UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
2018
OR
¨☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number:001-34887
Net Element, Inc.
(Exact name of registrant as specified in its charter)
Delaware | 90-1025599 | |
(State or other jurisdiction of
| (I.R.S. Employer
|
3363 NE 163rdStreet, Suite 705
| 33160 | |
(Address of principal executive offices) | (Zip Code) |
Registrant’s telephone number, including area code:(305) 507-8808
Securities registered under Section 12(b) of the Exchange Act:
Title of each class | Name of each exchange on which registered | |
Common Stock, par value $0.0001 per share | NASDAQ Capital Market |
Securities registered under Section 12(g) of the Exchange Act:
| Title of each class |
Warrants, each exercisable for one share of Common Stock |
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.¨ ☐ YES x☒ NO
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.¨ ☐ YES x☒ NO
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.x ☒ YES ¨☐ NO
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).x ☒ YES¨ ☐ NO
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405232.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.¨ ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large"large accelerated filer,” “accelerated filer”" "accelerated filer," "smaller reporting company," and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | Accelerated filer |
Non-accelerated filer | Smaller reporting company |
Emerging growth company ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).¨ ☐ YES x☒ NO
The aggregate market value of the registrant’s common equity, other than shares held by persons who may be deemed affiliates of the registrant, as of June 30, 20162018 was approximately $25,367,813 (based upon the reported closing price of $1.84 per share on June 30, 2016)$22,904,233.
The registrant had 17,681,7923,865,467 shares of common stock outstanding as of March 30, 2017.29, 2019.
DOCUMENTS INCORPORATED BY REFERENCE
None.
Page | ||
Item 1. | 5 | |
Item 1A. | 26 | |
Item 1B. | 34 | |
Item 2. | 34 | |
Item 3. | 35 | |
Item 4. | 35 | |
Item 5. | 35 | |
Item 6. | 35 | |
Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. | 36 |
Item 7A. | 45 | |
Item 8. | 45 | |
Item 9. | Changes In and Disagreements With Accountants on Accounting and Financial Disclosure. | 45 |
Item 9A. | 45 | |
Item 9B. | 46 | |
Item 10. | 47 | |
Item 11. | 50 | |
Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters. | 51 |
Item 13. | Certain Relationships and Related Transactions, and Director Independence. | 52 |
Item 14. | 53 | |
Item 15. | 54 | |
Item 16. | 63 | |
| 64 | ||
Forward-Looking StatementsNOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (this “Report”"Report"), including the sections entitled “Management’s Discussion and Analysis of Financial Conditions and Results of Operation” and “Risk Factors”, contains forward-lookingincludes statements that express our opinions, expectations, beliefs, plans, objectives, assumptions or projectionsregardingfutureeventsorfutureresultsandthereforeare,ormaybedeemedtobe,“forward-lookingstatements”withinthemeaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. You should not rely upon forward-looking statements as predictions of future events. The events and circumstances reflected in the forward-looking statements may not be achieved or occur.federal securities laws. All statements other than statements of historical fact, facts contained in this Report may be forward-lookingstatements, including, statements regarding our future results of operations and financial position, our business strategy and plans, our objectives for future operations and any statements of a general economic or industry specific nature, are forward-looking statements. You can identifynature.These forward-looking statements by the fact that they do not relate strictly to historical or current facts. Forward-looking statementscan generally arebe identified by the words “expects,use of forward-looking terminology, including the terms“believes,” “anticipates,“estimates,” “believes,“continues,” “intends,“anticipates,” “estimates,“expects,” “aims,“seeks,” “plans,“projects,” “may,“intends,” “will,“plans,” “continue,“may,” “seeks,“will,” “should,” “believe,” “potential” “would”or“should”or, thein each case, their negative of such terms and similar expressions. We have based theseor other variations or comparableterminology.
By their nature, forward-looking statements largely on our current expectations and projections about future events and trends that we believe, based on information currently available to our management, may affect our financial condition, results of operations, business strategy, short-term and long-term business operations and objectives, and financial needs. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including those described in the "Risk Factors" section in Part I, Item 1A of this Report. Moreover, we operate in a very competitive and rapidly changing environment.
If these or otherinvolve risks and uncertainties (including those described in Part I, Item 1A of this Reportbecause they relate to events and the Company’s subsequent filings with the U.S. Securities and Exchange Commission (the “SEC”depend on circumstances that may or 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 describednot occur in the reports we file from time-to-time with the SEC after the date of this Report.future. These factors include, among other factors:but are not limited to, the following:
the impact of any new or changes made to laws, regulations, card network rules or other industry standards affecting our business; | ||
the impact of any significant chargeback liability and liability for merchant or customer fraud, which we may not be able to accurately anticipate and/or collect; | ||
our ability to secure or successfully migrate merchant portfolios to new bank sponsors if current sponsorships are terminated; | ||
our and our bank sponsors’ ability to adhere to the standards of | ||
our reliance on third-party processors and service providers; | ||
our dependence on independent sales groups (“ISGs”) that do not serve us exclusively to introduce us to new merchant accounts; | ||
| our ability to retain clients, many of which are small- and medium-sized businesses ("SMBs"), which can be difficult and costly to retain; | ||
| • | our ability to pass along increases in interchange costs and other costs to our merchants; | |
our ability to protect against unauthorized disclosure of merchant and cardholder data, whether through breach of our computer systems or otherwise; | ||
the effect of the loss of key personnel on our relationships with ISGs, card | ||
the effects of increased competition, which could adversely impact our financial performance; | ||
the impact of any increase in attrition due to an increase in closed merchant accounts and/or a decrease in merchant charge volume that we cannot anticipate or offset with new accounts; | ||
the effect of adverse business conditions on our merchants; | ||
our ability to adopt technology to meet changing industry and customer needs or trends; | ||
the impact of any decline in the use of credit cards as a payment mechanism for consumers or adverse developments with respect to the credit card industry in general; | ||
the impact of any adverse conditions in industries in which we obtain a substantial amount of our bankcard processing volume; | ||
the impact of seasonality on our operating results; | ||
the impact of any failure in our systems due to factors beyond our control; | ||
the impact of any material breaches in the security of third-party processing systems we use; | ||
the impact of any new and potential governmental regulations designed to protect or limit access to consumer information; | ||
the impact on our profitability if we are required to pay federal, state or local taxes on transaction processing; | ||
the impact on our growth and profitability if the markets for the services that we offer fail to expand or if such markets contract; | ||
significant losses we have incurred and may continue to | ||
foreign laws and regulations, which are subject to change and uncertain interpretation; | ||
geopolitical instability and other conditions that may adversely affect trends in consumer, business and government spending; | ||
| • | the Company’s ability (or inability) to obtain additional financing in sufficient amounts or on acceptable terms when needed; | |
the impact on our operating results as a result of impairment of our goodwill and intangible assets; | ||
our material weaknesses in internal control over financial reporting and our ability to maintain effective controls over financial reporting in the future; and | ||
the |
World Wide Web addressesAlthoughwebasetheseforward-lookingstatementsonassumptionsthatwebelievearereasonablewhenmade,wecautionyouthatforward- lookingstatementsarenot guaranteesoffutureperformanceandthatouractualresultsofoperations,financialconditionandliquidity,andindustry developments may differ materially from statements made in or suggested by the forward-looking statements contained in this Annual Report on Form 10-K. If these or other risks and uncertainties (including those described in Part I, Item 1A of this Report and our subsequent filings with the U.S. Securities and Exchange Commission (the “SEC” or the “Commission”)) materialize, or if the assumptions underlying any of these statements prove incorrect, our actual results may be materially different from those expressed or implied by such statements. In addition, even if our results of operations, financial condition and liquidity,andindustrydevelopmentsareconsistentwiththeforward-lookingstatementscontainedinthisfiling,thoseresultsordevelopmentsmay not be indicative of results or developments in subsequentperiods.
In light of these risks and uncertainties, we caution you not to place undue reliance on these forward-looking statements. Any forward-looking statement that we make in this filing speaks only as of the date of such statement, and we undertake no obligation to update any forward-looking statement or to publicly announce the results of any revision to any of those statements to reflect future events or developments, except as required by applicable law. Comparisons of results for explanatory purposes onlycurrent and they (and the content contained therein) do not form a part of, andany prior periods are not incorporated by reference into, this Report.intended to express any future trends or indications of future performance, unless specifically expressed as such, and should only be viewed as historical data.
TABLE OF CONTENTS
Net Element, Inc., (“Net Element”) a Delaware corporation, is a holding company that conducts its operations through its subsidiaries. Net Element and its subsidiaries are referred to collectively as the “Company,” “Net Element,” “we,” “us,” or “our,” unless the context requires otherwise.
Company Overview
Net Element is a global financial technology and value-added solutions group that supports companies in accepting electronic payments acceptance in an omni-channela multi-channel environment that spans acrossincluding point-of-sale (“POS”)(POS), e-commerceecommerce and mobile devices. The Company operates in threetwo business segments as a provider of North AmericaAmerican Transaction Solutions Mobile Payment and International Transaction Solutions and Online Payment Solutions..
We offer a broad range of payment acceptance and transaction processing services that enable merchants of all sizes to accept and process over 100 different payment options in more than 40120 currencies, including credit, debit, prepaid and prepaidalternative payments. We also provide merchants with value-added services and technologies including integrated payment technologies, POS solutions, security solutions, fraud management, information solutions and analytical tools.
We are differentiated by our technology-centered value-added service offerings built around our payments ecosystem and our diversified business model, which enables us to provide our varied customer base with a broad range of solutions to our clients across the value chain of commerce-enablingtransaction-processing services and technologies. We create our value-added solutions from a suite of proprietary technology products which includes cloud-based applications, processingsingle source across numerous channels and geographic markets. We believe these capabilities provide several competitive advantages that will enable us to continue to penetrate our existing customer base with complementary new services, security offerings,win new customers, develop new sales channels and customer support programs that we configure to meet our clients’ individual needs.
enter new markets. We provide additional services including:believe these competitive advantages include:
● | Our ability to provide competitive products through use of proprietary technologies; | |
● | Our ability to provide in one package a range of services that traditionally had to be sourced from different vendors; | |
● | Our ability to provide a single agnostic on-boarding and merchant management platform to our indirect non-bank sales force ("Sales Partners"); | |
● | Our ability to provide management and optimization tools to our Sales Partners amongst multiple networks and platforms; | |
● | Our ability to serve customers with disparate operations in several geographies with technology solutions |
● | Our ability to capture and analyze data across the |
We have operations and offices located within the United States (“U.S.”) (domestic) and outside of the U.S. (international) where sales, customer service and/or administrative personnel are based. Through U.S. based subsidiaries, we generate revenues from transactional services, valued-added payment services and technologies forthat we provide to SMBs. Through wholly owned subsidiaries, we operate internationally with a focus on transactional services, mobile payment transactions, online payment transactions, value-added payment services and technologies in selected international markets.
Our business is characterized by transaction related fees, multi-year contracts, and a diverse client base, which allows us to grow alongside our clients. Our multi-year contracts allow us to achieve a high level of recurring revenues.revenues with the same clients. While the contracts typically do not specify fixed revenues to be realized thereunder, they do provide a framework for revenues to be generated based on volume of services provided during the contract’ssuch contracts’ term.
Products and Services Information
Our broad suite of services spans the entire transaction processing value chain of commerce enabling services and technologies and includes a range of front-end customer-facing solutions, as well as back-end support services and account reconciliation. We deliver our value-added solutions from a suite of proprietary technology products, software, cloud-based applications, processing services, fraud management offerings, and customer support programs that we configure to meet our client’s individual needs.
Many of our payment solutions are technology-enabled in that they incorporate or are incorporated into innovative, technology-driven solutions, including enterprise software solutions, designed to enable merchants to better manage their businesses.
Integrated and Vertical Markets. Our integrated and vertical market solutions provide advanced payments technology that is deeply integrated into business enterprise software solutions either owned by us or by our partners. We grow our business when new merchants implement our enterprise software solutions and when new or existing merchants enable payments services through enterprise software solutions sold by us or by our partners. Our primary technology-enabled solutions include integrated and vertical markets, ecommerce and multi-channel solutions, each as described below:
● | Unified Payments – doing business as Unified Payments, we provide businesses of all sizes and types throughout the United States with a wide range of fully-integrated payment acceptance solutions, value-added POS and business process management services; | |
● | PayOnline – through our subsidiary, PayOnline Systems (“PayOnline”), we provide a wide range of value-added online solutions in the selected international markets utilizing our fully-integrated, agnostic electronic commerce platform that simplifies complex enterprise online transaction processing challenges from payment acceptance and processing through risk prevention and payment security via point-to-point encryption and tokenization solutions; | |
● | Pay-Travel – integrated payment processing solutions to the travel industry, which includes integrations with various Global Distribution Systems (“GDS”) such as Amadeus®, Galileo®, Sabre®, additional geo filters and passenger name record (PNR) through Pay-Travel service offered by PayOnline; | |
● | Aptito POS Platform – an integrated POS platform developed on Apple’s® iOS and Android® mobile operating systems for the hospitality, retail, service and on the go industries. Our goal with Aptito is to create an easy to use POS and business management solution, which incorporates everything a small business needs to help streamline every-day management, operations and payment acceptance; | |
● | Restoactive– utilizing Aptito POS Platform architecture, we have developed and launched Restoactive, which seamlessly plugs into a current restaurant environment through integrations with some of the biggest POS and restaurant management platforms available on the market today; | |
● | Unified m-POS – mobile POS application makes accepting payments on the go easy and secure. Mobile application is EMV-compliant, accepts traditional and contactless transactions such as Apple Pay®. Unified m-POS application is available for download in Apple’s App Store and Google Play; | |
● | Zero Pay – zero-fee payment acceptance program for SMB merchants in the United States. Zero Pay program saves merchants costs involved in accepting credit and debit cards using mobile POS; | |
● | Netevia – our internally developed future-ready multi-channel payments and merchant management platform. Connecting and simplifying payments across sales channels through a single integration point, Netevia delivers end-to-end payment processing through easy-to-use APIs. The Netevia platform is the core of the company’s technology stack. |
Recent Developments
During 2016,2018 and through the filing of this Report, we continued to expandcompleted a number of transactions and other accomplishments in pursuit of our global transaction services instrategy of enhancing financial results, creating a strong operational foundation and competitive advantage. We believe the United Statesfollowing transactions and select international markets.actions have focused and strengthened our company and improved our capital structure and cash flow.
Our primary highlightsactions and achievements during 20162018, and through the filing of this Form 10K, were as follows:
New Partnerships:
● | Acquired recurring cash flow portfolio from Argus Merchant Services, projected to add over $4 million in gross profits over the next 4 years | |
● | Acquired recurring cash flow portfolio from Universal Payment Systems, projected to add over $5 million in gross profits over the next 4 years |
● | Ranked as one of the fastest growing companies in | |
● | Jon Najarian of CNBC "Halftime Report" and "Fast Money", and Jonathan Fichman, a fin-tech and startup executive, joined our |
New Key Client RelationshipsRecent Partnership and Achievements:
● | Entered into a | |
● | Partnered with VIP Systems to launch seamless payments for the multi-billion-dollar hospitality industry | |
● | Net Element was named one of the |
● |
Our subsidiary, Unified Payments, is among the |
Geographical ExpansionRecently Completed Product Launches:
● |
Launched multi-channel payments platform, Netevia, connecting and simplying payments across sales channels through a single integration point, delivering end-to-end payment processing through easy-to-use APIs. This model complements our ability to perform in a multi-channel environment, including point-of-sale (POS), e-commerce, and mobile devices | ||
● | Launched multi-channel Blockchain-powered payments | |
● | Launched subscription-based payment processing services for small businesses which targets the multi-billion dollar subscription economy | |
● | Launched Netevia Light POS, a seamless and secure mobile payments acceptance software available on smart terminals by PAX Technology | |
● | Launched Aptito on the world’s first smart payment terminal. This comprehensive POS solution is now available for restaurants on the Poynt Smart Payment terminal | |
● | Launched Netevia Smart Vendor payment solutions for B2B sales which will allow our Company access to the $7.7 trillion B2B sales market |
● | Launched an intelligent payments solution that addresses the needs of North America’s annual $845 billion events industry | |
● | Launched “Fast Pass Funding”, a same-day funding service available through our Netevia platform. |
Capital
Product Launches
Outlook
For the year 2017, weOur strategy is to ensure that our business remains successful in a rapidly changing market, creating sustainable value for all our stakeholders, including our clients, distribution partners and shareholders. We aim to achieve superior results for our clients by having a deep understanding of their payment acceptance needs, extensive market reach, strong product development and technology enablement.
