Earnings Call Transcript - NTWK Q2 2020

Operator, Operator

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.

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. 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 the link available in today's press release. Now I would like to turn the call over to Najeeb. Najeeb?

Najeeb Ghauri, CEO

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 our London office, where I'm visiting with members of our U.K. team and our business affiliates and getting updates on a number of the initiatives we've been pursuing 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 to the NASDAQ MarketSite in New York City for their formal closing bell ceremony. While NETSOL has presided over many closing bells and opening bells in the past since we went public, this particular event held special meaning 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 two areas, we've been able to build an adaptable technology organization 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 initiative focused on highlighting our expanded cloud-based offerings, 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 several other exciting projects, which I plan to detail shortly. 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 underlines the ongoing industry shift to more complex deployments. While our year-to-date results reflect our ongoing efforts to transition NETSOL towards a 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. Operationally, we began the initial application of our three-pronged growth strategy, which has yielded favorable results already. More specifically, in November, we closed our first official sale of NFS Ascent in North America, which represented the first SaaS-based agreement for Ascent in this region. Additionally, our mobility-focused 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, to walk us through our results for the quarter. Roger?

Roger Almond, CFO

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 quarter's inclusion of approximately $1.1 million in license fees related to our $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 automotive 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 was $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, as well as 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 declines 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, up 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 compensatory 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 rates 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 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 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?

Najeeb Ghauri, CEO

Thank you, Roger. I'll start my comments by highlighting some of the key operational achievements from the period. In the Asia Pacific region, with our previously announced contract worth $110 million with Daimler Financial Services in Germany, we are making significant progress on our multi-year, multi-country implementation roadmap. During this period, we successfully launched our NFS Ascent retail platform in Hong Kong, which includes our Omni-Point of Sale and contract management system. Looking ahead, we expect to announce upcoming launches in Singapore, Malaysia, and Thailand for Daimler Financial Services in the coming months. We have additional deployments planned for new territories and more launches scheduled for areas where we are partially operational, with announcements anticipated in the following calendar years. Overall, we are performing under budget and ahead of schedule. Regarding our ongoing project with BMW Financials in China, we announced a successful implementation and launch of our NFS Ascent wholesale platform in October. Notably, this implementation is the first BMW Group project in the finance and leasing phase delivered on time and within budget in the past nine years. Our customer is very pleased with the rollout, and we look forward to delivering the next phase, our retail platform, later this calendar year. During the quarter, we also launched our mCollector application for a top-tier multi-finance company in Indonesia, part of a larger contract signed in 2018. In New Zealand, we are making substantial progress towards deploying our NFS Ascent retail platform for a captive equipment finance company, with a projected launch timeframe in early fiscal 2021. In Europe, we signed a $4 million contract with BCA, a large independent vehicle finance company in the U.K., for implementing our NFS Ascent wholesale finance platform. We believe this initial rollout in Europe will be invaluable for future business in the region, and we are focused on ensuring a flawless implementation. We are also in the final stages with another customer in the U.K. for a launch of our LeaseSoft product. While we expect future business from this offering, our focus remains on expanding our growth through our flagship Ascent platform in Europe and the U.S. Now, I am excited to share updates about our new subscription-based pricing model for cloud-based products, which we believe will positively impact our business long-term. While multinational organizations may prefer the legacy licensing model, we think this new offering will be transformative for new deals with smaller and budget-conscious enterprises. The removal of upfront license fees allows organizations to spread software usage and maintenance costs over time, avoiding lengthy procurement cycles. Although we continue to grow our services revenues and maintenance fees, we remain vulnerable to the inherent irregularities of licensing contracts. Our goal is to strengthen our revenue base with consistent SaaS contracts. During fiscal Q2, we secured our first North American NFS Ascent win with SCI Lease Corp, a Canadian national automotive leasing company, marking our first SaaS-based agreement in this region. We aim for a smooth rollout with a target launch later this fiscal year. A successful deployment here will serve as a strong reference point in North America, similar to its role in Europe. I will now provide updates on our three-pronged growth strategy. First, our core business remains healthy, as evidenced by the operational highlights shared earlier. In Q2, we generated an additional $2 million by fulfilling extra service requests from customers across multiple regions, showcasing our team's adaptability. As deployments grow in complexity, we are strategically increasing our headcount at our Lahore campus to meet rising demands. Additionally, our new subscription pricing model and expanded geographic reach are yielding positive results. We have made leadership appointments to strengthen our regional teams. Chris Mobley has joined as the head of NFS Ascent wholesale operations in Europe and will focus on launching our new subscription pricing strategy and driving growth. We also plan to announce additional senior leadership positions in our Americas division soon. Moving to our second growth area, we see increasing interest in our Otoz Innovation Lab from a variety of potential customers, from international companies to fast-growing start-ups. We are engaged in pilot discussions with a significant customer and are optimistic about future opportunities. Our Otoz team has expanded to 30 developers, including a new leadership role focused on artificial intelligence efforts. We've made progress with our strategic partnership with Drivemate in Thailand, successfully enhancing their platform. Recently, we presented at the International Asset Finance Network Conference and won the P@SHA Innovation Award for our expertise in mobility. Lastly, we are evaluating market opportunities that are complementary to our business. As we head into the second half of the year, our pipeline and ongoing major rollouts position us well for sequential growth as we continue fiscal 2020. In light of recent global events, particularly concerning the Coronavirus outbreak, we have received inquiries about potential impacts on our business. So far, we have not seen any indications of negative effects on our operations. While there could be delays in business development, we haven't noticed any issues. We are closely monitoring the situation and prioritizing the health and safety of our employees. Now, I would like to open the line for questions.

