UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
FORM 10-QSB/A
(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, 2004
( ) 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 10,045,796 shares of its $.001 par value Common Stock issued and
outstanding as of November 4, 2004.
Transitional Small Business Disclosure Format (check one)
Yes No X
---- ----
1
NETSOL TECHNOLOGIES, INC.
INDEX
PART I. FINANCIAL INFORMATION Page No.
Item 1. Financial Statements
Consolidated Unaudited Balance Sheet as of September 30, 2004(restated) 3
Comparative Unaudited Consolidated Statements of Operations 4
for the Three Months Ended September 30, 2004 (restated) and 2003 (restated)
Comparative Unaudited Consolidated Statements of Cash Flow 5
for the Three Months Ended September 30, 2004 (restated) and 2003(restated)
Notes to the Unaudited Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis or Plan of Operation 16
Item 3. Controls and Procedures 22
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 22
Item 2. Changes in Securities 22
Item 3. Defaults Upon Senior Securities 22
Item 4. Submission of Matters to a Vote of Security Holders 23
Item 5. Other Information 23
Item 6. Exhibits and Reports on Form 8-K 23
(a) Exhibits
(b) Reports on Form 8-K
2
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET -- SEPTEMBER 30, 2004
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents $ 204,850
Certificates of deposit 141,403
Accounts receivable, net of allowance for doubtful accounts of $80,000 1,166,521
Revenues in excess of billings 1,562,045
Other current assets (restated) 708,773
------------
Total current assets 3,783,592
Property and equipment, net of accumulated depreciation 4,163,787
Intangibles:
Product licenses, renewals, enhancedments, copyrights,
trademarks, and tradenames, net 2,336,768
Customer lists, net 562,653
Goodwill (restated) 1,166,611
------------
Total intangibles (restated) 4,066,032
------------
Total assets (restated) $ 12,013,411
============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable and accrued expenses $ 1,856,704
Current portion of notes and obligations under capitalized leases 349,660
Billings in excess of revenues 54,900
Due to officers (restated) 35,969
Loans payable, bank 439,609
------------
Total current liabilities 2,736,842
Obligations under capitalized leases, less current maturities 73,895
Notes payable 75,075
Convertible debenture (restated) 872,743
------------
Total liabilities 3,758,555
Minority interest 186,615
Contingencies --
Stockholders' equity:
Common stock, $.001 par value; 25,000,000 share authorized;
9,613,468 issued and outstanding 9,613
Additional paid-in-capital (restated) 39,343,344
Treasury stock (27,197)
Accumulated deficit (restated) (30,842,579)
Stock subscription receivable (restated) (313,650)
Common stock to be issued 255,960
Other comprehensive loss (357,250)
------------
Total stockholders' equity (restated) 8,068,241
------------
Total liabilities and stockholders' equity (restated) $ 12,013,411
============
See accompanying notes to consolidated financial statements.
3
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
For the Three Months
Ended September 30,
2004 2003
------------ ------------
(Restated) (Restated)
Net revenues $ 2,058,305 $ 972,612
Cost of revenues 762,268 460,377
------------ ------------
Gross profit 1,296,037 512,235
Operating expenses:
Selling and marketing 119,348 19,222
Depreciation and amortization 295,537 305,135
Bad debt expense -- 52,318
Salaries and wages 347,237 315,540
Professional services, including non-cash
compensation 114,334 29,801
General and adminstrative 277,515 512,651
------------ ------------
Total operating expenses 1,153,971 1,234,667
------------ ------------
Income (loss) from operations 142,066 (722,432)
Other income and (expenses)
Loss on sale of assets (620) (36,988)
Beneficial conversion feature (37,500) --
Fair market value of warrants issued (28,024) --
Gain on forgiveness of debt 50,274 --
Interest expense (21,575) (37,169)
Other income and (expenses) 20,044 596
------------ ------------
Total other expenses (17,401) (73,561)
------------ ------------
Net income (loss) before minority interest in sub subsidiary 124,665 (795,993)
Minority interest in subsidiary 15,068 35,309
------------ ------------
Net income (loss) 139,733 (760,684)
Other comprehensive loss:
Translation adjustment (118,378) (79,788)
------------ ------------
Comprehensive income (loss) $ 21,355 $ (840,472)
============ ============
Net income (loss) per share:
Basic $ 0.01 $ (0.12)
============ ============
Diluted $ 0.01 $ (0.12)
============ ============
Weighted average number of shares outstanding
Basic 9,504,789 6,577,913
============ ============
Diluted 12,065,735 6,577,913
============ ============
See accompanying notes to consolidated financial statements.