Planned for 2019:
We will continue to focus on strategic partnershipsunderstanding our clients and addressing their payment acceptance needs in core market segments.
● | Continue growth in all key segments and expand our network of referral partners | |
● | Drive and improve client retention | |
● | Expand our client base in selected markets | |
● | Deliver value-added products to our clients to increase efficiencies and payment acceptance | |
● | Launch new tools to reach our clients, such as digital channels, and deepening partner relations |
The global payments industry continued to deliver healthy growth during 2018, with underlying transaction volumes demonstrating even greater strength. We believe that new and disruptive technologies will provide us the opportunity to differentiate ourselves from our competition, continue developing and delivering innovative productspayment solutions in 2019 and beyond.
● | Continue to enhance Netevia, our future-ready multi-channel payments platform, enabling intelligent routing of payments for the application development community | |
● | Continue to scale and enhance new product launches that will add value to our clients | |
● | Extend our capabilities in next-generation POS hardware and software, and deepening our partner proposition | |
● | Commence trials of advanced technologies around business intelligence and mobile based payments acceptance | |
● | Continue the further development of disruptive emerging technologies such as blockchain technologies, payments enablement for Internet of Things (“IoT”), biometrics payment acceptance and artificial intelligence | |
● | Continue research and investments in future emerging payment technologies |
Realize the full potential of our business model.
● | Deliver stronger organic growth | |
● | Develop additional payment network relationships to integrate with our technologies | |
| ● | Monetize acquisitions completed in 2018 | |
● | Seek acquisition or investment opportunities to deepen our technological and distribution capabilities |
We continue to believe that disruptive technologies such as blockchain, IoT, biometrics payments and artificial intelligence will further expandplay key roles in future commerce. These technologies will encourage innovation through development of value-added services and cater to both merchants and their customers.
We believe Netevia, our services, positioning Net Elementfuture-ready payments and merchant management platform will act as a convenient one-stop solutionframework and core for paymentsa number of value-added services that can connect merchants and consumers directly utilizing these disruptive technologies while increasing the economic efficiency of all transactions being made within the ecosystem. Specifically, Netevia delivers end-to-end payment processing through easy-to-use APIs and complements the Company’s ability to perform in a global merchant community. We also intendmulti-channel environment, including point-of-sale (POS), e-commerce and mobile devices and will enable the Company to expand our presence in North America through distribution and integrated-services programs. In addition, we intend to further consolidate and centralize our international operational infrastructure and resources.perform as a hub for disruptive emerging technology solutions.
Our Mission and Vision
Our mission is to power global commerce and allow our clients to conduct business globally.globally through a centralized solution. We believe that by understanding the consumer behavior and the needs of our merchants is the most effective and, ultimately, the most profitable means to accomplish our mission and create long-term value for all stakeholders.
We drive client growth through our in-depth knowledge of global transactional services and related value-added service offerings which separate us from the competition.
Our vision is to set the standard for omni-channelmulti-channel payments acceptance and value-added service offerings with focus on the creation of an unified global transaction acceptance ecosystem. We believe in disruptive emerging technologies and, as such, we have developed Netevia, our future-ready multi-channel payments platform to support development of value-added solutions designed for everyday commerce. Moving forward, we believe exciting projects and disruptive technologies like blockchain, IoT, biometric payments and artificial intelligence will provide us the opportunity to continue developing innovative payments solutions, which will provide value to our clients.
In order to achieve this vision, we seek to further develop single on-boarding, global transaction acceptance ecosystem. Manifesting this vision requires scaling our direct and indirect connectivity to multiple payment and mobile networks internationally. By operationalizingimplementing this vision, we believe that we will be able to provide centralized, global omni-channelmulti-channel transactional platform to our clients internationally.
Our Strategy
Our strategy is to power global commerce throughcapitalize on consumer appetite for digital payment methods, the perceived movement towards a world-wide, omni-channel solutions offering.cashless society. To continue to grow our business, our strategy is to focus on providing merchants with the ability to process a variety of electronic transactions across multiple channels. We seek to leverage the adoption of and transition to card, electronic and digital-based payments by expanding our market share through our distribution channels and services innovations. We also seek growth through strategic acquisitions to improve our offerings, scale and geography. We intend to continue to invest in and leverage our technology infrastructure and our people to increase our penetration in existing markets.
Key elements of our business strategy include:
● | Continued investment in our core technology and new | |
● | Allocation of resources and expertise to grow in commerce and payments segments; | |
● | Grow and control | |
● | Leverage technology and operational advantages throughout our global footprint; | |
● | Expansion of our cardholder and |
● | Continue to develop seamless multinational solutions for our clients; | |
● | Increase monetization while creating value for our clients; | |
● | Focus on continued improvement and operation excellence; and | |
● | Pursue potential domestic and international acquisitions of, investments in, and alliances with companies that have high growth potential, significant market presence or key technological capabilities. |
With our existing infrastructure and supplier relationships, we believe that we can accommodate expected portfoliorevenue growth. We believe that our available capacity and infrastructure will allow us to take advantage of operational efficiencies and increased margin as we grow our processing volume and expand to other geographical territories.
Market Overview
The financial technology and transaction processing industry is an integral part of today’s worldwide financial structure. The industry is continually evolving, driven in large part by technological advances. The benefits of card-based payments allow merchants to access a broader universe of consumers, enjoy faster settlement times and reduce transaction errors. By using credit or debit cards, consumers are able to make purchases more conveniently, whether in person, over the Internet, or by mail, fax or telephone, while gaining the benefit of loyalty programs, such as frequent flyer miles or cash back, which are increasingly being offered by credit or debit card issuers.
In addition, consumers are also beginning to use card-based and other electronic payment methods for purchases at an earlier age in life, and increasingly for small dollar amount purchases. Given these advantages of card-based payment systems to merchants and consumers, favorable demographic trends, and the resulting proliferation of credit and debit card usage, we believe businesses will increasingly seek to accept card-based payment systems in order to remain competitive.
Our management believesWe believe that cash transactions are becoming progressively obsolete. The proliferation of bankcards has made the acceptance of bankcard payments a virtual necessity for many businesses, regardless of size, in order to remain competitive. In addition, the advent and growth of e-commerce and crypto-currencies have marked a significant new trend in the way business is being conducted. E-commerce is dependent upon credit and debit cards, as well as other cashless payment processing methods.
The payment processing industry continues to evolve rapidly, based on the application of new technology and changing customer needs. We intend to continue to evolve with the market to provide the necessary technological advances to meet the ever-changing needs of our market place. Traditional players in the industry must quickly adapt to the changing environment or be left behind in the competitive landscape.
Business Segments
North American Transaction Solutions |
International Transaction Solutions | ||||||
Clients: | Businesses and business owners of all types and sizes. Current focus on SMB merchants | Online businesses, merchants requiring cross-border payment acceptance, content providers and mobile applications of all | |||||
Goals: | To help business grow commerce at the retail, online and | To help businesses transact online with ease and security and help digital merchants monetize their content in a mobile environment | |||||
Key Solutions: |
| ● Integrated payments acceptance ● Value-added ● Aptito POS technology
● Marketing / | ● Integrated online and mobile billing solutions
|
● Mobile content monetization and management ● Security / ● Marketing / | |||
Segment Revenue: | $59.1 million for 2018, up 16% from 2017 | $6.6 million for 2018, down 27% from 2017 | |||||
Dollars Volume Processed: | $2.9 billion for 2018, up 27% from 2017 | ||||||
$ |
We operate threetwo reportable business operating segments: (i) North AmericaAmerican Transaction Solutions and (ii) Mobile Solutions, and (iii) OnlineInternational Transaction Solutions. Our segments are designed to establish lines of businesses that support our client base with globalizedand further globalize our 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. The principal revenue stream for all segments came from service and transaction related fees during 2016 and 2015.2018.
PriorDuring the fourth quarter of 2017, we re-organized our segment data along geographic lines with two operating segments; North American Transaction Solutions and International Transaction Solutions. We also continue to May 20, 2015,break-out corporate overhead so that we had a single reportable business segment: payment processing for electronic commerce. On May 20, 2015, we obtained financial and operational controlcan better see the stand-alone potential of PayOnline, a providereach region.
Revenues from each of online payment processing of online transactions in emerging markets. Additionally, we rebranded our mobile payments business to Digital Provider and began reporting gross revenues for mobile payments where we provide access to branded content. Given the size of assets and revenues from PayOnline and Digital Provider, we began reporting segment information for three operating segments duringas a percentage of total revenues are displayed in the third quarterbelow table.
Year ended December 31, | ||||||
2018 | 2017 | |||||
Total revenues generated: | ||||||
North American Transaction Solutions | 90% |
| 85% |
| ||
International Transaction Solutions | 10% |
| 15% |
| ||
No country outside the U.S. represents greater than 10% of 2015.our total revenues.
Comparative segment revenues and related financial information pertaining to our segments for the years ended December 31, 20162018 and 20152017 are presented in the tables in Note 17,16, Segment Information, to our consolidated financial statements (the “Consolidated Financial Statements”), which are included elsewhere in this Report.
● | North |
● |
|
North AmericaAmerican Transaction Solutions Segment
The following table presents North AmericaAmerican Transaction Solutions segment information as a percentage of total revenue:
| 2016 | 2015 | |||||||
| Segment revenue | 78 | % | 68 | % | ||||
Operations.
North America Transaction Solutions Operations. Our largest segment, North AmericaAmerican Transaction Solutions, where through our subsidiary TOT Payments, LLC, doing business as Unified Payments, provideswe provide businesses of all sizes and types with a wide range of fully-integrated payment acceptance solutions at the point of sale, including Merchant Acquiring, e-commerce, mobile commerce, mPOSPOS and other business solutions. Our largest service in this segment is Merchant Acquiring, which facilitates the acceptance of cashless transactions at the POS, whether a retail transaction at a physical business location, a mobile commerce transaction through a mobile or tablet device, which includes m-POS acceptance, Android Pay™, Apple Pay™ and Samsung Pay or an electronic commerce transaction over the web. Geographical presence for this segment is North America.
Our North AmericaAmerican Transaction Solutions segment revenues are primarily derived from processing credit and debit cardpayment acceptance transactions in a multi-channel environment for SMB merchants and includes fees for providing processing, loyalty and software services, and sales and leasessupport of POS devices. Revenues are generated from a variety of sources, including:
● | Discount fees charged to a merchant for processing of a transaction. The discount fee is typically either a percentage of the purchase amount or an interchange fee plus a fixed dollar amount or percentage; | |
● | Processing fees charged to merchants for processing of a transaction; | |
● | Processing fees charged to our | |
● | Sales and | |
● | Fees from providing reporting and other services; | |
● | Software license fees for Aptito POS platform, which includes hospitality and SMB retail point-of-sale application; | |
● | PCI compliance fees charged to a merchant for providing PCI compliance on annual basis; and | |
● | Business software license fees for merchant analytics and back office reporting. |
For example, in a transaction using a Visa or MasterCard card, the allocation
We typically provide our services as part of a broader payment acceptance solution to our business clients across multiple channels, including:
● | Retail Merchants – physical businesses or storefront locations, such as retailers, supermarkets, restaurants, hotels and other |
● | Mobile Merchants – physical businesses with remote or wireless storefront locations, such as small retail and service providers that use mobile devices with POS capabilities to accept electronic payments, which we refer to asMobile; and |
● | Online – online businesses or website locations, such as retailers, digital content providers, and mobile application developers with Internet-based storefronts that can be accessed through a personal computer or a mobile device, where we refer to ase-commerce. |
North AmericaAmerican Transaction Solutions Marketing. We employ a variety of go-to-market strategies in our North AmericaAmerican Transaction Solutions segment. We mostly partner with indirect non-bank sales forces (“Sales Partners”),Partners, such as independent sales agents, independent sales groups and referral partners that user our brand to market services (“ISG”), independent sales groups that we sponsor to Card Brands as registered Independent Sales Organizations (“ISO”) – these groups market services under their own brands, independent software vendors (“ISV”), value added resellers (“VAR”), and payment services providers (“PSP”) to sell our payment solutions to SMB merchants. We believe that this sales approach provides us with access to an experienced sales force to market our services with limited investment in sales infrastructure and management time. We believe our focus on the unique needs of SMB allows us to develop compelling offerings for our sales channels to bring to prospective merchants and provides us with a competitive advantage in our target market.
Sales & Marketing Support – Among the services and capabilities we provide are rapid application response time, merchant application acceptance by fax or online submission,a proprietary and secure on-line sales portal, superior customer service, merchant reporting and robust analytics. In addition, by controlling the underwriting process we believe we offer the ISGs more rapid and consistent review of merchant applications than may be available from other service providers. Additionally, in certain circumstances, we offer our sales organizations tailored compensation programs and unique technology applications to assist them in the sales process. We keep an open dialogue with our sales partnersSales Partners to address their concerns as quickly as possible and work with them in investigating chargebacks or potentially suspicious activity with the aim of ensuring our merchants do not unduly suffer downtime or the unnecessary withholding of funds.
Sales & Marketing Compensation – As compensation for their referral of merchant accounts, we pay our Sales Partners an agreed-upon recurring commission, or percentage of the income we derive from the transactions we process from the merchants they refer to us. The amount of the recurring commissions we pay to our Sales Partners varies on a case-by-case basis and depends on several factors, including but not limited to the number and type of merchants each group refers to us. We provide additional incentives to our Sales Partners, including, from time to time, advances and merchant acquisition bonuses that are secured by income earned from the referred merchant and repayable from future compensation that may be earned by the groups in respect to the merchants they have referred to us. For the year ended December 31, 20162018 and 2015,2017, we had provided merchant acquisition incentives to Sales Partners in an aggregate amount of $1.3approximately $1.6 million and $0.87$1.8 million, respectively. Our organic growth plan calls for future incentives to be funded to our Sales Partners for referred merchants.
North AmericaAmerican Transaction Solutions. Our solutions are designed to help SMB merchants accept cashless payments in an omni-channela multi-channel payment environment, which spans across POS, e-commerce, mobile devices and mobile devices.smart payment terminals.
Aptito POS Platform – We acquiredAptito, anAn integrated POS platform developed on Apple’s® iOS and Android® mobile operating systemsystems for the hospitality, industry, in June 2013retail, service and invested inon the technology to significantly enhance and expand its capabilities and features.go industries. Our goal withAptito is to create an easy to use POS and business management solution, which incorporates everything a small business needs to help streamline every-day management, operations and payment acceptance. We have expanded the family ofAptito productsacceptance as well as provide efficient ways to includeAptito Hospitality POS, Aptito Retail POS,Restoactivedecrease labor and Unified m-POS.operation expenses by automating routine processes through innovative technologies.
