WASHINGTON, D.C. 20549
(Former name, former address and former
fiscal year, if changed since last report)
Indicate by check mark whether the registrant
is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.
See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,”
and “emerging growth company” in Rule 12b-2 of the Exchange Act.
The number of outstanding shares of common
stock, $.0001 par value, of the registrant as of May 15, 2017 was 17,629,817.
Net Element, Inc. is a corporation organized
under the laws of the State of Delaware. As used in this Quarterly Report on Form 10-Q (this “Report”), unless the
context otherwise requires, the terms “Company,” “we,” “us” and “our” refer to
Net Element, Inc. and, as applicable, its majority-owned and consolidated subsidiaries. References in this Report to “PayOnline”
refer, collectively, to PayOnline System LLC, Innovative Payment Technologies LLC, Polimore Capital Limited and Brosword Holding.
This Report contains forward-looking statements
within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of
1934, as amended. Any statements contained in this Report that are not statements of historical fact may be deemed forward-looking
statements. Forward-looking statements generally are identified by the words “expects,” “anticipates,”
“believes,” “intends,” “estimates,” “aims,” “plans,” “may,”
“will,” “continue,” “seeks,” “should,” “believe,” “potential”
or the negative of such terms and similar expressions. Forward-looking statements are based on current plans, estimates and projections,
and therefore you should not place too much reliance on them. Forward-looking statements speak only as of the date they are made,
and the Company undertakes no obligation to update any forward-looking statement in light of new information or future events,
except as expressly required by law. Forward-looking statements involve inherent risks and uncertainties, most of which are difficult
to predict and are generally beyond the Company’s control. The Company cautions you that a number of important factors could
cause actual results or outcomes to differ materially from those expressed in, or implied by, the forward-looking statements. These
factors include, among other factors:
If these or other risks and uncertainties
(including those described in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and
in Part II, Item 1A of this Report and the Company’s subsequent filings with the Commission) materialize, or if the assumptions
underlying any of these statements prove incorrect, the Company’s actual results may be materially different from those expressed
or implied by such statements. We undertake no obligation to publicly revise any forward-looking statement to reflect circumstances
or events after the date of this Report to reflect the occurrence of unanticipated events. You should, however, review the factors
and risks described in the reports we file from time-to-time with the Commission after the date of this Report.
World Wide Web addresses contained in this
Report are for explanatory purposes only and they (and the content contained therein) do not form a part of and are not incorporated
by reference into this Report.
PCI Certification
During 2015, we acquired a “Payment
Card Industry” (PCI) Certification with our acquisition of PayOnline. This certification had a fair market value of $449,000
at the date of acquisition. At March 31, 2017 and December 31, 2016, the net book value of this certification was $168,373 and
$205,790, respectively. For the three months ended March 31, 2017 and 2016, amortization for this certification was $37,417 and
$37,417, respectively.
Non-Compete Agreements
In connection with the Company’s
acquisition of Unified Payments, LLC in 2013, two key executives signed covenants not to compete. These covenants have a three-year
life and had a net book value of $0 and $11,667 at March 31, 2017 and 2016, respectively. For the three months ended March 31,
2017 and 2016, amortization was $0 and $70,000, respectively. Non-Compete agreements were fully amortized at December 31, 2016.
NOTE 7. ACCRUED EXPENSES
At March 31, 2017 and December 31, 2016,
accrued expenses amounted to $5,366,887 and $5,518,823, respectively. Accrued expenses represent expenses that are owed at
the end of the period and have not been billed by the provider or are estimates of services provided. The following table
details the items comprising the balances outstanding at March 31, 2017 and December 31, 2016.
|
|
March 31,
2017
|
|
|
December 31,
2016
|
|
Accrued professional fees
|
|
$
|
317,033
|
|
|
$
|
220,140
|
|
PayOnline accrual
|
|
|
3,509,256
|
|
|
|
3,784,451
|
|
Accrued interest
|
|
|
148,854
|
|
|
|
183,778
|
|
Accrued bonus
|
|
|
1,130,511
|
|
|
|
774,485
|
|
Accrued franchise taxes
|
|
|
-
|
|
|
|
180,000
|
|
Accrued foreign taxes
|
|
|
135,684
|
|
|
|
131,810
|
|
Short term loan advances
|
|
|
80,397
|
|
|
|
174,376
|
|
Other accrued expenses
|
|
|
45,152
|
|
|
|
69,783
|
|
|
|
$
|
5,366,887
|
|
|
$
|
5,518,823
|
|
The accrual for PayOnline at March 31,
2017 consists of a $0.3 million earn-out accrual and a $1.8 million stock price guarantee obligation pursuant to a settlement agreement
entered into in connection with the PayOnline acquisition. Additionally, the accrual includes a $1.4 million obligation for refundable
merchant reserves assumed pursuant to an amendment to the PayOnline acquisition agreement. See Note 11 for additional information.
The accrual for PayOnline at December 31,
2016 consists of a $0.3 million earn-out accrual and a $2.0 million stock price guarantee obligation pursuant to a settlement agreement
entered into in connection with the PayOnline acquisition. Additionally, the accrual includes a $1.4 million obligation for refundable
merchant reserves assumed pursuant to an amendment to the PayOnline acquisition agreement.
Accrued bonuses are attributed to our TOT
Group subsidiaries resulting from a discretionary bonus accrual for $1,130,511 and $774,485 at March 31, 2017 and December 31, 2016,
respectively.
NOTE 8. SHORT TERM DEBT
At March 31, 2017, short term
debt consists of $719,564 and $808,976 in principal repayments due to RBL during the third and fourth quarter of 2017,
respectively.
NOTE 9. LONG TERM DEBT
Long term debt consists of the following:
|
|
March 31, 2017
|
|
|
December 31, 2016
|
|
|
|
|
|
|
|
|
|
|
RBL Capital Group LLC
|
|
$
|
4,144,056
|
|
|
$
|
4,044,056
|
|
MBF Merchant Capital LLC
|
|
|
419,623
|
|
|
|
520,303
|
|
Less Current Portion
|
|
|
(719,564
|
)
|
|
|
(808,976
|
)
|
Long Term Debt
|
|
$
|
3,844,115
|
|
|
|
3,755,383
|
|
RBL Capital Group, LLC
Effective June 30, 2014, TOT Group,
Inc. and its subsidiaries as co-borrowers, TOT Payments, LLC, TOT BPS, LLC, TOT FBS, LLC, Process Pink, LLC, TOT HPS, LLC and
TOT New Edge, LLC, entered into a Loan and Security Agreement with RBL Capital Group, LLC (“RBL”), as lender (the
“RBL Loan Agreement”). Pursuant to the original terms of the RBL Loan Agreement, we could borrow up to
$10,000,000 from RBL during the 18 month period from the closing of this credit facility. Prior to maturity of the loan, the
principal amount of the borrowings under the credit facility will carry a fixed interest rate of the higher of 13.90% per
annum or the prime rate plus 10.65%. After maturity of the loan, until all borrowings are paid in full, with respect to the
advances under the credit facility, an additional three percent per annum would be added to such interest rate, and for any
other amounts, obligations or payments due to RBL, an annual default rate not to exceed the lesser of (i) the prime rate plus
13% per annum and (ii) 18.635% per annum. As further described below, borrowings from the line of credit in the amounts of
$3,315,000, $400,000 and $250,000 were converted into term loans. On May 2, 2016, we renewed our credit facility with RBL,
increasing the facility from, respectively, $10 million to $15 million and extended the term through February 2018. At March
31, 2017 and December 31, 2016, we had $10,855,944 and $10,955,944 available on our RBL credit line.
The co-borrowers’ obligations to RBL pursuant to the RBL
Loan Agreement are secured by a first priority security interest in all of the co-borrowers’ tangible and intangible assets,
including but not limited to their merchants, merchant contracts and proceeds thereof, and all right title and interest in co-borrowers’
processing contracts, contract rights, and portfolio cash flows with all processors of the co-borrowers.
On July 17, 2014, we entered into a $3,315,000 term note with
RBL. Net proceeds from the term note were used to repay a $3.0 million note previously due to MBF in addition to approximately
$239,000 for working capital. The term note required interest only payments at 13.90% interest through January 2015 commencing
on August 20, 2014 followed by monthly interest and principal payments of $90,421 through January 2019. The promissory note balance
reduced the amount available under our RBL credit line. The note also provided for a 2% front end fee due at execution of the note
and a 4% backend fee due at the final payment of the note. During 2016, Crede CG III, Ltd. (“Crede”) purchased $1,849,481
of the principal balance of this promissory note in various tranches. We exchanged and extinguished these promissory note tranches
for 164,262 shares of common stock during the second quarter of 2016, 992,032 shares of our common stock during the third quarter
of 2016, and 196,080 shares during the fourth quarter of 2016. See “—Crede CG III, Ltd.” At December 20, 2016,
the remaining balance of the note was refinanced into another note and its balance was $0 at March 31, 2017 and December 31, 2016.