4
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
For the Three Months
Ended September 30,
2004 2003
----------- -----------
(Restated) (Restated)
Cash flows from operating activities:
Net income (loss) from continuing operations $ 139,733 $ (760,684)
Adjustments to reconcile net income (loss) to net cash
Used in operating activities:
Depreciation and amortization 374,199 305,135
Gain on settlement of debt (50,274) --
Loss on sale of assets 620 36,988
Minority interest in subsidiary (15,068) (35,309)
Stock issued for services 25,745 --
Fair market value of warrants and stock options granted 28,024 --
Beneficial conversion feature 37,500 --
Changes in operating assets and liabilities:
(Increase) decrease in assets:
Accounts receivable (214,527) (475,023)
Other current assets (824,020) 48,129
Decrease in liabilities:
Accounts payable and accrued expenses (564,159) (205,295)
----------- -----------
Net cash used in operating activities (1,062,227) (1,086,059)
Cash flows from investing activities:
Purchases of property and equipment (213,990) (78,189)
Sales of property and equipment 86,988 130,185
Purchases of certificates of deposit -- (920,000)
Proceeds from sale of certificates of deposit 250,000 400,000
Increase in intangible assets - development costs (77,990) --
Capital investments in minority interest of subsidiary 191,606 --
Proceeeds from sale of minority interest of subsidiary -- 200,000
----------- -----------
Net cash provided by (used in) investing activities 236,614 (268,004)
Cash flows from financing activities:
Proceeds from sale of common stock 220,000 1,112,050
Proceeds from the exercise of stock options -- 238,250
Purchase of treasury shares (51,704) --
Proceeds from loans -- 500,000
Payments on capital lease obligations & loans (30,967) (358,589)
----------- -----------
Net cash provided by financing activities 137,329 1,491,711
Effect of exchange rate changes in cash 21,973 (59,610)
----------- -----------
Net (decrease) increase in cash and cash equivalents (666,311) 78,038
Cash and cash equivalents, beginning of period 871,161 214,490
----------- -----------
Cash and cash equivalents, end of period $ 204,850 $ 292,528
=========== ===========
See accompanying notes to consolidated financial statements.
5
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
(UNAUDITED)
For the Three Months
Ended September 30,
2004 2003
----------- -----------
SUPPLEMENTAL DISCLOSURES:
Cash paid during the period for:
Interest $ 21,575 $ 37,169
=========== ===========
Taxes $ 1,514 $ --
=========== ===========
NON-CASH INVESTING AND FINANCING ACTIVITIES:
Common stock issued for services and compensation $ 111,920 $ --
=========== ===========
Common stock issued for conversion of convertible debenture $ 150,000 $ --
=========== ===========
Common stock issued for settlement of debt $ 45,965 $ --
=========== ===========
See accompanying notes to consolidated financial statements.
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 annual report
on Form 10-KSB for the year ended June 30, 2004. 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 CONNECT (PVT), Ltd. (now,
NetSol Akhter Pvt. Ltd.) ("Connect"), NetSol Abraxas Australia Pty Ltd., NetSol
USA and NetSol Technologies UK, Ltd. 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:
On May 15, 2003, the Financial Accounting Standards Board (FASB) issued FASB
Statement No. 150 (FAS 150), Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity. FAS 150 changes the accounting
for certain financial instruments that, under previous guidance, could be
classified as equity or "mezzanine" equity, by now requiring those instruments
to be classified as liabilities (or assets in some circumstances) in the
statement of financial position. Further, FAS 150 requires disclosure regarding
the terms of those instruments and settlement alternatives. FAS 150 affects an
entity's classification of the following freestanding instruments: a)
Mandatorily redeemable instruments b) Financial instruments to repurchase an
entity's own equity instruments c) Financial instruments embodying obligations
that the issuer must or could choose to settle by issuing a variable number of
its shares or other equity instruments based solely on (i) a fixed monetary
amount known at inception or (ii) something other than changes in its own equity
instruments d) FAS 150 does not apply to features embedded in a financial
instrument that is not a derivative in its entirety. The guidance in FAS 150 is
generally effective for all financial instruments entered into or modified after
May 31, 2003, and is otherwise effective at the beginning of the first interim
period beginning after June 15, 2003. For private companies, mandatorily
redeemable financial instruments are subject to the provisions of FAS 150 for
the fiscal period beginning after December 15, 2003. The adoption of SFAS No.
150 does not have a material impact on the Company's financial position or
results of operations or cash flows.
In December 2003, the Financial Accounting Standards Board (FASB) issued a
revised Interpretation No. 46, "Consolidation of Variable Interest Entities"
(FIN 46R). FIN 46R addresses consolidation by business enterprises of variable
interest entities and significantly changes the consolidation application of
consolidation policies to variable interest entities and, thus improves
comparability between enterprises engaged in similar activities when those
activities are conducted through variable interest entities. The Company does
not hold any variable interest entities.
7
In March 2004, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and its
Application to Certain Investments." The EITF reached a consensus about the
criteria that should be used to determine when an investment is considered
impaired, whether that impairment is other-than-temporary, and the measurement
of an impairment loss and how that criteria should be applied to investments
accounted for under SFAS No. 115, "ACCOUNTING IN CERTAIN INVESTMENTS IN DEBT AND
EQUITY SECURITIES." EITF 03-01 also included accounting considerations
subsequent to the recognition of other-than-temporary impairment and requires
certain disclosures about unrealized losses that have not been recognized as
other-than-temporary impairments. Additionally, EITF 03-01 includes new
disclosure requirements for investments that are deemed to be temporarily
impaired. In September 2004, the Financial Accounting Standards Board (FASB)
delayed the accounting provisions of EITF 03-01; however, the disclosure
requirements remain effective for annual reports ending after June 15, 2004. The
Company will evaluate the impact of EITF 03-01 once final guidance is issued.
In April of 2004, the EITF reached consensus on the guidance provided in EITF
Issue No. 03-6, "Participating Securities and the Two-Class Method under SFAS
No. 128 Earnings Per Share" ("EITF 03-6"). EITF 03-6 clarifies whether a
security should be considered a "participating security" for purposes of
computing earnings per share ("EPS") and how earnings should be allocated to a
"participating security" when using the two-class method for computing basic
EPS. The adoption of EITF 03-6 does not have a significant impact on the
Company's financial position or results of operations.