● | Aptito |
● | Aptito Retail POS – cloud-based POS solution is available on Apple® iOS and Android® mobile operating platforms and allows retailers to focus on their business and improve the in-store experience. Retailers are able to customizeAptito Retail POS based on their environment. Peripherals forAptito Retail POSinclude a fully integrated cash drawer, thermal receipt printer, barcode scanner, barcode printer and EMV-compliant point of sale acceptance terminal. This allows retailers the ability to customize their POS solution based on their unique needs. The need for uptime in a retail environment is paramount and as such ourAptito Retail POS local server allows our merchants to remain online, even if the Internet connection to the cloud is lost. Our local server solution is automatically synchronized with the cloud, providing 99.99% uptime. |
● | Aptito Kiosk – innovative self-order kiosk gives customers complete control over their restaurant experience. Our innovative solution is a stellar addition to any hotel, fine dining or quick service restaurant and increases profit and decreases labor cost. |
● | Aptito Smart Payment Terminal – Aptito & Poynt, partnered to provide restaurants with a most robust seamless POS Solution using the latest technology available. By using the Aptito POS application on Poynt’s smart payment terminal, business owners can finally accept payments anywhere and get access to Poynt value-added applications marketplace to further expand Aptito POS capabilities. |
● | Restoactive – utilizingAptito POS Platform architecture, we have developed and launchedRestoactive, which seamlessly plugs into a current restaurant environment through integrations with some of the biggest POS and restaurant management platforms such as: MICROS®, POSitouch®, Aloha® and Symphony®. By integrating into the leading POS and restaurant management platforms,Restoactive is now accessible by over 500,000 restaurants in the United States. We believeRestoactive to be the first of its kind integrated platform, which introduces an all-in-one digital menu, kiosk and m-POS application into an existing POS environment without the need to displace existing restaurant management platforms. |
● | Unified m-POS – |
In addition to enhancing our ability to drive core merchant acquiring sales,Aptito POS Platform allows us to earn incremental revenue from business clients. Currently, theAptito revenue model is based on a SaaS fee, which we bill on a per station basis and additional services fee, which we bill for additional applications we offer.
We also believe that Aptito POS Platform can help enhance client retention because we believe it will become core to our client’sclients’ businesses and position us as a value-added partner. For example, business owners may useAptito our business management tools to manage their employees’ work schedules, payroll, patron reservations, operate customer loyalty and gift card programs, manage inventory, andand/or provide analytics on their business.
Other POS Platforms – We act as an authorized dealer for various POS manufacturers and POS software providers and deploy these systems where our proprietary products are not the best fit. Systems we offer are fully integrated with our payment acceptance capabilities.
Netevia Payments Platform – We believe Netevia, our future-ready payments platform will act as a framework and core for a number of value-added services that can connect merchants and consumers directly utilizing disruptive technologies while increasing the economic efficiency of all transactions being made within the ecosystem. Specifically, Netevia Payments Platform delivers end-to-end payment processing through easy-to-use APIs and complements the Company’s ability to perform in a multi-channel environment, including POS, e-commerce and mobile devices and will enable the Company to perform as a hub for disruptive emerging technology solutions. Netevia Payments Platform is the core of the Company’s technology stack.
● | Netevia Payment Gateway – Netevia's online payment gateway provides a set of APIs for online sellers to integrate payment acceptance, both B2C and B2B, into their platforms. Advanced merchant hierarchy and management functions include a virtual terminal and a suite of fraud management tools. |
● | Netevia Light POS – the combination of Netevia Light POS application and PAX Technology’s Android-based interactive smart payment terminals offers a robust and flexible state-of-the-art solution to help merchants seamlessly transact across multiple touch points, providing a convenient way of doing day-by-day operations through a modern, self-explainable user interface and user experience. A variety of functions, such as gratuity adjustment, on-screen signature capture, invoicing and support of the Zero Pay program makes this solution ideal for many types of businesses. |
● | Netevia Invoicing – invoicing solution that offers an ability to track and reconcile payments while allowing customers to receive and pay invoices via a Netevia HQ. Tasks that were once manual are now streamlined and automated, providing accounts receivable teams with a clear and complete view of invoice details and statuses. |
● | Netevia CryptoPay – fully compliant and secure multi-channel blockchain-powered cryptocurrency payment acceptance application available across multiple touch points including face-to-face via smart payment terminals and e-commerce, as well as, via API. |
Merchant Management Platform – We have developedSales CentralNetevia, a proprietary cloud-basedmerchant management platform for merchantsplatform. Netevia HQ is a value-added module of Netevia Payments Platform and sales partners (ISG’s)is designed to enhance responsiveness of our sales partnersSales Partners and improve sales efficiency. The cloud-based solution provides to both Sales Partners and merchants an integrated toolkit to more effectively manage a variety of sales, operations, reporting and accounting functions. The system is designed to improve conversion rates, technology advisory functions and to reduce deployment time for merchants. It also allows troubleshooting of merchant issues in real-time. Sales Centralreal-time with built in underwriting and risk monitoring functions. Netevia HQ is currently one of the few cloud-based systems nationwide that allows Sales Partners to onboard and monitor merchants on multiple processing platforms through a single interface.
● |
|
● |
|
● |
|
● | Unified Insights – the integratedUnified Insights module is a business dashboard focused on “Big Data” that gives merchants a 360-degree view of their business in a more usable format. With Unified Insights, merchants can compare current revenue, online reputation, and social media activity to their past performance and to similar business in their area. |
North AmericaAmerican Transaction Solutions Competition.Many large and small companies compete with us in providing payment processing services and related services to a wide range of merchants. Many of our current and prospective competitors have substantially greater financial, technical and marketing resources, larger customer bases, longer operating histories, more developed infrastructures, greater name recognition and/or more established relationships in the industry than we have. Because of this our competitors may be able to adopt more aggressive pricing policies than we can, develop and expand their service offerings more rapidly, adapt to new or emerging technologies and changes in customer requirements more quickly, take advantage of acquisitions and other opportunities more readily, achieve greater economies of scale, and devote greater resources to the marketing and sale of their services. There are also many smaller transaction processors that provide various services to small and medium sized merchants.
We believe that our specific focus on smaller merchants, in addition to our understanding of the needs and risks associated with providing payment processing services to small merchants and indirect non-bank sales forces, gives us a competitive advantage over larger competitors, which have a broader market perspective and priorities. We also believe that we have a competitive advantage over competitors of a similar or smaller size that may lack our extensive experience, value-added product offering and resources.
North AmericaAmerican Transaction Solutions Industry Mix and Geography.In the United States, we have developed significant expertise in industries that we believe present relatively low risks as the customers are generally present and the products or services are generally delivered at the time the transaction is processed. These include:
● | Restaurants | |
● | Schools and educational services | |
● | Brick and mortar retailers | |
● | Convenience and liquor stores | |
● | Professional service providers | |
● | Hotel and lodging establishments |
Merchants we served in the North American Transaction Solutions segment during 20162018 processed an average of $11,804 each$17,900 per month in credit cardcashless transactions and hadwith an average transaction value of $56.19approximately $50 per transaction. Larger payment processors have traditionally underserved these merchants. As a result, these merchants have historically paid higher transaction fees than larger merchants and have not been provided with tailored solutions and on-going services that larger merchants typically receive from larger payment processing providers.
OutOur total North AmericaAmerican Transaction Solutions processing volume for the year ended December 31, 20162018 was $1.6approximately $2.9 billion, a 60%27% increase over processing during the year ended December 31, 2015. Transactions processed for the year ended December 31, 2016 were 87.5 million, a 70% increase from transactions processed during the year ended December 31, 2015.2017.
Our card-present processing volume for the year ended December 31, 20162018 represented 73%76% of the total North AmericaAmerican Transaction Solution volume, and card-not-present processing volume represented 27%24%.
As of December 31, 2016,2018, approximately 36.6%43.2% of our SMB merchants were restaurants and 19.9%17.0% were health and beauty services, and 15.3%11.2% were general merchandise.merchandise, and 10.0% were professional services. The high concentration in restaurants reflects the efforts of our sales team actively targeting ourAptito POS product line. The following table reflects the percentage concentration of our merchant base by category:
| 2016 | 2015 | 2018 | 2017 | |||||||||||
| Restaurants | 36.6 | % | 47.9 | % | 43.2 | % | 39.6 | % | ||||||
| Health / Beauty | 19.9 | % | 7.1 | % | 17.0 | % | 22.0 | % | ||||||
| General Merchandise | 15.3 | % | 6.0 | % | 11.2 | % | 16.0 | % | ||||||
| Professional Services | 8.4 | % | 3.8 | % | 10.0 | % | 8.1 | % | ||||||
| Automotive | 7.1 | % | 5.0 | % | 6.6 | % | 7.1 | % | ||||||
| Food Stores | 5.8 | % | 5.7 | % | 6.8 | % | 5.8 | % | ||||||
| Educational Services | 4.4 | % | 15.9 | % | 2.4 | % | 4.4 | % | ||||||
| Hospitality/Lodging | 1.6 | % | 1.2 | % | ||||||||||
Hotels / Motels | 1.8 | % | 1.6 | % | ||||||||||
| Other | 0.9 | % | 7.4 | % | 1.0 | % | 1.0 | % | ||||||
In December 2016,2018, SMB merchants located in the following states represented the following percentage of our SMB card processing volume: New York represented 22.7%24.5%, Florida represented 11.34% California represented 9.12%, New Jersey represented 22.2%, California6.4% and Texas represented 10.4%, Pennsylvania represented 7.5%, and Florida represented 5.6%5.5%. No other state represented more than 3.6%5% of our total SMB card processing volume. Our geographic concentration tends to reflect states where we maintain a stronger sales force. We believe that the loss of any single SMB merchant would not have a material adverse effect on our financial condition or results of operations.
North AmericaAmerican Transaction Solutions Risk Management.In the United States, we focus our sales efforts on both lowlow-risk bankcard merchants and higher risk bankcard merchants. We have developed systems and procedures designed to minimize our exposure to potential merchant losses. While we also board higher risk merchants which provide a higher gross margin, these accounts are closely monitored by our risk underwriting department.
Effective risk management helps us minimize merchant losses for the mutual benefit of our merchants, Independent Sales Groups and ourselves. Our Underwriting and Risk Management Policy and procedures help to protect us from fraud perpetrated by our merchants. We believe our knowledge and experience in dealing with attempted fraud has resulted in our development and implementation of effective risk management and fraud prevention systems and procedures. In 2016,2018, we experienced net losses of .008%approximately $129,000 (or .004%) of our SMB card processing dollar volume.
We employ the following systems and procedures to minimize our exposure to merchant and transaction fraud:
● | Merchant Application Underwriting – there are varying degrees of risk associated with different merchant types based on their industry, the nature of the merchant’s business, processing volumes and average transaction size. As such, varying levels of scrutiny are needed to evaluate a merchant application and to underwrite a prospective merchant account. These range from basic due diligence for merchants with low risk profiles to more comprehensive review for higher risk merchants. The results of this assessment |
● | Merchant Monitoring – we employ several levels of merchant account monitoring to help us identify suspicious transactions and trends. Daily merchant activity is sorted into a number of customized reports by our systems. Our risk management team reviews any unusual activity highlighted by these reports, such as larger than normal transactions or credits, and monitors other parameters that are helpful in identifying suspicious activity. We have daily windows to decide if any transactions should be held for further review and this provides us time to interview a merchant or issuing bank to determine the validity of suspicious transactions. We also place merchants who require special monitoring on alert status and have engaged a third-party web crawling solution that scans all merchant websites for content and integrity. |
● | Investigation and Loss Prevention – if a merchant exceeds any parameters established by our underwriting and/or risk management staff or violates regulations established by the applicable bankcard network or the terms of our merchant agreement, one of our investigators will identify the incident and take appropriate action to reduce our exposure to loss and the exposure of our merchant. This action may include requesting additional transaction information, withholding or diverting funds, verifying delivery of merchandise or even deactivating the merchant account. Additionally, Relationship Managers may be instructed to retrieve equipment owned by us. In addition, to protect ourselves from unexpected losses, we maintain a reserve account with our sponsoring bank, which can be used to offset any losses incurred at a given time. As of December 31, |
● | Reserves – some of our merchants are required to post reserves (cash deposits) that are used to offset chargebacks incurred. Our sponsoring banks hold such reserves related to our merchant accounts as long as we are exposed to loss resulting from a merchant’s processing activity. In the event that a small company finds it difficult to post a cash reserve upon opening an account with us, we may build the reserve by retaining a percentage of each transaction the merchant performs until the reserve is established. This solution permits the merchant to fund our reserve requirements gradually as its business develops. As of December 31, |
North AmericaAmerican Transaction Solutions Sponsoring Banks and Data Processors. Because we are not a “member bank” as defined by Visa, MasterCard, American Express and Discover (“Card Associations”Brands”), in order to authorize and settle payment transactions for merchants, we must be sponsored by a financial institution that holds member bank status with the Card AssociationBrands (“Sponsorship Bank”) in the case of Visa and MasterCard) and various third-party vendors (“Data Processors”) to assist us with these functions. Card AssociationBrand rules restrict us from performing funds settlement or accessing merchant settlement funds and require that these funds be in the possession of a Sponsorship Bank until the merchant is funded.
Sponsoring Bank.We have agreements with several banks that sponsor us for membership in the Visa, MasterCard, American Express and Discover card associationsbrands and settle card transactions for our merchants. These agreements allow us to use the banks’ identification numbers, referred to as Bank Identification Number (“BIN”) for Visa transactions and Interbank Card Association (“ICA”) number for MasterCard transactions. The principal Sponsoring Bank through which we processed the majority of our transaction in the United States during 20162018 was BMO Harris Bank, N.A. On November 1, 2016, we moved all of our processing from BMO Harris Bank, N.A. to MerrickCitizens Bank, N.A. In addition, in February 2016, we entered into aprocess transactions through BIN sponsorship agreementagreements with Esquire Bank, N.A. As a result of our settlement with First Data, in 2016, we entered into a sponsoring agreement withand Wells Fargo Bank, N.A. From time to time, we may enter into agreements with additional banks.
Data Processor. We have agreements with severalData Processors to provide us with, on a non-exclusive basis, transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. Our primary processing vendor in the United States is Priority Payment Systems, LLC (“Priority”), which provides us with the processing conduit to the Total System Services, Inc. (“TSYS”) and First Data Corporation (“FDC”) authorization and settlement network. We have entered into several service agreements with Priority. Each of the Priority service agreements may be terminated by Priority if, among other things, (i) certain insolvency events occur with respect to us or (ii) we fail to maintain our good standing with Card Associations.Brands. We may terminate each of the agreements if, among other things, (i) certain insolvency events occur with respect to Priority, (ii) Priority materially breaches any of the terms, covenants or conditions of the agreements and fails to cure such breach within 30 days following receipt of written notice thereof, or (iii) under certain circumstances, Priority is unable to perform services described in the agreement. In addition, we maintain direct processing agreements with TSYS and FDC.
As an example of processing an electronic payment, the below diagram illustrates the participants involved in a payment transaction. There are four main participants, the Merchant, the Service Provider (Unified Payments), the Sponsoring Bank and the Data Processor. Merchants are primarily business owners that accept credit card payment in exchange for their merchandise and services.
MobileInternational Transaction Solutions Segment
The following table presents MobileInternational Transaction Solutions segment revenue as a percentage of total revenue:
| 2016 | 2015 | |||||||
| Segment revenue | 11 | % | 22 | % | ||||
Mobile Solutions Operations. In international markets (especially the Russian Federation and the CIS), we hold leadership position through our subsidiary, Digital Provider, where we enable Direct Carrier Billing utilizing billing infrastructure between Mobile Network Operators (“MNOs”) and content providers to facilitate content monetization. In the Russian Federation and CIS through agreements and integrations with marketing companies owned by the top 4 MNOs including Mobile TeleSystem (MTS), MegaFon, VimpelCom and TELE2, we enable mobile payments acceptance for networks that serve a combined 390 million mobile users.
During 2016, we had a monthly average of over 1.1 million consumers which we billed on a monthly basis. Our total Mobile Solutions transactions processed for the year ended December 31, 2016 was 73.3 million, a 19% decrease from transactions processed during the year ended December 31, 2015. Decrease in transactions processed was a result of shifted business model from one-time transactional business to subscription / recurring revenue model.