Effective February 10, 2015, we entered into a $400,000 term
note with RBL based on a draw down from the line of credit. The term note provided for interest-only payments at 13.90% interest
through July 20, 2015. From August 20, 2015 through July 20, 2019 (maturity date), we were obligated to make interest and principal
payments of $10,911 per month. We paid $8,000 in costs related to this loan. This term note was purchased by Crede, which was exchanged
and extinguished for an aggregate of 219,284 shares of our common stock on June 9, 2016, June 23, 2016, and June 30, 2016. The
balance of this note was $0 at March 31, 2017 and December 31, 2016.
Effective March 27, 2015, we entered into a $250,000 term note
with RBL based on the draw down from the line of credit. The term note provided for interest-only payments at 13.90% interest through
July 20, 2015. From August 20, 2015 through July 20, 2019 (the note maturity date), we were obligated to make interest and principal
payments of $6,819 per month. We paid $5,000 in costs related to this term note. This term note was purchased by Crede, which was
exchanged and extinguished for an aggregate of 91,744 shares of our common stock on May 9, 2016. The balance of this note was $0
at March 31, 2017 and December 31, 2016.
On May 4, 2016, we entered into a $250,000 term note with RBL.
The term note provided for interest-only payments at 14.15% interest through October 20, 2016. From November 20, 2016 through October
20, 2020 (the note maturity date), we were obligated to make interest and principal payments of $6,850 per month. The term note
also provided for a 2% front end fee, due upon the execution of the term note and a 4% back end fee due at the final payment of
the term note. On December 20, 2016, this note was refinanced into another term note and its balance was $0 at March 31, 2017 and
December 31, 2016.
On May 20, 2016, we entered into a $400,000 term note with RBL.
The term note provided for interest-only payments at 14.15% interest through November 20, 2015. From December 20, 2016 through
November 20, 2020 (the note maturity date), we were obligated to make interest and principal payments of $10,961 per month. The
term note also provided for a 2% front end fee, due upon the execution of the term note and a 4% back end fee due at the final
payment of the term note. On December 20, 2016, this note was refinanced into another term note and its balance was $0 at March
31, 2017 and December 31, 2016.
On June 23, 2016, we entered into a $190,000 term note with
RBL. The term note provided for interest-only payments at 14.15% interest through December 20, 2016. From January 20, 2017 through
December 20, 2020 (the note maturity date), we were obligated to make interest and principal payments of $5,206 per month. The
term note also provided for a 2% front end fee, due upon the execution of the term note and a 4% backend fee due at the final payment
of the term note. On December 20, 2016, this note was refinanced into another term note and its balance was $0 at March 31, 2017
and December 31, 2016.
On July 15, 2016, we entered into a $350,000 term note with
RBL. The term note provided for interest-only payments at 14.15% through January 20, 2017. From February 20, 2017 through January
20, 2021, we were obligated to make interest and principal payments of $9,591. The term note also provided for a 2% front end fee,
due upon the execution of the loan and a 4% back end fee due at the final payment of the term note. On December 20, 2016, this
note was refinanced into another term note and its balance was $0 at March 31, 2017 and December 31, 2016.
On August, 15, 2016, we entered into a $400,000 term note with
RBL. The term note provided for interest only payments at 14.15% through February 20, 2017. From March 20, 2017 through February
20, 2021, we were obligated to make interest and principal payments of $10,961. The term note also provided for a 2% front end
fee, due upon the execution of the loan and a 4% back end fee due at the final payment of the term note. On December 20, 2016,
this note was refinanced into another term note and its balance was $0 at March 31, 2017 and December 31, 2016.
On September 15, 2016, we entered into a $350,000 term note
with RBL. The term note provided for interest only payments at 14.15% through March 20, 2017. From April 20, 2017 through March
20, 2021, we were obligated to make interest and principal payments of $9,591. The term note also provided for a 2% front end fee,
due upon the execution of the loan and a 4% back end fee due at the final payment of the term note. On December 20, 2016, this
note was refinanced into another term note and its balance was $0 at March 31, 2017 and December 31, 2016.
On November 7, 2016, we entered into a $350,000 term note with
RBL. The term note provided for interest only payments at 14.15% through May 20, 2017. From June 20, 2017 through May 20, 2021,
we were obligated to make interest and principal payments of $9,591. The term note also provided for a 2% front end fee due upon
the execution of the loan and a 4% back end fee due at the final payment of the term note. On December 20, 2016, this note was
refinanced into another term note and its balance was $0 at March 31, 2017 and December 31, 2016.
On December 15, 2016, we entered into a $325,000 term note with
RBL. The term note provided for interest only payments at 14.15% through June 20, 2017. From July 20, 2017 through June 20, 2021,
we were obligated to make interest and principal payments of $8,906. The term note also provided for a 2% front end fee, due upon
the execution of the loan and a 4% back end fee due at the final payment of the term note. On December 20, 2016, this note was
refinanced into another term note and its balance was $0 at March 31, 2017 and December 31, 2016.
On December 20, 2016, we entered into a $4,044,055 term note
with RBL. This note effectively refinanced all RBL notes described above. The term note provides for interest only payments at
14.15% through May 20, 2017 of $47,686. From June 20, 2017 through May 20, 2021, we are obligated to make interest and principal
payments of $110,814. The term note also required a $20,000 front end refinancing fee upon execution of the loan and a $104,600
back end fee due at the final payment on May 20, 2021.
Effective March 30, 2017, we entered into a $100,000 term note
with RBL based on a draw down from the line of credit. The term note provides for interest-only payments at 14.4% interest through
May 20, 2017. From June 20, 2017 through May 20, 2021 (maturity date), we are obligated to make interest and principal payments
of $2,753 per month. We paid $2,000 in costs related to this term note at its inception and another $4,000 of costs is due at the
maturity of the note.
Also see subsequent events Note 17 for activity that occurred
after March 31, 2017.
MBF Merchant Capital, LLC
We issued the following notes payable to MBF Merchant Capital,
LLC (MBF), which is owned by William Healy, a member of our Board of Directors.
On March 28, 2016, we entered into a
$75,000 promissory were note with MBF. The promissory note provided for interest only payments at 14% through May 28, 2016.
From June 28, 2016 through March 28, 2017, we were obligated to make interest and principal payments of $7,990. The
promissory note also provided for a 6% backend fee due at the final payment of the promissory note. As of March 31, 2017 and
December 31, 2016, the balance of the note was $0 and $23,420, respectively.
On April 19, 2016, we entered into a $300,000 promissory note
with MBF. The promissory note provides for interest only payments at 15.5% through May 28, 2016. From June 28, 2016 through May
28, 2018, we are obligated to make interest and principal payments of $14,617. The promissory note also provides for a 6% back
end fee due at the final payment of the promissory note. At March 31, 2017 and December 31, 2016, the balance of the note was $186,112
and $221,826, respectively.
On July 1, 2016, our subsidiary, TOT Group, Inc., entered into
a $353,500 promissory note with MBF. The promissory note provides for interest only payments at 15.5% through June 28, 2016. From
July 28, 2016 through June 28, 2018, we are obligated to make interest and principal payments of $17,224. The promissory note also
provides for a 1% front end fee and for a 6.6% back end fee due at the final payment of the promissory note. At March 31, 2017
and December 31, 2016, the remaining balance of the note was $233,510 and $275,056, respectively.
Crede CG III, Ltd.
On May 2, 2016, we entered into a Master
Exchange Agreement with Crede (the “Master Exchange Agreement”), an entity that purchased a portion our previously
issued notes held by RBL described above. Pursuit to the Master Exchange Agreement, we have the right to request that Crede exchange
up to $3,965,000 of the RBL promissory notes for shares of our common stock.
On March 3, 2017, we entered into an Amendment to Master Exchange
Agreement with Crede, which extended the expiration date of the Master Exchange Agreement from December 31, 2016 to August 31,
2017. Accordingly, this extends the time to which we have the right to request Crede to exchange RBL promissory notes for shares
of the Company’s common stock on the terms and conditions set forth in the Master Exchange Agreement.
For the quarters ended March 31, 2017 and
2016, we did not exchange any shares of our common stock for RBL promissory notes. For the year ended December 31, 2016, we exchanged
1,663,402 shares of our common stock with Crede for an aggregate of $2,499,481 of RBL promissory notes, including the full exchange
of the $400,000 promissory note (originally entered into February 10, 2015) and $250,000 promissory note (originally entered into
March 27, 2015), and the partial exchange for $1,849,481 of the $3,315,000 promissory note (originally entered July 17, 2014).
These notes were purchased by Crede for an average per share exchange price of $1.76. The exchanges also settled current interest
and loan fees of $302,294 and a non-cash exchange premium of $487,064. Also see Note 17. Subsequent Events.
Scheduled Debt Principal Repayment
Scheduled principal maturities on indebtedness at March 31,
2017 is as follows:
2017 (9 months)
|
|
|
719,564
|
|
2018
|
|
|
1,068,621
|
|
2019
|
|
|
1,035,375
|
|
2020
|
|
|
1,191,838
|
|
2021
|
|
|
548,277
|
|
Balance March 31, 2017
|
|
$
|
4,563,676
|
|
NOTE 10. CONCENTRATIONS
The Company’s total revenue was $13,561,941 and $11,261,059
for the three months ended March 31, 2017 and 2016, respectively.
