It’s uncharacteristic of NetSol Technologies (KSE: NETSOL) to close out a financial year with a net loss, and that, too, a hefty one. But FY14 was one such rarity. Company financials must be a dampener for shareholders who have gotten used to attractive profit margins the Lahore-based software firm has been churning over the years.
NetSol, which derives bulk of its revenues from overseas sales of its software products, IT services and maintenance contracts, saw visible deterioration throughout its income statement. There was a large top line decline over previous year. Making matters worse were the core costs (cost of revenue), which exceeded the sales, reaching 100.5 percent of revenues. Thus from the outset, profit margins cried red.
Hemorrhage intensified when operating expenditures on selling and promotion activities and administration saw high double-digit increases. Rupee appreciation seen in 2H FY14 dealt another blow to the export-dependent firm. In the end, NetSol plunged into deep operating loss and net loss. Average shareholder lost Rs7.02 per share in FY14, compared to basic earnings of Rs13.48 the previous year.
So what’s going on at NetSol?
NetSol is currently standing at a juncture where it is phasing out its legacy flagship financial software product-–NetSol Financial Suite (NFS)-–with an advanced and improved software product-–NetSol Ascent. Ascent will serve as the firm’s new flagship offering. In recent reports to the shareholders, the management has been warning of a lean period ahead where the top line would come under pressure.
Transition pains explain why NetSol was adrift in FY14. It will be a while before Ascent, which was launched in October 2013, will gain full traction among the firm’s client-base and relevant markets. In the interim, NFS sales will suffer due to natural slowdown as well as some degree of cannibalization from the next-generation product. The FY14 top line slump is reflective of that, as the firm’s clients presumably wait for new product demos and/or cut down on existing licensing/service contracts.
In the meanwhile, there will be relentless pressure on core costs as well as operating expenses. The management realises that this is no time for NetSol to reduce the software development activities or rein in selling and promotion expenses. When a new product is out in the market, it needs all possible internal improvements and external push for its debut year to be seamless and exceed expectations.
That is why the management has been hiring more people for those tasks. FY14 financials are reflective of those increased expenditures. During the year, salary hikes and amortization and depreciation of finished software products also contributed to the growth in core costs and operating expenses.
To remain relevant in grueling and fast-paced software markets, tech firms have to keep re-inventing and their product development lines have to keep rolling out new software regularly. That’s what NetSol is trying to do. If things go well, NetSol will get its financials back in shape soon. Till then, bottom line will remain under pressure.
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NETSOL TECHNOLOGIES LIMITED
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Rs (mn) FY14 FY13 Chg
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Revenue-net 1,832 2,633 -30.4%
Cost of revenue (1,840) (1,087) 69.2%
Gross margin -0.5% 58.7% -
Selling and promotion expenses (183) (120) 52.5%
Administrative expenses (526) (415) 26.7%
Other income 164 185 -11.6%
Operating profit/(loss) (573) 1,171 -148.9%
Net profit/(loss) (619) 1,160 -153.3%
Net margin -33.8% 44.1% -
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Source: KSE announcement
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