August 15, 2005
VIA FACSIMILE & OVERNIGHT COURIER
(202) 942-9544
Barbara C. Jacobs
Assistant Director
Daniel Lee
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0406
RE: NetSol Technologies, Inc.
Form SB-2
File No. 333-116512
Form 10-KSB for the period ended June 30, 2004
Form 10-QSB for fiscal quarter ended September 30, 2004
Form 10-QSB for the fiscal quarter ended December 31, 2004
Form 10-QSB for the fiscal quarter ended March 31, 2005 File
No. 0-22773
Dear Ms. Jacobs,
Follows is our response to your comment letter dated August 2, 2005.
Post-effective Amendment No. 44 to Registration Statement on Form SB-2
General
1. The loan transactions that you described in your certain relationships and
related transactions section appear to be loans that are inconsistent with
Section 13(k) (1) of the Exchange Act. Section 13(k)(1) prohibits the
extensions of credit by issuers in the form of personal loans to their
directors or executive officers. The loans made by you to your officers in
order to facilitate their personal exercise of stock options appear to
fall within this prohibition. Please make disclosure in your filing
regarding such possible violation and the possible consequences.
As we have previously disclosed, it has been the practice of our executive
officers to exercise options against funds already due to them from the Company,
such as monies the officers personally loaned to the Company, deferred
compensation, and bonuses granted to them. Since our last filing, we have
conducted a detailed review of all of such funds due to the executive officers.
Our review discovered the existence of loans made by these officers to the
Company's Pakistani subsidiary in 2002. These loans were previously reflected in
the financial statements of the subsidiary. As a result of this discovery, we
have determined that immediately prior to their November 2003 option exercises,
the Company owed the named executive officers a total $201,698. Immediately
after the November 2003 exercise, $725 remained due to the officers. These
officers make it a practice to defer a portion of their monthly salary in order
to reduce any burden on the Company's cash flow. Accordingly, at any given time,
there are outstanding amounts due to these officers. Immediately prior to the
officers' March 2004 option exercises, approximately $49,764 was due from the
Company to the officers. Immediately following the March 2004 exercise, $24,511
was due from the officers to the Company. This amount was reduced, through the
normal salary deferral, to a positive amount due to the officers, of
approximately $3,000 by the end of May 2004. At June 30, 2004, and currently,
there are no outstanding amounts due by the named executive officers to the
Company. In December 2004, the named officers exercised options to acquire
shares that have subsequently been canceled by the Company. Our review has
determined that the promissory notes previously entered into are void because
the officers did not owe those funds to the Company as a result of both loans
made to the Company and compensation due to the officers that had been deferred.
We have revised the certain relationships and related transaction section of the
Form SB-2, and corresponding sections of the Form 10-KSB for June 30, 2004 and
the Forms 10-QSB for September 30, 2004, December 31, 2004, and March 31, 2005
to eliminate the references to the November 28, 2003 and March 31, 2004 and
December 2004 transactions.
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Risk Factors
Certain of Our Management Team Have Relationships...page 6
2. This risk factor discusses the risks related to transactions in which
members of management have loaned funds to you. It does not appear to be
case that members of management has made such loans. Rather, your
disclosure under certain relationships and related transactions indicates
that loans were made by you to members of management. Please revise as
necessary.
Our review has determined that funds were due to the executive officers from a
loan of moneys made to the Pakistani subsidiary in 2002. Accordingly, the risk
factor, as stated in our previous filing, was accurate and has not been
modified.
Certain Relationships and Related Transactions, page 51
3. With respect to the last paragraph in this section, your statement that
the terms of the management loan transactions are no less favorable to you
than a transaction with an unaffiliated third party appears to lack a
basis. It is unclear how a transaction in which you issue shares upon
exercise of a stock option and afford the person exercising the option a
loan with respect to the aggregate exercise price would be available to an
unaffiliated third party. Instead, stock options are most usually
associated with employees or persons with some relationship to the
company. Also, certain significant terms of the transaction such as the
use of the stock as collateral and the payment on the loan with salary
would not typically be available to unaffiliated third parties.
As a review of loans made by and compensation due to the named executive
officers resulted in a discovery that funds were due to these officers and that
the previous promissory notes are now void, we believe the disclosure is
accurate as stated.
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NetSol Technologies Inc. and Subsidiaries Pro-Forma Financial Statements
4. You indicate that you restated your March 31, 2005 financial statements to
reflect the change in your purchase price allocation for CQ Systems. It
does not appear that you have made corresponding adjustments to your pro
forma financial statements. Revise accordingly.
