Unassociated Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

FORM 8-K


CURRENT REPORT
Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

Date of Report (Date of earliest event reported): July 21, 2006 (May 6, 2006)


Commission file number: 0-22773

NETSOL TECHNOLOGIES, INC.
(Exact name of small business issuer as specified in its charter)

NEVADA
95-4627685
(State or other Jurisdiction of
(I.R.S. Employer NO.)
Incorporation or Organization)
  


23901 Calabasas Road, Suite 2072, Calabasas, CA 91302
(Address of principal executive offices) (Zip Code)

(818) 222-9195 / (818) 222-9197
(Issuer's telephone/facsimile numbers, including area code)

Item 1.01. Entry into a Material Definitive Agreement.

On May 6, 2006, NetSol Technologies, Inc., a Nevada corporation (the “Company”) entered into a Share Purchase Agreement whereby the Company agreed to acquire 100% of the issued and outstanding shares of McCue Systems, Inc., a California corporation (“McCue”) (the “Share Purchase Agreement”). Prior to the execution of the Share Purchase Agreement, McCue and the Company entered into a consulting agreement whereby the Company agreed to provide certain services to McCue. Other than this agreement, prior to the execution of the Share Purchase Agreement, there was no relationship between the Company and any of the parties to the Share Purchase Agreement.

This Amendment to the current report filed on May 9, 2006 is being filed to include financial statements of McCue and related pro forma financial information.
 
Exhibits

 
Listed below are the financial statements, pro forma financial information and exhibits, if any, filed as a part of this report.
 
a)
Financial Statements of the Business Acquired.
 
(1)
McCue Systems, Inc. Financial Statements for the year ended December 31, 2004 and 2005

(2)
McCue Systems, Inc. Financial Statements for the three months ended March 31, 2005 and 2006 (Unaudited)
 
(b)
Pro Forma Financial Information.
 
(1)
NetSol Technologies Inc. and Subsidiaries Pro Forma Financial Statements June 30, 2005 (Unaudited)
 
(2)
NetSol Technologies, Inc. and Subsidiaries Pro Forma Financial Statements for the nine months ended March 31, 2006 (Unaudited)
 
(c)
Exhibits
 
2.1
Share Purchase Agreement dated as of May 6, 2006 by and between the Company, McCue and the shareholders of McCue Systems Inc.* 
 
*
Previously filed
 

SIGNATURES

In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
  NETSOL TECHNOLOGIES, INC.
 
 		  
 		  
 
Date:  July 21, 2006 By:   /s/ NAEEM GHAURI
 
 
Name:   Naeem Ghauri
Title:     Chief Executive Officer
 
     
Date:  July 21, 2006 By:   /s/ TINA GILGER
 
 
Name:   Tina Gilger
Title:     Chief Financial Officer
 
 
MCCUE SYSTEMS, INCORPORATED

INDEX TO FINANCIAL STATEMENTS
 
Description
Page
   
F-2
   
F-3
   
F-4
   
F-5
   
F-7
   
F-8
 
F-1

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM 

Board of Directors
McCue Systems, Incorporated
Burlingame, California


We have audited the accompanying balance sheets of McCue Systems, Incorporated as of December 31, 2004 and 2005, and the related statements of operations, stockholders’ deficit and cash flows for the years ended December 31, 2004 and 2005. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, based on our audits, the financial statements referred to above present fairly, in all material respects, the financial position of McCue Systems, Incorporated as of December 31, 2004 and 2005, and the related statements of operations, stockholders’ deficit and cash flows for the years ended December 31, 2004 and 2005 in conformity with accounting principles generally accepted in the United States of America.


/s/ Kabani & Company, Inc.
CERTIFIED PUBLIC ACCOUNTANTS

Los Angeles, California
July 7, 2006
 
F-2
 
MCCUE SYSTEMS, INCORPORATED
BALANCE SHEETS
DECEMBER 31, 2004 and 2005
           
   
2004
  
2005
  
ASSETS
         
Current assets:
          
Cash and cash equivalents
  
$
494,857
  
$
814,868
  
Accounts receivable, net of allowance for doubtful accounts
              
of $44,067
    
1,068,797
   
1,050,570
 
Other current assets
    
83,879
   
80,884
 
 Total current assets
    
1,647,533
   
1,946,322
 
Property and equipment, net of accumulated depreciation
    
57,638
   
59,261
 
Intangible assets
    
139,200
   
232,781
 
Rent deposit
    
41,005
   
41,005
 
 Total assets
  
$
1,885,376
  
$
2,279,369
  
               
LIABILITIES AND STOCKHOLDERS' DEFICIT
             
Current liabilities:
              
Accounts payable and accrued expenses
  
$
644,673
  
$
633,656
  
Current portion of notes payable
    
64,121
   
—
  
Settlement payable
    
—
    
350,000
 
Unearned revenues
    
1,958,991
   
1,459,577
 
 Total current liabilities
    
2,667,785
   
2,443,233
 
Commitments and contingencies
    
—
    
—
  
               
Stockholders' deficit:
              
Series A Preferred Stock, no par value; 500,000 authorized;
              
none issued and outstanding
    
—
    
—
  
Series B Preferred Stock, no par value; 830,000 authorized;
              
none issued and outstanding
    
—
    
—
  
Common stock, no par value; 5,000,000 share authorized;
              
669,539 issued and outstanding
    
2,710,275
   
2,710,275
 
Stock subscription receivable
    
(125,000
)
  
—
  
APIC
    
31,728
   
31,728
 
Accumulated deficit
    
(3,399,412
)
  
(2,905,867
)
 Total stockholders' deficit
    
(782,409
)
  
(163,864
)
 Total liabilities and stockholders' deficit
  
$
1,885,376
  
$
2,279,369
  
               
               
See accompanying notes to these financial statements.
F-3
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF OPERATIONS
           
   
For the Years
  
   
Ended December 31,
  
   
2004
  
2005
  
Revenues:
          
License Fees
  
$
723,351
  
$
1,385,103
  
Maintance Fees
    
1,864,298
   
2,082,868
 
Consulting and services
    
1,663,277
   
1,694,357
 
Hardware sales
    
276,888
   
331,276
 
Application service provider (ASP)
    
—
    
154,033
 
Total revenues
  
$
4,527,814
  
$
5,647,637
  
               
Cost of revenues:
              
Salaries and consultants
    
1,945,721
   
2,089,758
 
Travel and entertainment
    
36,733
   
46,797
 
Hardware
    
220,682
   
219,415
 
Sourcecode escrow
    
3,878
   
7,988
 
ASP expense
    
—
    
130,311
 
Other
    
1,546
   
—
  
Total cost of revenues
    
2,208,560
   
2,494,269
 
Gross profit
    
2,319,254
   
3,153,368
 
               
Operating expenses:
              
Selling and marketing
    
764,032
   
523,053
 
Depreciation and amortization
    
87,516
   
58,005
 
Settlement costs
    
—
    
350,000
 
Bad debt expense
    
27,044
   
20
 
Salaries and wages
    
426,888
   
457,481
 
Professional services, including non-cash
              
 compensation
    
57,815
   
94,774
 
General and adminstrative
    
1,053,448
   
1,070,144
 
 Total operating expenses
    
2,416,743
   
2,553,477
 
Income (loss) from operations
    
(97,489
)
  
599,891
 
Other income and (expenses):
              
Interest expense 
    
(8,122
)
  
(4,561
)
Interest income 
    
20,669
   
15,325
 
Royalty income 
    
13,148
   
1,467
 
Royalty expense 
    
—
    
(7,830
)
Other income 
    
—
    
41,926
 
 Total other income
    
25,695
   
46,327
 
Net income (loss)
  
$
(71,794
)
$
646,218
  
               
Net income (loss) per share:
              
Basic
  
$
(0.11
)
$
0.97
  
Diluted
  
$
(0.11
)
$
0.90
  
               
Weighted average number of shares outstanding
              
Basic
    
669,539
   
669,539
 
Diluted
    
669,539
   
716,260
 
               
             
See accompanying notes to these financial statements.
F-4
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF STOCKHOLDERS’ DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 2004 AND 2005
                           
           
Additional
 
Stock
      
Total
  
   
Common Stock
  
Paid-In
  
Subscriptions
  
Accumulated
  
Stockholders'
  
   
Shares
  
Amount
  
Capital
  
Receivable
  
Deficit
  
Deficit
  
Balance at December 31, 2003
    
668,539
 
$
2,710,275
  
$
31,167
  
$
(125,000
)
$
(3,327,618
)
$
(711,176
)
Fair market value of options issued
                
561
               
561
 
Net loss for the year
                            
(71,794
)
  
(71,794
)
                                       
Balance at December 31, 2004
    
668,539
   
2,710,275
   
31,728
   
(125,000
)
  
(3,399,412
)
  
(782,409
)
Deemed dividend -
                                      
Write-off of subscription receivable
                      
125,000
   
(152,673
)
  
(27,673
)
Net income for the year
                            
646,218
   
646,218
 
Balance at December 31, 2005
    
668,539
 
$
2,710,275
  
$
31,728
  
$
—
  
$
(2,905,867
)
$
(163,864
)
                                       
                                       
See accompanying notes to these financial statements.
F-5
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF CASH FLOWS
           
   
For the Years
  
   
Ended December 31,
  
   
2004
  
2005
  
Cash flows from operating activities:
          
Net income (loss) from continuing operations
  
$
(71,794
)
$
646,218
  
Adjustments to reconcile net income (loss) to net cash
              
provided by operating activities:
              
Depreciation and amortization
    
87,516
   
58,005
 
Provision for uncollectible accounts
    
27,044
   
20
 
Fair market value of options granted
    
561
   
—
  
Changes in operating assets and liabilities:
              
(Increase) decrease in assets:
              
Accounts receivable
    
713,483
   
18,208
 
Other current assets
    
(26,217
)
  
(24,677
)
Increase (decrease) in liabilities:
              
Accounts payable and accrued expenses
    
17,380
   
(11,018
)
Unearned revenues
    
(197,876
)
  
(499,414
)
Litigation settlement
    
—
    
350,000
 
Net cash provided by operating activities
    
550,097
   
537,342
 
Cash flows from investing activities:
              
Purchases of property and equipment
    
(55,379
)
  
(34,785
)
Increase in intangible assets - development costs
    
(139,200
)
  
(118,425
)
Net cash used in investing activities
    
(194,579
)
  
(153,210
)
Cash flows from financing activities:
              
Payments on loans
    
(128,722
)
  
(64,121
)
               
Net increase in cash and cash equivalents
    
226,796
   
320,011
 
Cash and cash equivalents, beginning of period
    
268,061
   
494,857
 
Cash and cash equivalents, end of period
  
$
494,857
  
$
814,868
  
               
             
See accompanying notes to these financial statements.
F-6
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF CASH FLOWS
Continued
           
   
For the Years
  
   
Ended December 31,
  
 
2004
  
2005
  
SUPPLEMENTAL DISCLOSURES:
          
Cash paid during the period for:
              
Interest
  
$
8,122
  
$
4,561
  
Taxes
  
$
—
  
$
—
  
               
OTHER NON-CASH TRANSACTIONS:
              
Deemed dividend - write off of interest and stock subsriptions
              
receivable from a related party
  
$
—
  
$
152,673
  
               
               
See accompanying notes to these financial statements.
F-7
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
NOTE 1 - BUSINESS AND CONTINUED OPERATIONS

McCue Systems, Incorporated, a California corporation, (the “Company”) is a software development firm specializing in lease accounting and asset management applications for the financial services, automotive and high-tech industries. The Company is located in Burlingame, California and was incorporated in 1981. The Company’s product, LeasePak and its suite of modules, is a fully scalable, open architecture system available on multiple platforms. The Company also provides implementation, development, systems integration, and customization services for its clients.
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity:

The Company designs, develops, and markets, proprietary software products to primarily equipment and vehicle lessors in the financial services, automotive finance and high-tech industries in the United States. The Company also provides consulting services in exchange for fees from customers. 

