UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB
(Mark One)
|X| Quarterly report pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the quarterly period ended March 31, 2006
|_| For the transition period from __________ to __________
Commission file number: 0-22773
NETSOL TECHNOLOGIES, INC.
(Exact name of small business issuer as specified in its charter)
NEVADA 95-4627685
(State or other Jurisdiction of (I.R.S. Employer NO.)
Incorporation or Organization)
23901 Calabasas Road, Suite 2072, Calabasas, CA 91302
(Address of principal executive offices) (Zip Code)
(818) 222-9195 / (818) 222-9197
(Issuer's telephone/facsimile numbers, including area code)
Check whether the issuer: (1) filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the issuer was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.
Yes |X| No |_|
The issuer had 15,151,292 shares of its $.001 par value Common Stock issued and
outstanding as of May 5, 2006.
Transitional Small Business Disclosure Format (check one)
Yes |_| No |X|
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Page 1
NETSOL TECHNOLOGIES, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Unaudited Balance Sheet as of March 31, 2006 3
Comparative Unaudited Consolidated Statements of Operations
for the Three and Nine Months Ended March 31, 2006 and 2005 (restated) 4
Comparative Unaudited Consolidated Statements of Cash Flow
for the Nine Months Ended March 31, 2006 and 2005 (restated) 5
Notes to the Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operation 20
Item 3. Controls and Procedures 29
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Changes in Securities 30
Item 3. Defaults Upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 31
Item 6. Exhibits and Reports on Form 8-K 32
(a) Exhibits (b) Reports on Form 8-K
Signatures 32
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Page 2
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET -- MARCH 31, 2006
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,390,245
Certificates of deposit 2,098,003
Accounts receivable, net of allowance for doubtful accounts of $80,000 5,810,972
Revenues in excess of billings 3,416,762
Other current assets 2,067,396
----------------
Total current assets 15,783,378
PROPERTY AND EQUIPMENT, net of accumulated depreciation 6,425,581
INTANGIBLES:
Product licenses, renewals, enhancements, copyrights,
trademarks, and tradenames, net 4,623,098
Customer lists, net 1,083,528
Goodwill 1,166,611
----------------
Total intangibles 6,873,237
-----------------
TOTAL ASSETS $ 29,082,196
=================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 3,022,585
Current portion of notes and obligations under capitalized leases 1,076,757
Billings in excess of revenues 300,029
Due to officers 83,021
Deferred liability 313,397
Loans payable, bank 755,095
----------------
Total current liabilities 5,550,884
OBLIGATIONS UNDER CAPITALIZED LEASES, less current maturities 118,079
-----------------
TOTAL LIABILITIES 5,668,963
MINORITY INTEREST 1,385,010
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value; 45,000,000 share authorized;
15,142,185 issued and outstanding 15,142
Additional paid-in-capital 52,584,940
Treasury stock (27,197)
Accumulated deficit (29,968,384)
Stock subscription receivable (372,688)
Common stock to be issued 116,000
Other comprehensive loss (319,590)
----------------
TOTAL STOCKHOLDERS' EQUITY 22,028,223
-----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 29,082,196
=================
See accompanying notes to consolidated financial statements.
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Page 3
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Month Periods For the Nine Month Periods
Ended March 31, Ended March 31,
2006 2005 2006 2005
-------------- ------------- --------------- ---------------
(restated) (restated)
NET REVENUES $ 5,045,827 $ 3,190,918 $ 14,040,185 $ 7,972,450
COST OF REVENUES 2,318,529 1,342,216 5,962,913 2,943,871
-------------- ------------- --------------- ---------------
GROSS PROFIT 2,727,298 1,848,702 8,077,272 5,028,579
OPERATING EXPENSES:
Selling and marketing 444,472 219,399 1,190,906 474,099
Depreciation and amortization 594,385 384,649 1,711,771 1,007,789
Settlement costs - - 15,953 43,200
Bad debt expense 19,561 - 27,289 -
Salaries and wages 597,636 453,226 1,686,726 1,248,447
Professional services, including non-cash
compensation 126,806 112,830 365,152 368,135
General and adminstrative 675,339 462,421 1,850,885 1,011,653
-------------- ------------- --------------- ---------------
Total operating expenses 2,458,199 1,632,525 6,848,682 4,153,323
----------------------------- --------------- ---------------
INCOME FROM OPERATIONS 269,099 216,177 1,228,590 875,256
OTHER INCOME AND (EXPENSES)
Gain (Loss) on sale of assets (38,624) - (34,014) (620)
Beneficial conversion feature (2,628) (3,941) (14,389) (205,906)
Fair market value of warrants issued (12,016) - (21,505) (249,638)
Gain on forgiveness of debt 1,318 49,865 8,294 239,506
Interest expense (75,015) (47,356) (240,900) (177,356)
Interest income 93,376 11,181 272,417 12,978
Other income and (expenses) (2,484) (10,287) (57,129) 28,013
Income taxes (24,080) (58,787) (90,891) (61,260)
-------------- ------------- --------------- ---------------
Total other expenses (60,153) (59,325) (178,117) (414,283)
-------------- ------------- --------------- ---------------
NET INCOME BEFORE MINORITY INTEREST IN SUB SUBSIDIARY 208,946 156,852 1,050,473 460,973
MINORITY INTEREST IN SUBSIDIARY (187,127) (29,994) (699,872) (15,735)
-------------- ------------- --------------- ---------------
NET INCOME 21,819 126,858 350,601 445,238
OTHER COMPREHENSIVE (LOSS)/GAIN:
Translation adjustment (115,740) (11,252) 201,100 (219,660)
-------------- ------------- --------------- ---------------
COMPREHENSIVE INCOME (LOSS) $ (93,921) $ 115,606 $ 551,701 $ 225,578
============== ============= =============== ===============
NET INCOME PER SHARE:
Basic $ 0.00 $ 0.01 $ 0.02 $ 0.04
============== ============= =============== ===============
Diluted $ 0.00 $ 0.01 $ 0.02 $ 0.03
============== ============= =============== ===============
Weighted average number of shares outstanding
Basic 14,852,941 12,704,226 14,267,690 10,937,910
Diluted 15,278,168 15,642,431 14,692,917 13,750,981
See accompanying notes to consolidated financial statements.
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NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Nine Month Periods
Ended March 31,
2006 2005
---------------- ----------------
(Restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 350,601 $ 445,238
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 1,988,501 1,258,891
Provision for uncollectible accounts 27,289 -
Gain on settlement of debt (8,294) (239,506)
Loss on sale of assets 34,014 620
Minority interest in subsidiary 699,872 15,735
Stock issued for services 165,270 89,065
Fair market value of options and warrants granted 25,618 249,638
Beneficial conversion feature 14,389 205,906
CHANGES IN OPERATING ASSETS AND LIABILITIES:
INCREASE IN ASSETS:
Accounts receivable (1,931,901) (2,568,139)
Other current assets (2,593,864) (1,701,031)
DECREASE IN LIABILITIES:
Accounts payable and accrued expenses 491,148 394,862
Deferred Liability - 1,115,312
---------------------------------
NET CASH USED IN OPERATING ACTIVITIES (737,357) (733,409)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (2,063,284) (804,115)
Sales of property and equipment 111,417 86,988
Proceeds/(Purchases) of certificates of deposit - net (1,892,523) 341,403
Increase in intangible assets - development costs (726,408) (4,071,950)
Capital investments in minority interest of subsidiary - 537,803
Cash brought in at acquisition 2,132 145,297
---------------------------------
NET CASH USED IN INVESTING ACTIVITIES (4,568,666) (3,764,574)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock 1,400,000 1,512,000
Proceeds from the exercise of stock options 384,062 999,224
Capital contributed from sale of subsidary stock 4,031,001 1,589,974
Purchase of treasury shares - (51,704)
Proceeds from loans - 1,503,273
Capital lease obligations & loans (net) 417,678 (366,092)
---------------------------------
NET CASH PROVIDED BY FINANCING ACTIVITIES 6,232,741 5,186,675
EFFECT OF EXCHANGE RATE CHANGES IN CASH 91,800 36,175
---------------- ----------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 1,018,518 724,867
Cash and cash equivalents, beginning of period 1,371,727 871,161
---------------------------------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 2,390,245 $ 1,596,028
=================================
See accompanying notes to consolidated financial statements.
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Page 5
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
For the Nine Month Periods
Ended March 31,
2006 2005
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $ 206,141 $ 92,631
============= =============
Taxes $ 12,454 $ 72,870
============= =============
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued for services and compensation $ 101,190 $ 141,010
============= =============
Common stock issued for accrued expenses and accounts payable $ 64,078 $ 31,968
============= =============
Common stock issued for conversion of convertible debenture $ 150,000 $ 1,050,000
============= =============
Common stock issued for settlement of debt $ - $ 45,965
============= =============
Common stock issued for payment of note payable and related interest $ 71,018 $ -
============= =============
Common stock issued for acquisition of product license $ - $ 91,600
============= =============
Common stock issued for acquisition of subsidiary $ - $ 1,676,795
============= =============
See accompanying notes to consolidated financial statements.
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Page 6
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATION
The Company designs, develops, markets, and exports proprietary software
products to customers in the automobile finance and leasing, banking and
financial services industries worldwide. The Company also provides consulting
services in exchange for fees from customers.
The consolidated condensed interim financial statements included herein have
been prepared by the Company, without audit, pursuant to the rules and
regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with generally accepted accounting principles have been condensed or
omitted pursuant to such rules and regulations, although the Company believes
that the disclosures are adequate to make the information presented not
misleading.
These statements reflect all adjustments, consisting of normal recurring
adjustments, which, in the opinion of management, are necessary for fair
presentation of the information contained therein. It is suggested that these
consolidated condensed financial statements be read in conjunction with the
financial statements and notes thereto included in the Company's amended annual
report on Form 10-KSB/A for the year ended June 30, 2005. The Company follows
the same accounting policies in preparation of interim reports. Results of
operations for the interim periods are not indicative of annual results.
The accompanying consolidated financial statements include the accounts of the
Company and its wholly owned subsidiaries, NetSol Technologies (PVT), Ltd. ("PK
Tech"), NetSol (PVT), Limited ("PK Private"), NetSol Abraxas Australia Pty Ltd.
("NetSol Abraxas"), NetSol Technologies UK, Ltd. ("NetSol UK"), and CQ Systems
Ltd.("CQ Systems"), as well as the subsidiaries in which the Company owns a
controlling percentage, NetSol CONNECT (PVT), Ltd. (now, NetSol Akhter Pvt.
Ltd.) ("Connect"), TiG-NetSol (Pvt) Ltd. ("NetSol-TiG"), and Talk Trainers
(Private) Limited ("Talk Trainers"). All material inter-company accounts have
been eliminated in consolidation.
For comparative purposes, prior year's consolidated financial statements have
been reclassified to conform to report classifications of the current year.
NOTE 2 - USE OF ESTIMATES:
The preparation of financial statements in conformity with generally accepted
accounting principles in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
NOTE 3 - NEW ACCOUNTING PRONOUNCEMENTS:
In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error
Corrections." This statement applies to all voluntary changes in accounting
principle and requires retrospective application to prior period's financial
statements of changes in accounting principle, unless this would be
impracticable. This statement also makes a distinction between "retrospective
application" of an accounting principle and the "restatement" of financial
statements to reflect the correction of an error. This statement is effective
for accounting changes and corrections of errors made in fiscal years beginning
after December 15, 2005. The Company believes that the adoption of this standard
will have no material impact on its financial statements.
