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 September 30, 2005
( ) 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 14, 178,711 shares of its $.001 par value Common Stock issued and
outstanding as of November 7, 2005.
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 September 30, 2005 3
Comparative Unaudited Consolidated Statements of Income 4
for the Three Months Ended September 30, 2005 and 2004 (restated)
Comparative Unaudited Consolidated Statements of Cash Flow 5
for the Three Months Ended September 30, 2005 and 2004 (restated)
Notes to the Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operation 18
Item 3. Controls and Procedures 24
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Changes in Securities 25
Item 3. Defaults Upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
(a) Exhibits (b) Reports on Form 8-K
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Page 2
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET -- SEPTEMBER 30, 2005
(UNAUDITED)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 1,469,154
Certificates of deposit 2,487,577
Accounts receivable, net of allowance for doubtful accounts of $80,000 4,029,616
Revenues in excess of billings 3,018,048
Other current assets 1,603,439
------------
Total current assets 12,607,834
PROPERTY AND EQUIPMENT, net of accumulated depreciation 5,655,543
INTANGIBLES:
Product licenses, renewals, enhancedments, copyrights,
trademarks, and tradenames, net 4,811,643
Customer lists, net 1,397,837
Goodwill 1,166,611
------------
Total intangibles 7,376,091
------------
TOTAL ASSETS $ 25,639,468
============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable and accrued expenses $ 2,524,249
Current portion of notes and obligations under capitalized leases 1,087,110
Billings in excess of revenues 125,185
Due to officers 50,657
Deferred liability 313,397
Loans payable, bank 462,186
------------
Total current liabilities 4,562,784
OBLIGATIONS UNDER CAPITALIZED LEASES, less current maturities 142,647
CONVERTIBLE DEBENTURE 94,745
------------
TOTAL LIABILITIES 4,800,176
MINORITY INTEREST 1,067,406
COMMITMENTS AND CONTINGENCIES --
STOCKHOLDERS' EQUITY:
Common stock, $.001 par value; 45,000,000 share authorized;
13,953,266 issued and outstanding 13,953
Additional paid-in-capital 50,794,633
Treasury stock (27,197)
Accumulated deficit (30,115,240)
Stock subscription receivable (377,338)
Common stock to be issued 124,586
Other comprehensive loss (641,511)
------------
TOTAL STOCKHOLDERS' EQUITY 19,771,886
------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 25,639,468
============
See accompanying notes to the unaudited consolidated financial statements.
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NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
For the Three Months
Ended September 30,
2005 2004
------------ ------------
(restated)
NET REVENUES $ 4,469,985 $ 2,058,305
COST OF REVENUES 1,667,350 762,268
------------ ------------
GROSS PROFIT 2,802,635 1,296,037
OPERATING EXPENSES:
Selling and marketing 318,864 119,348
Depreciation and amortization 552,531 295,537
Settlement costs 15,953 --
Salaries and wages 536,376 347,237
Professional services, including non-cash
compensation 123,158 114,334
General and adminstrative 583,547 277,515
------------ ------------
Total operating expenses 2,130,429 1,153,971
------------ ------------
INCOME FROM OPERATIONS 672,206 142,066
OTHER INCOME AND (EXPENSES)
Gain (loss) on sale of assets 391 (620)
Beneficial conversion feature (6,569) (37,500)
Fair market value of options and warrants issued (9,489) (28,024)
Gain on forgiveness of debt 3,641 50,274
Interest expense (79,023) (21,575)
Interest income 84,412 --
Other income and (expenses) (32,503) 21,558
Income taxes (62,108) (1,514)
------------ ------------
Total other expenses (101,248) (17,401)
------------ ------------
NET INCOME BEFORE MINORITY INTEREST IN SUBSIDIARY 570,958 124,665
MINORITY INTEREST IN SUBSIDIARY (367,213) 15,068
------------ ------------
NET INCOME 203,745 139,733
OTHER COMPREHENSIVE LOSS:
Translation adjustment (120,820) (118,378)
------------ ------------
COMPREHENSIVE INCOME $ 82,925 $ 21,355
============ ============
NET INCOME PER SHARE:
Basic $ 0.01 $ 0.01
============ ============
Diluted $ 0.01 $ 0.01
============ ============
Weighted average number of shares outstanding
Basic 13,897,883 9,504,789
Diluted 14,246,614 12,065,735
See accompanying notes to the unaudited consolidated financial statements.
