NetSol Technologies Inc (NTWK) 2017 Q3 法說會逐字稿

Good morning, and welcome to the NetSol Technologies Fiscal 2017 Third Quarter Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to Patti McGlasson, General Counselor. Please go ahead.

Good morning, everyone, and thank you for joining us today to discuss NetSol Technologies Fiscal 2017 Third Quarter Results. On the call today are Najeeb Ghauri, Chairman and Chief Executive Officer; Roger Almond, Chief Financial Officer; Naeem Ghauri, President, Global Sales; and Jeff Bilbrey, President, North America.

Following a review of the company's business highlights and financial results, we will open up the call for questions. The call is scheduled for 1 hour.

Please note that all of 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, SEC filings, including its annual report on Form 10-Q and K -- and quarterly reports of Form 10-Q.

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

In addition, I'd like to remind everyone that today's call is being webcast at www.netsoltech.com. Following the conclusion of the call, the webcast may be accessed on the NetSol website, where it will be archived for 1 year.

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

Thank you, Patti, and good morning, everyone. Thank you for joining us today on our Third Quarter Fiscal 2017 Earnings Call. I will begin my remarks with an overview of our third quarter results as follows: Total net revenues for the third quarter was about $18 million. This represents an increase of 12.5% from the prior year period. This was a record Q3 for NetSol, and we are on track to deliver record revenues for the third consecutive year in fiscal 2017. Our adjusted EBITDA was $2.3 million in the third quarter, and net income was $700,000 in Q3 or $0.06 earning per share.

From an overall market perspective, we continue to see solid demand for our solution across our geographic footprint, and we are executing well with both new and existing customers. We remain excited and very optimistic about NetSol's future growth prospects, and we believe we are well positioned to capitalize on the significant long-term growth opportunity in the global finance and leasing industry. At the same time, we remain intensely

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our goal of driving margin expansion and increasing our earnings per share growth.

Looking closer at our fiscal Q3 results, we delivered a strong quarter for NFS Ascent license and services revenue, driven primarily by our large 12-country contract. We remain on track with this multiyear, multicountry implementation, and we continue to be pleased with our progress with this important client.

And other side -- on the other side, our legacy NFS revenue was softer than we expected in the third quarter. Several of our clients are now beginning to explore with us their migration path from legacy NFS to NFS Ascent, which has resulted in a greater than expected slowdown in NFS license and services revenues, especially in Asia Pacific, China to be more specific. We believe this tactical shift in our clients' demand toward Ascent from our legacy solutions represents a significant long-term opportunity for us, as we believe our existing client portfolio represents the most immediate and logical new growth opportunity for our NFS Ascent solution.

However, this positive long-term trend is also impacting our results in the near term, contributing to our reduced fiscal year 2017 guidance, which Roger will discuss later in the call. While we are tracking below our prior 2017 expectation, as I look ahead, the momentum we are noticing in terms of global demand for our solutions suite, the progress we are making in our sales and marketing execution for NFS Ascent and advancement of our cost efficiency programs gives me confidence in our ability to drive improved revenue and earnings growth in the years ahead.

I'd like to now discuss with you some [trends] and highlights we are noticing in our business which support our very positive outlook for NetSol, beginning with our largest market Asia Pacific. This is currently our most active market in terms of new NFS Ascent opportunities. In China, we are beginning to see a meaningful pickup in interest and increase activity from our existing NFS R1 clients who are now looking to potentially upgrade their platforms to NFS Ascent to address the future needs of their rapidly expanding portfolios.

This trend is highly encouraging since, as I mentioned earlier, we believe our existing clients are the most logical and immediate opportunities for transition to NFS Ascent over the medium term. Given our commanding market share with 29 clients, including both multinationals and local Chinese companies and the strength of our Ascent solution, we believe we are in a position of strength as the auto leasing industry continues to expand in China.