Based on comment 12 below, in which paragraph 46 of SFAS 141 requires the
recognition of the contingent consideration as if it were a liability, the
purchase price allocation for CQ Systems has been adjusted to reflect the
liability and reduction of goodwill as necessary. The proformas have been
revised accordingly.
Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm, page F-2
5. Your response to comment no. 8 in our letter dated June 22, 2005 indicates
that the report as modified to refer to "NetSol" rather than "Network"
Technologies due to a typographical error. The last sentence of the first
paragraph continues to refer to "Network" Technologies. Please revise the
audit reports in this registration statement and Form 10-KSB accordingly.
We have revised the audit reports accordingly.
Notes to Consolidated Financial Statements
Note 2 - Summary of Significant Accounting Policies
Revenue Recognition, page F-14 .
6. In your response to comment no. 13 in our letter dated June 22, 2005, you
state that the "whole amount of the license fee is recognized as revenue
in the period of signing of [a] contract" when an arrangement does not
contain any major customization. Tell us and revise to disclose how you
ensure that all of the revenue recognition criteria in paragraph 8 of SOP
97-2 are met in the period of signing of the contract.
Revenue is recognized in the period of signing when the arrangement does not
contain any major customization in accordance with paragraph 8 of SOP 97-2 as
all of the criteria are met:
a) Persuasive evidence of an arrangement exists - a contract has been
signed.
b) Delivery has occurred - the software is delivered usually within 30
days of the signing of the contract.
c) The vendor's fee is fixed or determinable - the fee is fixed when
the contract is signed.
d) Collectibility is probable - based on past history contracts are
collected within 90 days of signing.
We have revised our disclosure as follows:
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License Revenue. The Company recognizes revenue from license contracts without
major customization when a non-cancelable, non-contingent license agreement has
been signed, delivery of the software has occurred, the fee is fixed or
determinable, and collectibility is probable.
7. We note your response to comment no. 14 in our letter dated June 22, 2005.
As previously requested, revise your revenue recognition policy to
disclose the method you use to measure progress toward completion on
arrangements recognized using the percentage of completion method.
Indicate the output or input measures used to calculate the amount of
revenue to recognize in each period. Refer to paragraph 45 of SOP 81-1.
The method we use to measure progress toward completion is a `Unit of Work
Completed' method to determine the percentage of completion of a specific
project as allowed by Paragraph 44 of SOP 81-1. This is an "Output Measures"
(Paragraph 46 of SOP 81-1) as it determines the result achieved at a specific
date. Project managers certify the units (Modules) completed of the specific
project and they are further certified by the EVP IT / Operations. This measure
provides us a reasonable assurance of units (Modules) completed at specific date
out of total units (modules) to be developed.
Note: Complete module (Unit), means a module of a specific contract/software
that has been completed in all respect of Coding, Testing and Integration and
capable of being used independently.
We have revised our disclosure as follows:
Revenue from the sale of licenses with major customization, modification, and
development is recognized on a percentage of completion method, in conformity
with ARB 45 and SOP 81-1. Revenue from the implementation of software is
recognized on a percentage of completion method, in conformity with Accounting
Research Bulletin ("ARB") No. 45 and SOP 81-1. Any revenues from software
arrangements with multiple elements are allocated to each element of the
arrangement based on the relative fair values using specific objective evidence
as defined in the SOPs. An output measure of "Unit of Work Completed" is used to
determine the percentage of completion which measures the results achieved at a
specific date. Units completed are certified by the Project Manager and EVP IT/
Operations.
Note 11 - Convertible Debenture, page F-31
8. Based on the information provided in response to comment no. 17 in our
letter dated June 22, 2005, it appears that once the conversion terms were
set on May 4, 2005, you should have computed the value of the beneficial
conversion using the revised conversion terms and the commitment date
stock price. Please refer to Issue 7 of EITF 00-27 and tell us how you
considered this guidance in recording the value of the beneficial
conversion of $300,000.
Based on Issue 7 of EITF 00-27, the beneficial conversion feature expense has
been recomputed using the conversion terms set in the amended agreement dated
May 4, 2004. Below is the calculation for the re-computed beneficial conversion
feature expense.
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20 day average market price 2.251
Number of share issued 645,161
----------
Market price of shares $1,452,257
Cash received 1,200,000
----------
Beneficial Conversion Feature $ 252,257
==========
Note 11 in the June 30, 2004 10KSB has been revised as follows:
The Company received a net of $1,049,946 after placement expenses. The
beneficial conversion feature of the debenture was valued at $252,257. The
Company has recorded this as a contra-account against the loan balance and is
amortizing the beneficial conversion feature over the life of the loan. The net
balance at June 30, 2004, is $985,243.