In May of 2004, the FASB revised FASB Staff Position ("FSP") No. 106-1,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003" and issued FSP No. 106-2,
"Accounting and Disclosure Requirements Related to the Medicare Prescription
Drug, Improvement and Modernization Act of 2003" ("FSP No. 106-2"). FSP 106-2
provides accounting guidance to the employers who sponsor post retirement health
care plans that provide prescription drug benefits; and the prescription drug
benefit provided by the employer is "actuarially equivalent" to Medicare Part D
and hence qualifies for the subsidy under the Medicare amendment act. The
adoption of FSP 106-2 does not have a significant impact on the Company's
financial position or results of operations.
SEC Staff Accounting Bulletin (SAB) No. 105, "APPLICATION OF ACCOUNTING
PRINCIPLES TO LOAN COMMITMENTS," summarizes the views of the staff of the SEC
regarding the application of generally accepted accounting principles to loan
commitments accounted for as derivative instruments. SAB No.105 provides that
the fair value of recorded loan commitments that are accounted for as
derivatives under SFAS No. 133, "ACCOUNTING FOR DERIVATIVE INSTRUMENTS AND
HEDGING ACTIVITIES," should not incorporate the expected future cash flows
related to the associated servicing of the future loan. In addition, SAB No. 105
requires registrants to disclose their accounting policy for loan commitments.
The provisions of SAB No. 105 must be applied to loan commitments accounted for
as derivatives that are entered into after March 31, 2004. The adoption of this
accounting standard does not have a material impact on the Company's financial
statements.
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, 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
========== ========== ==========
8
Weighted average number of shares used to compute basic and diluted loss per
share is the same in the financial statements for the period ended September 30,
2003, since the effect of dilutive securities is anti-dilutive.
NOTE 5 - FOREIGN CURRENCY:
The accounts of NetSol Technologies UK, Ltd. use the British Pound; NetSol
Technologies, (PVT), Ltd, NetSol (Pvt), Limited and NetSol Connect PVT, Ltd. 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 $357,250 at September 30, 2004 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, 2004 and 2003, comprehensive loss in the consolidated
statements of operation included translation loss of $118,378 and $79,788,
respectively.
NOTE 6 - OTHER CURRENT ASSETS
Other current assets consist of the following at September 30, 2004:
Prepaid Expenses $ 441,206
Advance Income Tax 80,559
Employee Advances 33,948
Security Deposits 20,334
Other Receivables 132,726
---------
Total $ 708,773
=========
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, 2004, $6,995 was expensed.
NOTE 7 - DEBTS
NOTES PAYABLE
Notes payable as of September 30, 2004 consist of the following:
------------------------------------------------------------------------
Balance at Current Long-Term
Name 9/30/04 Maturities Maturities
------------------------------------------------------------------------
A. Cowler Settlement $131,935 $ 65,160 $ 66,775
H. Smith Settlement 180,321 180,321 --
A. Zaman Settlement 26,300 18,000 8,300
D&O Insurance 14,827 14,827 --
Subsidiary capital leases 71,352 71,352 --
-------- -------- --------
$424,735 $349,660 $ 75,075
======== ======== ========
On September 25, 2002 the Company signed a settlement agreement with Adrian
Cowler ("Cowler") and Surrey Design Partnership Ltd. The Company agreed to pay
Cowler (pound)218,000 pound sterling or approximately $320,460 USD including
interest, which the Company has recorded as a note payable in the accompanying
consolidated financial statements. The agreement calls for monthly payments of
(pound)3,000 until March 2004 and then (pound)4,000 per month until paid. As of
June 30, 2004, the balance was $146,516. During the three months ended September
30, 2004, the Company paid (pound)8,000 or $14,694. As of September 30, 2004,
the balance was $131,822. Of this amount, $65,160 has been classified as a
current liability and $66,775 as long-term liability in the accompanying
consolidated financial statements.
9
In November 2002, the Company signed a settlement agreement with Herbert Smith
for (pound)171,733 or approximately $248,871, including interest, which the
Company has recorded as a note payable in the accompanying consolidated
financial statements. The Company agreed to pay $10,000 upon signing of the
agreement, $4,000 per month for twelve months, and then $6,000 per month until
paid. The balance owing at June 30, 2004 was $199,321. During the three months
ended September 30, 2004, the Company paid $19,000. The balance owing at
September 30, 2004 was $180,321. The entire balance has been classified as
current and is included in "Current maturities of notes and obligations under
capitalized leases" in the accompanying consolidated financial statements.
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, 2004 and September 30, 2004 was
$26,300. Of this amount, $18,000 has been classified as a current liability and
$8,300 as long-term in the accompanying consolidated financials statements.
In January 2004, the Company renewed its director's and officer liability
insurance for which the annual premium is $167,000. In April 2004, the Company
arranged financing with AFCO Credit Corporation with a down payment of $50,100
with the balance to be paid in monthly installments. The balance owing as of
September 30, 2004 was $14,827.
In addition, the various subsidiaries had current maturities of capital leases
of $71,352 as of September 30, 2004.
BANK NOTE
The Company's Pakistan subsidiary, NetSol Technologies (Private) Ltd., has three
loans with a bank, secured by the Company's assets. These notes consist of the
following as of September 30, 2004:
TYPE OF MATURITY INTEREST BALANCE
LOAN DATE RATE USD
------------------------------------------------------------------
Export Refinance Every 6 months 4% $ 328,449
Term Loan April 20, 2005 10% 26,950
Line of Credit On Demand 8% 84,210
---------
Total $ 439,609
=========
DUE TO OFFICERS
The officers of the Company from time to time loan funds to the Company. As of
June 30, 2004, the officers had a balance owing to them of $17,219. During the
three months ended September 30, 2004, $18,750 of accrued wages was added to the
balance due to officers. The balance owing as of September 30, 2004 was $35,969.