Looking outside of China in our other APAC markets, such as Indonesia, Thailand and Australia, we have a growing pipeline of Tier 1 and Tier 2 prospect for NFS Ascent as well as new client opportunities for our legacy product suite. In Indonesia, for example, we recently announced a 5-year product license and maintenance service agreement with Mizuho Balimor Finance, or MBS, one of Indonesia's largest multi-finance companies, for our mobile or international or point-of-sale system. And we were also named MBS preferred vendor in the region.

Additionally during the quarter, we became a member of Indonesia's leading financial services association, giving us access to the association's large network of lease finance companies in the country, which has already led to increased interest and activity from prospects.

Turning to the European market. We are noticing a decline in new license sales of our regional LeaseSoft solution to both new and existing clients. While we continue to generate consistent maintenance and change request revenue from LeaseSoft, the outlook for growth is limited. However, we believe the European market is ready for NFS Ascent. To help drive future sales of NFS Ascent, we have realigned our European sales and marketing team and are focusing dedicated resources toward driving increased penetration of Ascent into the region.

In our North America market, we continue to have healthy pipeline across our solutions suite. While NFS Ascent is still relatively new to the North America market, we are quite encouraged by the traction we are noticing, and we are pursuing a handful of new potential opportunities. Alongside the work we are doing to drive Ascent sales in the market, we recently strengthened our LeasePak SaaS offering and did relaunch at an industry lead even, which has resulted in substantial traction and lead generation for NetSol.

Finally, I'm very pleased to say that we just recently went live our NFS R1 solution in the Mexico operations of a U.S. -based Fortune 500 drug manufacturing company. This implementation in Mexico is an exciting milestone for NetSol as it opens the door to the Latin American market with a strong, referenceable client.

Before moving on, I would like to focus back on NFS Ascent specifically. Overall, I want to emphasize that we remain excited and highly optimistic about the long-term success of our next-generation platform. A meaningful penetration will take time, but we are seeing solid interest for multinational auto captive, global equipment finance companies, banks and existing customers for NFS Ascent.

Our global Ascent pipeline currently includes many Tier 1 and Tier 2 auto asset finance companies. And the level of RFP, which is request for proposals, activity and number of ongoing conversations we are having continues to rise our -- the level of confidence in the growth potential of this winner solution. Our pipeline includes both upgrades from legacy NFS Ascent as well as organic opportunities from new prospects. Many of these potential opportunities represent multicountry, multi-million dollar implementations.

While we are encouraged by the momentum we are noticing in our Ascent pipeline, at the same time, we're also experiencing longer-than-expected sales and delivery cycles, predominately due to the complexities in the procurement process of our large client prospects. However, we have extensive experience working within these processes and remain confident in our success, given our solid track record.

Finally, I'd like to address the productivity and cost reduction initiatives that we announced on our last quarterly call, and I'm pleased to say that we made strong progress on this plan and we are on track to deliver $1.5 million of cost savings in the second half of fiscal 2017 and $4 million on an annualized basis beginning in fiscal 2018. We will continue to evaluate opportunities for additional cost reduction through consolidation and streamlining our global operation.

With that, I like now to turn call over to Roger Almond to review our financial performance. Roger?

Thank you, Najeeb. I will begin with a review of our fiscal third quarter financial results before discussing our fiscal year 2017 guidance. I will then turn the call back over Najeeb for closing remarks before opening the call for your questions.

Total revenues for the third quarter were $17.9 million, representing an increase of 12.4% year-over-year. Total license fees for the third quarter were $5.7 million, more than tripling the $1.8 million we delivered in the third quarter 2016. Our strong growth in the quarter primarily reflects increased license fees from the 12-country Ascent contract with our largest customer. Maintenance fees for the third quarter were $3.6 million, an increase of 5.1% from $3.4 million in the prior year period, primarily driven by new customer agreements that went live with our products during late fiscal [2017] and into fiscal year 2017.

Services revenues were $8.6 million for the fiscal third quarter, a decrease of approximately 19.5% from $10.7 million in the prior year period. The year-over-year decrease in our services revenue primarily reflects a decrease in implementation services as well as lower revenue generated from our NetSol innovation joint venture with [One Insure].