CQ Systems Limited Financial Statements
Independent Auditor's Report, page 2
9. We note the revised report of CMB Partnership for the financial statements
of CQ Systems as of March 31, 2004 and 2003. The report states that the
audits were conducted in accordance with auditing standards generally
accepted in the United Kingdom. As previously requested in comment no. 8
in our letter dated April 27, 2005, revise to state, if true, that the
audits were conducted in accordance with generally accepting auditing
standards in the United States. Please also revise the report included in
your Form 8-K/A accordingly.
The report has been corrected.
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Exhibits
10. Please obtain consents from your accountants that correspond to the dates
of their reports included in your Form SB-2.
Consents corresponding to the dates of their reports included in our Form
SB-2 have been obtained from our accountants.
Draft Form 10-KSB/A for the fiscal year ended June 30, 2004
Item 8A. Controls and Procedures
11. We note your response to no.19 in our letter dated June 22, 2005. Please
note that Item 308 of Regulation S-B requires disclosure of any changes
during the last fiscal quarter. We note that the modification to your
disclosure per your response indicates that the period for which any
change is to be disclosed is "[s]ubsequent to the date of such evaluation"
As such, the requirements of Item 308 do not appear to be met. Further,
please note that the draft disclosure you provided does not appear to be
the same as that set forth in your response. This comment also appears
applicable to the disclosure in your Form 10-QSB for the quarter ended
March 31, 2005.
Our disclosure in the case of the annual report has been modified to read:
Management, under the supervision and with the participation of the chief
executive officer and chief financial officer, conducted an evaluation of the
disclosure controls and procedures as defined in Rule 13a-15(e) as of the fiscal
quarter ending on June 30, 2004. Based upon that evaluation, the Chairman, Chief
Financial Officer and Chief Executive Officer concluded that our disclosure
controls and procedures are effective.
There has been no change in our internal control over financial reporting that
occurred in the fiscal quarter ended June 30, 2004 that has materially affected
or is reasonably likely to materially affect our internal control over financial
reporting."
Our disclosure in the case of the quarterly reports, with the exception of March
31, 2005, has been modified to read:
Management, under the supervision and with the participation of the chief
executive officer and chief financial officer, conducted an evaluation of the
disclosure controls and procedures as defined in Rule 13a-15(e) as of the end of
the period covered by this report on Form 10Q-SB. Based upon that evaluation,
the Chairman, Chief Financial Officer and Chief Executive Officer concluded that
our disclosure controls and procedures are effective.
There has been no change in our internal control over financial reporting that
occurred in the period covered by this report that has materially affected or is
reasonably likely to materially affect our internal control over financial
reporting.
Our disclosure in the case of the quarterly report ended March 31, 2005 has been
modified to read:
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Management, under the supervision and with the participation of the chief
executive officer and chief financial officer, conducted an evaluation of the
disclosure controls and procedures as defined in Rule 13a-15(e) as of the end of
the period covered by this report on Form 10Q-SB. Based upon that evaluation,
the Chairman, Chief Financial Officer and Chief Executive Officer concluded that
our disclosure controls and procedures are effective.
In response to the need to restate the financials for the periods ending June
30, 2004, September 30, 2004 and December 31, 2004, and commencing in the period
ending March 31, 2005, the controller, Chief Financial Officer and auditor have
agreed to meet each quarter to discuss any changes that may have occurred in
accounting policies and financial reporting which may have an impact on the
Company's reporting. Any material changes are reported to the audit committee.
The audit committee is charged with reviewing any new accounting policies with
the Company's auditor, as well as, with reviewing our periodic reports and other
public disclosures. Other than this change, there has been no change in our
internal control over financial reporting that occurred in the period covered by
this report that has materially affected or is reasonably likely to materially
affect our internal control over financial reporting.
We have corrected the inadvertent exclusion of the modified disclosure in the
10KSB/A.
Draft Form 10-QSB/A for the quarter ended March 31, 2005
Notes to Unaudited Consolidated Financial Statements
Note 15 - Acquisition of CQ Systems, page 17
12. We note your response to comment no. 4 in our letter dated June 22, 2005
and your statement that as a result of removing the liability associated
with your purchase of CQ Systems, the purchase price allocation for the
maintenance contracts and license contracts was reduced. In accordance
with the guidance in paragraph 46, since your business combination
involves contingent consideration, an amount equal to the sum of the
amounts assigned to assets acquired and liabilities assumed that exceeds
the non-contingent purchase price should be recognized as if it was a
liability prior to any pro rata allocation of this excess. Tell us how you
considered the guidance in paragraph 46 of SFAS 141 in your revised
purchase price allocation. Furthermore, explain why you believe it is
appropriate to allocate any amounts to goodwill since the costs of the
acquired entity (excluding the contingent installment) does not exceed the
acquired net assets.
