The Microcap Speculator

Pakistani software company Netsol (NTWK) is beginning to look interesting. Last May, I took modest profits on a long position in Netsol after the company announced disappointing results.

But Netsol’s second quarter 2008 earnings, announced in February, were back on track. Revenues increased 16% year-over-year to $8.4 million, gross margin increased year-over-year from 50% to 57%, operating income rose 284% year-over-year to $1.4 million from $377 thousand. For fiscal 2008, Netsol expects annual revenue growth between 25% and 30%, and diluted earnings per share of $0.28-$0.32.

At today’s close of $1.66, achieving the midpoint of that range would give Netsol a 2008 P/E of 5.53. That figure may even understate results on an enterprise value basis, as the company has over $8.5M in cash and equivalents and less than $0.6M in long-term debt.

Commenting on last quarter’s results, Chairman and CEO Ghauri said:

NetSol continued to make excellent progress across its key financial and operational objectives during the fiscal second quarter of 2008. Our double digit top line growth was driven by strong demand for our IT service offerings and solid gains in license and maintenance revenue streams. The combined revenue growth provided a strong foundation for NetSol to post impressive gains in GAAP net income and EBITDA profitability for the quarter, as compared to losses in the year ago period. NetSol’s bottom line profitability also benefited from the significant progress we continue to make in terms of improving operating efficiencies and managing costs. . . . . Overall, I am pleased with the progress we made in the first half of fiscal 2008 and I stand optimistic on growth prospects for fiscal 2008 as the second half of our fiscal year is historically stronger than the first half.

Our results during the fiscal second quarter were even more impressive when taking into account there were seven fewer billing days during the quarter for our largest business unit compared to the sequential first quarter of 2008, largely due to holidays, as well as the extraordinary events in Pakistan during the quarter.

Netsol has also made some important strides this quarter. In January, it landed a new customer for its flagship lease management software with a contract valued at $1.5M. Last month, Netsol announced a Basel II consulting contract with a leading Pakistani bank. The value of the latter contract was not disclosed, but it sounds substantial. Finally, a few weeks ago, Netsol authorized a one million share buyback.

NTWK’s chart remains a disaster by any measure. I would normally wait for the downtrend to be broken before buying. However, due to the paltry valuation and positive newsflow, I took an initial position on Monday at $1.58.

DISCLOSURE: Long NTWK as of 3/25/08.

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For the second quarter in a row, Pakistani IT concern NetSol (NTWK) announced disappointing earnings. It reported a net loss for the quarter of $323 thousand, or ($0.01) basic and diluted EPS, versus net income of $21 thousand, or $0.00 basic and diluted EPS in the prior year quarter. EBITDA for the third quarter was $676 thousand, or $0.04 per basic and diluted share.

The company did note several bright spots. Revenues increased 51%, driven by gains in license fees (+43%), maintenance fees (+115%), and service revenues (+41%). “LeaseSoft, NetSol’s flagship vehicle portfolio management system, is clearly gaining market share,” remarked Najeeb Ghauri, chairman and CEO.

However, NetSol has been unable to translate top line traction into bottom line gains. My investment thesis for NetSol was based on potential earnings growth that now appears less likely to materialize. As a result, I have sold my shares for a modest gain (~ 19%) and will watch from the sidelines until the company begins to deliver solid earnings.

DISCLOSURE: I have no position in NTWK. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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Right after the last post on NetSol (NTWK), the company announced yet another substantial contract win in Asia. This time NetSol landed its fifth major Chinese contract in the past twelve months, selling its premiere LeaseSoft software and related services valued at up to $2 million to the captive leasing subsidiary of a major automobile manufacturer. Chairman and CEO Najeeb Ghauri said that the company expects to report record LeaseSoft sales in the APAC region in 2007.

The fundamental trend for NetSol is very strong and could propel shares much higher.

DISCLOSURE: I am long NTWK. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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A few quick hits before I depart for a well-needed vacation:

• A reporter asked me the other day if I thought PIPE deals were universally bad for shareholders. I responded that I did not, although at the time I couldn’t recall an example of the type of deal I think is beneficial. Here’s one: my favorite aging society play, bingo hall operator Littlefield Corp. (LTFD.OB) announced that Value Fund Advisors LLC agreed to buy 400,000 shares in a PIPE deal at 15% above market prices. The institution also agreed to purchase an additional 100,000 shares in the following 3 months on the open market. Those kind of “positive PIPE” deals are fairly rare; I recall one a while ago with Crystallex (KRY).
• Investors took Advocat, Inc. (AVCA) to the woodshed after the nursing home operator said earnings would drop from about $3.35 last year to breakeven. The company said that “projected increases in reimbursement rates are insufficient to offset projected increases in rent expense (including cash and noncash rent) and operating costs, including market-driven increases in employee salaries and benefits costs.” There were red flags–as discussed here, fundamental trends clearly began to deteriorate last quarter.
• I’m digging the action in Deli Solar (DLSL.OB), up over 60% since I bought it only two weeks ago. Now if only my other stocks could behave so generously…
• NetSol’s (NTWK) second fiscal quarter 2007 earnings were mediocre but guidance was strong, and the company continues to report important new contracts in Australia and China.

Hopefully I will return tanned, rested and ready with some great new ideas to discuss.

DISCLOSURE: I am long DLSL.OB, LTFD.OB, KRY and NTWK. I have no position in AVCA. Not a recommendation to buy or sell any security. For informational and educational purposes only.

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