Earnings Call Transcript - NTWK Q2 2023

Operator, Operator

Good morning. Welcome to NetSol Technologies Second Quarter 2023 Earnings Conference Call. On the call today are Najeeb Ghauri, Chairman and Chief Executive Officer; Roger Almond, Chief Financial Officer; and Patti McGlasson, General Counsel. Please note, this call is being recorded. 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 the 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. 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 and 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?

Najeeb Ghauri, CEO

Thank you, Patti, and good morning, everyone. We've made a lot of strategic progress this quarter, which I look forward to sharing with you. That said, our second quarter financial results were not where we wanted them to be. There were various reasons for this, some within our control and some outside of our control. First, it's important to understand that in the second quarter last year, we had $3.5 million in one-time revenue due to a one-time cumulative catch-up on a large contract, which impacted our comparisons. Second, approximately $2 million in revenue that we expected to realize in the quarter was delayed, and we expect to realize it in the third fiscal quarter. With this lower revenue, our margin and profitability were below our expectations. As such, we have reexamined our cost structure to not only better align it with today's revenue but also reprioritize our capital allocation to the most attractive parts of our business with the greatest opportunity to drive sustained growth in revenue and profitability. We expect to cut at least $4 million in costs from the business by the end of the fiscal year. In short, we will be a more focused company better positioned to achieve a return to positive cash flow for our shareholders. Before we get into the details of the quarter, let's keep a few things in mind. Number one, we have a hard-fought market-leading position in Asia, a growing market share in Europe, and a unique opportunity to grow in the U.S. Number two, the higher margin recurring revenue portion of our business is doing well, and there's opportunity for it to do better. And three, we are at the front end of some of the most innovative technology for our clients. For example, we were ahead of the curve on integrating AI and machine learning into our customer products and are laser-focused on delivering this to our customers. And four, our balance sheet is rock solid with a competitive advantage of a strong cash position built from good old-fashioned cash generation. We have every intention to get back to positive cash generation and have a clear plan to get there. We are focused on expanding our presence in the North American market, particularly in the U.S., which is our most vibrant market. We are very excited about the opportunities we are seeing for our products and services in this region. For example, Otoz, our mobile, AI and machine learning-based solution, has emerged as a very attractive product in this market, and we continue to develop and evolve our product range to specifically target North American customers. We're also growing our partnership with consultants, system integrators, and tech partners, including Amazon Web Services and a Tier 1 automotive company through Otoz that will further help to scale our North American operations. During this quarter, we went live with our 37th dealer, and we now have dealers in 16 states. Our sales pipeline remained strong with an increase to $250 million in the second quarter. The sales cycles can be very long in our business, particularly for some of the larger deals, but we are enhancing our positioning to compete for some of these larger deals and are quite optimistic about many of the opportunities we are pursuing. Before I provide a more in-depth overview of our business, I'd first like to turn the call over to Roger Almond, our CFO, who will walk you through our financials for the quarter. Go ahead, Roger.