In February 2006, FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments". SFAS No. 155 amends SFAS No 133, "Accounting for
Derivative Instruments and Hedging Activities", and SFAS No. 140, "Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities". SFAS No. 155, permits fair value remeasurement for any hybrid
financial instrument that contains an embedded derivative that otherwise would
require bifurcation, clarifies which interest-only strips and principal-only
strips are not subject to the requirements of SFAS No. 133, establishes a
requirement to evaluate interest in securitized financial assets to identify
interests that are freestanding derivatives or that are hybrid financial
instruments that contain an embedded derivative requiring bifurcation, clarifies
that concentrations of credit risk in the form of subordination are not embedded
derivatives, and amends SFAS No. 140 to eliminate the prohibition on the
qualifying special-purpose entity from holding a derivative financial instrument
that pertains to a beneficial interest other than another derivative financial
instrument. This statement is effective for all financial instruments acquired
or issued after the beginning of the Company's first fiscal year that begins
after September 15, 2006. SFAS No. 155 is not expected to have a material effect
on the consolidated financial position or results of operations of the Company.
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Page 7
In March 2006 FASB issued SFAS 156 `Accounting for Servicing of Financial
Assets' this Statement amends FASB Statement No. 140, Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities, with
respect to the accounting for separately recognized servicing assets and
servicing liabilities. This Statement:
1. Requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract.
2. Requires all separately recognized servicing assets and servicing
liabilities to be initially measured at fair value, if practicable.
3. Permits an entity to choose `Amortization method' or `Fair value
measurement method' for each class of separately recognized
servicing assets and servicing liabilities.
4. At its initial adoption, permits a one-time reclassification of
available-for-sale securities to trading securities by entities with
recognized servicing rights, without calling into question the
treatment of other available-for-sale securities under Statement
115, provided that the available-for-sale securities are identified
in some manner as offsetting the entity's exposure to changes in
fair value of servicing assets or servicing liabilities that a
servicer elects to subsequently measure at fair value.
5. Requires separate presentation of servicing assets and servicing
liabilities subsequently measured at fair value in the statement of
financial position and additional disclosures for all separately
recognized servicing assets and servicing liabilities.
This Statement is effective as of the beginning of the Company's first fiscal
year that begins after September 15, 2006. Management believes that this
statement will not have a significant impact on the consolidated financial
statements.
NOTE 4 - NET INCOME PER SHARE:
Net income per share is calculated in accordance with the Statement of financial
accounting standards No. 128 (SFAS No. 128), "Earnings per share". Basic net
income per share is based upon the weighted average number of common shares
outstanding. Diluted net income per share is based on the assumption that all
dilutive convertible shares and stock options were converted or exercised.
Dilution is computed by applying the treasury stock method. Under this method,
options and warrants are assumed to be exercised at the beginning of the period
(or at the time of issuance, if later), and as if funds obtained thereby were
used to purchase common stock at the average market price during the period.
The following is a reconciliation of the numerators and denominators of the
basic and diluted earnings per share computations:
-----------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED MARCH 31, 2006 NET INCOME SHARES PER SHARE
-----------------------------------------------------------------------------------------------------
Basic earnings per share:
Net income available to common shareholders $ 350,601 14,267,690 $ 0.02
Effect of dilutive securities
Stock options 423,865
Warrants 1,362
--------------- --------------- --------------
Diluted earnings per share $ 350,601 14,692,917 $ 0.02
=============== =============== ==============
-----------------------------------------------------------------------------------------------------
FOR THE NINE MONTHS ENDED MARCH 31, 2005 NET INCOME SHARES PER SHARE
-----------------------------------------------------------------------------------------------------
Basic earnings per share:
Net income available to common shareholders $ 445,238 10,937,910 $ 0.04
Effect of dilutive securities
Stock options 1,981,309
Warrants 831,761
--------------- --------------- --------------
Diluted earnings per share $ 445,238 13,750,980 $ 0.03
=============== =============== ==============
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NOTE 5 - FOREIGN CURRENCY:
The accounts of NetSol Technologies UK, Ltd., and CQ Systems use the British
Pound; NetSol Technologies, (PVT), Ltd, NetSol (Pvt), Limited, NetSol Connect
PVT, Ltd., NetSol-TiG, and Talk Trainers use Pakistan Rupees; and NetSol Abraxas
Australia Pty, Ltd. uses the Australian dollar as the functional currencies.
NetSol Technologies, Inc., and subsidiary NetSol USA, Inc., use the U.S. dollars
as the functional currencies. Assets and liabilities are translated at the
exchange rate on the balance sheet date, and operating results are translated at
the average exchange rate throughout the period. Accumulated translation losses
of $319,590 at March 31, 2006 are classified as an item of accumulated other
comprehensive loss in the stockholders' equity section of the consolidated
balance sheet. During the nine months ended March 31, 2006 and 2005,
comprehensive income (loss) in the consolidated statements of operation included
translation income of $201,100 and loss of $219,660, respectively.
NOTE 6 - RESTRICTED CASH
During the quarter ended December 31, 2005 the Company established a Letter of
Credit with its bank in the amount of $206,900 for the purpose of purchasing a
third-party software package to be used in a project for one of its customers.
The funds were transferred into a separate bank account and were to be released
to the vendor when certain criteria were met. During the quarter ended March 31,
2006, the conditions were met and the funds were released to the vendor.
NOTE 7 - OTHER CURRENT ASSETS
Other current assets consist of the following at March 31, 2006:
Prepaid Expenses $ 1,054,961
Advance Income Tax 191,343
Employee Advances 52,044
Security Deposits 82,496
Other Receivables 595,037
Other Assets 91,515
---------------
Total $ 2,067,396
===============
In August 2004, the Company entered into a two-year consulting agreement with a
non-related third party whereby the Company agreed to pay the consultant a total
of 100,000 shares of its common stock valued at $111,920. This has been recorded
as a prepaid expense and is being amortized over the life of the service
agreement. During the nine months ended March 31, 2006 and 2005, $41,700 and
$34,975 was expensed respectively.
NOTE 8 - DEBTS
NOTES PAYABLE
Notes payable as of March 31, 2006 consist of the following:
------------------------------------------------------------ ----------------- ------------------
Balance at Current Long-Term
Name 3/31/06 Maturities Maturities
------------------------------------------------------------ ----------------- ------------------
A. Zaman Settlement $ 16,300 $ 16,300 $ -
D&O Insurance 129,882 129,882 -
Professional Liability Insurance 2,640 2,640 -
Noon Group 555,390 555,390 -
Gulf Crown 250,000 250,000 -
Subsidiary Capital Leases 122,545 122,545 -
------------- ----------------- ------------------
$ 1,076,757 $ 1,076,757 $ -
============= ================= ==================
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Page 9
In June 2002, the Company signed a settlement agreement with a former employee
for payment of past services rendered. The Company agreed to pay the employee a
total of $75,000. The agreement calls for monthly payments of $1,500 per month
until paid. The balance owing at June 30, 2005 and March 31, 2006 was $16,300.
The entire balance has been classified as a current liability in the
accompanying consolidated financials statements.
In February 2005, the Company received a loan from Noon Group in the amount of
$500,000. The note carries an interest rate of 9.75% per annum and is due in one
year. The maturity date of the loan may be extended at the option of the holder
for an additional year. During the nine months ended March 31, 2006, $36,596 of
accrued interest was recorded for this loan. Total accrued interest added to the
loan at March 31, 2006 was $55,390. In March, 2006, the note was extended for
another year.
In February 2005, the Company received a loan from Gulf Crown Investments in the
amount of $250,000. The note carries an interest rate of 9.75% per annum and is
due in one year. The maturity date of the loan may be extended at the option of
the holder for an additional year. During the nine months ended March 31, 2006,
$18,298 of accrued interest was recorded for this loan. On March 31, 2006, the
total accrued interest of $27,695 was paid to the note holder. On April 12,
2006, the principle of the note was paid to the note holder.
In May 2005, the Company executed a note in favor of Maxim Group, LLC ("Maxim")
in the amount of $250,000. The funds were due as compensation for mergers and
acquisition related services provided by Maxim Group, LLC, in connection with
the CQ Systems Ltd. transaction. The note was due on July 25, 2005 and carries
an interest rate of 12% starting on the due date and increases 1.5% per month
thereafter. The note called for $150,000 to be paid with 80,214 shares the
Company's common stock and the balance of $100,000 to be paid in cash. In May
2005, the shares were issued. In addition, the loan called for $3,000 worth of
additional shares for each month that the shares are not registered after the
120 day maturity date and a $10,000 penalty for late payment. On October 3,
2005, the Company paid Maxim $50,000 cash, and issued a total of 36,606 shares
valued at $71,018 for the balance of the note of $50,000, accrued interest of
$2,453 and penalties of $16,000.
In October 2005, the Company renewed its professional liability insurance for
which the annual premium is $8,050. The Company has arranged for financing with
the insurance company with a down payment of $1,610 and ten monthly payments of
$674 each. During the nine months ended March 31, 2006, the Company paid $3,800.
The balance owing at March 31, 2006 was $2,640 and is classified as a current
liability in the accompanying consolidated financials statements.
In January 2006, the Company renewed its directors and officers' liability
insurance for which the annual premium is $185,000. In January 2006, the Company
arranged financing with AFCO Credit Corporation with a down payment of $19,007
with the balance to be paid in nine monthly installments of $19,007 each. The
balance owing as of March 31, 2006 was $129,881.
In addition, the various subsidiaries had current maturities of capital leases
of $122,545, as of March 31, 2006.
BANK NOTE
The Company's Pakistan subsidiaries, NetSol Technologies (Private) Ltd., and
NetSol (Private) Ltd., each have one loan with a bank, secured by the Company's
assets. These notes consist of the following as of March 31, 2006:
TYPE OF MATURITY INTEREST BALANCE
LOAN DATE RATE USD
----------------------------------------------------------------------------
Export Refinance Every 6 months 8% $ 665,779
Line of Credit December 31, 2006 11% 89,316
-----------------
Total $ 755,095
=================
DUE TO OFFICERS
The officers of the Company from time to time loan funds to the Company. As of
June 30, 2005, the officers had a balance owing to them of $47,636. One of the
officers has deferred the increase in his wages. During the nine months ended
March 31, 2006, $37,500 of accrued wages was added to the balance due to
officers and $30,464 was remitted to one officer against the amounts owing to
him. The balance owing as of March 31, 2006 was $47,172. In addition, an officer
of Talk Trainers had $35,849 owed to him as of March 31, 2006.
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Page 10
NOTE 9 - STOCKHOLDERS' EQUITY:
EQUITY TRANSACTIONS
PRIVATE PLACEMENTS
In August 2004, the Company sold 190,476 shares of the Company's common stock
for $200,000 in a private placement. Of this amount $91,500 had been received
during the fiscal year ended June 30, 2005 and a total of 87,143 shares were
issued to the purchaser. The remaining balance of $108,500 or 103,333 shares are
shown as "Shares to Be Issued" on the accompanying financial statements.
In January 2006, the Company sold 933,334 shares of the Company's common stock
for $1,400,000 in a private placement.
SERVICES, ACCRUED EXPENSES AND PAYABLES
During the nine months ended March 31, 2006, the Company issued 5,500 restricted
Rule 144 common shares in exchange for services rendered valued at $9,957.
Compensation expense was calculated based upon the fair market value of the
freely trading shares as quoted on NASDAQ over the service period.
