DEF 14A 1 v052873_def14a.htm
UNITED STATES SECURITIES AND EXCHANGE COMMISSION 
WASHINGTON, DC 20549 
SCHEDULE 14A 
(Rule 14a-101) 
SCHEDULE 14A INFORMATION 
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NetSol Technologies, Inc. 
(Name of Registrant as Specified In Its Charter)
 
(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
 
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netsol Logo
 
NetSol Technologies, Inc.
23901 Calabasas Road, Suite 2072
Calabasas, CA 91302
Phone: (818) 222-9195
Fax: (818) 222-9197

September 15, 2006

To Our Stockholders:

We cordially invite you to attend a special meeting of stockholders to be held at 10:00 a.m. on October 18, 2006 at the offices of NetSol Technologies, Inc., 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302. The office phone number is 818-222-9195.

At the special meeting, you will be asked to consider and vote upon a proposal, to approve the full issuance and exercise of: (i) shares of common stock underlying convertible notes; (ii) shares of common stock underlying shares of preferred stock; (iii) shares of common stock as a dividend payable or redemption under the terms of the preferred stock; (iv) upon exercise of the warrants granted to Maxim Group, LLC as part of their compensation as placement agent; and, (v) upon exercise of the warrants all issued as part of a financing in the amount of $5.5 million (the “Financing”). The financing, consisting of convertible notes, which are in an aggregate principal amount of $5.5 million and bear interest at the rate of 12%, were issued on June 15, 2006 and are due on June 15, 2007. A detailed discussion of this proposal starts on page 20 of this proxy.
 
You will also be asked to approve the amendment of the articles of incorporation of the Company to permit the board of directors to designate the rights and privileges of the Company’s preferred stock by resolution as permitted by Nevada Revised Statutes 78.1955. A detailed discussion of this proposal starts on page 58 of this proxy.
 
Additionally, you will be asked to act on such other business as may properly come before the special meeting.

This is your opportunity as a shareholder to exercise your vote in the best interests of your Company.  

Whether or not you attend the Special meeting, it is important that your shares be represented and voted at the meeting. Therefore, I urge you to promptly vote and submit your proxy card in the postage paid envelope as soon as possible.

Your participation in the special meeting, via proxy or in person, is important and allows you a voice in determining the future of your Company.

Enclosed is a notice of special meeting and proxy statement containing detailed information concerning the business to be conducted at the meeting. Whether or not you plan to attend the special meeting, we urge you to read this material carefully. On behalf of the Board of Directors, I would like to express our appreciation for your continued interest in the Company. We look forward to seeing you at the meeting.

Sincerely,

Najeeb U. Ghauri   Naeem U. Ghauri
Chairman of the Board                  Chief Executive Officer

3


NOTICE OF SPECIAL MEETING OF STOCKHOLDERS

To be held October 18, 2006

TO THE STOCKHOLDERS OF NETSOL TECHNOLOGIES, INC.

NOTICE IS HEREBY GIVEN that a Special Meeting of Stockholders, including any adjournments or postponements thereof, of NetSol Technologies, Inc. (the "Company"), will be held on October 18, 2006 at 10:00 a.m. local time at the offices of the Company located at 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302 for the following purposes:

1.
To consider and vote upon a proposal, to approve the full issuance and exercise of: (i) shares of common stock underlying convertible notes; (ii) shares of common stock underlying shares of preferred stock; (iii) shares of common stock as a dividend payable or redemption under the terms of the preferred stock; (iv) shares of common stock upon exercise of warrants granted to Maxim Group, LLC as part of their compensation as placement agent and, (v) shares of common stock upon exercise of the warrants in full without any limitations on the number of shares to be issued, all issued as part of a financing in the amount of $5.5 million (the “Financing”). The financing, consisting of convertible notes, which are in an aggregate principal amount of $5.5 million and bear interest at the rate of 12%, were issued on June 15, 2006 and are due on June 15, 2007;
 
2.
To consider and vote on the amendment of our articles of incorporation to permit the board of directors to designate the rights and privileges of the Company’s authorized preferred stock by resolution; and
 
3.
To consider such other matters as may properly come before the Special Meeting.

The proceeds of the Financing were used to fund the initial payment of the McCue Systems, Inc. acquisition; to fund the final cash portion of the payment to former CQ Systems, Ltd. shareholders as part of the acquisition of CQ Systems, Ltd. (now NetSol-CQ) by the Company; and, for working capital. The Company is not seeking approval of either the McCue Systems, Inc. or CQ Systems, Ltd. acquisition in this proxy. However, a detailed discussion of McCue Systems, Inc. and NetSol-CQ is contained in the proxy beginning on pages 42 and 50 respectively.

In connection with the Financing, we seek approval from the shareholders of an issuance of common stock which exceeds 20% of our issued and outstanding common stock as of May 5, 2006. Should stockholder approval of the issuance of the shares of common stock upon conversion of the notes and preferred stock and exercise of the warrants not be obtained, the convertible notes would only be converted into and the exercise of warrants would only be permitted to the extent that such conversion and exercise would not, when aggregated with the McCue Systems, Inc. transaction, result in an issuance of 20% or more of the issued and outstanding shares, excluding treasury shares, of common stock as of May 5, 2006.

Only stockholders of record as shown on the books of the Company at the close of business on September 15, 2006, the record date and time fixed by the Board of Directors, will be entitled to vote at the meeting and any adjournment thereof.

By order of the Board of Directors
NetSol Technologies, Inc.

Naeem Ghauri
Chief Executive Officer

September 15, 2006
Calabasas, California
 
4


TO ASSURE YOUR REPRESENTATION AT THE MEETING, PLEASE SIGN, DATE AND RETURN YOUR PROXY IN THE ENCLOSED ENVELOPE WHETHER OR NOT YOU EXPECT TO ATTEND IN PERSON. STOCKHOLDERS WHO ATTEND THE MEETING MAY REVOKE THEIR PROXIES AND VOTE IN PERSON IF THEY DESIRE.

NetSol Technologies, Inc.
23901 Calabasas Road Suite 2072  
Calabasas, CA 91302
 
5


TABLE OF CONTENTS

PROXY STATEMENT GENERAL INFORMATION
   
8
 
Solicitation of Proxies
   
8
 
Voting and Revocation of Proxies
   
8
 
Voting Securities and Principal Holders Thereof
   
9
 
Interests of Persons in Matters to be Acted Upon
   
10
 
Voting at the Meeting
   
10
 
Returned Proxy Cards Which Do Not Provide Voting Instructions
   
10
 
Shares Held in Street Name
   
10
 
Changing Your Vote
   
11
 
         
QUESTIONS AND ANSWERS ABOUT THE MATTERS SUBJECT TO VOTE
   
12
 
         
SELECTED HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA
   
14
 
         
APPROVAL TO ISSUE THE AMOUNT OF SHARES OF COMMON STOCK UPON CONVERSION OF THE PREFERRED SHARES; AS DIVIDENDS OR REDEMPTION UNDER THE TERMS OF THE PREFERRED SHARES; ON EXERCISE OF WARRANTS    
20 
 
         
Introduction
   
20
 
Description of the Financing
   
20
 
Description of Securities
   
22
 
The McCue Acquisition
   
23
 
The CQ Acquisition
   
25
 
Nasdaq Listing Requirements and the Necessity of Stockholder Approval
   
25
 
Required Vote
   
26
 
Recommendation of the Board of Directors
   
26
 
         
INFORMATION ABOUT NETSOL TECHNOLOGIES, INC.
   
27
 
The Business
   
27
 
Legal Proceedings
   
28
 
Market for Registrant’s Common Equity and Related Stockholder Matters
   
28
 
Management’s Discussion and Analysis or Plan of Operations
   
29
 
Change in Financial Condition
   
33
 
Quarter Ended March 31, 2006 as Compared to Quarter Ended March 31, 2005
   
33
 
Nine Month Period Ended March 31, 2006 as Compared to Nine Month Period ended March 31, 2005
   
36
 
Liquidity and Capital Resources
   
38
 
The Year Ended June 30, 2005 as Compared to the Year Ended June 30, 2004
   
40
 
Liquidity and Capital Resources
   
42
 
Dividends and Redemption
   
43
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
   
43
 
         
INFORMATION ABOUT MCCUE SYSTEMS, INC.
   
43
 
The Business
   
43
 
Selected Historical Financial Data
   
44
 
Management’s Discussion and Analysis or Plan of Operations
   
45
 
Change in Financial Condition
   
48
 
Three Months Ended March 31, 2006 as Compared to the Three Months Ended March 31, 2005
   
48
 
Liquidity and Capital Resources
   
49
 
The Year Ended December 31, 2005 as Compared to the Year Ended December 31, 2004
   
49
 
Liquidity and Capital Resources
   
50
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
   
51
 

6


INFORMATION ABOUT CQ SYSTEMS, LTD.
   
51
 
The Business
   
51
 
Selected Historical Financial Data
   
51
 
Management’s Discussion and Analysis or Plan of Operations
   
53
 
Change in Financial Condition
   
56
 
Nine Months Ended December 31, 2004 as Compared to the Nine Months Ended December 31, 2003 56
       
Liquidity and Capital Resources
   
57
 
The Year Ended March 31, 2004 as Compared to the Year Ended March 31, 2003
   
57
 
Liquidity and Capital Resources
   
58
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosures
   
58
 
         
APPROVAL TO AMEND THE ARTICLES OF INCORPORATION OF THE COMPANY TO PERMIT THE
       
         
BOARD OF DIRECTORS TO DESIGNATE BY RESOLUTION ACCORDING TO NEVADA REVISED STATUTES 78.1955 THE POWERS, PREFERENCES AND RELATIVE RIGHTS OF PREFERRED STOCK AND QUALITIFCATIONS, LIMITATIONS AND RESTRICTIONS THEREOF
   
59
 
         
INDEX TO FINANCIAL STATEMENTS
   
62
 
 
ANNEXES
A     CONVERTIBLE NOTE AND WARRANT PURCHASE AGREEMENT
B     12% CONVERTIBLE NOTE
C     COMMON STOCK PURCHASE WARRANT
D     INVESTORS RIGHTS AGREEMENT
E      FORM OF 7% CUMULATIVE CONVERTIBLE PREFERRED STOCK
F      PLACEMENT AGENT WARRANT


7


PROXY STATEMENT GENERAL INFORMATION

SOLICITATION OF PROXIES

This Proxy Statement is furnished to holders of the common stock, par value $.001 per share, of NetSol Technologies, Inc., a Nevada corporation (the "Company"), in connection with the solicitation by the Company's Board of Directors of proxies for use at the Company's Special Meeting of Stockholders (the "Special Meeting") to be held on October 18,, 2006 at 10:00 a.m. local time at the offices of the Company located at 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302. The purpose of the Special Meeting and the matters to be acted on there are set forth in the accompanying Notice of Special Meeting of Stockholders.

The Special Meeting has been called for the purpose of the following:

1. To consider and vote upon a proposal, to the extent required by and for purposes of NASD Marketplace Rule 4350(i), to approve the full issuance and exercise of: (i) shares of common stock underlying convertible notes; (ii) shares of common stock underlying shares of preferred stock; (iii) shares of common stock as a dividend payable or redemption under the terms of the preferred stock; (iv) shares of common stock upon exercise of the warrants granted to Maxim Group, LLC (the “placement agent”) as part of their compensation for acting as the placement agent and, (v) shares of common stock upon exercise of the warrants in full without any limitations on the number of shares to be issued, all issued as part of a financing in the amount of $5.5 million (the “Financing”). The financing, consisting of convertible notes, which are in an aggregate principal amount of $5.5 million and bear interest at the rate of 12%, were issued on June 15, 2006 and are due on June 15, 2007.

2. To amend the articles of incorporation to permit the board of directors to designate the rights and privileges of the Company’s authorized preferred stock pursuant to Nevada Revised Statutes Section 78.1955.

3. To consider such other matters as may properly come before the Special Meeting.

The board of directors solicits the accompanying proxy to those stockholders of record as of the close of business on September 15, 2006. These materials are expected to be first mailed to stockholders on or about September 15, 2006. The cost of making the solicitation includes the cost of preparing and mailing the Notice of Special Meeting, Proxy Statement, proxy card and the payment of charges made by brokerage houses and other custodians, nominees and fiduciaries for forwarding documents to stockholders. In certain instances, directors and officers of the Company may make special solicitations of proxies either in person, telephone or by mail. Expenses incurred in connection with special solicitations are expected to be nominal. The Company will bear all expenses incurred in connection with the solicitation of proxies for the Special Meeting.

VOTING AND REVOCATION OF PROXIES

A stockholder giving a proxy on the enclosed form may revoke it at any time prior to the actual voting at the Special Meeting by filing written notice of the termination of the appointment with an officer of the Company, by attending the Special Meeting and voting in person or by filing a new written appointment of a proxy with an officer of the Company. The revocation of a proxy will not affect any vote taken prior to the revocation. Unless a proxy is revoked or there is a direction to abstain on one or more proposals, it will be voted on each proposal and, if a choice is made with respect to any matter to be acted upon, in accordance with such choice. If no choice is specified, the proxies intend to vote the shares represented thereby to approve Proposals No. 1 and 2 as set forth in the accompanying Notice of Special Meeting of Stockholders, and in accordance with their best judgment on any other matters that may properly come before the Special Meeting.
 
8


VOTING SECURITIES AND PRINCIPAL HOLDERS THEREOF

As of July 6, 2006, there were 16,169,982 shares of common stock issued and outstanding. Common stock is the only class of outstanding voting securities as of that date. Each share of common stock is entitled to one vote.

The following table sets forth certain information regarding the beneficial ownership of the Company's Common Stock, its only class of outstanding voting securities as of July 6, 2006, by (i) each person who is known to the Company to own beneficially more than 5% of the outstanding Common Stock with the address of each such person, (ii) each of the Company's present directors and officers, and (iii) all officers and directors as a group:

Name and Address
 
 
Number of
Shares(1)(2)
 
 
Percentage
Beneficially
owned(5)
 
               
Najeeb Ghauri (3)
   
2,412,650
   
14.92
%
Naeem Ghauri (3)
   
2,261,367
   
13.98
%
Salim Ghauri (3)
   
2,377,416
   
14.70
%
Jim Moody (3)
   
183,000
   
*
 
Eugen Beckert (3)
   
178,900
   
*
 
Shahid Javed Burki (3)
   
204,000
   
*
 
Derek Soper (3)
   
243,000
   
*
 
Patti McGlasson (3)
   
125,000
   
*
 
Tina Gilger(3)
   
61,731
   
*
 
Aqeel Karim Dhedhi (4)
   
870,067
   
5.38
%
The Tail Wind Fund Ltd.(6)(7)
   
1,600,828
   
9.90
%
All officers and directors
             
as a group (nine persons)
   
8,047,064
   
49.76
%
 
* Less than one percent

(1) Except as otherwise indicated, the Company believes that the beneficial owners of the common stock listed below, based on information furnished by such owners, have sole investment and voting power with respect to such shares, subject to community property laws where applicable. Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities.

(2) Beneficial ownership is determined in accordance with the rules of the Commission and generally includes voting or investment power with respect to securities. Shares of common stock relating to options currently exercisable or exercisable within 60 days of July 6, 2006 are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares shown as beneficially owned by them. Includes shares issuable upon exercise of options exercisable within 60 days as follows: Mr. Najeeb Ghauri, 1,900,000; Mr. Naeem Ghauri, 1,910,000; Mr. Salim Ghauri, 1,900,000; Mr. Jim Moody, 150,000; Mr. Eugen Beckert, 135,000; Mr. Shahid Burki, 150,000; Mr. Derek Soper, 200,000; Ms. Tina Gilger, 60,000; and Ms. Patti McGlasson, 100,000.

(3) Address c/o NetSol Technologies, Inc. at 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302.

(4) Address: 605 Continental Trade Center, Khaybran-E-Iqbal, Karachi, Pakistan.

(5) Shares issued and outstanding as of July 6, 2006 were 16,169,982.

(6) Address: The Bank of Nova Scotia Trust Company (Bahamas) Ltd., Windermere House, 404 East Bay Street, P.O. Box SS-5539, Nassau, Bahamas. Tail Wind Advisory & Management Ltd., a UK corporation authorized and regulated by the Financial Services Authority of Great Britain (“TWAM”), is the investment manager for The Tail Wind Fund Ltd., and David Crook is the CEO and controlling shareholder of TWAM. Each of TWAM and David Crook expressly disclaims any equitable or beneficial ownership of the shares being referred to hereunder and held by The Tail Wind Fund Ltd

9

 
(7) Subject to the Ownership Limitation (defined below), The Tail Wind Fund Ltd. (“Tail Wind”) would own a total of 2,500,001 shares of Common Stock, including 1,666,667 shares of Common Stock issuable upon conversion of $2,750,000 in principal amount of the issuer’s 12% Convertible Notes due June 15, 2007 (“Notes”) issued to Tail Wind on June 21, 2006, and (ii) 833,334 shares of Common Stock issuable upon exercise of Warrants issued to Tail Wind on such date (“Warrants”). In accordance with Rule 13d-4 under the Securities Exchange Act of 1934, as amended, because the number of shares of Common Stock into which the Reporting Person's Notes and Warrants are convertible and exercisable is limited, pursuant to the terms of such instruments, to that number of shares of Common Stock which would result in the Reporting Person having beneficial ownership of 9.9% of the total issued and outstanding shares of Common Stock (the "Ownership Limitation"), Tail Wind Fund Ltd. disclaims beneficial ownership of any and all shares of Common Stock that would cause the Reporting Person's beneficial ownership to exceed the Ownership Limitation. In accordance with the Ownership Limitation, Tail Wind, based upon 16,169,982 shares of common stock outstanding, beneficially owns 2,500,001 shares of Common Stock and disclaims beneficial ownership of 899,173 shares of Common Stock.