Total cost of revenues were $9 million for the third quarter, an increase of 4.4% from the third quarter of 2016, primarily driven by a higher salaries, consulting costs and travel expenses.

Gross profit for the third quarter was $9 million or 50.1% of total net revenues, up 21.7% from $7.4 million or 46.3% in net revenues in the prior year period.

Total operating expenses for the third quarter were $7.2 million, an increase of 16.2% from $6.2 million in the same period last year. The increase in our operating expenses primarily reflects increased spend in support of our product and solution sales effort and higher general and administrative expenses related to strategic hires, which is partially offset by lower R&D cost and depreciation and amortization.

GAAP net income attributable to NetSol for the fiscal third quarter 2017, inclusive of minority interest, was $0.7 million or $0.06 per diluted share compared with net income of $0.8 million or $0.08 per diluted share in the prior year period. Growth in our revenue and operating profit was primarily offset by controlling interest in the third quarter 2017 driven by our geographic mix of profits.

Moving to our non-GAAP metrics. Adjusted EBITDA was $2.3 million in the fiscal third quarter 2017, consistent with the $2.3 million in the prior year period. At March 31, 2017, cash and cash equivalents were $8.5 million compared with $11.6 million at June 30, 2016, and $11.9 million at March 31, 2016.

Before moving to our guidance, I'd like to address the restatement of our prior financial report, which is also mentioned in our earnings press release. Based upon our new independent auditor's position regarding the timing of revenue recognition for our complex 12-country NFS Ascent contract, we will amend our financial statements for the first and second quarters of fiscal 2016 and fiscal 2017.

To be clear, the revisions related to the timing of when the revenue should have been realized and not the revenue itself, and is based primarily upon our auditor's position on revenue recognition for this complex contract, which differs from our prior methodology. Importantly, the impact from these revisions are immaterial to our reported financial results for the year ended June 30, 2016, and in the 9 months ended March 31, 2017. More specifically, the net impact from the amendments to our revenue and net income for the first 6 months of fiscal 2016 is 0. In addition, for the first 6 months of fiscal 2017 ended December 31, 2016, the total impact of the restatement to our net revenue is a positive $296,000, and impact to our net income is a positive $197,000. Further detail of the amendment can be found in our 10-Q, which will be filed later today.

Now moving on to our guidance. As Najeeb mentioned, a slowdown in legacy NFS license and services revenues is expected to continue to impact our fiscal 2017 second half results. In addition, the nonconversion of some new client contracts that we expected to materialize in the second half of fiscal 2017 is also having an impact in our guidance. As a result, we are revising our full year fiscal 2017 guidance from net revenues -- for net revenues down to $66 million to $67 million, and our EBITDA guidance range down to $5 million to $6 million.

With that, I will now turn the call back to Najeeb for some closing remarks.

Thanks, Roger. While we are experiencing a softer-than-expected fiscal 2017, the strong fundamental long-term drive of our business remain unchanged. First, we are a leader in a large and growing market with significant opportunity for continued share gain, especially in the high-growth Asia Pacific market, and in North America, where we see tremendous white space for growth.

Second, we see a significant opportunity for growth driven by our industry-leading NFS Ascent solution. As I mentioned before, we are very encouraged by the momentum we are noticing in our Ascent pipeline. We view every single one of our major multinational client as a potential target for an upgrade to NFS Ascent. As our clients' businesses continue to grow, we believe they will have a greater need to transition to our NFS Ascent solution to address their need for a more robust platform that has the ability manage much higher volumes.

And third, our broad suite of legacy products, such as LeasePak in North America, our NFS R1 in a few markets in APAC and Latin America, are ripe, further, for these legacy solutions. Our wealth of knowledge gained from working with large multinational clients, our local expertise and lower cost of delivery continue to enable us to serve multiple market segments in varying segments of maturity.