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NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW
(UNAUDITED)
For the Three Months
Ended September 30,
2005 2004
----------- -----------
(restated)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income from continuing operations $ 203,745 $ 139,733
Adjustments to reconcile net income to net cash
used in operating activities:
Depreciation and amortization 644,733 374,199
Gain on settlement of debt (3,641) (50,274)
(Gain) loss on sale of assets (391) 620
Minority interest in subsidiary 367,213 (15,068)
Stock issued for services 60,856 25,745
Fair market value of warrants and stock options granted 9,489 28,024
Beneficial conversion feature 6,569 37,500
CHANGES IN OPERATING ASSETS AND LIABILITIES:
(INCREASE) DECREASE IN ASSETS:
Accounts receivable (123,256) (214,527)
Other current assets (1,731,193) (824,020)
DECREASE IN LIABILITIES:
Accounts payable and accrued expenses (540,968) (564,159)
----------- -----------
NET CASH USED IN OPERATING ACTIVITIES (1,106,844) (1,062,227)
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (817,676) (213,990)
Sales of property and equipment 91,046 86,988
Purchases of certificates of deposit (2,282,097) --
Proceeds from sale of certificates of deposit -- 250,000
Increase in intangible assets - development costs (211,844) (77,990)
Capital investments in minority interest of subsidiary -- 191,606
Proceeeds from sale of minority interest of subsidiary -- --
----------- -----------
NET CASH (USED IN) PROVIDED BY INVESTING ACTIVITIES (3,220,571) 236,614
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from sale of common stock -- 220,000
Proceeds from the exercise of stock options 288,062 --
Capital contributed from sale of subsidiary stock 4,031,001 --
Purchase of treasury shares -- (51,704)
Proceeds from loans -- --
Capital lease obligations & loans 0 net 91,236 (30,967)
----------- -----------
NET CASH PROVIDED BY FINANCING ACTIVITIES 4,410,299 137,329
EFFECT OF EXCHANGE RATE CHANGES IN CASH 14,543 21,973
----------- -----------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 97,427 (666,311)
Cash and cash equivalents, beginning of period 1,371,727 871,161
----------- -----------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 1,469,154 $ 204,850
=========== ===========
See accompanying notes to the unaudited consolidated financial statements.
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NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOW (CONTINUED)
(UNAUDITED)
For the Three Months
Ended September 30,
2005 2004
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $ 57,398 $ 21,575
======== ========
Taxes $ -- $ 1,514
======== ========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued for services and compensation $ 60,855 $111,920
======== ========
Common stock issued for conversion of convertible debenture $ 50,000 $150,000
======== ========
Common stock issued for settlement of debt $ -- $ 45,965
======== ========
See accompanying notes to the unaudited consolidated financial statements.
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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 annual report
on Form 10-KSB 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 (Pvt), Limited ("PK Private"),
NetSol Technologies Limited ("UK"), NetSol-Abraxas Australia Pty Ltd.
("Abraxas"), NetSol Altvia, Inc. ("USA"), CQ Systems Limited ("CQ"), and its
majority-owned subsidiaries, NetSol Technologies (Pvt), Ltd.("PK Tech"), NetSol
Connect (Pvt), Ltd. ("Connect"), and TIG-NetSol (Pvt) Limited ("TIG"). 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 December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment,
an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires
companies to recognize in the statement of operations the grant- date fair value
of stock options and other equity-based compensation issued to employees. FAS
No. 123R is effective beginning in the Company's first quarter of fiscal 2006.
The Company is evaluating the effects adoption of SFAS 123R will have on its
financial statements.
In December 2004, the FASB issued SFAS Statement No. 153, "Exchanges of
Non-monetary Assets." The Statement is an amendment of APB Opinion No. 29 to
eliminate the exception for non-monetary exchanges of similar productive assets
and replaces it with a general exception for exchanges of non-monetary assets
that do not have commercial substance. The Company believes that the adoption of
this standard will have no material impact on its financial statements.
