NetSol: mixed bag

Following a tough Apr-Jun quarter during the height of coronavirus first wave, NetSol Technologies Limited (PSX: NetSol) has had a rather mixed quarter in the period ended September 30, 2020. On the negative side, there is the topline drop of 15 percent year-on-year in that period, after a topline decline of 28 percent in the Covid quarter. But on the positive side, the bottom line roared back to profitable expansion, followed by a 76 percent net profit plunge on a yearly basis in the Apr-Jun quarter.

Bulk of NetSol sales originate from exports of software licenses, services and maintenance, mainly in the lease-finance market of the Asia-Pacific region. The firm has two main products: flagship NetSol Financial Suite (NFS) Ascent, followed by NFS Digital. The software company expects some topline wobbles as the business is transitioning towards a ‘subscription-based’ pricing model to achieve higher revenue growth by expanding its target market.

But still, the sales weakness continues to emanate this year mainly from lackluster sales due to challenges in acquiring new clients. The double-digit decline in net sales in yet another quarter is on account of ‘nil’ sales coming from the segment of ‘license’. It is hard to take promising business leads to fruition when there are travel restrictions affecting outreach to new customers and clients are wary of making investment decisions.

The topline would have fallen even more if it wasn't for double-digit growth in ‘service’ and ‘maintenance’ revenue streams for the implementation, enhancement and upkeep of software at existing clients. Cost of sales helped with a more-than-proportionate decline. This helped the firm in that the cost of sales consumed one percentage point less of topline, standing at 60 percent in 1QFY21.

But the less-than-proportionate yearly declines fall in administrative and selling/marketing expenses relative to the topline decline meant that these two heads exhausted 28 percent of net sales in the quarter, up from 25 percent in 1QFY20. This led to a drop in operating profits of 21 percent year-on-year in the quarter, with the operating margin dropping by nearly a percentage point over last year to 12.5 percent.

The journey from negative growth in operating profits to a significant expansion in net profits is explained by the sharp 90 percent drop in ‘other operating expenses’. In short, the company was in a state of net profit in the Jul-Sep quarter, but it was mostly due to non-core reasons. Now that the world is at the outset of a second Covid wave, it will further test NetSol’s operational and financial resilience.