Earnings Call Transcript - NTWK Q1 2023

Patti McGlasson, General Counsel

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. I'll now provide the necessary cautions regarding the forward-looking statements made by management during this call. 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 at www.netsoltech.com and via the link available in today's press release. Now, I'd like to turn the call over to Najeeb.

Najeeb Ghauri, Chairman and CEO

Thank you, Patti and good morning everyone. In the first quarter, we capitalized on the strong momentum built over the course of the past year. Few key takeaways from the quarter. One, as an international company, like many companies, we saw the impact of currency swings in the quarter. Though it is important to look at the results on a constant currency basis. For the quarter, we drove a 15.6% revenue increase on a constant currency basis. Two, a key focus of ours has been to drive long-term growth in our recurring revenues, specifically SaaS and support. This grew 16.6% in the quarter, a bit faster than consolidated revenue. Three, we invest in our people and our growth. We have many exciting growth initiatives that we will get into. But importantly, we need the best people to make that happen. We saw an increase in SG&A, and investing in our people is one of the key reasons for this. Inflation also added to our costs. That said, making sure our people are motivated is critical for long-term shareholder value. Over time, as the business continues to scale, we should be able to drive considerable profitability. Number four, much of our business consists of very long-term contracts. And we continue to build upon this aspect of the business in the quarter. Looking forward, our pipeline is encouraging on this front. And five, our balance sheet is a real competitive asset for us. We do not have a need for capital and have a large cash position that enables us to take a long-term view of the business. Even with economic uncertainty, our recurring revenues, long-term contracts, and robust pipeline, coupled with our strong cash and liquidity position, put us in a very strong position. Within our core business, the pipeline and mix of opportunities remains robust, particularly in our European and North American growth markets, giving us confidence in our ability to drive additional contract signings over the coming months. Within our more venture-focused operations, the continued rollout of Otoz digital retail platform, in partnership with MINI Anywhere has been a resounding early success. Now, with 38 dealerships, 10 additional after the close of this quarter, Q1 subscribed in 15 US states. This success validates our confidence in this platform, as well as providing monthly SaaS subscription revenue of approximately $100,000. In addition to this early success, Otoz has signed a contract with a Tier 1 automotive company in the US for our mobility solution to manage back office operations for vehicles and subscriptions. Across the company, we have expanded our footprint by opening a new office in Tianjin, China to support both the ongoing delivery operations, as well as the professional services vertical growth in China. In Pakistan, China, and in the US, we have hired to not only expand our opportunities and increase sales efforts, but to fulfill the implementation and delivery needs of current and new customers. We are confident that the investments we have made in our leadership, workflows, technology, and expanded sales efforts will bear fruit. With that overview completed, I will now hand the call over to our CFO, Roger Almond, who will walk you through the financial results of the quarter.