Our Carrier Billing Solution is positioned in the center of the mobile commerce for digital goods and services with billing checkout and offers various mobile payment solutions for web services and mobile applications. We enable monetization for digital content providers through smartphones, feature phones or web without a credit card or a bank account. Utilizing the source of funds that MNOs have already integrated into every mobile phone (a monthly bill for post-paid phones and stored credit for prepaid phones), merchants won’t need to collect any customer credit card or bank information to complete their sale. Our mobile campaign tools allow for the delivery of scalable mobile campaigns on behalf of our content partners.
Digital Provider’s current customers span across variety of industries and operate across different markets. Our clients include mobile operator designated companies, merchants, content and service providers. Our platform is used by over a thousand merchants.
Our Mobile Solutions segment revenues are primarily derived from processing of a mobile transactions for digital merchants, such as: social networks, game developers, online magazines, mobile applications and other digital media operators to monetize their content in a mobile environment and includes fees for providing processing, content management and distribution, and software services. In addition, in 2016, we began offering mobile users our Digital Provider branded content, which we acquire from multiple content providers. Revenues are generated from a variety of sources, including:
For example, in a transaction using a mobile device as a form of payment, the allocation of funds resulting from a $10 transaction from our branded content follows.
Mobile Solutions Marketing. We employ a variety of go-to-market strategies in our Mobile Solutions segment. We mostly partner with mobile operators, broadcast media networks, internet portals and content providers, and marketing and sales promotion partners.
Other industries using mobile messaging and mobile billing solutions include banking, retailing, brokering, tourism, transportation, games, and education.
Mobile Solutions. Our solutions are designed to help digital merchants accept mobile payments transactions utilizing direct billing access to MNOs in emerging markets.
Trinity Mobile Billing Platform – We have developed theTrinity Platform as a proprietary high-performance mobile acceptance, billing and content aggregation platform for value-added services (“VAS”). Using the Platform, our partners can aggregate mobile traffic utilizing the most popular methods of monetization on the VAS market.
Mobile Solutions Competition. Digital Provider primarily competes with other companies operating in the mobile payment processing market in emerging markets. Certain competitors have been in business longer than Digital Provider and have significantly greater financial and other resources than Digital Provider. In order to successfully increase our business in that market, we must convince content providers to use Digital Provider’s services over competitive platforms that may already be in use. Digital Provider must also retain good relations with MNOs providing service. We believe that Digital Provider will be able to effectively compete in the mobile payment processing market in Russia based primarily upon services offered, functionality and ease of use of features offered. Failure to successfully continue developing Digital Provider’s payment processing operations, maintain Digital Provider’s existing contracts with MNOs and content providers and enter into additional contracts with content providers to use Digital Provider’s services may harm our revenue and business prospects.
Mobile Solutions Risk Management. We are responsible for content compliance and merchant underwriting and are subject to chargebacks for the full value of the transaction. If any such chargebacks arise we pass these chargebacks to our merchants, in the event we are unsuccessful in passing these charges to the merchant we are responsible for these chargebacks. During 2016 and 2015 we had no losses from our mobile payments processing volume as all chargebacks were collected from content partners and aggregators.
Mobile Solutions Licensing and Certifications. The relationships between Digital Provider and telecommunications carriers in Russia are governed by the general rules of civil law for the provision of services (Chapter 39 of the Civil Code of the Russian Federation). In addition, because the “information and entertainment services” (content services) provided by Digital Provider are inextricably linked with the networks of telecommunications carriers, these services are subject to the requirements of the Rules of Mobile Communications Services Provision, approved by the Decree No. 328 of the Russian Federation Government dated May 25, 2005. These Rules govern the relationship between a customer using mobile communication services and a telecommunications carrier in respect of mobile radio communications services, mobile radiotelephone services and/or mobile satellite radio services in the public network. Although Digital Provider is not a telecommunications carrier, many requirements of the decree above are present in Digital Provider’s contracts with telecommunications carriers.
Mobile Solutions Mobile Network Operators. In order for us to provide payment and SMS messaging services to mobile subscribers and debit their accounts for payments, we need to have contractual agreements with marketing subsidiaries of mobile operators, which allow us to bill mobile subscribers. We have direct and indirect agreements with mobile operators and mobile operator aggregators in over 40 countries. In addition, we also have contracts and our platform is integrated with various mobile operator aggregators, which give us access to mobile operator networks in approximately 50 countries.
An example of processing a mobile transaction, the below diagram illustrates the participants involved in a mobile payment transaction. Merchants are primarily content or digital goods providers including social networks, games and online magazines.
Online Solutions Segment
The following table presents Online Solutions Segment information as a percentage of total revenue:
| 2016 | 2015 | |||||||
| 11 | % | 9 | % | |||||
| Segment revenue | Acquired May 20, 2015 | |||||||
Online Solutions Operations. Through our subsidiary, PayOnline, we provide a wide range of value-added online and mobile solutions utilizing our fully-integrated, platform agnostic electronic commerce offering that simplifies complex enterprise online transaction processing challenges from payment acceptance and processing through risk prevention and payment security via point-to-point encryption and tokenization solutions. Our proprietary SaaS suite of solutions for electronic and mobile commerce gateway and payment processing platform is compliant at Level 1 of PCI DSS, streamlines the order-to-cash process, improves electronic payment acceptance and reduces the scope of burden of PCI DSS compliance. PayOnline holds thea leadership position in the Russian Federation as one of the largest independent Internet Payment Services Provider (“IPSP”).
During 2017, we combined our online and mobile payments business into a single International Transaction Solutions segment. Our Onlineonline payment solutions company, PayOnline, now provides all operational support for our mobile payments business. Our mobile payments business is transitioning to a joint venture business model and we are in discussions with several potential partners regarding joint business development.
Our International Transaction Solutions segment revenues are primarily derived from processing credit and debit cardcashless transactions for online merchants and includes fees for providing processing, loyalty and software services. Revenues are generated from a variety of sources, including:
● | Discount fees charged to a merchant for processing of a transaction. The discount fee is typically a percentage of the purchase amount; |
● | Processing fees charged to merchants for processing of a transaction; |
● | Processing fees charged to our sales partners who have outsourced their transaction processing to us; |
● | Fees from providing reporting and other services; |
● | Software license fees for |
● | Payment gateway transaction fees; | |
● | Business software license fees for merchant analytics, |
● | Big Data monetization through upsell on payment confirmation page to the end consumer. |
In a transaction using a Visa or MasterCard card, the allocation of funds resulting from a $100 transaction is as follows:
* Excludes commissions
Approximately 20% of leading e-commerce merchants in Russia use the PayOnline platform to accept payment transactions in Russia, Europe and Asia.
InternationalOnline Transaction Solutions Marketing. The vast majority of PayOnlineInternational Transaction Solutions sales are direct sales, through our marketing efforts and fully automated leads management system. The marketing department of PayOnlineInternational Transaction Solutions segment consists of 54 specialists, responsible for product pricing, company branding and positioning, monitoring of competitors and technological developments, public relations and web marketing activities. Our marketing mix includes, but not limited to:
● | Search Engine Optimization – PayOnline is in the top 10 results with most frequently used keywords in Google.ru and Yandex search engines. | |
● | Social Media – PayOnline social media channels include Facebook, Vkontakte, Twitter, | |
● | Corporate Blog – Our corporate blog featured on popular developer communities like HabraHabr and GeekTimes | |
● | Industry Research – Every year PayOnline specialists prepare and publish over 120+ research papers on popular e-commerce and IT development forums. | |
● | RUNET – PayOnline is a payment processing provider for RUNET-ID (Russia’s largest Internet professionals’ social platform), Russian Internet Forum and Russian Interactive Week. | |
● | Conferences – Every year our experts participate in 30+ trade shows and professional conferences. | |
● | Education – Our senior managers are frequently invited by top Russian Federation universities and business schools as lecturers. |
Merchants we served during 2018 in the International Transaction Solutions segment processed an average of $49,000 per month in cashless transactions with an average transaction value of approximately $13 per transaction. Banks and traditional processors have traditionally underserved these merchants due to multi-national and cross-border requirements for these merchants.
Our total International Transaction Solutions processing volume for the year ended December 31, 2018 was approximately $354 million, a 33% decrease over processing during the year ended December 31, 2017.
During 2018, our sales department consistsconsisted of 253 specialists who are responsible for managing the leads, execution of the client agreements, client boarding, customization of the solutions, implementation of the payment acceptance solutions and post-sale client relationship. During 2016, we attracted 320 new clients, of which 92% were in Russian Federation / CIS and 8% in Europe and Asia. Merchants we served during 2016 processed an average of $54,325 each month in credit card transactions and had an average transaction value of $21.30 per transaction.relationship
International TransactionOnline Solutions. Our solutions combine payment processing, mobile commerce, online shopping cart tools, web site design, web hosting and web related services APIs and SDKs which enable businesses to establish a presence and commercial capability on the Internet or within a Mobile Application environment in a quick and simple fashion.
PayOnline Platform– We have developed the PayOnline Platform, a proprietary technology platform serving large and fast growingfast-growing internet-led multinationals with complex payment needs, supported by our vertical expertise. Our reliable and secure proprietary technology platform enables merchants to accept a vast array of payment types, across multiple channels, anywhere in the world. Utilizing PayOnline Platform, we have built universal flexible payment solution adapted for websites and mobile applications. The solution includes:
● | Personal Client Area: web-interface for clients to control and manage payments. |
● | Adaptive payment form with the possibility of customization. |
● | Simple payment process: binding card to account, moment payments, recurrent payments, temporary blocking of payment, reserving of payments, invoicing by e-mail. |
● | Customization of protocol 3-D Secure for client's business needs. |
● | Ability to customize the default settings of anti-fraud system. |
● |
| Integrations with various Global Distribution Systems (“GDS”) such as Amadeus®, Galileo®, Sabre®, additional geo filters and passenger name record (PNR). |
● | Integrations with Apple iOS, Android and Microsoft mobile platforms for mobile application. |
Payments from Start to Finish. PayOnline Platform reduces the payment integration time for merchants, banks and SaaS providers to just a few minutes with its PayOnline Application Program Interface (“API”) service. Easy, easier, easiest: PayOnline integration service simplifies complex payment integration when using APIs and makes the laborious task of adapting payment processes obsolete.
Complete Toolkit for Online Business.More than 20 integration modules for the world's most popular CMS (Content Management System) are available for clients with sites created on basis of CMS. A complete, modular system of web-based services gives our merchants the flexibility to add more options as and when required - without costly or lengthy IT projects.
International TransactionOnline Solutions Competition. PayOnlineInternational Transaction Solutions segment primarily competes with other companies operating in the online payment processing market in emerging markets. In our key geographical market – Russian Federation, we compete primarily with the acquiring banks and payment processors (including payment aggregators). PayOnlineWe cannot compete with acquiring banks or payment processors on pricing. Our major advantages relate to our robust, payment processor agnostic solution that simplifies complex enterprise online payment processing challenges from payment acceptance and processing through to risk prevention and payment security via tokenization solutions. Our competitive advantages include:
● | Suite of individually tailored e-commerce solutions | |
● | Payment conversion management | |
● | Seamless client payment acceptance implementation | |
● | Quick development and implementation of custom payment acceptance solutions | |
● | Multiple integrated payment acceptance methods | |
● | Wide geography of payment acceptance with a single integration | |
● | More than | |
● | Proprietary Anti-Fraud System |
International TransactionOnline Solutions Industry Mix and Geography.Mix. We have developed significant expertise in industries that we believe present opportunities for growth. These include:
● | Internet stores | |
● | Professional service providers | |
● | Travel services | |
● | Telecommunications | |
● | Social media networks | |
● | Financial services | |
● | Utilities and government services | |
● | Digital content providers |
The following table reflects the percentage concentration of our merchant base by class:
| 2016 | 2015 | 2018 | 2017 | |||||||||||
| Internet Stores | 40.5 | % | 31.2 | % | 46.0 | % | 36.8 | % | ||||||
| Professional Service Providers | 19.5 | % | 21.1 | % | ||||||||||
Professional Service | 10.0 | % | 23.0 | % | ||||||||||
| Travel Services | 13.6 | % | 11.0 | % | 6.0 | % | 17.2 | % | ||||||
| Telecommunications | 12.5 | % | 8.2 | % | 13.0 | % | 12.0 | % | ||||||
| Social Media Networks | 3.8 | % | 8.1 | % | - | % | 3.3 | % | ||||||
| Financial Services | 3.8 | % | 7.7 | % | - | % | 1.1 | % | ||||||
| Utilities and Government Services | 4.8 | % | 6.3 | % | - | % | 0.4 | % | ||||||
| Digital content providers | 4.4 | % | 5.3 | % | 3.0 | % | 3.4 | % | ||||||
| Other | 1.6 | % | 1.1 | % | 22.0 | % | 2.8 | % | ||||||
International TransactionOnline Solutions Risk Management. In the emerging markets, we focus our sales efforts on electronic commerce merchants and have developed systems and procedures designed to minimize our exposure to potential merchant losses.
We have developedlosses and continue to improveprovide our proprietary fraud-monitoring system. To ensure the highest security level, our anti-fraud system is operating in tight connectionmerchants with our internal 3-D Secure MPI (message passing interface) module. Proprietary fraud filters and anti-fraud BIN monitoring allows disabling and filtering acceptance of virtual pre-paid cards.cross-border payment acceptance.
Effective risk management helps us minimize merchant losses for the mutual benefit of our merchants and ourselves. Our Anti-Fraud System allows us to identify and prevent up to 99.98%99.9% of potential fraud related to bankcard processing in the electronic commerce environment. Our Underwriting and Risk Management Policy and procedures help to protect us from fraud perpetrated by our merchants. 154150 different fraud filters allow our clients to maintain high level or payment conversion, averaging at 98.7%99.2%, while maintaining chargeback related losses as low as .0002 (or 0.023%).Our risk management is conducted in both manual and automatic modes.
Manual Risk Management involves specialists of our Underwriting and Risk Management Department, who are responsible for the following:
● | Analysis of risks and underwriting of our partners, i.e. acquiring banks, financial companies and payment processors | |
● | Analysis of potential risks and underwriting of our potential clients, i.e. merchants accepting payments over internet | |
● | Manual validation of disputed payments | |
● | Advising of our potential and current clients on how to correctly setup up fraud monitoring methods and tools | |
● | Future development of our fraud monitoring and prevention systems, based on the client needs and recent trends in e-commerce and m-commerce marketplace and regulations |
PayOnline Anti-Fraud Systemis our proprietary fully automated risk managementFully Automated Risk Management system. The system is generally based on the latest know-how of the informational and financial security aspects of the payment processing industry, as well as rules and recommendations of Visa and MasterCard on fraud prevention in electronic commerce.
Major components ofPayOnline Anti-Fraud System include but are not limited to:
● | Advance monitoring of the bank card transaction in automated mode, using | |
● | Additional validation of the bankcard by using 3-D Secure protocol or validation by charging random amount on the card. | |
● | Monitoring of the transactions by specialists of the Underwriting and Risk Management Department. |
Online Solutions Licensing and Certifications. In order to perform services at the highest level of safety and quality of service, PayOnline holds various industry certifications and licenses.
● | PCI DSS | |
● | SDP / CISP – PayOnline has passed international certification by Visa and MasterCard and is involved in MasterCard Site Data Protection (“SDP”) program and the Visa Cardholder Information Security Program (“CISP”). | |
● | MasterCard– Since 2009, PayOnline is accredited as the official international Service Provider of MasterCard Worldwide, participates in the MasterCard SDP program and, in | |
● | Visa –Since 2009, PayOnline is accredited as the official Service Provider of Visa International payment system, participates in the Visa CISP program and holds the status of Visa Third Party Processor (“TPP”). | |
● | Cryptographic Transport Layer Security (“TLS”) Protocol – Data exchange between the enterprise e-commerce and PayOnline is made via secure channels, using the HTTPS protocol. TLS cryptographic protocol uses asymmetric cryptography for authentication, symmetric encryption for confidentiality and authenticity of the message codes to preserve the integrity of messages. | |
● | Qualys – PayOnline regularly passes ASV-scan procedure (automated external security audit) provided by Qualys in accordance with the requirements of international payment systems to companies with certified PCI DSS. |
International TransactionOnline Solutions Sponsoring Banks and Data Processors.Because we are not a “member bank” or a licensed financial services institution as defined by Visa, MasterCard, American Express and Discover (“Card Associations”Brands”), in order to authorize and settle payment transactions for merchants, we must be partner with a financial institution that holds member bank status with the Card AssociationBrands (“Partner Bank”) and various third-party vendors (“Data Processors”) to assist us with these functions. Card AssociationBrand rules restrict us from performing funds settlement or accessing merchant settlement funds and require that these funds be in the possession of a Partner Bank until the merchant is funded.