Roger Almond, CFO

Thanks, Najeeb. Turning to our fiscal second quarter 2023 financial results for the period ended December 31, 2022, our total net revenues for the second quarter of fiscal 2023 were $12.4 million compared with $15.5 million in the prior year period. On a constant currency basis, net revenues were $14.6 million. License fees were $15,900 compared with $1.9 million in the prior year period and were $16,200 on a constant currency basis. Recurring revenue or subscription and support revenues were $6.5 million compared with $9.4 million in the prior year period. The decrease in total subscription and support revenues for the second quarter of 2023 was primarily due to the recording of approximately $3.5 million as a one-time cumulative catch-up in the second quarter of 2022 due to our amendment to our 10-year contract with Daimler Financial Services. On a normalized basis, excluding the one-time cumulative catch-up in the same quarter of last year, we actually saw an increase in our total subscription and support revenue for the quarter on both a GAAP and a constant currency basis. Total services revenues were $5.9 million compared with $4.1 million in the prior year period. On a constant currency basis, total services revenues were $6.9 million. Services revenues were derived from services provided to both current customers as well as services provided to new customers as part of the implementation process. Total cost of revenues was $9.3 million for the second quarter, an increase of $1.4 million from the second quarter of fiscal year 2022. On a constant currency basis, total cost of revenues was $11.3 million. Gross profit for the second quarter of fiscal 2023 was $3.1 million or 25.4% of net revenues compared to $7.6 million or 49.4% of net revenues in the second quarter of fiscal 2022. On a constant currency basis, gross profit was $3.3 million. Operating expenses for the second quarter were $6.2 million or 50% of sales compared to $6 million or 38.7% of sales in the same period last year. On a constant currency basis, operating expenses for the second quarter were $7.2 million or 49.4% of sales. Turning to our profitability metrics. For the second quarter of fiscal 2023, we had a net loss from operations of $3 million compared to net income from operations of $1.7 million in the prior year period. On a constant currency basis, the net loss from operations was $3.9 million. Our GAAP net loss attributable to NetSol for the second quarter of fiscal 2023 totaled $2.1 million or $0.19 per diluted share compared with GAAP net income of $1.4 million or $0.13 per diluted share in the second quarter of last year. On a constant currency basis, our net loss attributable to NetSol totaled $2.7 million or $0.24 per diluted share. As always, it's important to point out that included in our net loss this quarter was a gain of $657,000 on foreign currency exchange transactions compared to a gain of $901,000 in Q2 of last year. On a constant currency basis, we realized a gain of $827,000 on foreign currency exchange transactions. 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 markets. Moving to our non-GAAP metrics. Non-GAAP adjusted EBITDA for the second quarter of fiscal 2023 was a loss of $1.3 million or $0.12 per diluted share compared with non-GAAP adjusted EBITDA of $2.1 million or $0.19 per diluted share in the second quarter of last year. Please see the reconciliation schedules contained in our earnings release for our revised calculations of adjusted EBITDA for the quarters ended December 31, 2022, and 2021. Turning to our balance sheet. At the quarter end, we had cash and cash equivalents of approximately $21 million or approximately $1.86 per diluted common share. The NetSol stockholders' equity at December 31, 2022, was $44.4 million or $3.93 per share. That concludes my prepared remarks. Now I will turn the time back over to Najeeb for an overview of our business updates. Najeeb?