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents:

Equivalents

For purposes of the statement of cash flows, cash equivalents include all highly liquid debt instruments with original maturities of three months or less which are not securing any corporate obligations.

Concentration

Financial instruments that potentially subject the Company to concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents consist primarily of interest-bearing accounts which may exceed the maximum amount covered by depository insurance. The Company’s policy is to place its cash on deposit in high credit quality instruments in financial institutions in the United States.
 
Accounts Receivable:

The Company performs ongoing credit evaluations of its customers and generally does not require collateral for sales on credit. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis.

Property and Equipment:

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation is computed using various methods over the estimated useful lives of the assets, ranging from three to seven years.
F-8
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
The Company accounts for the costs of computer software developed or obtained for internal use in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” The Company capitalizes costs of materials, consultants, and payroll and payroll-related costs for employees incurred in developing internal-use computer software. These costs are included with “Computer equipment and software.” Costs incurred during the preliminary project and post-implementation stages are charged to general and administrative expense.

Intangible Assets:

The Company capitalizes certain computer software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Costs incurred internally to create a computer software product or to develop an enhancement to an existing product are charged to expense when incurred as research and development expense until technological feasibility for the respective product is established. Capitalization ceases when the product or enhancement is available for general release to customers.

The Company makes on-going evaluations of the recoverability of its capitalized software projects by comparing the amount capitalized for each product to the estimated net realizable value of the product. If such evaluations indicate that the unamortized software development costs exceed the net realizable value, the Company writes off the amount which the unamortized software development costs exceed net realizable value. Capitalized and purchased computer software development costs are being amortized ratably based on the projected revenue associated with the related software or on a straight-line basis over three years, whichever method results in a higher level of amortization.

Revenue Recognition:

The Company recognizes its revenue in accordance with the Securities and Exchange Commissions (“SEC”) Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”) and The American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-4 and SOP 98-9, SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” and Accounting Research Bulletin 45 (ARB 45) “Long-Term Construction Type Contracts.” The Company’s revenue recognition policy is as follows:

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 collectibilty is probable. 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.

Services Revenue: Revenue from consulting services is recognized as the services are performed for time-and-materials contracts. Revenue from training and development services is recognized as the services are performed. Revenue from maintenance agreements is recognized ratably over the term of the maintenance agreement, which in most instances is one year.
F-9
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Fair Value:

Unless otherwise indicated, the fair values of all reported assets and liabilities, which represent financial instruments, none of which are held for trading purposes, at the approximate carrying values of such amounts.

Advertising Costs:

The Company expenses the cost of advertising as incurred. Advertising costs for the years ended December 31, 2004 and 2005 were $151,290 and $139,625, respectively.

Net Income (Loss) Per Share:

Net income/(loss) per share is calculated in accordance with the Statement of Financial Accounting Standards No. 128 (SFAS No. 128), “Earnings per share.” Basic net income/loss per share is based upon the weighted average number of common shares outstanding. Diluted net income per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

For the year ended December 31, 2005
  
Net Income
  
Shares
  
Per Share
  
Basic earnings per share:
                    
Net income available to common shareholders
  
$
646,218
    
669,539
 
$
0.97
  
Effect of dilutive securities
                    
Stock options
          
46,721
       
Warrants
              
—
              
Diluted earnings per share
  
$
646,218
    
716,260
 
$
0.90
  
 
The weighted average number of shares used to compute basic and diluted loss per share is the same in these financial statements for the year ended December 31, 2004 since the effect of dilutive securities is anti-dilutive.

Accounting for Stock-Based Compensation:

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which applies the fair-value method of accounting for stock-based compensation plans. In accordance with this standard, the Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.

In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44 (Interpretation 44), “Accounting for Certain Transactions Involving Stock Compensation.” Interpretation 44 provides criteria for the recognition of compensation expense in certain stock-based compensation arrangements that are accounted for under APB Opinion No. 25, Accounting for Stock-Based Compensation. Interpretation 44 became effective July 1, 2000, with certain provisions that were effective retroactively to December 15, 1998 and January 12, 2000. Interpretation 44 did not have any material impact on the Company’s financial statements.
F-10
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Income Taxes:

No provision was made for income tax for the year ended December 31, 2004 and 2005, since the Company had significant net operating loss carry forwards. During the years ended December 31, 2004 and 2005, the Company incurred net operating losses for tax purposes of approximately $57,000 and ($663,000), respectively. As of December 31, 2004 and 2005, the Company had total federal net operating losses for tax purposes of approximately $2,099,000 and $1,436,000, respectively. The federal net operating loss carryforwards may be used to reduce taxable income through the year 2025. As of December 31, 2004 and 2005, the Company had total state net operating losses for tax purposes of approximately $1,832,000 and $1,169,000, respectively. The state net operating loss carryforwards may be used to reduce taxable income through the year 2009. The availability of the Company’s net operating loss carryforwards are subject to limitation if there is a 50% or more positive change in the ownership of the Company’s stock. The provision for income taxes consists of the state minimum tax imposed on corporations.

The gross deferred tax asset balance as of December 31, 2004 and 2005 was approximately $877,000 and $1,143,000, respectively. A 100% valuation allowance has been established against the deferred tax assets, as the utilization of the loss carryforwards cannot reasonably be assured.

The components of the net deferred tax asset are summarized below:

 
December 31, 2004
  
December 31, 2005
  
 
          
Deferred tax assets
          
Accruals deductible in different period
  
$
165,000
  
$
165,000
  
General business credit
    
224,000
    
224,000
  
Net operating losses
    
743,000
    
477,000
  
Other
    
11,000
    
11,000
  
Less: valuation allowance
    
(1,143,000
)
  
(877,000
)
  $ 
—
  
$
—
  

The following is a reconciliation of the provision for income taxes at the U.S. federal income tax rate to the income taxes reflected in the Statement of Operations:

   
December 31, 2005
  
December 31, 2004
  
         
Tax expense (credit) at statutory rate-federal
    
(34
)%
  
(34
)%
State tax expense net of federal tax
    
(6
)
  
(6
)
Changes in valuation allowance
    
40
    
40
  
Tax expense at actual rate
    
—
    
—
  

Income tax expense consisted of the following:

   
2004
  
2005
  
Current tax expense:
          
Federal
  
$
—
  
$
—
  
State
    
800
    
800
  
Total current
  
$
800
  
$
800
  
               
Increase (decrease) in deferred tax asset:
              
Federal
  
$
19,000
  
$
(225,000
)
State
    
4,000
    
(40,000
)
Total
 
$
23,000
  
$
(752,000
)
Less: valuation allowance
    
(23,000
)
  
752,000
  
Net deferred tax asset
    
—
    
—
  
Tax expense
  
$
800
  
$
800
  
 
F-11
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Derivative Instruments:

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” SFAS No. 133, as amended by SFAS No. 137, is effective for fiscal years beginning after June 15, 2000. SFAS No. 133 requires the Company to recognize all derivatives as either assets or liabilities and measure those instruments at fair value. It further provides criteria for derivative instruments to be designated as fair value, cash flow and foreign currency hedges and establishes respective accounting standards for reporting changes in the fair value of the derivative instruments. After adoption, the Company is required to adjust hedging instruments to fair value in the balance sheet and recognize the offsetting gains or losses as adjustments to be reported in net income or other comprehensive income, as appropriate. The Company has complied with the requirements of SFAS 133, the effect of which was not material to the Company’s financial position or results of operations as the Company does not participates in such activities.

Impairment of Long-Lived Assets and Long-Lived Assets to be disposed of:

Effective January 1, 2002, the Company adopted Statement of Financial Accounting Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" ("SFAS 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of," and the accounting and reporting provisions of APB Opinion No. 30, "Reporting the Results of Operations for a Disposal of a Segment of a Business." The Company periodically evaluates the carrying value of long-lived assets to be held and used in accordance with SFAS 144. SFAS 144 requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal.
 
New Accounting Pronouncements:

In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires companies to recognize in the statement of operations the grant- date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective beginning in the Company's first quarter of fiscal 2006. The Company is evaluating the effects adoption of SFAS 123R will have on its financial statements.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior period’s financial statements of changes in accounting principle, unless this would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company believes that the adoption of this standard will have no material impact on its financial statements.
F-12
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities”, and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. SFAS No. 155, permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of the Company’s first fiscal year that begins after September 15, 2006. SFAS No. 155 is not expected to have a material effect on the financial position or results of operations of the Company.
 
In March 2006 FASB issued SFAS 156 ‘Accounting for Servicing of Financial Assets’ this Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement:
 
1.
Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract.
 
2.
Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.
 
3.
Permits an entity to choose ‘Amortization method’ or ‘Fair value measurement method’ for each class of separately recognized servicing assets and servicing liabilities.
 
4.
At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.
 
5.
Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.
 
This Statement is effective as of the beginning of the Company’s first fiscal year that begins after September 15, 2006. Management believes that this statement will not have a significant impact on the consolidated financial statements.
 
Reclassifications:

For comparative purposes, prior year’s consolidated financial statements have been reclassified to conform with report classifications of the current year.