NOTE 8 - STOCKHOLDERS' EQUITY:
REVERSE STOCK SPLIT
On August 18, 2003, the Company affected a 1 for 5 reverse stock split for all
the issued and outstanding shares of common stock. All historical share and per
share amounts in the accompanying consolidated financial statements have been
restated to reflect the 5:1 reverse stock split.
EQUITY TRANSACTIONS
Private Placements
In August 2004, the Company received $200,000 for the purchase of 190,476 shares
of the Company's common stock. As of September 30, 2004, the stock had not been
issued and is reflected as "Stock to be Issued" on the accompanying consolidated
financial statements.
10
Services
In August 2004, the Company entered into a two-year consulting agreement with a
non-related third party whereby the Company issued 50,000 shares of its common
stock valued at $55,960 for the first year of service and has agreed to issue an
additional 50,000 shares at the beginning of the second year. The value of these
shares of $55,960 is included in the "Stock to be Issued" on the accompanying
consolidated financial statements.
Issuance of shares for Conversion of Debt
During the quarter ended September 30, 2004, 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.
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, 2004 was $333,650. During the quarter ended September
30, 2004, the Company received a payment of $20,000 on the receivable. The
balance at September 30, 2004 was $313,650.
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, 2004:
Exercise Exercise
Options Price Warrants Price
-------------- --------------- ----------- --------------
Outstanding and exercisable, June 30, 2004 1,862,277 $0.75 to $5.00 693,182 $0.50 to $5.00
Granted - - 40,323 $3.30
Exercised - - - -
Expired (10,000) $1.00 -
------------- -----------
Outstanding and exercisable, Sept. 30, 2004 1,852,277 733,505
============= ===========
There were no options granted or exercised during the quarter ended September
30, 2004.
During the quarter ended September 30, 2004, 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. 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 $28,024 or $0.69 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 82%
Dividend yield 0%
11
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. 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
September 30, 2004:
Product Licenses Customer Lists Total
---------------- ---------------- ----------------
Intangible asset - June 30, 2004 $ 5,450,357 $ 1,977,877 $ 7,428,234
Additions 77,990 -- 77,990
Effect of translation adjustment (15,517) -- (15,517)
Accumulated amortization (3,176,062) (1,415,224) (4,591,286)
---------------- ---------------- ----------------
Net balance - June 30, 2004 $ 2,336,768 $ 562,653 $ 2,899,421
================ ================ ================
Amortization expense:
Three months ended Sept. 30, 2004 $ 200,907 $ 78,916 $ 279,823
Three months ended Sept. 30, 2003 $ 196,856 $ 78,916 $ 275,772
The above amortization expense includes amounts in Cost of Goods Sold for
capitalized software development costs.
Amortization expense of intangible assets over the next five years is as
follows:
----------------------------------------------------------------------------------------------------------
FISCAL YEAR ENDING
Asset 6/30/05 6/30/06 6/30/07 6/30/08 6/30/09 TOTAL
----------------------------------------------------------------------------------------------------------
Product Licences $ 535,122 $ 713,498 $ 33,372 $ 33,372 $ 7,612 $1,322,976
Customer Lists 236,751 276,326 44,076 5,500 -- 562,653
---------------------------------------------------------------------- ----------
$ 771,873 $ 989,824 $ 77,448 $ 38,872 $ 7,612 $1,885,629
====================================================================== ==========
There were no impairments of the goodwill asset in the period ended September
30, 2004 and 2003.
12
NOTE 10 - LITIGATION:
On March 3, 2004 Uecker and Associates, Inc. as the assignee for the benefit of
the creditors of PGC Systems, Inc. formerly known as Portera Systems, Inc. filed
a request for arbitration demanding payment from NetSol for the amounts due
under a software agreement in the amount of $175,700. On March 31, 2004, the
Company filed an answering statement to the request of Uecker & Associates
denying each and every allegation contained in the Claim filed by Uecker &
Associates and stating NetSol's affirmative defenses. The claim is being settled
by binding arbitration before the American Arbitration Association (AAA). The
parties selected an arbitrator in April 2004; however, due to demands to her
schedule, in August 2004, AAA requested that the parties select another
arbitrator. The parties have selected a new arbitrator. A preliminary hearing
was set with the new arbitrator on September 29, 2004. Discovery deadlines and
motion deadlines were set by the new arbitrator. Dates for the arbitration
hearing have been set for November 15 and 16, 2004. NetSol intends to vigorously
defend this action.
NOTE 11 - GOING CONCERN:
The Company's consolidated financial statements are prepared using the
accounting principles generally accepted in the United States of America
applicable to a going concern, which contemplates the realization of assets and
liquidation of liabilities in the normal course of business. As of September 30,
2004, the Company had net working capital of $1,046,750, and an accumulated
deficit of $30,842,579. This factor raises substantial doubt about the Company's
ability to continue as a going concern.