Najeeb Ghauri, CEO

Thank you, Roger. As I mentioned earlier, we are implementing cost reduction initiatives that we believe will drive efficiency and better align our resources. We expect that our efficiency measures will add at least $4 million in EBITDA in the next fiscal year and accelerate our return to profitability. Perhaps the most exciting component in our growth strategy right now is our expansion into the North American market. This market represents a robust growth opportunity for our business, particularly as we exit the coronavirus pandemic, which created accelerated demand for modernization and digitization in the industry. Specifically, we are seeing demand related to customers that required a digital entry point to their financial services provider and employees who have shifted to remote work and acquired the ability to digitally provide financial services to customers. As a result, our core customers, financial institutions, automotive and equipment OEMs, and automotive dealers realize that their IT infrastructure needed to adapt to these changes, and our products are ideally suited to meet their needs. Moreover, the increased demand for cloud-based services has positioned our NETSOL Cloud Services division to capture increased market share as we support both new and existing customers in modernizing their IT infrastructures. To that end, Otoz offerings continue to see excellent traction in the United States, which illustrates the power of NetSol's commitment to innovation. Since last quarter, Otoz has expanded its U.S. presence to include 37 dealers across the 16 states, showcasing the healthy and growing demand for our SaaS and AI-based platforms in this region. Additionally, in the second quarter of fiscal 2023, we entered into a new multimillion-dollar agreement with a Tier 1 automotive company in the United States, which will implement and license our Otoz Mobility Solution to manage back-office operations for vehicle subscriptions. Otoz penetration in the U.S. has been an excellent catalyst for our growth in this market, and we are further accelerating our expansion by investing in our partnerships with consultants, system integrators, and other technology partners. In the second quarter, we were pleased to expand our partnership with Amazon Web Services, or AWS, and became an API gateway delivery partner. We expect this partnership to position NETSOL to expand our cloud capabilities by providing us with a fully managed service with developers to create, publish, maintain, monitor, and secure application programming interfaces at any scale. Finally, we are making good progress establishing a support and delivery system center in Austin, Texas, which is quickly becoming a hotspot for tech businesses in the U.S. This planned location is expected to accommodate a sales and support staff, which will grow in the coming months. Now let me talk about the APAC and Europe region. Our business in the Asia Pacific and European markets continue to provide stable and reliable revenues. In APAC, our revenues decreased compared to the second quarter of 2022. However, this is our largest and most established market, and with the progress that we continue to make on our multi-year, multi-country implementation roadmap, we are confident that we are positioned for sustainable positive results in this region. Our European operations provide us with more growth opportunities as compared to APAC, where we are already established as a leading provider of finance-leading software in the region. Our cloud-based and SaaS offerings continue to gain traction in the European market, contributing to our recurring subscription and support base revenues, which we believe represent a very attractive opportunity for NETSOL going forward. Our second quarter revenues in the European market increased slightly compared to the prior year period. We anticipate that through a combination of our cloud-based and SaaS offering and the implementation of NFS Ascent for a major Scandinavian bank across four countries in 2024, we are well positioned to deliver improved results. In summary, while our second quarter results were not where we wanted to be, we are enthusiastic about the value-driving initiatives underway. We are making significant progress executing our strategy to grow in the U.S. We are initiating a cost reduction plan that will cut over $4 million out of the business while not impacting key growth areas such as the U.S. Our technology partnerships and technology offerings continue to grow. And finally, with strong market share and a healthy balance sheet, we have a very strong foundation upon which we wish to build. And with that, we can open the call for questions.

Operator, Operator

Our first question comes from Todd Felte from AGES Financial Services.

Todd Felte, Analyst

A few times during the call, you referred to your market-leading position in Europe. I was wondering if you could give us an estimate of your percentage of market share in Europe, Asia Pacific region, and North America.

Najeeb Ghauri, CEO

Thank you for your question, Todd. As you are aware, the market is quite fragmented across all three regions, making it challenging to accurately assess our market position. However, we have been established in Europe since 2005 with an office in Horsham, where we have a substantial team. Recently, we've secured new contracts, including one with a Scandinavian bank, which is a new account, along with other developments in the region. We believe we are increasing our market share in Europe, evidenced by the number of competitors and our involvement in various RFPs. In APAC, particularly in China, we maintain our status as a leading company, backed by our strong contract portfolio. We are confident in our leading position across APAC, even though pinning down an exact percentage is difficult. Our presence in Japan, China, Australia, and New Zealand is robust. I'm optimistic about our China market growth, especially since we've introduced a new vertical to support local businesses, called professional services. Our head of operations, Amanda Li, has ambitious plans to promote this offering, and we've hired around 45 to 47 local employees in China over the past six months. There is significant growth potential in professional services at an impressive rate. Regarding North America, this market is particularly exciting for us. Although we haven't seen immediate results this quarter, we've invested over 1.5 years into bringing in senior executives, including Peter Minshall. In our core business areas of Ascent and mobility, we've signed a significant contract with AutoNation, a well-known name. We're engaged in several major RFPs and have a billion-dollar sales pipeline primarily focused in the United States. Our U.S. strategy is intentional; we’re investing now as we have maximized our potential in APAC and are making a one-time investment in China. Despite the struggles of other economies, the U.S. economy remains strong. We're also establishing a new office in Austin, Texas, which will serve as our hub for U.S. customers and the market. Given our activities over the past year, although the sales cycle is lengthy, the values are appealing, and we are confident in making notable progress in the second half of the year. While the nature of our business is unpredictable, we are strong candidates for major opportunities and are excited about our full commitment to the U.S. market. We believe this market will significantly impact the company's landscape in the upcoming quarters and years, and we are confident that investing in it is the right choice.