In July 2004, the Board of Directors and officers were granted the right to
receive shares of the Company's common stock if certain conditions were met
during their 2004 - 2005 term of office. These conditions were met and a total
of 28,000 restricted Rule 144 common shares were issued in August 2005 and
11,000 shares were issued in March 2006. The shares were valued at the fair
market value at the date of grant of $57,034 or $1.46 per share.
In October 2005, the Company issued 36,607 restricted Rule 144 common shares
valued at $71,018 in payment of $50,000 in principal, $16,000 in penalties and
$2,453 in accrued interest on a note payable (see Note 7).
In October 2005, the Company entered into an agreement with a vendor whereby the
Company issued the vendor 27,231 shares valued at $52,828 for the payment of
outstanding invoices in the amount of $50,923. As a result, the Company recorded
a loss on settlement of debt in the amount of $1,905.
In October 2005, the Company entered into an agreement with a vendor whereby the
Company agreed to issue $2,500 worth of stock per month as payment for services
rendered. The stock is to be issued after the end of each quarter. The Company
issued 3,983 shares of its common stock during the quarter ended March 31, 2006
for the previous quarter services and recorded 3,772 shares of common stock
valued at $7,500 to "Stock to Be Issued" under this agreement during the quarter
ended March 31, 2006.
In March 2006, the Company entered into an agreement with a former consultant
whereby the Company agreed to issue the consultant 10,000 restricted Rule 144
shares of its common stock valued at $19,200 for past services.
STOCK OPTIONS AND WARRANTS EXERCISED
During the nine months ended March 31, 2006, the Company issued 175,000 shares
of its common stock for the exercise of options valued at $195,000. Of these,
$52,500 has been recorded as "Stock Subscription Receivable".
ISSUANCE OF SHARES FOR CONVERSION OF DEBT
During the quarter ended September 30, 2005, one of the convertible debenture
holders elected to convert their note into common stock. The total of the note
converted was $50,000 and the Company issued 26,882 shares of its common stock
to the note holder.
During the quarter ended March 31, 2005, two of the convertible debenture
holders elected to convert their notes into common stock. The total of the notes
converted was $100,000 and the Company issued 53,764 shares of its common stock
to the note holders.
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STOCK SUBSCRIPTION RECEIVABLE
Stock subscription receivable represents stock options exercised and issued that
the Company has not yet received the payment from the purchaser as they were in
process when the quarter ended.
The balance at June 30, 2005 was $616,650. During the nine months ended March
31, 2006, the Company received a total of $252,812 as payment on the receivable
and recorded $52,500 as receivable. The Company also recorded the cancellation
of $43,650 due as a charge to additional paid-in capital as a result of a review
of the records when the amount was recorded in 2000. It was determined the
amount was not due and therefore was cancelled. The balance at March 31, 2006
was $372,688.
COMMON STOCK PURCHASE WARRANTS AND OPTIONS
From time to time, the Company issues options and warrants as incentives to
employees, officers and directors, as well as to non-employees.
Common stock purchase options and warrants consisted of the following during the
nine months ended March 31, 2006:
Exercise Exercise
Options Price Warrants Price
--------------- --------------- ------------ ---------------
Outstanding and exercisable, June 30, 2005 5,038,000 $0.75 to $5.00 655,280 $1.75 to $5.00
Granted 1,322,500 $1.65 to $2.89 40,323 $3.30
Exercised (175,000) $0.75 to $1.75 -
Expired - -
--------------- ------------
Outstanding and exercisable, March 31, 2006 6,185,250 695,603
During the nine months ended March 31, 2006, a total of 1,320,000 options were
granted to employees of the Company and are fully vested and expire ten years
from the date of grant unless the employee terminates employment, in which case
the options expire within 30 days of their termination. The exercise price of
the options ranges from $1.65 to $2.89. No expense was recorded for the granting
of these options.
During the nine months ended March 31, 2006, a total of 2,500 options were
granted to a consultant and are fully vested from the date of grant. The
options expire in ten years and have an exercise price of $1.98 per share. The
options were valued using the fair value method at $4,113 or $1.65 per share and
recorded the expense in the accompanying consolidated financial statements. The
Black-Scholes option pricing model used the following assumptions:
Risk-free interest rate 3.25%
Expected life 10 years
Expected volatility 82%
Dividend yield 0%
During the nine months ended March 31, 2005, 714,000 options were granted to
employees of the company and are fully vested and expire ten years from the date
of grant unless the employee terminates employment, in which case the options
expire within 30 days of their termination. No expense was recorded for the
granting of these options.
In compliance with FAS No. 148, the Company has elected to continue to follow
the intrinsic value method in accounting for its stock-based employee
compensation plan as defined by APB No. 25 and has made the applicable
disclosures below.
Had the Company determined employee stock based compensation cost based on a
fair value model at the grant date for its stock options under SFAS 123, the
Company's net earnings per share would have been adjusted to the pro forma
amounts for nine months ended March 31, 2006 and 2005 as follows:
2006 2005
------------------ ------------------
Net income - as reported $ 350,601 $ 445,238
Stock-based employee compensation expense,
included in reported net loss, net of tax - -
Total stock-based employee compensation
expense determined under fair-value-based
method for all rewards, net of tax (1,496,750) (313,195)
------------------ ------------------
Pro forma net loss $ (1,146,149) $ 132,043
================== ==================
Earnings per share:
Basic, as reported 0.02 0.04
Diluted, as reported 0.02 0.03
Basic, pro forma (0.08) 0.01
Diluted, pro forma (0.08) 0.01
--------------------------------------------------------------------------------
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Pro forma information regarding the effect on operations is required by SFAS
123, and has been determined as if the Company had accounted for its employee
stock options under the fair value method of that statement. Pro forma
information using the Black-Scholes method at the date of grant based on the
following assumptions:
Risk-free interest rate 3.25%
Expected life 10 years
Expected volatility 54% - 57%
Dividend yield 0%
During the quarter ended September 30, 2005, one debenture holder converted
their note into common stock. As part of the conversion, warrants to purchase a
total of 13,441 common shares were issued to the note holder. The warrants
expire in five years and have an exercise price of $3.30 per share. The warrants
were valued using the fair value method at $9,489 or $0.71 per share and
recorded the expense in the accompanying consolidated financial statements. The
Black-Scholes option pricing model used the following assumptions:
Risk-free interest rate 3.25%
Expected life 5 years
Expected volatility 56%
Dividend yield 0%
During the quarter ended March 31, 2006, two debenture holders converted their
notes into common stock. As part of the conversion, warrants to purchase a total
of 26,882 common shares were issued to the note holders. The warrants expire in
five years and have an exercise price of $3.30 per share. The warrants were
valued using the fair value method at $12,016 or $0.45 per share and recorded
the expense in the accompanying consolidated financial statements. The
Black-Scholes option pricing model used the following assumptions:
Risk-free interest rate 3.25%
Expected life 5 years
Expected volatility 44%
Dividend yield 0%
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NOTE 10 - INTANGIBLE ASSETS:
Intangible assets consist of product licenses, renewals, enhancements,
copyrights, trademarks, trade names, customer lists and goodwill. The Company
evaluates intangible assets, goodwill and other long-lived assets for
impairment, at least on an annual basis and whenever events or changes in
circumstances indicate that the carrying value may not be recoverable from its
estimated future cash flows. Recoverability of intangible assets, other
long-lived assets and, goodwill is measured by comparing their net book value to
the related projected undiscounted cash flows from these assets, considering a
number of factors including past operating results, budgets, economic
projections, market trends and product development cycles. If the net book value
of the asset exceeds the related undiscounted cash flows, the asset is
considered impaired, and a second test is performed to measure the amount of
impairment loss. Potential impairment of goodwill after July 1, 2002 has been
evaluated in accordance with SFAS No. 142. The SFAS No. 142 is applicable to the
financial statements of the Company beginning July 1, 2002.
As part of intangible assets, the Company capitalizes certain computer software
development costs in accordance with SFAS No. 86, "Accounting for the Costs of
Computer Software to be Sold, Leased, or Otherwise Marketed." Costs incurred
internally to create a computer software product or to develop an enhancement to
an existing product are charged to expense when incurred as research and
development expense until technological feasibility for the respective product
is established. Thereafter, all software development costs are capitalized and
reported at the lower of unamortized cost or net realizable value.
Capitalization ceases when the product or enhancement is available for general
release to customers.
The Company makes on-going evaluations of the recoverability of its capitalized
software projects by comparing the amount capitalized for each product to the
estimated net realizable value of the product. If such evaluations indicate that
the unamortized software development costs exceed the net realizable value, the
Company writes off the amount by which the unamortized software development
costs exceed net realizable value. Capitalized and purchased computer software
development costs are being amortized ratably based on the projected revenue
associated with the related software or on a straight-line basis over three
years, whichever method results in a higher level of amortization.
Product licenses and customer lists were comprised of the following as of March
31, 2006:
Product Licenses Customer Lists Total
-------------------- ------------------- -----------------
Intangible asset - June 30, 2005 $ 8,799,323 $ 3,294,758 $ 12,094,080
Additions 688,341 - 688,341
Effect of translation adjustment (27,040) - (27,040)
Accumulated amortization (4,837,526) (2,211,230) (7,048,756)
-------------------- ------------------- -----------------
Net balance - March 31, 2006 $ 4,623,098 $ 1,083,528 $ 5,706,625
==================== =================== =================
Amortization expense:
Nine months ended March 31, 2006 $ 1,048,591 $ 471,465 $ 1,520,056
==================== =================== =================
Nine months ended March 31, 2005 $ 645,942 $ 258,696 $ 904,638
==================== =================== =================
The above amortization expense includes amounts in "Cost of Goods Sold" for
capitalized software development costs of $56,528 and $40,014 for the nine
months ended March 31, 2006 and 2005, respectively.
Amortization expense of intangible assets over the next five years is as
follows:
---------------------------------------------------------------------------------------------------------------
FISCAL PERIOD ENDING
Asset 3/31/06 3/31/07 3/31/08 3/31/09 3/31/10 TOTAL
---------------------------------------------------------------------------------------------------------------
Product Licences $ 761,903 $ 591,872 $ 589,722 $ 510,507 $ - $ 2,454,004
Customer Lists 315,348 263,376 263,376 241,428 - 1,083,528
----------------------------------------------------------------------- -------------
$ 1,077,251 $ 855,248 $ 853,098 $ 751,935 $ - $ 3,537,532
======================================================================= =============
There were no impairments of the goodwill asset in the nine months ended March
31, 2006 and 2005.
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NOTE 12 - LITIGATION:
To the best knowledge of Company's management and counsel, there is no material
litigation pending or threatened against the Company.