Partner BankBanks. Since 2008, PayOnline has been working to increase the number of partnership agreements and platform integrations with different banks, financial institutions and payment processors. Our worldwide expansion requires a broader range of regions and currencies covered by such partnership agreements, enabling us to provide international payment processing.
Our key partnerships and integrations in the Russian Federation include:
● | Bank of Moscow | ● | QIWI Bank |
● | VTB | ● | WebMoney |
● | Round Bank | ● | Absolutbank |
● | Raiffesenbank | ● | Yandex.Money |
● | SDM Bank |
Our key international partnerships and integrations in CIS:include:
● |
Our key partnerships and integrations in Europe, Asia and United States include:
| Latvijas Pasta Banka | ● | Kyrgyzkommertsbank | |
● | Rietumu Bank | ● | Paysafe |
● | Wirecard Bank | ● | Authorize.net |
● | Kazkommertsbank | ● | Skrill |
● | Kazkommertsbank Tajikistan | ● | PayPal |
● | Poynt | ● | Paya |
● | TSYS | ● | Esquire Bank |
● | Experian | ● | Docusign |
● | Clover | ● | Cardflight |
● | HP | ● | Pax |
As an example of processing an electronic payment, the below diagram illustrates the participants involved in a payment transaction. There are four main participants, the Merchant, the Service Provider (PayOnline), the Partner Bank and the Data Processor (PayOnline). Merchants are primarily business owners that accept credit card payment in exchange for their merchandise and services.
Research and Development
We recognize the importance of having access to the leading technology in order to develop advanced products for our customers, independent sales agents, consumers and for our own internal use. To this end, development of our products is conducted in-house. We are maintaining three development centers and four development teams of IT architects, quality assurance professionals and software developers. We support mobile platforms including Apple® iOS, Android®, and Windows®. We also support server sideserver-side software development for Java, ASP.NET, and PHP platforms. We also provide user experience (UX) and user interface (UI) engineering and system administration dedicated to financial services and value-added technology businesses.
Our IT development center is headquartered in North Miami Beach, Florida (U.S.), where we employ a Chief Technology Officer (“CTO”), IT Systems Administrator and POS products Testing & Development Engineer.
Our Moscow (Russia) IT development center employs two technical directors, managing Digital Provider andthe PayOnline platform development teams.
Our representative office in Yekaterinburg (Russia) employs two team leaders managing Sales CentralNetevia and our value-added services development teams.
Our total IT employees totaled 47 at December 31, 2016.
Intellectual Property
We have several trademarks and service marks, which are important to our business. The following trademarks and service marks are the subject of trademark registrations and are used in our financial services business:
● | Net Element | ● | Restoactive |
● | Unified Payments | ● | TOT |
● | PayOnline | ● | Netevia |
● | Payonline.ru | ● | Aptito |
● | Digital Provider | ● | Team Unified |
We regard our software as proprietary and attempt to protect it, where applicable, with copyrights, trade secret measures and non-disclosure agreements. Despite these protections, it may be possible for competition or users to copy aspects of our intellectual property or to obtain information that we regard as trade secrets. Existing copyright laws afford only limited practical protection for computer software. The laws of foreign countries generally do not protect our proprietary rights in our products to the same extent as the laws of the United States. In addition, we may experience more difficulty in enforcing our proprietary rights in certain foreign jurisdictions.
Employees
Our total number of staff as of December 31, 20162018 was 14088 full-time employees. The staff North American Transaction Solutions segment includes 71 employees, of which 27 work for Net Element Software located in the United States is 26 employees. Additionally, inYekaterinburg, Russia and for International Transaction Solutions, Moscow, Russia we have 114 employees consisting of 15 employees at Digital Provider (mobile payments), 12 employees at Net Element Russia (Executives/Accounting), 68 employees at PayOnline (online payments) and 19 employees in Yekaterinburg (System Development).had 17 employees.
Corporate History
Our Company was formed in 2010 and incorporated as a Cayman Islands exempted company with limited liability under the name Cazador Acquisition Corporation Ltd. (“Cazador”). Cazador was a blank check company incorporated for the purpose of effecting a merger; share capital exchange; asset acquisition; share purchase; reorganization or similar business combination with one or more operating businesses or assets. In 2012, Cazador completed a merger (the “Merger”) with Net Element, Inc., a Delaware corporation, which was a company with businesses in the online media and mobile commerce payment processing markets. Immediately prior to the effectiveness of the Merger, the Company (then known as Cazador) changed its jurisdiction of incorporation by discontinuing as an exempted company in the Cayman Islands and continuing and domesticating as a corporation incorporated under the laws of the State of Delaware. Effective upon consummation of the Merger, (i) Net Element, Inc. was merged with and into the Company, resulting in Net Element ceasing to exist and the Company continuing as the surviving company in the Merger, and (ii) the Company changed its name to Net Element International, Inc. In 2013, the Company divested its non-core entertainment assets. In December 2013, the Company changed its name to Net Element, Inc. We entered the mobile payments business through the launch of Tot Money (renamed Digital Provider in 2015) in Russia in 2012. We entered the financial technology and value-added transactional service business through the acquisitions of Unified Payments in April 2013 and Aptito in June 2013. We entered the online payment business with our acquisition of PayOnline in May 2015. During 2017, Digital Provider's operations were combined into PayOnline.
Our principal office is located at 3363 NE 163rdStreet, Suite 705, North Miami Beach, Florida 33160, and our main telephone number is (305) 507-8808.
Regulation
Regulations
Various aspects of our business are subject to U.S. and non-U.S. federal, state and local regulation. The operations of our subsidiary, Digital Provider,PayOnline, are subject to regulation in non-U.S. markets it operates in and may become subject to the laws and regulations of additional foreign jurisdictions as and when its business expands into additional markets. Many domestic and foreign laws and regulations that affect companies conducting business on the Internet and companies transmitting user information and payments via text message or other electronic means are still evolving and the interpretation of such laws and regulations are often uncertain. Failure to comply with applicable laws and regulations may result in the suspension or revocation of licenses or registrations, the limitation, suspension or termination of services and/or the imposition of civil and criminal penalties and/or fines. The services of Digital ProviderPayOnline to mobile phone carriers also are subject to certain of the rules and policies of such carriers and ongoing contractual covenants with such carriers, the violation of which may result in penalties and/or fines and possible termination of Digital Provider’sPayOnline's services. Certain of our services are also subject to rules set by various payment networks, such as Visa and MasterCard, as more fully described below under “Association"Association and Network Rules”Rules".
Association and Network Rules.Rules. While not legal or governmental regulation, we are subject to the network rules of Visa, MasterCard and other payment networks. In order to provide processing services, a number of our subsidiaries are registered with Visa and/or MasterCard as service providers for member institutions. Various subsidiaries of ours are also processor level members of numerous networks or are otherwise subject to various network rules in connection with processing services and other services we provide. As such, we are subject to applicable card association, networks and national scheme rules that could subject us to fines or penalties. The payment networks routinely update and modify their requirements. On occasion, we receive notices of non-compliance and fines, which might be related to excessive chargebacks by a merchant or data security failures. Our failure to comply with the networks’networks' requirements or to pay the fines they impose could cause the termination of our registration and require us to stop providing payment services.
Dodd-Frank Act.Act. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 was signed into law in the United States. The Dodd-Frank Act has resulted in significant structural and other changes to the regulation of the financial services industry. Among other things, the Dodd-Frank Act established the Consumer Financial Protection Bureau, or CFPB, to regulate consumer financial services, including many offered by our clients.
The Dodd-Frank Act provided two self-executing statutory provisions limiting the ability of payment card networks to impose certain restrictions that became effective in July 2010. The first provision allows merchants to set minimum dollar amounts (not to exceed $10) for the acceptance of a credit card (and allows federal governmental entities and institutions of higher education to set maximum amounts for the acceptance of credit cards). The second provision allows merchants to provide discounts or incentives to entice consumers to pay with cash, checks, debit cards or credit cards, as the merchant prefers.
Separately, the so-called Durbin Amendment to the Dodd-Frank Act provided that interchange fees that a card issuer or payment network receives or charges for debit transactions will now be regulated by the Federal Reserve and must be “reasonable"reasonable and proportional”proportional" to the cost incurred by the card issuer in authorizing, clearing and settling the transaction. Payment network fees, such as switch fees may not be used directly or indirectly to compensate card issuers in circumvention of the interchange transaction fee restrictions. In July 2011, the Federal Reserve published the final rules governing debit interchange fees. Effective in October 2011, debit interchange rates for card issuing financial institutions with more than $10 billion of assets are capped at $0.21 per transaction with an additional component of five basis points of the transaction’stransaction's value to reflect a portion of the issuer’sissuer's fraud losses plus, for qualifying issuing financial institutions, an additional $0.01 per transaction in debit interchange for fraud prevention costs. The debit interchange fee would be $0.24 per transaction on a $38 debit card transaction, the average transaction size for debit card transactions. In July 2013, the U.S. District Court for the District of Columbia determined that the Federal Reserve’sReserve's regulations implementing the Durbin Amendment were invalid. The U.S. Court of Appeals for the District of Columbia, or D.C. Circuit, reversed this decision on March 21, 2014, generally upholding the Federal Reserve’sReserve's interpretation of the Durbin Amendment and the Federal Reserve’sReserve's rules implementing it. On August 18, 2014, the plaintiffs in this litigation filed a petition for a writ of certiorari asking the U.S. Supreme Court to review the D.C. Circuit’sCircuit's decision with respect to the interchange fee cap. We continue to monitor developments in the litigation surrounding these rules. Regardless of the outcome of the litigation, the cap on interchange fees is not expected to have a material direct impact on our results of operations.
In addition, the new rules contain prohibitions on network exclusivity and merchant routing restrictions. Beginning in October 2011, (i) a card payment network may not prohibit a card issuer from contracting with any other card payment network for the processing of electronic debit transactions involving the issuer’sissuer's debit cards and (ii) card issuing financial institutions and card payment networks may not inhibit the ability of merchants to direct the routing of debit card transactions over any card payment networks that can process the transactions. Since April 2012, most debit card issuers have been required to enable at least two unaffiliated card payment networks on each debit card. We do not expect the prohibition on network exclusivity to impact our ability to pass on network fees and other costs to our clients. These regulatory changes create both opportunities and challenges for us. Increased regulation may add to the complexity of operating a payment processing business, creating an opportunity for larger competitors to differentiate themselves both in product capabilities and service delivery.
Federal Trade Commission Act and Other Laws Impacting our Customers’ Business.Customers' Business. All persons engaged in commerce, including, but not limited to, us and our merchant and financial institution customers are subject to Section 5 of the Federal Trade Commission Act prohibiting unfair or deceptive acts or practices, or UDAP. In addition, there are other laws, rules and or regulations, including the Telemarketing Sales Act, that may directly impact the activities of our merchant customers and in some cases may subject us, as the merchant’smerchant's payment processor, to investigations, fees, fines and disgorgement of funds in the event we are deemed to have aided and abetted or otherwise provided the means and instrumentalities to facilitate the illegal activities of the merchant through our payment processing services. Various federal and state regulatory enforcement agencies including the Federal Trade Commission, or FTC, and the states’states' attorney general have authority to take action against nonbanks that engage in UDAP or violate other laws, rules and regulations and to the extent we are processing payments for a merchant that may be in violation of laws, rules and regulations, we may be subject to enforcement actions and as a result may incur losses and liabilities that may impact our business.
RulesAnti-Money Laundering and Policies of and Contractual Covenants with Mobile Phone Carriers. While not governmental regulation, Digital Provider isCounter Terrorist Regulation. We are also subject to certainU.S. federal anti-money laundering laws and regulations, including the Bank Secrecy Act, as amended by the USA PATRIOT Act of 2001 (collectively, the rulesBSA). The BSA requires, among other things, that money services businesses to develop and policiesimplement risk-based anti-money laundering programs, report large cash transactions and suspicious activity and maintain transaction records
We are additionally subject to economic and trade sanctions programs administered by the impositionTreasury Department’s Office of finesForeign Assets Control, or penalties as a resultOFAC. These programs prohibit or restrict transactions to or from or dealings with specified countries, their governments and, in certain circumstances, their nationals, narcotics traffickers, and terrorists or terrorist organizations. We are also subject to other countries’ laws, where applicable, regarding anti-money laundering, counter terrorist financing and proceeds of failurecrime.
Privacy. Our financial institution clients are required to comply with such rules,privacy regulations imposed under the Gramm-Leach-Bliley Act. These regulations place restrictions on the use of non-public personal information. All financial institutions must disclose detailed privacy policies and/or contractual covenants. Digital Provider’s failure to complytheir customers and offer them the opportunity to direct the financial institution not to share information with third parties. The regulations, however, permit financial institutions to share information with non-affiliated parties who perform services for the mobile phone carriers’ respectivefinancial institutions. We believe that our company’s present activities fall under exceptions to the consumer notice and opt-out requirements orin this law for third-party service providers to payfinancial institutions. However, the fines or penalties they impose could result inlaws governing privacy generally remain unsettled. We will update our policies and procedures, where relevant, should it be determined that our activities do not fall within exceptions to Gramm-Leach-Bliley Act requirements. Our businesses operating outside of the terminationU.S. may be subject to other legal requirements concerning the use and protection of Digital Provider’s services.certain customer information.
Laws and Rules of the Russian Federation.The relationships between Digital Provider (formerly known as TOT Money) and telecommunications carriers in Russia are governed by the general rules of civil law for the provision of services (Chapter 39 of the Civil Code of the Russian Federation). In addition, because the “information and entertainment services” (content services) provided by Digital Provider are inextricably linked with the networks of telecommunications carriers, these servicesAnti-Corruption. We are subject to the requirements of the Rules of Mobile Communications Telephone Services Provision, approved by the Decree No. 328 of the Russian Federation Government dated December 9, 2014. These rules govern the relationship between a customer using mobile communication services and a telecommunications carrier in respect of mobile radio communications services, mobile radiotelephone services and/or mobile satellite radio services in the public network. Although Digital Provider is not a telecommunications carrier, many requirements of such Rules are present in Digital Provider’s contracts with telecommunications carriers, and such contracts impose responsibility and liability on Digital Provider for violations.
Digital Provider has a license for the provision of telematics services in Russia. Digital Provider is considered an operator of telematics services in Russia because it has a direct connection to equipment of telecommunications carriers and it affects electronic communications (i.e., receiving, processing and/or transmitting electronic messages). Operators of telematics services in Russia are regulated by the Federal Law “On Communication” dated July 2, 2003 No. 126-FZ. This Federal Law provides the legal basis for activity in the field of communications in the Russian Federation and territories under the Russian Federation jurisdiction, defines the powers of public authorities in the field of communications, as well as the rights and responsibilities of persons involved in such activities or using communication services. Digital Provider also is subject to the Rules of Telematics Services Provision approved by the Decree of the Russian Federation Government dated September 10, 2007 No. 575. These Rules govern the relationship between a customer or a user, on the one hand, and a telecommunications carrier providing telematics communication services, on the other hand, in the provision of telematics communication services.