INTERESTS OF CERTAIN PERSONS IN MATTERS TO BE ACTED UPON
 
No director of executive officer holds a substantial interest, either directly or indirectly, in any matter to be acted upon.
 
VOTING AT THE MEETING

Only stockholders of record at the close of business on July 7, 2006 are entitled to notice of and to vote at the Special Meeting or any adjournments thereof. Each share of Common Stock is entitled to one vote on the matters to be presented at the Special Meeting.

A majority of the votes entitled to be cast on matters to be considered at the Special Meeting, present in person or by proxy, will constitute a quorum at the Special Meeting. If a share is represented for any purpose at the Special Meeting, it is deemed to be present for all other matters. Abstentions and broker nonvotes will be counted for purposes of determining the presence or absence of a quorum. "Broker nonvotes" are shares held by brokers or nominees which are present in person or represented by proxy, but which are not voted on a particular matter because instructions have not been received from the beneficial owner. Under applicable Nevada law, the effect of broker nonvotes on a particular matter depends on whether the matter is one as to which the broker or nominee has discretionary voting authority. Under applicable Nevada law, as it applies to the proposals presented to stockholders at this special meeting, Broker non-votes shall be treated as an abstention and such Broker non-votes shall be included in the total shares voted for the purpose of quorum requirements and determining whether a majority of stockholders have approved the transactions. Treatment of Broker non-votes as an abstentions results in these votes being treated as “no” votes in so far as a majority of all votes cast, including broker non-votes must be voted in favor for a proposal to be approved. A majority of votes in favor must be acquired in order for the proposals to be approved.
 
RETURNED PROXY CARDS WHICH DO NOT PROVIDE VOTING INSTRUCTIONS

Proxies that are signed and returned will be voted in the manner instructed by a stockholder. If you sign and return your proxy card with no instructions, the proxy will be voted "For" with respect to the item set forth in the Proposal.

SHARES HELD IN “STREET NAME”

If your shares are held in “street name”, your broker can vote your shares only if you provide instructions on how to vote. You should instruct your broker to vote your shares in accordance with directions provided by your broker.
 
10


CHANGING YOUR VOTE

You may revoke your proxy at any time before the proxy is voted at the Special Meeting. In order to do this, you must:

- send us written notice, stating your desire to revoke your proxy, or

- send us a signed proxy that bears a later date than the one you intend to revoke, or

- attend the Special Meeting and vote in person. In this case, you must notify the Inspector of Elections or Secretary of the Company that you intend to vote in person.

A list of those stockholders entitled to vote at the Special Meeting will be available for a period of ten days prior to the Special Meeting for examination by any stockholder at the Company's principal executive offices, 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302, and at the Special Meeting.
 
11


QUESTIONS AND ANSWERS ABOUT THE MATTERS SUBJECT TO VOTE

What is being voted on?

The issuance of shares of common stock of the Company upon the conversion notes, and upon the conversion of preferred stock into which the convertible notes may convert, to investors in the Financing; the issuance of shares of common stock as payment of dividends, at the Company’s discretion, and on redemption under the anticipated terms of the convertible preferred shares; and, to approve the issuance of shares of common stock upon the exercise of warrants in full without any limitations on the number of shares to be issued, issued to these same investors. Assuming the stockholders approve this proposal, the Company would be required to issue 5,500 shares of Series A 7% Cumulative Convertible Preferred Stock which, upon issuance, would represent 100% of the issued and outstanding Preferred Stock of the Company.  The Convertible Preferred Stock may be converted, based on an initial conversion price, into approximately 3,333,333 shares of common stock, which, based on the issued and outstanding shares of common stock on July 6, 2006, when issued would represent 17.09% of the issued and outstanding shares of common stock of the Company. Assuming the cumulative dividend is paid entirely in shares of common stock and that the preferred shares are converted within one year, the Company estimates that it could issue 251,249 shares of common stock of the Company, representing 1.27% of the issued and outstanding shares of common stock of the company at July 6, 2006, to the investors in the Financing as payment of the 7% cumulative dividend.  The Company has also issued warrants to the investors in the Financing to acquire up to 1,666,668 shares of common stock, representing, upon issuance and based on the issued and outstanding shares of common stock at July 6, 2006 and the issuance of the common stock into which the preferred stock is convertible, 7.87% of the issued and outstanding shares of common stock of the Company. The Company has also issued to the Placement Agent, warrants to acquire up to 266,666 shares of common stock, representing 1.649% of the issued and outstanding shares of common stock of the company at July 6, 2006. Taking into account all of the above issuances, the Company would be required to issue shares of common stock totaling 34.12% of the issued and outstanding shares of common stock at July 6, 2006.

The amendment of our articles of incorporation to permit the board of directors to designate the rights and privileges of the Company’s authorized preferred stock pursuant to Nevada Revised Statutes Section 78.1955.

Why are we seeking approval for the issuance of the shares of common stock?

As a result of being listed on the Nasdaq Capital Market, issuances of our common stock are subject to the NASD Marketplace Rules, such as Rule 4350. For example, under rule 4350(i)(1)(D) stockholder approval must be sought when in connection with a transaction other than a public offering involving the sale, issuance or potential issuance by the issuer of common stock (or securities convertible into or exercisable into common stock) equal to 20% or more of the common stock or 20% or more of the voting power outstanding before the issuance for less than the greater of book or market value of the stock.

The terms of the Financing provide anti-dilution protection to the investors which may result in common stock being issued to the investors at less than the market value of the stock on the Financing issuance date. Additionally, the common stock which would be issued if the Convertible Notes were to be converted into convertible preferred stock and such preferred stock was converted into common stock, dividends owed to the preferred stockholders were paid in common stock, the preferred stock were redeemed by the issuance of common stock and the warrants were exercised would constitute the issuance of more than 20% of the common stock issued and outstanding on the Financing date. Further the percentage of the Financing used to fund the purchase of McCue Systems, Inc. aggregated using Nasdaq rules with the shares of common stock issued to the McCue Systems, Inc. shareholders in the acquisition exceeds 20% of the issued and outstanding shares, excluding treasury stock, on the date in which we entered into the stock purchase agreement with the McCue Systems, Inc. shareholders. Accordingly, stockholder approval is required for the issuance of shares of common stock contemplated by the Financing. However, the Convertible Notes are due in one year and bear interest at the rate of 12% per annum. Should stockholder approval of the common stock issuance not be obtained, we will pay the principal and interest on the note per their terms.

Why are we seeking to amend our articles of incorporation?

Our articles of incorporation authorize the issuance of up to 5 million shares of preferred stock.

12

 
In a Certificate of Amendment of the Articles of Incorporation of the Company filed with the Nevada Secretary of State on March 20, 2002, the articles of incorporation were amended to permit the board of directors to designate by resolution the voting powers, designations, preferences, limitations, restrictions and relative rights of the preferred stock.

In a Certificate of Amendment of the Articles of Incorporation of the Company filed with the Nevada Secretary of State on August 12, 2003, filed for the purpose of accomplishing a reverse stock split, the provision of Article III of the Articles of Incorporation providing such powers to the board of directors was inadvertently omitted.

We propose to amend the articles of incorporation to return these powers back to the board of directors thus permitting the board of directors to designate by resolution the voting powers, designations, preferences, limitations, restrictions and relative rights of the Series A 7% Cumulative Convertible Preferred Stock contemplated to be issued if shareholder approval of proposal number one and two is acquired.
 
13


SELECTED HISTORICAL AND PRO FORMA COMBINED FINANCIAL DATA

We are providing the following selected financial information to assist you in understanding the use of proceeds from the Financing. We derived the historical information from the audited consolidated financial statements of NetSol Technologies, Inc and Subsidiaries as of and for the years ended June 30, 2004 and 2005, and from the unaudited consolidated financial statements as of and for each of the nine months ended March 31, 2005 and 2006.

The information is only a summary and should be read in conjunction with each company’s historical financial statements and related notes contained elsewhere herein. The historical results included below and elsewhere in this document are not indicative of the future performance of NetSol Technologies, Inc. or the combined company.
 
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
SELECTED CONDENSED BALANCE SHEET DATA

   
As of
June 30, 2005
 
As of
March 31, 2006
 
   
(Audited)
 
(Unaudited)
 
ASSETS
             
               
Current Assets
 
$
8,373,861
 
$
15,783,378
 
Property & equipment, net
   
5,114,776
   
6,425,581
 
Intangible assets, net
   
7,637,397
   
6,873,237
 
               
Total assets
 
$
21,126,034
 
$
29,082,196
 
               
 
             
LIABILITIES & STOCKHOLDERS' EQUITY
             
               
Current liabilities
 
$
4,915,561
 
$
5,550,884
 
Obligations under capitalized leases,
             
less current maturities
   
122,426
   
118,079
 
Convertible debenture
   
138,175
   
-
 
               
Total liabilities
   
5,176,162
   
5,668,963
 
Minority interest
   
700,320
   
1,385,010
 
               
Stockholders' equity
   
15,249,552
   
22,028,223
 
               
Total liabilities and stockholders' equity
 
$
21,126,034
 
$
29,082,196
 
 
14

 
NETSOL TECHNOLOGIES, INC. AND SUBSIDIARIES
SELECTED CONDENSED STATEMENTS OF OPERATION DATA
 
   
For the years
 
For the nine months
 
 
 
Ended June 30,
 
Ended March 31,
 
 
 
2005
 
2004
 
2006
 
2005
 
 
 
(Audited)
 
(Unaudited)
 
Statement of Operations:
                         
Revenues
 
$
12,437,653
 
$
5,749,062
 
$
14,040,185
 
$
7,972,450
 
Cost of Sales
   
4,754,749
   
2,699,675
   
5,962,913
   
2,943,871
 
Gross Profit
   
7,682,904
   
3,049,387
   
8,077,272
   
5,028,579
 
                           
Operating Expenses
   
6,618,199
   
5,757,405
   
6,848,682
   
4,153,323
 
Income (loss) from operations
   
1,064,705
   
(2,708,018
)
 
1,228,590
   
875,256
 
                           
Other income and (expenses)
   
(290,307
)
 
(142,199
)
 
(178,117
)
 
(414,283
)
Income (loss) before minority interest
   
774,398
   
(2,850,217
)
 
1,050,473
   
460,973
 
Minority interest in subsidiary
   
(111,073
)
 
273,159
   
(699,872
)
 
(15,735
)
Net Income (loss)
 
$
663,325
 
$
(2,577,058
)
$
350,601
 
$
445,238
 
                           
                           
Earnings Per Share:
                         
Basic
 
$
0.06
 
$
(0.30
)
$
0.02
 
$
0.04
 
Diluted
 
$
0.04
 
$
(0.30
)
$
0.02
 
$
0.03
 
                           
Weighted average number of shares outstanding:
                         
Basic
   
11,597,625
   
7,881,554
   
14,267,690
   
10,937,910
 
Diluted
   
14,776,323
   
7,881,554
   
14,692,917
   
13,750,981
 
 
SELECTED PRO-FORMA COMBINED INFORMATION:
 
The following selected unaudited Pro-Forma condensed combined Balance Sheet and Statement of Operations have been derived from the audited consolidated financial statements of NetSol Technologies, Inc. (“NetSol”) as of and for the year ending June 30, 2005 and the unaudited consolidated statements of NetSol Technologies, Inc. (“NetSol”) as of and for the nine months ending March 31, 2006, and the unaudited financial statements of McCue Systems, Incorporated (a California corporation) (“McCue Systems”) as of June 30, 2005 and March 31, 2006. The pro-forma Statement of Financial Conditions and the pro-forma Statements of Operations assumes the acquisition was consummated as of July 1, the beginning of NetSol Technologies fiscal year.
 
15

 
NETSOL TECHNOLOGIES, INC. AND MCCUE SYSTEMS, INC.
UNUAUDITED PRO-FORMA CONDENSED COMBINED BALANCE SHEETS

   
As of
June 30, 2005
 
As of
March 31, 2006
 
           
ASSETS
             
               
Current Assets
 
$
10,133,595
   
17,673,259
 
Property & equipment, net
   
5,165,584
   
6,490,287
 
Intangible assets, net
   
12,139,573
   
11,083,978
 
               
Total assets
 
$
27,438,752
 
$
35,247,524
 
               
 
             
LIABILITIES & STOCKHOLDERS' EQUITY
             
               
Current liabilities
 
$
7,625,089
   
7,876,544
 
Obligations under capitalized leases,
             
less current maturities
   
122,426
   
118,079
 
Notes payable
   
2,117,864
   
2,117,864
 
Deferred liability
   
313,397
   
313,397
 
Convertible debenture
   
138,175
   
-
 
               
Total liabilities
   
10,316,951
   
10,425,884
 
Minority interest
   
700,320
   
1,385,010
 
               
Stockholders' equity
   
16,421,481
   
23,436,631
 
               
Total liabilities and stockholders' equity
 
$
27,438,752
 
$
35,247,524
 
 
16

 
NETSOL TECHNOLOGIES, INC. AND MCCUE SYSTEMS, INC.
UNUAUDITED PRO-FORMA CONDENSED
COMBINED STATEMENTS OF OPERATION

   
For the year
 
For the nine
 
 
 
ended
 
months ended
 
 
 
 June 30,
2005
 
March 31,
2006
 
           
Net Revenue
 
$
16,853,333
 
$
18,548,596
 
Cost of revenue
   
7,063,482
   
7,862,072
 
Gross profit
   
9,789,851
   
10,686,524
 
               
Operating expenses
   
9,911,339
   
9,658,121
 
Income (loss) from operations
   
(121,488
)
 
1,028,403
 
               
Other income and (expenses)
   
(284,236
)
 
(120,952
)
Income (loss) from continuing operations
   
(405,724
)
 
907,451
 
               
Minority interest in subsidiary
   
(111,073
)
 
(699,872
)
Net income (loss)
   
(516,797
)
 
207,579
 
               
Other comprehensive income (loss):
             
Translation adjustment
   
(282,129
)
 
201,100
 
Comprehensive income (loss)
 
$
(798,926
)
$
408,679
 
               
               
EARNINGS PER SHARE
             
Weighted -average number of shares outstanding:
             
Basic
   
13,225,377
   
15,895,442
 
Diluted
   
16,404,075
   
16,381,144
 
               
Income (loss) per share
             
Basic
 
$
(0.04
)
$
0.01
 
Diluted
 
$
(0.03
)
$
0.01
 
 
The following selected unaudited Pro-Forma condensed combined Balance Sheet and Statement of Operations have been derived from the audited consolidated financial statements of NetSol Technologies, Inc. (“NetSol”) as of and for the year ending June 30, 2004 and the unaudited consolidated statements of NetSol as of and for the six months ending December 31, 2004 and the audited financial statements of CQ Systems Limited (a UK corporation) (“CQ Systems”) as of and for the year ended March 31, 2004 and the unaudited financial statements of CQ Systems as of and for the nine months ending December 31, 2004. The unaudited Pro Forma Statement of Financial Conditions and Statement of Operations reflect the 100% acquisition of CQ Systems by NetSol under a stock purchase agreement. The Company has accounted for the acquisition under the purchase method of accounting for business combinations. The pro-forma Statement of Financial Conditions assumes the acquisition was consummated as of December 31, 2004, and the pro-forma Statements of Operations assumes the acquisition was consummated as of July 1, 2003, the beginning of NetSol Technologies fiscal year.