NOTE 13 - SEGMENT INFORMATION
The following table presents a summary of operating information and certain
year-end balance sheet information for the nine months ended March 31:
2006 2005
------------------ ------------------
Revenues from unaffiliated customers: (restated)
North America $ 45,250 $ 295,725
International 13,994,935 7,676,725
------------------ ------------------
Consolidated $ 14,040,185 $ 7,972,450
================== ==================
Operating loss:
North America $ (2,623,075) $ (1,932,368)
International 3,851,665 2,807,624
------------------ ------------------
Consolidated $ 1,228,590 $ 875,256
================== ==================
Identifiable assets:
North America $ 5,679,763 $ 6,568,062
International 23,402,433 15,241,710
------------------ ------------------
Consolidated $ 29,082,196 $ 21,809,772
================== ==================
Depreciation and amortization:
North America $ 1,445,977 $ 860,330
International 542,524 147,460
------------------ ------------------
Consolidated $ 1,988,501 $ 1,007,790
================== ==================
Capital expenditures:
North America $ - $ -
International 2,177,827 624,703
------------------ ------------------
Consolidated $ 2,177,827 $ 624,703
================== ==================
NOTE 14 - MINORITY INTEREST IN SUBSIDIARY
NetSol Connect:
In August 2003, the Company entered into an agreement with United Kingdom based
Akhter Group PLC ("Akhter"). Under the terms of the agreement, Akhter Group
acquired 49.9 percent of the Company's subsidiary; Pakistan based NetSol Connect
PVT Ltd. ("Connect"), an Internet service provider ("ISP"), in Pakistan through
the issuance of additional Connect shares. As part of this Agreement, Connect
changed its name to NetSol Akhter. The partnership with Akhter Computers is
designed to rollout connectivity and wireless services to the Pakistani national
market. On signing of this Agreement, the Shareholders agreed to make the
following investment in the Company against issuance of shares of Connect.
Akhter US$ 200,000
The Company US$ 50,000
During the quarter ended September 30, 2003, the funds were received by Connect
and a minority interest of $200,000 was recorded for Akhter's portion of the
subsidiary. During the quarter ended December 31, 2003, Akhter paid an
additional $10,000 to the Company for this purchase. Per the agreement, it was
envisaged that Connect would require a maximum $500,000 for expansion of its
business from each partner. Akhter was to meet the initial financial
requirements of the Connect until November 1, 2003. As of December 31, 2004,
both NetSol and Akhter had injected the majority of their committed cash to meet
the expansion requirement of the company. As of December 31, 2004, a total of
$751,356 had been transferred to Connect.
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For the nine months ended March 31, 2006 and 2005, the subsidiary had net income
of $48,838 and net losses of $23,576, respectively, of which $24,370 and
($14,259) respectively, was recorded against the minority interest. The balance
of the minority interest at March 31, 2006 was $348,308.
NetSol-TiG:
In December 2004, NetSol forged a relationship with a UK based public company
TiG Plc. A joint venture agreement was signed by the two companies to create a
new company, TiG NetSol Pvt Ltd. ("NetSol-TiG"), with 50.1% ownership by NetSol
Technologies, Inc. and 49.9% ownership by TiG. The agreement anticipates TiG's
technology business to be outsourced to NetSol's offshore development facility.
Both companies, according to this agreement, would invest a total of $1 million
or $500,000 each for infrastructure, dedicated personnel and systems in the
NetSol IT campus in Lahore.
During the year ended June 30, 2005, the Company invested $253,635 and TiG
invested $251,626. The new subsidiary began operations during the quarter ended
March 31, 2005.
For the nine months ended March 31, 2006, the subsidiary had net income of
$622,684, of which $310,719 was recorded against the minority interest. For the
three months ended March 31, 2005, (the first quarter of activity) the
subsidiary had net income of $55,110, of which $27,500 was recorded against the
minority interest. The balance of the minority interest at March 31, 2006 was
$687,808.
NetSol Technologies, Limited ("PK Tech")
In August 2005, the Company's wholly-owned subsidiary, NetSol Technologies
(Pvt), Ltd. ("PK Tech") became listed on the Karachi Stock Exchange in Pakistan.
The Initial Public Offering ("IPO") sold 9,982,000 shares of the subsidiary to
the public thus reducing the Company's ownership by 28.13%. Net proceeds of the
IPO were $4,890,224. As a result of the IPO, the Company is required to show the
minority interest of the subsidiary on the accompanying consolidated financial
statements.
For the nine months ended March 31, 2006, the subsidiary had net income of
$1,300,277, of which $365,768 was recorded against the minority interest. The
balance of the minority interest at March 31, 2006 was $365,768.
Talk Trainers (Private) Limited ("Talk Trainers")
In February 2006, the Company purchased for $60,012 50.1% of the outstanding
shares in Talk Trainers (Private) Limited, ("Talk Trainers"), a Pakistan
corporation which provides educational, professional courses, training and Human
Resource services to the corporate sector. The major stockholder of Talk
Trainers was Mr. Ayub Ghuari, brother to the executive officers of the Company,
and therefore the acquisition was recorded at historical cost as the entities
are under common control. As the effects of this transaction are immaterial to
the Company overall, no pro forma information is provided.
For the three months ended March 31, 2006, the subsidiary had a net loss of
$1,974, of which $985 was recorded against the minority interest. The balance of
the minority interest at March 31, 2006 was ($16,874).
NOTE 15 - CONVERTIBLE DEBENTURE
On March 24, 2004, the Company entered into an agreement with several investors
to acquire Series A Convertible Debentures (the "Bridge Loan") whereby a total
of $1,200,000 in debentures were procured through Maxim Group, LLC. The Company
received a net of $1,049,946 after placement expenses. In addition, the
beneficial conversion feature of the debenture was valued at $252,257. The
Company has recorded this as a contra-account against the loan balance and is
amortizing the beneficial conversion feature over the life of the loan. During
the nine months ended March 31, 2006, the Company amortized $11,825. The
unamortized balance at March 31, 2006 was $0.
During the nine months ended March 31, 2006, three of the convertible debenture
holders elected to convert their notes into common stock. The total of the notes
converted was $150,000 and the Company issued 80,646 shares of its common stock
to the note holders. The net balance at March 31, 2006, was $0.
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Under the terms of the Bridge Loan agreements, and supplements thereto, the
debentures bear interest at the rate of 10% per annum, payable on a quarterly
basis in common stock or cash at the election of the Company. The maturity date
is 24 months from the date of signing, or March 26, 2006. Pursuant to the terms
of a supplemental agreement dated May 5, 2004 between NetSol and the debenture
holders, the conversion rate was set at one share for each $1.86 of principal.
During the nine months ended March 31, 2006, the Company recorded interest
expense on the debentures in the amount of $5,440.
In addition, each debenture holder is entitled to receive at the time of
conversion warrants equal to one-half of the total number of shares issued. The
total number of warrants that may be granted is 322,582. The warrants expire in
five years and have an exercise price of $3.30 per share. The fair value of the
warrants will be calculated and recorded using the Black-Scholes method at the
time of granting, when the debenture is converted. During the nine months ended
March 31, 2006, three debenture holders converted their notes into common stock.
As part of the conversion, warrants to purchase a total of 40,323 common shares
were issued to the note holders, (see note 9). The warrants were valued using
the fair value method at $21,505. The expense was recorded in the accompanying
consolidated financial statements.
NOTE 16 - GAIN ON SETTLEMENT OF DEBT
During the nine months ended March 31, 2006, the Company entered into agreements
with several vendors whereby the vendors agreed to accept as payment in full
amounts less than the invoiced amount. As a result of these settlements, the
Company recorded a net gain on settlement of debt of $8,294.
In September 2004, the Company transferred 24,004 of its treasury shares valued
at $45,965 to Brobeck Phleger & Harrison, Llp, in exchange of debt, as part of a
settlement agreement. The Company recorded a gain of $8,285 on the settlement.
During the quarter ended September 30, 2004, the Company evaluated the
liabilities of its discontinued operations and determined that $41,989 was no
longer payable. The Company recorded a gain of $41,989 as a result of the
write-off of these liabilities from its financial statements.
In October 2004, the Company reached an agreement with a vendor to settle the
amounts owing. The vendor agreed to accept $29,642 as payment in full. As a
result, the Company recorded a gain on forgiveness of debt of $11,029.
In December 2004, the Company reached an agreement with Cowler to pay the
balance owing on the loan in one lump-sum payment (see Note 7). Cowler agreed to
accept (pound)52,000 or $103,371 as payment in full. As a result, the Company
recorded a gain on forgiveness of debt of $21,148.
During the quarter ended December 31, 2004, a former officer of Abraxas, the
Company's Australian subsidiary, agreed to forgive amounts accrued to him for
long-term service leave prior to the Company's acquisition in 1999. The amounts
accrued were during the period of 1984 to 1999. As a result, the Company
recorded a gain on forgiveness of debt of $107,190.
In February 2005, the Company reached an agreement with a former vendor to
settle amounts owing. The vendor agreed to accept $27,580 as payment in full. As
a result, the Company recorded a gain on forgiveness of debt of $27,581.
During the quarter ended March 31, 2005, the Company wrote-off old invoices for
services under the statute of limitations. The vendor has not contacted the
Company in over four years and the original services were in dispute at the time
they were rendered. As a result, the Company recorded a gain on forgiveness of
debt of $22,562.
NOTE 17 - ACQUISITION OF CQ SYSTEMS
On January 19, 2005, the Company entered into an agreement to acquire 100% of
the issued and outstanding shares of common stock of CQ Systems Ltd., a company
organized under the laws of England and Wales. The acquisition closed on
February 22, 2005.
NOTE 18 - RESTATEMENT
Subsequent to the issuance of the Company's financial statements for the nine
months ended March 31, 2005 and 2004, the Company determined that certain
transactions and presentation in the financial statements had not been accounted
for properly in the Company's financial statements. Specifically, the amount of
impairment of goodwill was over-recorded and classified as amortization expense,
and the beneficial conversion feature of the convertible debenture was
overstated and loans to officers hadn't been properly reflected on the financial
statements and the exercise of options against these loans had been recorded as
receivables as of June 30, 2004. In addition for the period ended March 31,
2005, the amount of deferred liability in connection with the acquisition of CQ
Systems was over-stated.
--------------------------------------------------------------------------------
Page 17
The Company has restated its financial statements for these adjustments as of
March 31, 2005.
The effect of the correction of the error is as follows:
AS
PREVIOUSLY AS
REPORTED RESTATED
------------------ ----------------
BALANCE SHEET
As of March 31, 2005
--------------------
Assets:
Other current assets $ 1,207,016 $ 1,182,456
Goodwill $ 3,404,886 $ 1,166,611
Total intangibles $ 9,762,937 $ 7,524,662
Total assets $ 24,072,607 $ 21,809,772
Liabilities:
Current portion of notes $ 4,814,463 $ 1,460,876
Due to officers $ -- $ 40,136
Deferred liability $ -- $ 1,115,312
Convertible debenture payable $ 120,000 $ 134,234
Total liabilities $ 8,506,805 $ 6,322,899
Stockholder's Equity:
Additional paid-in capital $ 46,817,522 $ 46,769,779
Accumulated deficit $(30,488,248) $(30,537,075)
Subscription receivable $ 1,328,142 $ (1,187,150)
Total stockholder's equity $ 15,186,050 $ 15,107,121
STATEMENT OF OPERATIONS:
For the nine months ended
March 31, 2005
--------------
Depreciation and amortization $ 986,755 $ 1,007,789
General and adminstrative $ 1,032,687 $ 1,011,653
Total operating expenses $ 4,153,323 $ 4,153,323
Income from operations $ 875,256 $ 875,256
Beneficial conversion feature exp $ (239,416) $ (206,906)
Other income (expense) $ (2,779) $ (20,269)
Net income $ 429,218 $ 445,238
Net income (loss) per share:
Basic $ 0.04 $ 0.04
Diluted $ 0.03 $ 0.03
NOTE 19 - SUBSEQUENT EVENTS
On May 6, 2006, the Company entered into an agreement to acquire 100% of the
issued and outstanding stock of with McCue Systems, Inc. ("McCue"), a California
corporation. The agreement calls for a closing date on or around June 30, 2006.