Of the $13,561,941 in revenues for the three months ended March
31, 2017, $12,729,663 (which also includes PayOnline) was derived from processing of Visa®, MasterCard®, Discover®
and American Express® card transactions and $832,278 was derived from providing mobile payment services branded content the
three months ended March 31, 2017.
Total revenue was $11,261,059 for the three months ended March
31, 2016, of which $9,363,82 (which also includes PayOnline) was derived from processing of Visa®, MasterCard®,
Discover® and American Express® card transactions, and $1,897,239 that was derived from providing mobile payment services
branded content the three months ended March 31, 2016.
The credit card processing revenues were from merchant customer
transactions, which were processed primarily by two third-party processors (greater than 5%) during the three months ended March
31, 2017 and 2016. For the three months ended March 31, 2017 and 2016, the Company processed 73% and 71%, respectively, of its
total revenue with Priority Payment, Inc. (f/k/a Cynergy Data, LLC) and 5% and 18%, respectively, of its total revenue with Vantiv,
Inc. (f/k/a National Processing Company (NPC)).
Mobile electronic payment revenues were derived from merchant
customer transactions processed by mobile operators. For the three months ended March 31, 2017, no mobile operator processed transactions
that generated more than 5% our revenues. For the three months ended March 31, 2016, Beeline (OJSC Vimpelcom) processed transactions
that generated 7% of our revenues.
NOTE 11. COMMITMENTS AND CONTINGENCIES
PayOnline Acquisition Commitments
On May 20, 2015, our subsidiaries TOT Group
Europe, Ltd. and TOT Group Russia LLC, entered into an agreement with Maglenta Enterprises Inc. and Champfremont Holding Ltd. (together,
the “Sellers”) to acquire all of the assets and liabilities that comprise PayOnline. PayOnline’s business includes
the operation of a protected payment processing system to accept bank card payments for goods and services.
Purchase consideration consisted of a combination
of $3.6 million in cash, and restricted common shares with a value of $3.6 million, payable in five quarterly installments, and,
if applicable, additional earn-out payments in cash and restricted common shares based on a multiple of EBITDA and subject to certain
EBITDA target achievement in the applicable quarter. The PayOnline acquisition agreement set forth the determination of the value
of such shares based on the closing stock price on the date before each applicable payment date. The agreement called for a guarantee,
payable in cash, for decreases in the market value of the restricted common shares issued at 12 months from the date of the respective
issuances. On May 19, 2016, we recognized a charge in the amount of $2,162,861 for decreases in the market value of the restricted
common shares issued pursuant to the stock price guarantee.
On October 25, 2016, we entered into a
settlement agreement with the Sellers relating to the stock price guarantee provision in the PayOnline acquisition agreement pursuant
to which we agreed to pay the Sellers an aggregate of $2,288,667 plus 10% per annum interest accrued from May 20, 2016 in installments
pursuant to the payment schedule set forth in the settlement agreement (also see Note 17). On October 25, 2016, we entered into
an amendment to the PayOnline acquisition agreement with the Sellers, in which we agreed to assume $1,433,475 of certain refundable
merchant deposit reserves. These reserves are expected to be refunded in 2017.
Leases
In May 2013, we entered into a lease agreement for approximately 4,716 square
feet of office space located at 3363 N.E. 163rd Street, Suites 705 through 707, North Miami Beach, Florida 33160. The term of the
lease agreement was from May 1, 2013 through December 31, 2016, with monthly rent increasing from $16,800 per month at
inception to $19,448 per month (or $233,377 per year) for the period from January 1, 2016 through December 31, 2016.
In September 2016, this lease was extended for a period of five
years commencing January 1, 2017 and expiring December 31, 2021 with monthly base rent increasing each year from $20,421 per month
beginning January 1, 2017 ($245,046 per year) to $24,821 per month beginning January 1, 2021 ($297,855 per year). The extension
has an early termination provision that allows us to cancel the lease with no cancellation fee if we enter into a new lease agreement
with Canal Park Office, LLC. We are currently negotiating with Canal Park Office, LLC for a new, larger space.
NetLabs Systems, LLC, through its Russian representative office,
currently leases 1,654 square feet of office space in Yekaterinburg, Russia, where it conducts Value Added Services and Sales Central
CRM development activities, at annual rent of approximately $24,300. The current lease term expires in June 1, 2017.
PayOnline Systems leases approximately 5,090 square feet of
office space in Moscow, Russia at an annual rent of $141,867. The current lease term for the office space expires on July
15, 2017. For the first regional office, PayOnline leases approximately 276 square feet of office space in Ekaterinburg, Russia
at annual rent of $3,328. For the second regional office, PayOnline leases approximately 155 square feet of office space in Almaty,
Russia at annual rent of $1,340. The leases are automatically renewable.
Net Element Russia leases
approximately 2,033 square feet of office space in Moscow, Russia at annual rent of $73,960, as well as one corporate
apartment at annual rent of $22,600. The current lease term for the office space expires on January 31, 2018 and we expect to
renew this lease at that time. The current lease term for the corporate apartment expires on August 16, 2017. The corporate
apartment lease will be terminated on May 31, 2017. There is no cost for early termination.
We believe that our facilities are suitable and adequate for
our present purposes, and we anticipate that we will be able to extend our existing leases on terms satisfactory to us or acquire
new facilities on acceptable terms.
Litigation
Aptito.com,
Inc.
On August 6, 2014, our subsidiary (Aptito, LLC) filed a lawsuit against Aptito.com, Inc. and the shareholders of Aptito.com,
Inc., in state court in the 11th Judicial Circuit in and for Miami-Dade County. This is an interpleader action in regards
to 125,000 shares of stock. Aptito, LLC acquired Aptito.com, Inc. in exchange for, among other things, 125,000 shares of
Net Element, Inc. stock. There has been disagreement among the Aptito.com, Inc. shareholders as to proper distribution
of the 125,000 shares. To avoid any liability in regards to improper distribution, Aptito, LLC filed the interpleader action so
as to allow the defendants to litigate amongst themselves as to how the shares should be distributed. Aptito.com, Inc.
opposes the motion to interplead and has filed counterclaims relative to Aptito, LLC non-delivery of the 125,000 shares. On
February 10, 2017, the Court held a hearing on Aptito.com, Inc.’s motion to dismiss the complaint and Aptito,
LLC and Net Element’s motion to dismiss Aptito.com, Inc.’s counterclaims. The Court denied Aptito.com,
Inc.’s motion to dismiss and granted Aptito, LLC and Net Element’s motion to dismiss the counterclaims without
prejudice. The Court also indicated that it will hold a hearing on the motion to interplead. A hearing date has yet to be
scheduled. If the motion to interplead is granted, it will be up to the defendants to litigate as to the proper distribution
of shares and Aptito, LLC should be discharged from any purported liability. On March 20, 2017, Aptito. com filed amended counterclaims against Aptito, LLC as well as claims against the Company alleging
amongst other matters, breach of contract and violations of federal and state securities laws. These counterclaims are without
merit and Aptito, LLC and the Company have filed a motion to dismiss the claims and a motion for sanctions. Counsel is trying
to schedule a hearing date for determination on these matters in July 2017.
Gene Zell
In June 2014, we, as plaintiff, commenced an action in the Miami-Dade Circuit Court, Florida against Gene Zell for defamation
of our Company and CEO and tortious interference with our business relationships. In October 2014, the court granted a temporary
injunction against Zell enjoining him from posting any information about our Company and CEO on any website and enjoining him
from contacting our business partners or investors. Zell violated the Court Order and the Court granted a Motion imposing
sanctions against Zell. We continue to seek enforcement of the Court Order. On April 13, 2015, Zell filed a Motion to set aside
the Court Order alleging he was unaware of the Court Proceedings. The Court, on August 26, 2015, dismissed Zell’s Motion to dissolve the injunction. In March 2017 the Court dismissed
another Motion brought by Zell to dissolve the injunction. Accordingly the injunction order prohibiting Zell from making further
defamatory posts remains in place. The Company intends to protect its rights by ongoing enforcement of the Injunction.
Other Legal Proceedings
We are involved in certain legal proceedings
and claims which arise in the ordinary course of business. In our opinion, based on consultations with outside counsel, the results
of any of these ordinary course matters, individually and in the aggregate, are not expected to have a material effect on our results
of operations, financial condition, or cash flows. As more information becomes available, if management should determine that an
unfavorable outcome is probable on such a claim and that the amount of such probable loss that it will incur on that claim is reasonably
estimable, we will record a reserve for the claim in question. If and when we record such a reserve is recorded, it could be material
and could adversely impact our results of operations, financial condition, and cash flows.
NOTE 12. RELATED PARTY TRANSACTIONS
In 2016, we and our subsidiary, TOT Group, Inc., entered into
certain term loan notes with MBF. For additional information about such term loan notes, see “MBF Merchant Capital, LLC”
in Note 9. William Healy, a member of our Board of Directors, is the sole member of MBF.