Todd Felte, Analyst

Okay. I mean when I look at the 30,000-foot view, I see that we've hired over 500 employees in the last few quarters. Our revenue has decreased in the last few quarters. But our sales pipeline has gone from under $200 million to $250 million. So when we do finally have this breakthrough, do you expect the revenues to jump from $12 million? Are we going to start having $20 million to $25 million quarters, given our pipeline is $250 million? And it's just a little frustrating that salaries and consultant expenses have now grown to over 50% of revenue. So we've got all these new employees on, and we're kind of hoping that the dam breaks, so to speak, and we see this jump in revenues. I was hoping you could add some color to that.

Najeeb Ghauri, CEO

Todd, I really understand your frustration. And I think I recognize that not just you but all the investors wish to see real results and have an impressive ROI eventually at some point. The color on the hiring of the people, I'll give you three categories. In the COVID period, things were really tough. You know the story. Everybody was going through the same thing. And now we are over a year beyond the COVID pandemic. What we have done is, there are three key areas that we added as new additional verticals to grow revenue. We don't want to depend completely on the flagship Ascent. It is a long field cycle. You want to go into some more digital mobility platform, where you have more sales opportunities and higher sales volumes. Now, AWS is one area. We hired almost 75 or 80 people in the last nine months. We're investing in their certification and training, and there are doors opening up. And that's a brand-new investment within six or nine months. So we hope to see some results, and there's a lot of activity going on. The second area is professional services. China is the key right now where we really invested in. We've never invested so much in the local Chinese sales force or team specialized in professional services. What it does is that this is a time, I believe, to invest in growing the business in different verticals linked to FinTechs and our core business. So China is another place we're investing. And of course, in the U.S., we will continue to bring people from across our company globally and hire local. You can imagine the magnitude and size of the U.S. market. We believe the reason we are late to the market is that we have now enough implementations of Ascent, particularly in China and the 12 markets of Asia Pacific and some now in Europe. What it does is it has given us a much better ability to position ourselves on multimillion-dollar projects because we have experience in the Chinese market with large OEMs like BMW and Daimler Financial Services. These are top-notch names, and these are great reference points to bid for local U.S. customers. In addition to not just this core business that we're trying to position ourselves where the pipeline is, we're also building our SaaS revenues in cloud and mobility. So there's a lot of action in a lot of fronts, and you see the numbers; you're right, we have added 450 to 500 people. But at the same time, this exercise is ongoing. We started this exercise a few weeks ago before this quarter ended to find ways to become a more efficient company, to be leaner, and to be more productive. And the reason is we had to put a lot of bench. I mean, the numbers I just mentioned, this is the largest bank we ever had in our history, simply because these are new opportunistic verticals. We believe strongly that we can do a good job given that our experience as an IT company and now in FinTech, we have the ability to reach out to larger customers and demonstrate that we can build new opportunity in the U.S. market, not just our main business but new opportunities like AWS and professional services and so forth. These are investment driven. It's tough. We monitor our cash and hiring very carefully. And now we're in the process aggressively to at least take out 20% of the headcount to be a more efficient company. The numbers I just mentioned; my goal is to at least achieve a $4 million improved bottom line in EBITDA and net income. These are hard decisions, but they are necessary under the current environment filled with inflation and other issues. You mentioned rightly that we have to maintain our core team in Lahore and other offices around the world to ensure that we do not lose them due to high inflation, and we will do whatever it takes to not lose our good employees while bringing fresh new people in to build investment for the future in the U.S. I think these are all right points indicating that not only will we grow revenue in the coming quarters but also achieve very profitable gross profit and net income.

Todd Felte, Analyst

Okay. If I was trying to model this out, given the $250 million backlog, the long sales cycle, and also all the exciting opportunities you just discussed, I mean a year from now, are we hoping to be doing $20 million to $25 million in revenue a quarter? Or is that too optimistic? Or is the growth going to be...