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.
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Page 7
NOTE 4 - EARNINGS PER SHARE:
"Earnings 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 THREE MONTHS ENDED SEPTEMBER 30, 2005 NET INCOME SHARES PER SHARE
----------------------------------------------------------------------------------------------------
Basic earnings per share: $ 203,745 13,897,883 $ 0.01
Net income available to common shareholders
Effect of dilutive securities
Stock options 347,064
Warrants 1,667
--------------- -------------- --------------
Diluted earnings per share $ 203,745 14,246,614 $ 0.01
=============== ============== ==============
----------------------------------------------------------------------------------------------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2004 NET INCOME SHARES PER SHARE
----------------------------------------------------------------------------------------------------
Basic earnings per share: $ 139,733 9,504,789 $ 0.01
Net income available to common shareholders
Effect of dilutive securities
Stock options 1,852,277
Warrants 708,668
--------------- -------------- --------------
Diluted earnings per share $ 139,733 12,065,734 $ 0.01
=============== ============== ==============
NOTE 5 - FOREIGN CURRENCY:
The accounts of NetSol Technologies UK, Ltd., and CQ Systems Ltd. use the
British Pound; NetSol Technologies, (PVT), Ltd, NetSol (Pvt), Limited, NetSol
Connect PVT, Ltd., and NetSol-TiG, 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 $641,511 at September 30, 2005 are classified as an item of accumulated other
comprehensive loss in the stockholders' equity section of the consolidated
balance sheet. During the three months ended September 30, 2005 and 2004,
comprehensive loss in the consolidated statements of operation included
translation loss of $120,820 and $118,378, respectively.
NOTE 6 - OTHER CURRENT ASSETS
Other current assets consist of the following at September 30, 2005:
Prepaid Expenses $ 929,967
Advance Income Tax 159,670
Employee Advances 41,574
Security Deposits 68,018
Other Receivables 313,707
Other Assets 90,503
----------
Total $1,603,439
==========
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Page 8
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 quarter ended September 30, 2005 and 2004, $13,990 and
$6,995 was expensed, respectively.
NOTE 7 - DEBTS
NOTES PAYABLE
Notes payable as of September 30, 2005 consist of the following:
------------------------------------------------------------------
Balance at Current Long-Term
Name 9/30/05 Maturities Maturities
------------------------------------------------------------------
A. Zaman Settlement $ 16,300 $ 16,300 $ -
D&O Insurance 12,513 12,513 -
Noon Group 531,082 531,082 -
Gulf Crown 265,541 265,541 -
Maxim Group 102,453 102,453 -
Subsidiary Capital Leases 159,221 159,221 -
----------- ------------ ----------
1,087,110 1,087,110 -
=========== ============ ==========
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 September 30, 2005 was
$16,300. The entire balance has been classified as a current liability in the
accompanying consolidated financials statements.
In January 2005, the Company renewed its director's and officer liability
insurance for which the annual premium is $138,050. In February 2005, the
Company arranged financing with AFCO Credit Corporation with a down payment of
$27,610 with the balance to be paid in monthly installments. The balance owing
as of September 30, 2005 was $12,513 and is 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 quarter ended September 30, 2005, $12,288 of
accrued interest was recorded for this loan. Total accrued interest added to the
loan at September 30, 2005 was $31,082.
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 quarter ended September 30, 2005,
$6,144 of accrued interest was recorded for this loan. accrued interest added to
the loan at September 30, 2005 was $15,541.
In May 2005, the Company received a loan from Maxim Group, LLC in the amount of
$250,000. The note is 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.
During the quarter ended September 30, 2005, $2,453 of accrued interest was
recorded for this loan. Total accrued interest added to the loan at September
30, 2005 was $2,453.
In addition, the various subsidiaries had current maturities of capital leases
of $159,221 as of September 30, 2005.