--------------------------------------------------------------------------------
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According to the terms of the Share Purchase Agreement, the Company is to
acquire 100% of the issued and outstanding shares of McCue from McCue's current
shareholders, whose identity is set forth in the Share Purchase Agreement (the
"McCue Shareholders") at the completion date in exchange for a purchase price
consisting of: a) 50% of McCue's total gross revenue for the audited twelve
month period ending December 31, 2005 after an adjustment for any revenue
occurring outside of the company's ordinary scope of operations as defined by US
GAAP multiplied by 1.5 payable: (i) 50% in shares of restricted common stock of
the Company at the 30 day volume weighted average price ("VWAP) for each of the
30 trading days prior to the execution date of this agreement or at the VWAP for
each of the 30 trading days prior to November 30, 2005 whichever is the greater
VWAP; and, (ii) 50% in cash; b) 25% of McCue's total gross revenue for the
twelve months ending December 31, 2006 multiplied by 1.5 payable, at the
Company's discretion: (i) wholly in cash; or (ii) on the same basis and on the
same terms as the initial payment provided that under no circumstances shall the
total number of shares of common stock issued to the McCue Shareholders exceed
19% of the issued and outstanding shares of common stock, less treasury shares,
of the Company at May 6, 2006; and c) 25% of McCue's total gross revenue for the
twelve months ending December 31, 2007 multiplied by 1.5 payable, at the
Company's discretion: (i) wholly in cash; or (ii) on the same basis and on the
same terms as the initial payment provided that under no circumstances shall the
total number of shares of common stock issued to the McCue Shareholders exceed
19% of the issued and outstanding shares of common stock, less treasury shares,
of the Company at May 6, 2006.
At the time of this report, the audit of McCue's financial statements for the
year ended December 31, 2005 are still underway and the final purchase price is
to be determined based on the audited December 31, 2005 revenues. The estimated
purchase price is approximately $8.6 million.
In April 2006, the Company paid $250,000 cash to settle the note payable due to
Gulf Crown Investments.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION
The following discussion is intended to assist in an understanding of the
Company's financial position and results of operations for the quarter and nine
months ending March 31, 2006.
Forward-Looking Information.
This report contains certain forward-looking statements and information relating
to the Company that is based on the beliefs of its management as well as
assumptions made by and information currently available to its management. When
used in this report, the words "anticipate", "believe", "estimate", "expect",
"intend", "plan", and similar expressions as they relate to the Company or its
management, are intended to identify forward-looking statements. These
statements reflect management's current view of the Company with respect to
future events and are subject to certain risks, uncertainties and assumptions.
Should any of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from those
described in this report as anticipated, estimated or expected. The Company's
realization of its business aims could be materially and adversely affected by
any technical or other problems in, or difficulties with, planned funding and
technologies, third party technologies which render the Company's technologies
obsolete, the unavailability of required third party technology licenses on
commercially reasonable terms, the loss of key research and development
personnel, the inability or failure to recruit and retain qualified research and
development personnel, or the adoption of technology standards which are
different from technologies around which the Company's business ultimately is
built. The Company does not intend to update these forward-looking statements.
INTRODUCTION
NetSol is an end-to-end information technology ("IT") and business consulting
services provider for the lease and finance, banking and financial services
sectors. We operate on a global basis with locations in the U.S., Europe, East
Asia and Asia Pacific. We help our clients identify, evaluate, and implement
technology solutions to meet their most critical business challenges and
maximize their bottom line. Our products include sophisticated software
applications for the asset-based lease and financial institutions. By utilizing
our worldwide resources, we believe we are able to deliver high quality,
cost-effective IT services, ranging from consulting and application development
to systems integration and outsourcing. We have achieved the ISO 9001 and SEI
(Software Engineering Institute) Capable Maturity Model ("CMM") Level 4
certifications. Additionally, through our Internet Service Provider ("ISP")
Backbone, located in Karachi, Pakistan, we offer a package of wireless broadband
services, which include high-speed Internet access, support and maintenance.
Our subsidiary, NetSol Technologies Pvt. Ltd., a Pakistan Limited Company,
("NetSol PK"), develops the majority of our software. NetSol PK was the first
company in Pakistan to achieve the ISO 9001 and SEI CMM Level 4 software
development assessment. As maintained by the SEI, maturity levels measure the
maturity of a software company's methodology that in turn ensures enhanced
product quality resulting in faster project turn-a-round and a shortened time to
market. In August 2005, NetSol PK completed a listing of its shares on the
Karachi Stock Exchange.
During recent years, we have focused on developing software applications for the
leasing and financial service sectors. In late 2002, we launched a suite of
software products under the name LeaseSoft. The LeaseSoft suite is comprised of
four major integrated asset-based leasing/financing software applications. The
suite, consisting of a Credit Application Creation System (LeaseSoft.CAC), a
Credit Application Processing System (LeaseSoft.CAP), a Contract Activation &
Management System (LeaseSoft.CAM) and a Wholesale Finance System
(LeaseSoft.WFS), whether used alone or together, provides the user with an
opportunity to address specific sub-domains of the leasing/financing cycle from
the credit approval process through the tracking of the finance contract and
asset.
In February 2005, we acquired 100% of CQ Systems Ltd., an IT products and
service company based in the UK. As a result of this acquisition, we have access
to a broad European customer base using IT solutions complementary to NetSol's
LeaseSoft product. We plan to leverage CQ Systems' knowledge base and strong
presence in the Asset Finance market to launch LeaseSoft in the UK and
continental Europe. CQ's strong sales and marketing capability would further
help us gain immediate recognition and positioning for the LeaseSoft suite of
products. CQ provides sophisticated accounting and administrative software,
along with associated services, to leasing and finance companies located in
Europe, Asia and Africa. The products include software modules for asset
finance, consumer finance, motor finance, general finance and insurance premium
finance. The modules provide an end-to-end contractual solution - from
underwriting, contract administration and accounting, through asset disposal and
remarketing. Customers include notable European companies such as Scania Finance
GB, DaimlerChrysler Services, Broadcastle PLC, Bank of Scotland Equipment
Finance and Deutsche Leasing Ltd.
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Page 20
Together with this focus on providing an outsourcing, off-shore solution to
existing and new customers, NetSol has also adopted a dynamic growth strategy
through aggressive acquisitions. In October 2005, NetSol-CQ as a combined
company launched an aggressive marketing campaign under the banner of LeaseSoft
for the European market. Just recently NetSol-CQ signed a multi million dollar
new contract with a major banking institution in London.
PLAN OF OPERATIONS
Management has set the following new goals for NetSol's next 12 months.
Initiatives and Investment to Grow Capabilities
o Achieve CMM Level 5 Accreditation in 2006.
o Enhance Software Design, Engineering and Service Delivery
Capabilities by increasing investment in training and development.
o Enhance and invest in R&D or between 7-10% of yearly budgets in
financial, banking and various other domains within NetSol's core
competencies.
o Aggressively expand the sales and marketing organization in all key
locations by hiring senior and successful personnel.
o Recruit additional senior level managers both in Lahore, China and
UK to be able to support potential new customers from the North
American, Asia Pacific and European markets.
o Aggressively exploit the booming Chinese market by strengthening
NetSol's presence in China.
o Launch its marketing presence in the US markets through M&A
activities in the domain of our core competencies.
o Replicate the successful acquisition model and integration of CQ
Systems in the USA.
o Re-brand NetSol and CQ product line with new marketing packaging and
branding for global marketing.
o Increase Capex to enhance Communications and Development
Infrastructure.
Top Line Growth through Investment in aggressively marketing organically and by
mergers and acquisition ("M&A") activities:
o Launch LeaseSoft into new markets by assigning new, well-established
companies as distributors in Europe, Asia Pacific and North America.
o Expand aggressively in China for LeaseSoft and related services.
o Expand relationships with key customers in the US, Europe and Asia
Pacific.
o Product positioning through alliances, joint ventures and
partnerships.
o Focus on key new fortune 1000 customers globally and grow within
existing key customers.
o Aggressively bid and participate in $5MN plus projects in UK and
Asia Pacific by leveraging NetSol CQ as combined asset.
o Embark on roll up strategy by broadening M&A activities broadly in
the software development domain.
o
Funding and Investor Relations:
o Successfully raise new capital from institutional investors and
emerging markets to position NetSol for growth and visibility .
o Launched an aggressive marketing campaign with institutional
investors and micro cap funds in April 2006 .
o Infuse new capital from the potential exercise of employee options
for business development, to enhance balance sheet and further
investment in infrastructures.
o Continue to efficiently and prudently manage cash requirements.
o Public relations campaign to attract long term institutional
holdings.
--------------------------------------------------------------------------------
Page 21
Improving the Bottom Line:
o Continue to review costs at every level to consolidate and enhance
operating efficiencies.
o Grow process automation.
o Profit Centric Management Incentives.
o More local empowerment and P&L Ownership in each Country Office.
o Improve productivity at the development facility and business
development activities.
o Cost efficient management of every operation and continue further
consolidation to improve bottom line.
o Integrate and centralize the US, UK and Australian operations and
improve the costs and bottom line.
Management believes that NetSol is in a position to derive higher productivity
based on current capital employed.
Management continues to be focused on building its delivery capability and has
achieved key milestones in that respect. Key projects are being delivered on
time and on budget, quality initiatives are succeeding, especially in maturing
internal processes. Management believes that further leverage was provided by
the development `engine' of NetSol, which became CMM Level 2 in early 2002. In a
quest to continuously improve its quality standards, NetSol reached CMM Level 3
assessment in July 2003. According to the website of SEI of Carnegie Mellon
University, USA, only a few software companies in the world have announced their
assessment of level 3. As a result of achieving CMM level 4, NetSol is
experiencing a growing demand for its products and alliances from blue chip
companies worldwide. NetSol is now aiming for CMM level 5, the highest CMM level
in the next year. NetSol plans to further enhance its capabilities by creating
similar development engines in other Southeast Asian countries with CMM levels
quality standards. This would make NetSol much more competitive in the industry
and provide the capabilities for development in multiple locations. Increases in
the number of development locations with these CMM levels of quality standards
will provide customers with options and flexibility based on costs and broader
access to skills and technology.
MATERIAL TRENDS AFFECTING THE COMPANY
NetSol has identified the following material trends affecting the Company.
Positive trends:
o Continued positive EBITDA trends of NetSol attracting funds and
institutions globally
o Outsourcing of services and software development is growing
worldwide.
o The Global IT budgets are estimated to exceed $1.2 trillion in 2004
and beyond, according to the internal estimates of Intel
Corporation. About 50% of this IT budget would be consumed in the US
market alone primarily on the people and processes.
o Cost arbitrage, labor costs still very competitive and attractive
when compared with India.
o Regional stability and improving political environment between
Pakistan and India.
o Economic turnaround in Pakistan including: a steady increase in
gross domestic product; much stronger dollar reserves, which is at
an all time high of over $13 billion; stabilizing reforms of
government and financial institutions; improved credit ratings in
the western markets, and elimination of corruption at the highest
level.
o Stronger ties between the US and Pakistan creating new investment
and trade opportunities.
o Robust growth in outsourcing globally and investment of major US and
European corporations in the developing countries.
o Chinese economic boom leading to new market opportunities
o Improved perception of Pakistan economy in the western media casting
positive impact on NetSol future outlook.