NOTE 3 - MAJOR CUSTOMERS

At December 31, 2004, three customers accounted for 35%, 19% and 10% of revenues or a total of $2,899,953 and a total balance of $818,874 in accounts receivable at year end. At December 31, 2005 four customers accounted for 29%, 11%, 11% and 10% of revenues during 2005 or a total of $3,443,965 and a total balance of $682,699 in accounts receivable at year end. No other individual client represents more than 10% of the revenue for the years ended December 31, 2004 and 2005.
F-13
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
NOTE 4 - OTHER CURRENT ASSETS

Other current assets consist of the following as of December 31, 2004 and 2005:
 
 
2004
  
2005
  
Prepaid Expenses
  
$
45,981
  
$
48,825
  
Employee Advances
    
13,200
   
32,059
 
Interest Receivable
    
24,698
   
—
  
Total
 
$
83,879
  
$
80,884
  
 
NOTE 5 - PROPERTY AND EQUIPMENT

Property and equipment, net, consists of the following at December 31, 2004 and 2005:
 
 
2004
  
2005
  
Office furniture and equipment
  
$
89,632
  
$
89,632
  
Computer equipment
    
450,623
   
484,223
 
Subtotal
    
540,255
   
573,855
 
Accumulated depreciation
    
(482,617
)
  
(514,594
)
   
$
57,638
  
$
59,261
  
 
For the years ended December 31, 2004 and 2005, fixed asset depreciation expense totaled $87,516 and $33,161, respectively.

NOTE 6 - INTANGIBLE ASSETS

Intangible assets consist of computer software development costs at December 31, 2004 and 2005:
 
 
2004
  
2005
  
Intangible asset - Beginning
  
$
407,746
    
546,946
 
Additions
    
139,200
   
118,425
 
Accumulated amortization
    
(407,746
)
  
(432,590
)
Net balance - Ending
  
$
139,200
  
$
232,781
  
               
               
Amortization expense
  
$
—
  
$
24,844
  
 
F-14

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Amortization expense of intangible assets over the next three years is as follows: 

 
YEAR ENDING
      
Asset
  
12/31/06
  
12/31/07
  
12/31/08
  
TOTAL
  
Capitalized Software R&D
  
$
85,875
  
$
85,875
  
$
61,031
  
$
232,781
  
   
$
85,875
  
$
85,875
  
$
61,031
  
$
232,781
  

NOTE 7 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consisted of the following as of December 31, 2004 and 2005:

 
2004
  
2005
  
Accounts Payable - trade
  
$
287,774
  
$
135,283
  
Bank Overdraft
    
21,701
   
—
  
Sales Tax Payable
    
13,704
   
2,241
 
Section 125 Plan Payable
    
2,103
   
3,886
 
Accrued Liabilities
    
28,129
   
89,454
 
Accrued Payroll
    
19,870
   
—
  
Accrued Commissions
    
29,189
   
57,899
 
Accrued Vacation Payable
    
242,203
   
301,040
 
Other Payable
    
—
    
43,853
 
Total
  
$
644,673
  
$
633,656
  
 
On May 16, 2005, the Company entered into an agreement with a customer whereby the Company agreed to refund a portion of the license fee purchased by the customer. The total amount to be refunded was $78,933 and is to be paid in nine quarterly installments of $8,770. During the year ended December 31, 2005, $35,080 was paid and a balance of $43,853 was owed at December 31, 2005, which was recorded as other payable.

NOTE 8 - DEBTS

NOTES PAYABLE - CURRENT

On March 29, 2002, the Company entered into an agreement with the preferred stock holders whereby the Company repurchased the outstanding preferred shares with cash in the amount of $487,132 and notes payable of $194,834 with a three-year maturity date and an interest rate of 8% per annum, simple interest. The notes were payable in quarterly installments. As of December 31, 2003 the loan balance was $192,844. During the year ended December 31, 2004, $128,722 was paid on the notes and the balance owing was $64,121. During the year ended December 31, 2005, the balance owing was paid.

NOTE 9 - SETTLEMENT PAYABLE

The Company was sued by two former employees in 1999 (see note 14). On April 17, 2006, a settlement agreement was entered into whereby the Company agreed to pay a total of $700,000 to the two former employees. $350,000 of the $700,000 was paid by the Company’s insurance company directly to the two former employees upon the signing of the settlement agreement. The Company paid $275,000 upon the signing of the settlement agreement and agreed to pay the remaining $75,000 within 90 days of the settlement agreement. As the amount of the settlement was undeterminable at December 31, 2004, no amount was recorded as a liability in 2004. The Company’s direct liability of $350,000 was recorded as of December 31, 2005 as the amount became determinable before the issuance of the financial statements. It is shown as a settlement payable.
 
F-15

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
NOTE 10 - STOCKHOLDERS’ EQUITY

Deemed dividend and write off of stock subscription receivable

In September 2000, a major shareholder and President of the Company exercised warrants to purchase 166,667 shares of the Company’s common stock at $0.75 per share. The Company agreed to loan the amount to the officer to purchase the shares. The loan carried an interest rate of 9% per annum. In August 2003, the interest rate was lowered to 5.5% per annum. As of December 31, 2003, the balance of interest owing was $17,804. During the year ended December 31, 2004, $6,894 in interest was recorded and the balance owing at December 31, 2004 was $24,698. In January 2005, the interest rate was lowered to 2.38%. During the year ended December 31, 2005, $2,975 of interest was recorded. On December 31, 2005, the Board of Directors authorized the write-off of the balance owing, including interest. The total amount written-off was $152,673 and was recorded as a deemed dividend in the statement of stockholders’ deficit in the year ended December 31, 2005.

NOTE 11 - INCENTIVE AND NON-STATUTORY STOCK OPTION PLAN

Under the 1997 Employee Stock Option Plan (the “Option Plan”), the Company may grant options to purchase up to 450,000 shares of common stock to employees and consultants at prices not less than the fair market value at date of grant for incentive stock options and not less than 85% of fair market value for nonstatutory stock options. For owners of more than 10% of the Company’s stock, options may only be granted for an exercise price of no less than 110% of fair market value on the date of grant for both incentive and nonstatutory stock options. These options generally expire five years from the date of grant and generally vest 33% one year from the date of grant and 1/36th each month thereafter for the next 24 months. In the event of a merger of the Company with or into another corporation, or the sale of substantially all of the assets of the Company, all outstanding options granted vest immediately.

NOTE 12 - COMMON STOCK PURCHASE WARRANTS AND OPTIONS

From time to time, the Company issues options and warrants as incentives to employees, officers and directors, as well as to non-employees.

Common stock purchase options and warrants consisted of the following as of December 31, 2004 and 2005:

       
Weighted
      
Weighted
  
       
Average
      
Average
  
       
Exercise
      
Exercise
  
 
Options
  
Price
  
Warrants
  
Price
  
Outstanding as of December 31, 2003
    
9,008
 
$
1.01
    
334,294
 
$
0.72
  
Granted
    
91,000
 
$
0.72
              
Exercised
    
—
          
—
        
Expired
    
—
               
—
        
Outstanding as of December 31, 2004
    
100,008
 
$
0.75
    
334,294
       
Granted
    
193,400
 
$
0.75
              
Exercised
    
—
          
—
        
Expired
    
—
               
—
        
Outstanding as of December 31, 2005
    
293,408
 
$
0.82
    
334,294
       
 
F-16

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
The following summary presents the weighted average exercise prices, number of options and warrants outstanding and exercisable, and the remaining contractual lives of the Company’s stock options and warrants as of December 31, 2004 and 2005:

   
OPTIONS
  
WARRANTS
  
 
12/31/2004
  
12/31/2005
  
12/31/2004
  
12/31/2005
  
Number Outstanding
    
100,008
   
293,408
   
334,294
   
334,294
 
Weighted Average Remaining Life
    
3.93
   
4.00
   
5.00
   
4.00
 
Weighted Average Exercise Price
  
$
0.75
  
$
0.82
  
$
0.72
  
$
0.72
  
Number Exercisable
    
8,340
   
39,341
   
—
    
—
  
Weighted Average Exercise Price
  
$
1.04
  
$
0.79
              
 
During the year ended December 31, 2004, 88,000 options were granted to employees and officers of the company. The options vest over three years, 33% after one year and 1/36th per month for 24 months, and expire five years from the date of grant unless the employee terminates employment, in which case the options expire within 90 days of the employee’s termination date

In addition, 3,000 options were granted to a consultant and expire five years from the date of grant. The options were valued using the fair value method at $561 or $0.187 per share and were recorded as an expense in the accompanying financial statements. The Black-Scholes option pricing model used the following assumptions:

Risk-free interest rate
    
6.0
%
Expected life
    
5 years
  
Expected volatility
    
.001
%
Dividend yield
    
0
%

During the year ended December 31, 2005, 167,900 options were granted to employees and officers of the company. The options vest over three years, 33% after one year and 1/36th per month for 24 months, and expire five years from the date of grant unless the employee terminates employment, in which case the options expire within 90 days of their termination.

In addition, 25,500 options were granted to consultants and expire five years from the date of grant. No expense was recorded for these options since their fair value calculated by Black-schole option pricing model is zero. The Black-Scholes option pricing model used the following assumptions:

Risk-free interest rate
    
6.0
%
Expected life
    
5 years
  
Expected volatility
    
.001
%
Dividend yield
    
0
%

In 2002, the Company granted 334,294 warrants to purchase Series A preferred stock with an exercise price of $0.72 per share as part of a preferred stock repurchase agreement with the former preferred stockholders. These warrants become exercisable only at the time of a liquidation event defined as a) a merger or consolidation of the Company with another Company, b) a sale of substantially all the assets of the Company to another Company or c) an IPO and expire seven years from the time of grant. No expense has been taken on these warrants until such time as they become exercisable.

In compliance with FAS No. 148, the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation plan as defined by APB No. 25 and has made the applicable disclosures below.
 
F-17

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Had the Company determined employee stock based compensation cost based on a fair value model at the grant date for its stock options under SFAS 123, the Company's net earnings per share would have been adjusted to the pro forma amounts for years ended December 31, 2004 and 2005 as follows:

 
2004
  
2005
  
Net income (loss) - as reported
  
$
(71,794
)
$
646,218
  
Stock-based employee compensation expense,
              
included in reported net loss, net of tax
    
—
    
—
  
Total stock-based employee compensation
              
expense determined under fair-value-based
              
method for all rewards, net of tax
    
(385
)
  
(10,566
)
Pro forma net income (loss)
  
$
(72,179
)
$
635,652
  
             
Earnings per share:
              
Basic, as reported
    
(0.11
)
  
0.97
 
Diluted, as reported
    
(0.11
)
  
0.91
 
               
Basic, pro forma
    
(0.11
)
  
0.95
 
Diluted, pro forma
    
(0.11
)
  
0.90
 
 
Pro forma information regarding the effect on operations is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. Pro forma information using the Black-Scholes method at the date of grant is based on the following assumptions:
 
 
2004
  
2005
  
Expected life (years)
    
5 years
    
5 years
  
Risk-free interest rate
    
6.0
%
  
6.0
%
Dividend yield
    
—
    
—
  
Volatility
    
.001
%
  
.001
%


NOTE 13 - EMPLOYEE BENEFIT PLANS

The Company has a qualified employee savings and retirement plan (401(k) plan). The 401(k) plan allows the Company to make discretionary contributions of up to 3% of employee’s salary given at the discretion of the board and/or management. The Company made no contributions during the years ended December 31, 2004 and 2005.

