Well, we -- we got slowed -- yes, we got slowed a little bit due to the situation in China, we were very close to signing a client in China. But then we had to stop some travel going back and forth. But that's certainly a bit of an aberration, and we're hoping things come down in China soon and that the normal travel resumes. So essentially, the client that we had been hoping to sign is in China. It's a Tier 1 auto captive finance company with very big ambition to go into mobility. And they want to launch their mobility with a Otoz platform as a pilot. And then we're also looking to sign up clients in the U.S., again, another Tier 1. That is progressing well. We can't predict the date, but it should be the second half of this year. And lastly, our existing client Drivemate, which is using our platform. That company since has started using parts of our platform, their business is multiplied. They are 3 to 4x in revenue and transactions since Otoz started to work for them. And we haven't even completed the entire delivery yet, which is going to be in May. So really we are seeing Otoz in the live production environment already, parts of it. And we'll have it in full production in May, and that's going to help with references to clients that we're hoping to sign. And keeping in mind, Otoz is literally less than a year old in terms of its development cycle. So we are way ahead in our timeline, how quickly we have delivered the platform. So we're very optimistic for the next second half.

Okay. Well, that sounds exciting. And then lastly, you've been talking about M&A now for -- well, what's exactly looking for in terms of M&A?

Yes. Look, yes, Anja. I did say in my remarks that this is a work in progress. We have certain criteria, the parameters, which we believe, given the opportunities out there in various markets for us, especially North America and Europe, we see a lot of opportunities that can really complement our business and create some accretive growth in our revenue. We haven't done that for quite some time. If you look at the history, one major acquisition was back in 2006. The last one we did is VLS in 2 parts. But business has so many opportunities, and we have responsibility to definitely explore and bring a win-win deal for the company and for the shareholders. So as they develop, we'll definitely share with the market.

[Operator Instructions] At this time, this does conclude our question-and-answer session. If your questions were not addressed during the Q&A session, please contact NETSOL's Investor Relations team by e-mailing them at investors@netsoltech.com or by calling them at (949) 574-3860. I'd now like to turn the call back over to Mr. Ghauri for closing remarks.

Thank you for joining us today. I especially want to thank our investors for their continued support, our loyal customers and our most dedicated employees worldwide for their ongoing contribution. We look forward to updating you on our next call. Operator?

Ladies and gentlemen, this does conclude NETSOL's fiscal second quarter 2020 earnings call. You may now disconnect. Thank you for your participation, and have a wonderful day.