Negative trends:
o Continued political and geographical conflicts in the Middle East
and South-East Asia are creating challenging times for economic
development. In addition, the existence of religious, extremism, and
radical elements are causing tensions in the region.
o The disturbance in Middle East and rising terrorist activities post
9/11 worldwide have resulted in issuance of travel advisory in some
of the most opportunistic markets. In addition, travel restrictions
and new immigration laws provide delays and limitations on business
travel.
o The devastating earthquake in northern parts of Pakistan may slow
growth for local business in the short run.
o Skyrocketing oil prices caused by the unfortunate hurricanes,
tensions in the Middle East and Iran, and the surge in global demand
for oil could affect the US and global economy.
o Continuous impact of Iraq war on US and global economy and potential
threats surrounding US and Iran tensions
--------------------------------------------------------------------------------
Page 22
CRITICAL ACCOUNTING POLICIES
Our financial statements and related public financial information are based on
the application of accounting principles generally accepted in the United States
("GAAP"). GAAP requires the use of estimates; assumptions, judgments and
subjective interpretations of accounting principles that have an impact on the
assets, liabilities, and expense amounts reported. These estimates can also
affect supplemental information contained in the external disclosures of the
Company including information regarding contingencies, risk and financial
condition. Management believes our use of estimates and underlying accounting
assumptions adhere to GAAP and are consistently and conservatively applied.
Valuations based on estimates are reviewed for reasonableness and conservatism
on a consistent basis throughout the Company. Primary areas where our financial
information is subject to the use of estimates, assumptions and the application
of judgment include our evaluation of impairments of intangible assets, and the
recoverability of deferred tax assets, which must be assessed as to whether
these assets are likely to be recovered by us through future operations. We base
our estimates on historical experience and on various other assumptions that we
believe to be reasonable under the circumstances. Actual results may differ
materially from these estimates under different assumptions or conditions. We
continue to monitor significant estimates made during the preparation of our
financial statements.
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS
The recoverability of these assets requires considerable judgment and is
evaluated on an annual basis or more frequently if events or circumstances
indicate that the assets may be impaired. As it relates to definite life
intangible assets, we apply the impairment rules as required by SFAS No. 144,
"Accounting for the Impairment or Disposal of Long-Lived Assets" which requires
significant judgment and assumptions related to the expected future cash flows
attributable to the intangible asset. The impact of modifying any of these
assumptions can have a significant impact on the estimate of fair value and,
thus, the recoverability of the asset.
INCOME TAXES
We recognize deferred tax assets and liabilities based on the differences
between the financial statement carrying amounts and the tax bases of assets and
liabilities. We regularly review our deferred tax assets for recoverability and
establish a valuation allowance based upon historical losses, projected future
taxable income and the expected timing of the reversals of existing temporary
differences. During fiscal year 2005-2006, we estimated the allowance on net
deferred tax assets to be one hundred percent of the net deferred tax assets.
CHANGES IN FINANCIAL CONDITION
QUARTER ENDED MARCH 31, 2006 AS COMPARED TO THE QUARTER ENDED MARCH 31, 2005:
Net revenues for the quarters ended March 31, 2006 and 2005 were $5,045,827 and
$3,190,918, respectively. Net revenues are broken out among the subsidiaries as
follows:
2006 2005
------------- -------------
Netsol USA $ 41,500 0.82% $ 21,606 0.68%
Netsol Tech 1,677,884 33.25% 1,623,307 50.87%
Netsol Private 449,465 8.91% 95,367 2.99%
Netsol Connect 201,375 3.99% 294,420 9.23%
Netsol-TiG 431,046 8.54% 154,046 4.83%
Netsol UK 720,514 14.28% 125,782 3.94%
Netsol-CQ 1,480,169 29.33% 799,761 25.06%
Netsol-Abraxas Australia 35,225 0.70% 76,629 2.40%
Talk Trainers 8,649 0.17% - 0.00%
----------------------- -----------------------
Total Net Revenues $ 5,045,827 100.00% $ 3,190,918 100.00%
======================= =======================
--------------------------------------------------------------------------------
Page 23
This reflects an increase of $1,854,909 or 58.13% in the current quarter as
compared to the quarter ended March 31, 2005. The increase is attributable to
new orders of licenses, an increase in services business, the integration of the
revenues contributed by the subsidiary CQ Systems in UK acquired February 2005,
the growing outsourcing business of NetSol-TiG (JV) and additional maintenance
work. The Company's biggest revenue growth was achieved in the two UK operations
and the new joint-venture with TiG, which generated sales both domestically and
internationally. The Company experienced a modest increase in domestic business
in Pakistan as the country began recovering from the earthquake on October 8,
2005. The demand for the Company's IT services in Asia Pacific and Europe is
consistent and solid.
During the quarter ended March 31, 2006, the parent company managed several
projects with Seattle based Capital Stream generating modest revenues. The
projects call for outsourcing of software development services taking advantage
of our off-shore development facility in Lahore. In addition, in February 2006,
the Parent company signed a master consulting agreement with McCue Systems, Inc.
("McCue"), a California corporation to assist in customer implementations,
quality assurance and off-shore software development. To date, no revenues have
been generated from this agreement as the programmers are in the process of
becoming familiar with McCue's LeasePak system.
NetSol made a significant move by acquiring 100% of a UK based software company,
CQ Systems Ltd., in February 2005. The acquisition of CQ Systems has provided
NetSol a very strong and seasoned management team with a mature, profitable,
business. The acquisition of CQ Systems provided tremendous new business
opportunities for NetSol in the European markets. We have experienced a seamless
integration at every level of both companies. In November 2005, we launched the
combined company as NetSol-CQ and the LeaseSoft brand in European market. Just
recently NetSol-CQ signed off a multi-million dollar LeaseSoft agreement with a
major financial institution. Due to confidentiality agreement with our new
client we are not able to disclose the name of the client.
NetSol has been actively pursuing a few target companies in USA and in Europe
for acquisitions. A lot of effort has been made in pursuing the US based IT
products based company, McCue Systems, Inc., in Burlingame, California. With
both external and internal due diligence and with the assistance of our
management and our mergers and acquisitions professionals, Maxim Group, we
entered into a definitive agreement to acquire 100% of McCue Systems. This
agreement was signed May 6, 2006. The company expects to complete the
transaction by June 30, 2006. This acquisition would effectively launch NetSol
in the US leasing and finance markets and will provide a solid footprint in
North America. This will be all accretive revenue for NetSol that will be
reported and consolidated from July 2006. The company will continue to explore
new M&A opportunities that are synergistic and grow our business exponentially
and accretively.
During the quarter ended March 31, 2006, our Asia Pacific region signed off new
implementations of LeaseSoft at ORIX Leasing Singapore, a new implementation of
LeaseSoft at Daimler Chrysler Auto Finance, China, Mercedes - Benz Finance Co,
Japan and in Daimler Chrysler Leasing Thailand. In addition, NetSol completed
several implementations of LeaseSoft with our major customers in Asia Pacific
markets. NetSolCQ signed a new contract with a large banking institution in the
UK that was valued at over $1 million. The UK operations since the acquisition
of CQ Systems in 2005, continues to enhance market penetration in UK markets and
generate new business. As a result, several new customers were signed up as the
awareness and brand acceptance of NetSolCQ as combined company gains momentum.
Our majority owned subsidiary, NetSol Technologies Ltd., in Lahore has
experienced major new business development activities in both the Pakistani
public and private sectors. While we have signed several new contracts in the
public sector, these agreements are confidential and are not allowed to be
disclosed as these contracts involve some sensitive IT solutions and project
managements within the government ministries. NetSol sees a very robust and high
volume new business environment in Pakistan as the economy continues to grow
over 8% each year. NetSol is an extremely enviable position to leverage from its
name and reputation.
NetSol's Global Frame Agreement signed in early 2005 with DaimlerChrysler
Services ("DCS") qualifies NetSol as a preferred vendor to DCS in 40 plus
countries where DCS operates. As a direct result of the successful
implementations of some of our current systems with DaimlerChrysler and the
signing of the global frame agreement, we are noticing a significant increase in
demand for LeaseSoft. Although the sales cycle for LeaseSoft is rather long, we
are experiencing a 100% increase in product demonstration, evaluation and
assessment by blue chip companies in the UK, Australia, Japan, Europe, North
America and Pakistan. In fiscal year 2005, NetSol raised the pricing of its
LeaseSoft licenses significantly due primarily to a surge in demand. In spring
of 2005, one complete system was sold to Toyota Leasing Thailand ("TLT") for
nearly $2.3 million that includes over $1.2 million for license fees.
--------------------------------------------------------------------------------
Page 24
A number of large leasing companies will be looking to renew legacy
applications. This places NetSol in a very strong position to capitalize on any
upturn in IT spending by these companies. NetSol is well positioned to sell
several new licenses in fiscal year 2006-2007 that could potentially increase
the sales and bottom line. As the Company continues to sell more of these
licenses, management believes it is possible that the margins could increase to
upward of 70%. The license prices of these products vary from $300,000 to an
excess of $1,000,000 with additional charges for customization and maintenance
of between 20%-30% each year.
The gross profit was $2,727,298 in the quarter ending March 31, 2006 as compared
with $1,848,702 for the same quarter of the previous year for an increase of
$878,596. The gross profit percentage decreased slightly to approximately 54% in
the quarter ended March 31, 2006 compared to approximately 58% for the quarter
ended March 31, 2006. This is mainly due to the increase in direct costs of
hiring new technology personnel as the Company gears up for the increased demand
in its products and services. Our main technology campus in Lahore hired over 90
new developers and programmers in the last four months. In comparison to the
prior quarter ended December 31, 2005, the cost of sales increased approximately
$341,495, revenues increased $521,454, and an overall increase of 3% in gross
profit.
Operating expenses were $2,458,199 for the quarter ending March 31, 2006 as
compared to $1,632,525, for the corresponding period last year. The increase is
mainly attributable to increased selling and marketing activities, additional
employees and an increase in overall activities due to our increased marketing
efforts. Also contributing to the higher costs was the full integration of CQ
Systems and the joint-venture NetSol-TiG. Depreciation and amortization expense
amounted to $594,385 and $384,649 for the quarter ended March 31, 2006 and,
2005, respectively, reflecting the intangible assets purchased from the CQ
Systems acquisition in February 2005, the addition of the new building in Lahore
in the prior year and new computer equipment purchased to gear up for the
increased demand in our products and services. Combined salaries and wages costs
were $597,636 and $453,226 for the comparable periods, respectively, or an
increase of $144,410 from the corresponding period last year. Salaries, as a
percentage of sales, were 12% for the current quarter as compared to 14% in the
prior period. The addition of the subsidiary, CQ Systems and the forming of the
joint-venture with TiG, as well as an increase in development, sales and
administration employees resulted in the increase.
Selling and marketing expenses were $444,472 and $219,399, in the quarter ended
March 31, 2006 and 2005, respectively, an increase of $225,073 reflecting the
growing sales activity of the Company, including the launch of NetSol-CQ as a
combined entity to the European market. Advertising expense was $144,163 for the
current quarter. The Company is in a growth phase and is increasing its overall
sales and marketing activities. Sales and marketing was 9% of sales for the
current quarter as compared to 7% in the corresponding period last year. The
Company wrote-off as uncollectible bad debts of $19,561 in the current quarter
compared to $0 for the comparable prior period in the prior year. Professional
services expense increased slightly to $126,806 in the quarter ended March 31,
2006, from $112,830 in the corresponding period last year.
Income from operations was $269,099 compared to a loss of $216,177 for the
quarters ended March 31, 2006 and 2005, respectively. This represents an
increase of $52,922 or 24.48% for the quarter compared with the comparable
period in the prior year.