NOTE 14 - COMMITMENTS AND CONTINGENCIES

Leases

The Company leases its facility under an operating lease that expires in July 2007. Rent expense is as follows for the remaining lease term:

July 1, 2005 - June 30, 2006: $20,051 per month.
July 1, 2006 - June 30, 2007: $20,552 per month.

Rent expense was $236,683 and $243,861 in 2004 and 2005, respectively.
 
F-18

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
Litigation

On July 27, 1999, two former employees of the Company, Mohamad Rashedi and Gregory Saylor, and the company formed by the former employees (Integrated Support Services, a general partnership "IS") filed a complaint in the Superior Court of San Mateo County alleging damages for unfair competition, defamation, restraint of trade and prevention of employment. A counter-suit was filed by the Company against the plaintiffs alleging misappropriation of proprietary materials. On or about Feb. 16, 2001, the matter went to trial and a verdict was entered against the defendants and the plaintiffs were found not guilty on the defendants counter-suit. Defendants moved for a new trial on the damages which was granted. The new trial was scheduled to commence on April 17, 2006.

While the Company believes that it is not liable for damages to the plaintiffs, in the interest of settling the matter and avoiding the expenses of trial, the Company executed a Settlement and Release Agreement on April 17, 2006. The terms of the Settlement and Release Agreement call for the Company to pay the two former employees $625,000 upon the execution of the Settlement and Release Agreement and $75,000 within 90 days of the execution of the Settlement and Release Agreement. The Company's insurance carrier paid half of the settlement cost directly to the two former employees upon the signing of the settlement agreement. As of June 12, 2006 the full settlement amount had been paid and a dismissal with prejudice of the action was filed effective June 22, 2006.

NOTE 15 - ROYALTY AGREEMENTS

Under royalty agreements, sales of certain products require the Company to pay royalties to third parties under specified circumstances and/or under specified time frames. Royalty expense was $0 and $7,830 in 2004 and 2005, respectively.  In addition, the Company receives royalties on the sales of certain products. Royalty income was $13,148 and $1,467 in 2004 and 2005, respectively.

NOTE 16 - RELATED PARTY TRANSACTIONS

In September 2000, a major shareholder and President of the Company exercised warrants to purchase 166,667 shares of the Company’s common stock at $0.75 per share. The Company agreed to loan the amount to the President to purchase the shares. The loan carried an interest rate of 9% per annum. In August 2003, the interest rate was lowered to 5.5% per annum. As of December 31, 2003, the balance of interest owing was $17,804. During the year ended December 31, 2004, $6,894 in interest was recorded and the balance owing at December 31, 2004 was $24,698. In January 2005, the interest rate was lowered to 2.38%. During the year ended December 31, 2005, $2,975 of interest was recorded. On December 31, 2005, the Board of Directors authorized the write-off of the balance owing, including interest. The total amount written-off was $152,673 and was recorded as a deemed dividend.

The employment agreement with the President of the Company calls for bonuses to be paid to him based on certain milestones achieved and sales generated. During 2004 and 2005, $18,000 and $66,829 was accrued. At December 31, 2004 and 2005, $18,000 and $84,829 remained unpaid and is included in accrued liabilities in these financial statements. Salaries paid to the President of the Company were $224,400, which included $66,000 of retroactive pay deferred from 2002, in 2004 and $160,710 in 2005.

NOTE 17 - SUBSEQUENT EVENTS (unaudited)

On May 6, 2006 the stockholders voted in favor of the Company being acquired by NetSol Technologies, Inc. (“NetSol”), a publicly listed corporation on the NASDAQ exchange, (NTWK). Under the agreement, NetSol will purchase 100% of the outstanding stock of McCue. The estimated purchase price based on the December 31, 2005 revenues is $8.5 million dollars. The agreement calls for a closing date on or about June 30, 2006.
 
F-19

MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
 
According to the terms of the Share Purchase Agreement, NetSol is to acquire 100% of the issued and outstanding shares of McCue from McCue’s current shareholders, whose identity is set forth in the Share Purchase Agreement (the “McCue Shareholders”) at the completion date in exchange for a purchase price consisting of: a) 50% of McCue’s total gross revenue for the audited twelve month period ending December 31, 2005 after an adjustment for any revenue occurring outside of the company’s ordinary scope of operations as defined by US GAAP multiplied by 1.5 payable: (i) 50% in shares of restricted common stock of NetSol at the 30 day volume weighted average price (“VWAP) for each of the 30 trading days prior to the execution date of this agreement or at the VWAP for each of the 30 trading days prior to November 30, 2005 whichever is the greater VWAP; and, (ii) 50% in cash; b) 25% of McCue’s total gross revenue for the twelve months ending December 31, 2006 multiplied by 1.5 payable, at NetSol’s discretion: (i) wholly in cash; or (ii) on the same basis and on the same terms as the initial payment provided that under no circumstances shall the total number of shares of common stock issued to the McCue Shareholders exceed 19% of the issued and outstanding shares of common stock, less treasury shares, of NetSol at May 6, 2006; and c) 25% of McCue’s total gross revenue for the twelve months ending December 31, 2007 multiplied by 1.5 payable, at the Company’s discretion: (i) wholly in cash; or (ii) on the same basis and on the same terms as the initial payment provided that under no circumstances shall the total number of shares of common stock issued to the McCue Shareholders exceed 19% of the issued and outstanding shares of common stock, less treasury shares, of NetSol at May 6, 2006.

The initial payment will consist of approximately $2.1 million in cash and 985,213 shares of NetSol’s restricted common stock.

During May and June 2006, 281,908 options were exercised for a total of $230,276 of which $4,020 was received in cash and the remaining amount of $226,356 was recorded as a receivable. The amount due from the shareholders will be withheld from any funds due to them at the close of the acquisition by NetSol. In addition, the option holders were granted a loan from the Company of $0.33 per share to help defray any tax consequence of the option exercise. This loan is to be repaid from the proceeds of the second and third installment of the purchase price of the acquisition by NetSol.

During May and June 2006, 323,682 warrants were exercised. Of these, 281,540 were exercised under a cashless exercise provision of $0.85 per share and 238,735 shares were issued as a result. $1,542 was received in cash and a receivable for $28,800 was recorded. The receivable will be withheld from any funds due to them at the close of the acquisition by NetSol.

On June 12, 2006 the Company paid the remaining balance of $75,000 due on the settlement agreement (See Note 14). On June 22, 2006 a dismissal of the case was filed with the court.
 
F-20
MCCUE SYSTEMS, INCORPORATED

INDEX TO UNAUDITED FINANCIAL STATEMENTS
 
Description
Page
   
F-2
   
F-3
   
F-4
   
F-6
 
F-1
 
MCCUE SYSTEMS, INCORPORATED
BALANCE SHEETS
DECEMBER 31, 2004 and 2005
(UNAUDITED)
           
   
2005
  
2006
  
ASSETS
          
Current assets:
          
Cash and cash equivalents
  
$
542,415
  
$
886,714
  
Accounts receivable, net of allowance for doubtful accounts
              
 of $44,067
    
1,164,055
   
893,919
 
Other current assets
    
80,218
   
68,243
 
 Total current assets
    
1,786,688
   
1,848,876
 
Property and equipment, net of accumulated depreciation
    
47,852
   
64,706
 
Intangible assets
    
139,200
   
211,312
 
Rent deposit
    
41,005
   
41,005
 
 Total assets
  
$
2,014,745
  
$
2,165,899
  
               
LIABILITIES AND STOCKHOLDERS' DEFICIT
              
Current liabilities:
              
Accounts payable and accrued expenses
  
$
545,219
  
$
640,205
  
Current portion of notes payable
    
64,121
   
—
  
Settlement payable
    
—
    
350,000
 
Unearned revenues
    
2,101,875
   
1,458,244
 
 Total current liabilities
    
2,711,215
   
2,448,449
 
Commitments and contingencies
    
—
    
—
  
               
Stockholders' deficit:
              
Series A Preferred Stock, no par value; 500,000 authorized;
              
none issued and outstanding
    
—
    
—
  
Series B Preferred Stock, no par value; 830,000 authorized;
              
none issued and outstanding
    
—
    
—
  
Common stock, no par value; 5,000,000 share authorized;
              
669,539 issued and outstanding
    
2,710,275
   
2,710,275
 
APIC
    
31,728
   
31,728
 
Stock subscription receivable
    
(125,000
)
  
—
  
Accumulated deficit
    
(3,313,473
)
  
(3,024,553
)
 Total stockholders' deficit
   
(696,470
)
  
(282,550
)
 Total liabilities and stockholders' deficit
 
$
2,014,745
  
$
2,165,899
  
               
               
See accompanying notes to these financial statements.
F-2
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF OPERATIONS
(UNAUDITED)
           
   
For the three months
  
   
Ended March 31,
  
   
2005
  
2006
  
Revenues:
          
License Fees
  
$
246,960
  
$
169,126
  
Maintance Fees
    
485,660
   
599,545
 
Consulting and services
    
463,763
   
281,389
 
Hardware sales
    
9,800
   
7,791
 
Application service provider (ASP)
    
—
    
76,011
 
Total revenues
  
$
1,206,183
  
$
1,133,862
  
               
Cost of revenues:
              
Salaries and consultants
    
598,466
   
583,968
 
Travel and entertainment
    
7,621
   
5,510
 
Hardware
    
3,375
   
5,145
 
Sourcecode escrow
    
3,398
   
1,107
 
ASP expense
    
—
    
24,479
 
Total cost of revenues
    
612,860
   
620,209
 
Gross profit
    
593,323
   
513,653
 
               
Operating expenses:
              
Selling and marketing
    
112,801
   
156,271
 
Depreciation and amortization
    
9,785
   
29,368
 
Salaries and wages
    
182,085
   
171,058
 
Professional services, including non-cash
              
compensation
    
4,470
   
85,296
 
General and adminstrative
    
200,358
   
200,826
 
 Total operating expenses
    
509,499
   
642,819
 
Income (loss) from operations
    
83,824
   
(129,166
)
Other income and (expenses):
              
Interest expense
    
(1,282
)
  
—
  
Interest income
    
2,996
   
6,632
 
Royalty income
    
401
   
—
  
Other income
    
—
    
3,848
 
 Total other income
    
2,115
   
10,480
 
Net income (loss)
  
$
85,939
  
$
(118,686
)
             
Net income (loss) per share:
              