During the three months ended March
31, 2017 and 2016, agent commissions resulting from merchant processing of $24,926 and $0, respectively, were paid to Prime
Portfolios, LLC, an entity owned by Oleg Firer, our CEO, and Steven Wolberg, our Chief Legal Officer.
On March 1, 2017, we entered into a promissory
note with Star Capital Management, LLC, an entity which our CEO is the managing member, in the principal amount of $348,083 (the
“Note”). Pursuant to the Note, previously advanced funds with the interest accrued through the date of the Note as
determined at the execution of the Note in a total of $348,083. The Note provides for 18 monthly interest payments of $3,481 through
September 30, 2018 followed by one interest and principle payment on October 1, 2018. The principal balance of the Note outstanding
bears interest at the rate of 12% per annum. In the event of any capital raise by us that is not in the ordinary course of business
and that results in funding in excess of $5 million (a “Liquidity Event”), the maturity date will be accelerated to
coincide with the closing date of such Liquidity Event. The balance of this loan at March 31, 2017 and 2016 was $348,083 and $0,
respectively and is included in the $356,200 balance in Due to related parties on our balance sheet at March 31, 2017.
NOTE 13. STOCKHOLDERS’ EQUITY
On May 25, 2016, we effected a one-for-ten reverse stock split
of our common stock. Our consolidated financial statements and disclosures reflect for this change in capital structure for all
periods presented.
On June 12, 2015 and June 13, 2016, our shareholders approved
100,000,000 increases in our authorized common stock to 300,000,000 and 400,000,000, respectively.
Equity Incentive Plan Activity
On December 5, 2013, our shareholders approved the Net Element
International, Inc. 2013 Equity Incentive Plan (the “2013 Plan”). Awards under the 2013 Plan may be granted in any
one or all of the following forms: (i) incentive stock options meeting the requirements of Section 422 of the Internal Revenue
Code of 1986, as amended; (ii) non-qualified stock options (unless otherwise indicated, references to “Options” include
both Incentive Stock Options and Non-Qualified Stock Options); (iii) stock appreciation rights, which may be awarded either in
tandem with Options or on a stand-alone basis; (iv) shares of common stock that are restricted; (v) units representing shares of
common stock; (vi) units that do not represent shares of common stock but which may be paid in the form of common stock; and (vii)
shares of common stock that are not subject to any conditions to vesting. The maximum aggregate number of shares of common stock
available for award under the 2013 Plan at March 31, 2017 and December 31, 2016 was 207,938 and 1,280,258, respectively. The 2013
Plan is administered by the compensation committee.
On February 28, 2017, the Compensation Committee (the “Committee”)
of our Board of Directors approved and authorized grants of the following equity awards to our employees and consultants of the
Company pursuant to the 2013 Plan, as amended:
|
(i)
|
451,054
qualified options to acquire shares of our common stock (50% of such options vesting immediately and the balance 50% of such options
vesting in 4 equal proportions quarterly after the grant date) and
|
|
(ii)
|
626,678
restricted shares of our common stock (50% of such shares vesting immediately and the balance 50% of such shares vesting in 4
equal proportions quarterly after the grant date).
|
Awards Outside the 2013 Plan
On February 28, 2017, the Committee awarded to Oleg Firer, our Chief Executive Officer, 471,388 restricted shares of our common stock as performance bonus
subject to shareholder approval.
Other Stock Issuance
Pursuant to the earn out installment
provisions of the PayOnline purchase agreement, we issued an additional 130,823 shares of our common stock and paid $108,583
during March 2017. We accrued but not yet issued 20,161 shares to our independent directors for payment of services during
the first quarter of 2017.
Agreement with ESOUSA Holdings
On July 6, 2016, we entered into a common
stock purchase agreement (“Purchase Agreement”), with ESOUSA Holdings, LLC, a New York limited liability company (“ESOUSA”),
which provides that ESOUSA is committed to purchase up to an aggregate of $10 million of our shares of common stock over the 30-month
term of the Purchase Agreement. In consideration for entering into the Purchase Agreement, we paid shares of our common stock with
a value equivalent $200,000 as a commitment fee to ESOUSA. The number of shares was calculated using the average of volume weighted
average price for our common stock during the 3 trading day period immediately preceding the date of issuance of such shares. Accordingly,
on August 31, 2016, we issued 131,171 shares of our common stock to ESOUSA based on the price of $1.5247 per share.
In connection with the ESOUSA Purchase Agreement, we issued
the following shares of our common stock to ESOUSA during the three months ended March 31, 2017:
Issue
|
|
Number of
|
|
|
Purchase
|
|
|
Share
|
|
Date
|
|
Shares
|
|
|
Amount
|
|
|
Price
|
|
January 19, 2017
|
|
|
240,964
|
|
|
$
|
200,000
|
|
|
$
|
0.83
|
|
January 25, 2017
|
|
|
176,471
|
|
|
|
150,000
|
|
|
|
0.85
|
|
February 8, 2017
|
|
|
1,161,442
|
|
|
|
1,000,000
|
|
|
|
0.86
|
|
March 27, 2017
|
|
|
103,790
|
|
|
|
87,132
|
|
|
|
0.84
|
|
Totals
|
|
|
1,682,667
|
|
|
$
|
1,437,132
|
|
|
$
|
0.85
|
|
NOTE 14. WARRANTS AND NON-INCENTIVE
PLAN OPTIONS
Warrants
In 2013, our predecessor entity (then known as Cazador Acquisition
Corporation Ltd.) issued 8,940,000 warrants to purchase 894,000 shares of common stock in connection with its private placement
and initial public offering. At March 31, 2017 and December 31, 2016, we had warrants outstanding to purchase 893,890 shares
of common stock. At March 31, 2017, the warrants have a weighted average exercise price of $75.00 per share purchased and a weighted
average remaining contractual term of 0.50 years (0.75 years at December 31, 2016). These warrants are “out-of-the-money”
and have no intrinsic value at March 31, 2017 and December 31, 2016. The warrants are exercisable only if a registration statement
relating to the common shares issuable upon exercise of the warrants is effective and current. These warrants expire on October
1, 2017.
Non-Incentive Plan Options
At March 31, 2017 and December 31, 2016, we had 1,602,142 non-incentive
options outstanding with an exercise price of $2.18 and a remaining contract term of 3.67 and 3.92 years, respectively. These options
were out of the money at March 31, 2017 and December 31, 2016 and had no intrinsic value.
NOTE 15. INCOME TAXES
Our net deferred tax assets primarily are comprised of net operating
loss carryforwards (“NOLs”), and basis difference in goodwill and intangibles. These NOLs total approximately $52.3
million and $45.9 million for federal, and approximately $12.4 million and $10.8 million for foreign NOLs as of March 31, 2017
and March 31, 2016, respectively.
The timing and manner in which we will be able to utilize our
NOLs is limited by Section 382 of the Internal Revenue Code of 1986, as amended (IRC). IRC Section 382 imposes limitations on a
corporation’s ability to use its NOLs when it undergoes an “ownership change.” Generally, an ownership change
occurs if one or more shareholders, each of whom owns 5% or more in value of a corporation’s stock, increase their percentage
ownership, in the aggregate, by more than 50% over the lowest percentage of stock owned by such shareholders at any time during
the preceding three-year period. Because on June 10, 2014, we underwent an ownership change as defined by IRC Section 382, the
limitation applies to us. The losses generated prior to the ownership change date (pre-change losses) are subject to the Section
382 limitation. The pre-change losses may only become available to be utilized by us at the rate of $2.4 million per year. Any
unused losses can be carried forward, subject to their original carry forward limitation periods. In the year 2017, approximately
$2.4 million in the pre-change losses was released from the Section 382 loss limitation. We can still fully utilize the NOLs generated
after the change of the ownership, which was approximately $12.5 million. Thus, we expect the total of approximately $16.6 million
as of March 31, 2017 is available to offset future taxable income.
In order to fully utilize the net deferred tax assets, we will
need to generate sufficient taxable income in future years to utilize its NOLs prior to their expiration. ASC Topic 740, “Income
Taxes”, requires us to analyze all positive and negative evidence to determine if, based on the weight of available evidence,
we are more likely than not to realize the benefit of the net deferred tax assets. The recognition of the net deferred tax assets
and related tax benefits is based upon our conclusions regarding, among other considerations, estimates of future earnings based
on information currently available, current and anticipated customers, contracts and product introductions, as well as historical
operating results and certain tax planning strategies.
We have evaluated the available evidence and the likelihood
of realizing the benefit of our net deferred tax assets. From our evaluation, we have concluded that based on the weight of available
evidence, it is more likely than not that we will not realize any of the benefit of its net deferred tax assets. Accordingly, at
March 31, 2017, we maintain a full valuation allowance totaling approximately $24.4 million.
NOTE 16. SEGMENT INFORMATION
Our three reportable segments include:
(i) North American Transaction Solutions for electronic commerce, (ii) Mobile Solutions (primarily servicing the Russian Federation
and CIS) and (iii) Online Solutions. Management determines the reportable segments based on the internal reporting used by our
Chief Operating Decision Maker to evaluate performance and to assess where to allocate resources. During the three months ended
March 31, 2017 and 2016, the principal revenue stream for all segments came from services fees and branded content.