In addition to our top line growth drivers, our ongoing focus on generating additional margin expansion through organizational transformation and cost reduction initiative will help to drive increased EPS growth. We will continue to carefully review our cost with a specific focus on optimizing them in order to drive a mentality of long-term profitable growth for our business.

With that, I like to open the call up for questions. Operator?

(Operator Instructions) The first question comes from Howard Halpern with Taglich Brothers.

In terms of -- talk about the sales cycle. And could you just sort of break it down between, I guess, new potential customers and what you believe the sales cycle is for these -- the legacy customers that are likely to convert? And also, in terms of that, what is the potential, if say, half of your legacy customers would eventually convert? What is that pool of potential revenue?

Yes. Thank you for asking that question. I'll have Naeem answer that, please.

Yes. Howard. Well, we have at least 3 of our existing legacy clients in China who have expressed interest. Not only interest, we are under RFP and evaluation process. And there's at least one more new prospect out of China which is also evaluating the software. So between these 4, we are very well positioned. The sales cycle are long, as we said in the press release, and the evaluation process itself is quite stringent. And there's several rounds of presentations and demonstrations, the workshops that go on, because typically, these solutions last, like, 10 to 15 years and is a mission-critical software. So certainly, they have a very, very regimented procurement process to be -- to evaluate the solution. So we -- it's hard to predict the timing on these, but we are well into the RFPs. I say potentially, we are about halfway through, and we started about 2 to 3 months ago. So I would say we would start to make good progress by Q1, Q2 of next year in all of these. And your last question was on the revenue, I think that's the tough one. But these are typically multi-million dollar deals, they're very large deals. One of them is at least for multiple countries for the new prospect, and the others are for China at the moment. But these clients are also in other markets, so potentially can be multiple markets, too.

Okay. Now in terms of the cost reduction that's going on, is that going to primarily be felt in the gross margin? Because I did see in the fourth quarter, G&A was up sequentially. So are we really focused here on gross margin rather than G&A?

Yes. I think I'll add one comment and maybe Roger can come in. I think we concluded this first phase of our cost rationalization around the first quarter -- I mean, the third quarter, which was March, the one we just reported. So the impact of that is not showing -- maybe showing partly in the P&L, because in that period, we also -- it's a routine annual increments for the core team in Lahore, which is almost 900 of them. So there a little wash. But I think as I said, we're confident that by the time we finish the second half or when we report June 30, we will have seen at least $1.5 million of net impact from that cost-cut initiative. Do you want to know more? Roger, do you want to add a few more on this?

Well, I think the answer to the question, I think you'll see it in 2 places. But you do have the reduction of personnel up in the -- that will be part of your cost of revenue. We look across all areas of where we could maybe have some excess fat, I guess, out there and we want to cut. So that will be in the G&A expenses also. So I think by the end of the fourth quarter, you'll see both the cost of revenue number coming down in line, and you'll see some G&A decrease also as we look to cut cost in both those areas.

(Operator Instructions) The next question comes from Mike Vermut with Newland Capital.

I've got a few questions for you here. Sort of I guess kind of hitting on that same subject concerning the contracts we're currently bidding on. Are a lot of these competitively bid? Are they renewals and looking to upgrade to Ascent? Just looking at the probability that we will be the winner on those. And moving out of Asia into the Americas and Europe, what are the sizes of those deals? And where are we in the process? I remember a little while ago, we were one of the final -- it sounded like, one of the final bidders on a few of them, possibly. And just how everything is progressing there.

Yes. Naeem, you want to answer that?

Yes, yes. Sure. So the one that we just mentioned in China and Asia, they are upgrade projects, the 3 of them, Mike. Now they are still competitive because all major Tier 1 companies, by their own internal compliance, their procurement compels them go to market, go to tender. They cannot choose the incumbent, that's typically the compliance internally. However, switching to new vendor is always a big risk, and so there's a lot of hedging if they stay with the incumbent. So because we have distinct advantages in understanding their data and their business and their processes and any new vendor that comes in has to have a pretty steep learning curve. Otherwise, they could not succeed. That's why we have very, very strong position, but we certainly still are in a competitive landscape. That wouldn't change. There's very, very few companies, Mike, that would award a contract in that kind of a value without a competitive tender.