Roger Almond, Chief Financial Officer

Thanks, Najeeb. Turning to our fiscal first quarter 2023 financial results for the period ended September 30th, our total net revenues for the first quarter of fiscal 2023 were $12.7 million compared with $13.4 million in the prior year period. The decrease in total net revenues was driven by the devaluation of the foreign currencies compared to the US dollar. On a constant currency basis, net revenues increased 15.6% to $15.5 million. The increase in revenues on a constant currency basis was driven by an increase in license fees of $314,000, an increase in subscription support revenues of $1 million, and an increase in services revenue of $753,000. Recurring revenue or subscription and support revenues were $6 million. On a constant currency basis, this revenue grew 16.6% to $7.3 million compared with $6.2 million in the prior year period. The increase in total subscription and support revenues for the year was a result of several customers who went live with our product in fiscal 2022. We anticipate subscription and support revenue to gradually increase as we implement both our NFS Legacy Product and our NFS Ascent Product. Total service revenues were $6.4 million and on a constant currency basis were $7.9 million compared to $7.2 million in the prior year period. The increase in services revenue for the quarter on a constant currency basis was due to an increase in service revenue for ongoing customers' implementation in China. Services revenue is derived from services provided to both current customers and new customers as part of the implementation process. Total cost of revenues was $8.5 million for the first quarter, an increase of $500,000 from $8 million in the first quarter of 2022. And on a constant currency basis, total cost of revenues was $10.8 million, or an increase of $2.8 million. The increase in cost of sales for the quarter on a constant currency basis was primarily due to increases in salaries and consultant fees of $2.1 million; travel costs of $293,000; depreciation of $121,000; and other costs of $350,000. Gross profit for the first quarter fiscal 2023 was $4.3 million, or 33.5% of net revenues compared to $5.4 million or 40.6% of net revenues in the first quarter of fiscal 2022. On a constant currency basis, gross profit was $4.7 million. The decrease in gross profit on a constant currency basis was primarily due to increases in cost of revenues of $2.8 million, offset by a $2.1 million increase in revenues on a constant currency basis. Operating expenses for the first quarter were $6.1 million or 48.4% of sales compared to $6.1 million or 45.3% of sales in the same period last year. On a constant currency basis, operating expenses for the first quarter were $7.4 million or 47.6% of sales. The increase in operating expenses on a constant currency basis for the quarter was primarily due to increases in selling and marketing expenses of $513,000; general and administrative expenses of $438,000; and research and development costs of $347,000. Turning to our profitability metrics, for the first quarter of fiscal 2023, we had a net loss from operations of $1.9 million and on a constant currency basis net loss of $2.7 million, compared to a net loss of $640,000 in Q1 last year. Our GAAP net loss attributable to NetSol for the first quarter fiscal 2023 totaled $621,000 or $0.06 per diluted share, and on a constant currency basis our net loss totaled $912,000 or $0.08 per diluted share. This compares with GAAP net income of $188,000, or $0.02 per diluted share in the first quarter of last year. The decrease in GAAP net income attributable to NetSol for the quarter was primarily the result of costs to support revenues increasing at a greater rate than increases in revenues. As I mentioned on previous calls, it's important to point out that included in our net loss this quarter was a gain of $1.3 million on foreign currency exchange transactions and on a constant currency basis $1.8 million compared to a gain of $1.3 million in Q1 of last year. Because we operate in several geographic regions, a significant portion of our business is conducted in currencies other than the US dollar. A decrease in the value of the US dollar compared to foreign currency exchange rates generally has affected increasing our revenues, but it also increases our expenses denominated in currencies other than the US dollar. Similarly, as a US 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 US dollar. We plan our business accordingly by deploying additional resources to areas of expansion while continuing to monitor overall expenditures, given the economic uncertainties of our target markets. Moving to our non-GAAP metrics. Our non-GAAP adjusted EBITDA for the first quarter fiscal 2023 totaled a negative $20,000 or $0.0 per diluted share, and on a constant currency basis at negative $136,000 or $0.01 per diluted share compared with non-GAAP adjusted EBITDA of $770,000 or $0.07 per diluted share in the first quarter of last year. Please see the reconciliation schedules contained in our earnings release for revised calculations of adjusted EBITDA for the quarters ended September 30th, 2022 and 2021. Turning to your balance sheet, at quarter end, we had cash and cash equivalents of approximately $21 million or approximately $1.86 per diluted common share. Total NetSol stockholders' equity at September 30, 2022 was $42.1 million or $3.73 per share. That concludes my prepared remarks. I'll now turn the call back over to Najeeb for an overview of our business update.