Basic
  
$
0.13
  
$
(0.18
)
Diluted
  
$
0.12
  
$
(0.18
)
               
Weighted average number of shares outstanding
              
Basic
    
669,539
   
669,539
 
Diluted
    
698,075
   
669,539
 
             
             
See accompanying notes to these financial statements.
F-3
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
           
   
For the three months
  
   
Ended March 31,
  
   
2005
  
2006
  
Cash flows from operating activities:
          
Net income (loss) from continuing operations
  
$
85,939
  
$
(118,686
)
Adjustments to reconcile net income to net cash
              
provided by operating activities:
              
Depreciation and amortization
    
9,785
   
29,368
 
Changes in operating assets and liabilities:
              
(Increase) decrease in assets:
              
Accounts receivable
    
(95,257
)
  
156,651
 
Other current assets
    
3,663
   
12,641
 
Increase (decrease) in liabilities:
              
Accounts payable and accrued expenses
    
(99,456
)
  
6,549
 
Unearned revenues
    
142,884
   
(1,333
)
Net cash provided by operating activities
    
47,558
   
85,190
 
Cash flows from investing activities:
              
Purchases of property and equipment
    
—
    
(13,344
)
Net cash used in investing activities
    
—
    
(13,344
)
Cash flows from financing activities:
              
Payments on loans
    
—
    
—
  
Net cash used in financing activities
    
—
    
—
  
Net increase in cash and cash equivalents
    
47,558
   
71,846
 
Cash and cash equivalents, beginning of period
    
494,857
   
814,868
 
Cash and cash equivalents, end of period
  
$
542,415
  
$
886,714
  
               
               
See accompanying notes to these financial statements.
F-4
 
MCCUE SYSTEMS, INCORPORATED
STATEMENTS OF CASH FLOWS
(UNAUDITED)
Continued
       
   
For the three months
  
   
Ended March 31,
  
 
2005
  
2006
  
SUPPLEMENTAL DISCLOSURES:
          
Cash paid during the period for:
              
Interest
  
$
1,282
  
$
—
  
Taxes
  
$
—
  
$
1,600
  
             
             
See accompanying notes to these financial statements.
F-5
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 1 - BUSINESS AND CONTINUED OPERATIONS

McCue Systems, Incorporated, a California corporation, (the “Company”) is a software development firm specializing in lease accounting and asset management applications for the financial services, automotive and high-tech industries. The Company is located in Burlingame, California and was incorporated in 1981. The Company’s product, LeasePak and its suite of modules, is a fully scalable, open architecture system available on multiple platforms. The Company also provides implementation, development, systems integration, and customization services for its clients.
 
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Business Activity:

The Company designs, develops, and markets, proprietary software products to primarily equipment and vehicle lessors in the financial services, automotive finance and high-tech industries in the United States. The Company also provides consulting services in exchange for fees from customers. 

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Cash and Cash Equivalents:

Equivalents

For purposes of the statement of cash flows, cash equivalents include all highly liquid debt instruments with original maturities of three months or less which are not securing any corporate obligations.

Concentration

Financial instruments that potentially subject the Company to concentration of credit risk consist of cash and cash equivalents and accounts receivable. Cash and cash equivalents consist primarily of interest-bearing accounts which may exceed the maximum amount covered by depository insurance. The Company’s policy is to place its cash on deposit in high credit quality instruments in financial institutions in the United States.
 
Accounts Receivable:

The Company performs ongoing credit evaluations of its customers and generally does not require collateral for sales on credit. The Company maintains reserves for potential credit losses on accounts receivable. Management reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of these reserves. Reserves are recorded primarily on a specific identification basis.

Property and Equipment:

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred; additions, renewals and betterments are capitalized. When property and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations. Depreciation is computed using various methods over the estimated useful lives of the assets, ranging from three to seven years.
 
F-6
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
The Company accounts for the costs of computer software developed or obtained for internal use in accordance with Statement of Position 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use.” The Company capitalizes costs of materials, consultants, and payroll and payroll-related costs for employees incurred in developing internal-use computer software. These costs are included with “Computer equipment and software.” Costs incurred during the preliminary project and post-implementation stages are charged to general and administrative expense.

Intangible Assets:

The Company capitalizes certain computer software development costs in accordance with SFAS No. 86, “Accounting for the Costs of Computer Software to be Sold, Leased, or Otherwise Marketed.” Costs incurred internally to create a computer software product or to develop an enhancement to an existing product are charged to expense when incurred as research and development expense until technological feasibility for the respective product is established. Capitalization ceases when the product or enhancement is available for general release to customers.

The Company makes on-going evaluations of the recoverability of its capitalized software projects by comparing the amount capitalized for each product to the estimated net realizable value of the product. If such evaluations indicate that the unamortized software development costs exceed the net realizable value, the Company writes off the amount which the unamortized software development costs exceed net realizable value. Capitalized and purchased computer software development costs are being amortized ratably based on the projected revenue associated with the related software or on a straight-line basis over three years, whichever method results in a higher level of amortization.

Revenue Recognition:

The Company recognizes its revenue in accordance with the Securities and Exchange Commissions (“SEC”) Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements” (“SAB 101”) and The American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 97-2, “Software Revenue Recognition,” as amended by SOP 98-4 and SOP 98-9, SOP 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts,” and Accounting Research Bulletin 45 (ARB 45) “Long-Term Construction Type Contracts.” The Company’s revenue recognition policy is as follows:

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 collectibilty is probable. 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.

Services Revenue: Revenue from consulting services is recognized as the services are performed for time-and-materials contracts. Revenue from training and development services is recognized as the services are performed. Revenue from maintenance agreements is recognized ratably over the term of the maintenance agreement, which in most instances is one year.
 
F-7
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

Fair Value:

Unless otherwise indicated, the fair values of all reported assets and liabilities, which represent financial instruments, none of which are held for trading purposes, at the approximate carrying values of such amounts.

Advertising Costs:

The Company expenses the cost of advertising as incurred. Advertising costs for the three months ended March 31, 2005 and 2006 were $35,669 and $52,028, respectively.

Net Income (Loss) Per Share:

Net income/(loss) per share is calculated in accordance with the Statement of Financial Accounting Standards No. 128 (SFAS No. 128), “Earnings per share.” Basic net income/loss per share is based upon the weighted average number of common shares outstanding. Diluted net income per share is based on the assumption that all dilutive convertible shares and stock options were converted or exercised. Dilution is computed by applying the treasury stock method. Under this method, options and warrants are assumed to be exercised at the beginning of the period (or at the time of issuance, if later), and as if funds obtained thereby were used to purchase common stock at the average market price during the period.

The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations:

For the three months ended March 31, 2005
 
Net Income
  
Shares
  
Per Share
  
Basic earnings per share:
              
Net income available to common shareholders
  
$
85,939
    
669,539
 
$
0.13
  
Effect of dilutive securities
                    
Stock options
          
28,536
       
Warrants
          
—
        
Diluted earnings per share
  
$
85,939
    
698,075
 
$
0.12
  
 
The weighted average number of shares used to compute basic and diluted loss per share is the same in these financial statements for the three months ended March 31, 2006 since the effect of dilutive securities is anti-dilutive.

Accounting for Stock-Based Compensation:

The Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, which applies the fair-value method of accounting for stock-based compensation plans. In accordance with this standard, the Company accounts for stock-based compensation in accordance with Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees.

In March 2000, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 44 (Interpretation 44), “Accounting for Certain Transactions Involving Stock Compensation.” Interpretation 44 provides criteria for the recognition of compensation expense in certain stock-based compensation arrangements that are accounted for under APB Opinion No. 25, Accounting for Stock-Based Compensation. Interpretation 44 became effective July 1, 2000, with certain provisions that were effective retroactively to December 15, 1998 and January 12, 2000. Interpretation 44 did not have any material impact on the Company’s financial statements.
 
F-8
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
New Accounting Pronouncements:

In December 2004, the FASB issued FASB Statement No. 123R, "Share-Based Payment, an Amendment of FASB Statement No. 123" ("FAS No. 123R"). FAS No. 123R requires companies to recognize in the statement of operations the grant- date fair value of stock options and other equity-based compensation issued to employees. FAS No. 123R is effective beginning in the Company's first quarter of fiscal 2006. The Company is evaluating the effects adoption of SFAS 123R will have on its financial statements.

In May 2005, the FASB issued SFAS No. 154, "Accounting Changes and Error Corrections." This statement applies to all voluntary changes in accounting principle and requires retrospective application to prior period’s financial statements of changes in accounting principle, unless this would be impracticable. This statement also makes a distinction between "retrospective application" of an accounting principle and the "restatement" of financial statements to reflect the correction of an error. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company believes that the adoption of this standard will have no material impact on its financial statements.

In February 2006, FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments”. SFAS No. 155 amends SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities”, and SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. SFAS No. 155, permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument. This statement is effective for all financial instruments acquired or issued after the beginning of the Company’s first fiscal year that begins after September 15, 2006. SFAS No. 155 is not expected to have a material effect on the financial position or results of operations of the Company.
 
In March 2006 FASB issued SFAS 156 ‘Accounting for Servicing of Financial Assets’ this Statement amends FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities. This Statement:
 
1.
Requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract.
 
2.
Requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable.
 
3.
Permits an entity to choose ‘Amortization method’ or ‘Fair value measurement method’ for each class of separately recognized servicing assets and servicing liabilities.
 
4.
At its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value.
 
5.
Requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.
 
This Statement is effective as of the beginning of the Company’s first fiscal year that begins after September 15, 2006. Management believes that this statement will not have a significant impact on the consolidated financial statements.
 
F-9
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
Reclassifications:

For comparative purposes, prior year’s consolidated financial statements have been reclassified to conform with report classifications of the current year.

NOTE 3 - MAJOR CUSTOMERS

At March 31, 2005, two customers accounted for 34%, and 10% of revenues or a total of $530,079 and a total balance of $334,789 in accounts receivable at quarter end. At March 31, 2006 three customers accounted for 34%, 12%, 11% of revenues or a total of $648,594 and a total balance of $416,608 in accounts receivable at quarter end. No other individual client represents more than 10% of the revenue for the three months ended March 31, 2005 and 2006.

NOTE 4 - OTHER CURRENT ASSETS

Other current assets consist of the following as of March 31, 2005 and 2006:

   
For the three months
  
   
ended March 31,
  
 
2005
  
2006
  
Prepaid Expenses
  
$
39,087
  
$
47,060
  
Employee Advances
    
15,700
   
21,183
 
Interest Receivable
    
25,431
   
—
  
Total
  
$
80,218
  
$
68,243
  

NOTE 5 - PROPERTY AND EQUIPMENT

Property and equipment, net, consists of the following at March 31, 2005 and 2006:
 
 
2005
  
2006
  
Office furniture and equipment
  
$
89,632
  
$
89,632
  
Computer equipment
    
450,623
   
497,567
 
Subtotal
    
540,255
   
587,199
 
Accumulated depreciation
    
(492,403
)
  
(522,493
)
   
$
47,852
  
$
64,706
  
 
For the three months ended March 31, 2005 and 2006, fixed asset depreciation expense totaled $9,785 and $7,899, respectively.
 