Factors management used to identify
the entity’s reportable segments
The Company’s reportable segments
are business units that offer different products and services in different geographies. The reportable segments are each managed
separately because they offer distinct products with different delivery and service processes.
North American Transaction Solutions
Our U.S. payment processing business segment
consists of the former Unified Payments business and Aptito. This segment operates primarily in North America. In March 2013, we
acquired all of the business assets of Unified Payments, a provider of comprehensive turnkey, payment processing solutions to small
and medium size business owners (merchants) and independent sales organizations across the United States.
In April 2013, we purchased 80% of Aptito,
a cloud based Software-as-a-Service (“SaaS”) restaurant management solution, which provides integrated POS, mPOS, Kiosk,
Digital Menus functionality to drive consumer engagement via Apple® iPad®-based POS, kiosk and all other cloud-connected
devices.
Mobile Solutions
Our Russian mobile and online payment processing
segment consists of Digital Provider, which operates primarily in the Russian Federation and CIS.
In June 2012, we formed our subsidiary,
OOO TOT Money, to develop a business in mobile commerce payment processing. TOT Money launched its initial operations in Russia
as a payment facilitator using SMS (short message services, which is a text messaging service) and MMS (multimedia message services)
for mobile phone subscribers in Russia. During 2015, we changed or business model, rebranded our name to Digital Provider, and
began to offer branded content to subscribers.
Online Solutions
On May 20, 2015, we acquired the net assets
that comprise PayOnline, which includes a protected payment processing system to accept bank card payments for goods and services.
PayOnline primarily operates in Russia and CIS.
The accounting policies of the individual
transactions in the reportable segments are the same as those of the Company, as described in Note 1. Transactions between reportable
segments are primarily conducted at market rates, resulting in segment profits or expenses that are eliminated for reporting consolidated
results.
Segment Summary Information
The following tables present financial
information of the Company’s reportable segments at March 31, 2017 and 2016. The “Corporate Expenses & Eliminations”
column includes all corporate expenses and intercompany eliminations for consolidated purposes.
Three months ended March 31, 2017
|
|
North
American
Transaction
Solutions
|
|
|
Mobile
Solutions
|
|
|
Online
Solutions
|
|
|
Corporate
Expenses &
Eliminations
|
|
|
Total
|
|
Net revenues
|
|
$
|
10,964,919
|
|
|
$
|
856,993
|
|
|
$
|
1,740,029
|
|
|
$
|
-
|
|
|
$
|
13,561,941
|
|
Cost of revenues
|
|
|
9,461,449
|
|
|
|
816,963
|
|
|
|
1,181,580
|
|
|
|
-
|
|
|
|
11,459,992
|
|
Gross Margin
|
|
|
1,503,470
|
|
|
|
40,030
|
|
|
|
558,449
|
|
|
|
-
|
|
|
|
2,101,949
|
|
Gross margin %
|
|
|
14
|
%
|
|
|
5
|
%
|
|
|
32
|
%
|
|
|
-
|
|
|
|
15
|
%
|
General, administrative, and asset disposal
|
|
|
751,234
|
|
|
|
124,204
|
|
|
|
549,608
|
|
|
|
1,406,115
|
|
|
|
2,831,161
|
|
Non-cash compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
596,404
|
|
|
|
596,404
|
|
Provision for bad debt
|
|
|
276,324
|
|
|
|
288
|
|
|
|
1,887
|
|
|
|
1,260
|
|
|
|
279,759
|
|
Depreciation and amortization
|
|
|
358,756
|
|
|
|
1,047
|
|
|
|
290,097
|
|
|
|
7,463
|
|
|
|
657,363
|
|
Interest expense (income), net
|
|
|
175,180
|
|
|
|
-
|
|
|
|
-
|
|
|
|
94,508
|
|
|
|
269,688
|
|
Other expenses
|
|
|
-
|
|
|
|
2,807
|
|
|
|
2,953
|
|
|
|
13
|
|
|
|
5,773
|
|
Net (loss) for segment
|
|
$
|
(58,024
|
)
|
|
$
|
(88,316
|
)
|
|
$
|
(286,096
|
)
|
|
$
|
(2,105,763
|
)
|
|
$
|
(2,538,199
|
)
|
Segment assets
|
|
$
|
14,170,749
|
|
|
$
|
3,631,656
|
|
|
$
|
4,971,352
|
|
|
$
|
211,015
|
|
|
$
|
22,984,772
|
|
Three Months Ended March 31, 2016
|
|
North
American
Transaction
Solutions
|
|
|
Mobile
Solutions
|
|
|
Online
Solutions
|
|
|
Corporate
Expenses &
Eliminations
|
|
|
Total
|
|
Net revenues
|
|
$
|
7,852,648
|
|
|
$
|
1,993,504
|
|
|
$
|
1,414,907
|
|
|
$
|
-
|
|
|
|
11,261,059
|
|
Cost of revenues
|
|
|
6,653,033
|
|
|
|
1,814,588
|
|
|
|
917,620
|
|
|
|
-
|
|
|
|
9,385,241
|
|
Gross Margin
|
|
|
1,199,615
|
|
|
|
178,916
|
|
|
|
497,287
|
|
|
|
-
|
|
|
|
1,875,818
|
|
Gross margin %
|
|
|
15
|
%
|
|
|
9
|
%
|
|
|
35
|
%
|
|
|
-
|
|
|
|
17
|
%
|
General, administrative, and asset disposal
|
|
|
656,526
|
|
|
|
71,078
|
|
|
|
334,459
|
|
|
|
1,026,250
|
|
|
|
2,088,313
|
|
Non-cash compensation
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
360,984
|
|
|
|
360,984
|
|
Provision for bad debt
|
|
|
251,341
|
|
|
|
-
|
|
|
|
400
|
|
|
|
-
|
|
|
|
251,741
|
|
Depreciation and amortization
|
|
|
320,071
|
|
|
|
4,190
|
|
|
|
487,383
|
|
|
|
76,474
|
|
|
|
888,118
|
|
Interest expense, net
|
|
|
147,784
|
|
|
|
-
|
|
|
|
-
|
|
|
|
2,654
|
|
|
|
150,438
|
|
Other expenses
|
|
|
-
|
|
|
|
4,955
|
|
|
|
16,864
|
|
|
|
-
|
|
|
|
21,819
|
|
Net (loss) income for segment
|
|
$
|
(176,107
|
)
|
|
$
|
98,693
|
|
|
$
|
(341,819
|
)
|
|
$
|
(1,466,362
|
)
|
|
$
|
(1,885,595
|
)
|
Segment assets
|
|
$
|
6,866,093
|
|
|
$
|
2,487,714
|
|
|
$
|
6,644,945
|
|
|
$
|
5,617,004
|
|
|
|
21,615,756
|
|
Item 2. Management’s
Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion should be read
and evaluated in conjunction with the unaudited condensed consolidated financial statements and notes thereto contained in this
Report and with the discussion under “Forward-Looking Statements” on page 2 at the beginning of this Report and the
Risk Factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2016 and in
Part II, Item 1A of this Report.
Results of Operations for the Three
Months Ended March 31, 2017 Compared to the Three Months Ended March 31, 2016
We reported a net loss attributable to stockholders of $2,487,498,
or $0.15 per share, for the three months ended March 31, 2017 as compared to a net loss attributable to stockholders of $1,847,719,
or $0.16 per share, for the three months ended March 31, 2016. This resulted in an increase in net loss attributable to stockholders of $639,779 primarily as a
result of higher general and administrative expenses and non-cash compensation expense offset by an improved gross margin.
Net revenues consist primarily of
payment processing fees. Net revenues were $13,561,941 for the three months ended March 31, 2017 as compared to $11,261,059
for the three months ended March 31, 2016. The increase in net revenue is primarily due to organic growth of merchants in our
North American Transaction Solutions segment which resulted in an increase to North American Transaction Solutions segment
revenue of $3,112,271, (or 40% increase) for the three months ended March 31, 2017 versus the three months ended March 31,
2016. Increases in our North American Transaction Solutions segment revenue were primarily due to continued growth of SMB
merchants with emphasis on value-added offerings. This was partially offset by a $1,136,511, (or 57%) decrease in our Mobile
Solutions segment, as we continue to seek capital needed to prepay for content delivered through our platform as well as
diversity to post-paid markets. Our Online Solutions segment revenue increased $325,122 (or 23%), from $1,414,907 for
the three months ended March 31, 2016 to $1,740,029 for the three months ended March 31, 2017, primarily due to changes in
foreign currency exchange rates.