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BANK NOTE
The Company's Pakistan subsidiary, NetSol Technologies (Private) Ltd., has two
loans with a bank, secured by the Company's assets. These notes consist of the
following as of September 30, 2005:
TYPE OF MATURITY INTEREST BALANCE
LOAN DATE RATE USD
-----------------------------------------------------------------------
Export Refinance Every 6 months 8% $ 238,363
Line of Credit On Demand 12% 223,823
---------
Total $ 462,186
=========
DUE TO OFFICERS
The officers of the Company from time to time loan funds to the Company in
addition to deferring compensation. As of June 30, 2005, the officers had a
balance owing to them of $47,636. Two of the officers have deferred the increase
in their wages. During the three months ended September 30, 2005, $22,500 of
accrued wages was added to the balance due to officers. In addition, $19,479 was
reimbursed to one officer against the amounts owing to him. The balance owing as
of September 30, 2005 was $50,657.
NOTE 8 - 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.
SERVICES
During the quarter ended September 30, 2005, the Company issued 2,500 restricted
Rule 144 common shares in exchange for services rendered valued at $3,822.
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. In
addition, 11,000 shares were recorded as "Shares to be Issued" and are valued at
$16,088. The shares were valued at the fair market value at the date of grant of
$57,034 or $1.46 per share.
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.
OPTIONS AND WARRANTS EXERCISED
During the quarter ended September 30, 2005, the Company issued 65,000 shares of
its common stock for the exercise of options valued at $48,750.
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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
processing when the quarter ended.
The balance at June 30, 2005 was $616,650. During the quarter ended September
30, 2005, the Company received a total of $239,312 as payment on the receivable.
The balance at September 30, 2005 was $377,338.
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
three months ended September 30, 2005:
Exercise Exercise
Options Price Warrants Price
--------- --------------- ------------ --------------
Outstanding and exercisable, June 30, 2005 5,038,000 $0.75 to $5.00 655,280 $0.50 to $5.00
Granted 320,000 $1.75 to $2.89 13,441 $ 3.30
Exercised (65,000) $ 0.75 --
Expired -- --
--------- ------------
Outstanding and exercisable, September 30, 2005 5,293,000 668,721
During the quarter ended September 30, 2005, a total of 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 $1.75 to $2.89.
There were no options granted during the quarter ended September 30, 2004.
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 quarter ended September 30, 2005 as follows:
2005
-----------
Net income (loss) - as reported $ 203,745
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 (388,750)
-----------
Pro forma net loss $ (185,005)
===========
Earnings per share:
Basic, as reported 0.01
Diluted, as reported 0.01
Basic, pro forma (0.01)
Diluted, pro forma (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%
NOTE 9 - 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.
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.
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Page 12
Product licenses and customer lists were comprised of the following as of
September 30, 2005:
Product Licenses Customer Lists Total
Intangible asset - June 30, 2005 $ 8,799,323 $ 3,294,757 $ 12,094,080
Additions 228,597 -- 228,597
Effect of translation adjustment (14,750) (14,750)
Accumulated amortization (4,201,528) (1,896,920) (6,098,448)
---------------- -------------- ------------
Net balance - September 30, 2005 $ 4,811,642 $ 1,397,837 $ 6,209,479
================ ============== ============
Amortization expense:
Three months ended Sept. 30, 2005 $ 345,754 $ 157,155 $ 502,909
Three months ended Sept. 30, 2004 $ 200,907 $ 78,916 $ 279,823
The above amortization expense includes amounts in "Cost of Goods Sold" for
capitalized software development costs of $18,875 and $10,621 for the quarters
ended September 30, 2005 and 2004, respectively.
At September 30, 2005 and 2004, product licenses, renewals, enhancements,
copyrights, trademarks, and tradenames, included unamortized software
development and enhancement costs of $1,572,675 and $1,013,791, respectively, as
the development and enhancement is yet to be completed. Software development
amortization expense was $27,755 and $10,621 for the quarters ended September
30, 2005 and 2004, respectively.