F-10
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)

NOTE 6 - INTANGIBLE ASSETS

Intangible assets consist of computer software development costs at March 31, 2005 and 2006:

 
2005
  
2006
  
Intangible asset - Beginning
  
$
546,946
    
665,371
 
Additions
    
—
    
—
  
Accumulated amortization
    
(407,746
)
  
(454,059
)
Net balance - Ending
  
$
139,200
  
$
211,312
  
               
               
Amortization expense
  
$
—
  
$
21,469
  
 
Amortization expense of intangible assets over the next three years is as follows: 

 
YEAR ENDING
      
Asset
  
3/31/07
   
3/31/08
   
3/31/09
  
TOTAL
  
Capitalized Software R&D
  
$
85,875
   
$
85,875
   
$
39,562
  
$
211,312
  
Total  
$
85,875
   
$
85,875
   
$
39,562
  
$
211,312
  

NOTE 7 - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consisted of the following as of March 31, 2005 and 2006:

   
For the three months
  
   
ended March 31,
  
 
2005
  
2006
  
Accounts Payable - trade
  
$
141,339
  
$
205,381
  
Bank Overdraft
    
4,243
   
—
  
Sales Tax Payable
    
56,302
   
(9,289
)
Section 125 Plan Payable
    
3,274
   
2,859
 
Accrued Liabilities
    
30,200
   
38,606
 
Accrued Payroll
    
12,161
   
—
  
Accrued Commissions
    
27,566
   
40,642
 
Accrued Vacation Payable
    
268,851
   
318,152
 
Accrued Interest Payable
    
1,282
   
—
  
Other Payable
    
—
    
43,853
 
Total
  
$
545,218
  
$
640,204
  
 
On May 16, 2005, the Company entered into an agreement with a customer whereby the Company agreed to refund a portion of the license fee purchased by the customer. The total amount to be refunded was $78,933 and is to be paid in nine quarterly installments of $8,770. During the year ended December 31, 2005, $35,080 was paid and a balance of $43,853 was owed at December 31, 2005, which was recorded as other payable. No payment was made during the three months ended March 31, 2006.
 
F-11
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 8 - DEBTS

NOTES PAYABLE - CURRENT

On March 29, 2002, the Company entered into an agreement with the preferred stock holders whereby the Company repurchased the outstanding preferred shares with cash in the amount of $487,132 and notes payable of $194,834 with a three-year maturity date and an interest rate of 8% per annum, simple interest. The notes were payable in quarterly installments. As of December 31, 2003 the loan balance was $192,844. During the year ended December 31, 2004, $128,722 was paid on the notes and the balance owing was $64,121. No payments were made during the three months ended March 31, 2005. During the year ended December 31, 2005, the balance owing was paid.

NOTE 9 - SETTLEMENT PAYABLE

The Company was sued by two former employees in 1999 (see note 14). On April 17, 2006, a settlement agreement was entered into whereby the Company agreed to pay a total of $700,000 to the two former employees. $350,000 of the $700,000 was paid by the Company’s insurance company directly to the two former employees upon the signing of the settlement agreement. The Company paid $275,000 upon the signing of the settlement agreement and agreed to pay the remaining $75,000 within 90 days of the settlement agreement. As the amount of the settlement was undeterminable at December 31, 2004, no amount was recorded as a liability in 2004. The Company’s direct liability of $350,000 was recorded as of December 31, 2005 as the amount became determinable before the issuance of the financial statements. It is shown as a settlement payable. As of March 31, 2006, the balance of the settlement payable is $350,000.

NOTE 10 - STOCKHOLDERS’ EQUITY

Deemed dividend and write off of stock subscription receivable

In September 2000, a major shareholder and President of the Company exercised warrants to purchase 166,667 shares of the Company’s common stock at $0.75 per share. The Company agreed to loan the amount to the officer to purchase the shares. The loan carried an interest rate of 9% per annum. In August 2003, the interest rate was lowered to 5.5% per annum. As of December 31, 2003, the balance of interest owing was $17,804. During the year ended December 31, 2004, $6,894 in interest was recorded and the balance owing at December 31, 2004 was $24,698. In January 2005, the interest rate was lowered to 2.38%. During the year ended December 31, 2005, $2,975 of interest was recorded. On December 31, 2005, the Board of Directors authorized the write-off of the balance owing, including interest. The total amount written-off was $152,673 and was recorded as a deemed dividend in the statement of stockholders’ deficit in the year ended December 31, 2005.

NOTE 11 - INCENTIVE AND NON-STATUTORY STOCK OPTION PLAN

Under the 1997 Employee Stock Option Plan (the “Option Plan”), the Company may grant options to purchase up to 450,000 shares of common stock to employees and consultants at prices not less than the fair market value at date of grant for incentive stock options and not less than 85% of fair market value for nonstatutory stock options. For owners of more than 10% of the Company’s stock, options may only be granted for an exercise price of no less than 110% of fair market value on the date of grant for both incentive and nonstatutory stock options. These options generally expire five years from the date of grant and generally vest 33% one year from the date of grant and 1/36th each month thereafter for the next 24 months. In the event of a merger of the Company with or into another corporation, or the sale of substantially all of the assets of the Company, all outstanding options granted vest immediately.
 
F-12
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
NOTE 12 - COMMON STOCK PURCHASE WARRANTS AND OPTIONS

From time to time, the Company issues options and warrants as incentives to employees, officers and directors, as well as to non-employees.

Common stock purchase options and warrants consisted of the following as of March 31, 2005 and 2006:

       
Exercise
      
Exercise
  
 
Options
  
Price
  
Warrants
  
Price
  
Outstanding December 31, 2004
    
100,008
 
$
0.72 to $1.25
    
334,294
 
$
0.72
  
Granted
    
94,000
 
$
0.72
              
Exercised
    
—
          
—
        
Expired
    
—
          
—
        
Outstanding March 31, 2005
    
194,008
         
334,294
       
                         
Outstanding December 31, 2005
    
293,408
 
$
0.72 to $1.25
    
334,294
 
$
0.72
  
Granted
    
—
  
$
0.72
              
Exercised
    
—
          
—
        
Expired
    
—
          
—
        
Outstanding March 31, 2006
    
293,408
         
334,294
       
 
The following summary presents the weighted average exercise prices, number of options and warrants outstanding and exercisable, and the remaining contractual lives of the Company’s stock options and warrants as of March 31, 2005 and 2006:

   
OPTIONS
  
WARRANTS
  
 
3/31/2005
  
3/31/2006
  
3/31/2005
  
3/31/2006
  
Number Outstanding
    
100,008
   
293,408
   
334,294
   
334,294
 
Weighted Ave Remaining Life
    
3.92
   
3.65
   
5.00
   
4.00
 
Weighted Ave Exercise Price
  
$
0.75
  
$
0.82
  
$
0.72
  
$
0.72
  
Number Exercisable
    
39,341
   
91,175
   
—
    
—
  
 
During the three months ended March 31, 2005, 94,000 options were granted to employees and officers of the company. The options vest over three years, 33% after one year and 1/36th per month for 24 months, and expire five years from the date of grant unless the employee terminates employment, in which case the options expire within 90 days of the employee’s termination date. No expense was recorded for the granting of these options. The Black-Scholes option pricing model used the following assumptions:

Risk-free interest rate
    
6.0
%
Expected life
    
5 years
  
Expected volatility
    
.001
%
Dividend yield
    
0
%
 
There were no options or warrants granted during the three months ended March 31, 2006.

In 2002, the Company granted 334,294 warrants to purchase Series A preferred stock with an exercise price of $0.72 per share as part of a preferred stock repurchase agreement with the former preferred stockholders. These warrants become exercisable only at the time of a liquidation event defined as a) a merger or consolidation of the Company with another Company, b) a sale of substantially all the assets of the Company to another Company or c) an IPO and expire seven years from the time of grant. No expense has been taken on these warrants until such time as they become exercisable.

In compliance with FAS No. 148, the Company has elected to continue to follow the intrinsic value method in accounting for its stock-based employee compensation plan as defined by APB No. 25 and has made the applicable disclosures below.
 
F-13
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
Had the Company determined employee stock based compensation cost based on a fair value model at the grant date for its stock options under SFAS 123, the Company's net earnings per share would have been adjusted to the pro forma amounts for three months ended March 31, 2005 and 2006 as follows:

   
2005
  
2006
  
Net income (loss) - as reported
  
$
85,939
  
$
(118,686
)
Stock-based employee compensation expense,
              
included in reported net loss, net of tax
    
—
    
—
  
Total stock-based employee compensation
              
expense determined under fair-value-based
              
method for all rewards, net of tax
    
(17,578
)
  
—
  
Pro forma net income (loss)
  
$
68,361
  
$
(118,686
)
             
Earnings per share:
              
Basic, as reported
    
0.13
   
(0.18
)
Diluted, as reported
    
0.12
   
(0.18
)
               
Basic, pro forma
    
0.10
   
(0.18
)
Diluted, pro forma
    
0.10
   
(0.18
)
 
Pro forma information regarding the effect on operations is required by SFAS 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of that statement. Pro forma information using the Black-Scholes method at the date of grant is based on the following assumptions:

 
2005
  
2006
  
Expected life (years)
    
5 years
    
5 years
  
Risk-free interest rate
    
6.0
%
  
6.0
%
Dividend yield
    
—
    
—
  
Volatility
    
.001
%
  
.001
%
 
NOTE 13 - EMPLOYEE BENEFIT PLANS

The Company has a qualified employee savings and retirement plan (401(k) plan). The 401(k) plan allows the Company to make discretionary contributions of up to 3% of employee’s salary given at the discretion of the board and/or management. The Company made no contributions during the three months ended March 31, 2005 and 2006.

NOTE 14 - COMMITMENTS AND CONTINGENCIES

Litigation

On July 27, 1999, two former employees of the Company, Mohamad Rashedi and Gregory Saylor, and the company formed by the former employees (Integrated Support Services, a general partnership "IS") filed a complaint in the Superior Court of San Mateo County alleging damages for unfair competition, defamation, restraint of trade and prevention of employment. A counter-suit was filed by the Company against the plaintiffs alleging misappropriation of proprietary materials. On or about Feb. 16, 2001, the matter went to trial and a verdict was entered against the defendants and the plaintiffs were found not guilty on the defendants counter-suit. Defendants moved for a new trial on the damages which was granted. The new trial was scheduled to commence on April 17, 2006.
 