17

 
 
NETSOL TECHNOLOGIES, INC. AND CQ SYSTEMS LIMITED
UNUAUDITED PRO-FORMA CONDENSED COMBINED BALANCE SHEETS

   
As of
 
As of
 
   
June 30,
2004
 
December 31,
2004
 
           
ASSETS
             
               
Current Assets
 
$
5,193,978
 
$
6,855,422
 
Property & equipment, net
   
4,464,097
   
4,615,834
 
Intangible assets, net
   
7,725,726
   
7,510,838
 
               
Total assets
 
$
17,383,801
 
$
18,982,094
 
               
 
             
LIABILITIES & STOCKHOLDERS' EQUITY
             
               
Current liabilities
 
$
4,751,718
 
$
4,040,534
 
Obligations under capitalized leases,
             
less current maturities
   
98,028
   
181,713
 
Notes payable
   
89,656
   
-
 
Deferred liability
   
2,052,254
   
1,886,587
 
Convertible debenture
   
985,243
   
130,292
 
               
Total liabilities
   
7,976,899
   
6,239,126
 
Minority interest
   
410,728
   
99,752
 
               
Stockholders' equity
   
8,996,174
   
12,643,216
 
               
Total liabilities and stockholders' equity
 
$
17,383,801
 
$
18,982,094
 

18

 
NETSOL TECHNOLOGIES, INC. AND CQ SYSTEMS LIMITED
UNUAUDITED PRO-FORMA CONDENSED
COMBINED STATEMENTS OF OPERATION

   
For the year
 
For the six
 
 
 
ended
 
months ended
 
 
 
June 30,
2004
 
December 31,
2004
 
           
Net Revenue
 
$
10,389,715
 
$
7,266,798
 
Cost of revenue
   
4,533,669
   
3,151,661
 
Gross profit
   
5,856,046
   
4,115,137
 
               
Operating expenses
   
8,354,927
   
3,705,427
 
Income (loss) from operations
   
(2,498,881
)
 
409,710
 
               
Other income and (expenses)
   
(357,018
)
 
(348,176
)
Income (loss) from continuing operations
   
(2,855,899
)
 
61,534
 
Minority interest in subsidiary
   
273,159
   
14,259
 
Net income (loss)
   
(2,582,740
)
 
75,793
 
               
Other comprehensive income (loss):
             
Translation adjustment
   
(277,022
)
 
(269,044
)
Comprehensive income (loss)
 
$
(2,859,762
)
$
(193,251
)
               
EARNINGS PER SHARE
             
               
Weighted -average number of
             
shares outstanding
   
8,663,518
   
10,855,918
 
               
Income (loss) per share
 
$
(0.30
)
$
0.01
 
 
 
19

 
(Proposal No. One)

APPROVAL TO ISSUE THE AMOUNT OF SHARES OF COMMON STOCK UPON CONVERSION OF THE PREFERRED SHARES; AS DIVIDENDS OR REDEMPTION UNDER THE TERMS OF THE PREFERRED SHARES; ON EXERCISE OF WARRANTS.

The discussion in this proxy statement of the terms of the financing dated June 15, 2006, by and between the Company and the investors is contained in the stock purchase agreement, the convertible note, the warrant, the investor rights agreement and the certificate of designation (collectively referred to as the “Financing Documents”). A copy of the form of the Financing Documents is attached as Annex A-E to this proxy statement and is incorporated in this proxy statement by reference. To assist you with your understanding of the Financing’s affects on the Company, we have included, after the Description of the Financing, a discussion of NetSol’s business including but not limited to NetSol’s financial statements for the year ended June 30, 2005 and the quarter ended March 31, 2006, a discussion of McCue’s business and financial statements, including pro forma financial information and a discussion of NetSol-CQ’s business and financial statements, including pro forma financial information.
 
Introduction
 
The purpose of Proposal 1 is to obtain the stockholder approval necessary under applicable Nasdaq Stock Market rules to allow for the full issuance and exercise of: (i) shares of Common Stock underlying Convertible Notes; (ii) underlying shares of preferred stock; (iii) as dividends and/or redemption under the terms of the preferred shares; and, (iv) upon exercise of the Warrants issued by the Company to the investors in the Financing.   In the event that stockholder approval of this proposal is not acquired, the investors in the Financing may convert that portion of the Convertible Note and exercise that portion of the Warrants that when issued will not result in a violation of NASD Marketplace rules. Additionally, if stockholder approval of this proposal is not acquired, the Company will pay the principal and interest due under the Convertible Notes according to its terms.
 
Description of the Financing
 
On June 15, 2006, the Company entered into an agreement with 5 accredited investors whereby the Company issued 5 convertible notes for an aggregate principal value of $5,500,000. These notes bear interest at the rate of 12% per annum and are due in full one year from the issuance date or on June 15, 2007 (the “Financing”). In connection with the Financing, the Company entered into the following documents: A Convertible Note and Warrant Purchase Agreement (the “SPA”)(Attached to this proxy statement as Annex A), 12% Convertible Notes (the “Convertible Notes”)(Attached to this proxy statement as Annex B), Common Stock Purchase Warrant (the “Warrants”)(Attached to this proxy statement as Annex C), Investor Rights Agreement (the “IRA”)(Attached to this proxy statement as Annex D) and agreed to a form of 7% Cumulative Convertible Preferred Stock (the “Preferred Stock”)(Attached to this proxy statement as Annex E) and, the Placement Agent Warrant Agreement (the “Placement Agent Warrant)(Attached to this proxy statement as Annex F).
 
The proceeds of the Financing are being used by the Company to: (i) pay the initial cash consideration due to McCue shareholders as part of the acquisition of McCue Systems, Inc. by the Company; (ii) pay the final cash consideration due to former CQ Systems Inc. shareholders as part of the acquisition of CQ Systems, Ltd. (now NetSol-CQ); and, (iii) as working capital. The initial cash consideration due to McCue shareholders is $2,117,864 and represents 38.51% of the total proceeds raised. The final cash consideration due to former CQ Systems, Inc. shareholders is £1,064,369 (which represents $1,936,200.17 at the exchange rate of British pounds sterling into U.S. Dollars at June 28, 2006). The CQ payment represents 35.20% of the total funds raised in the Financing. The remaining funds are being used to pay fees due under the terms of the Financing and as working capital.
 
Pursuant to the terms of the SPA, each purchaser received a Convertible Note in the amount of their investment and a Warrant in an amount equal to 50% of the aggregate principal value of the Notes divided by the conversion value (currently $1.65 per share). Based on an aggregate principal value of $5,500,000, the investors were entitled to Warrants to acquire up to 1,666,667 shares of common stock at an exercise price per warrant of $2.00. The Warrants may be exercised at any time, to the extent that such conversion does not violate Nasdaq Market Place rules, and in full at such time after our stockholders approve the issuance of shares underlying such warrants until five years from the issuance date of the warrants, or June 15, 2011.
 
20

 
As part of the consideration paid for its services in facilitating the Financing, Maxim Group, LLC (the “Placement Agent”) received warrants to acquire up to 266,666 shares of common stock of the Company at the exercise price of $1.65 per share. Such warrants do not contain anti-dilution protection. However, the warrants may be exercised at any time, to the extent that such conversion does not violate Nasdaq Market Place rules, and in full at such time after our stockholders approve the issuance of shares underlying such warrants until two years from the issuance date of the warrants or June 20, 2008.
 
The Convertible Notes may immediately convert into shares of common stock of the Company at the conversion value (initially set at one share per $1.65 of principal dollar) to the extent that such conversion does not violate Nasdaq Market Place rules. To date, no shares of common stock have been issued to the investors in the Financing. Also, under the terms of the Financing, the Convertible Notes will convert into shares of Preferred Stock upon the approval of this proposal by the stockholders.
 
If stockholder approval is not acquired, quarterly interest payments of $166,665 would be due with a final principal payment of $5,500,000 on June 15, 2007. If quarterly interest payments were not made, and instead was compounded until the principal due date, a payment of $6,197,538 would be due on June 15, 2007. The Company has issued guidance assuming revenues of $30,000,000 for the fiscal year ending June 30, 2007. Assuming this guidance is realized and that expenses and other costs remain consistent, we would anticipate having sufficient cash on hand to meet the principal and interest obligation according to the terms at June 30, 2007. Should there by any short fall, we would be able to meet the obligation by using available credit facilities in the United Kingdom and Pakistan without any liquidity concerns for the Company.
 
The Preferred Stock (which certificate of designation is attached to Annex E and which will be filed with the Nevada Secretary of State only upon approval of the Proposals set forth in this Proxy) are convertible into shares of common stock at such time and at such value as is set forth in the Certificate of Designation. The initial conversion value shall be $1.65. The conversion value is subject to adjustment as set forth in the Certificate of Designation. The holders of the Preferred Stock are entitled to receive cumulative dividends at the rate of 7% per annum from the date of issuance of each share of preferred stock until paid. The dividends may be paid, at the Company’s option, in cash or in shares of common stock in arrears on the first business day of each calendar quarter of each year. The Company may force a conversion of the Preferred Stock in the event that the market price of the Company’s common stock is greater than 200% of the conversion value. If any shares of the Preferred Stock remain outstanding on June 15, 2009, the Company shall redeem such shares for an amount in cash equal to the liquidation preference plus all accrued but unpaid dividends. Anti-dilution protection is afforded to the holders by providing for an adjustment of the conversion price in certain circumstances. The conversion price is adjusted for dividends subdivisions, combinations, distributions and issuances of shares, or securities convertible into shares, of common stock of the Company issued at an effective per share selling price which is the less than the greater of the fair market price or the conversion value as of the issuance date. If the issued value is less than the greater of the fair market price or the conversion value, then a new conversion value is reached by multiplying the conversion value then in effect by a fraction of the number of shares of common stock outstanding immediately prior to the issuance plus the number of shares issued at the new issuance price and the number of shares issued and outstanding immediately after such date. By way of example only, let’s say that the Company issues 100,000 shares at $1.50, a number which is less than the initial conversion value of $1.65. Let’s also say for purposes of this example only that prior to this issuance there were 16,100,000 shares of common stock of the Company issued and outstanding. The initial conversion value would be adjusted by multiplying $1.65 by .997568 (the fraction 16,100,000 plus 60,606 (the number of shares that $100,000 would purchase at the initial conversion price of $1.65), or 16,60,606, divided by 16,200,000 (the number of shares issued and outstanding after the issuance). This example results in a reduction of the conversion value to $1.6459. No adjustment occurs for any issuance or sales outstanding prior to the Financing, or to any officer, director or employee of the Company pursuant to a bona fide option or equity incentive plan duly adopted by the Company. The Preferred Stock bears voting rights in an amount equal to the conversion value of the preferred stock into common stock, without giving effect to any anti-dilution provisions of the Preferred Stock. Conversion of the Preferred Stock is subject to beneficial ownership caps of from 4.9% to 9.9% of the total number of shares of common stock of the Company then issued and outstanding.
 
The IRA requires the Company to register, on a registration statement to be filed with the SEC within 8 business days of the special shareholders’ meeting, such number of shares of common stock into which the Preferred Stock is convertible, such number of shares of that represent 150% of the shares of common stock for issuance upon the conversion of the preferred stock or notes, as the case may be and 100% of the shares of common stock for issuance upon the exercise of the warrants. The IRA requires the registration statement to be effective within 120 days of the closing of the Financing. Should the registration statement not be effective by that date or should the registration statement not be filed within 8 business days of the special shareholders’ meeting, each holder shall be entitled to cash compensation equal to 1% of principal value of the note for every 30 days of non-compliance (or a proportionally smaller amount if less than 30 days).
 
21


The issuance of shares of common stock of the Company upon the conversion notes, and upon the conversion of preferred stock into which the convertible notes may convert, to investors in the Financing; the issuance of shares of common stock as payment of dividends, at the Company’s discretion, and on redemption under the anticipated terms of the convertible preferred shares; and, to approve the issuance of shares of common stock upon the exercise of warrants in full without any limitations on the number of shares to be issued, issued to these same investors. Assuming the stockholders approve this proposal, the Company would be required to issue 5,500 shares of Series A 7% Cumulative Convertible Preferred Stock which, upon issuance, would represent 100% of the issued and outstanding Preferred Stock of the Company.  The Convertible Preferred Stock may be converted, based on an initial conversion price, into approximately 3,333,333 shares of common stock, which, based on the issued and outstanding shares of common stock on July 6, 2006, when issued would represent 17.09% of the issued and outstanding shares of common stock of the Company. Assuming the cumulative dividend is paid entirely in shares of common stock and that the preferred shares are converted within one year, the Company estimates that it could issue 251,249 shares of common stock of the Company, representing 1.27% of the issued and outstanding shares of common stock of the company at July 6, 2006, to the investors in the Financing as payment of the 7% cumulative dividend.  The Company has also issued warrants to the investors in the Financing to acquire up to 1,666,668 shares of common stock, representing, upon issuance and based on the issued and outstanding shares of common stock at July 6, 2006 and the issuance of the common stock into which the preferred stock is convertible, 7.87% of the issued and outstanding shares of common stock of the Company. The Company has also issued to the Placement Agent, warrants to acquire up to 266,666 shares of common stock, representing 1.649% of the issued and outstanding shares of common stock of the company at July 6, 2006. Taking into account all of the above issuances, the Company would be required to issue shares of common stock totaling 34.12% of the issued and outstanding shares of common stock at July 6, 2006.
 
Description of Securities
 
The Convertible Notes may convert into our common stock, par value $0.001 per share. We only have one class of common stock. Our capital stock consists of 45,000,000 shares of common stock, par value $.001 per share and 5,000,000 shares of preferred stock, $.001 par value. Each share of common stock is entitled to one vote at annual or special stockholders meetings.
 
The Convertible Notes will convert into the Preferred Stock following stockholder approval. No shares of preferred stock have been issued. We are seeking your approval to amend the articles of incorporation to permit the board of directors to designate the rights and privileges of the Preferred Stock. The Preferred Stock (which certificate of designation is attached to Annex E and which will be filed with the Nevada Secretary of State only upon approval of the proposals set forth in this Proxy) are convertible into shares of common stock at such time and at such value as is set forth in the Certificate of Designation. The initial conversion value shall be $1.65. The conversion value is subject to adjustment as set forth in the Certificate of Designation. The holders of the Preferred Stock are entitled to receive cumulative dividends at the rate of 7% per annum from the date of issuance of each share until paid. The dividends may be paid, at the Company’s option, in cash or in shares of common stock in arrears on the first business day of each calendar quarter of each year. The Company may force a conversion of the Preferred Stock in the event that the market price of the Company’s common stock is greater than 200% of the conversion value. If any shares of the Preferred Stock remain outstanding on June 15, 2009, the Company shall redeem such shares for an amount in cash equal to the liquidation preference plus all accrued but unpaid dividends. Anti-dilution protection is afforded to the holders by providing for an adjustment of the conversion price in certain circumstances as is set forth in the Certificate of Designation. The conversion price is adjusted for dividends subdivisions, combinations, distributions and issuances of shares, or securities convertible into shares, of common stock of the Company issued at an effective per share selling price which is the less than the greater of the fair market price or the conversion value as of the issuance date. If the issued value is less than the greater of the fair market price or the conversion value, then a new conversion value is reached by multiplying the conversion value then in effect by a fraction of the number of shares of common stock outstanding immediately prior to the issuance plus the number of shares issued at the new issuance price and the number of shares issued and outstanding immediately after such date. By way of example only, let’s say that the Company issues 100,000 shares at $1.50, a number which is less than the initial conversion value of $1.65. Let’s also say for purposes of this example only that prior to this issuance there were 16,100,000 shares of common stock of the Company issued and outstanding. The initial conversion value would be adjusted by multiplying $1.65 by .997568 (the fraction 16,100,000 plus 60,606 (the number of shares that $100,000 would purchase at the initial conversion price of $1.65), or 16,160,606, divided by 16,200,000 (the number of shares issued and outstanding after the issuance). This example results in a reduction of the conversion value to $1.6459. No adjustment occurs for any issuance or sales outstanding prior to the Financing, or to any officer, director or employee of the Company pursuant to a bona fide option or equity incentive plan duly adopted by the Company. The Preferred Stock bears voting rights in an amount equal to the conversion value of the preferred stock into common stock, without giving effect to any anti-dilution provisions of the Preferred Stock. Conversion of the Preferred Stock is subject to beneficial ownership caps of from 4.9% to 9.9% of the total number of shares of common stock of the Company then issued and outstanding.

22

 
The terms of the warrant agreements permit exercise for a period of five years and contain standard weighted average anti-dilution protections. The anti-dilution protections contained in the warrant mirror those provided in the Preferred Stock. The terms of the IRA requires that shares of common stock underlying the warrants be registered for resale with the SEC. Should the Company fail to register the shares of common stock by November 1, 2006, the investors in the Financing may require the Company to redeem the warrants which can not be exercised because of Nasdaq Marketplace rules. The redemption price is equal to the value of such warrants being redeemed as determined by using the Black-Scholes option pricing formula on Bloomberg. As the exercise price is $2.00 per share, the Black-Scholes option pricing formula would have to exceed $2.00 in order to require any cash outlay for redemption by the Company. Even at our highest per share market price in recent days of $2.11 the Black-Scholes pricing formula results in an option pricing of $1.94. At $1.94, the warrants have no value and accordingly, the Company would have no obligations to pay any cash if redemption is requested.

The terms of the Placement Agent warrant agreement permit exercise for a period of two years, and does not contain standard weighted average anti-dilution protections. As with the other securities issued in the Financing, the Placement Agent may only exercise such portion of the warrants which would not result in a violation of Nasdaq Market Place Rules. The exercise price is $1.65 per share.
 