The following
table sets forth our sources of revenues, cost of revenues and gross margins for the three months ended March 31, 2017 and 2016:
Gross Margin Analysis
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three
|
|
|
|
|
|
Three
|
|
|
|
|
|
|
|
|
|
Months Ended
|
|
|
|
|
|
Months Ended
|
|
|
|
|
|
Increase /
|
|
Source of Revenues
|
|
March 31, 2017
|
|
|
Mix
|
|
|
March 31, 2016
|
|
|
Mix
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North American Transaction Solutions
|
|
$
|
10,964,919
|
|
|
|
81
|
%
|
|
$
|
7,852,648
|
|
|
|
70
|
%
|
|
$
|
3,112,271
|
|
Mobile Solutions
|
|
|
856,993
|
|
|
|
6
|
%
|
|
|
1,993,504
|
|
|
|
18
|
%
|
|
|
(1,136,511
|
)
|
Online Solutions
|
|
|
1,740,029
|
|
|
|
13
|
%
|
|
|
1,414,907
|
|
|
|
12
|
%
|
|
|
325,122
|
|
Total
|
|
$
|
13,561,941
|
|
|
|
100
|
%
|
|
$
|
11,261,059
|
|
|
|
100
|
%
|
|
$
|
2,300,882
|
|
|
|
Three
|
|
|
|
|
|
Three
|
|
|
|
|
|
|
|
|
|
Months Ended
|
|
|
% of
|
|
|
Months Ended
|
|
|
% of
|
|
|
Increase /
|
|
Cost of Revenues
|
|
March 31, 2017
|
|
|
revenues
|
|
|
March 31, 2016
|
|
|
revenues
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North American Transaction Solutions
|
|
$
|
9,461,449
|
|
|
|
86
|
%
|
|
$
|
6,653,033
|
|
|
|
85
|
%
|
|
$
|
2,808,416
|
|
Mobile Solutions
|
|
|
816,963
|
|
|
|
95
|
%
|
|
|
1,814,588
|
|
|
|
91
|
%
|
|
|
(997,625
|
)
|
Online Solutions
|
|
|
1,181,580
|
|
|
|
68
|
%
|
|
|
917,620
|
|
|
|
65
|
%
|
|
|
263,960
|
|
Total
|
|
$
|
11,459,992
|
|
|
|
85
|
%
|
|
$
|
9,385,241
|
|
|
|
83
|
%
|
|
$
|
2,074,751
|
|
|
|
Three
|
|
|
|
|
|
Three
|
|
|
|
|
|
|
|
|
|
Months Ended
|
|
|
% of
|
|
|
Months Ended
|
|
|
% of
|
|
|
Increase /
|
|
Gross Margin
|
|
March 31, 2017
|
|
|
revenues
|
|
|
March 31, 2016
|
|
|
revenues
|
|
|
(Decrease)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
North American Transaction Solutions
|
|
$
|
1,503,470
|
|
|
|
14
|
%
|
|
$
|
1,199,615
|
|
|
|
15
|
%
|
|
$
|
303,855
|
|
Mobile Solutions
|
|
|
40,030
|
|
|
|
5
|
%
|
|
|
178,916
|
|
|
|
9
|
%
|
|
|
(138,886
|
)
|
Online Solutions
|
|
|
558,449
|
|
|
|
32
|
%
|
|
|
497,287
|
|
|
|
35
|
%
|
|
|
61,162
|
|
Total
|
|
$
|
2,101,949
|
|
|
|
15
|
%
|
|
$
|
1,875,818
|
|
|
|
17
|
%
|
|
$
|
226,131
|
|
Cost of revenues represents
direct costs of generating revenues, including commissions, mobile operator fees, purchases of short numbers, interchange
expense and processing fees. Cost of revenues for the three months ended March 31, 2017 were $11,459,992 as compared to
$9,385,241 for the three months ended March 31, 2016. The $2,074,751 increase in cost of revenues was primarily due to a
$2,808,416 increase in our North American Transaction Solutions segment due to increased volume. There was also a $263,960
increase in cost of revenues resulting from our Online Solutions segment operations also primarily due to changes in foreign
currency rates. This was offset by a $997,625 decrease in our Mobile Solutions segment cost of revenues, which resulted from the
decrease in sales for our Mobile Solutions segment for the three months ended March 31, 2017.
Gross Margin for the three months ended
March 31, 2017 was $2,101,949, or 15% of net revenue, as compared to $1,875,818, or 17% of net revenue, for the three months ended
March 31, 2016. The $226,131 increase in gross margin was due to the increased volume of processing in our North American Transaction
Solutions offset by a decrease of $138,886 in our Mobile Solutions margin caused from a decrease in business.
Total operating expenses were $4,364,687 for the three months
ended March 31, 2017. Total operating expenses for the three months ended March 31, 2017 consisted of general and administrative
expenses of $2,831,161, non-cash compensation expenses of $596,404, provision for bad debts of $279,759, and depreciation and amortization
of $657,363. Total operating expenses were $3,589,156 for the three months ended March 31, 2016, which consisted of general and
administrative expenses of $2,088,313, non-cash compensation expenses of $360,984, provision for bad debts of $251,741, and depreciation
and amortization of $888,118.
The components of our general and administrative expenses are
discussed below.
General and administrative
expenses for the three months ended March 31, 2017 and 2016 consisted of operating expenses not otherwise delineated in
our Consolidated Statements of Operations and Comprehensive Loss and include salaries and benefits, professional fees, rent,
travel expense, filing fees, transaction gains, office expenses, communication expense, insurance expense, and other
expenses required to run our business, as follows:
Three Months Ended March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category
|
|
North America Transaction Solutions
|
|
|
Mobile Solutions
|
|
|
Online Solutions
|
|
|
Corporate Expenses & Eliminations
|
|
|
Total
|
|
Salaries, benefits, taxes and contractor payments
|
|
$
|
480,617
|
|
|
$
|
123,818
|
|
|
$
|
221,755
|
|
|
$
|
841,520
|
|
|
$
|
1,667,710
|
|
Professional fees
|
|
|
168,076
|
|
|
|
25,071
|
|
|
|
225,342
|
|
|
|
255,201
|
|
|
|
673,690
|
|
Rent
|
|
|
-
|
|
|
|
15,169
|
|
|
|
39,468
|
|
|
|
98,428
|
|
|
|
153,065
|
|
Business development
|
|
|
1,824
|
|
|
|
962
|
|
|
|
9,020
|
|
|
|
1,581
|
|
|
|
13,387
|
|
Travel expense
|
|
|
32,804
|
|
|
|
5,096
|
|
|
|
1,171
|
|
|
|
56,225
|
|
|
|
95,296
|
|
Filing fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
6,426
|
|
|
|
6,426
|
|
Transaction (gains) losses
|
|
|
-
|
|
|
|
(49,324
|
)
|
|
|
3,316
|
|
|
|
1,731
|
|
|
|
(44,277
|
)
|
Office expenses
|
|
|
52,645
|
|
|
|
2,712
|
|
|
|
17,297
|
|
|
|
75,443
|
|
|
|
148,097
|
|
Communications expenses
|
|
|
13,319
|
|
|
|
700
|
|
|
|
30,087
|
|
|
|
20,624
|
|
|
|
64,730
|
|
Insurance expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
44,107
|
|
|
|
44,107
|
|
Other expenses
|
|
|
1,949
|
|
|
|
-
|
|
|
|
2,152
|
|
|
|
4,829
|
|
|
|
8,930
|
|
Total
|
|
$
|
751,234
|
|
|
$
|
124,204
|
|
|
$
|
549,608
|
|
|
$
|
1,406,115
|
|
|
$
|
2,831,161
|
|
Three Months Ended March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category
|
|
North America Transaction Solutions
|
|
|
Mobile Solutions
|
|
|
Online Solutions
|
|
|
Corporate Expenses & Eliminations
|
|
|
Total
|
|
Salaries, benefits, taxes and contractor payments
|
|
$
|
393,446
|
|
|
$
|
107,925
|
|
|
$
|
112,773
|
|
|
$
|
564,803
|
|
|
$
|
1,178,947
|
|
Professional fees
|
|
|
163,239
|
|
|
|
1,108
|
|
|
|
83,743
|
|
|
|
276,297
|
|
|
|
524,387
|
|
Rent
|
|
|
-
|
|
|
|
11,086
|
|
|
|
32,092
|
|
|
|
93,066
|
|
|
|
136,244
|
|
Business development
|
|
|
8,770
|
|
|
|
-
|
|
|
|
24,673
|
|
|
|
-
|
|
|
|
33,443
|
|
Travel expense
|
|
|
41,312
|
|
|
|
3,875
|
|
|
|
2,938
|
|
|
|
8,884
|
|
|
|
57,009
|
|
Filing fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
16,499
|
|
|
|
16,499
|
|
Transaction (gains) losses
|
|
|
-
|
|
|
|
(55,533
|
)
|
|
|
62,763
|
|
|
|
7,736
|
|
|
|
14,966
|
|
Office expense
|
|
|
19,599
|
|
|
|
2,054
|
|
|
|
11,311
|
|
|
|
29,510
|
|
|
|
62,474
|
|
Communications expense
|
|
|
30,160
|
|
|
|
274
|
|
|
|
4,091
|
|
|
|
23,432
|
|
|
|
57,957
|
|
Insurance expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
3,125
|
|
|
|
3,125
|
|
Other expenses
|
|
|
-
|
|
|
|
289
|
|
|
|
75
|
|
|
|
2,898
|
|
|
|
3,262
|
|
Total
|
|
$
|
656,526
|
|
|
$
|
71,078
|
|
|
$
|
334,459
|
|
|
$
|
1,026,250
|
|
|
$
|
2,088,313
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Category
|
|
North America Transaction Solutions
|
|
|
Mobile Solutions
|
|
|
Online Solutions
|
|
|
Corporate Expenses & Eliminations
|
|
|
Total
|
|
Salaries, benefits, taxes and contractor payments
|
|
$
|
87,171
|
|
|
$
|
15,893
|
|
|
$
|
108,982
|
|
|
$
|
276,717
|
|
|
$
|
488,763
|
|
Professional fees
|
|
|
4,837
|
|
|
|
23,963
|
|
|
|
141,599
|
|
|
|
(21,096
|
)
|
|
|
149,303
|
|
Rent
|
|
|
-
|
|
|
|
4,083
|
|
|
|
7,376
|
|
|
|
5,362
|
|
|
|
16,821
|
|
Business development
|
|
|
(6,946
|
)
|
|
|
962
|
|
|
|
(15,653
|
)
|
|
|
1,581
|
|
|
|
(20,056
|
)
|
Travel expense
|
|
|
(8,508
|
)
|
|
|
1,221
|
|
|
|
(1,767
|
)
|
|
|
47,341
|
|
|
|
38,287
|
|
Filing fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(10,073
|
)
|
|
|
(10,073
|
)
|
Transaction (gains) losses
|
|
|
-
|
|
|
|
6,209
|
|
|
|
(59,447
|
)
|
|
|
(6,005
|
)
|
|
|
(59,243
|
)
|
Office expense
|
|
|
33,046
|
|
|
|
658
|
|
|
|
5,986
|
|
|
|
45,933
|
|
|
|
85,623
|
|
Communications expense
|
|
|
(16,841
|
)
|
|
|
426
|
|
|
|
25,996
|
|
|
|
(2,808
|
)
|
|
|
6,773
|
|
Insurance expense
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
40,982
|
|
|
|
40,982
|
|
Other expenses
|
|
|
1,949
|
|
|
|
(289
|
)
|
|
|
2,077
|
|
|
|
1,931
|
|
|
|
5,668
|
|
Total
|
|
$
|
94,708
|
|
|
$
|
53,126
|
|
|
$
|
215,149
|
|
|
$
|
379,865
|
|
|
$
|
742,848
|
|
Salaries, benefits, taxes and contractor payments were $1,367,710
for the three months ended March 31, 2017 as compared to $1,178,947 for the three months ended March 31, 2016.