F-14
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
While the Company believes that it is not liable for damages to the plaintiffs, in the interest of settling the matter and avoiding the expenses of trial, the Company executed a Settlement and Release Agreement on April 17, 2006. The terms of the Settlement and Release Agreement call for the Company to pay the two former employees $625,000 upon the execution of the Settlement and Release Agreement and $75,000 within 90 days of the execution of the Settlement and Release Agreement. The Company's insurance carrier paid half of the settlement cost directly to the two former employees upon the signing of the settlement agreement. As of June 12, 2006 the full settlement amount had been paid and a dismissal with prejudice of the action was filed effective June 22, 2006.

NOTE 15 - ROYALTY AGREEMENTS

Under royalty agreements, sales of certain products require the Company to pay royalties to third parties under specified circumstances and/or under specified time frames. Royalty expense was $0 for the three months ended March 31, 2005 and 2006, respectively.  In addition, the Company receives royalties on the sales of certain products. Royalty income was $401 and $0 for the three months ended March 31, 2005 and 2006, respectively.

NOTE 16 - RELATED PARTY TRANSACTIONS

In September 2000, a major shareholder and President of the Company exercised warrants to purchase 166,667 shares of the Company’s common stock at $0.75 per share. The Company agreed to loan the amount to the President to purchase the shares. The loan carried an interest rate of 9% per annum. In August 2003, the interest rate was lowered to 5.5% per annum. As of December 31, 2003, the balance of interest owing was $17,804. During the year ended December 31, 2004, $6,894 in interest was recorded and the balance owing at December 31, 2004 was $24,698. In January 2005, the interest rate was lowered to 2.38%. During the three months ended March 31, 2005, $733 of interest was recorded. On December 31, 2005, the Board of Directors authorized the write-off of the balance owing, including interest. The total amount written-off was $152,673 and was recorded as a deemed dividend.

The employment agreement with the President of the Company calls for bonuses to be paid to him based on certain milestones achieved and sales generated. During fiscal years ended December 31, 2004 and 2005, $18,000 and $66,829 was accrued, respectively. At March 31, 2005 and 2006, $18,000 and $29,552 remained unpaid and is included in accrued liabilities in these financial statements.

NOTE 17 - SUBSEQUENT EVENTS (unaudited)

On May 6, 2006 the stockholders voted in favor of the Company being acquired by NetSol Technologies, Inc. (“NetSol”), a publicly listed corporation on the NASDAQ exchange, (NTWK). Under the agreement, NetSol will purchase 100% of the outstanding stock of McCue. The estimated purchase price based on the December 31, 2005 revenues is $8.5 million dollars. The agreement calls for a closing date on or about June 30, 2006.
 
F-15
 
MCCUE SYSTEMS, INCORPORATED
NOTES TO FINANCIAL STATEMENTS
(UNAUDITED)
 
According to the terms of the Share Purchase Agreement, NetSol is to acquire 100% of the issued and outstanding shares of McCue from McCue’s current shareholders, whose identity is set forth in the Share Purchase Agreement (the “McCue Shareholders”) at the completion date in exchange for a purchase price consisting of: a) 50% of McCue’s total gross revenue for the audited twelve month period ending December 31, 2005 after an adjustment for any revenue occurring outside of the company’s ordinary scope of operations as defined by US GAAP multiplied by 1.5 payable: (i) 50% in shares of restricted common stock of NetSol at the 30 day volume weighted average price (“VWAP) for each of the 30 trading days prior to the execution date of this agreement or at the VWAP for each of the 30 trading days prior to November 30, 2005 whichever is the greater VWAP; and, (ii) 50% in cash; b) 25% of McCue’s total gross revenue for the twelve months ending December 31, 2006 multiplied by 1.5 payable, at NetSol’s discretion: (i) wholly in cash; or (ii) on the same basis and on the same terms as the initial payment provided that under no circumstances shall the total number of shares of common stock issued to the McCue Shareholders exceed 19% of the issued and outstanding shares of common stock, less treasury shares, of NetSol at May 6, 2006; and c) 25% of McCue’s total gross revenue for the twelve months ending December 31, 2007 multiplied by 1.5 payable, at the Company’s discretion: (i) wholly in cash; or (ii) on the same basis and on the same terms as the initial payment provided that under no circumstances shall the total number of shares of common stock issued to the McCue Shareholders exceed 19% of the issued and outstanding shares of common stock, less treasury shares, of NetSol at May 6, 2006.

The initial payment will consist of approximately $2.1 million in cash and 985,213 shares of NetSol’s restricted common stock.

During May and June 2006, 281,908 options were exercised for a total of $230,276 of which $4,020 was received in cash and the remaining amount of $226,356 was recorded as a receivable. The amount due from the shareholders will be withheld from any funds due to them at the close of the acquisition by NetSol. In addition, the option holders were granted a loan from the Company of $0.33 per share to help defray any tax consequence of the option exercise. This loan is to be repaid from the proceeds of the second and third installment of the purchase price of the acquisition by NetSol.

During May and June 2006, 323,682 warrants were exercised. Of these, 281,540 were exercised under a cashless exercise provision of $0.85 per share and 238,735 shares were issued as a result. $1,542 was received in cash and a receivable for $28,800 was recorded. The receivable will be withheld from any funds due to them at the close of the acquisition by NetSol.

On June 12, 2006 the Company paid the remaining balance of $75,000 due on the settlement agreement (See Note 14). On June 22, 2006 a dismissal of the case was filed with the court.
 
F-16

NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
PRO-FORMA FINANCIAL STATEMENTS
JUNE 30, 2005
(UNAUDITED)

The following unaudited Pro-Forma Statement of Financial Conditions and Statement of Operations have been derived from the audited consolidated financial statements of NetSol Technologies, Inc. (“NetSol”) as of June 30, 2005 and the unaudited financial statements of McCue Systems, Incorporated (a California corporation) (“McCue Systems”) as of June 30, 2005. The unaudited Pro Forma Statement of Financial Conditions and Statement of Operations reflect the 100% acquisition of McCue 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 and the pro-forma Statements of Operations assumes the acquisition was consummated as of July 1, 2004, the beginning of NetSol Technologies fiscal year.

The initial purchase of $4,235,706 is price is based on the December 31, 2005 audited financial statements of McCue Systems. The other half is due in two installments; the first 25% after the audited December 31, 2006 financial statements have been prepared, and the second 25% after the audited December 31, 2007 financial statements have been prepared.


The Pro-Forma Statement of Financial Conditions and Statement of Operations should be read in conjunction with the Consolidated Financial Statements of NetSol, related Notes to the financial statements, and the Financial Statements of McCue Systems. The Pro-Forma statements do not purport to represent what the Company’s financial condition and results of operations would actually have been if the acquisition of McCue Systems had occurred on the date indicated or to project the Company’s results of operations for any future period or date. The Pro-Forma adjustments, as described in the accompanying data, are based on available information and the assumptions set forth in the notes below, which management believes are reasonable.
 
Page 1
 
NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
CONSOLIDATED PRO-FORMA STATEMENT OF FINANCIAL CONDITIONS
AS OF JUNE 30, 2005
(UNAUDITED)

   
NetSol
 
McCue Systems
             
   
as of 6/30/05
 
as of 6/30/05
 
Pro Forma
     
Pro Forma
 
   
(Audited)
 
(Unaudited)
 
Adjustment
     
Combined
 
                       
ASSETS
                               
                                 
Current Assets
 
$
8,373,861
  
$
1,759,734
              
$
10,133,595
  
Property & equipment, net
   
5,114,776
   
50,808
   
-
         
5,165,584
 
Intangible assets, net
   
7,637,397
   
136,950
   
5,056,995
   
(1)
 
  
12,139,573
 
                 
(691,769
)
  
(2)
 
      
Total assets
 
$
21,126,034
  
$
1,947,492
  
$
4,365,226
        
$
27,438,752
  
                                 
 
                                
LIABILITIES & STOCKHOLDERS' EQUITY
                               
                                 
Current liabilities
 
$
4,602,164
  
$
2,768,781
  
$
254,144
    
(3)
 
$
7,625,089
  
Obligations under capitalized leases,
                               
less current maturities
    
122,426
   
-
   
-
         
122,426
 
Notes payable
    
-
   
-
   
2,117,864
   
(1)
 
  
2,117,864
 
Deferred liability
    
313,397
   
-
   
-
   
(1)
 
  
313,397
 
Convertible debenture
    
138,175
   
-
               
138,175
 
                                 
Total liabilities
   
5,176,162
   
2,768,781
   
2,372,008
         
10,316,951
 
Minority interest
    
700,320
   
-
   
-
         
700,320
 
                                 
Stockholders' equity;
                               
Common stock
   
13,831
   
2,710,275
   
(2,709,317
)
  
(1)
 
  
14,789
 
Additional paid in capital
   
46,610,747
   
31,727
   
2,085,157
   
(1)
 
  
48,727,631
 
Stock subscription receivable
   
(616,650
)
  
(125,000
)
  
125,000
   
(1)
 
  
(616,650
)
Treasury stock
   
(27,197
)
  
-
   
-
         
(27,197
)
Common stock to be issued
   
108,500
                     
108,500
 
Other comprehensive income (loss)
   
(520,691
)
  
-
   
-
         
(520,691
)
Accumulated deficit
   
(30,318,988
)
  
(3,438,291
)
  
3,438,291
   
(1)
 
  
(31,264,901
)
                 
(945,913
)
  
(2), (3)
 
  
 
  
Total stockholders' equity
   
15,249,552
   
(821,289
)
  
1,993,218
         
16,421,481
 
                                 
Total liabilities and stockholders' equity
 
$
21,126,034
  
$
1,947,492
  
$
4,365,226
        
$
27,438,752
  
 
 
Page 2
 
NOTES:
 
(1) Elimination of Common stock and accumulated earnings of McCue Systems before the acquisition and to record the purchase of McCue Systems by NetSol.
The initial purchase price is $4,235,706 of which one-half is due at closing in cash and stock. The 2nd installment is due 12 months later and the 3rd installment is due 24 months later, based upon audited financials statements of the subsequent periods.
The initial purchase price and 1st installment allocation is as follows:
Purchase Price allocation:
       
1st Installment
  
Common Stock, 958,213 shares
       
$
958
  
Additional paid in capital
         
2,116,884
 
Cash, provided by financing
         
2,117,864
 
Additional consideration payable
         
-
 
Total purchase price
       
$
4,235,706
  
               
McCue equity (net assets and liabilities)
       
$
(821,289
)
Intangible assets:
             