 
On May 6, 2006, the Company entered into an agreement to acquire all of the issued and outstanding shares of common stock of McCue Systems, Inc., a California corporation located at 111 Anza Blvd., Suite 310, Burlingame, California 94010; telephone number is (650) 348-0650. McCue Systems, Inc. has over 30 years of experience in developing business solutions for the equipment and vehicle leasing industry as a provider of lease/loan portfolio management software for banks, leasing companies and manufacturers. Its flagship product, LeasePak, simplifies lease/loan administration and asset management by accurately tracking leases, loans and equipment from origination through end-of-term and disposition.
 
McCue Systems provides the leasing technology industry in the development of Web-enabled and Web-based tools to deliver superior customer service, reduce operating costs, streamline the lease management lifecycle, and support collaboration with origination channel and asset partners. LeasePak can be configured to run on HP-UX, SUN/Solaris or Linux, as well as for Oracle and Sybase users. And for scalability, McCue Systems offers the LeasePak Bronze, Silver and Gold Editions for systems and portfolios of virtually all sizes and complexities. McCue Systems’ solutions provide the equipment and vehicle leasing infrastructure at leading Fortune 500 banks and manufacturers, as well as for some of the industry’s leading independent lessors, including Cisco, Hyundai, JP Morgan/Chase, ORIX, and Volkswagen Credit.

With common customers and common goals, we believe the acquisition of McCue provides a complimentary North American presence to our global offering of software and services to the lease and finance industry.

The stock purchase agreement was filed as part of our current report on form 8-K filed on May 9, 2006. Pursuant to the terms of the stock purchase agreement, as consideration for the shares of McCue Systems, Inc., we shall pay the following:

23

 
(a) an amount equal to 50% of McCue’s total revenue for the twelve months ending December 31, 2005, after an adjustment, if necessary, for any revenue occurring outside McCue’s ordinary scope of operations, multiplied by 1.5 of which 50% shall be paid in shares of restricted common stock of NetSol at the 30 day volume weighted average price (“VWAP”) for each of the 30 trading days prior to the execution of the Stock Purchase Agreement or at the VWAP for each of the 30 trading days prior to November 30, 2005 whichever is greater. VWAP shall be calculated by taking the closing price of NetSol’s common stock as traded on the NASDAQ Small Cap Market under the symbol NTWK (“NetSol Shares”) for each of the 30 trading days used in the VWAP calculation multiplied by the daily volume for each of the 30 trading days used in the VWAP calculation, the product of the preceding calculation is divided by 30 and then divided by the average of the daily volume for each of the 30 trading days used in the VWAP calculation and 50% payable in U.S. Dollars payable at Closing;

(b) an amount equal to 25% of McCue’s total revenue for the twelve months ending December 31, 2006 after an adjustment for Extraordinary Revenue multiplied by 1.5 of which 50% is payable in cash and 50% is payable in shares of restricted common stock of NetSol payable by June 30, 2007; and,

(c) an amount equal to 25% of McCue’s total revenue for the twelve months ending December 31, 2007 after an adjustment for Extraordinary Revenue multiplied by 1.5 of which 50% is payable in cash and 50% is payable in shares of restricted common stock of NetSol payable by June 30, 2008.

Under no circumstances shall the total number of shares of common stock issued to the McCue Shareholders or to others as part of the cash portion of the consideration exceed 19.9% of the issued and outstanding shares of common stock, less treasury shares, of the Company at May 6, 2006.

McCue’s total revenues for December 31, 2005 were $5,647,637. Multiplying that total by the multiple of 1.5 results in total consideration of $8,471,456 of which 50% was paid at closing on June 30, 2006, or $4,235,728. Of this consideration, $2,117,864 is payable in cash and $2,117,864 is payable in restricted shares of common stock of the Company. The price per share was determined based on the VWAP calculations set forth above to be $2.21 per share, resulting in a total of 958,213.5 shares being due at closing.

The next payment is due on June 30, 2007 and is based on the McCue revenue for the year ending December 31, 2006. The final payment is due on June 30, 2008 and is based on the McCue revenue for the year ending December 31, 2007. Assuming that the revenues remain constant over the next two years, the Company would issue as consideration an additional 958,213.5 shares for a total shares issuance of 1,916,427. While the number of shares issuable to McCue may increase or decrease over the pay-out schedule, the stock purchase agreement contains a provision which prohibits the issuance of any shares in excess of 19.9% of the issued and outstanding shares as of May 5, 2006. Excess consideration will be paid in cash.
 
As of May 5, 2006, there were 15,148,292 shares of common stock of the Company issued and outstanding, less treasury shares. Accordingly, the current calculation of shares to be issued to McCue shareholders constitute 12.65% of the issued and outstanding shares at that date.
 
In accordance with Nasdaq Stock Market rules, the aggregate number of shares of Common Stock issued or issuable by the Company: (i) in the McCue transaction and (ii) upon conversion of that portion of the Financing attributable to the McCue transaction (collectively, the “Aggregated Shares”), shall not exceed 19.99% of the outstanding shares of Common Stock as of May 5, 2006 (the “Maximum Common Stock Issuance”), unless the issuance of that number of Aggregated Shares that would result in the issuance of an amount in excess of the Maximum Common Stock Issuance (the “Overage Amount”) shall first be approved by the Company’s stockholders.
 
24

 
The CQ Systems Ltd. Acquisition
 
On January 19, 2005, the Company entered into a Share Purchase Agreement whereby the Company agreed to acquire 100% of the issued and outstanding shares of CQ Systems Ltd., a company organized under the laws of England and Wales (“CQ”), now NetSolCQ Ltd. (the “CQ SPA”). Established in 1986 as CQ Systems Ltd., and now part of the NetSol Technologies, Inc. group, NetSolCQ provides software and services to the financial services industry. NetSolCQ is a provider of software solutions to the asset, motor, consumer, wholesale and premium finance sectors with 75 banking, independent and captive finance house clients in the UK, Europe, Africa and Asia.

According to the terms of the Share Purchase Agreement, the Company acquired 100% of the issued and outstanding shares of CQ from CQ’s former shareholders, whose identity is set forth in the CQ SPA (the “CQ Shareholders”) at the completion date in exchange for a purchase price consisting of: a) 50.1% of CQ’s total gross revenue for the twelve month period ending 31st of March, 2005 after an adjustment for any extraordinary revenue, i.e. non-trading revenue (“LTM Revenue”) multiplied by 1.3 payable: (i) 50% in shares of restricted common stock of the Company at a per share cost basis of $2.313 and as adjusted by the exchange rate of U.S. Dollar to British Pound (at the spot rate for the purchase of sterling with U.S. dollars certified by NatWest Bank plc as prevailing at or about 11:00 a.m.) on January 19, 2005 and, (ii) 50% in cash; and b) 49.9% of CQ’s LTM Revenue for the period ending 31st March 2006 multiplied by 1.3 payable, at the Company’s discretion: (i) wholly in cash; or (ii) on the same basis and on the same terms as the initial payment provided, however that the cost basis of the Company’s common stock shall be based on the 20 day volume weighted average of the Company’s shares of common stock as traded on NASDAQ 20 days prior to March 31, 2006 and, provided that under no circumstances shall the total number of shares of common stock issued to the CQ Shareholders exceed 19% of the issued and outstanding shares of common stock, less treasury shares, of the Company at January 19, 2005. It was the intention of the Company, when executing the CQ SPA to pay the cash portion of the consideration by incurring short term debt. Short term debt was used to finance the initial cash payment. When the final cash consideration was due in June 2006, approximately 15 months after the initial closing, the Company determined that the terms of the Convertible Notes were better terms to finance the final cash payment.

The acquisition closed on February 21, 2005 based on March 31, 2004 financial statements of CQ Systems Ltd. with the payment of approximately $1.7 million in cash and 675,292 shares of Company common stock based on a $2.46 per share cost basis. The final share consideration of 884,536 shares of common stock of NetSol was issued on June 2, 2006. The final cash consideration due to former CQ Systems, Inc. shareholders was £1,064,369 (which represents $1,966,954 at the exchange rate of $1.848). The CQ payment represents 35.20% of the total funds raised in the Financing.

With common customers and common goals, we believe the acquisition of CQ Systems has provided a complimentary European presence to our global offering of software and services to the lease and finance industry.

The CQ SPA and related financial information was filed as part of our current report and amendments thereto on form 8-K filed on October 3, 2005 and January 25, 2005.

Nasdaq Listing Requirements and the Necessity of Stockholder Approval
 

The terms of the Financing provide anti-dilution protection to the investors which may result common stock being issued to the investors at less than the market value of the stock on the Financing issuance date. Additionally, the common stock which would be issued if the Convertible Notes were to be converted into the Preferred Stock and the Preferred Stock was converted into common stock, dividends owed to the preferred stockholders were paid in common stock, the preferred stock were redeemed by the issuance of common stock and the Warrants were exercised would constitute the issuance of more than 20% of the common stock issued and outstanding on the Financing date. Further the percentage of the Financing used to fund the purchase of McCue Systems, Inc. aggregated using Nasdaq rules with the shares of common stock issued to the McCue Systems, Inc. shareholders in the acquisition exceeds 20% of the issued and outstanding shares, excluding treasury stock, on the date in which we entered into the stock purchase agreement with the McCue Systems, Inc. shareholders. Accordingly, stockholder approval is required for the issuance of shares of common stock contemplated by the Financing. However, the Convertible Notes are due in one year and bear interest at the rate of 12% per annum. Should stockholder approval of the common stock issuance not be obtained, we will pay the principal and interest on the note per their terms.

25

 
As of May 5, 2006, there were 15,148,292 shares of common stock of the Company issued and outstanding, less treasury shares. Accordingly, the current estimate of the number of shares to be issued to McCue shareholders constitutes 12.65% of the issued and outstanding shares at May 5, 2006.

Approximately 38.51% of the funds raised in the Financing, specifically $2,117,864, are being used to pay the initial cash portion of the McCue acquisition. The notes are convertible into preferred shares which convert into common stock at the per share price of $1.65 per share. The certificate of designation of the Preferred Stock provides a 7% dividend. If the entire cash portion of the McCue acquisition were to be converted into common stock, the number of shares being issued at $1.65 per share would be equal to 1,283,554 shares. As part of the financing, warrants to acquire shares of common stock at an exercise price of $2.00 per share were issued. 38.51% of the warrants could be exercised to acquire 641,833 shares of common stock. Assuming that the stockholders approval of the common stock related to the Convertible Notes, we would issue approximately 3,841,814 shares of common stock related to the McCue acquisition. This number represents 25.36% of the issued and outstanding shares, less treasury stock, as of May 5, 2006. Assuming that the Nasdaq Stock Market Staff will aggregate the shares of common stock to be issued to former McCue Systems, Inc. shareholders together with the common stock to be issued upon conversion of that portion of the Convertible Notes and Warrants attributable to the McCue transaction, (a total potential of 3,841,814) as having been issued as part of the same transaction, such amount is in excess of 20% of the outstanding shares of Common Stock on May 5, 2006.

We are also assuming that the Nasdaq Staff shall further take the position that, as a result of the weighted average anti-dilution protection afforded to the investors under the Financing, there is a potential that shares of common stock into which the Convertible Notes could convert and the Warrants could be exercised could be issued at less than the market value of the Common Stock on June 15, 2006 and, therefore, the Nasdaq 20% Financing Rule is implicated.
 
The Company’s stockholders are being asked to approve the issuance to the investors in the Financing of the allow for the full issuance and exercise of: (i) shares of Common Stock underlying Convertible Notes; (ii) of shares of common stock underlying shares of Preferred Stock; (iii) as dividends and/or redemption under the terms of the Preferred Stock; and, (iv) upon exercise of the Warrants issued by the Company to the investors in the Financing.  
 
Required Vote
 
The affirmative vote of a majority of the issued and outstanding shares of the Common Stock entitled to vote thereon is necessary for approval of the issuance of: (i) shares of Common Stock underlying Convertible Notes; (ii) shares of Common Stock underlying shares of Preferred Stock; (iii) as dividends and/or redemption under the terms of the preferred shares; and, (iv) upon exercise of the Warrants issued by the Company to the investors in the Financing.  
 
Recommendation of the Board of Directors
 
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE “FOR” THE APPROVAL OF THE ISSUANCE OF SHARES OF COMMON STOCK UPON CONVERSION OF THE PREFERRED SHARES; AS DIVIDENDS OR REDEMPTION UNDER THE TERMS OF THE PREFERRED SHARES; AND, ON EXERCISE OF THE WARRANTS.
 
26

 
INFORMATION ABOUT NETSOL TECHNOLOGIES, INC.
 
NetSol Technologies, Inc. ("NetSol" or the "Company") is an end-to-end information technology ("IT") and business consulting services provider for the lease and finance, banking and financial services industries. Since it was founded in 1997, the Company has developed enterprise solutions that help clients use IT more efficiently in order to improve their operations and profitability and to achieve business results. The Company’s focus has remained the lease and finance, banking and financial services industries. The Company operates on a global basis with locations in China, Europe, East Asia and the U.S. By utilizing its worldwide resources, the Company believes it has been able to deliver high quality, cost-effective IT products and IT services. The Company’s subsidiary, NetSol Technologies Pvt. Ltd. ("NetSol PK") develops the majority of the software for the Company. NetSol PK was the first software company in Pakistan in 1998 to achieve the ISO 9001 accreditation and was again the first software company in Pakistan to obtain Carnegie Mellon’s Software Engineering Institute (“SEI”) Capable Maturity Model (“CMM”) Level 4 assessment in 2004 Level 5 assessment in 2006.

NetSol offers a broad spectrum of IT products and IT services which management believes deliver a high return on investment for its customers. NetSol has nearly perfected its delivery capabilities by continuously investing in maturing its software development and Quality Assurance (“QA”) processes. NetSol believes its key competitive advantage is its ability to build high quality enterprise applications using its offshore development facility in Lahore, Pakistan. A major portion of NetSol’s revenues are derived from exports in general and LeaseSoft in particular. The use of the facility in Pakistan as the basis for software development, configuration and professional services represents a cost-effective and economical cost arbitrage model that is based on the globally acclaimed advantages of outsourcing and offshore development. NetSol management believes that the use of this model will only further benefit the Company in its penetration of European, developed and developing country markets.

NetSol Properties

The Company’s headquarters have been located at 23901 Calabasas Road, Suite 2072, Calabasas, CA 91302 since 2003. Located in approximately 1,919 rentable square feet, with a monthly rent of $4,317. The lease is a one-year lease expiring in December 2006.

Other leased properties as of the date of this report are as follows:

Location
 
Approximate Square Feet
 
Purpose/Use
 
Monthly Rental Expense
Australia
 
1,140
 
Computer and General Office
 
$1,380
Beijing
 
188
 
General Office
 
$1,900
Burlingame(McCue Systems)
 
9,554
 
Computer and General Office
 
$20,552
Horsham (NetSol-CQ)
 
6,570
 
Computer and General Office
 
$10,989
London (NetSol UK)
 
378
 
General Office
 
$5,500
 
The Australia lease is a three-year lease that expires in September 2007 and currently is rented at the rate of $1,380 per month. The Beijing lease is a one year lease that expires in July 2007. The monthly rent is $2,280 per month with the first two months free bringing the average monthly rent to $1,900 per month. Our London, UK operations are currently conducted in leased premises operating on a month-to-month basis with current rental costs of approximately 3,700 British pounds plus VAT of 17.5% per month. The NetSol-CQ System facilities, located in Horsham, United Kingdom, are leased until June 23, 2011 for an annual rent of £75,000 (approximately $131,871.15). McCue Systems, located in Burlingame, California are leased until June 30, 2007 with a monthly rent of $20,552.

Upon expiration of its leases, the Company does not anticipate any difficulty in obtaining renewals or alternative space.

27

 
The newly built Technology Campus was inaugurated in Lahore, Pakistan in May 2004. This facility consists of 40,000 square feet of computer and general office space. This facility is state of the art, purpose-built and fully dedicated for IT and software development; the first of its kind in Pakistan. Title to this facility is held by NetSol Technologies Pvt. Ltd. and is not subject to any mortgages.

LEGAL PROCEEDINGS.

To the best knowledge of Company’s management and counsel, there is no material litigation pending or threatened against the Company.

MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

(a) MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

MARKET INFORMATION - Common stock of NetSol Technologies, Inc. is listed and traded on NASDAQ Capital Market under the ticker symbol "NTWK."

The table shows the high and low intra-day prices of the Company's common stock as reported on the composite tape of the NASDAQ for each quarter during the last two fiscal years.
 