Najeeb Ghauri, Chairman and CEO

Thank you, Roger. I'll now take a minute to provide updates within the major components of our growth strategy. We are seeing a return to sales growth with a related increase in expenses to support our increased business activity. Our cash position remains healthy, providing additional resources to support our core business, as well as strategic investment in high-return long-term opportunities including our work in the Otoz Innovation Lab. We are cautiously optimistic about our growth overall on a constant currency basis, but are cognizant of the macro and microeconomic challenges facing the world. We hope to be in a better position to provide some financial guidance when we announce second quarter 2023. With that said, we anticipate continuous and double-digit revenue growth of annual recurring revenue in SaaS and support services. Moving on the second component of our strategy, we are innovating in new areas and looking to create partnerships with technology and personnel, which can be a major benefit to our other organizations as well as our own. To this end, I like to take some time to provide a brief update on our progress within the Otoz Innovation Lab. Recent traction in the US through Otoz offering has provided excellent validation of NetSol's commitment to innovation. The MINI Anywhere program, powered by Otoz's Digital Retailing Suite has now been adopted by 38 MINI dealers across 15 states, which include 10 additional enrollments post Q1. At the end of Q1, monthly SaaS subscription and services revenue grew to just over $75,000 with 28 dealers live on the platform and with the 38 dealership enrollment today, monthly recurring revenue reaches approximately $100,000. One of the main catalysts for the continued adoption and buy-in from MINI USA and dealership is the blended one to five lead conversion ratio that MINI Anywhere has achieved, meaning for every five opportunities we're identified through the platform, one of those leads will convert to a vehicle sale. This is proof that despite recent inventory shortages, e-commerce for big ticket purchases is a necessity for the next generation of consumers. Another factor that has been key to the platform's success is the continuous addition of new features primarily driven by understanding dealer and customer needs through data we derive from analytics, user forums, interviews, surveys, and market research. In the most recent update, several enhancements were added including chat capability, allowing customers and dealers to communicate directly in-app and enhance sales enablement tools, allowing dealers to send recommended vehicles and personalized deal structures as deep links for customers to transact seamlessly. The features together cater to more dynamic sales interactions that blend physical and digital touch points and facilitates upselling of add-on products, or negotiation of deal terms. As we progress with enrolling the platform across the nation, we continue to receive multiple dealer enrollments every month. We look forward to continuing the journey with our other partners at MINI USA. And we are very proud to be front and center of technology fit for the industry's shift to digital sales models. We started Otoz because we saw the beginnings of a fundamental change in consumer behavior, not only the way they purchase assets, but also in the way they use assets. Consumer seeks flexibility, affordability, and convenience. And the industry responded by offering new mobility models and alternate usage options, such as car sharing and car subscriptions. We formed a vision to provide OEMs, lenders, and retailers with the technology backbone and tools to sustainably launch and scale these new types of models. As further validation to that vision, I'm excited to share that we've signed a new agreement with a Tier 1 automotive company in the US to provide our Otoz Mobility platform, which will manage back office operations for their vehicles subscription business. Undoubtedly, our success in MINI was a strong reference in winning this contract. And we look forward to evolving both partnerships over the coming months. Looking ahead, we are taking the next steps in our commitments to FinTech innovation, and building innovative SaaS products under the umbrella of our newly formed Appex marketplace starting with our most recent launch of Flex, an API-based, ready-to-use calculation engine that guarantees precise calculations at all stages of the contract lifecycle through various calculation types. Flex is a one-stop solution, providing an instant cloud-based calculation engine with an out-of-the-box integration that can be implemented in an organization's products, services, and ecosystem. We have already seen early traction with European Merchant Bank becoming the fourth subscriber to the Flex solution. Over the coming months, we will continue to market Flex to the global credit industry and launch more build places products like Flex under our Appex marketplace. With two leading US automotive companies trusting the Otoz platform and early traction of our first pure SaaS play product Flex, we are now positioned to be a leading provider of disruptive, innovative, and digital solutions, complementing our flagship asset offerings in the US market and globally. With this already completed, I will now get into our operational updates from this quarter. Starting in APAC and with the previously announced 12-country $110 million contract with Mercedes Benz mobility. We are continuing to make considerable progress along our multi-year multi-country implementation roadmap. I'm happy to report today that we have now successfully delivered 85% of the program. At the moment, we have ongoing implementations in Japan, Korea, Australia, and Taiwan that are expected to be completed within 2023. Finally, our second largest flagship Ascent contract with BMW services saw over $30 million. A global automotive services company in China continues to move forward. Based on additional implementation considerations, we are currently anticipating a 2023 go-live. With the recent execution of new SOWs with different customers across the globe, I'm happy to report that our professional services vertical has started to grow nicely. Demand for additional customization services from existing APAC lines continues to rise as the quarter witnessed revenues earned in excess of $200,000 from these additional services alone. Existing support revenue from our APAC lines is also expected to go up in the following year on account of renegotiations underway and additional services delivered to APAC lines. Looking ahead, our pipeline of opportunities within the APAC region continues to grow. We are encouraged by the quality of opportunities we are seeing in our largest core market and believe the ongoing recovery in this region to be emblematic of a larger return to work across our global operations. Moving next to our European operations, or NTE. Europe and North America remain exciting new growth areas for NetSol. We are strategically marketing our cloud and SaaS-based offering, specifically in these regions, which are contributing to the growing subscription and support revenues noted earlier. We have several opportunities with Europe specifically, that are making their way through the sales cycle. While we can't control when some of these deals get signed, we believe our current momentum, combined with a critical mass of potential deals bodes well for some future events in the coming months. During this quarter, we continue to implement NFS event for a major Scandinavian bank with the plan for full country go-live by 2024. We anticipate considerable new work to be generated from the European market as we move through the process of these implementations. Finishing with our North American operations or NTA, we previously announced the first official sale for NFS Ascent in the US market, and an agreement with Motorcycle Group to deploy the cloud-based version of our flagship platform across their entire operations, including our omnichannel point of sale and contract management system to support retail lending and leasing. Motorcycle Group consists of Moto Lease and Moto Loan, presenting lease and loan offers simultaneously to qualified applicants for their motorcycle and powersports dealers can maximize their sales and enable consumers to prequalify and select their vehicle through motorcycles advisors. Project implementation began in July with an expected go-live in February 2023. Going forward, we will be looking to leverage this breakthrough demand to prospective clients throughout the North American market. Our current pipeline of opportunities in this region remains the greatest near-term growth opportunity for our business. In summary, we had a strong start to the year. We are seeing healthy recovery in all our operating regions and are making investments today that will support sustainable growth for the future. And with that, we can open the call for questions.