Management recognizes that the Company must generate additional resources to
enable it to continue operations. In the current period, the Company realized a
significant increase in net revenues. Management is taking steps to continue
comparable revenue increases in the upcoming periods. Management is also
continuing to pursue cost cutting measures at every entity level. Additionally,
management's plans include the sale of additional equity securities and debt
financing from related parties and outside third parties. However, of course, no
assurance can be guaranteed that the Company will be successful in raising
additional capital or continue the current growth trend in net revenues.
Further, there can be no assurance, assuming the Company successfully raises
additional equity, that the Company will achieve profitability or positive cash
flow.
NOTE 12 - 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:
13
2004 2003
(Restated) (Restated)
Revenues from unaffiliated customers:
North America $ 170,134 $ 80,348
International 1,888,171 892,264
------------ ------------
Consolidated $ 2,058,305 $ 972,612
============ ============
Operating income (loss):
North America $ (536,290) $ (733,523)
International 678,356 11,091
------------ ------------
Consolidated $ 142,066 $ (722,432)
============ ============
Identifiable assets:
North America $ 3,606,534 $ 4,897,721
International 8,406,877 4,534,952
------------ ------------
Consolidated $ 12,013,411 $ 9,432,673
============ ============
Depreciation and amortization:
North America $ 263,503 $ 264,001
International 32,034 41,134
------------ ------------
Consolidated $ 295,537 $ 305,135
============ ============
Capital expenditures:
North America $ -- $ 19,019
International 213,990 59,170
------------ ------------
Consolidated $ 213,990 $ 78,189
============ ============
NOTE 13 - MINORITY INTEREST IN SUBSIDIARY
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
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 September 30, 2004,
both NetSol and Akhter had injected the majority of their committed cash to meet
the expansion requirement of the company. As of September 30, 2004, a total of
$615,493 had been transferred to Connect.
14
For the three months ended September 30, 2004, the subsidiary had net losses of
$30,196, of which $15,068 was recorded against the minority interest. The
balance of the minority interest at September 30, 2004 was $186,615.
NOTE 14 - 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, 2004, is $872,743.
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, 2004, 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.
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, 2004, 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 8) The warrants were valued
using the fair value method at $28,024 and was recorded as an expense in the
accompanying consolidated financial statements.
NOTE 15 - 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, Llp, 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 16 - SUBSEQUENT EVENTS
In October 2004, several employees exercised stock options to purchase 205,000
shares of the Company's common stock for $200,000 in cash.
In October 2004, a private placement was made for the purchase of 200,000 shares
of the Company's common stock for $200,000 cash.
NOTE 17- RESTATEMENT
Subsequent to the issuance of the Company's financial statements for the three
months ended September 30, 2004 and 2003, 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.
The Company has restated its financial statements for these adjustments as of
September 30, 2004 and 2003.
The effect of the correction of the error is as follows:
15
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 For the three months ended
September 30, 2004 September 30, 2003
------------------------------ ------------------------------
Cost of revenues $ 751,647 $ 762,268
Gross profit $ 1,306,658 $ 1,296,037
Depreciation and amortization $ 413,824 $ 295,537 $ 412,801 $ 305,135
Total operating expenses $ 1,272,258 $ 1,153,971 $ 1,342,333 $ 1,234,667
Income (loss) from operations $ 34,400 $ 142,066 $ (830,098) $ (722,432)
Other income and (expense) $ 22,335 $ 20,044
Net income (loss) $ 34,358 $ 139,733 $ (868,350) $ (760,684)
Net income (loss) per share:
Basic $ 0.00 $ 0.01 $ (0.13) $ (0.12)
Diluted $ 0.00 $ 0.01 $ (0.13) $ (0.12)
16
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 three
months ending September 30, 2004.
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. Operating on a global basis with locations in the U.S., Europe,
India, East Asia and Asia Pacific, the Company helps its clients identify,
evaluate, and implement technology solutions to meet their most critical
business challenges and maximize their bottom line. The Company's products
include sophisticated software applications for the asset-based lease and
finance industry, and with the acquisition of Pearl Treasury Systems, the "PTS
System" designed to seamlessly handle foreign exchange and money market trading
for use by financial institutions and customers.
The Company's IP backbone, located in Karachi, Pakistan at our subsidiary,
Network Technologies Pvt. Ltd., develops the majority of the Company's software
and has achieved the ISO 9001 and Software Engineering Institute Capability
Maturity Model Level 3 software development assessment. The economies of scale
presented by our Pakistani operations have permitted the Company to capitalize
on the upward trend in information technology outsourcing. Economic pressures
have driven more companies to outsource major elements of their IT operations,
particularly application development and technology consulting. NetSol has
capitalized on this market trend by providing an off-shore development model at
costs well below those of companies located in India, Europe and the United
States.
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 the Company's next 12 months.
Initiatives and Investment to Grow Revenues and Capabilities
o Achieve CMM Level 4 Accreditation in 2004.
o Enhance Software Design, Engineering and Service Delivery
Capabilities by increasing investment in training.
o Enhance and invest in R&D or between 5-7% of yearly budgets in
financial, banking and various other domains within NetSol's core
competencies.
o Recruit additional senior level marketing and technical
professionals in Lahore, London, and Adelaide offices to be able to
support potential new customers from the North American and European
markets.
o Embark on a program of recruiting the best available talent in
project and program management.