   
2005-2006
 
2004-2005
 
Fiscal Quarter
 
High
 
Low
 
High
 
Low
 
                   
1st (ended September 30)
   
2.36
   
1.65
   
1.99
   
1.09
 
2nd (ended December 31)
   
2.39
   
1.70
   
2.71
   
1.14
 
3rd (ended March 31)
   
2.19
   
1.75
   
2.67
   
1.82
 
4th (ended June 30)
   
2.40
   
1.63
   
2.15
   
1.84
 

RECORD HOLDERS - As of August 1, 2006, the number of holders of record of the Company's common stock was 215. As of August 1, 2006, there were 17,153,475 shares of common stock issued and outstanding.

DIVIDENDS - The Company has not paid dividends on its Common Stock in the past two fiscal years.

SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLAN
 
28


The table shows information related to our equity compensation plans as of June 30, 2005:

   
Number of
securities to
be issued
upon
exercise of
outstanding
options,
warrants
and rights
 
Weighted-average
exercise price of
outstanding
options, warrants
and rights
 
Number of securities
remaining
available for
future issuance
under equity
compensation
plans
(excluding
securities
reflected in
column (a))
 
Equity Compensation Plans approved by Security holders
   
5,038,000(1
)
$
2.60(2
)
 
3,013,667(3
)
Equity Compensation Plans not approved by Security holders
   
None
   
None
   
None
 
Total
   
5,038,000
 
$
2.60
   
3,013,667
 
 
(1)  
Consists of 111,000 under the 2001 Incentive and Nonstatutory Stock Option Plan; 1,139,500 under the 2002 Incentive and Nonstatutory Stock Option Plan; 787,500 under the 2003 Incentive and Nonstatutory Stock Option Plan; and 3,000,000 under the 2004 Incentive and Nonstatutory Stock Option Plan.
   
(2)  
The weighted average of the options is $2.60.
   
(3)  
Represents 1,123,500 available for issuance under the 2003 Incentive and Nonstatutory Stock Option Plan; and, 1,890,167 available for issuance under the 2004 Incentive and Nonstatutory Stock Option Plan.
 
Management's Discussion and Analysis Or Plan Of Operation
 
The following discussion is intended to assist in an understanding of the Company's financial position and results of operations for the quarter and nine months ending March 31, 2006.

Forward-Looking Information.

This report contains certain forward-looking statements and information relating to the Company that is based on the beliefs of its management as well as assumptions made by and information currently available to its management. When used in this report, the words "anticipate", "believe", "estimate", "expect", "intend", "plan", and similar expressions as they relate to the Company or its management, are intended to identify forward-looking statements. These statements reflect management's current view of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. Should any of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this report as anticipated, estimated or expected. The Company's realization of its business aims could be materially and adversely affected by any technical or other problems in, or difficulties with, planned funding and technologies, third party technologies which render the Company's technologies obsolete, the unavailability of required third party technology licenses on commercially reasonable terms, the loss of key research and development personnel, the inability or failure to recruit and retain qualified research and development personnel, or the adoption of technology standards which are different from technologies around which the Company's business ultimately is built. The Company does not intend to update these forward-looking statements.
 
INTRODUCTION

NetSol is an end-to-end information technology (“IT”) and business consulting services provider for the lease and finance, banking and financial services sectors. We operate on a global basis with locations in the U.S., Europe, East Asia and Asia Pacific. We help our clients identify, evaluate, and implement technology solutions to meet their most critical business challenges and maximize their bottom line. Our products include sophisticated software applications for the asset-based lease and financial institutions. By utilizing our worldwide resources, we believe we are able to deliver high quality, cost-effective IT services, ranging from consulting and application development to systems integration and outsourcing. We have achieved the ISO 9001 and SEI (Software Engineering Model (“CMM”) Level 4 certification in 2004 and CMMi Level 5 was achieved in August 2006. We have achieved the ISO 9001 and SEI (Software Engineering Institute) Capable Maturity Model (“CMM”) Level 4 certifications in 2005 and CMMI Level 5 was achieved in August 2006. Additionally, through our Internet Service Provider (“ISP”) Backbone, located in Karachi, Pakistan, we offer a package of wireless broadband services, which include high-speed Internet access, support and maintenance.

29

 
Our subsidiary, NetSol Technologies Pvt. Ltd., a Pakistan Limited Company, (“NetSol PK”), develops the majority of our software. NetSol PK was the first company in Pakistan to achieve the ISO 9001 and SEI CMM Level 4 software development assessment. As maintained by the SEI, maturity levels measure the maturity of a software company’s methodology that in turn ensures enhanced product quality resulting in faster project turn-a-round and a shortened time to market. In August 2005, NetSol PK completed a listing of its shares on the Karachi Stock Exchange.

During recent years, we have focused on developing software applications for the leasing and financial service sectors. In late 2002, we launched a suite of software products under the name LeaseSoft. The LeaseSoft suite is comprised of four major integrated asset-based leasing/financing software applications. The suite, consisting of a Credit Application Creation System (LeaseSoft.CAC), a Credit Application Processing System (LeaseSoft.CAP), a Contract Activation & Management System (LeaseSoft.CAM) and a Wholesale Finance System (LeaseSoft.WFS), whether used alone or together, provides the user with an opportunity to address specific sub-domains of the leasing/financing cycle from the credit approval process through the tracking of the finance contract and asset.
 
In February 2005, we acquired 100% of CQ Systems Ltd., an IT products and service company based in the UK. As a result of this acquisition, we have access to a broad European customer base using IT solutions complementary to NetSol’s LeaseSoft product. We plan to leverage CQ Systems’ knowledge base and strong presence in the Asset Finance market to launch LeaseSoft in the UK and continental Europe. CQ’s strong sales and marketing capability would further help us gain immediate recognition and positioning for the LeaseSoft suite of products. CQ provides sophisticated accounting and administrative software, along with associated services, to leasing and finance companies located in Europe, Asia and Africa. The products include software modules for asset finance, consumer finance, motor finance, general finance and insurance premium finance. The modules provide an end-to-end contractual solution - from underwriting, contract administration and accounting, through asset disposal and remarketing. Customers include notable European companies such as Scania Finance GB, DaimlerChrysler Services, Broadcastle PLC, Bank of Scotland Equipment Finance and Deutsche Leasing Ltd.
 
Together with this focus on providing an outsourcing, off-shore solution to existing and new customers, NetSol has also adopted a dynamic growth strategy through aggressive acquisitions. In October 2005, NetSol-CQ as a combined company launched an aggressive marketing campaign under the banner of LeaseSoft for the European market. Just recently NetSol-CQ signed a multi million dollar new contract with a major banking institution in London.

PLAN OF OPERATIONS

Management has set the following new goals for NetSol’s next 12 months.

Initiatives and Investment to Grow Capabilities

·  
Enhance Software Design, Engineering and Service Delivery Capabilities by increasing investment in training and development.
·  
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.
·  
Aggressively expand the sales and marketing organization in all key locations by hiring senior and successful personnel.
·  
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.
   
   
 
30

 
   
·  
Aggressively exploit the booming Chinese market by strengthening NetSol’s presence in China.
·  
Launch its marketing presence in the US markets through M&A activities in the domain of our core competencies.
·  
Replicate the successful acquisition model and integration of CQ Systems in the USA.
·  
Re-brand NetSol and CQ product line with new marketing packaging and branding for global marketing.
·  
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:

·  
Launch LeaseSoft into new markets by assigning new, well-established companies as distributors in Europe, Asia Pacific and North America.
·  
Expand aggressively in China for LeaseSoft and related services.
·  
Expand relationships with key customers in the US, Europe and Asia Pacific.
·  
Product positioning through alliances, joint ventures and partnerships.
·  
Focus on key new fortune 1000 customers globally and grow within existing key customers.
·  
Aggressively bid and participate in $5MN plus projects in UK and Asia Pacific by leveraging NetSol CQ as combined asset.
·  
Embark on roll up strategy by broadening M&A activities broadly in the software development domain.
  
 

Funding and Investor Relations:

·  
Successfully raise new capital from institutional investors and emerging markets to position NetSol for growth and visibility.
·  
Launched an aggressive marketing campaign with institutional investors and micro cap funds in April 2006.
·  
Infuse new capital from the potential exercise of employee options for business development, to enhance balance sheet and further investment in infrastructures.
·  
Continue to efficiently and prudently manage cash requirements.
·  
Public relations campaign to attract long term institutional holdings.
 
Improving the Bottom Line:

·  
Continue to review costs at every level to consolidate and enhance operating efficiencies.
·  
Grow process automation.
·  
Profit Centric Management Incentives.
·  
More local empowerment and P&L Ownership in each Country Office.
·  
Improve productivity at the development facility and business development activities.
·  
Cost efficient management of every operation and continue further consolidation to improve bottom line.
·  
Integrate and centralize the US, UK and Australian operations and improve the costs and bottom line.

Management believes that NetSol is in a position to derive higher productivity based on current capital employed.

Management continues to be focused on building its delivery capability and has achieved key milestones in that respect. Key projects are being delivered on time and on budget, quality initiatives are succeeding, especially in maturing internal processes. Management believes that further leverage was provided by the development ‘engine’ of NetSol, which became CMM Level 2 in early 2002. In a quest to continuously improve its quality standards, NetSol reached CMM Level 3 assessment in July 2003. According to the website of SEI of Carnegie Mellon University, USA, only a few software companies in the world have announced their assessment of level 3. As a result of achieving CMM level 4, NetSol is experiencing a growing demand for its products and alliances from blue chip companies worldwide. NetSol is now aiming for CMM level 5, the highest CMM level in the next year. NetSol plans to further enhance its capabilities by creating similar development engines in other Southeast Asian countries with CMM levels quality standards. This would make NetSol much more competitive in the industry and provide the capabilities for development in multiple locations. Increases in the number of development locations with these CMM levels of quality standards will provide customers with options and flexibility based on costs and broader access to skills and technology.

31

 
MATERIAL TRENDS AFFECTING THE COMPANY

NetSol has identified the following material trends affecting the Company.

Positive trends:

·  
Continued positive EBITDA trends of NetSol attracting funds and institutions globally.
·  
Outsourcing of services and software development is growing worldwide.
·  
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.
·  
Cost arbitrage, labor costs still very competitive and attractive when compared with India.
·  
Regional stability and improving political environment between Pakistan and India.
·  
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.
·  
Stronger ties between the US and Pakistan creating new investment and trade opportunities.
·  
Robust growth in outsourcing globally and investment of major US and European corporations in the developing countries.
·  
Chinese economic boom leading to new market opportunities.
·  
Improved perception of Pakistan economy in the western media casting positive impact on NetSol future outlook.
.
Negative trends:

·  
Continued political and geographical conflicts in the Middle East and South-East Asia are creating challenging times for economic development. In addition, the existence of religious, extremism, and radical elements are causing tensions in the region.
·  
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.
·  
The devastating earthquake in northern parts of Pakistan may slow growth for local business in the short run.
·  
Skyrocketing oil prices caused by the unfortunate hurricanes, tensions in the Middle East and Iran, and the surge in global demand for oil could affect the US and global economy.
·  
Continuous impact of Iraq war on US and global economy and potential threats surrounding US and Iran tensions.
 
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.

32

 
VALUATION OF LONG-LIVED AND INTANGIBLE ASSETS

The recoverability of these assets requires considerable judgment and is evaluated on an annual basis or more frequently if events or circumstances indicate that the assets may be impaired. As it relates to definite life intangible assets, we apply the impairment rules as required by SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which requires significant judgment and assumptions related to the expected future cash flows attributable to the intangible asset. The impact of modifying any of these assumptions can have a significant impact on the estimate of fair value and, thus, the recoverability of the asset.

INCOME TAXES

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. During fiscal year 2005-2006, we estimated the allowance on net deferred tax assets to be one hundred percent of the net deferred tax assets.

CHANGES IN FINANCIAL CONDITION

Quarter Ended March 31, 2006 as compared to the Quarter Ended March 31, 2005:

Net revenues for the quarters ended March 31, 2006 and 2005 were $5,045,827 and $3,190,918, respectively. Net revenues are broken out among the subsidiaries as follows:

   
2006
 
 
 
2005
     
Netsol USA
 
$
41,500
   
0.82
%
$
21,606
   
0.68
%
Netsol Tech
   
1,677,884
   
33.25
%
 
1,623,307
   
50.87
%
Netsol Private
   
449,465
   
8.91
%
 
95,367
   
2.99
%
Netsol Connect
   
201,375
   
3.99
%
 
294,420
   
9.23
%
Netsol-TiG
   
431,046
   
8.54
%
 
154,046
   
4.83
%
Netsol UK
   
720,514
   
14.28
%
 
125,782
   
3.94
%
Netsol-CQ
   
1,480,169
   
29.33
%
 
799,761
   
25.06
%
Netsol-Abraxas Australia
   
35,225
   
0.70
%
 
76,629
   
2.40
%
Talk Trainers
   
8,649
   
0.17
%
 
-
   
0.00
%
Total Net Revenues
 
$
5,045,827
   
100.00
%
$
3,190,918
   
100.00
%
 
This reflects an increase of $1,854,909 or 58.13% in the current quarter as compared to the quarter ended March 31, 2005. The increase is attributable to new orders of licenses, an increase in services business, the integration of the revenues contributed by the subsidiary CQ Systems in UK acquired February 2005, the growing outsourcing business of NetSol-TiG (JV) and additional maintenance work. The Company’s biggest revenue growth was achieved in the two UK operations and the new joint-venture with TiG, which generated sales both domestically and internationally. The Company experienced a modest increase in domestic business in Pakistan as the country began recovering from the earthquake on October 8, 2005. The demand for the Company’s IT services in Asia Pacific and Europe is consistent and solid.

33

 
During the quarter ended March 31, 2006, the parent company managed several projects with Seattle based Capital Stream generating modest revenues. The projects call for outsourcing of software development services taking advantage of our off-shore development facility in Lahore. In addition, in February 2006, the Parent company signed a master consulting agreement with McCue Systems, Inc. (“McCue”), a California corporation to assist in customer implementations, quality assurance and off-shore software development. To date, no revenues have been generated from this agreement as the programmers are in the process of becoming familiar with McCue’s LeasePak system.

NetSol made a significant move by acquiring 100% of a UK based software company, CQ Systems Ltd., in February 2005. The acquisition of CQ Systems has provided NetSol a very strong and seasoned management team with a mature, profitable, business. The acquisition of CQ Systems provided tremendous new business opportunities for NetSol in the European markets. We have experienced a seamless integration at every level of both companies. In November 2005, we launched the combined company as NetSol-CQ and the LeaseSoft brand in European market. Just recently NetSol-CQ signed off a multi-million dollar LeaseSoft agreement with a major financial institution. Due to confidentiality agreement with our new client we are not able to disclose the name of the client.

NetSol has been actively pursuing a few target companies in USA and in Europe for acquisitions. A lot of effort has been made in pursuing the US based IT products based company, McCue Systems, Inc., in Burlingame, California. With both external and internal due diligence and with the assistance of our management and our mergers and acquisitions professionals, Maxim Group, we entered into a definitive agreement to acquire 100% of McCue Systems. This agreement was signed May 6, 2006. The company expects to complete the transaction by June 30, 2006. This acquisition would effectively launch NetSol in the US leasing and finance markets and will provide a solid footprint in North America. This will be all accretive revenue for NetSol that will be reported and consolidated from July 2006. The company will continue to explore new M&A opportunities that are synergistic and grow our business exponentially and accretively.

During the quarter ended March 31, 2006, our Asia Pacific region signed off new implementations of LeaseSoft at ORIX Leasing Singapore, a new implementation of LeaseSoft at Daimler Chrysler Auto Finance, China, Mercedes - Benz Finance Co, Japan and in Daimler Chrysler Leasing Thailand. In addition, NetSol completed several implementations of LeaseSoft with our major customers in Asia Pacific markets. NetSolCQ signed a new contract with a large banking institution in the UK that was valued at over $1 million. The UK operations since the acquisition of CQ Systems in 2005, continues to enhance market penetration in UK markets and generate new business. As a result, several new customers were signed up as the awareness and brand acceptance of NetSolCQ as combined company gains momentum.

Our majority owned subsidiary, NetSol Technologies Ltd., in Lahore has experienced major new business development activities in both the Pakistani public and private sectors. While we have signed several new contracts in the public sector, these agreements are confidential and are not allowed to be disclosed as these contracts involve some sensitive IT solutions and project managements within the government ministries. NetSol sees a very robust and high volume new business environment in Pakistan as the economy continues to grow over 8% each year. NetSol is an extremely enviable position to leverage from its name and reputation.

NetSol’s Global Frame Agreement signed in early 2005 with DaimlerChrysler Services (“DCS”) qualifies NetSol as a preferred vendor to DCS in 40 plus countries where DCS operates. As a direct result of the successful implementations of some of our current systems with DaimlerChrysler and the signing of the global frame agreement, we are noticing a significant increase in demand for LeaseSoft. Although the sales cycle for LeaseSoft is rather long, we are experiencing a 100% increase in product demonstration, evaluation and assessment by blue chip companies in the UK, Australia, Japan, Europe, North America and Pakistan. In fiscal year 2005, NetSol raised the pricing of its LeaseSoft licenses significantly due primarily to a surge in demand. In spring of 2005, one complete system was sold to Toyota Leasing Thailand (“TLT”) for nearly $2.3 million that includes over $1.2 million for license fees.