Segment
|
|
Salaries
and
benefits for the
three months
ended
March 31, 2017
|
|
|
Salaries and
benefits for the
three months
ended
March 31, 2016
|
|
|
Increase /
(Decrease)
|
|
North American Transaction Solutions
|
|
$
|
480,617
|
|
|
$
|
393,446
|
|
|
$
|
87,171
|
|
Mobile Solutions
|
|
|
123,818
|
|
|
|
107,925
|
|
|
|
15,893
|
|
Online Solutions
|
|
|
221,755
|
|
|
|
112,773
|
|
|
|
108,982
|
|
Corporate Expenses & Eliminations
|
|
|
841,520
|
|
|
|
564,803
|
|
|
|
276,717
|
|
Total
|
|
$
|
1,667,710
|
|
|
$
|
1,178,947
|
|
|
$
|
488,763
|
|
The increase in salaries of $488,763
was due primarily to the increase of Corporate expenses for a $300,000 discretionary bonus payable to our CEO and approved by
the Board of directors. The bonus is payable when cash flow of the business can support the payment. Additionally, North
American Transaction Solutions segment salaries increased $87,171 due to an increase in headcount and sales incentives for
key employees. We also saw an increase of $108,982 and $15,893, respectively, in our Online Solutions and Mobile Solutions
segments which were primarily due to the Ruble exchange rate and to a lesser extent, salary increases.
Professional fees were $673,690 for the three months ended March
31, 2017 as compared to $524,387 for the three months ended March 31, 2016.
Three Months Ended March 31, 2017
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Professional Fees
|
|
North American
Transaction
Solutions
|
|
|
Mobile
Solutions
|
|
|
Online
Solutions
|
|
|
Corporate
Expenses &
Eliminations
|
|
|
Total
|
|
General Legal
|
|
$
|
42,599
|
|
|
$
|
-
|
|
|
$
|
713
|
|
|
$
|
33,526
|
|
|
$
|
76,838
|
|
SEC Compliance Legal Fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
23,750
|
|
|
|
23,750
|
|
Accounting and Auditing
|
|
|
-
|
|
|
|
-
|
|
|
|
9,219
|
|
|
|
112,782
|
|
|
|
122,001
|
|
Tax Compliance and Planning
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
14,900
|
|
|
|
14,900
|
|
Consulting
|
|
|
125,477
|
|
|
|
25,071
|
|
|
|
215,410
|
|
|
|
70,243
|
|
|
|
436,201
|
|
Total
|
|
$
|
168,076
|
|
|
$
|
25,071
|
|
|
$
|
225,342
|
|
|
$
|
255,201
|
|
|
$
|
673,690
|
|
Three Months Ended March 31, 2016
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Professional Fees
|
|
North American
Transaction
Solutions
|
|
|
Mobile
Solutions
|
|
|
Online
Solutions
|
|
|
Corporate
Expenses &
Eliminations
|
|
|
Total
|
|
General Legal
|
|
$
|
28,171
|
|
|
$
|
200
|
|
|
$
|
513
|
|
|
$
|
24,911
|
|
|
$
|
53,795
|
|
SEC Compliance Legal Fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
43,750
|
|
|
|
43,750
|
|
Accounting and Auditing
|
|
|
-
|
|
|
|
-
|
|
|
|
578
|
|
|
|
121,344
|
|
|
|
121,922
|
|
Tax Compliance and Planning
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
Consulting
|
|
|
105,068
|
|
|
|
908
|
|
|
|
82,652
|
|
|
|
116,292
|
|
|
|
304,920
|
|
Total
|
|
$
|
133,239
|
|
|
$
|
1,108
|
|
|
$
|
83,743
|
|
|
$
|
306,297
|
|
|
$
|
524,387
|
|
Variance
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Professional Fees
|
|
North American
Transaction
Solutions
|
|
|
Mobile
Solutions
|
|
|
Online
Solutions
|
|
|
Corporate
Expenses &
Eliminations
|
|
|
Increase /
(Decrease)
|
|
General Legal
|
|
$
|
14,428
|
|
|
$
|
(200
|
)
|
|
$
|
200
|
|
|
$
|
8,615
|
|
|
$
|
23,043
|
|
SEC Compliance Legal Fees
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
(20,000
|
)
|
|
|
(20,000
|
)
|
Accounting and Auditing
|
|
|
-
|
|
|
|
-
|
|
|
|
8,641
|
|
|
|
(8,562
|
)
|
|
|
79
|
|
Tax Compliance and Planning
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
14,900
|
|
|
|
14,900
|
|
Consulting
|
|
|
20,409
|
|
|
|
24,163
|
|
|
|
132,758
|
|
|
|
(46,049
|
)
|
|
|
131,281
|
|
Total
|
|
$
|
34,837
|
|
|
$
|
23,963
|
|
|
$
|
141,599
|
|
|
$
|
(51,096
|
)
|
|
$
|
149,303
|
|
Professional fees increased by $149,303
mainly due to Online Solutions segments’ consulting fees which increased by $132,758 mainly due to an increase in portfolio management consulting.
Non-cash compensation expense from share-based
compensation was $596,404 for the three months ended March 31, 2017, compared to $360,984 for the three months ended March 31,
2016. The majority of these expenses were for employee and consultant incentives in both periods.
We recorded bad debt expense of $279,759
for the three months ended March 31, 2017 as compared to $251,741 for the three months ended March 31, 2016. For the three months
ended March 31, 2017, we recorded a loss which was primarily comprised of $286,943 in ACH rejects offset by a $7,184 recovery from
our Russian operations. For the three months ended March 31, 2016, we recorded a loss which was primarily comprised of $263,789
in ACH rejects offset by a $12,048 recovery from our Russian operations.
Depreciation
and amortization expense consists primarily of the amortization of merchant portfolios plus depreciation expense on fixed assets,
client acquisition costs, capitalized software expenses, trademarks, domain names and employee non-compete agreements. Depreciation
and amortization expense was $657,363 for the three months ended March 31, 2017 as compared to $888,118 for the three months ended
March 31, 2016.