Right. And just before we go onto the Americas here, are we talking on these upgrades multiyear $10 million, $20 million type contracts that we're looking at here?

Yes.

Is it -- obviously, it's not a Daimler size, but they're huge contracts that would kind of pad our growth for years to come if we get them?

Yes. Well, all these companies -- yes, okay. So all the 3 vendors, we are -- I'm sorry. All the 3 clients we are dealing with for the upgrade, they are very large volume. They would be in the Tier 1 space in China. They have hundreds of thousands of cars on lease and finance, so they would spend that kind of money. It would be difficult for them not to, it's the other way around. So it is very well within the $10 million to $20 million for each of them. So -- and then one of them is a multiple-country, but they will start with China and then they want to then roll out to another 7 or 8 markets, similar to the other contract that we have.

Okay. And I don't want to paint you in the corner, but you would say, probability because we are incumbent, it's quite high that we win these over the next 6 to 9 months?

Well, I would stay from giving the probability a name because we have to be cautious...

I didn't say probability. I didn't say a number, I said a high probability in your opinion.

I already said that, Mike. We are in a very good position, being the incumbent dealer.

Yes, okay. Excellent. Great. Excellent. Okay. So now Europe and the Americas.

Yes, yes. Okay, so Europe is we are in the middle of an implementation for an Ascent client. And we expect -- the go-live is imminent. That's going to make us very referenceable in Europe. So we're waiting for that to happen. And I think the first phase should be in the month of June, and we'll definitely make an announcement when that happens. That certainly opens a door to a number of new potential prospects. In the U.S., we have currently 2 opportunities that we are working on very diligently. There's 2 -- there was 2 others where one of the companies have decided to not go ahead with the project. Anyway, they just -- It wasn't like we lost it to anybody else. So that project is put on hold, and they have said we were actually the top of the list of the 4 or 5 vendors that they had. But unfortunately, they said they want to probably defer it for 6 months to a year. So we will know then what happens. The other one, we're still waiting to hear. So there's one that is deferred. There's 1 we're waiting to hear and there's 2 more which we are working on.

Okay. And how -- from what you see, I guess, what are the rough sizes of -- what kind of contracts are we talking about, size-wise, in the U.S.? And if you can give us some color into the competitive bidding process. Who are the others that we're out there against? And how those look for us, in your opinion?

Yes, Jeff, you want to have Jeff...

We don't -- yes, Jeff, you can come in a second, but I'm just going to say -- make one point, and then Jeff can maybe come in with more color. But all the Ascent deals that we're doing, we're not going to do anything south of $10 million because we -- is a premium solution with a huge amount of R&D into it. And the kind of clients we're attracting, we'll expect to spend that kind of money over 5 to 10 years. So we would be -- we will not be looking at anything less than that. Jeff, you want to say something?

Yes. No, I can add to that a little bit. So the -- when we talk about these deals, it might help to contextualize them a little bit further. Some -- a couple of them are in the finance or banking sector. And over the course of a few years, those are going to be worth millions of dollars, probably not north of $10 million. And one of them is with a multinational auto captive, and that one is definitely north of $10 million in terms of value. So these are all active pursuits. Obviously can't give names or anything like that, but very, very active pursuits. We're deep into the process, again. And just add some color into what Naeem said earlier, one of those that we lost, just to show the flexibility of the Ascent platform. So I just mentioned the auto captives and banks. And the one that went on hold because of an internal reorg decision and they'll come back in 6 months or a year, that was actually with a software company looking to finance their software products. It's one of the top 3 software companies globally, a brand name that we all know, and we were the finalist there. Unfortunately, before we got to put ink on paper or anything like that, they did have to go quiet because of an internal reorg. So we are seeing good traction in the marketplace. We are seeing that the Ascent platform is broad and able to go across industries, and whether that's banking finance or other specialty. And so we're going along and we're hopefully going to get one of these closed here.