A number of large leasing companies will be looking to renew legacy applications. This places NetSol in a very strong position to capitalize on any upturn in IT spending by these companies. NetSol is well positioned to sell several new licenses in fiscal year 2006-2007 that could potentially increase the sales and bottom line. As the Company continues to sell more of these licenses, management believes it is possible that the margins could increase to upward of 70%. The license prices of these products vary from $300,000 to an excess of $1,000,000 with additional charges for customization and maintenance of between 20%-30% each year.
 
34

 
The gross profit was $2,727,298 in the quarter ending March 31, 2006 as compared with $1,848,702 for the same quarter of the previous year for an increase of $878,596. The gross profit percentage decreased slightly to approximately 54% in the quarter ended March 31, 2006 compared to approximately 58% for the quarter ended March 31, 2006. This is mainly due to the increase in direct costs of hiring new technology personnel as the Company gears up for the increased demand in its products and services. Our main technology campus in Lahore hired over 90 new developers and programmers in the last four months. In comparison to the prior quarter ended December 31, 2005, the cost of sales increased approximately $341,495, revenues increased $521,454, and an overall increase of 3% in gross profit.
 
Operating expenses were $2,458,199 for the quarter ending March 31, 2006 as compared to $1,632,525, for the corresponding period last year. The increase is mainly attributable to increased selling and marketing activities, additional employees and an increase in overall activities due to our increased marketing efforts. Also contributing to the higher costs was the full integration of CQ Systems and the joint-venture NetSol-TiG. Depreciation and amortization expense amounted to $594,385 and $384,649 for the quarter ended March 31, 2006 and, 2005, respectively, reflecting the intangible assets purchased from the CQ Systems acquisition in February 2005, the addition of the new building in Lahore in the prior year and new computer equipment purchased to gear up for the increased demand in our products and services. Combined salaries and wages costs were $597,636 and $453,226 for the comparable periods, respectively, or an increase of $144,410 from the corresponding period last year. Salaries, as a percentage of sales, were 12% for the current quarter as compared to 14% in the prior period. The addition of the subsidiary, CQ Systems and the forming of the joint-venture with TiG, as well as an increase in development, sales and administration employees resulted in the increase.

Selling and marketing expenses were $444,472 and $219,399, in the quarter ended March 31, 2006 and 2005, respectively, an increase of $225,073 reflecting the growing sales activity of the Company, including the launch of NetSol-CQ as a combined entity to the European market. Advertising expense was $144,163 for the current quarter. The Company is in a growth phase and is increasing its overall sales and marketing activities. Sales and marketing was 9% of sales for the current quarter as compared to 7% in the corresponding period last year. The Company wrote-off as uncollectible bad debts of $19,561 in the current quarter compared to $0 for the comparable prior period in the prior year. Professional services expense increased slightly to $126,806 in the quarter ended March 31, 2006, from $112,830 in the corresponding period last year.

Income from operations was $269,099 compared to a loss of $216,177 for the quarters ended March 31, 2006 and 2005, respectively. This represents an increase of $52,922 or 24.48% for the quarter compared with the comparable period in the prior year.

Net income was $21,819 compared to $126,858 for the quarters ended March 31, 2006 and 2005, respectively. This is a decrease of $105,039 or 82.8% compared to the prior year. The current fiscal quarter amount includes a net reduction of $187,127 compared to $29,994 in the prior period for the 49.9% minority interest in NetSol Connect, NetSol-TiG, and Talk Trainers owned by another party, and the 28.13% minority interest in NetSol PK. For the quarters ended March 31, 2006 and 2005, respectively, the Company recognized an expense of $2,628 and $3,941 for the beneficial conversion feature on convertible debentures and a gain of $1,318 and $49,865 from the settlement of debts and $12,016 and $0 expense for the fair value of options and warrants issued. Net income per share, basic and diluted, was $0.00 for the quarter ended March 31, 2006 as compared to $0.01 for the corresponding period last year.

The net earnings before interest, taxes, depreciation and amortization, ( “EBITDA”) income was $715,299 compared to $617,650 or an increase of 15.81% after amortization and depreciation charges of $594,385 and $384,649, income taxes of $24,080 and $58,787, and interest expense of $75,015 and $47,356, respectively. Although the net EBITDA income is a non-GAAP measure of performance we are providing it for the benefit of our investors and shareholders to assist them in their decision-making process.
 
35

 
Nine Month Period Ended March 31, 2006 as compared to the Nine Month Period Ended March 31, 2005:
 
Net revenues for the nine months ended March 31, 2006 and 2005 were $14,040,185 and $7,972,450, respectively. Net revenues are broken out among the subsidiaries as follows:

   
2006
 
 
 
2005
     
Netsol USA
 
$
45,250
   
0.32
%
$
295,725
   
3.71
%
Netsol Tech
   
4,692,344
   
33.42
%
 
4,564,167
   
57.25
%
Netsol Private
   
1,196,098
   
8.52
%
 
562,872
   
7.06
%
Netsol Connect
   
676,956
   
4.82
%
 
852,640
   
10.69
%
Netsol-TiG
   
1,122,787
   
8.00
%
 
154,046
   
1.93
%
Netsol UK
   
1,929,666
   
13.74
%
 
574,849
   
7.21
%
Netsol-CQ
   
4,176,299
   
29.75
%
 
799,761
   
10.03
%
Netsol-Abraxas Australia
   
192,136
   
1.37
%
 
168,390
   
2.11
%
Talk Trainers
   
8,649
   
0.06
%
 
-
   
0.00
%
Total Net Revenues
 
$
14,040,185
   
100.00
%
$
7,972,450
   
100.00
%

This reflects an increase of $6,067,735 or 76.11% in the current nine months as compared to the nine months ended March 31, 2005. The increase is attributable to new orders of licenses and an increase in services business, including additional maintenance work, and the addition of two new subsidiaries. The Company’s biggest revenue growth was achieved in the two UK operations and the new joint-venture with TiG, which generated sales both domestically and internationally. The Company experienced a modest increase in domestic business in Pakistan as the country began recovering from the earthquake on October 8, 2005. The demand for the Company’s IT services in Asia Pacific and Europe is consistent and solid.

During the quarter ended March 31, 2006, the parent company managed several projects with Seattle based Capital Stream generating modest revenues. The projects call for outsourcing of software development services taking advantage of our off-shore development facility in Lahore. In addition, in February 2006, the Parent company signed a master consulting agreement with McCue Systems, Inc. (“McCue”), a California corporation to assist in customer implementations, quality assurance and off-shore software development. To date, no revenues have been generated from this agreement as the programmers are in the process of becoming familiar with McCue’s LeasePak system.

NetSol made a significant move by acquiring 100% of a UK based software company, CQ Systems Ltd., in February 2005. The acquisition of CQ Systems has provided NetSol a very strong and seasoned management team with a mature, profitable, business. The acquisition of CQ Systems provided tremendous new business opportunities for NetSol in the European markets. We have experienced a seamless integration at every level of both companies. In November 2005, we launched the combined company as NetSol-CQ and the LeaseSoft brand in European market. Just recently NetSol-CQ signed off a multi-million dollar LeaseSoft agreement with a major financial institution. Due to confidentiality agreement with our new client we are not able to disclose the name of the client.

NetSol has been actively pursuing a few target companies in USA and in Europe for acquisitions. A lot of effort has been made in pursuing the US based IT products based company, McCue Systems, Inc., in Burlingame, California. With both external and internal due diligence and with the assistance of our management and our mergers and acquisitions professionals, Maxim Group, we entered into a definitive agreement to acquire 100% of McCue Systems. This agreement was signed May 6, 2006. The company expects to complete the transaction by June 30, 2006. This acquisition would effectively launch NetSol in the US leasing and finance markets and will provide a solid footprint in North America. This will be all accretive revenue for NetSol that will be reported and consolidated from July 2006. The company will continue to explore new M&A opportunities that are synergistic and grow our business exponentially and accretively.

During the quarter ended March 31, 2006, our Asia Pacific region signed off new implementations of LeaseSoft at ORIX Leasing Singapore, a new implementation of LeaseSoft at Daimler Chrysler Auto Finance, China, Mercedes - Benz Finance Co, Japan and in Daimler Chrysler Leasing Thailand. In addition, NetSol completed several implementations of LeaseSoft with our major customers in Asia Pacific markets. NetSolCQ signed a new contract with a large banking institution in the UK that was valued at over $1 million. The UK operations since the acquisition of CQ Systems in 2005, continues to enhance market penetration in UK markets and generate new business. As a result, several new customers were signed up as the awareness and brand acceptance of NetSolCQ as combined company gains momentum.

36

 
Our majority owned subsidiary, NetSol Technologies Ltd., in Lahore has experienced major new business development activities in both the Pakistani public and private sectors. While we have signed several new contracts in the public sector, these agreements are confidential and are not allowed to be disclosed as these contracts involve some sensitive IT solutions and project managements within the government ministries. NetSol sees a very robust and high volume new business environment in Pakistan as the economy continues to grow over 8% each year. NetSol is an extremely enviable position to leverage from its name and reputation.

NetSol’s Global Frame Agreement signed in early 2005 with DaimlerChrysler Services (“DCS”) qualifies NetSol as a preferred vendor to DCS in 40 plus countries where DCS operates. As a direct result of the successful implementations of some of our current systems with DaimlerChrysler and the signing of the global frame agreement, we are noticing a significant increase in demand for LeaseSoft. Although the sales cycle for LeaseSoft is rather long, we are experiencing a 100% increase in product demonstration, evaluation and assessment by blue chip companies in the UK, Australia, Japan, Europe, North America and Pakistan. In fiscal year 2005, NetSol raised the pricing of its LeaseSoft licenses significantly due primarily to a surge in demand. In spring of 2005, one complete system was sold to Toyota Leasing Thailand (“TLT”) for nearly $2.3 million that includes over $1.2 million for license fees.

A number of large leasing companies will be looking to renew legacy applications. This places NetSol in a very strong position to capitalize on any upturn in IT spending by these companies. NetSol is well positioned to sell several new licenses in fiscal year 2006-2007 that could potentially increase the sales and bottom line. As the Company continues to sell more of these licenses, management believes it is possible that the margins could increase to upward of 70%. The license prices of these products vary from $300,000 to an excess of $1,000,000 with additional charges for customization and maintenance of between 20%-30% each year.
 
The gross profit was $8,077,272 for the nine months ending March 31, 2006 as compared with $5,028,579 for the same period of the previous year. The gross profit percentage has decreased 5.54% to 57.53% in the current fiscal year from 63.07% for the nine months ended March 31, 2005. This is mainly due to the increase in direct costs of hiring new technology personnel as the Company gears up for the increased demand in its products and services. Our main technology campus in Lahore hired over 90 new developers and programmers in the last four months.
 
Operating expenses were $6,848,682 for the nine months ending March 31, 2006 as compared to $4,153,323, for the corresponding period last fiscal year for an increase of $2,695,359. The increase is mainly attributable to increased selling and marketing activities, additional employees and an increase in overall activities due to our increased marketing efforts. Also contributing to the higher costs was the full integration of CQ Systems and the joint-venture NetSol-TiG. In addition, the Company as a whole contributed over $92,000 to charity organizations for the Earthquake Relief for Northern Pakistan. As a percentage of sales, operating expenses decreased 3% to 49% from 52% in the prior nine-month period. Depreciation and amortization expense amounted to $1,711,771 and $1,007,789 for the nine months ended March 31, 2006 and 2005, respectively, reflecting the intangible assets purchased from the CQ Systems acquisition in February 2005, the addition of the new building in Lahore in the prior year and new computer equipment purchased to gear up for the increased demand in our products and services. Combined salaries and wage costs were $1,686,726 and $1,248,447 for the nine months ended March 31, 2006 and 2005, respectively, or an increase of $438,279 from the corresponding period last year. As a percentage of sales, salaries was 12% as compared to 16% for the corresponding period last year. The addition of the new subsidiary, CQ Systems and the forming of the joint-venture with TiG, as well as an increase in development, sales and administration employees resulted in the increase.
 
Selling and marketing expenses were $1,190,906 and $474,099 for the nine months ended March 31, 2006 and 2005, respectively, an increase of $716,807 reflecting the growing sales activity of the Company, including the launch of NetSol-CQ as a combined entity to the European market. Advertising expense was $270,508 for the current nine-month period. The Company is in a growth phase and is increasing its overall sales and marketing activities. Sales and marketing was 9% of sales for the current quarter as compared to 6% in the corresponding period last year. The Company wrote-off as uncollectible bad debts of $27,289 and $0 for the nine months ended March 31, 2006 and 2005, respectively. Professional services expense decreased to $365,152 in the nine months ended March 31, 2006, from $368,135 in the corresponding period last year.
 
37

 
Income from continued operations was $1,228,590 compared to $875,256 for the nine months ended March 31, 2006 and 2005, respectively. This represents an increase of $353,334 or 40.37% for the nine-month period compared to the prior year. This is directly due to increased sales, reduction of operational expenses, improved gross margins, and the addition of two new subsidiaries.
 
Net income was $350,601 for the nine months ended March 31, 2006 compared to $445,238 for the nine months ended March 31, 2005. This is a decrease of $94,637 or 21.26% compared to the prior year. The current nine-month period amount includes a net reduction of $699,872 compared to $15,735 in the prior period for the 49.9% minority interest in NetSol Connect, NetSol-TiG, and Talk Trainers owned by another party, and the 28.13% minority interest in NetSol PK. For the nine months ended March 31, 2006 and 2005, respectively, the Company recognized an expense of $14,389 and $205,906 for the beneficial conversion feature on convertible debentures and a gain of $8,294 and $239,506 from the settlement of debts and $21,505 and $249,638 expense for the fair value of options and warrants issued. Net income per share was $0.02, basic and diluted, for the nine months ended March 31, 2006 as compared to $0.04, basic and $0.03 diluted for the corresponding period last year.
 
The net earnings before interest, taxes, depreciation and amortization, ( “EBITDA”) income was $2,394,163 compared to $1,691,643 or an increase of 41.53% after amortization and depreciation charges of $1,711,771 and $1,008,789, income taxes of $90,891 and $61,260, and interest expense of $240,900 and $177,356, respectively. Although the net EBITDA income is a non-GAAP measure of performance we are providing it for the benefit of our investors and shareholders to assist them in their decision-making process.
 
LIQUIDITY AND CAPITAL RESOURCES

The Company's cash position was $2,390,245 at March 31, 2006 compared to $1,596,031 at March 31, 2005. In addition the Company had $2,098,003 as compared to $1,083,450 in certificates of deposit, respectively. The total cash position, including the certificates of deposits, was $4,488,248 and $2,679,481 as of March 31, 2006 and 2005.
 
The Company’s current assets as of March 31, 2006 were 54.27% of total assets, an increase of 10.82% from 43.45% as of March 31, 2005. In addition, our working capital (current assets minus current liabilities) was $10,232,494.
 
Net cash used for operating activities amounted to $737,357 for the nine months ended March 31, 2006, as compared to $733,409 for the comparable period last fiscal year. The decrease is mainly due to an increase in net income as well as an increase in prepaid expenses and accounts receivable.
 
Net cash used by investing activities amounted to $4,568,666 for the nine months ended March 31, 2006, as compared to $3,764,574 for the comparable period last fiscal year. The difference lies primarily in the purchase of subsidiary which increased intangible assets and the purchase property and equipment during the current fiscal year. The Company had purchases of property and equipment of $2,063,284 compared to $804,115 for the comparable period last fiscal year. During the prior fiscal year, an additional $287,797 and $250,006 was infused into the Company’s minority interest in the Company’s subsidiaries NetSol Connect and NetSol-TiG.
 
Net cash provided by financing activities amounted to $6,232,741 and $5,186,675 for the nine months ended March 31, 2006, and 2005, respectively. The current fiscal period included the cash inflow of $1,400,000 compared to $1,512,000 from issuance of equity and $384,062 compared to $999,224 from the exercising of stock options and warrants. In addition, the Company received net proceeds of $4,031,001 from the sale of a subsidiary’s common stock in an IPO on the Karachi Stock Exchange as compared to $1,589,974 in the prior year. In addition the Company and had net proceeds on loans and capital leases of $417,678 as compared to $1,137,181 in the comparable period last year.
 
The Company plans on pursuing various and feasible means of raising new funding to expand its infrastructure, enhance product offerings and beef up marketing and sales activities in strategic markets. The strong growth in earnings and the signing of larger contracts with Fortune 500 customers largely depends on the financial strength of NetSol. Generally, the bigger name clients and new prospects diligently analyze and take into consideration a stronger balance sheet before awarding big projects to vendors. Therefore, NetSol would continue its effort to further enhance its financial resources in order to continue to attract large name customers and big value contracts. Management feels that a major requirement of institutional investors is a much stronger balance sheet and a healthy cash position.
 
