NetSol Technologies Inc (NTWK) 2016 Q2 法說會逐字稿

Good morning and welcome to the NetSol second quarter 2016 earnings conference call. All participants will be in listen-only mode. (Operator Instructions).

After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded.

I would now like to turn the conference over to Patti McGlasson, Senior Vice President, Legal and Corporate Affairs, General Counsel, and Corporate Secretary. Please go ahead.

Good morning, everyone, and thank you for joining us today to discuss NetSol Technologies' fiscal 2016 second quarter results.

On the call today are Najeeb Ghauri, Chairman and Chief Executive Officer; Roger Almond, Chief Financial Officer; and Naeem Ghauri, President and Head of Global Sales.

Following a review of the Company's business highlights and financial results, we will open the call up for questions. The call is scheduled for one hour.

First, some housekeeping before we begin. Please note that all of the information discussed on today's call is covered under the Safe Harbor provisions of the Private Security Litigation Reform Act. The Company's discussion may include forward-looking information 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 its Annual Reports on 10-K and Quarterly Reports on Form 10-Q.

I would also like to point out that NetSol will be discussing certain non-GAAP measures. The released issued earlier today contains a reconciliation of these non-GAAP financial results to the most comparable GAAP measures.

In addition, I'd like to remind everyone that today's call is being webcast at www.netsoltech.com. At the conclusion of the call, the webcast may be accessed on the NetSol website, where it will be archived for 90 days.

With that, I will now turn the call over to Najeeb. Najeeb?

Thank you, Patti, and welcome, everyone. To those on the call in the US and North America, as well as those coming from Europe and Asia, I am very pleased to be reporting from NetSol's global delivery center in Lahore Pakistan, while Naeem Ghauri from Bangkok, and Roger Almond from our headquarters in Los Angeles.

We are very pleased with our results today, highlighting the leverage we have built in our business. We also are pleased to reinstate guidance, the first time we have done from a quantitative standpoint since before our NFS Ascent transition period, as a result of greater visibility, in part due to multiple longer-term contracts underway, including our 12-country NFS ascent contract, further underscoring our confidence at a number of positive developments.

New wins in Europe, including an important win for NFS Ascent in the region, with a tier one SF finance institution, which serves as a strong reference point for our marketing efforts.

Continued requests and a growing new business pipeline in China, something I've highlighted in the past two quarters, and which continues to be the case today.

Increased utilization and change order requests by current customers, and strong revenue contributions from our joint venture with the integration group where we provide outsourced technology services. We're also now exploring additional opportunities in high-value technology outsourcing services to further our growth in this portion of our business.

This all adds up to more predictable and stable growth, building upon our existing revenue streams. The large, 12-country NFS Ascent implementation, along with the new Ascent win in Europe, are having a positive impact on our new business pipeline, demos, and discussions are being held throughout the world with both current and potential new customers.

Indeed, it is a very exciting time in the history of NetSol. With that, I'll turn the call over to Roger Almond to review our financial performance, and then to Naeem Ghauri to provide more color on our 12-country implementation. Roger, please?

Roger?

Mr. Almond, your line may be muted.

Are you there? Sorry about that.

Thank you, Najeeb. We reported strong results for the quarter, as the net revenue grew 31% to $16.2 million, with $12.2 million coming from total services revenue.

This growth, combined with our cost containment efforts, led to our achieving GAAP profitability, recording $0.08 in diluted earnings per share for the quarter, or, on a non-GAAP basis, $0.32 per adjusted dilute share.

This compares with a $0.14 GAAP loss per diluted share for the same period last year, or $0.14 per adjusted diluted share. The adjusted EPS adds back stock-based compensation to EBITDA, and we believe this metric is a better indicator of our performance moving forward.

License fees were $710,000 Q2 compared with $2.1 million last year, with the difference being reflected -- being related to the sales mix. Total maintenance fees, including related-party maintenance fees, remain consistent at $3.3 million for both 2015 and 2014.

As a percentage of total revenue, total cost of revenue for the second quarter 2016 decreased to 50% from 60% for the same period last year.

Gross profit rose to $8 million from $5 million last year.

Operational expenses were nearly flat, year over year, with an increase in selling and marketing expenses related to new business efforts, offset by a decrease in general and administrative expenses as a result of cost rationalization initiatives.

For the first six months of fiscal 2016, total revenue increased to $29.5 million from $22.6 million for the same period one year ago.

The Company reported GAAP net income of $464,000 or $0.04 per diluted share for the first six months of fiscal 2016, versus a net loss of $3.2 million, or $0.34 per diluted share, for the same period last year.