Net income was $21,819 compared to $126,858 for the quarters ended March 31,
2006 and 2005, respectively. This is a decrease of $105,039 or 82.8% compared to
the prior year. The current fiscal quarter amount includes a net reduction of
$187,127 compared to $29,994 in the prior period for the 49.9% minority interest
in NetSol Connect, NetSol-TiG, and Talk Trainers owned by another party, and the
28.13% minority interest in NetSol PK. For the quarters ended March 31, 2006 and
2005, respectively, the Company recognized an expense of $2,628 and $3,941 for
the beneficial conversion feature on convertible debentures and a gain of $1,318
and $49,865 from the settlement of debts and $12,016 and $0 expense for the fair
value of options and warrants issued. Net income per share, basic and diluted,
was $0.00 for the quarter ended March 31, 2006 as compared to $0.01 for the
corresponding period last year.
The net earnings before interest, taxes, depreciation and amortization, (
"EBITDA") income was $715,299 compared to $617,650 or an increase of 15.81%
after amortization and depreciation charges of $594,385 and $384,649, income
taxes of $24,080 and $58,787, and interest expense of $75,015 and $47,356,
respectively. Although the net EBITDA income is a non-GAAP measure of
performance we are providing it for the benefit of our investors and
shareholders to assist them in their decision-making process.
--------------------------------------------------------------------------------
Page 25
NINE MONTH PERIOD ENDED MARCH 31, 2006 AS COMPARED TO THE NINE MONTH PERIOD
ENDED MARCH 31, 2005:
Net revenues for the nine months ended March 31, 2006 and 2005 were $14,040,185
and $7,972,450, respectively. Net revenues are broken out among the subsidiaries
as follows:
2006 2005
--------------- --------------
Netsol USA $ 45,250 0.32% $ 295,725 3.71%
Netsol Tech 4,692,344 33.42% 4,564,167 57.25%
Netsol Private 1,196,098 8.52% 562,872 7.06%
Netsol Connect 676,956 4.82% 852,640 10.69%
Netsol-TiG 1,122,787 8.00% 154,046 1.93%
Netsol UK 1,929,666 13.74% 574,849 7.21%
Netsol-CQ 4,176,299 29.75% 799,761 10.03%
Netsol-Abraxas Australia 192,136 1.37% 168,390 2.11%
Talk Trainers 8,649 0.06% - 0.00%
------------------------ --------------------------
Total Net Revenues $ 14,040,185 100.00% $ 7,972,450 100.00%
======================== ==========================
This reflects an increase of $6,067,735 or 76.11% in the current nine months as
compared to the nine months ended March 31, 2005. The increase is attributable
to new orders of licenses and an increase in services business, including
additional maintenance work, and the addition of two new subsidiaries. The
Company's biggest revenue growth was achieved in the two UK operations and the
new joint-venture with TiG, which generated sales both domestically and
internationally. The Company experienced a modest increase in domestic business
in Pakistan as the country began recovering from the earthquake on October 8,
2005. The demand for the Company's IT services in Asia Pacific and Europe is
consistent and solid.
During the quarter ended March 31, 2006, the parent company managed several
projects with Seattle based Capital Stream generating modest revenues. The
projects call for outsourcing of software development services taking advantage
of our off-shore development facility in Lahore. In addition, in February 2006,
the Parent company signed a master consulting agreement with McCue Systems, Inc.
("McCue"), a California corporation to assist in customer implementations,
quality assurance and off-shore software development. To date, no revenues have
been generated from this agreement as the programmers are in the process of
becoming familiar with McCue's LeasePak system.
NetSol made a significant move by acquiring 100% of a UK based software company,
CQ Systems Ltd., in February 2005. The acquisition of CQ Systems has provided
NetSol a very strong and seasoned management team with a mature, profitable,
business. The acquisition of CQ Systems provided tremendous new business
opportunities for NetSol in the European markets. We have experienced a seamless
integration at every level of both companies. In November 2005, we launched the
combined company as NetSol-CQ and the LeaseSoft brand in European market. Just
recently NetSol-CQ signed off a multi-million dollar LeaseSoft agreement with a
major financial institution. Due to confidentiality agreement with our new
client we are not able to disclose the name of the client.
NetSol has been actively pursuing a few target companies in USA and in Europe
for acquisitions. A lot of effort has been made in pursuing the US based IT
products based company, McCue Systems, Inc., in Burlingame, California. With
both external and internal due diligence and with the assistance of our
management and our mergers and acquisitions professionals, Maxim Group, we
entered into a definitive agreement to acquire 100% of McCue Systems. This
agreement was signed May 6, 2006. The company expects to complete the
transaction by June 30, 2006. This acquisition would effectively launch NetSol
in the US leasing and finance markets and will provide a solid footprint in
North America. This will be all accretive revenue for NetSol that will be
reported and consolidated from July 2006. The company will continue to explore
new M&A opportunities that are synergistic and grow our business exponentially
and accretively.
During the quarter ended March 31, 2006, our Asia Pacific region signed off new
implementations of LeaseSoft at ORIX Leasing Singapore, a new implementation of
LeaseSoft at Daimler Chrysler Auto Finance, China, Mercedes - Benz Finance Co,
Japan and in Daimler Chrysler Leasing Thailand. In addition, NetSol completed
several implementations of LeaseSoft with our major customers in Asia Pacific
markets. NetSolCQ signed a new contract with a large banking institution in the
UK that was valued at over $1 million. The UK operations since the acquisition
of CQ Systems in 2005, continues to enhance market penetration in UK markets and
generate new business. As a result, several new customers were signed up as the
awareness and brand acceptance of NetSolCQ as combined company gains momentum.
--------------------------------------------------------------------------------
Page 26
Our majority owned subsidiary, NetSol Technologies Ltd., in Lahore has
experienced major new business development activities in both the Pakistani
public and private sectors. While we have signed several new contracts in the
public sector, these agreements are confidential and are not allowed to be
disclosed as these contracts involve some sensitive IT solutions and project
managements within the government ministries. NetSol sees a very robust and high
volume new business environment in Pakistan as the economy continues to grow
over 8% each year. NetSol is an extremely enviable position to leverage from its
name and reputation.
NetSol's Global Frame Agreement signed in early 2005 with DaimlerChrysler
Services ("DCS") qualifies NetSol as a preferred vendor to DCS in 40 plus
countries where DCS operates. As a direct result of the successful
implementations of some of our current systems with DaimlerChrysler and the
signing of the global frame agreement, we are noticing a significant increase in
demand for LeaseSoft. Although the sales cycle for LeaseSoft is rather long, we
are experiencing a 100% increase in product demonstration, evaluation and
assessment by blue chip companies in the UK, Australia, Japan, Europe, North
America and Pakistan. In fiscal year 2005, NetSol raised the pricing of its
LeaseSoft licenses significantly due primarily to a surge in demand. In spring
of 2005, one complete system was sold to Toyota Leasing Thailand ("TLT") for
nearly $2.3 million that includes over $1.2 million for license fees.
A number of large leasing companies will be looking to renew legacy
applications. This places NetSol in a very strong position to capitalize on any
upturn in IT spending by these companies. NetSol is well positioned to sell
several new licenses in fiscal year 2006-2007 that could potentially increase
the sales and bottom line. As the Company continues to sell more of these
licenses, management believes it is possible that the margins could increase to
upward of 70%. The license prices of these products vary from $300,000 to an
excess of $1,000,000 with additional charges for customization and maintenance
of between 20%-30% each year.
The gross profit was $8,077,272 for the nine months ending March 31, 2006 as
compared with $5,028,579 for the same period of the previous year. The gross
profit percentage has decreased 5.54% to 57.53% in the current fiscal year from
63.07% for the nine months ended March 31, 2005. This is mainly due to the
increase in direct costs of hiring new technology personnel as the Company gears
up for the increased demand in its products and services. Our main technology
campus in Lahore hired over 90 new developers and programmers in the last four
months.
Operating expenses were $6,848,682 for the nine months ending March 31, 2006 as
compared to $4,153,323, for the corresponding period last fiscal year for an
increase of $2,695,359. The increase is mainly attributable to increased selling
and marketing activities, additional employees and an increase in overall
activities due to our increased marketing efforts. Also contributing to the
higher costs was the full integration of CQ Systems and the joint-venture
NetSol-TiG. In addition, the Company as a whole contributed over $92,000 to
charity organizations for the Earthquake Relief for Northern Pakistan. As a
percentage of sales, operating expenses decreased 3% to 49% from 52% in the
prior nine-month period. Depreciation and amortization expense amounted to
$1,711,771 and $1,007,789 for the nine months ended March 31, 2006 and 2005,
respectively, reflecting the intangible assets purchased from the CQ Systems
acquisition in February 2005, the addition of the new building in Lahore in the
prior year and new computer equipment purchased to gear up for the increased
demand in our products and services. Combined salaries and wage costs were
$1,686,726 and $1,248,447 for the nine months ended March 31, 2006 and 2005,
respectively, or an increase of $438,279 from the corresponding period last
year. As a percentage of sales, salaries was 12% as compared to 16% for the
corresponding period last year. The addition of the new subsidiary, CQ Systems
and the forming of the joint-venture with TiG, as well as an increase in
development, sales and administration employees resulted in the increase.
Selling and marketing expenses were $1,190,906 and $474,099 for the nine months
ended March 31, 2006 and 2005, respectively, an increase of $716,807 reflecting
the growing sales activity of the Company, including the launch of NetSol-CQ as
a combined entity to the European market. Advertising expense was $270,508 for
the current nine-month period. The Company is in a growth phase and is
increasing its overall sales and marketing activities. Sales and marketing was
9% of sales for the current quarter as compared to 6% in the corresponding
period last year. The Company wrote-off as uncollectible bad debts of $27,289
and $0 for the nine months ended March 31, 2006 and 2005, respectively.
Professional services expense decreased to $365,152 in the nine months ended
March 31, 2006, from $368,135 in the corresponding period last year.
Income from continued operations was $1,228,590 compared to $875,256 for the
nine months ended March 31, 2006 and 2005, respectively. This represents an
increase of $353,334 or 40.37% for the nine-month period compared to the prior
year. This is directly due to increased sales, reduction of operational
expenses, improved gross margins, and the addition of two new subsidiaries.
--------------------------------------------------------------------------------
Page 27
Net income was $350,601 for the nine months ended March 31, 2006 compared to
$445,238 for the nine months ended March 31, 2005. This is a decrease of $94,637
or 21.26% compared to the prior year. The current nine-month period amount
includes a net reduction of $699,872 compared to $15,735 in the prior period for
the 49.9% minority interest in NetSol Connect, NetSol-TiG, and Talk Trainers
owned by another party, and the 28.13% minority interest in NetSol PK. For the
nine months ended March 31, 2006 and 2005, respectively, the Company recognized
an expense of $14,389 and $205,906 for the beneficial conversion feature on
convertible debentures and a gain of $8,294 and $239,506 from the settlement of
debts and $21,505 and $249,638 expense for the fair value of options and
warrants issued. Net income per share was $0.02, basic and diluted, for the nine
months ended March 31, 2006 as compared to $0.04, basic and $0.03 diluted for
the corresponding period last year.