Customer Lists
   
3,331,337
   
3,331,337
 
Licenses
   
127,510
   
127,510
 
Goodwill
   
5,833,894
   
1,598,148
 
     
9,292,741
   
5,056,995
 
               
         
$
4,235,706
  
 
(2) Amortization of intangible assets acquired
(3) Interest payable accrued on the notes issued for the financing at 12% per annum
Page 3

NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
CONSOLIDATED PRO-FORMA STATEMENT OF OPERATIONS
FOR THE TWELVE MONTH PERIOD ENDED JUNE 30, 2005
(UNAUDITED)

   
NetSol
 
McCue Systems
             
   
For the twelve month period ended 6-30-05 
  
Pro Forma
     
Pro Forma
 
   
(Audited)
 
(Unaudited)
 
Adjustment
     
Combined
 
                       
Net Revenue
 
$
12,437,653
  
$
4,415,680
  
$
-
        
$
16,853,333
  
                                 
Cost of revenue
   
4,754,749
   
2,308,733
   
-
         
7,063,482
 
                                 
Gross profit
   
7,682,904
   
2,106,947
   
-
         
9,789,851
 
                                 
Operating expenses
   
6,618,199
   
2,347,229
   
691,769
   
(2)
 
  
9,911,339
 
                 
254,144
   
(3)
 
      
Income (loss) from operations
   
1,064,705
   
(240,282
)
  
(945,913
)
        
(121,488
)
                 
 
              
Other income and (expenses)
   
(290,307
)
  
6,071
   
-
         
(284,236
)
                                 
Income (loss) from continuing operations
   
774,398
   
(234,211
)
  
(945,913
)
        
(405,724
)
                                 
Minority interest in subsidiary
   
(111,073
)
  
-
   
-
         
(111,073
)
                                 
Net income (loss)
   
663,325
   
(234,211
)
  
(945,913
)
        
(516,797
)
                                 
Other comprehensive income (loss):
                               
Translation adjustment
   
(282,129
)
  
-
   
-
         
(282,129
)
                                 
Comprehensive income (loss)
 
$
381,196
  
$
(234,211
)
$
(945,913
)
      
$
(798,926
)
                                 
EARNINGS PER SHARE
                               
                                 
Weighted -average number of shares outstanding:
                               
Basic
   
12,555,838
   
669,539
               
13,225,377
 
Diluted
   
15,734,536
   
669,539
               
16,404,075
 
                                 
Income (loss) per share
                               
Basic
 
$
0.05
  
$
(0.35
)
            
$
(0.04
)
Diluted
 
$
0.04
  
$
(0.35
)
            
$
(0.03
)
 
NOTES:
(1)
Weighted-average number of shares outstanding for the combined entity includes all shares issued for the acquisition of 958,213 shares as if outstanding as of July 1, 2004.
(2)
Amortization of intangible assets acquired in acquisition.
(3)
Interest on notes payable for the financing of the initial installment @ 12% per annum.
 
Page 4

NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
PRO-FORMA FINANCIAL STATEMENTS
MARCH 31, 2006
(UNAUDITED)

The following unaudited Pro-Forma Statement of Financial Conditions and Statement of Operations have been derived from the unaudited consolidated financial statements of NetSol Technologies, Inc. (“NetSol”) as of March 31, 2006 and the unaudited financial statements of McCue Systems, Incorporated (a California corporation) (“McCue Systems”) as of March 31, 2006. The unaudited Pro Forma Statement of Financial Conditions and Statement of Operations reflect the 100% acquisition of McCue 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 and the pro-forma Statements of Operations assumes the acquisition was consummated as of July 1, 2005, the beginning of NetSol Technologies’ fiscal year.

The initial purchase of $4,235,706 is price is based on the December 31, 2005 audited financial statements of McCue Systems. The other half is due in two installments; the first 25% after the audited December 31, 2006 financial statements have been prepared, and the second 25% after the audited December 31, 2007 financial statements have been prepared.

The Pro-Forma Statement of Financial Conditions and Statement of Operations should be read in conjunction with the Consolidated Financial Statements of NetSol, related Notes to the financial statements, and the Financial Statements of McCue Systems. The Pro-Forma statements do not purport to represent what the Company’s financial condition and results of operations would actually have been if the acquisition of McCue Systems had occurred on the date indicated or to project the Company’s results of operations for any future period or date. The Pro-Forma adjustments, as described in the accompanying data, are based on available information and the assumptions set forth in the notes below, which management believes are reasonable.



NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
CONSOLIDATED PRO-FORMA STATEMENT OF FINANCIAL CONDITIONS
AS OF MARCH 31, 2006
(UNAUDITED)
                 
 
   
NetSol
 
McCue Systems
             
   
3/31/2006
  
3/31/2006
  
Pro Forma
     
Pro Forma
 
   
(Unaudited)
 
(Unaudited)
 
Adjustment
     
Combined
 
                       
ASSETS
                     
                       
Current Assets
 
$
15,783,378
  
$
1,889,881
          
(1
)
$
17,673,259
  
Property & equipment, net
   
6,425,581
   
64,706
   
-
         
6,490,287
 
Intangible assets, net
   
6,873,237
   
211,312
   
4,518,256
   
(1
)
  
11,083,978
 
                 
(518,827
)
  
(2
)
      
Total assets
 
$
29,082,196
  
$
2,165,899
  
$
3,999,429
        
$
35,247,524
  
                                 
 
                                
LIABILITIES & STOCKHOLDERS' EQUITY
                               
                                 
Current liabilities
 
$
5,237,487
  
$
2,448,449
  
$
190,608
    
(3
)
$
7,876,544
  
Obligations under capitalized leases,
                               
less current maturities
    
118,079
   
-
   
-
         
118,079
 
Notes payable
    
-
   
-
   
2,117,864
   
(1
)
  
2,117,864
 
Deferred liability
    
313,397
   
-
   
-
         
313,397
 
Convertible debenture
    
-
   
-
               
-
 
                                 
Total liabilities
   
5,668,963
   
2,448,449
   
2,308,472
         
10,425,884
 
Minority interest
    
1,385,010
   
-
   
-
         
1,385,010
 
                                 
Stockholders' equity;
                               
Common stock
   
15,142
   
2,710,275
   
(2,709,317
)
  
(1
)
  
16,100
 
Additional paid in capital
   
52,584,940
   
31,727
   
2,085,157
   
(1
)
  
54,701,824
 
Stock subscription receivable
   
(372,688
)
  
-
   
-
         
(372,688
)
Treasury stock
   
(27,197
)
  
-
   
-
         
(27,197
)
Common stock to be issued
   
116,000
                     
116,000
 
Other comprehensive income (loss)
   
(319,590
)
  
-
   
-
         
(319,590
)
Accumulated deficit
   
(29,968,384
)
  
(3,024,552
)
  
3,024,552
   
(1
)
  
(30,677,819
)
                 
(709,435
)
  
(2), (3
)
  
 
  
Total stockholders' equity
   
22,028,223
   
(282,550
)
  
1,690,958
         
23,436,631
 
                                 
Total liabilities and stockholders' equity
 
$
29,082,196
  
$
2,165,899
  
$
3,999,429
        
$
35,247,524
  



NOTES:
                 
(1) Elimination of Common stock and accumulated earnings of McCue Systems before the acquisition and to record the purchase of McCue Systems by NetSol.
The initial purchase price is $4,235,706 of which one-half is due at closing in cash and stock. The 2nd installment is due
12 months later and the 3rd installment is due 24 months later, based upon audited financials statements of the subsequent periods.
 
The initial purchase price and 1st installment allocation is as follows:
 
Purchase Price allocation:
         
1st Installment
 
Common Stock, 958,213 shares
       
$
958
  
Additional paid in capital
         
2,116,884
 
Cash, provided by financing
         
2,117,864
 
Additional consideration payable
         
-
 
Total purchase price
       
$
4,235,706
  
               
McCue equity (net assets and liabilities)
       
$
(282,550
)
Intangible assets:
             
Customer Lists
   
3,331,337
   
3,331,337
 
Licenses
   
127,510
   
127,510
 
Goodwill
   
5,295,155
   
1,059,409
 
     
8,754,002
   
4,518,256
 
               
         
$
4,235,706
  
 
(2) Amortization of intangible assets acquired
(3) Interest payable accrued on the notes issued for the financing at 12% per annum

 
 
 

NETSOL TECHNOLOGIES INC AND SUBSIDIARIES
CONSOLIDATED PRO-FORMA STATEMENT OF OPERATIONS
FOR THE NINE MONTH PERIODS ENDED MARCH 31, 2006
(UNAUDITED)
 
   
NetSol
 
McCue Systems
             
   
Nine month period ended 3-31-06
 
 
  
Pro Forma
     
Pro Forma
 
   
(Unaudited)
 
(Unaudited)
 
Adjustment
     
Combined
 
       
 
              
Net Revenue
 
$
14,040,185
  
$
4,508,411
  
$
-
        
$
18,548,596
  
                                 
Cost of revenue
   
5,962,913
   
1,899,159
   
-
         
7,862,072
 
                                 
Gross profit
   
8,077,272
   
2,609,252
   
-
         
10,686,524
 
                                 
Operating expenses
   
6,848,682
   
2,100,006
   
518,827
   
(2
)
  
9,658,121
 
                 
190,608
   
(3
)
      
Income (loss) from operations
   
1,228,590
   
509,246
   
(709,435
)
        
1,028,403
 
                               
Other income and (expenses)
   
(178,117
)
  
57,165
   
-
         
(120,952
)
                                 
Income (loss) from continuing operations
   
1,050,473
   
566,411
   
(709,435
)
        
907,451
 
                                 
Minority interest in subsidiary
   
(699,872
)
  
-
   
-
         
(699,872
)
                                 
Net income (loss)
   
350,601
   
566,411
   
(709,435
)
        
207,579
 
                                 
Other comprehensive income (loss):
                               
Translation adjustment
   
201,100
   
-
   
-
         
201,100
 
                                 
Comprehensive income (loss)
 
$
551,701
  
$
566,411
  
$
(709,435
)
      
$
408,679
  
                                 
                                 
EARNINGS PER SHARE
                               
                                 
Weighted -average number of shares outstanding:
                               
Basic
   
15,225,903
   
669,539
               
15,895,442
 
Diluted
   
15,651,130
   
730,014
               
16,381,144
 
                                 
Income (loss) per share:
                               
Basic
 
$
0.02
  
$
0.85
              
$
0.01
  
Diluted
 
$
0.02
  
$
0.78
              
$
0.01
  
 
NOTES:
                                
(1) Weighted-average number of shares outstanding for the combined entity includes all shares issued for the acquisition of 958,213 shares as if outstanding as of July 1, 2004.
(2) Amortization of intangible assets acquired in acquisition
(3) Interest on notes payable for the financing of the initial installment @ 12% per annum.