Operator, Operator

Thank you. We'll now conduct a question-and-answer session. Our first question comes from Carl Phillips with Union Street Capital. Please proceed with your question.

Unidentified Analyst, Analyst

Hey, thanks for taking my questions. So, my first question is, I know that you invested in the business a bit this quarter and had some inflation pressure. But you know, as you think about the business over the mid to long term, how should I think about where margins could potentially go if you're able to continue to drive revenue growth? I saw just to be clear, I'm not looking for guidance, I just want to understand how you're thinking about this?

Najeeb Ghauri, Chairman and CEO

Thank you. Historically, gross margins have been strong, around 16%, and operating margins have ranged from 30% to 40%. In peak times like 2019, these margins were at their best. I believe that as we continue to grow revenue and sign more contracts, it will positively impact both margins. Additionally, we have transitioned to a SaaS revenue model over the past two years. Although this shift initially had a negative effect on revenue growth, SaaS revenue growth is now impressive, and we're seeing healthy growth in this fiscal year. I'm confident that revenue will increase and margins will improve, sustaining this growth in the long term.

Unidentified Analyst, Analyst

Got it. Okay. And then your recurring revenue grew that faster than your consolidated revenue this quarter and I was just wondering, is this a trend that we can expect to sustain?

Najeeb Ghauri, Chairman and CEO

I find the signs to be encouraging. I've openly discussed the challenges we've faced in our industry, but I'm confident due to our strong pipeline. Activities are increasing across all regions: North America, Europe, and Asia-Pacific. We believe we can achieve sustainable revenue growth and a faster compound annual growth rate overall. This trend in revenue is very promising. Our investments in personnel, technology, and leadership are driven by the expanding opportunities we see. While it's taking time, I believe these are strong indicators for consistently growing revenue.

Unidentified Analyst, Analyst

Got it. Okay. Thank you. That's it for me.

Najeeb Ghauri, Chairman and CEO

Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Robert Greene with Partners. Please proceed with your question.

Unidentified Analyst, Analyst

Hey guys. Thanks for taking my questions as well. First off, does uncertainty concerning new cars affect your business?

Najeeb Ghauri, Chairman and CEO

Hello, sorry, we lost you. Hello.

Unidentified Analyst, Analyst

Hello. Can you hear me?

Najeeb Ghauri, Chairman and CEO

Yes. Yes, can you please start over again? Sorry, we missed it.

Unidentified Analyst, Analyst

No worries. So, does uncertainty concerning new cars affect your business?

Najeeb Ghauri, Chairman and CEO

I think yes or no. I believe, of course, there's the shortage supply chain, worldwide. We're seeing noticeable activity on both fronts. I believe the particularly North American market is quite resilient and strong. We have more opportunities the last few months than ever before. That's a sign that the US market is healthy and strong. And there is still demand for all of our business, our product, and our solution. So, I'm pretty encouraged with opportunities in the US. So, I don't see any threat of any kind of further deterioration design.

Unidentified Analyst, Analyst

Got it. Got it. Thank you. And then just second, it looks like North America did well this quarter. Just a relatively new market for you. Could you expand on how North America kind of fits into your global strategy?

Najeeb Ghauri, Chairman and CEO

This is not a new market for us. We have been focusing on the Asia-Pacific region because we have captured a significant market share there, particularly in China, and in other markets throughout the region. We contribute a lot from that area, and it always required more readiness in terms of product, team, and experience compared to other regions. Our strategy is to replicate our success in China, especially with large Tier 1 customers, within the US market. This is a major market, the largest of all regions. We are setting ourselves up with the right team, strategy, and new verticals, in addition to our core business. I believe that NetSol US will yield our most significant successes in the upcoming years. We've been focused on APAC and Europe for many years by choice, and over the last two years, we have actively engaged with new and existing customers to bring in the right talent to unlock this market impressively in the near future. This is an exciting time for us in the US, and we hope to secure some contracts in the coming months.

Unidentified Analyst, Analyst

Great, great. Thank you. That's all for me.

Najeeb Ghauri, Chairman and CEO

Thank you.

Operator, Operator

Thank you. 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 emailing them at [email protected] or by calling them at 949-574-3860. I'd like to turn the call back over to Mr. Ghauri for his closing remarks.

Najeeb Ghauri, Chairman and CEO

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

Operator, Operator

Thank you for joining us today for NetSol's fiscal first quarter 2023 earnings call. You may now disconnect.