Non-GAAP adjusted EBITDA was $4.8 million, or adjusted EPS of $0.46 per diluted share for the first six months of fiscal 2016, compared with $2.4 million or adjusted EPS of $0.26 per diluted share, for the same period in fiscal 2015.

At December 31st, 2015, cash and cash equivalents were approximately $14 million versus $14.2 million at June 30, 2015. Accounts receivable, and accounts receivable related party combined were $11.8 million, up from approximately $10 million at June 30, 2015. The quality of our receivables remains strong.

Turning now to our outlook, looking at the remainder of the fiscal year, we currently expect minimum revenues of $62 million, with positive GAAP earnings per share and continued adjusted EPS growth.

Now I will turn the call over to Naeem to discuss our 12-country NFS Ascent deal. Naeem?

Thank you, Roger. In late December, we announced a transformative 20-country deal, upgrading an existing customer to NetSol's new NFS Ascent platform in Australia, China, Hong Kong, India, Japan, and a host of additional countries including, for the first time, South Africa.

I'm pleased to share that we are now implementing Ascent for this customer in China. We'll soon be kicking off the projects in Australia, South Africa, and South Korea.

Revenue from these implementations are anticipated to begin in the current quarter and will be more meaningful later fiscal 2017 and beyond. However, from a marketing standpoint, this contract represents a strong endorsement from a prestigious and very long standing customer, and a development that we are already leveraging.

As many of you had questions on how the $100 million deal would manifest in our financials, I would like to provide a little more context to help you gain a better understanding. When we announced the agreement, we stated the contract was valued at more than $100 million. We translated into euros -- to dollars at a rate of EUR1.09 to $1.

Since the contract is in euros, my discussion will be in euros. The contract states that we will be paid EUR71 million for license and maintenance over the 10-year period, and that each individual country will contract for the services to customize and implement the software.

The services component becomes a little trickier to estimate. For example, services revenue can be broken down into three buckets -- continued services for the legacy product for each country until NFS Ascent is implemented in that particular country; customization and implementation of NFS Ascent; and change requests and services for NFS Ascent once it is installed.

As services are up to each individual country, we were required to be conservative. However, we already are seeing service levels higher than what we had originally forecasted, which leads up to believe that the total revenue -- total value of the contract over the period could be considerably more than the $100 million value we announced.

This means that we could expect around EUR7 million to EUR8 million per year, on top of what we already received from the customer in new revenue. As we have stated in the past, this provides for a stable base of revenue on which we will continue to build.

We look forward to executing against this contract and updating you periodically as we progress.

With that, I'll turn the call back over to Najeeb.

Thank you, Naeem. With a number of large contracts underway, and a growing new business pipeline throughout the world, comprised of an entire product portfolio, we are so excited about the opportunity ahead, and confident in our growth trajectory.

With that, I'll now open the call up to questions. Operator?

Thank you. (Operator Instructions). And our first question will come from Howard Halpern from Taglich Brothers. Please go ahead.

Congratulations, guys. This was a great kickoff to, I guess, your second quarter, but off to calendar 2016. Great quarter.

Thank you.

The first question, I guess, is a modeling question going forward. What -- what do you see as the actual mix between the three components of revenue? Because in this quarter, it was essentially 75% services, 20% maintenance. Do you see that changing as the quarters go by?

Are you inferring about three -- three points, licensing, maintenance, and services, three components?

Yes, I mean, essentially there are three buckets, license fees, the maintenance fees, and then you have the service fees, including the related party in each of those other components. But if you just take those three buckets, the services were -- made up 75% of the total revenue. Is that the mix that you see going forward, or do you think there will be adjustments to that mix?

Naeem, do you want to answer this?

Yes, sure. So, Howard, the license revenue, as you can see, historically has been a higher percentage in the past, right? So, this is quite unusual, and it's clear because of how the existing product solution, which is our current NFS R1 solution is sundowning, and how Ascent is starting to pick up.

So, you can see, we have not factored in much, if any, license from Ascent. So, starting from that low base now, which is under $1 million in this quarter, we only see upside on license from here.

Okay. And is the license revenue now from the large contract, is that going to be, again, country by country as you start implementing through the 20 countries?

I think Roger has figured that out. I think it's going to be amortized over a period, and so, you start to see quite regular chunks of license coming in, in the next fiscal year, especially --

Let me make a correction, Howard. It is 12 countries, not 20 countries.

Sorry, 12, yes.

Howard, let me -- this is Roger. I can just add a little color on that. So, what'll happen with the NFS Ascent deal, we'll recognize the license revenue over the period of the installation. So, if you figure you have five years, five to six years of installation, then the license fee will be recognized evenly -- or not evenly, ratably would be a better word, ratably over the five year period, as we install in each of the individual countries.