Excellent. And then that takes us back onto -- I got a couple more for you here. So based on what see here, obviously, it's taking longer to close, but these are large deals, right? So if we get a few of these closed, like you said, in the first, second quarter, we should see -- and with the cost savings, we should see decent revenue and EPS growth into '18 and '19, right? If these things fall into place, nothing has stagnated here.

No. I think, as I said in my prepared remark, the outlook is quite promising, Mike. We are quite encouraged and excited about what outlook. We do, do all these deals, we just heard from Naeem and Jeff. And the good thing is you're hearing more interest from our existing clients, in China especially, who wants to upgrade to Ascent. There are 3, 4 of them, and then Jeff just mentioned about the North America. I believe it's, again, all a matter of timing. When we can sign them, when we can book them, in which quarter, in which part of first half, second half, time will tell. I guess when we report year end, we'll be in a better position to share some -- latest at the time.

Excellent. Excellent. Okay. And then my last question here, and this is more of a bigger picture. From all the research we can do here, we have the best product out there. I think we have the best cost structure, right? We have -- and with the engineers in Lahore, our cost structure probably can't be replicated. Is it the company -- and I know that there's a lot of leasing bids out there, is there anything, in your opinion, holding it back? Or is it just timing on all of this? Is there anything else competitively that's changed out there? Is it who we're going up against with their balance sheets? Is it larger competitors? Or is it just timing and it's just taking longer?

Najeeb, can I jump in?

Well, I mean -- yes, yes. Go ahead. Go ahead. You can go ahead.

I'm sorry. I think the issue is not really so much the competition because, from our own research, Mike, when we embarked on the Ascent program, we knew what was being offered by competitors. So I can tell you one thing, there's not even 1 company out there that have invested completely organically into a new product from ground up. What they have done is they have taken the existing products and modernized them or give them a good makeover. To fundamentally change your architecture, your tech stack and go to market with a new product, it is more painstaking. However, the results then actually position you at a different level from your competition. So we continuously meet prospects and clients who are surprised and, quite frankly, blown away with what they see with Ascent. So that's why we're getting so much traction. And some of those Tier 1s which never looked at us before are inviting us to tender. And I don't know whether you read the news. One of our competitors, which is similar sized, you should actually look them up in the U.K., is a company called Alfa. I don't know if you heard about them or not. They're a similar-sized company, and they're just going to do IPO at June at GBP 800 million valuation. And their revenue -- so I'm just saying I believe we are grossly undervalued for whatever reason. So I think at some point, we'll just get on the radar and then people will realize what we have to offer is really quite compelling as opposed to some of our competitors.

Excellent. And then one last question. So the way I look at the balance sheet, as these we start to hit and as the large contract out there starts to build, cash should start to increase on the balance sheet looking forward, collection-wise? And then with the cost cuts coming in?

Yes. And I think they both will have positive impact. You're absolutely right.

Okay. So should this be a low point on the cash? And it's not -- and we're not in a bad position, by any means, but should we assume cash starts to build from here?

I think we've got pretty good, sound receivables if you'll look at. Pretty sizable receivables, but also excess revenue building. So we're pretty comfortable with those receivables.

Excellent. Okay. All right. Appreciate it. And good luck on these wins. I do believe it will change the dynamics of the company when they start landing.

Sure. Thank you, Mike.

Thank you, Mike.

Yes. Thanks, Mike.

(Operator Instructions) This concludes our question-and-answer session. I would like to turn the conference back over to Najeeb for any closing remarks.

Well, thank you again for joining us today. On behalf of our board and management team, I want to thank the entire NetSol team throughout the globe for their continued hard work and their dedication to our clients. And I want to thank our shareholders for their continued support. We'll see you next time. Thank you, operator. You can end the call now, operator.

Okay. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

Thank you. Thank you, guys. We'll talk to you next time, okay?