38

 
Management expects to continue to improve its cash position in the current and future quarters due to the new business signed up in the last quarter. Since our newly listed subsidiary on the Karachi Stock Exchange (“KSE”) has performed much better than our own expectation i.e. the stock has more than doubled from its IPO price, we have another vehicle to meet the growing needs of new capital. Any new capital raise would depend on future M&A initiatives. Management would exercise its best judgment in choosing the most viable option for financing. In addition, the Company anticipates additional exercises of employee stock options in the current and subsequent quarters. The Company has consistently improved its cash position in last four quarters through employees’ exercise of options, the IPO of the Pakistani subsidiary, private placements, and the signing of new business. We anticipate this trend to continue in the current and future quarters, further improving the cash resources and liquidity position. Management is committed to implementing the growth business strategy that was ratified by the board of directors in July 2005. The company would continue to inject new capital towards expansion, grow sales and marketing and further enhancement of delivery capabilities.
 
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:
 
·  
In next three months the final payment of CQ Systems would be due based on the formula of ‘earn out’. This could be in the range of $1.0MN to $3.6MN.
·  
Notes payable for approximately $800,000.
·  
Working capital of $1.0 million for US business expansion, new business development activities and infrastructure enhancements.
·  
In the next three months the first installment for the purchase of McCue Systems would be due of approximately $2.0 MN.

While there is no guarantee that any of these methods will result in raising sufficient funds to meet our capital needs or that even if available will be on terms acceptable to the Company, we will consider raising capital through equity based financing and, warrant and option exercises. We would, however, use some of our internal cash flow to meet certain obligations as mentioned above.

The methods of raising funds for capital needs may differ based on the following:

·  
Stock volatility due to market conditions in general and NetSol stock performance in particular. This may cause a shift in our approach to raising new capital through other sources such as secured long term debt.

·  
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.
 
39


RESULTS OF OPERATIONS

THE YEAR ENDED JUNE 30, 2005 COMPARED TO THE YEAR ENDED JUNE 30, 2004

Net revenues for the year ended June 30, 2005 were $12,437,653 as compared to $5,749,062 for the year ended June 30, 2004. Net revenues are broken out among the subsidiaries as follows:
 
 
 
 
2005 
 
 
 
 
2004 
   
 
Netsol USA
 
$
295,725
   
2.38
%
$
676,857
   
11.77
%
Netsol Tech (1)
   
6,557,031
   
52.73
%
 
3,190,049
   
55.49
%
Netsol Private (2)
   
776,572
   
6.24
%
 
483,788
   
8.42
%
Netsol Connect
   
1,143,616
   
9.19
%
 
778,598
   
13.54
%
Netsol UK
   
687,620
   
5.53
%
 
356,215
   
6.20
%
Netsol-Abraxas Australia
   
217,470
   
1.75
%
 
263,555
   
4.58
%
CQ Systems
   
2,311,345
   
18.58
%
 
-
   
0.00
%
Netsol-TiG
   
448,274
   
3.60
%
 
-
   
0.00
%
Total Net Revenues
 
$
12,437,653
   
100.00
%
$
5,749,062
   
100.00
%
 
(1) Refers to NetSol Technologies (Pvt.) Limited
(2) Refers to NetSol (Private) Limited

The total consolidated net revenue for fiscal year 2005 was $12,437,653 compared to $5,749,062 in fiscal year 2004. This is a nearly 116% increase in revenue. The increase is attributable to increased sales, the acquisition of CQ Systems and the forming of the joint-venture with TiG.

The fiscal year ended June 30, 2005 was a very busy and exciting period for NetSol worldwide. 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 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. 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 $100,000 to an excess of $1,000,000 with additional charges for customization and maintenance of between 20%-30% each year.

40

 
The gross profit was $7,682,904 for year ended June 30, 2005 as compared with $3,049,387 for the same period of the previous year. This is a 152% increase. The gross profit percentage was 62% for the current fiscal year and 53% in the prior year. While the cost of sales and the cost of delivery of projects have both been reduced in the current year, the Company maintained all its delivery commitments and has won new business from existing and new customers. While management is striving to negotiate better pricing on new agreements, the Company has been required to react to overall general economic factors in determining its present pricing structure. The gross profit margin was also improved due to improved quality standards such as achieving the assessment of CMM Level 4 in 2004.

Operating expenses were $6,618,199 for the year ended June 30, 2005 as compared to $5,757,405 for the year ended June 30, 2004. During the years ended June 30, 2005 and 2004, the Company issued 188,972 and 48,613 restricted common shares in exchange for services rendered, respectively. The Company recorded this non-cash compensation expense of $246,650 and $48,240 for the years ended June 30, 2005 and 2004, respectively. Total professional service expense, including non-cash compensation, was $604,192 and $464,332 for the years ended June 30, 2005 and 2004, respectively. During the years ended June 30, 2005 and 2004, the Company recorded depreciation and amortization expense of $1,564,562 and $1,240,792, included in this increase is the addition of the completion of the Lahore facility. Salaries and wages expenses were $2,022,183 and $1,493,252 for the years ended June 30, 2005 and 2004, respectively, or an increase of $528,931 or 35%. 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 current fiscal year. General and administrative expenses were $1,588,456 and $1,759,607 for the years ended June 30, 2005 and 2004, respectively, a decrease of $171,151. This decrease is due to consolidation of US offices, streamlining of corporate overheads and reduction of operating expenses in the Lahore facility due to elimination of building rent. In the prior year, the general and administrative expense included non-recurring expenses for moving both the headquarters office and the Pakistan companies into the new facility, $105,608 in costs for placing the convertible debenture and $122,500 for settlement of legal disputes. Also, the Company had to incur extra costs for the annual shareholders meeting including proxies mailing and other administrative related costs and travel expenses.

Selling and marketing expenses increased to $782,488 for the year ended June 30, 2005 as compared to $253,701 for the year ended June 30, 2004, reflecting the growing sales activity of the Company and the addition of the new subsidiary, CQ Systems and the joint-venture, NetSol-TIG. The Company wrote-off, as uncollectible, bad debts of $13,118 and $219,909, during the years ended June 30, 2005 and 2004, respectively.

The income from operations in fiscal year 2005 was $1,064,705 compared to a net loss from operations of $2,708,018 in fiscal year 2004. Included in these amounts are non-cash charges of depreciation and amortization of $1,564,562 and $1,240,792, settlement expenses of $43,200 and $122,500 and bad debt expense of $13,118 and $219,909, respectively. Net income in fiscal year 2005 was $663,325 compared to a net loss of $2,577,058 in fiscal year 2004 or 125.74% decrease. The current fiscal year amount includes a net reduction of $111,073 compared to an add-back of $273,159 in the prior year for the 49.9% minority interest in NetSol Connect and NetSol-TiG owned by another party. The Company also recognized non-recurring expenses including $209,848 and $137,230 expense for the beneficial conversion feature on notes payable and convertible debenture, a gain of $0 and $104,088, from writing off a note payable in one of the subsidiaries that had been paid through the issuance of stock by the parent in the prior year and, a gain of $404,136 and $216,230 from the settlement of a debt, respectively. In addition, during the current fiscal year, the Company recorded an expense of $255,130 for the fair market value of options and warrants granted. The net income per share was $0.06 in 2005 compared to a loss of $0.33 in 2004. The total weighted average of shares outstanding basic was 11.6 million and diluted was 14.8 million against basic and diluted 7.9 million in 2004.
 
The net EBITDA income for fiscal 2005 was $2,454,164 compared to loss of $1,029,751 in fiscal 2004 after amortization and depreciation charges of $1,564,562 and $1,240,792, income taxes of $10,416 and $76,638, and interest expense of $215,861 and 229,877, 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.
 
41


Liquidity And Capital Resources

The Company's cash position was $1,371,727 at June 30, 2005 compared to $871,161 at June 30, 2004. In addition the Company had $205,480 compared to $391,403 in certificates of deposit. The total cash position, including the certificates of deposits, was $1,577,207as of June 30, 2005 compared to $1,262,564 million as of June 30, 2004.
 
Net cash provided by operating activities amounted to $243,872 for the year ended June 30, 2005, as compared to used for $1,770,591 for the comparable period last fiscal year. The decrease is mainly due to an increase in accounts receivable and other assets offset by an increase in accounts payable.
 
Net cash used by investing activities amounted to $4,697,488 for the year ended June 30, 2005, as compared to providing $3,406,964 for the comparable period last fiscal year. The difference lies primarily in the purchase of CQ Systems and the related increase in intangible assets acquired. During the prior fiscal year, the Company had proceeds of $210,000 from the sale of a minority interest in the Company’s subsidiary NetSol Connect, whereas in the current fiscal year the Company received $178,521 of additional capital from the minority interests. In addition, the Company had net purchases of property and equipment of $1,468,499 compared to $2,861,754 for the comparable period last fiscal year. The majority of this reflects the capitalized costs of the Lahore facility of approximately $1.37 million and $2.32 million, respectively.
 
Net cash provided by financing activities amounted to $4,826,927 and $5,774,256 for years ended June 30, 2005, and 2004, respectively. The current fiscal year included the cash inflow of $1,512,000 from the sale of common stock and $1,260,057 from the exercising of stock options and warrants, compared to $1,848,750 and $1,445,392 in the prior year, respectively. In the current fiscal year, the Company had net proceeds from loans of $1,247,351 as compared to $1,301,571 in the comparable period last year. The Company also obtained a $1,200,000 convertible debenture during the prior fiscal year. The short term notes acquired during the current fiscal year were utilized to execute the acquisition of CQ Systems.
 
As of June 30, 2005 the Company's working capital (current assets less current liabilities) totaled $3,458,302 compared to $410,991 as of June 30, 2004, an increase of $3,047,311. In the current fiscal year, the Company sold a total of $1,512,000 of its common stock in private placements. In fiscal 2004, the Company raised capital from financing with Maxim Group of $1.85 million, net of expenses. In addition, $1.2 million in convertible debentures were issued during the prior fiscal year and approximately $487,000 from the exercising of warrants. The Company has over $3.9 million in accounts receivable and $1.96 million in revenues in excess of billings. 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 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 Company has consistently improved its cash position in last four quarters through investors’ exercise of warrants, employee options exercised, 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.
 
NetSol’s Technology Campus in Lahore was completed in May 2004 and the staff was relocated into this new building. The Phase One will easily hold up to 500 programmers, engineers and other related staff. NetSol has already experienced a very positive response to this move from the business community, our existing customers and prospective new customers worldwide. The completion of technology campus is a major milestone for NetSol, employees, customers and the shareholders. Due to its recent growth, management has already started the planning of constructing a new phase by erecting another structure behind the current building.
 
42


Dividends and Redemption

It has been the Company's policy to invest earnings in the growth of the Company rather than distribute earnings as dividends. This policy, under which dividends have not been paid since the Company's inception and is expected to continue, but is subject to regular review by the Board of Directors.

Changes In And Disagreements With Accountants On Accounting And Financial Disclosure 

Kabani & Company’s report on NetSol’s financial statements for the fiscal years ended June 30, 2004 and June 30, 2005, did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles, except for a going concern uncertainty for June 30, 2004.

In connection with the audit of NetSol's financial statements for the fiscal years ended June 30, 2004 and June 30, 2005 there were no disagreements, disputes, or differences of opinion with Kabani & Company on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures, which, if not resolved to the satisfaction of Kabani & Company would have caused Kabani & Company to make reference to the matter in its report.

Saeed Kamran Patel & Co.’s report on NetSol’s Pakistan subsidiaries financial statements for the fiscal years ended June 30, 2004 and June 30, 2005, did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.

In connection with the audit of NetSol's Pakistan subsidiaries financial statements for the fiscal years ended June 30, 2004 and June 30, 2005 there were no disagreements, disputes, or differences of opinion with Saeed Kamran Patel & Co. on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures, which, if not resolved to the satisfaction of Saeed Kamran Patel & Co. would have caused it to make reference to the matter in its report.
 
INFORMATION ABOUT MCCUE SYSTEMS, INC.
 
Located at 111 Anza Blvd., Suite 310, Burlingame, California 94010; telephone number is (650) 348-0650, McCue Systems, Inc. has over 30 years of experience in developing business solutions for the equipment and vehicle leasing industry as a provider of lease/loan portfolio management software for banks, leasing companies and manufacturers. Its flagship product, LeasePak, simplifies lease/loan administration and asset management by accurately tracking leases, loans and equipment from origination through end-of-term and disposition.
 
McCue Systems provides the leasing technology industry in the development of Web-enabled and Web-based tools to deliver superior customer service, reduce operating costs, streamline the lease management lifecycle, and support collaboration with origination channel and asset partners. LeasePak can be configured to run on HP-UX, SUN/Solaris or Linux, as well as for Oracle and Sybase users. And for scalability, McCue Systems offers the LeasePak Bronze, Silver and Gold Editions for systems and portfolios of virtually all sizes and complexities. McCue Systems’ solutions provide the equipment and vehicle leasing infrastructure at leading Fortune 500 banks and manufacturers, as well as for some of the industry’s leading independent lessors, including Cisco, Hyundai, JP Morgan/Chase, ORIX, and Volkswagen Credit.

McCue Systems, Inc. leases 9,554 square feet of office space in Burlingame, California. The monthly lease cost is $20,552. The lease expires on June 30, 2007. McCue Systems, Inc. does not anticipate any difficulty in either renewing its lease or acquiring substitute premises upon expiration of the current term. McCue Systems, Inc. is not aware of any threatened or outstanding legal proceedings.
 
43


SELECTED HISTORICAL FINANCIAL DATA

We derived the historical information from the audited financial statements as of and for the years ended December 31, 2004 and 2005 and from the unaudited financial statements as of and for each of the three months ended March 31, 2005 and 2006.

The information is only a summary and should be read in conjunction with each company’s historical financial statements and related notes contained elsewhere herein. The historical results included below and elsewhere in this document are not indicative of the future performance of McCue Systems, Inc., NetSol Technologies, Inc. or the combined company.
 
MCCUE SYSTEMS, INCORPORATED
SELECTED CONDENSED BALANCE SHEET DATA

   
As of
 
As of
 
As of
 
As of
 
   
December 31, 2004
 
December 31, 2005
 
March 31, 2005
 
March 31, 2006
 
   
(Audited)
 
(Audited)
 
(Unaudited)
 
(Unaudited)
 
ASSETS
                         
                           
Current Assets
 
$
1,647,533
   
1,946,322
 
$
1,786,688
 
$
1,848,876
 
Property & equipment, net
   
57,638
   
59,261
   
47,852
   
64,706
 
Intangible assets, net
   
139,200
   
232,781
   
139,200
   
211,312
 
Rent deposits
   
41,005
   
41,005
   
41,005
   
41,005
 
Total assets
 
$
1,885,376
 
$
2,279,369
 
$
2,014,745
 
$
2,165,899
 
                           
LIABILITIES & STOCKHOLDERS' DEFICIT
                         
                           
Current liabilities
 
$
2,667,785
   
2,443,233
 
$
2,711,215
 
$
2,448,449
 
Stockholders' deficit
   
(782,409
)
 
(163,864
)
 
(696,470
)
 
(282,550
)
                           
Total liabilities and stockholders' deficit
 
$
1,885,376
 
$
2,279,369
 
$
2,014,745
 
$
2,165,899
 

44

 
MCCUE SYSTEMS, INCORPORATED
SELECTED CONDENSED STATEMENTS OF OPERATION DATA

   
For the years
 
For the three months
 
 
 
Ended December 31,
 
Ended March 31,
 
 
 
2005
 
2004
 
2006
 
2005
 
 
 
(Audited)
 
(Unaudited)
 
Statement of Operations:
                         
Revenues
 
$
4,527,814
 
$
5,647,637
 
$
1,206,183
 
$
1,133,862
 
Cost of Sales
   
2,208,560
   
2,494,269
   
612,860
   
620,209
 
Gross Profit
   
2,319,254
   
3,153,368
   
593,323
   
513,653
 
                           
Operating Expenses
   
2,416,743
   
2,553,477
   
509,499
   
642,819
 
Income (loss) from operations
   
(97,489
)
 
599,891
   
83,824
   
(129,166
)
                           
Other income
   
25,695
   
46,327
   
2,115
   
10,480
 
Net Income (loss)
 
$
(71,794
)
$
646,218
 
$
85,939
 
$
(118,686
)
                           
                           
Earnings Per Share:
                         
Basic
 
$
(0.11
)
$
0.97
 
$
0.13
 
$
(0.18
)
Diluted
 
$
(0.11
)
$
0.90
 
$
0.12
 
$
(0.18
)
                           
Weighted average number of shares outstanding:
                         
Basic
   
669,539
   
669,539
   
669,539
   
669,539
 
Diluted
   
669,539
   
716,260
   
698,075
   
669,539
 
 
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 three months ended March 31, 2006.