Amortization expense of intangible assets over the next five years is as
follows:
----------------------------------------------------------------------------------------------
FISCAL PERIOD ENDING
Asset 9/30/06 9/30/07 9/30/08 9/30/09 9/30/10 TOTAL
----------------------------------------------------------------------------------------------
Product Licences $1,101,966 $ 591,872 $ 591,872 $ 563,876 $ 240,416 $3,090,002
Customer Lists 497,969 263,376 263,376 263,376 109,740 1,397,837
---------- ---------- ---------- ---------- ---------- ----------
$1,599,935 $ 855,248 $ 855,248 $ 827,252 $ 350,156 $4,487,839
========== ========== ========== ========== ========== ==========
There were no impairments of the goodwill asset in the period ended September
30, 2005 and 2004.
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NOTE 10 - SEGMENT INFORMATION
The following table presents a summary of operating information and certain
year-end balance sheet information for the three months ended September 30:
2005 2004
Revenues from unaffiliated customers:
North America $ -- $ 170,134
International 4,469,985 1,888,171
------------ ------------
Consolidated $ 4,469,985 $ 2,058,305
============ ============
Operating income (loss):
North America $ (913,708) $ (536,290)
International 1,585,914 678,356
------------ ------------
Consolidated $ 672,206 $ 142,066
============ ============
Identifiable assets:
North America $ 5,839,916 $ 3,606,534
International 19,799,552 8,406,877
------------ ------------
Consolidated $ 25,639,468 $ 12,013,411
============ ============
Depreciation and amortization:
North America $ 482,991 $ 263,503
International 161,742 110,696
------------ ------------
Consolidated $ 644,733 $ 374,199
============ ============
Capital expenditures:
North America $ -- $ --
International 817,676 213,990
------------ ------------
Consolidated $ 817,676 $ 213,990
============ ============
NOTE 11 - 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 new 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
anticipated that Connect would require a maximum of $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 June 30, 2005, a total of
$751,356 had been transferred to Connect, of which $410,781 was from Akhter.
--------------------------------------------------------------------------------
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For the quarters ended September 30, 2005 and 2004, the subsidiary had net
income of $51,538 and net losses of $30,196, respectively, of which $25,717
and ($15,068) respectively, was recorded against the minority interest. The
balance of the minority interest at September 30, 2005 was $349,655.
NetSol-TiG:
In December 2004, NetSol forged a formed a joint venture with with a UK based
public company TIG Plc. A new 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 in next few months 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 and the new subsidiary began operations.
For the quarter ended September 30, 2005, the subsidiary had net income of
$240,166, of which $119,843 was recorded against the minority interest. The
balance of the minority interest at September 30, 2005 was $496,098.
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 quarter ended September 30, 2005, the subsidiary had net income of
$787,960, of which $221,653 was recorded against the minority interest. The
balance of the minority interest at September 30, 2005 was $221,653.
NOTE 12 - 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. The net
balance at September 30, 2005, is $94,745.
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 quarter ended September 30, 2005, one of the convertible debenture
holders elected to convert its 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.
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 three months ended
September 30, 2005, one debenture holders converted its note into common stock.
As part of the conversion, warrants to purchase a total of 13,441 common shares
were issued to the note holders. The warrants were valued using the fair value
method at $9,489 and was recorded as an expense in the accompanying consolidated
financial statements.
--------------------------------------------------------------------------------
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NOTE 13 - GAIN ON SETTLEMENT OF DEBT
In September 2004, the Company transferred 24,004 of its treasury shares valued
at $45,965 to Brobeck Phleger & Harrison, LLC, in exchange of debt, as part of
the 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.
NOTE 14 - 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.
The following is the proforma financial information of the Company for the three
months ended September 30, 2004 assuming the transaction had been consummated at
the beginning of the fiscal year ended June 30, 2005:
For the three
months ended
Sept. 30, 2004
(Unaudited)
STATEMENT OF OPERATIONS:
Revenues $3,188,757
Cost of Sales 1,503,358
----------
Gross Profit 1,685,399
Operating Expenses 1,567,915
----------
Income (loss) from operations 117,484
Other income and (expenses) 1,991
----------
Income (loss) before minority interest 119,475
Minority interest in subsidiary 15,068
----------
Net Income (loss) $ 134,543
==========
Earnings Per Share:
Basic $ 0.01
Diluted $ 0.01
NOTE 15 - SUBSEQUENT EVENTS
In October 2005, the note payable and related accrued interest to Maxim was
settled with $50,000 cash and 36,607 shares of the Company's common stock with a
fair market value of $68,453. In addition, 27,231 shares with a fair market
value of $50,923 was issued for the payment of past due invoices. There was no
gain or loss recorded on this transaction.