The activity of Digital Provider to some extent is regulated by the Federal Law “On Operational and Investigative Activities” dated August 12, 1995 No. 144-FZ. This Federal Law determines the content of the operational and investigative activities in the Russian Federation, and provides for a system of guarantees in the process of operational and investigative operations. Operational and investigative activities include activities carried out openly and secretly by operational branches of certain government bodies in order to protect life, health, rights and freedoms of the person and the citizen, property, security of the society and the state from criminal attacks.
In carrying out activities on the Internet in Russia, Digital Provider is subject to the Federal Law “On Advertising” dated March 13, 2006 No. 38-FZ. The objectives of this Federal Law are the development of markets for goods and services based on the principles of fair competition, ensuring the common economic space in the Russian Federation, the realization of the rights of consumers to receive fair and accurate advertising, creating favorable conditions for the production and distribution of public service announcements, preventions of violations of the Russian Federation on advertising, as well as the suppression of improper advertising. Digital Provider’s activities on the Internet in Russia also are subject to the Federal Law “On Protection of Children from Information Harmful to Health” dated December 29, 2010 No. 436-FZ. This Federal Law provides regulations protecting children from information harmful to their health and/or development.
Concerning relations with Federal communication service providers, Digital Provider can be involved in regulation of personal data of subscribers. In case of transferring by Federal communication service providers’ information which includes personal data Digital Provider has to take measures to protect such data as the operator of personal data must take. The list of such measures is described in Federal Law “On Personal Data” dated 27.07.2006 No 152. This Federal Law and Federal Law “On Communication” establish rules of usage of personal data of subscribers. Taking into account that this regulation is to be applied only in case of transferring information with personal data from Federal communication service providers it is important to clarify that common execution of contracts with these providers do not stipulate transferring of personal data.
Business activities of PayOnline in Russian Federation are governed by the general rules of civil law (for example, Chapter 39 of the Civil Code of the Russian Federation) and by specialapplicable anti-corruption laws, such as the Federal LawU.S. Foreign Corrupt Practices Act, in the jurisdictions in which we operate. Anti-corruption laws generally prohibit offering, promising, giving, or authorizing others to give anything of June 27, 2011 N 161-FZ «On the National Payment System», Federal Law of 27.07. 2006 N 152-FZ "On Personal Data".value, either directly or indirectly, to a government official or private party in order to influence official action or otherwise gain an unfair business advantage
InAnti-Boycott. We are required to comply with U.S. anti-boycott regulations. U.S. law prohibits cooperation with any “illegal boycott request,” which includes a request from a third party to take certain actions against countries friendly to the frameworkU.S. These prohibited actions include, but are not limited to, refusal to do business with or in countries friendly to the U.S., or with other persons or entities that do business in or with countries friendly to the U.S.; furnishing information about business relationships with or in countries friendly to the U.S.; and executing business documents such as contracts, letters of the Federal Law of June 27, 2011, No. 161-FZ "On the National Payment System", PayOnline activities are regarded as the activities of the "operation center" (Article 17), which aims to ensure the exchange of electronic messages between billing participants in accordance with the rules of the payment system.credit, warranties that contain illegal boycott requests.
It should also be noted that in connection with the introduction of changes to the law that came into force on September 1, 2015, according to which all personal data of individuals - citizens of the Russian Federation, should be collected, processed and stored on the territory of the Russian Federation. PayOnline was forced to terminate long-term relations with the New York data center Stafford and transfer all servers to the territory of the Russian Federation.
Federal Law No. 152-FZ of July 27, 2006 "On Personal Data" as a whole regulates the activities of absolutely all organizations that process personal data of individuals. PayOnline, following the requirements of the law, registered as a personal data operator in Roskomnadzor under the number: 10-0104880.
Other Laws and Regulations
Since we collect certain information from members and users on our platform, itwe will be subject to current and future government regulations regarding the collection, use and safeguarding of consumer information over the Internet and mobile communication devices. These regulations and laws may involve taxation, tariffs, user privacy, rights of publicity, data protection, content, intellectual property, distribution, electronic contracts and other communications, consumer protection and electronic payment services. In many cases, it may be unclear how existing laws governing issues such as property ownership, sales and other taxes, libel and personal privacy apply to the Internet or mobile communication services as the vast majority of these laws were adopted prior to the advent of these technologies and do not contemplate or address the unique issues raised by the Internet and e-commerce.
There are a number of legislative proposals that are anticipated or pending before the U.S. Congress, various state legislative bodies, and foreign governments concerning data protection which could affect us. Many states, for example, have already passed laws requiring notification to subscribers when there is a security breach of personal data. It is possible that these laws may be interpreted and applied in a manner that is inconsistent with our data practices. If so, in addition to the possibility of fines, this could result in an order requiring that we change our data practices, which could have an adverse effect on our business. In addition, some states are interpreting their own statutes differently than federal law. This may create additional compliance burdens.
We are subject to foreign laws and regulations that affect the electronic payments industry in each of the foreign countries in which we operate. Some of these countries, such as the Russian Federation and the United Kingdom, have undergone significant political, economic and social change in recent years. In these countries, there is a greater risk of new, unforeseen changes that could result from, among other things, instability or changes in a country’s or region’s economic conditions; changes in laws or regulations or in the interpretation of existing laws or regulations, whether caused by a change in government or otherwise; increased difficulty of conducting business in a country or region due to actual or potential political or military conflict; or action by the European Union or the United States, Canada or other governments that may restrict our ability to transact business in a foreign country or with certain foreign individuals or entities, such as sanctions by or against the Russian Federation.
Legislation could be passed that limits our ability to use or store information about our users. The Federal Trade Commission (the “FTC”"FTC") and various states have established regulatory guidelines issued under the Federal Trade Commission Act and various state acts, respectively, that govern the collection, use and storage of consumer information, establishing principles relating to notice, consent, access and data integrity and security. Our practices are designed to comply with these guidelines. For example, we disclose that we collect a range of information about our users, such as their names, email addresses, search histories and activity on our platform. We also use and store such information primarily to personalize the experience on our platforms, provide customer support and display relevant advertising. While we do not sell or share personally identifiable information with third parties for direct marketing purposes, we do have relationships with third parties that may allow them access to user information for other purposes.
The foregoing list of laws and regulations to which we are subject is not exhaustive, and the regulatory framework governing our operations changes continuously. Enactment of new laws and regulations may affect our operations, and could potentially result in increased regulatory compliance costs, litigation expense, adverse publicity, and/or loss of revenue. We believe our policies and practices comply with the FTC privacy guidelines and other applicable laws and regulations. However, if our belief proves incorrect, or if these guidelines, laws or regulations or their interpretations change or new legislation or regulations are enacted, we may be compelled to provide additional disclosures to our users, obtain additional consents from our users before collecting or using their information or implement new safeguards to help our users manage our (or others’others') use of their information, among other changes.
Rules and Policies of and Contractual Covenants with Mobile Phone Carriers. While not governmental regulation, PayOnline is subject to certain of the rules and policies of mobile phone carriers to which PayOnline provides payment processing services and ongoing contractual covenants with such mobile phone carriers. The mobile phone carriers may from time to time update or otherwise modify or supplement their rules and policies. PayOnline periodically is subject to the imposition of fines or penalties as a result of failure to comply with such rules, policies and/or contractual covenants. PayOnline’s failure to comply with the mobile phone carriers’ respective requirements or to pay the fines or penalties they impose could result in the termination of PayOnline’s services.
Telematics Laws and Regulations in the Russian Federation. The relationships between PayOnline and telecommunications carriers in Russia are governed by the general rules of civil law for the provision of services (Chapter 39 of the Civil Code of the Russian Federation). In addition, because the “information and entertainment services” (content services) provided by PayOnline are inextricably linked with the networks of telecommunications carriers, these services are subject to the requirements of the Rules of Mobile Communications Services Provision, approved by the Decree of the Russian Federation Government dated May 25, 2005 No. 328. These Rules govern the relationship between a customer using mobile communication services and a telecommunications carrier in respect of mobile radio communications services, mobile radiotelephone services and/or mobile satellite radio services in the public network. Although PayOnline is not a telecommunications carrier, many requirements of such Rules are present in PayOnline’s contracts with telecommunications carriers, and such contracts impose responsibility and liability on PayOnline for violations.
PayOnline has a license for the provision of telematics services in Russia. PayOnline is considered an operator of telematics services in Russia because it has a direct connection to equipment of telecommunications carriers and it affects electronic communications (i.e., receiving, processing and/or transmitting electronic messages). Operators of telematics services in Russia are regulated by the Federal Law “On Communication” dated July 2, 2003 No. 126-FZ. This Federal Law provides the legal basis for activity in the field of communications in the Russian Federation and territories under the Russian Federation jurisdiction, defines the powers of public authorities in the field of communications, as well as the rights and responsibilities of persons involved in such activities or using communication services. PayOnline also is subject to the Rules of Telematics Services Provision approved by the Decree of the Russian Federation Government dated September 10, 2007 No. 575. These Rules govern the relationship between a customer or a user, on the one hand, and a telecommunications carrier providing telematics communication services, on the other hand, in the provision of telematics communication services.
The activity of PayOnline to some extent is regulated by the Federal Law “On Operational and Investigative Activities” dated August 12, 1995 No. 144-FZ. This Federal Law determines the content of the operational and investigative activities in the Russian Federation, and provides for a system of guarantees in the process of operational and investigative operations. Operational and investigative activities include activities carried out openly and secretly by operational branches of certain government bodies in order to protect life, health, rights and freedoms of the person and the citizen, property, security of the society and the state from criminal attacks.
In carrying out activities on the Internet in Russia, PayOnline is subject to the Federal Law “On Advertising” dated March 13, 2006 No. 38-FZ. The objectives of this Federal Law are the development of markets for goods and services based on the principles of fair competition, ensuring the common economic space in the Russian Federation, the realization of the rights of consumers to receive fair and accurate advertising, creating favorable conditions for the production and distribution of public service announcements, preventions of violations of the Russian Federation on advertising, as well as the suppression of improper advertising. PayOnline’s activities on the Internet in Russia also are subject to the Federal Law “On Protection of Children from Information Harmful to Health” dated December 29, 2010 No. 436-FZ. This Federal Law provides regulations protecting children from information harmful to their health and/or development.
Concerning relations with Federal communication service providers, PayOnline can be involved in regulation of personal data of subscribers. In case of transferring by Federal communication service providers’ information which includes personal data PayOnline has to take measures to protect such data as the operator of personal data must take. The list of such measures is described in Federal Law “On Personal Data” dated 27.07.2006 No 152. This Federal Law and Federal Law “On Communication” establish rules of usage of personal data of subscribers. Taking into account that this regulation is to be applied only in case of transferring information with personal data from Federal communication service providers it is important to clarify that common execution of contracts with these providers do not stipulate transferring of personal data.
Seasonality
Historically, we have experienced seasonal fluctuations in our revenues as a result of consumer spending patterns.patterns, especially in the restaurant business. Revenues have been weaker during the first quarter of the calendar year and stronger during the second, third and fourth quarters. We expect our business to continue experiencing seasonal fluctuations consistent with this historical pattern.
Available Information
We are subject to the informational requirements of the Securities Exchange Act of 1934, as amended ('the Exchange Act") and file or furnish reports, proxy statements, and other information with the SEC. You can read our SEC filings over the Internet at the SEC’s website at www.sec.gov. Our filings with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to those reports, also are available free of charge on the investors section of our website at http://investor.netelement.cominvestor.netelement.com/en/ir when such reports are available on the SEC’s website. Further corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of business conduct and ethics, is also available on the investors section of our website.
You may also read and copy any document we file with the SEC at its public reference facilities at 100 F Street, N.E., Room 1580, Washington, DC 20549. You may also obtain copies of the documents at prescribed rates by writing to the Public Reference Section at the SEC at 100 F Street, NE, Room 1580, Washington, DC 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference facilities. The contents of the websites referred to above are not incorporated into this filing or in any other report or document we file with the SEC, and any references to these websites are intended to be inactive textual references only.
Investing in our securities involves a high degree of risk. You should carefully consider the risks and uncertainties described below, together with all of the other information in this Report, including “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and related notes, as well as the preceding “Business” section of this Report, before engaging in any transaction in our securities. Any of the following risks could materially and adversely affect our business, financial condition, results of operations and/or prospects, and cause the value of our securities to decline, which could cause you to lose all or part of your investment.
Risks Related to Our Business and Operations
Our financial condition creates doubt asWe have incurred significant losses and we may continue to whether we will continue as a going concern. If we do not continue as a going concern, investors may lose their entire investment.experience losses in the future.
Since our inception, we have incurred significant operating losses. We sustained a net loss of approximately $13.6$5 million for the year ended December 31, 20162018 and an accumulated deficit of approximately $157$172.2 million at December 31, 2016.2018. We had a negative working capital of approximately $6.3$1.3 million at December 31, 2016.2018. Our current assets at December 31, 20162018 included $0.6approximately $1.6 million in cash. $7.6cash, $6.3 million of accounts receivable and $1.5$1.7 million in prepaid expenses. Our current liabilities included $13.0approximately $8.9 million in accounts payable and accrued expenses, $1.4$1.5 million in deferred revenue $0.8 millionand $433,000 in current notes payable and $0.3 million in due to related parties.payable. As of the filing date of this Report with the SEC, management expects that our cash balance, cash flows from operations, and access to our credit facilities, if required, will not be sufficient to fund our current operations through 2017. We will require additional capital in order to continue our existing business operations and to fund our obligations. We currently believe that we will require an additional $4.8$3.3 million in financing to continue operations as currently conducted, continue our payment processing businesses and to pay for other currently anticipated capital expendituresprojected operating cash flow shortfall over the next 12twelve months. We also are obligatedmay continue to make a $1.8 million paymentincur losses in May 2017 relatingthe future and may never generate revenues sufficient to our obligations under the PayOnline acquisition.become profitable or to sustain profitability.
The Company is continuing with its plan to further fund, grow and expand its payment processing operations through organic growth and acquisition of profitable residual buyouts.
To fund our operating cash needs, we may need to borrow additional capital from our current credit facilities or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financings. The Company has been successful in restructuring its current debt facilities with commercially acceptable terms that ensures the continued operation of its business for the foreseeable future. As of December 31, 2018, the Company had approximately $10.8 million in available credit facilities.
Continuing losses may impair our ability to raise any additional funds required to continue and expand our operations. Additional funds for the continued expansion of our business 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.
To fund our operating cash needs, we may need to raise additional capital through loans or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financings. The Company has been successful in restructuring its current debt facilities with commercially acceptable terms that ensures the continued operation of its business for the foreseeable future.
Global economic, political, and other conditions may adversely affect trends in consumer, business, and government spending, which may adversely impact the demand for our services and our revenue and profitability.
Financial services, payments, and technology industries in which we operate depend heavily upon the overall level of consumer, business, and government spending. A sustained deterioration in the general economic conditions (including distress in financial markets, turmoil in specific economies around the world, and additional government intervention), particularly in the United States or Europe, or increases in interest rates in key countries in which we operate may adversely affect our financial performance by reducing the number or average purchase amount of transactions involving payment cards. A reduction in the amount of consumer spending could result in a decrease of our revenue and profits. The current threats to global economic growth include geopolitical instability in Russia, Ukraine, the Middle East and other oil producing countries. Instability in these regions could affect economic conditions in Europe and the United States.