Okay. Okay.

And with this contract kicking in now, can we model in that gross margin will continue to improve from this level?

Yes, I think if you notice, we'll be around 45%, 47% in Q2, and absolutely I'm pretty confident is you look at the minimum guidance to $1 million, that will be doing at least what it says in the guidance, $32 million, $33 million. And I already -- I'm very optimistic the margin will continue to improve.

Okay. And one final one, just about -- just the general economic environment that we see, and you probably see better globally. Are the companies that you are in touch with, are they really looking more and planning for longer-term investments and ignoring sort of the noise that's going on a daily or weekly basis with currency fluctuations and perceived economic disruptions that might occur?

Actually, on the contrary, Howard, we're seeing a lot more traction, as Naeem mentioned in his prepared remarks, since the announcement of this contract, then, with Ascent. We've seen a lot more interest from US, from China, from Europe.

So, really, maybe our niche is so, maybe even strong, that we can continue to penetrate, now that we are growing and our next generation is pretty much on track, and some countries will be going live, the ones we sold before.

So, I don't really feel that way. Naeem, do you agree with me?

We really see -- experience the converse since this year started, especially, we've had a whole lot of activity. I think probably the news helped, and there have been a lot of new interest -- new interest from companies we hadn't spoken to before. So, there's one or two quiet, if you like, more on the cutting-edge companies in the US who are starting to talk to us. So, I think that's only helping us.

Okay.

A relevant point will be also -- sorry, Howard. Let me just add one more point. A relevant point to your question is, if you look at China, of course, there's a lot of noises about China's issues, but in our case, our customers, existing customers and the new customer, are really busy selling both cars and a lot of leases.

So, to the point that we are actually seeing a lot of new opportunities in that market.

Okay. Well, guys, congratulations and keep up the great work. Look forward to more contracts on the way.

That's the plan.

Our next question will come from Mike Hughes from SGF Capital. Please go ahead.

Thank you. Good morning.

Just question on the services revenue, the unrelated party portion. It was $6.8 million in the September quarter, and then it was $9.6 million in the quarter you just reported. Can you just give a little bit of color on the sequential ramp? Is that mostly related to the big deal, or is something else going on there?

Roger, please?

No, I think that's across the board. I mean, you still have revenue that's coming in from the 16 point million dollar contract that we discussed, but if you look across the board at all of our customers, we're seeing increased service revenue for our European areas, in the US, and especially in the A-Pac regions. And so, as we've continued to add customers -- and these are, even if you add the R1 customers, which we announced over the last couple of years, which shows that higher revenue for a license, as we add those customers on, then the services, the change requests, those continue to grow.'

So, I wouldn't say it's all tied to the new contract, as it's tied to all of the different services across the entire Company.

Roger, would you be willing to say how much of it was related to the new contract, just rough ballpark?

Yes, I can give that. So, if you look at 9-30, we only had $902,000 -- let's say $900,000 related to the new contract, and then we had in the next quarter basically $700,000. So, we even had a little bit of a slowdown in services in that second quarter here for the large contract.

So, as you can see, the bulk of our services is coming from all customers, which is a good sign that it's not just coming from one large contract. And we'll continue now in the third and fourth quarter to see that services continue to increase as we start the implementation of the NFS Ascent with the new large contract that we just signed.

Okay, that's really encouraging. Just a point of clarification. Naeem, I was a little bit confused. You commented that there would be EUR7 million to EUR8 million in euro terms on top of existing revenue. Naeem, could you just explain that once more? I apologize.

Sure. Sure. So, what we are looking at, first we have to establish what was the current revenue from the same client. So, we normalize that, let's say, for the next year, and we say with that as a baseline, and then on top of that, incremental growth from this client is roughly EUR7 million to EUR8 million in new revenue. So, this goes straight on top.

Okay, good. Thank you very much.

And then you had very impressive operating cash flow in the quarter, a little over $5 million. I saw on the Karachi stock exchange that you've been continuing to buy back shares in NetSol PK. Will we continue to see that, or what are the plans for the cash flow over time?

Yes, I think as we did mention the (inaudible) in the past a lot of questions were asked, we did start buying in the Q2 period, and I think it's now about 66% ownership, up by, I think, a point, and we continue onward this respective quarter. We'll report that in the end of the quarter.

I cannot say what is happening in the next quarter, but our plans are that it's all encouraging, and we saw an opportunity and we've continued to manage our cash in the way that we continue to grow the company, do all the things that we need to, to really continue the momentum, and then, based on that, we'll see, wait and see.