NOTE 16 - RESTATEMENT
Subsequent to the issuance of the Company's financial statements as of and for
the three months ended September 30, 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.
In addition, 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.
--------------------------------------------------------------------------------
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The Company has restated its financial statements for these adjustments as of
September 30, 2004.
The effect of the correction of the error is as follows:
AS
PREVIOUSLY AS
REPORTED RESTATED
------------ ------------
BALANCE SHEET
As of September 30, 2004
----------------------------
Assets:
Other current assets $ 718,134 $ 708,773
Goodwill $ 831,594 $ 1,166,612
Total intangibles $ 3,731,015 $ 4,066,033
Total assets $ 11,687,755 $ 12,013,411
Liabilities:
Due to officers $ -- $ 35,969
Convertible debenture payable $ 825,000 $ 872,743
Total liabilities $ 3,674,844 $ 3,758,555
Stockholder's Equity:
Additional paid-in capital $ 39,621,500 $ 39,343,344
Stock subscription receivable $ (458,809) $ (313,650)
Other comprehensive loss $ (233,899) $ (357,250)
Accumulated deficit $(31,340,872) $(30,842,579)
Total stockholder's equity $ 7,826,296 $ 8,068,241
STATEMENT OF OPERATIONS:
For the three months ended
September 30, 2004
----------------------------
Cost of revenues $ 751,647 $ 762,268
Gross profit $ 1,306,658 $ 1,296,037
Depreciation and amortization $ 413,824 $ 295,537
Total operating expenses $ 1,272,258 $ 1,153,971
Income (loss) from operations $ 34,400 $ 142,066
Other income and (expense) $ 22,335 $ 20,044
Net income (loss) $ 34,358 $ 139,733
Net income (loss) per share:
Basic $ 0.00 $ 0.01
Diluted $ 0.00 $ 0.01
--------------------------------------------------------------------------------
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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 ending
September 30, 2005.
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
industries. 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 finance industry. 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 3
certifications. Additionally, through our IP Backbone, located in Karachi,
Pakistan, we offer a package of wireless broadband services, which include
high-speed Internet access, support and maintenance.
Our subsidiary, Network 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 July 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 industries. In late 2002, we launched a new 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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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 accretive acquisitions.
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 2005-2006.
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 Formally launch LeaseSoft under the combined banner of NetSol CQ in
Europe in November 2005.
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 Aggressive marketing 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 Enhance the sales and marketing organization by hiring new key
executives in the US, UK and Asia.
Funding and Investor Relations:
o Effectively raise new capital from most economical and emerging
markets to position NetSol for growth to the next level.
o Attract long term institutional investors and partners both in the
US and in Asia.
o Infuse new capital from the potential exercise of employee options
for business development, enhance balance sheet and further
investment in infrastructures.
o Continue to efficiently and prudently manage cash requirements and
raise capital from the markets only as it deems absolutely necessary
to execute the growth strategy both organically and through
acquisitions.
o Enhance the visibility of company's stock to US based amongst small
to mid sized funds, institutional investors, market makers and
research analysts.
Improving the Bottom Line:
o Continue to review costs at every level to consolidate and enhance
operating efficiencies.
o Grow process automation.
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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 headquarters 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 NETSOL
NetSol has identified the following material trends affecting NetSol
Positive trends:
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 Overall economic expansion worldwide and explosive growth in the
merging markets specifically.
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.
Negative trends:
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 Negative perception and image created by extremism and terrorism in
the South Asian region.
o Skyrocketing oil prices and unfortunate affects of Hurricane Katrina
on US economy.
o Continuous impact of Iraq war on US and global economy.