17
o In June 2004, the Company relocated its entire staff in Lahore to
three floors of its newly built, fully dedicated and wholly owned
Technology Campus. The Company is in the process of expanding the
last two remaining floors to add new personnel.
o Increase Capex, to enhance Communications and Development
Infrastructure.
o Launch new business development initiatives for various products and
services such as LeaseSoft in hyper growth economies such as China.
o Create new technology partnership with Oracle and strengthen our
relationship with Intel in Asia Pacific and in the USA.
o Aggressive marketing strategy in local government and private
sectors in Pakistan.
o Ramping up the telecom sectors through its majority owned subsidiary
NetSol Akhter and injecting needed capital. The telecom sector is
one of the most untouched sectors in Pakistan. NetSol has seized
this opportunity to aggressively market its products and services
with its strong infrastructure, brand name and resources in this
region.
o Aggressive new business development activities in UK and European
markets through organic growth, new alliances and mergers and
acquisition.
Top Line Growth through Investment in 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 including Japan.
o Expand relationships with key customers in the US, Europe and Asia
Pacific.
o Product Positioning through alliances, joint ventures and
partnerships.
o Direct Marketing of Services.
o Embark on roll up strategy by broadening M&A activities broadly in
the software development domain.
o Effectively position and marketing campaign for `Trapeze' or PTS.
This is a potentially big revenue generator in the banking domain
for which NetSol has already invested significant time and resources
towards completing the development of this application. Seeking
major development partners to market this treasury systems in the
global markets.
With these goals in mind, the Company entered in to the following significant
and new strategic alliances and relationships:
LeaseSoft Distributors. NetSol is also very active in appointing key
distributors in Japan, Asia and in Europe for its LeaseSoft products. As soon we
have signed these agreements, the shareholders will be notified through press
releases.
DaimlerChrysler. NetSol signed a global frame agreement with DaimlerChrysler,
Germany for LeaseSoft products and services that now expands the marketing reach
to over 60 countries. DaimlerChrysler as a group represent the largest customers
for NetSol.
Intel Corporation. NetSol forged what management believes to be a very important
and strategic alliance with Intel Corporation to develop a blueprint that would
give broader exposure and introduction to NetSol's LeaseSoft products to a
global market. NetSol recently attended major events in China and in San
Francisco through its Intel relationship, which was designed to connect and
introduce the Company to Intel partners worldwide.
Investment Banking Relations. The relationship with Maxim Group, LLC, NetSol's
investment banker located in New York, continues to grow as the bank has
effectively raised new capital and has been assisting the Company in executing
its M&A and growth strategy. NetSol UK, the Company's wholly owned United
Kingdom subsidiary, has engaged The Altra Group, a local M&A company to assist
it in identifying opportunities in the European markets.
Launch of Indian Subsidiary. On March 17, 2004, NetSol announced that it has
launched a wholly-owned subsidiary, NetSol International Pvt. Ltd., in
Bangalore, India. NetSol established this subsidiary as a service delivery base
for legacy systems migration, IT consultancy and certain software engineering
skills that are more readily available in India. The Indian IT-enabled services
business produces over $12 billion in export earnings and is growing at over 20%
annually. By establishing the Indian subsidiary, NetSol hopes to tap into the
growing Indian market.
18
Funding and Investor Relations.
o The Company is exploring various means and most cost efficient
methods to inject new capital for the explosive growth it is
experiencing. Our focus is in emerging capital markets, UK and USA.
o Continue to raise capital at attractive terms through private
placements offering restricted securities, convertible debt
debentures and, as needed, new public offerings, for its many
initiatives and programs. Several of the Company's current
institutional investors based in the UK and USA have regularly
participated through new private placement transactions or by
exercising their warrants or converting their notes into NetSol
restricted common shares.
o Infuse new capital from potential exercise of outstanding investor
warrants and employees options for business development and
enhancement of infrastructures.
o Continuing to efficiently and prudently manage cash requirements and
raise capital from the markets only as it deems absolutely necessary
to execute the growth strategy.
o NetSol has engaged a brokerage house in New York for new investor
relations and company coverage. Just recently they initiated and
distributed research coverage of NetSol with a "buy" rating.
Improving the Bottom Line.
o Continue to review costs at every level and take appropriate steps
to further reduce operating overheads.
o Discontinue any programs, projects or offices that are not producing
desirable and positive results
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 Improve prices of all our product offerings, yet maintain the
competitiveness. This will further improve gross margins across the
board.
After streamlining key operations, Management believes that NetSol is in a
position to derive higher productivity based on current capital employed.
Nonetheless, as the business ramps up, management anticipates the need to hire
additional personnel.
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 3, the Company is
experiencing a growing demand for its products and alliances from blue chip
companies worldwide. NetSol is now aiming for CMM level 4 in 2004 and
potentially CMM level 5, the highest CMM level, in 2005. 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 Outsourcing of services and software development is growing
worldwide.
o The Global IT budgets are estimated to exceed $1.2 trillion in 2004,
according to the internal estimates of Intel Corporation. About 50%
of this IT budget would be consumed in the U.S. market alone
primarily on the people and processes.
o Burgeoning Chinese markets and economic boom.
o Overall economic expansion worldwide and explosive growth in the
merging markets specifically.
19
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 strong stock markets.
o Pakistan's continuous fight against extremism and terrorism in the
region, boosting confidence of foreign investors and companies.
o Major turnarounds in the telecom sector as new opportunities are
arising due to privatization, new incentives, reduction of bandwidth
prices and tariffs.
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 potential impact of higher U.S. interest rates including, but
not limited to, fear of inflation that may drive down IT budges and
spending by U.S. companies.
o Higher oil prices worldwide may slow down the global economy causing
delays in new orders and reduction in budgets.