Najeeb Ghauri, CEO

It's not too optimistic. You're right on the money; it's not too optimistic. It is actually our own wish and goals to achieve those double numbers. I think when we talk about these high pipeline, look, I'm sure you're familiar with how long the sales cycle can be in our kind of business. We're not all that shell company which has the customers spending days, weeks, months narrowing down from ten to five to three to now two. I'm giving just a generic example. And some of them want to visit Lahore, which is where you could sign. One or two of these deals in the next six months can hit the number you're talking about, and I'm pretty confident of that. One way to look at it is our current revenue is pretty stable. Because this quarter, you didn't see any growth, and we obviously could not recognize at least $2 million in Q2 due to the timeline, but the deal was signed, and this is based in Australia. We think we can recognize that in Q3. But the real excitement is the big deals we are working on day and night. Patti follows through with these customers and goes through all these detailed legal agreements. So that means that our office in Lahore is very active right now. I'm here, and I can see that. We do need some good luck as well. We are not missing any opportunity. And we would like to turn the corner. I mean we know we have disappointed the market, and I admit that. But sometimes you don't have a lot of control; you do your best, feel confident that you’ll make it, and then things get delayed. We are very confident we will have some new contracts in the coming months that will dramatically change our numbers.

Todd Felte, Analyst

Okay. Well, that's great to hear on the potential upcoming revenue growth. I hope you keep us all informed and announce some of these contracts and revenue as they come in, and I'll get off the call. I've taken enough of your time and I thank you for answering the questions.

Najeeb Ghauri, CEO

You are always welcome, Todd. Thank you and have a good day.

Operator, Operator

Our next question comes from the line of an indiscernible speaker.

Unidentified Analyst, Analyst

First one, could you just provide a little more insight concerning the timing of the implementation of the $4 million in cost reductions? Will this be immediate or implemented over the balance of the year?

Najeeb Ghauri, CEO

We have started the process a few weeks ago, and it is a work in progress with our HR and each head of the departments have been given targets to implement these across their division or departments within the company. The timeline is you'll see some tangible value, if not in the third quarter, then in the fourth quarter by the time you have some severances and the timeline all come together. But the real benefit will be in the fiscal year 2024, beginning of 2024, which is about two quarters from now.

Unidentified Analyst, Analyst

Got it. Okay. And then just to make sure I'm understanding. So will the efficiency measures impact your strategic investment in the U.S.? Or are they mostly focused on other parts of your business?

Najeeb Ghauri, CEO

No. The U.S. is where we're investing, actually. We are very lean, both in my U.S. operation in North America and our corporate team is very lean. Actually, we're also downsizing our U.S. corporate offices to a bit more leaner instead of investing in the business side of it. Now we will be investing in people, in infrastructure, travel back and forth. The U.S. market provides a big opportunity for us, and we'll put all our best talent, energy, and financial investment into it to see real results from our efforts over the years.

Unidentified Analyst, Analyst

Okay. Great. And then just my last question. So you mentioned AI and machine learning in your offerings. Just wondering if you could provide a little more color around how this technology is integrated into your solutions.

Najeeb Ghauri, CEO

Well, AI is very popular worldwide, as you know. In our business, customers are benefiting from our different modules. We implemented AI and machine learning into our offerings on a case-by-case basis, depending on the need of the customers. Our algorithm is capable of identifying risk on application during the valuation process for leases or loans. We are able to train our people on specific data provided by banks or financing companies and so on. I think there's a lot going on in this new tool that is becoming one of the hottest tools right now in all the developing technology sectors. I am confident that AI will be a leading force in many, many ways to help our customers build into the product and make the product more quick and efficient. We’ve hired a couple of MIT PhDs, and we brought them to our facility in Lahore, where they are playing a big part in building solutions for our customer base. So it's a very good development for the company.

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 would now like to turn the call back over to Mr. Ghauri for his 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 for their ongoing contributions. We look forward to updating you on our next call.

Operator, Operator

Thank you for joining us today for NETSOL's Fiscal Second Quarter 2023 Earnings Call. You may now disconnect your lines.