NetSol Technologies Limited

NetSol Technologies Limited (NetSol) is Pakistan's largest locally-based software development company. The Lahore-based firm provides a variety of information technology services and custom software offerings, with specialisation in technology outsourcing, systems integration, application development, business intelligence, and information security.
NetSol's forte has largely been a lease finance industry, but its products are also marketed to manufacturing, banking, healthcare, education, information technology, insurance, e-government and defence concerns. The firm derives most of its revenues from overseas. Some Fortune 500 manufacturers are among its contractors, including global automakers, and financial institutions. Domestic business has been typically low. Besides low demand, that is also partly due to the company's exclusive focus towards overseas markets to better utilise and monetize its human resource, which is the key to making cutting-edge software products.
NetSol's majority shareholding rests with the NetSol Technologies, Inc, which is listed on Nasdaq Dubai and has offices in Pakistan, USA, UK, China, Australia and Thailand. NetSol Pakistan is listed on all three stock exchanges of Pakistan. The scrip has long been famous among shareholders for its attractive profit margins.
FINANCIAL PERFORMANCE IN FY14 But lately, the wheels seem to be coming off from the NetSol bandwagon. Following a superb financial performance in FY13, a year which saw NetSol cross the $10 million net profit milestone, there has been a hard fall in the year ended June 30, 2014. Overall, net revenues slouched in excess of 30 percent year-on-year, thereby setting up the stage for a major loss-making year in this profitable firm's financial history.
What has happened to the top line is something the management had been warning its shareholders will happen in the short-term. Late last calendar year, NetSol introduced a new and improved software product, NetSol Ascent, to its current and potential clients overseas. While that product is expected to grow business in the medium term, it has put immense pressure on the company's top line by slowing down the sales of existing flagship product, NetSol Financial Suite (NFS). The management insists that this transition from legacy to advanced product is a natural outcome and will be over soon, as the new product starts to gain foothold.
The impact is visible on the revenue streams. The software "licensing" segment has come under pressure as its contribution to net revenues slid from 37 percent in FY13 to 21 percent in FY14. That reflects a cool down in new software sales, which itself spells doom for future services and maintenance contracts that typically follow a licensing deal.
But NetSol probably followed the right strategy in its bid to come out of the dilemma that strikes companies facing dwindling top line: cut down costs to contain the damage or spend more to earn more. The management did not give in to the urge to cut back on expenditures that go in to developing and improving its software products and services, the firm's bread and butter.
One can see that approach written all over a 69 percent jump in cost of sales, or the core cost. That core costs even surpassed net revenues is a sign of concern, for all ensuing profit margins went straight into the red. Maybe the firm could have been more efficient about the needed expenses. Yet, the important thing is that the firm perhaps has eye on the ball: short-term pain for long-term gain. Plus, a large part of the Rs 753 cost increment in FY14 is explained by much higher bookings under depreciation and amortisation expenditure heads.
Similar pattern is visible on the front of operating expenditures. The selling and promotion expenses perched high in FY14 by 52 percent year-on-year. The administrative expenses also soared by a high, 27 percent over previous year. The operating efficiency argument could again be raised here, but it is obvious that the management did not take the foot off the paddle. NetSol depends on overseas software licensing deals, so it spends most of its promotional and administrative budget in its target markets, mostly in the Asia-Pacific region.
However, the usual neutralising effect on this spending, provided by the firm's 'other income' account - which includes foreign currency gains, dividend income and returns on bank deposits - was diluted in FY14 as this non-core income head went down by 12 percent year-on-year. That was mostly due to a 72 percent drop in foreign currency gains, triggered by a strengthened rupee in 2HFY14.
In the end, the top line drawdown and formidable cost pressures led the firm to close FY14 with a nearly 34 percent net margin in the red zone - or Rs 618.5 million in net loss for the year. The firm prides itself on delivering attractive margins year after year, so it must have been a tough year for both the management and the shareholders to witness the undoing that was FY14.
INTO FY15 The pains of transition to NetSol Ascent have carried forward to FY15. Net revenues slid by 7 percent year-on-year in 1QFY15. The scale of top line descent seems controlled. But the cost pressure was still relentless - cost of services went up 53 percent in first quarter. Selling expenses also soared above-normal, at 20.5 percent year-on-year. The firm closed 1QFY15 with a net loss of Rs 190 million, or 38.6 percent of net revenues, compared to a Rs 140 million profit score the previous year.
How long before Netsol comes back to its winning ways - that is, double-digit top line growth - is a question to which answer is unclear yet. Discussions with the management suggest that recovery is in the offing and improvements will be visible by the end of the ongoing fiscal. NetSol seems focused on product development and promotion, and that seems to be the right way to ride out this bumpy transition.