Adverse economic trends may accelerate the timing, or increase the impact of, risks to our financial performance. Such trends may include, but are not limited to, the following:
● | Declining economies, foreign currency fluctuations, and the pace of economic recovery can change consumer spending behaviors on which a significant portion of our revenues are dependent. | |
● | Low levels of consumer and business confidence typically associated with recessionary environments, and those markets experiencing relatively high unemployment, may cause decreased spending by cardholders. | |
● | Budgetary concerns in the United States and other countries around the world could affect the United States and other specific sovereign credit ratings, impact consumer confidence and spending, and increase the risks of operating in those countries. | |
● | Emerging market economies tend to be more volatile than the more established markets we serve in the United States and Europe, and adverse economic trends may be more pronounced in such emerging markets. | |
● | Financial institutions may restrict credit lines to cardholders or limit the issuance of new cards to mitigate cardholder defaults. | |
● | Uncertainty and volatility in the performance of our clients' businesses may make estimates of our revenues, rebates, incentives, and realization of prepaid assets less predictable. | |
● | Our clients may decrease spending for value-added services. | |
● | Government intervention, including the effect of laws, regulations, and /or government investments in our clients, may have potential negative effects on our business and our relationships with our clients or otherwise alter their strategic direction away from our products. |
A weakening in the economy could also force some retailers to close, resulting in exposure to potential credit losses and declines in transactions, and reduced earnings on transactions due to a potential shift to large discount merchants. Additionally, credit card issuers may reduce credit limits and become more selective in their card issuance practices. Changes in economic conditions could adversely impact our future revenues and profits and result in a downgrade of our corporate capacity to borrow, which may lead to termination or modification of certain contracts and make it more difficult for us to obtain new business. Any of these developments could have a material adverse impact on our overall business and results of operations.
Our ability to anticipate and respond to changing industry trends and the needs and preferences of our clients and consumers may affect our competitiveness or demand for our products, which may adversely affect our operating results.
Financial services, payments, and technology industries are subject to rapid technological advancements, new products and services, including mobile payment applications, evolving competitive landscape, developing industry standards, and changing client and consumer needs and preferences. We expect that new services and technologies applicable to the financial services, payments, and technology industries will continue to emerge. These changes in technology may limit the competitiveness of and demand for our services. Also, our clients and their customers continue to adopt new technology for business and personal uses. We must anticipate and respond to these changes in order to remain competitive within our relative markets. For example, our ability to provide innovative POS technologies to our merchant clients could have an impact on our North AmericaAmerican Transaction Solutions segment.
Failure to develop value-added services that meet the needs and preferences of our clients could have an adverse effect on our ability to compete effectively in our industry. Furthermore, clients' and their customers' potential negative reaction to our products and services can spread quickly through social media and damage our reputation before we have the opportunity to respond. If we are unable to anticipate or respond to technological changes or evolving industry standards on a timely basis, our ability to remain competitive could be materially adversely affected.
Substantial and increasingly intense competition worldwide in the financial services, payments, and technology industries may materially and adversely affect our overall business and operations.
Financial services, payments, and technology industries are highly competitive and our payment solutions compete against all forms of financial services and payment systems, including cash and checks, and electronic, mobile, and e-commerce payment platforms. If we are unable to differentiate ourselves from our competitors, drive value for our clients and/or effectively align our resources with our goals and objectives, we may not be able to compete effectively. Our competitors may introduce their own value-added or other services or solutions more effectively than we do, which could adversely impact our growth. We also compete against new entrants that have developed alternative payment systems, e-commerce payment systems, and payment systems for mobile devices. Failure to compete effectively against any of these competitive threats could have a material adverse effect on us. In addition, the highly competitive nature of our industry could lead to increased pricing pressure which could have a material impact on our overall business and results of operations.
Potential changes in the competitive landscape, including disintermediation from other participants in the payments value chain, could harm our business.
We expect that the competitive landscape will continue to change, including:
● | Rapid and significant changes in technology, resulting in new and innovative payment methods and programs that could place us at a competitive disadvantage and that could reduce the use of our products. | |
● | Competitors, clients, governments, and other industry participants may develop products that compete with or replace our value-added products and services. | |
● | Participants in the financial services, payments, and technology industries may merge, create joint ventures, or form other business combinations that may strengthen their existing business services or create new payment services that compete with our services. | |
● | New services and technologies that we develop may be impacted by industry-wide solutions and standards related to migration to EMV chip technology, tokenization, or other safety and security technologies. |
Failure to compete effectively against any of these competitive threats could have a material adverse effect on us.
The market for our electronic commerce services is evolving and may not continue to develop or grow rapidly enough for us to develop and increase our profitability.
If the number of electronic commerce transactions does not continue to grow or if consumers or businesses do not continue to adopt our services, it could have a material adverse effect on the profitability of our business, financial condition, and results of operations. We believe future growth in the electronic commerce market will be driven by the cost, ease-of-use, and quality of products and services offered to consumers and businesses. In order to consistently increase and maintain our profitability, consumers and businesses must continue to adopt our services, including our merchant suite, Aptito and PayOnline solutions.
If we cannot compete effectively, we will lose business.
We believe our mobile payment processing business is positioned to be competitive in our target markets. We cannot guarantee that we will be able to maintain or increase revenues from our existing operations, or that our proposed future operations will be implemented successfully. Our principal competitive considerations include:
● | financial resources to allocate to proper marketing and sales efforts; |
● |
| the ability to develop and maintain our operations, applications and technologies; | ||
● | the ability to effectively implement our business plans and strategies; | |
● | establishing our brand name; | |
● | financial resources to support working capital needs and required capital investments; and | |
● | effects of sanctions on our business. |
We rely on third-party processors and service providers; if they fail or no longer agree to provide their services, our merchant relationships could be adversely affected and we could lose business.
We rely on agreements with several large payment processing organizations to enable us to provide card authorization, data capture, settlement and merchant accounting services and access to various reporting tools for the merchants we serve. We also outsource other services including reorganizing and accumulating daily transaction data on a merchant-by-merchant and card issuer-by-card issuer basis and forwarding the accumulated data to the relevant bankcard associations.Payment Card Brands. Many of these organizations and service providers are our competitors, and we do not have long-term contracts with most of them. Typically, our contracts with these third parties are for one-year and are subject to cancellation upon limited notice by either party. The termination by our service providers of their arrangements with us or their failure to perform their services efficiently and effectively may adversely affect our relationships with the merchants whose accounts we serve and may cause those merchants to terminate their processing agreements with us.us.
We rely on bank sponsors, which have substantial discretion with respect to certain elements of our business practices, in order to process bankcard transactions. If these sponsorships are terminated and we are not able to secure or successfully migrate merchant portfolios to new bank sponsors, we will not be able to conduct our business.
Because we are not a bank, we are unable to belong to and directly access theattain direct membership to Visa and MasterCard bankcard associations.MasterCard. Visa and MasterCard operating regulations require us to be sponsored by a bank in order to process bankcard transactions. We are currently registered with Visa and MasterCard through the sponsorship from banks that are members of the card associations.brands. The principal sponsoring bank through which we process the significant majority of our transactions is BMO Harris Bank. If our sponsorships are terminated and we are not able to secure or successfully migrate merchant portfolios to new bank sponsors, we will not be able to conduct our business.
If we or our bank sponsors fail to adhere to the standards of the Visa and MasterCard, payment card associations, our registrations with these associationsorganizations could be terminated, and we could be required to stop providing payment processing services for Visa and MasterCard.
Substantially all of the transactions we process involve Visa or MasterCard. If we or our bank sponsors fail to comply with the applicable requirements of the Visa or MasterCard payment card associations,brands, Visa or MasterCard could suspend or terminate our registration. The termination of our registration or any changes in the Visa or MasterCard rules that would impair our registration could prevent us from providing transactional processing services.
If PayOnline fails to maintain its key partnerships with banks, financial institutions or payment processors, our financial results could be adversely affected.
PayOnline’s business relies on partnering with different banks, financial institutions and payment processors to expand globally in order to enable it to provide international payment processing. To the extent PayOnline fails to maintain key partnerships with such banks, financial institutions or payment processors, our financial results could be adversely affected. Such failure to maintain partnerships may be due to mergers and/or consolidations of banks, financial institutions and payment processors, which may result in potential changes in their business processes that could negatively affect PayOnline operations, in particular in emerging markets, such as Kazakhstan.
We periodically experience increases in interchange and other related costs, and if we cannot pass these increases along to our merchants, our profit margins will decline.
We pay interchange fees and assessments to issuing banks through the card associationsbrands for each transaction we process using their credit and debit cards. From time to time, the card associationsbrands increase the interchange fees that they charge processors and the sponsoring banks. At their sole discretion, our sponsoring banks have the right to pass any increases in interchange fees on to us. In addition, our sponsoring banks may seek to increase their Visa and MasterCard sponsorship fees to us, all of which are based upon the dollar amount of the payment transactions we process. If we are not able to pass these fee increases along to merchants through corresponding increases in merchant discount, our profit margins will decline.
To acquire and retain merchant accounts, we depend on independent non-bank sales groups that do not serve us exclusively.
We rely on the efforts of ISGs to market our services to merchants seeking to establish a credit card processing relationship. ISGs are companies that seek to introduce to us, as well as our competitors, newly established and existing small merchants, including retailers, restaurants and other service providers. Generally, our agreements with ISGs are not exclusive and they have the right to refer merchants to other providers of transaction payment processing services. Our failure to maintain our relationships with our existing ISGs and to recruit and establish new relationships with other ISGs could adversely affect our revenues and internal growth and increase our merchant attrition.
Unauthorized disclosure of data, whether through cybersecurity breaches, computer viruses or otherwise, could expose us to liability, protracted and costly litigation and could damage our reputation.
We process, store and/or transmit sensitive data, such as names, addresses, credit or debit card numbers and bank account numbers, and we may have liability if we fail to protect this data in accordance with applicable laws and our clients’ specifications. The loss of data could result in significant fines and sanctions by our clients or governmental bodies, which could have a material adverse effect on our business, financial condition and results of operations. These concerns about security are increased when we transmit information over the Internet. Computer viruses can be distributed and spread rapidly over the Internet and could infiltrate our systems, which might disrupt our services and make them unavailable. In addition, a significant cybersecurity breach could result in payment networks prohibiting us from processing transactions on their networks or the loss of clients. We have been in the past and could be in the future, subject to breaches of security by hackers. It is possible that our encryption of data and other protective measures may not prevent unauthorized access. Although we have not to date incurred material losses or liabilities as a result of those breaches, a future breach of our system may subject us to material losses or liability, including payment of fines and claims for unauthorized purchases with misappropriated credit or debit card or bank account information or other similar fraud claims. A misuse of such data or a cybersecurity breach could harm our reputation and deter clients from using electronic payments generally and our services specifically, increase our operating expenses in order to correct the breaches or failures, expose us to uninsured liability, increase our risk of regulatory scrutiny, subject us to lawsuits and/or result in the imposition of material penalties and fines under applicable laws or by our clients.
Our operating results are subject to seasonality, and, if our revenues are below our seasonal norms during our historically stronger quarters, our financial results could be adversely affected.
We have experienced in the past, and expect to continue to experience, seasonal fluctuations in our revenues as a result of consumer spending patterns. Historically, revenues have been weaker during the first quarter of the calendar year and stronger during the second, third and fourth quarters. If, for any reason, our revenues are below seasonal norms during the second, third or fourth quarter, our business, financial condition and results of operations could be materially adversely affected.
New and potential governmental regulations designed to protect or limit access to consumer information could adversely affect our ability to provide, or impair the value of, the services we currently provide to our merchants.
Due to the increasing public concern over consumer privacy rights, governmental bodies in the United States and abroad have adopted, and are considering adopting, additional laws and regulations restricting the purchase, sale and sharing of personal information about customers. For example, the Gramm-Leach-Bliley Act requires non-affiliated third-party service providers to financial institutions to take certain steps to ensure the privacy and security of consumer financial information. We believe our present activities fall under exceptions to the consumer notice and opt-out requirements contained in this law for third-party service providers to financial institutions. However, the laws governing privacy generally remain unsettled. Even in areas where there has been some legislative action, such as the Gramm-Leach-Bliley Act and other consumer statutes, it is difficult to determine whether and how existing and proposed privacy laws or changes to existing privacy laws will apply to our business. Limitations on our ability to access and use customer information could adversely affect our ability to provide the services we currently offer to our merchants or impair the value of these services. Several states have proposed legislation that would limit the use of personal information gathered using the Internet. Some proposals would require proprietary online service providers and website owners to establish privacy policies. The California Consumer Privacy Act will go into effect on January 1, 2020. It will impose significant requirements on covered businesses, including mandatory disclosure of customers’ data when requested, customer data erasure in some contexts, and notification that customers can object to sale of their data, among numerous other provisions. It is foreseeable that other states may follow with similar legislation. Congress has also considered privacy legislation that could further regulate the use of consumer information obtained over the Internet or in other ways. Our compliance with these privacy laws and related regulations could materially affect our operations.
Changes to existing laws or the passage of new laws could:
● | create uncertainty in the marketplace that could reduce demand for our services; | |
● | restrict or limit our ability to sell certain products and services to certain customers; | |
● | limit our ability to collect and to use merchant and cardholder data; or | |
● | increase the cost of doing business as a result of litigation costs or increased operating costs; |
Any changes to existing laws or the passage of new laws that have effects such as those described above could have a material adverse effect on our business, financial condition and results of operations.
If we are required to pay federal, state or local taxes on transaction processing, it could negatively impact our profit margins.
Transaction processing companies may become subject to federal, state or local taxation of certain portions of their fees charged to merchants for their services. Application of these taxes is an emerging issue in our industry and taxing jurisdictions have not yet adopted uniform positions on this topic. If we are required to pay such taxes and are unable to pass this tax expense through to our merchant clients, or are unable to produce increased cash flow to offset such taxes, these taxes would negatively impact our profit margins.
The volume and amounts of the accounts receivable suitable for assignment to the lenders under our current factoring lines of credit as of the time we choose to draw under such facilities may vary, thus potentially reducing the amounts of such draws. Any such reductions may adversely affect our ability to satisfy our working capital and other liquidity needs.
Our credit facilities are currently structured as factoring lines of credit. Pursuant to these credit facilities, we assign certain (but not all) of our trade receivables from mobile operators to our lenders. The amounts of our draws under such facilities from time to time will depend on the amounts of the accounts receivable suitable to the lenders under such credit facilities for such assignment as of the time we choose to draw under such facility. If we require access to immediate liquidity to meet our working capital requirements, our draws under our credit facilities to satisfy those needs could be potentially reduced (depending on the amounts of the accounts receivable suitable to the lenders as of the time of any such draw), which could adversely affect our ability to satisfy our working capital and other liquidity needs.
We are subject to foreign laws and regulations, which are subject to change and uncertain interpretation.
We are subject to foreign laws and regulations that affect the electronic payments industry in each of the foreign countries in which we operate. Some of these countries, such as the Russian Federation, have undergone significant political, economic and social change in recent years. In these countries, there is a greater risk of new, unforeseen changes that could result from, among other things, instability or changes in a country’s or region’s economic conditions; changes in laws or regulations or in the interpretation of existing laws or regulations, whether caused by a change in government or otherwise; increased difficulty of conducting business in a country or region due to actual or potential political or military conflict; or action by the European Union, the United States or other governments that may restrict our ability to transact business in a foreign country or with certain foreign individuals or entities, such as sanctions by or against the Russian Federation.
Proposed foreign legislation and regulations could also affect our business. For example, the Russian Federal Tax Service is interested in all betting sites that render services to Russian citizens and wants to have these sites operate their business within the Russian Federation. Some believe that Russian regulators will lobby for a ban on payments for betting sites operating outside of Russia. If such a bill is adopted, then betting sites not registered in Russia could be limited in their ability to process payments, which could harm our customers and adversely affect our payment processing business.
Our management has identified continued material weaknesses in our controls and procedures as of December 31, 2016,2018, which, if not properly remedied, could result in material misstatements in our financial statements.
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 in “Management’s Report on Internal Control Over Financial Reporting” in Part II, Item 9A of this Report. 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 continuewe plan to address deficiencies as resources permit.identified over the next 9 to 12 months.
Acquisition activities could result in operating difficulties, dilution to our stockholders and other harmful consequences, and we may not achieve the anticipated benefits of the acquisitions.