The net earnings before interest, taxes, depreciation and amortization, (
"EBITDA") income was $2,394,163 compared to $1,691,643 or an increase of 41.53%
after amortization and depreciation charges of $1,711,771 and $1,008,789, income
taxes of $90,891 and $61,260, and interest expense of $240,900 and $177,356,
respectively. Although the net EBITDA income is a non-GAAP measure of
performance we are providing it for the benefit of our investors and
shareholders to assist them in their decision-making process.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position was $2,390,245 at March 31, 2006 compared to
$1,596,031 at March 31, 2005. In addition the Company had $2,098,003 as compared
to $1,083,450 in certificates of deposit, respectively. The total cash position,
including the certificates of deposits, was $4,488,248 and $2,679,481 as of
March 31, 2006 and 2005.
The Company's current assets as of March 31, 2006 were 54.27% of total assets,
an increase of 10.82% from 43.45% as of March 31, 2005. In addition, our working
capital (current assets minus current liabilities) was $10,232,494.
Net cash used for operating activities amounted to $737,357 for the nine months
ended March 31, 2006, as compared to $733,409 for the comparable period last
fiscal year. The decrease is mainly due to an increase in net income as well as
an increase in prepaid expenses and accounts receivable.
Net cash used by investing activities amounted to $4,568,666 for the nine months
ended March 31, 2006, as compared to $3,764,574 for the comparable period last
fiscal year. The difference lies primarily in the purchase of subsidiary which
increased intangible assets and the purchase property and equipment during the
current fiscal year. The Company had purchases of property and equipment of
$2,063,284 compared to $804,115 for the comparable period last fiscal year.
During the prior fiscal year, an additional $287,797 and $250,006 was infused
into the Company's minority interest in the Company's subsidiaries NetSol
Connect and NetSol-TiG.
Net cash provided by financing activities amounted to $6,232,741 and $5,186,675
for the nine months ended March 31, 2006, and 2005, respectively. The current
fiscal period included the cash inflow of $1,400,000 compared to $1,512,000 from
issuance of equity and $384,062 compared to $999,224 from the exercising of
stock options and warrants. In addition, the Company received net proceeds of
$4,031,001 from the sale of a subsidiary's common stock in an IPO on the Karachi
Stock Exchange as compared to $1,589,974 in the prior year. In addition the
Company and had net proceeds on loans and capital leases of $417,678 as compared
to $1,137,181 in the comparable period last year.
The Company plans on pursuing various and feasible means of raising new funding
to expand its infrastructure, enhance product offerings and beef up marketing
and sales activities in strategic markets. The strong growth in earnings and the
signing of larger contracts with Fortune 500 customers largely depends on the
financial strength of NetSol. Generally, the bigger name clients and new
prospects diligently analyze and take into consideration a stronger balance
sheet before awarding big projects to vendors. Therefore, NetSol would continue
its effort to further enhance its financial resources in order to continue to
attract large name customers and big value contracts. Management feels that a
major requirement of institutional investors is a much stronger balance sheet
and a healthy cash position.
Management expects to continue to improve its cash position in the current and
future quarters due to the new business signed up in the last quarter. Since our
newly listed subsidiary on the Karachi Stock Exchange ("KSE") has performed much
better than our own expectation i.e. the stock has more than doubled from its
IPO price, we have another vehicle to meet the growing needs of new capital. Any
new capital raise would depend on future M&A initiatives. Management would
exercise its best judgment in choosing the most viable option for financing. In
addition, the Company anticipates additional exercises of employee stock options
in the current and subsequent quarters. The Company has consistently improved
its cash position in last four quarters through employees' exercise of options,
the IPO of the Pakistani subsidiary, private placements, and the signing of new
business. We anticipate this trend to continue in the current and future
quarters, further improving the cash resources and liquidity position.
Management is committed to implementing the growth business strategy that was
ratified by the board of directors in July 2005. The company would continue to
inject new capital towards expansion, grow sales and marketing and further
enhancement of delivery capabilities.
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As a growing company, we have on-going capital expenditure needs based on our
short term and long term business plans. Although our requirements for capital
expenses vary from time to time, for the next 12 months, we have the following
capital needs: (If we are filing this after the McCue announcement, which we
are, we need to mention the McCue expenditure)
o In next three months the final payment of CQ Systems would be due
based on the formula of `earn out'. This could be in the range of
$1.0MN to $3.6MN
o Notes payable for approximately $800,000
o Working capital of $1.0 million for US business expansion, new
business development activities and infrastructure enhancements.
o In the next three months the first installment for the purchase of
McCue Systems would be due of approximately $2.0 MN
While there is no guarantee that any of these methods will result in raising
sufficient funds to meet our capital needs or that even if available will be on
terms acceptable to the Company, we will consider raising capital through equity
based financing and, warrant and option exercises. We would, however, use some
of our internal cash flow to meet certain obligations as mentioned above.
The methods of raising funds for capital needs may differ based on the
following:
o Stock volatility due to market conditions in general and NetSol stock
performance in particular. This may cause a shift in our approach to
raising new capital through other sources such as secured long term debt.
o Analysis of the cost of raising capital in the U.S., Europe or emerging
markets. By way of example only, if the cost of raising capital is high in
one market and it may negatively affect the company's stock performance,
we may explore options available in other markets.
Should global or other general macro economic factors cause an adverse climate,
we would defer new financing and use internal cash flow for capital
expenditures.
ITEM 3. CONTROLS AND PROCEDURES
Management, under the supervision and with the participation of the chief
executive officer and chief financial officer, conducted an evaluation of the
disclosure controls and procedures as defined by rule 13a-15(e) as of the end of
the period covered by this interim report on Form 10-QSB. Based upon that
evaluation, the Chairman, Chief Financial Officer and Chief Executive Officer
concluded that our disclosure controls and procedures are effective.
There has been no change, including corrective actions with regard to
deficiencies or weaknesses in the Company's internal controls or in other
factors that has materially affected, or is reasonably likely to materially
affect, these internal controls over financial reporting.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES.
In January 2006, two convertible debenture holders converted their debentures,
per the terms of the debenture, into 53,764 shares of common stock of the
Company. These investors were originally part of the March 2004 bridge financing
and the issuance was made in reliance on an exemption from registration pursuant
to Regulation D of the Securities Act of 1933, as amended.
In January 2006, the company issued 266,667 shares in exchange for $400,000 to
an accredited non-U.S. investor as part of a private offering to such investor.
This issuance was made in reliance on an exemption from registration pursuant to
Regulation S of the Securities Act of 1933, as amended.
In January 2006, the company issued 666,667 shares in exchange for $1,000,000 to
an accredited non-U.S. investor as part of a private offering to such investor.
This issuance was made in reliance on an exemption from registration pursuant to
Regulation S of the Securities Act of 1933, as amended.
The company issued 4,483 shares to an accredited investor as payment for
services provided. The shares were issued in reliance on rule 4(1) of the
Securities Act of 1933
In March 2006, the company issued 10,000 shares of common stock to a former
consultant of the Company as settlement of compensation due to him. This
consultant is an accredited investor and the issuance was made in reliance on an
exemption from registration in reliance on rule 4(1) of the Securities Act of
1933.
In March 27, 2006, the company issued 11,000 shares to a member of its board of
directors. These shares were earned in previous year as compensation for board
service and approved by the shareholders at the annual meeting of shareholders.
The shares were issued in reliance on an exemption from registration pursuant to
Regulation S of the Securities Act of 1933, as amended.
During the quarter ended March 31, 2006, the Company issued 30,000 shares of its
common stock for the exercise of options valued at $52,000.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
NetSol conducted its annual meeting of shareholders on April 21, 2006. The
following are the items that were voted upon.
1. Election of Directors
The following persons were elected directors of the Company to hold office until
the next Annual General Meeting of the Shareholders. The following sets for the
voting tabulation for each director
Director Voted Witheld Percent Total Shares Voted
-------------------------------------------------------------------------------------------------------------------
Najeeb Ghauri 11,753,916 56,074 99.52 (78.1*) 11,809,990
Naeem Ghauri 11,770,821 39,169 99.67 (78.21*) 11,809,990
Salim Ghauri 11,770,841 39,149 99.67 (78.21*) 11,809,990
Jim Moody 11,783,158 26,832 99.77 (78.29*) 11,809,990
Shahid Burki 11,777,878 32,112 99.73 (78.26*) 11,809,990
Eugen Beckert 11,765,853 44,137 99.62 (78.18*) 11,809,990
Derek Soper 11,785,330 24,660 99.79 (78.31*) 11,809,990
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2. Ratification of Appointment of Auditors
Kabani & Company Inc. was appointed as Auditors for the Company to hold office
until the close of the next annual general meeting of the Company. The directors
were authorized to fix the remuneration to be paid to the auditors. The
following sets forth the tabulation of the shares voting for this matter.
Total Shares Voted For Against Abstain Percent
------------------------------------------------------------------------------------------
11,809,990 11,670,935 110,725 28,330 98.82% (77.25%*)
*Represents the total percentage voting in favor based on the total issued and
outstanding on the record date
3. Adoption of the 2005 Employee Stock Option Plan
The Board of Directors of the Company adopted the 2005 Stock Option Plan (the
"Stock Option Plan") subject to acceptance by the shareholders of the Company.
This plan offers restricted shares only.
The purpose of the Stock Option Plan is to allow the Company to grant options to
directors, officers, employees and service providers, as additional
compensation, and as an opportunity to participate in the profitability of the
Company. Options will be exercisable over periods of up to ten years as
determined by the board of directors of the Company and are required to have an
exercise price of no less than the fair market value on the day the option is
granted. The total number of shares available under the 2005 Stock Option Plan
is 5,000,000. If an award of options expires or is canceled without having been
fully exercised or vested, the unvested or canceled options generally will be
available again for grants under the awards.
The following sets forth the tabulation of the shares voting for this matter.
Total Shares Voted For Against Abstain Broker Non-Vote Percent
--------------------------------------------------------------------------------------------------------------------
11,809,990 6,026,737 187,429 23,130 5,572,694 51.03%
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
EXHIBITS:
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(CEO)
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
(CFO)
32.1 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (CEO)
32.2 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002 (CFO)
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REPORTS ON FORM 8-K.
a) On February 9, 2006, NetSol Technologies, Inc. filed a current report
containing the contents of its press release announcing the results of
operations and financial conditions for the quarter ended December 31, 2005.
b) On March 17, 2006, NetSol Technologies, Inc. filed a current report
announcing that it had expanded the scope of its principal auditor's, Kabani &
Company, Inc., audit to include the Pakistani subsidiaries of the Company.
Kabani & Company, Inc. replaced Saeed Kamran & Patel in this capacity.
c) On March 22, 2006, NetSol Technologies, Inc. filed an amendment to its
current report on Form 8-K filed on March 31, 2005 which had reported the
restatement of its previously issued financial statements, related audit report
and completed internal review. The amended report stated that in response to
comments received from the Securities Exchange Commission to the annual reports
filed on Form 10-KSB for the periods ending June 30, 2004 and June 30, 2005 and
the quarterly reports on Form 10-QSB for the periods ended September 30, 2004,
December 31, 2004 and March 31, 2005 management determined that the financial
statements contained errors which required a restatement of the financial
statements for those periods.
SIGNATURES
In accordance with the requirements of the Exchange Act, the registrant caused
this amended report to be signed on its behalf by the undersigned, thereunto
duly authorized.
NETSOL TECHNOLOGIES, INC.
Date: May 9, 2006 /s/ Naeem Ghauri
---------------------------
NAEEM GHAURI
Chief Executive Officer
Date: May 9, 2006 /s/ Tina Gilger
---------------------------
TINA GILGER
Chief Financial Officer
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