Forward-Looking Information.

This report contains certain forward-looking statements and information relating to the Company that is based on the beliefs of its management as well as assumptions made by and information currently available to its management. When used in this report, the words "anticipate", "believe", "estimate", "expect", "intend", "plan", and similar expressions as they relate to the Company or its management, are intended to identify forward-looking statements. These statements reflect management's current view of the Company with respect to future events and are subject to certain risks, uncertainties and assumptions. Should any of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those described in this report as anticipated, estimated or expected. The Company's realization of its business aims could be materially and adversely affected by any technical or other problems in, or difficulties with, planned funding and technologies, third party technologies which render the Company's technologies obsolete, the unavailability of required third party technology licenses on commercially reasonable terms, the loss of key research and development personnel, the inability or failure to recruit and retain qualified research and development personnel, or the adoption of technology standards which are different from technologies around which the Company's business ultimately is built. The Company does not intend to update these forward-looking statements.
 
45


INTRODUCTION

With over 30 years of experience in developing business solutions for the equipment and vehicle leasing industry, McCue Systems Inc. is the leading provider of lease/loan portfolio management software for banks, leasing companies, and manufacturers. Its flagship product, LeasePak, simplifies lease/loan administration and asset management by accurately tracking leases, loans, and equipment from origination through end-of-term and disposition.

McCue Systems has developed network and Web-based tools to provide lessors with superior customer service, reduced operating costs, streamlined lease operations and enhanced collaboration with origination channel and asset partners.

By harnessing the most advanced technologies, McCue Systems offers the right operating platform for almost any enterprise. McCue Systems offers the LeasePak Bronze, Silver, and Gold Editions for systems and portfolios of virtually all sizes and complexities. McCue Systems’ solutions has a high standard for reliability, providing the equipment and vehicle leasing infrastructure at leading Fortune 500 banks and manufacturers, as well as for the industry’s leading bank, independent and manufacturing captive lessors, including Cisco Capital, Hyundai Motor Finance, JP Morgan/Chase, ORIX, and Volkswagen Credit US.

The leasing experts at McCue Systems work closely with lessors to put the company’s leasing expertise to work to streamline lease operations and enhance customer retention at every stage of the lease lifecycle.

Management is performing due diligence and is seriously considering joining forces with a company that would allow McCue to take advantage of the global markets. McCue is considering public as well as financially strong private candidates which would provide a level of assurance to our existing and future customers as to the long term viability of the combined organization.

PLAN OF OPERATIONS

Management has set the following new goals for McCue Systems’ next 12 months.
 
·  
Improve Financial Performance
·  
Management Alignment
        Effective Business Plan Overhead
        Implement Strategy for focusing on Medium to Small Accounts
·  
Stronger Product Presentation
        Improved LeasePak demo scripts
        Show operational benefits
        Align demos with strategic branding messages
·  
Active Marketplace Involvement
        Grow Outbound Telemarketing
        Gather more Competitive Intelligence
       Enhanced Pipeline Management
·  
Account Management Strategy
        Defined Key Account strategies
        Specific assigned senior managers for key accounts
        Added outbound C-level communications from marketing
·  
Improved Responsiveness
        Better Product Reliability out the Door
Reporting and Tracing Discrepancies from the Field
        Broader Development and Support Bandwidth
                Support
                Implementation
                Development
 
46

 
·  
Improved Support for Productivity for End Users
       Rollout LeasePak Productivity Suite
       Better LeasePak User Interface
       Improve LeasePak Asset Level Accounting / Billing

MATERIAL TRENDS AFFECTING THE COMPANY

McCue Systems has identified the following material trends affecting the Company.

Positive trends:

·  
Continued recovery of the equipment leasing industry.
·  
Continued growth in capital equipment sales across industries. 
·  
We anticipate that our biggest competitors (IDS / Oracle / SAP) will continue to face serious challenges in this vertical.
·  
A number of large leasing companies, manufacturers, and bank equipment leasing operations will be looking to replace legacy and aging systems. This places McCue Systems in a very strong position to capitalize on any upturn in IT spending by these companies.
·  
McCue Systems will continue to enjoy the benefits of its highly effective marketing efforts and industry presence. The presence of CEO John McCue on the Board of Directors of the dominant equipment leasing trade association in the US, the Equipment Leasing Association, and his anticipated election to the Board of Trustees of The Equipment Leasing and Finance Foundation will continue to bolster the dominance of the McCue Systems brand.

Negative trends:

·  
McCue Systems will continue to face challenges in expanding the delivery capacity of its Development Department, as a result of the expense of qualified software engineers and the expense of training of new technical resources.
·  
McCue Systems will continue to be capital-restrained, as a result of its policy to limit it capital spending to self-generated capital funds.
 
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.

47

 
INCOME TAXES

We recognize deferred tax assets and liabilities based on the differences between the financial statement carrying amounts and the tax bases of assets and liabilities. We regularly review our deferred tax assets for recoverability and establish a valuation allowance based upon historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. During fiscal year 2005-2006, we estimated the allowance on net deferred tax assets to be one hundred percent of the net deferred tax assets.
 
CHANGES IN FINANCIAL CONDITION

Three Months Ended March 31, 2006 as compared to the Three Months Ended March 31, 2005:

Net revenues for the three months ended March 31, 2006 and 2005 were $1,133,862 and $1,206,183, respectively. This reflects a decrease of $72,321 or 6% in the current year as compared to the three months ended March 31, 2005. The decrease is mainly attributable to the lower license fees and consulting fees. License fees decreased $77,834 or 32% and consulting fees decreased $182,374 or 39%. However, maintenance fees increased $113,885 or 242% and we added a new model during the prior year for using our leasing software, the application provider service (“ASP”) which contributed $76,011 and $0, respectively. Designed for entry-level customers, the solution can be deployed in under 60 days, with cost structures scaling commensurately with the customers operational needs. The ASP offering provides monthly hosting fees along with an initial implementation fee. The ASP solution is co-managed with Lease Dimensions of Portland Oregon.

During the quarter ended March 31, 2006, McCue Systems achieved the following sales objectives:

Key Equipment Finance - Significant Add-on Business
Chase Equipment Leasing - Significant Add-on Business

McCue Systems’ gross profit was $513,653 for the three months ended March 31, 2006 as compared with $593,323 for the previous year for a decrease of $79,670 or a 13.43%. The gross profit percentage decreased to approximately 45% for the three months ended March 31, 2006 compared to approximately 49% for the comparable period in the prior year. The total cost of revenues only increased $7,349 or 1.2%. The lower gross profit is a result of lower revenues.

Operating expenses were $642,819 and $509,499 for the three months ended March 31, 2006 and 2005, respectively. This reflects an increase of $133,320 or 26%. The increase is mainly attributable to increased selling and marketing expenses and professional fees. Selling and marketing expenses were $156,271 and $112,801, for the three months ended March 31, 2006 and 2005, respectively, an increase of $43,470. Professional services expense increased $80,826 to $85,296 in the three months ended March 31, 2006, from $4,470 in the comparable period in the prior year, included in the current year expense is $15,000 for audit fees not previously incurred.

Loss from operations was $129,166, compared to an income of $83,824 for the three months ended March 31, 2006 and 2005, respectively. This represents a decrease of $212,990.

Net loss was $118,686 compared to income of $85,939 for the three months ended March 31, 2006 and 2005, respectively. This is a decrease of $204,625.

The net earnings before interest, taxes, depreciation and amortization, (“EBITDA”) was a loss of $89,318 compared to income of $97,006 or a decrease of $186,324 after amortization and depreciation charges of $29,360 and $9,785, interest expense of $0 and $1,282, 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.

48

 
LIQUIDITY AND CAPITAL RESOURCES

McCue Systems’ cash position was $886,714 at March 31, 2006 compared to $542,415 at March 31, 2005.

The Company’s current assets as of March 31, 2006 were 85.36% of total assets, a 3% decrease from 88.68% as of March 31, 2005.

Net cash provided by operating activities amounted to $85,190 for the three months ended March 31, 2006, as compared to $47,558 for the comparable period in the prior year. The increase is mainly due to increased accounts receivable. Net cash used in investing activities for the purchase of property and equipment was $13,344 and $0 for the three months ended March 31, 2006 and 2005, respectively.

For the short term, McCue Systems continues to pursue its strategy of self-funding growth through its own retained earnings and cash reserves. This has been the company’s operating philosophy since 1989 and we have been able to operate within these constraints through a variety of economic conditions. This philosophy, while limiting growth, appears to management to be the most viable considering that there are limited funding alternatives for a private company of our size in our focused vertical market.
 
Management expects to continue to improve its cash position in the current and future quarters due to both closely managing expenses as well as generating ongoing revenues from its maintenance agreements, backlog of revenue to be delivered, Application Service Provider revenues as well as new license sales.

CHANGES IN FINANCIAL CONDITION

Year Ended December 31, 2005 as compared to the Year Ended December 31, 2004:

Net revenues for the years ended December 31, 2005 and 2004 were $5,647,637 and $4,527,814, respectively. This reflects an increase of $1,119,823 or 24.73% in the current year as compared to the year ended December 31, 2004. The increase is mainly attributable to new orders of licenses. License fees increased $661,752 or 91.48%. In addition, maintenance fees increased 11.72%. During the year, MSI undertook the development and deployment of its first customers under an Application Service Provider (ASP) model. Designed for entry-level customers, the solution deployed in under 60 days each with cost structures scaling commensurately with the customers operational needs. The ASP offering provides monthly hosting fees along with an initial implementation fee. The ASP solution is co-managed with LeaseDimensions of Portland Oregon.

During the year ended December 31, 2005, McCue Systems achieved the following revenue objectives:

License:
 
$
1,385,103
 
Maintenance:
   
2,082,868
 
Consulting & Services:
   
1,694,357
 
Hardware Sales:
   
331,276
 
Application Service Provider:
   
154,033
 
Total Revenue
 
$
5,647,637
 
 
During the year ended December 31, 2005, McCue Systems achieved the following sales objectives:

·  
Hyundai Motor Finance Company - New Client
·  
Continental Servicing - New Client
·  
City National Bank - New Client
·  
Provident Inventory Finance - New Client
·  
National City Commercial Capital Corp - Significant User Addition
·  
Key Equipment Finance - Significant User Addition
 
49

 
McCue Systems’ gross profit was $3,153,368 for the year ended December 31, 2005 as compared with $2,319,254 for the previous year for an increase of $834,114 or a 35.96% increase. The gross profit percentage increased to approximately 56% for the year ended December 31, 2005 compared to approximately 51% for previous year. Although our salaries, source code escrow fees, and travel increased, the pricing of our licensing and services and greater sales offset these increases.
 
Operating expenses were $2,553,477 for the year ended December 31, 2005 as compared to $2,416,743 for the previous year. This reflects an increase of $136,734 or 5.66&. The increase is mainly attributable to the one-time charge of $350,000 for settlement costs of litigation occurring over the past several years. Selling and marketing expenses were $523,053 and $764,032, for the year ended December 31, 2005 and 2004, respectively, a decrease of $240,979. The Company wrote-off as uncollectible bad debts of $20 in the current year compared to $27,044 for the prior year. Professional services expense increased $36,959 to $94,774 in the year ended December 31, 2005, from $57,815 in the previous year.

Income from operations was $599,891 compared to a loss of $97,489 for the years ended December 31, 2005 and 2004, respectively. This represents an increase of $697,380.

Net income was $646,218 compared to a loss of $71,794 for the years ended December 31, 2005 and 20054, respectively. This is an increase of $718,012.

The net earnings before interest, taxes, depreciation and amortization, ( “EBITDA”) income was $1,058,784 compared to $23,844 or an increase of $1,034,940 after amortization and depreciation charges of $58,005 and $87,516, interest expense of $4,561 and $8,122, and the non-recurring expense of $350,000 and $0, 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

McCue Systems’ cash position was $814,868 at December 31, 2005 compared to $494,857 at December 31, 2004.

The Company’s current assets as of December 31, 2005 were 85.39% of total assets, a 2% decrease from 87.38% as of December 31, 2004.

Net cash provided by operating activities amounted to $537,342 for the year ended December 31, 2005, as compared to $550,097 for the previous year. The decrease is mainly due to an increase in net income as well as decrease in unearned revenues and the one-time settlement charge for litigation of $350,000.
 
Net cash used in investing activities amounted to $153,210 for the year ended December 31, 2005, as compared to $194,579 for the previous year. The difference lies primarily in purchasing less property and equipment and capitalizing less development costs as intangible assets. The Company had purchases of property and equipment of $34,785 compared to $55,379 for the prior year.
 
Net cash used by financing activities amounted to $64,121 and $128,722 for the years ended December 31, 2005 and 2004, respectively, for the payment on loans.
 
McCue Systems continues to pursue its strategy of self-funding growth through its own retained earnings and cash reserves. This has been the company’s operating philosophy since 1989and we have been able to operate within these constraints through a variety of economic conditions. The Company’s Cash, Accounts Receivable (net of uncollectible accounts of $44,067) and Accounts Payable balances as of December 31, 2005 are $814,868, $1,050,570 and $633,656 respectively. The Company has accrued $350,000 at year-end as a reserve for the potential settlement of on-going litigation.

Management expects to continue to improve its cash position in the current and future quarters due to both closely managing expenses as well as generating ongoing revenues from its maintenance agreements, backlog of revenue to be delivered, Application Service Provider revenues as well as new license sales and sales of additional seats and modules to existing customers.

50


Changes In And Disagreements With Accountants On Accounting And Financial Disclosure 

Kabani & Company’s report on McCue’s financial statements for the fiscal years ended December 31, 2005 and December 31,2004 did not contain an adverse opinion or disclaimer of opinion, and was not qualified or modified as to uncertainty, audit scope, or accounting principles.

In connection with the audit of McCue's financial statements for the fiscal years ended December 31, 2005 and December 31, 2004 there were no disagreements, disputes, or differences of opinion with Kabani & Company on any matters of accounting principles or practices, financial statement disclosure, or auditing scope and procedures, which, if not resolved to the satisfaction of Kabani & Company would have caused Kabani & Company to make reference to the matter in its report.
 
INFORMATION ABOUT CQ SYSTEMS LTD. (NOW NETSOLCQ LTD.)
 
On January 19, 2005, the Company entered into a Share Purchase Agreement whereby the Company agreed to acquire 100% of the issued and outstanding shares of CQ Systems Ltd., a company organized under the laws of England and Wales (“CQ”), now NetSolCQ Ltd. (the “CQ SPA”). Established in 1986 as CQ Systems Ltd., and now part of the NetSol Technologies, Inc. group, NetSolCQ provides software and services to the financial services industry. NetSolCQ is a provider of software solutions to the asset, motor, consumer, wholesale and premium finance sectors with 75 banking, independent and captive finance house clients in the UK, Europe, Africa and Asia. NetSolCQ is located at Planet House North Heath Lane, Horsham West Sussex, RH 125QE, United Kingdom. Telephone number is 44-0-1403-282300. NetSol CQ leases approximately 6,570 square feet of office and computer space at the monthly rent of $10,989. The lease expires on June 23, 2011. NetSolCQ does not anticipate any difficulty in renewing this lease or acquiring substitute premises at the conclusion of the term.

SELECTED HISTORICAL FINANCIAL INFORMATION

We derived the historical information from the audited financial statements as of and for the years ended March 31, 2003 and 2004 and from the unaudited financial statements as of and for each of the nine months ended December 31, 2004 and 2003.

The information is only a summary and should be read in conjunction with each company’s historical financial statements and related notes contained elsewhere herein. The historical results included below and elsewhere in this document are not indicative of the future performance of NetSolCQ Ltd., NetSol Technologies, Inc. or the combined company.

51

 
CQ SYSTEMS LIMITED
SELECTED CONDENSED BALANCE SHEET DATA

   
As of
 
As of
 
As of
 
As of
 
   
March 31,
2004
 
March 31,
2003
 
Dec. 31,
2004
 
Dec. 31,
2003
 
   
(Audited)
 
(Audited)
 
(Unaudited)
 
(Unaudited)
 
ASSETS
                     
                       
Current Assets
 
£
1,270,269
 
£
931,158
 
£
1,058,989
 
£
1,237,982
 
Property & equipment, net
   
141,570
   
125,051
   
181,922
   
155,136
 
Total assets
 
£
1,411,839
 
£
1,056,209
 
£
1,240,911
 
£
1,393,118
 
                           
LIABILITIES & STOCKHOLDERS' EQUITY
                         
                           
Current liabilities
 
£
869,967
 
£
721,739
 
£
766,214
 
£
746,980
 
Long-term liabilities
   
41,186
   
6,473
   
69,787
   
42,808
 
Stockholders' equity
   
500,686
   
327,997
   
404,910
   
603,330
 
                           
Total liabilities and stockholders' equity
 
£
1,411,839
 
£
1,056,209
 
£
1,240,911
 
£
1,393,118
 
 

52

 
CQ SYSTEMS LIMITED
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