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 2004-2005, we estimated the allowance on net
deferred tax assets to be one hundred percent of the net deferred tax assets.
20
CHANGES IN FINANCIAL CONDITION
Quarter Ended September 30, 2004 as compared to the Quarter Ended September 30,
2003:
Net revenues for the quarter ended September 30, 2004 were $2,058,305 as
compared to $972,612 for the quarter ended September 30, 2003. Net revenues are
broken out among the subsidiaries as follows:
2004 2003
---------- ----------
Netsol USA $ 170,134 $ 80,348
Netsol Tech 1,113,859 546,897
Netsol Private 302,809 60,579
Netsol Connect 268,334 144,212
Netsol UK 172,261 67,874
Netsol-Abraxas Australia 30,908 72,702
---------- ----------
Total Net Revenues $2,058,305 $ 972,612
========== ==========
This reflects an increase of $1,085,693 or 111.63% in the current quarter as
compared to the quarter ended September 30, 2003. The increase is attributable
to new orders of licenses and an increase in services business, including
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. The
export licenses of LeaseSoft and maintenance related services surged primarily
due to the most recent endorsement by our biggest customer DaimlerChrysler of
Germany. NetSol and DaimlerChrysler signed a global frame agreement that added
new revenues and assisted in acquiring new customers such as Toyota Leasing
Thailand and Mauritius Commercial Bank.
Our telecom company, NetSol Akhter, added its 50th new corporate customer in
Pakistan which customers include, but are not limited to: AKD Securities,
Reuters and, Marriot Hotels.
Its U.S. subsidiary, NetSol Altvia, has created a growing niche in the
"not-for-profit" business space in the Washington D.C. area. The Washington D.C.
area office continues to sign new business for both its Knowledge Base Product
and professional services. NetSol USA has been managing several projects with
Seattle based Capital Stream since November 2003. Overall, NetSol USA has
generated revenue in excess of $600,000 with margins exceeding 40%.
NetSol UK continues its business development activities and has seen good
traction in its sales pipeline. NetSol UK added a very strategic new customer
TiG ("The Innovation Group"), a publicly listed UK company. We believe our
relationship with TiG will yield significant new recurring revenues to the
subsidiary. NetSol UK has ongoing relationships with Habib Allied Bank and DCD
Group. These relationships are bringing recurring revenues and are expected to
continue in the near term.
As a direct result of the successful implementations of some of our current
systems with DaimlerChrysler, we are noticing an increasing 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 and Pakistan. The
crown jewel of our product line "CMS' ("Contract Management System") which was
sold to three companies of DaimlerChrysler Asia Pacific Region in 2001 for a
combined value in excess of two million dollars was implemented and delivered to
customers in 2003. Based on ELA, (Equipment and Leasing Association of N.
America) the size of the world market for the leasing and financing industry is
in excess of $500 billion of which the software sector represents over a billion
dollars. 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 2005 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 $100,000 to $500,000 with additional
charges for customization and maintenance of between 20%-30% each year. The
Company, in parallel, has developed banking applications software to boost its
product line and these systems were sold to Citibank and Askari Banks in
Pakistan in 2002. New customers in the banking sector are also growing and the
Company expects substantial growth in this area in the coming year.
The gross profit was $1,296,037 in the quarter ending September 30, 2004 as
compared with $512,235 for the same quarter of the previous year for an increase
of $783,802. The gross profit percentage has increased to approximately 63% in
the quarter ended September 30, 2004 from approximately 53% for the quarter
ended September 30, 2003. In comparison to the prior quarter ended June 30,
2004, the cost of sales decreased approximately $248,573 and revenues increased
$190,974, an overall increase of 10% in gross profit.
21
Operating expenses were $1,153,971 for the quarter ending September 30, 2004 as
compared to $1,234,667, for the corresponding period last year. The increase is
selling and marketing expenses and salaries was offset by a similar decrease in
general and administrative expenses and professional fees. The Company has
streamlined its operations by consolidation, divestment and enhanced operating
efficiencies. Depreciation and amortization expense amounted to $295,537 and
$305,135 for the quarter ended September 30, 2004 and 2003, respectively.
Combined salaries and wage costs were $347,237 and $315,540 for the comparable
periods, respectively, or an increase of $31,697 from the corresponding period
last year.
Selling and marketing expenses were $119,348 and $19,222, in the quarter ended
September 30, 2004 and 2003, respectively, reflecting the growing sales activity
of the Company. The Company wrote-off as uncollectible bad debts of $0 in the
current quarter compared to $52,318 for the comparable prior period in the prior
year. Professional services expense increased to $114,334 in the quarter ended
September 30, 2004, from $29,801 in the corresponding period last year.
Income from operations was $142,066 compared to a loss of $722,432 for the
quarters ended September 30, 2004 and 2003, respectively. This represents a
decrease of $864,498 for the quarter compared with the comparable period in the
prior year. This is directly due to reduction of operational expenses and
improved gross margins.
Net income was $139,733 compared to net losses of $760,684 for the quarters
ended September 30, 2004 and 2003, respectively. This is a reduction of 120%
compared to the prior year. The add-back for the 49.9% minority interest in
NetSol Connect owned by another party was $15,068 compared to $35,309. During
the current quarter, the Company also recognized an expense of $37,500 for the
beneficial conversion feature on convertible debentures, an expense of $28,024
for the fair market value of warrants issued and a gain of $50,274 from the
settlement of a debt. Net income per share, basic and diluted, was $0.01 for the
quarter ended September 30, 2004 as compared with a loss per share of $0.12 for
the corresponding period last year.