We have a board meeting next week in -- for the whole parent company in Lahore, and we'll further look at some of the new ideas, also.

Okay, great. And then one last one for you. Najeeb, did you say there was a new European client win in the quarter? Is that correct? Or is that something you had announced in the past?

Yes, I think it's -- that was the one in Q2, right, Naeem?

Yes. There is -- there was a win, but I don't know which quarter it came in, the news, or -- it's difficult to say. But there has been one big win in Europe.

Yes, I think it was the Q2 quarter, quarter number two. Yes, I think that was back in October. That was the $8 million (inaudible).

That's right. That's already factored into -- not all of it, but some of the revenue is starting to come in from that contract.

Yes, yes.

All right, super. Thank you for your time.

Thank you.

Thanks, Mike.

(Operator Instructions). Our next question will come from Mike Vermut from Newland Capital. Please go ahead.

Hi, guys. Fantastic quarter there.

Thank you.

Thank you, Mike.

A quick question for you. When you announced the $100 million deal in a multi-country rollout, are you seeing that type of interest with some of your other very large customers, that they're starting a discussion now, maybe we upgrade to the NFS Ascent, and maybe not of that scale, but that kind of a trigger to start pushing more conversions to Ascent?

Shall I --

Yes, and Naeem is the best one to answer that.

Yes, Mike, see if you look at our client list, which is on the website, our current platform is already servicing, at least maybe 20 very large auto-captive clients around the world. And all these are potential targets for us to upgrade to. Every single one of them is a potential upgrade prospect. So, you can imagine, as heading sales, for me, the first go-to client would be the one who is already our client.

So, yes, absolutely, we are very, very aggressively going after some of our existing clients to convert. They're in different stages. It's difficult for me and early for me to share any progress, but all I can say is that they are our natural targets, all of them.

And then, can you also give me a little -- a little help thinking about the size and types of contracts in the US and Europe now? Is that -- are those going to be in the $5 million to $10 million range? Or how do those look? Because that's a -- as you start moving into the US market, that's a whole 'nother branch for us.

Well, we have plans to launch very, very soon, and it's almost imminent into the US market with Ascent, and we've already started speaking to two or three clients, and so our next big initiative will be in the US. The typical Ascent client is really at a different level to what R1 clients were. It's a solution based at a totally different level in terms of pricing and its complexity and its flexibility.

So, we are actually looking at much bigger, bigger ticket deals. There may not be as many deals, but each deal is much bigger ticket in its overall value, 10-year value.

Yes, US is a very big market for us, and now we feel that a bit of maturity of Ascent now we can go after the US market. So, it is a good time for us.

Excellent. And then, one other last question. On the large deal announced, is there a linear growth progression we can assume over fiscal '17, '18, and '19, just for modeling purposes? Is it -- does it grow year-by-year, or is it going to be kind of flat-line, year to year.

I don't believe it's a flat-line.

No, no way it's a flat-line, Mike. I'm not the CFO, but I can tell you from my perspective, the way the [flash] model works is that it is back-end loaded, and what is happening in the first five years is already very healthy. But it is back-end-loaded, so it will continue to grow in terms of yearly revenue. It will be growing year over year.

That' fantastic. This is exciting times for the Company, guys. Congratulations.

Great, great. Thank you.

Yes, thank you.

Thanks.

Our next question will come from Jon Evans of JWEST. Please go ahead.

I was curious just to talk to you a little bit about the license fee piece, and so, if you look at the six months license fees as a percent of your revenue, it's about 6.5% and last year it was about 16%, and, I guess, as you go through the back half, or you go into '17, do you see that percentage, then, of license fees getting back up into the mid-to-high teens as a part of the revenue?

I think I answered that earlier, but I'll reiterate. The license fees that you see in the six months past, they are a little bit of an aberration, and not the trend, because of sundowning our existing products. So, we had made the market aware that the current platform license revenues will start to decrease as Ascent starts to pick up. So, as you see, this is probably our low point in terms of the current product base and its license fees. And Ascent hasn't factored in yet, into this mix.

So, when Ascent starts to factor in, especially for the large contract, you'll see these license numbers go up.

Right. But I mean, when you think about that, do you think that you get kind of into the mid-teens or, like, 20% of revenue? I mean, obviously, you're going to have a lot of services, and I don't want to pin you down from a numbers standpoint, but the margins related to software are so much higher than services, and if you come in with 18% or 20%, you're going to see gross margins go up 900 to 1,000 basis points in a quarter.