Interest expense was $269,688 for the three
months ended March 31, 2017 as compared to $150,438 for three months ended March 31, 2016, representing an increase of $119,250 as follows:
Funding Source
|
|
Three months ended
March 31, 2017
|
|
|
Three months ended
March 31, 2016
|
|
|
Increase /
(Decrease)
|
|
MBF Notes
|
|
$
|
18,813
|
|
|
$
|
-
|
|
|
$
|
18,813
|
|
RBL Notes
|
|
|
143,058
|
|
|
|
147,784
|
|
|
|
(4,726
|
)
|
Other
|
|
|
107,817
|
|
|
|
2,654
|
|
|
|
105,163
|
|
Total
|
|
$
|
269,688
|
|
|
$
|
150,438
|
|
|
$
|
119,250
|
|
Other interest costs primarily consisted of $45,132 resulting from the stock price guarantee related to the PayOnline acquisition
and $57,159 resulting from the promissory note entered into on March 1, 2017 with Star Capital Management, LLC. (See Note
12. Related Party Transactions).
The net loss attributable to non-controlling interests amounted
to $50,701 for three months ended March 31, 2017 as compared to $37,876 for the three months ended March 31, 2016.
Liquidity and Capital Resources
Our total assets at March 31,
2017 were $23.0 million compared to $23.3 million at December 31, 2016. The period over period change in total assets is
primarily attributable to a decrease in accounts receivables, due to collections of North American Transaction Solutions
segment annual fees, a $0.2 million decrease in other long term assets due to a return of excess reserves held by North
American Transaction Solutions
segment processors, offset by a $0.2 million increase in prepaid and other expenses primarily due to
our Mobile Solutions
segment providing advances to partners.
At December 31, 2016, we had total current assets of $9.2 million
including $0.6 million of cash, $7.1 million of accounts receivable, and $1.5 million of prepaid expenses and other assets.
We currently believe that we will require an additional $4.8
million to finance continuing operations as currently conducted over the next 12 months. In addition, we have a payment obligation
of approximately $1.8 million associated with our PayOnline acquisition. These conditions raise substantial doubt about our ability
to continue as a going concern.
Additional funds may be raised through
debt financing and/or the issuance of equity securities, there being no assurance that any type of financing on terms satisfactory
to us will be available or otherwise occur. Debt financing must be repaid regardless of whether we generate revenues or cash flows
from operations and may be secured by substantially all of our assets. Any equity financing or debt financing that requires the
issuance of equity securities or warrants to the lender would cause the percentage ownership by our current stockholders to be
diluted, which dilution may be substantial. Also, any additional equity securities issued may have rights, preferences or privileges
senior to those of existing stockholders. If such financings are not available when required or are not available on acceptable
terms, we may be unable to implement our business plans or take advantage of business opportunities, any of which could have a
material adverse effect on our business, financial condition, results of operations and/or prospects and may ultimately require
us to suspend or cease operations, which could cause investors to lose the entire amount of their investment.
The net loss attributable to Net Element,
Inc. stockholders was $2.4 million for the three months ended March 31, 2017 compared to $1.8 million for the three months ended
March 31, 2016.
Operating activities used $956,223
of cash for the three months ended March 31, 2017 as compared to $947,001 of cash used for the three months ended March 31,
2016. Negative operating cash flow of $956,223 for the three months ended March 31, 2017 was primarily due to a net loss of
$2,487,498 and a $231,755 increase in prepaid and other assets and a $445,953 net decrease of deferred revenue primarily
resulting from amortization of annual fees, offset by a $449,284 increase in accounts payable and accrued expenses and a
$510,498 decrease in account receivable.
For the three months ended March 31,
2017, investing activities used $403,230 in cash primarily for client acquisition costs as compared to $396,819 of cash
used primarily to purchase portfolios and client acquisition costs for the three months ended March 31, 2016.
Financing activities provided $1,493,611
in cash for the three months ended March 31, 2017 as compared to $985,045 of cash provided from financing activities for the three
months ended March 31, 2016. Financing activities provided $1,493,611 for the three months ended March 31, 2017, primarily from
the sale of stock. Financing activities provided $985,045 in cash for the three months ended March 31, 2016 resulting from related
party advances of $910,045 and proceeds from indebtedness of $75,000.
We have Russian operations that transact in foreign currencies
including Russian Rubles, Euros, and Kazakhstan Tenges. The effect of exchange rate changes increased our US Dollar-denominated
cash balance by $57,288 for the three months ended March 31, 2017 as compared to a $57,537 increase for the three months ended
March 31, 2016.
Off-balance sheet arrangements
At March 31, 2017, we did not have any
off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.
Item 3. Quantitative
and Qualitative Disclosures about Market Risk.
Not applicable.
Item 4. Controls
and Procedures.
Our disclosure controls and procedures
are designed to provide reasonable assurance that information required to be disclosed in our reports filed or submitted under
the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules
and forms, and that such information is accumulated and communicated to our management, including our chief executive officer and
chief financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating
the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply
its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
As of the end of the period covered by
this Report, our management conducted an evaluation, under the supervision and with the participation of our chief executive officer
and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule
15d-15(e) under the Exchange Act). Based on that evaluation, our chief executive officer and chief financial officer concluded
that our disclosure controls and procedures were not effective because there are a limited number of personnel employed and we
cannot have an adequate segregation of duties, and due to the material weaknesses in our internal control over financial reporting
as discussed below under “Management’s Report on Internal Control Over Financial Reporting.” Accordingly, management
cannot provide reasonable assurance of achieving the desired control objective. Management works to mitigate these risks by being
personally involved in all substantive transactions and attempts to obtain verification of transactions and accounting policies
and treatments involving our operations, including those overseas. We are in the process of reviewing and, where necessary, modifying
controls and procedures throughout the Company, particularly in light of our recent acquisitions and the continued integration
of these businesses. We will continue to address deficiencies as resources permit.
Management’s Report on Internal
Control over Financial Reporting
Management of the Company is responsible
for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under Exchange
Act). Internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability
of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the
maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets
of the Company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial
statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being
made only in accordance with authorizations of management and directors of the Company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Company’s assets that could
have a material effect on the financial statements.
We recognize that because of its inherent
limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies and procedures may deteriorate.
Management of the Company conducted an
assessment of the effectiveness of the Company’s internal control over financial reporting as of March 31, 2017, based on
the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the
Treadway Commission (the “COSO II Framework”). Based on management’s assessment in accordance with the criteria
in the COSO Framework, our management concluded that our internal control over financial reporting was not effective as of March
31, 2017.
Management is aware of the following material
weaknesses (a material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting
such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements
will not be prevented or detected and corrected on a timely basis) in the Company’s internal control over financial reporting:
Control Environment
|
■
|
Inadequate
Policies and Procedures: Based on management’s review of key accounting policies and procedures, our management determined
that such policies and procedures were inadequate as of March 31, 2017. Management identified certain policies and procedures
as inadequate regarding the design of the control and formal written documentation.
|
|
■
|
We do not have sufficient personnel or financial resources to provide adequate risk assessment functions.
|
|
■
|
Changing Board of Directors and Key Employees: A changing organizational structure provided challenges to ensure a sound control environment with appropriate tone, authority, responsibilities, and high ethical values. Due to continued changes in board membership, executive management and the composition of Company subsidiaries, we have not been able to provide adequate training to new board members and employees in order to establish adequate best practice procedures.
|
Control Activities
|
■
|
Testing of Internal Controls: The Company’s accounting staff is relatively small and the Company does not have the required infrastructure for meeting the demands of being a U.S. public company. As a result we have identified deficiencies in our internal controls within our key business processes, particularly with respect to the design of quarterly accounting, financial statement close, consolidation, and external financial reporting procedures. Management believes there are control procedures that are effective in implementation within our key business processes. However, certain of these processes could not be formally tested because of lack of design, inadequate documentation, and lack of financial resources.
|
Information and Communication
|
■
|
We did not have adequate written procedures, risk assessment processes or board of directors training at March 31, 2017. Our quarterly reporting process, particularly in Russia, requires additional controls and processes.
|
Monitoring
|
■
|
Internal Control Monitoring: As a result of our limited financial personnel and ineffective controls (both preventative and detective) management’s ability to monitor the design and operating effectiveness of our internal controls is limited. Accordingly, management’s ability to timely detect, prevent and remediate deficiencies and potential fraud risks is inadequate.
|
These material weaknesses impede the ability
of management to adequately oversee our internal control over financial reporting on a consistent basis. Management intends to
continue focusing its remediation efforts in the near term on providing board and committee members with tools and COSO training
designing revised accounting and financial reporting policies and procedures that will help ensure that adequate internal controls
over financial reporting are met. Additionally, these revised procedures will be formally documented and procedures will focus
on transaction processing, period-end account analyses and providing for additional review and monitoring procedures and periodically
assess the need for additional accounting resources as the business develops and resources permit. Management also is committed
to taking further action and implementing enhancements or improvements as resources permit. We recognize that, due to the size
and stage of development of our foreign businesses, implementation of additional measures may take considerable time.
Notwithstanding the material weaknesses
discussed above, our management has concluded that the financial statements included in this Report fairly present in all material
respects our financial condition, results of operations and cash flows for the periods presented in conformity with generally accepted
accounting principles.
Except as specifically described above
in this Item 4, there was no change in our internal control over financial reporting during our first fiscal quarter of 2017 that
has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.