The net EBITDA income was $435,270 compared to loss of $455,549 after
amortization and depreciation charges of $295,537 and $305,135 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 $204,850 at September 30, 2004 compared to
$292,528 at September 30, 2003. In addition the Company had $141,403 in
certificates of deposit, of which $121,163 is being used as collateral for the
financing of the directors' and officers' liability insurance. In October 2004,
the balance of the loan for the insurance was paid off and the certificate
released. The total cash position, including the certificates of deposits, was
$346,253 as of September 30, 2004.
Net cash used for operating activities amounted to $1,062,227 for the quarter
ended September 30, 2004, as compared to $1,086,059 for the comparable period
last fiscal year. The increase is mainly due to an increase in prepaid expenses
and accounts receivable. In addition, the Company experienced a decrease of
$564,159 in its accounts payable and accrued expenses.
Net cash provided by investing activities amounted to $236,614 for the quarter
ended September 30, 2004, as compared to using $268,004 for the comparable
period last fiscal year. The difference lies primarily in the net proceeds of
$250,000 in certificates of deposits in the current fiscal year compared to
purchases of $520,000 in the prior year. During the current fiscal year, an
additional $191,606 was infused into the Company's minority interest in the
Company's subsidiary NetSol Connect. In addition, the Company had net purchases
of property and equipment of $127,002 compared to net sales of $51,996 for the
comparable period last fiscal year.
Net cash provided by financing activities amounted to $137,329 and $1,491,711
for the quarters ended September 30, 2004, and 2003, respectively. The quarter
ended September 30, 2004 included the cash inflow of $220,000 compared to
$1,112,050 from issuance of equity and $0 compared to $238,250 from the
exercising of stock options and warrants. In the current fiscal period, the
Company had net payments on loans and capital leases of $30,967 as compared to
net proceeds of $141,411 in the comparable period last year.
22
The 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 investor warrants and
employee stock options in the current and subsequent quarters. The cash position
has declined in the last quarter as compared with quarter ended in June 30,
2004. This was primarily due to new capital raised in the quarter ended in June
30, 2004. During the current quarter, management reduced the current liabilities
significantly by paying down these obligations. Management anticipates receiving
proceeds from option exercises in the coming months and will continue to explore
the best possible means and terms to raise new capital . Management is confident
of being able to strengthen its cash position and further improve the liquidity
position. Management is committed to implementing the growth business strategy
that was ratified by the board of directors in December 2003. The Company would
continue to inject new capital towards expansion, growing sales and marketing
and further enhancement of delivery capabilities. However, management is
committed to ensuring the most efficient and cost effective means of raising
capital and utilization.
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 next 12 months, we have following capital
needs:
o Injection of new capital of up to $500,000 in a strategic
joint-venture of NetSol-TiG. This partnership serves to outsource
TiG's software development business to our offshore-based
development facility.
o New capital requirement for NetSol Akhter, the telecom division in
an amount up to $2.0 million as required by the agreement with
Akhter.
o Working capital of $1.0 million for debts payments, new business
development activities and infrastructure enhancements.
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.
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.
23
PART II OTHER INFORMATION
Item 1. Legal Proceedings
On March 3, 2004 Uecker and Associates, Inc. as the assignee for the benefit of
the creditors of PGC Systems, Inc. formerly known as Portera Systems, Inc. filed
a request for arbitration demanding payment from NetSol for the amounts due
under a software agreement in the amount of $175,700. On March 31, 2004, we
filed an answering statement to the request of Uecker & Associates denying each
and every allegation contained in the Claim filed by Uecker & Associates and
stating NetSol's affirmative defenses. The claim is being settled by binding
arbitration before the American Arbitration Association (AAA). The parties
selected an arbitrator in April 2004; however, due to demands to her schedule,
in August 2004, AAA requested that the parties select another arbitrator. The
parties selected a new arbitrator. A preliminary hearing was set with the new
arbitrator on September 29, 2004. The Parties entered into a Settlement
Agreement in November 2004, whereby NetSol is to pay a one time payment of
$75,000. At the time payment is received, Uecker is to file a dismissal with
prejudice on this matter.
Item 2. Changes in Securities.
In August 2004, the Company issued 50,000 shares valued at $55,960 to Westrock
Advisors for consulting services. These shares were issued in reliance on an
exemption from registration available under Regulation D of the Securities Act
of 1933, as amended.
In August and September 2004, three holders of $150,000 in convertible
debentures converted their notes into 80,646 shares of the Company's common
stock.
In September 2004, the Company sold 190,476 shares of its common stock in
private placements valued at $200,000. As of September 30, 2004, these shares
have not been issued. These shares were issued in reliance on an exemption from
registration available under Regulation S of the Securities Act of 1933, as
amended.
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 August 10, 2004, NetSol Technologies, Inc. issued a press release
announcing that it expects to meet is financial guidance for the year ended June
30, 2004 and providing guidance for the 2005 fiscal year.
b) On September 15, 2004, NetSol Technologies, Inc. issued a press release
announcing results of operations and financial conditions for the fiscal year
ended June 30, 2004 and providing additional guidance for the 2005 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: March 21, 2006 /s/ Naeem Ghauri
----------------------------------------
NAEEM GHAURI
Chief Executive Officer
Date: March 21, 2006 /s/ Najeeb Ghauri
----------------------------------------
NAJEEB GHAURI
Chief Financial Officer and Chairman
25