So, that's what I'm trying to understand. Is it -- do you go back to that more normal bit in the back half?

Well, I think it's -- I'm not the CFO, but I can tell you one thing. This is probably our low point in percentage-wise.

Okay.

So, if you can imagine, the very large deal on its own, we haven't even factored any license in yet, Roger, have we? Have you put any license in?

Yes, we did have license. Jon, let me see if I can just kind of explain what's happened in kind of the two different license revenues that you would see.

So, basically, you're going to have your R1 or legacy product, and that's kind of the off-the-shelf product, and so, as we sign a new customer, which, in China, that's a really hot market for us with our R1 is you're going to see, out of a $1.5 million contract, you're going to pick up $1 million in license fee and $500,000 in services to get them up and running.

Now, with NFS Ascent, it turns completely the opposite direction. If you look at the $16 million deal that we signed, about $1.8 million of that was license. Almost $8 million was going to be your services to get that up and running, customization, and then, you have your maintenance on the back end.

So, going forward, you're going to see license, as a percentage of the total mix as a smaller portion, because of the customization and the services associated with it.

Now, as Naeem said, our $700,000 for this quarter is very low, and as we start implementing NFS's -- this big deal that we just signed, the $100 million deal, you're going to start seeing higher license revenue as start amortizing -- or amortizing that into revenue.

So, I think there's a low point, as Naeem said, right now, but it will not get up to the percentages that it was in the past.

Roger, will you -- will you break that out? So, in other words, will you have maybe two revenue lines, one for the license fee, which is kind of the older, off-the-shelf product, and one that is for the new product and that's more custom, et cetera, or no?

No, we'll probably just leave it all at license, and then we'll probably break it out in the MD&A section as we talk about the change or what-not. We've kind of done that a little bit in our MD&A, just talking about the mix of our revenue there, but I will -- you will see that services will continue to increase and then we will be -- license revenue will still be getting strong, but as a percentage, it will -- it won't be up to where we used to be.

Okay.

I think I should add one point, Roger. I think, probably, what we are confusing with is that when services increase in a big way, then license percentages, even though in value they will grow, but in percentage terms, it may be still smaller, because services revenue is spiking.

And the other point to note is that the services revenue for Ascent is at a much higher man-day rate than we are traditionally been charging for our legacy products. So, it's more profitable revenue, about 40%, 50% higher in per man-day that we charge our clients than we used to be charging for R1.

So, overall, the percentage of the license revenue might be lower, but the values will grow because service revenue is growing disproportionately higher.

Right, and license revenue can get back up to the same levels that hey have been in the past with the signing of these new deals, but because services are so -- we're going to spend so much -- receive so much revenue in services, as a percentage, it's going to go down, but dollar-value-wise, it's still going to be very good.

Got it, and then just --

Also, I think, guys, I want to make one comment. As these implementations happen in each country, I think, then, we will ramp-up. Right, Roger, each country will have more license revenue even like 9.1.2 go live on each country?

Correct, correct.

So, Roger, can I just ask you relative to the software? So, the new software, does it have the same type of gross margins as the R1 product, or is it less or more?

Well, I guess -- that's kind of a tricky question, because it depends on the -- the product to get R1 installed was a very quick -- we charged you, let's say, $1 million for license, and then you had $250,000, $500,000 in services. And once you have that customer up, then you're earning service revenue as you have different change requests.

On this deal that we signed, as Naeem pointed out, we have higher man-day rates for the -- built into the services portion. So, we have pretty good rates, I guess, on the gross margin there.

So, what you really have is you have your total salaries and consultants and what-not for your cost of revenue, and that's kind of going to be at a base rate that will be incremental for raises throughout the -- for each year, and then, as you add additional people, depending on the size of the -- how large the Company gets.

So, to basically say, it's not like building a widget to where you can say exactly what that cost of revenue is going to be. So, but these -- we do have higher margins built into the services on this new deal, which should provide better margin for us, going forward.

Okay, great. Hey, thanks, Roger. I appreciate it.

Yes.

(Operator Instructions). Having no further questions, this will conclude our question-and-answer session. I would like to turn the conference back over to Najeeb Ghauri for any closing remarks.

Well, thank you very much for joining us today. As you can see, we are really excited about the numbers we just delivered, and the big contract we just -- and the implementation phases. We're really bullish about the way the Company is growing, and becoming much more stable revenue to predict.

So, as always, on behalf of our board and management team throughout the globe, I express my deep gratitude to our shareholders for their continued support and trust in our business strategy. Thank you, and have a good day.

The conference is now concluded. Thank you for attending today's presentation. You may all now disconnect your lines.