We have considered the guidance of paragraph 46 of SFAS 141, which states, "If a
business combination involves a contingent consideration agreement that might
result in recognition of an additional element of cost of the acquired entity
when the contingency is resolved (a contingency based on earnings), an amount
equal to the lesser of the maximum amount of the contingent consideration or the
excess shall be recognized as if it was a liability." The below table shows the
calculation we used to determine the amount to be recognized as a liability. As
the table shows, we have recorded $313,397 as a liability.
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Purchase Price Less Contingent Installments
Purchase Price $ 7,532,297
Less contingent consideration (3,353,587)
-----------
4,178,710
Net tangible assets (984,420)
-----------
Total Intangible Assets 3,194,290
Allocations of Intangible Assets:
Product License 2,190,807
Customer Lists 1,316,880
-----------
3,507,687
Liability to be recorded (313,397)
-----------
$ 3,194,290
===========
Based on our evaluation using this guidance, we have determined that no goodwill
should be recorded until the contingent consideration amount is finalized and
becomes issuable. The amount previously recorded has been removed. The
disclosure has been modified accordingly:
The initial purchase price was (pound)3,576,335 or $6,730,382, of which one-half
was due at closing payable in cash and stock and the other half is due when the
audited March 31, 2006 financial statements are completed. On the closing date,
$1.7 million was paid and 681,965 shares were issued to the shareholders of CQ,
valued at $1,676,795 at an average share price of $2.46 (see Note 8) was
recorded. In addition, the agreement called for the accumulated retained
earnings amounting to (pound)423,711 or $801,915 of CQ Systems as of the closing
date to be paid to the shareholders in cash and stock. In April 2005, the
additional cash of (pound)350,000 or $662,410 was paid and 77,503 shares of the
Company's common stock valued at $139,505 were issued. The total amount paid at
closing was $4,178,710.
In accordance with SFAS 141, the Company has recognized the lesser of the
maximum amount of the contingent consideration based on earnings or the excess
of the fair market value of assets acquired over the purchase price as a
deferred liability. The deferred liability balance at March 31, 2005 was
$1,115,312, which includes the $801,915 paid in April 2005. The purchase price
has been allocated as follows:
Purchase Price Allocation:
Purchase Price $ 7,532,297
Less contingent consideration (3,353,587)
-----------
Net purchase price $ 4,178,710
===========
Net tangible assets $ 984,420
Intangible Assets:
Product License 2,190,807
Customer Lists 1,316,880
Deferred liability (313,397)
-----------
Net purchase price $ 4,178,710
===========
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Item 3. Controls and Procedures
13. You indicate that your controller, chief financial officer and auditor
meet each quarter to discuss any changes that may have occurred in
accounting policies and financial reporting. Tell us how this additional
procedure addresses the facts and circumstances leading to your
restatements of the June 30, September 30 and December 31, 2004 financial
statements. In this regard, explain how this process ensures that you are
properly applying existing accounting and financial reporting
requirements.
The restatement of the financial statements of June 30, September 30 and
December 31, 2004 were as a result of the treatment of goodwill as an expense.
Our financial statements are, as is required, audited on an annual basis and
reviewed on a quarterly basis. We have relied on the advice of our auditors in
the treatment of entries in the financial statements and of apprising us of
changes to accounting principals. We believe that a meeting each quarter,
focused solely on changes or questioning of accounting policies may avoid any
failure to report such changes to management and, may cause a reexamination of
current policies in place. Further, effective July 20, 2005, Ms. Tina Gilger,
joined the Company as Chief Financial Officer. We are hopeful that Ms. Gilger's
experience as a CPA will further bolster the ability of management to monitor
accounting policies so to avoid restatements in the future. There is no way to
absolutely "ensure" that we are properly applying existing accounting and
financial reporting requirements. However, these quarterly meetings together
with the diligence of the new CFO may act to prevent any failure to properly
apply in the future.
* * * *
Thank you for your attention to this matter. Please contact the undersigned
(818) 222-9195 ext. 110, or Ms. Malea Farsai at (818) 222-9195 ext. 105 if you
require any clarification or have any questions.
Very truly yours,
/s/ Patti L. W. McGlasson
Patti L. W. McGlasson
Corporate Counsel
NetSol Technologies, Inc.
Cc: Naeem Ghauri, CEO NetSol Technologies, Inc.
Jason Niethamer, Melissa Walsh, U.S. SEC
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