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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, 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 SEPTEMBER 30, 2005 AS COMPARED TO THE QUARTER ENDED SEPTEMBER 30,
2004:
Net revenues for the quarter ended September 30, 2005 were $4,469,985 as
compared to $2,058,305 for the quarter ended September 30, 2004. Net revenues
are broken out among the subsidiaries as follows:
2005 2004
---------- ----------
Netsol USA $ -- $ 170,134
Netsol Tech 1,662,351 1,113,859
Netsol Private 477,186 302,809
Netsol Connect 252,337 268,334
Netsol-TiG 345,705 --
Netsol UK 238,672 172,261
CQ Systems 1,406,011 --
Netsol-Abraxas Australia 87,723 30,908
---------- ----------
Total Net Revenues $4,469,985 $2,058,305
========== ==========
This reflects an increase of $2,411,680 or 117% in the current quarter as
compared to the quarter ended September 30, 2004. The increase is attributable
mostly to growth in services business, a full quarter of revenues attributed by
the newly acquired CQ Systems in UK, growing outsourcing business of NetSol-TIG
(JV) and additional maintenance work. The Company's biggest revenue growth was
achieved in all three of its Pakistan based subsidiaries, which generated sales
both domestically and internationally. The Company has experienced solid and
consistent demand for IT services in the domestic sectors of Pakistan.
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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 Company added a few major new customers such as DaimlerChrysler in China,
Japan, and New Zealand and Toyota Leasing Thailand and China. In addition, many
new customers were added in Pakistan in both the public and private sectors.
NetSol signed many new alliances and partnerships in fiscal year 2005. The most
significant of all was the joint venture with a UK based company, The Innovation
Group ("TiG"). NetSol owns 51% of this new entity while TIG owns 49%. The
partnership is designed to outsource the global IT projects of TiG to NetSol in
Pakistan.
NetSol's global frame agreement 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 that could potentially increase the
sales and bottom line. As the Company sells 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 $2,802,635 in the quarter ending September 30, 2005 as
compared with $1,296,037 for the same quarter of the previous year for an
increase of $905,082. The gross profit percentage remains at approximately 63%
in the quarter ended September 30, 2005. In comparison to the prior quarter
ended June 30, 2005, the cost of sales decreased approximately $143,528 and
revenues increased $4,782 or an overall increase of 3% in gross profit.
Operating expenses were $2,130,429 for the quarter ending September 30, 2005 as
compared to $1,153,971, 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. Depreciation and amortization expense amounted to $552,531 and $295,537
for the quarter ended September 30, 2005 and 2004, respectively, reflecting the
intangible assets purchased from the CQ Systems acquisition in February 2005.
Combined salaries and wage costs were $536,376 and $347,237 for the comparable
periods, respectively, or an increase of $189,139 from 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. Approximately 250 new
employees were added throughout the Company during the last fiscal year.
Selling and marketing expenses were $318,864 and $119,348, in the quarter ended
September 30, 2005 and 2004, respectively, reflecting the growing sales activity
of the Company. Professional services expense increased slightly to $123,158 in
the quarter ended September 30, 2005, from $114,334 in the corresponding period
last year.
Income from operations was $672,206 compared to $142,066 for the quarters ended
September 30, 2005 and 2004, respectively. This represents an increase of
$530,140 or 373% for the quarter compared with the comparable period in the
prior year. This is directly due to improved sales activity.
Net income was $203,745 compared to $139,733 for the quarters ended September
30, 2005 and 2004, respectively. This is an increase of $151,786 or 45.81%
compared to the prior year. The current fiscal quarter amount includes a net
reduction of $367,213 compared to an add-back of $15,068 in the prior period for
the 49.9% minority interest in NetSol Connect and NetSol-TiG owned by another
party, and the 28.13% minority interest in NetSol PK. During the current
quarter, the Company also recognized an expense of $6,569 compared to $37,500
for the beneficial conversion feature on convertible debentures, an expense of
$9,489 compared to $28,024 for the fair market value of warrants issued and a
gain of $3,641 compared to $50,274 from the settlement of a debt. Net income per
share, basic and diluted, was $0.01 for the quarters ended September 30, 2005
and 2004.