Operator, Operator

We have a question from Anja Soderstrom with Sidoti.

Anja Soderstrom, Analyst

Congratulations on a good quarter.

Najeeb Ghauri, CEO

Thank you, Anja.

Anja Soderstrom, Analyst

Can you hear me clearly?

Najeeb Ghauri, CEO

Yes, yes, yes. Go ahead.

Anja Soderstrom, Analyst

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?

Najeeb Ghauri, CEO

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 in 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. Different demos are going on in different markets. So I feel, given the visibility and traction we have, some deals are about to close, in the European market and good progress in North America and overall Asia. So I'm quite comfortable that the second half, we are cautiously optimistic it will be better than H1. Naeem, do you want to say something?

Naeem Ghauri, President, Global Sales and CEO, Otoz

Yes. And traditionally, our second half has always been better for many, many years. A lot of the deals are back-end loaded. Many clients make decisions closer to the end of their fiscal year. 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 finalized. So essentially, they should come in during the second half.

Anja Soderstrom, Analyst

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

Naeem Ghauri, President, Global Sales and CEO, Otoz

Yes. I believe our subscription model is distinct because these decisions are typically classified as operational expenses rather than capital expenditures. Additionally, the buying cycle is shorter due to the smaller, recurring monthly payments instead of a large upfront license fee. As we previously announced, this is the approach we are transitioning to, which has proven successful for most companies in our industry. The Software as a Service subscription model is well established and represents the future. This reflects the path we are currently on.

Anja Soderstrom, Analyst

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

Najeeb Ghauri, CEO

Yes, that's never going to be zero. There are always 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 decide we absolutely won't do that at all. And we only offer one option, which is subscription. 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.

Anja Soderstrom, Analyst

Okay. And then the $2 million additional in the services you booked for this quarter, what drove that? Is that additional services 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?

Najeeb Ghauri, CEO

Additional services, what we call change requests, are always going to be part of our business because business realities change for clients. Sometimes it's regulatory requirements and sometimes it's a business requirement that the change will come in, and they pay a hefty premium for those changes. Those will continue, but it is very difficult to predict them. However, as part of any project, we have never done a project where there has not been additional change requests; it always is the case, but predicting that number from quarter-to-quarter is challenging.

Anja Soderstrom, Analyst

Okay. It seems there will be some exciting announcements regarding the Otoz Lab. Are these new customers considering it, or are current customers looking to add it to their existing services?

Najeeb Ghauri, CEO

So our target audience is always going to be the large client base we already have. I would say maybe, around 10% would not be, but 80% to 90% of our current clients are looking to enter mobility, smart mobility, on-demand mobility, and they all need solutions. I recently attended an event in London, where we did a keynote speech, and we had a lot of interest from companies across Europe and the U.S. who came to our stand to talk about mobility. So we are attracting both existing clients, for which we have a very much a captive audience, as well as new prospects who are very interested to know about our Otoz initiatives. Really, at this stage, our initial business will come from existing clients because it's a faster route to signing contracts.

Anja Soderstrom, Analyst

What sort of timeline could we expect until something is announced for that, on your client, like a year? Or is that a couple of months?

Najeeb Ghauri, CEO

We got slowed down 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 a bit of an aberration, and we're hoping things calm down in China soon and that normal travel resumes. Essentially, the client we're hoping to sign is in China. It's a Tier 1 automotive captive finance company with big ambitions to enter mobility. And they want to launch their mobility pilot with our Otoz platform. We're also looking to sign clients in the U.S. as well, another Tier 1. That is progressing well, but we can't predict the date. It should be in the second half of this year. Lastly, our existing client Drivemate has started using parts of our platform, and their business has multiplied. They are 3 to 4 times in revenue and transactions since Otoz started working for them. And we haven't even completed the entire delivery yet, which is scheduled for May. We are seeing Otoz already in the live production environment, and we’ll have it in full production in May, which will help with references to clients we hope to sign. Keep in mind, Otoz is less than a year old in terms of its development cycle, so we're way ahead of our timeline, how quickly we have delivered the platform. We're very optimistic for the next second half.

Anja Soderstrom, Analyst

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

Najeeb Ghauri, CEO

Yes, I did say in my remarks that this is a work in progress. We have certain criteria and parameters, given the opportunities out there in various markets for us, especially in North America and Europe. We see many 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 was VLS in two parts. The business has many opportunities, and we have a responsibility to explore and bring a win-win deal for the company and shareholders. As opportunities develop, we will share them with the market.

Operator, Operator

At this time, this concludes our question-and-answer session. If your questions were 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 now like to turn the call back over to Mr. Ghauri for closing remarks.

Najeeb Ghauri, CEO

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 contributions. We look forward to updating you on our next call. Operator?

Operator, 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.