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The net EBITDA income was $897,407 compared to $458,359 after amortization and
depreciation charges of $552,531 and $295,537, income taxes of $62,108 and
$1,514, and interest expense of $79,023 and $21,575, 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. The increase in amortization and depreciation is mostly
attributed to the amortization of the intangible assets acquired in the purchase
of CQ Systems.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash position was $1,469,154 at September 30, 2005 compared to
$204,850 at September 30, 2004. In addition the Company had $2,487,577 in
certificates of deposit in the form of short-term investment accounts. The total
cash position, including the certificates of deposits, was $3,956,731 as of
September 30, 2005.
Net cash used for operating activities amounted to $1,106,844 for the quarter
ended September 30, 2005, as compared to $1,062,227 for the comparable period
last fiscal year. The increase is mainly due to an increase in prepaid expenses
and other assets.
Net cash used by investing activities amounted to $3,220,571 for the quarter
ended September 30, 2005, as compared to provided by $236,614 for the comparable
period last fiscal year. The difference lies primarily in the increase in net
purchases of certificates of deposits in the current fiscal year of $2,282,097
compared to net proceeds of $250,000 in the prior year. In addition, the Company
had net purchases of property and equipment of $726,630 compared to $127,002 for
the comparable period last fiscal year.
Net cash provided by financing activities amounted to $4,410,299 and $137,329
for the quarters ended September 30, 2005, and 2004, respectively. The quarter
ended September 30, 2005 included the cash inflow of $0 compared to $220,000
from issuance of equity and $288,062 compared to $0 from the exercising of stock
options and warrants. In the current fiscal period, the Company had net proceeds
on loans and capital leases of $91,236 as compared to net payments of $30,967 in
the comparable period last year. 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.
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. 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.
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:
o In next 6 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 $3.7MN
o Notes payable for approximately $800,000
o Working capital of $1.0 million for UK business expansion, new
business development activities and infrastructure enhancements.
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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 the
following methods: equity based financing; 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 raise 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 in rule 13a-15(e) as of the end of
the period covered by this interim report on Form 10-QSB. Based on their
evaluation, the chief executive officer and chief financial officer have
concluded that our disclosure controls and procedures are effective.
There has been no change in our internal control over financial reporting that
occurred in the period covered by this report that has materially affected or is
reasonably likely to materially affect our internal control over financial
reporting.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES.
In August 2005, we issued 26,882 shares as conversion of a convertible debenture
originally issued to this investor in March 2004. The original issuance of the
convertible debenture and the issuance of these shares were made in reliance on
an exemption from registration available under Rule 506 of Regulation D of the
Securities Act of 1933, as amended (the "Act").
In August, 2005, we issued a total of 28,000 shares to 3 directors of the
Company as compensation for board service during the July 2004 to June 2005
period. Two of these directors are accredited U.S. residents and the issuance to
them was made in reliance on an exemption from registration under Section 4(2)
of the Act. One of the directors is an accredited non-U.S. resident and the
issuance to him was made in reliance on an exemption from registration available
under Regulation S of the Act.
In August 2005, we issued 2,500 shares to an employee and officer of the Company
as compensation for service rendered. The issuance to this employee was made in
reliance on an exemption from registration under Section 4(2) of the Act.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None
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)
REPORTS ON FORM 8-K.
a) On July 14, 2005, NetSol Technologies, Inc. filed an amended 8-K to a
previous 8-K filed on January 29, 2005. This amendment included the financial
statements for CQ Systems Ltd for the period ended March 31, 2004 and a revised
auditor's report.
b) On July 15, 2005, NetSol Technologies, Inc. filed an 8-K reporting that it
had issued a press release announcing that it expects to meet is financial
guidance for the year ended June 30, 2005.
c) On July 21, 2005, NetSol Technologies filed an 8-K reporting that Mr. Najeeb
Ghauri had resigned as Chief Financial Officer of the Company and that Ms. Tina
Gilger was appointed as his replacement.
d) On September 15, 2005, NetSol Technologies filed an 8-K reporting that it had
issued press released announcing its results of operations for the period ending
June 30, 2005 and providing guidance for the next fiscal year.
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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: November 10, 2005 /s/ Naeem Ghauri
---------------------------
NAEEM GHAURI
Chief Executive Officer
Date: November 10, 2005 /s/Tina Gilger
---------------------------
TINA GILGER
Chief Financial Officer
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