We have built our current business primarily through acquisitions of intellectual property and other assets in connection with acquiring businesses, such as Unified Payments, Aptito and PayOnline, and we intend to selectively pursue strategic acquisitions in the future. Future acquisitions could divert management’s time and focus from operating our business. In addition, integrating an acquired company, business or technology is risky and may result in unforeseen operating difficulties and expenditures. Foreign acquisitions also involve unique risks related to integration of operations across different cultures and languages, currency risks and the particular economic, political and regulatory risks associated with specific countries. We may not accurately assess the value or prospects of acquisition candidates, and the anticipated benefits from our future or even past acquisitions may not materialize. In addition, future acquisitions or dispositions could result in potentially dilutive issuances of our equity securities, including our common stock, the incurrence of significant amounts of debt, contingent liabilities or amortization expenses, or write-offs of goodwill, any of which could negatively affect our financial condition.
We are dependent upon certain key relationships. If any of our key relationships were to deteriorate, our business prospects, financial condition and results of operations could be materially adversely affected.
Our success, particularly the success of our payment processing business, is dependent, in part, upon industry relationships of our Chief Executive Officer, Oleg Firer. If we were to lose the services of Mr. Firer, or if the industry relationships of Mr. Firer on which we rely were to deteriorate, our business prospects, financial condition and results of operations could be materially adversely affected. To our knowledge, Mr. Firer currently has no plans to retire or leave us in the near future, and we are not aware of any material adverse developments in his industry relationships. We do not have “key person” insurance on the life of Mr. Firer or any other member of our management team.
If we fail to adequately protect or enforce our intellectual property rights, competitors may create and market products and services similar to ours. In addition, we may be subject to intellectual property litigation and infringement claims by third parties.
Our ability to compete effectively is dependent in part upon the proprietary nature of our technologies and software platforms. We generally rely on a combination of trade secret, copyright, trademark and patent law to protect our proprietary rights in our intellectual properties. Although we attempt to protect our proprietary technologies through trade secrets, trademarks, patents and license and other agreements, these may be insufficient. In addition, if we license our software in non-U.S. countries, because of differences in foreign laws concerning proprietary rights, our intellectual properties may not receive the same degree of protection in non-U.S. countries as they would in the United States. We may not always be able to successfully protect or enforce our proprietary information and assets against competitors, which may materially adversely affect our business prospects, financial condition and results of operations. In addition, there can be no assurance that our competitors will not independently utilize existing technologies to develop products that are substantially equivalent or superior to ours, which also could materially adversely affect our business prospects, financial condition and results of operations.
Although we do not believe that our intellectual properties infringe the rights of others, and while to date we have not been subject to such claims, we may be exposed to, or threatened with, future litigation by other parties alleging that our technologies infringe their intellectual property rights. Any intellectual property claims, regardless of their merit, could be time consuming, expensive to litigate or settle and could divert management resources and attention. An adverse determination in any intellectual property claim could require us to pay damages and/or stop using our technologies and other material found to be in violation of another party’s rights and could prevent us from licensing our technologies to others. In order to avoid these restrictions, we may have to seek a license. Such a license may not be available on reasonable terms, could require us to pay significant license fees and may significantly increase our operating expenses. A license also may not be available to us at all. As a result, we may be required to use and/or develop non-infringing alternatives, which could require significant effort and expense. If we cannot obtain a license or develop alternatives for any infringing aspects of our business, we may be forced to limit our technologies and may be unable to compete effectively. Any of these adverse consequences could have a material adverse effect on our business prospects, financial condition and results of operations.
Further, from time to time we may be engaged in disputes regarding the licensing of our intellectual property rights, including matters related to the terms of our licensing arrangements. These types of disputes can be asserted by our licensees or prospective licensees or by other third parties as part of negotiations with us or in private actions seeking monetary damages or injunctive relief or in regulatory actions. Requests for monetary and injunctive remedies asserted in claims like these could be material and could have a significant impact on our business prospects. Any disputes with our licensees, potential licensees or other third parties could materially adversely affect our business prospects, financial condition and results of operations.
Fluctuations in foreign currency exchange rates could negatively affect our financial results.
We earn revenues and interest income, pay expenses, own assets and incur liabilities in countries using currencies other than the U.S. dollar. In the year ended December 31, 2016,2018, we used one functional currency - the Russian ruble - in addition to the U.S. dollar, and derived more than 22%approximately 10% of our total net revenues from operations outside the United States in Russia and CIS. Operations were ceased in the Ukraine in February 2015 and we have no further exposure to the Ukraine hryvnia after that date. As of December 31, 2016,2018, the foreign exchange rate for the Russian Rubleruble has improveddecreased by approximately 20% as compared to the Daily rate at December 31, 2015.2017. Because our consolidated financial statements are presented in U.S. dollars, we must translate net revenues, interest income and expenses, as well as assets and liabilities, into U.S. dollars at exchange rates in effect during or at the end of each reporting period. Therefore, increases or decreases in the value of the U.S. dollar against other major currencies will affect the amounts of our net revenues, interest income, operating expenses and the value of balance sheet items, including intercompany assets and obligations. Because we have operations in Russia, our exchange rate risk is highly sensitive to the prevailing value of the U.S. dollar relative to the Russian ruble, which exchange rates have fluctuated significantly in recent months as a result, in part, of the continuing instability in Ukraine and Syria as well as continued sanctions against Russia. Fluctuations in foreign currency exchange rates, particularly the U.S. dollar against the Russian ruble, may materially adversely affect our financial results.
Our business is subject to complex and evolving U.S. and foreign laws and regulations regarding privacy, data protection and other matters. Many of these laws and regulations are subject to change and uncertain interpretations, and could result in claims, changes to our business practices, increased cost of operations or declines in user growth or engagement, or otherwise harm our business.
We are subject to a number of foreign and domestic laws and regulations that affect companies conducting business on the Internet and companies transmitting user information and payments via text message or other electronic means, many of which are still evolving and the interpretation of which are often uncertain. Failure to comply with applicable laws and regulations may result in the suspension or revocation of licenses or registrations, the limitation, suspension or termination of services and/or the imposition of civil and criminal penalties and/or fines. The services of Digital ProviderPayOnline to mobile phone carriers also are subject to certain of the rules and policies of such carriers and ongoing contractual covenants with such carriers, the violation of which may result in penalties and/or fines and possible termination of Digital Provider’sPayOnline’s services. For additional information, see “Business Description - Regulation” in Part I, Item 1 of this Report.
Poor perception of our brand, business or industry could harm our reputation and adversely affect our business prospects, financial condition and results of operations.
The success of our business depends in part on our reputation within our industries and with our clients and consumers. We may be the subject of unflattering reports in blogs, video blogs and the media about our business and our business model. Any damage to our reputation could harm our ability to obtain and retain contracts with mobile phone carriers, content providers, advertisers and other customers, which could materially adversely affect our results of operations, financial condition and business.
Our business is subject to the risks of hurricanes, floods, fires and other natural catastrophic events and to interruption by man-made problems such as computer viruses or terrorism.
Our systems and operations are vulnerable to damage or interruption from hurricanes, floods, fires, power losses, telecommunications outages, terrorist attacks, acts of war, human errors, break-ins and similar events. Our U.S. corporate offices are located in Miami, Florida, which is an area that is at high risk of hurricane and flood damage. In addition, acts of terrorism, which may be targeted at metropolitan areas that have higher population density than rural areas, could cause disruptions in our business or the economy as a whole. The servers that we use through various third partythird-party service providers are not located in Miami, Florida but may also be vulnerable to computer viruses, break-ins and similar disruptions from unauthorized tampering with our computer systems, which could lead to interruptions, delays, loss of critical data or the unauthorized disclosure of confidential information. Such service providers may not have sufficient protection or recovery plans in certain circumstances, and our insurance may not be sufficient to compensate us for losses that may occur. As we rely heavily on our servers, computer and communications systems and the Internet to conduct our business, such disruptions could negatively impact our ability to run our business and either directly or indirectly disrupt our customers’ respective businesses, which could have an adverse effect on our business prospects, operating results and financial condition.
We incur increased costs as a result of being a public company.
As a public company, we currently incur significant legal, accounting and other expenses not incurred by private companies. It may be time consuming, difficult and costly for us to develop, implement and maintain the additional internal controls, processes and reporting procedures required by federal statutes, SEC rules, other government regulations affecting public companies and/or stock exchange compliance requirements. We may need to hire additional financial reporting, internal auditing and other finance staff in order to develop, implement and maintain appropriate internal controls, processes and reporting procedures, which will increase our expenses and adversely affect our operating results and financial condition.
We are the subject of various legal proceedings which could have a material adverse effect on our business, financial condition or operating results.
We are involved in various litigation matters. We may, from time to time, also be involved in or be the subject of governmental or regulatory agency inquiries or investigations. If we are unsuccessful in our defense in the litigation matters, or any other legal proceeding, we may be forced to pay damages or fines and/or change our business practices, any of which could have a material adverse effect on our business, financial condition and results of operations. For more information about our legal proceedings, see “Legal Proceedings” in Part I, Item 3 of this Report.
Our merchants may be unable to satisfy obligations for which we may also be liable.
We are subject to the risk of our merchants being unable to satisfy obligations for which we may also be liable. For example, we and our merchant acquiring alliances may be subject to contingent liability for transactions originally acquired by us that are disputed by the cardholder and charged back to the merchants. If we or the alliance is unable to collect this amount from the merchant because of the merchant’s insolvency or other reasons, we or the alliance will bear the loss for the amount of the refund paid to the cardholder. We have an active program to manage our credit risk and often mitigate our risk by obtaining collateral. It is possible, however, that a default on such obligations by one or more of our merchants could have a material adverse effect on our business.
Fraud by merchants or others could have a material adverse effect on our business, financial condition, and results of operations.
We may be subject to potential liability for fraudulent electronic payment transactions or credits initiated by merchants or others. Examples of merchant fraud include when a merchant or other party knowingly uses a stolen or counterfeit credit, debit or prepaid card, card number, or other credentials to record a false sales transaction, processes an invalid card, or intentionally fails to deliver the merchandise or services sold in an otherwise valid transaction. Criminals are using increasingly sophisticated methods to engage in illegal activities such as counterfeiting and fraud. It is possible that incidents of fraud could increase in the future. Failure to effectively manage risk and prevent fraud would increase our chargeback liability or other liability. Increases in chargebacks or other liability could have a material adverse effect on our business, financial condition, and results of operations.
Risks Relating to Blockchain Technology
We may not be successful in developing our blockchain technology solutions, and even if such platform is developed, there are a number of risks that may prevent its widespread adoption.
We are continuing the development of a decentralized crypto-based ecosystem that will act as a framework for a number of value-added services that can connect merchants and consumers directly utilizing blockchain technology while increasing the economic efficiency of all transactions being made within the ecosystem. However, blockchain technology is new and its uses are constantly evolving. Accordingly, we may not be successful in completing and fully-implementing our blockchain technology solutions in a timely manner or at all.
In addition, even if we are able to fully implement our blockchain platform, such technology is subject to a number of risks that may prevent its widespread adoption, including:
● | Risks of unfavorable regulatory action in one or more jurisdictions. Blockchain technologies and cryptocurrencies have been the subject of scrutiny by various regulatory bodies around the world. We could be impacted by one or more regulatory inquiries or actions, including but not limited to restrictions on the use of blockchain technology, which could impede or limit the development of our anticipated blockchain technology solutions. |
● | Risks relating to competition and alternative platforms. Blockchain industry is highly competitive and competition should intensify in the future. There are many platforms that enable the use of blockchain technologies in the payments ecosystem. Additional competitors are likely to enter the industry in the future. There is also competition from the traditional payment networks, all of which could potentially negatively impact us. |
● | Risks associated with unauthorized access. Third parties that gains access to a user’s login credentials or private keys may be able to transfer the user’s value. To minimize this risk, the users should guard against unauthorized access to their electronic devices. |
● | Risks that our anticipated blockchain technology solutions, as developed, will not meet the expectations of its target audience. Our anticipated blockchain technology solutions are presently under development and may undergo significant changes before beta and/or final release. Any expectations regarding the form and functionality of our anticipated blockchain technology solutions may not be met upon release, for any number of reasons including change in the design and implementation plans and execution. |
● | Risks of theft and hacking. Hackers or other groups or organizations may attempt to interfere with the blockchain technology or the availability of our anticipated blockchain technology solutions in any number of ways, including without limitation denial of service attacks, Sybil attacks, spoofing, smurfing, malware attacks, or consensus based attacks. We expect to spend significant resources to consistently penetrate test and monitor its technology to prevent any such threats. |
● | Risk of security weaknesses in the core infrastructure and software. Some parts of the core software may be based on open-source software. There is a risk that the development team or other third parties may intentionally or unintentionally introduce weaknesses or bugs into the core infrastructure elements of our anticipated blockchain technology solutions, which may materially interfere with its use. |
● | Risk of weaknesses or exploitable breakthroughs in the field of cryptography. Advances in cryptography, or technical advances such as the development of quantum computers, could present risks to cryptocurrencies and network, which could result in theft or loss. |
● | Unanticipated risks. Blockchain technology, cryptocurrency and cryptographic tokens are new and untested technologies. In addition to the risks set forth here, there are risks that we cannot anticipate. Risks may further materialize as unanticipated combinations or variations from the risks set forth here. |
We may not be able to develop new products or enhance the capabilities related to blockchain technology that is being developed by us to keep pace with our industry’s rapidly changing technology and customer requirements.
The industry for blockchain technology is characterized by rapid technological changes, new product introductions, enhancements, and evolving industry standards. Our business prospects depend on our ability to develop new products and applications for our technology in new markets that develop as a result of technological and scientific advances, while improving performance and cost-effectiveness. New technologies, techniques or products could emerge that might offer better combinations of price and performance than the blockchain technology solutions that are being developed by us. It is important that we anticipate changes in technology and market demand. If we do not successfully innovate and introduce new technology into our anticipated technology solutions or effectively manage the transitions of our technology to new product offerings, our business, financial condition and results of operations could be harmed.
Risks Related to Our Common Stock
Kenges Rakishev, the Chairman of our Board of Directors, ownsOur officers, directors and their affiliates own a large portion of the Company’sour common stock. Future sales or distributions of the Company’sour common stock in the public market by the Companyus or Mr. Rakishevour officers, directors and their affiliates could adversely affect the trading price of the Company’sour common stock.
At March 30, 2017, Kenges Rakishev, the Chairman ofApril 1, 2019, our Board of Directors,officers, directors and their affiliates beneficially owned approximately 18%10.55% of the Company’sour common stock. Sales or distributions of a substantial number of shares of the Company’sour common stock by Mr. Rakishevour officers, directors and their affiliates in the public market, or the perception that these sales or distributions might occur, may cause the market price of the Company’sour common stock to decline.
In addition, we may sell equity securities in the future to obtain funds for general corporate, working capital, acquisitions or other purposes. We may sell these securities at a discount to the then market price. Any future sales of equity securities will dilute the holdings of existing stockholders, possibly reducing the value of their investment.
In addition, we may sell equity securities in the future to obtain funds for general corporate, working capital, acquisitions or other purposes. We may sell these securities at a discount to the then market price. Any future sales of equity securities will dilute the holdings of existing stockholders, possibly reducing the value of their investment.
The market price and trading volume of our common stock may be volatile, which could result in rapid and substantial losses for our stockholders.
You should consider an investment in our common stock to be risky, and you should invest in our common stock only if you can withstand a significant loss and wide fluctuations in the market value of your investment. Many factors could cause the market price of our common stock to rise and fall, including the following:
● | our announcements or our competitors’ announcements regarding new products or services, enhancements, significant contracts, acquisitions or strategic investments; |
● | changes in earnings estimates or recommendations by securities analysts, if any, who cover our common stock; |
● | results of operations that are below our announced guidance or below securities analysts’ or consensus estimates or expectations; |
● | fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us; |
● | changes in our capital structure, such as future issuances of securities, sales of large blocks of common stock by our stockholders or our incurrence of additional debt; |
● | investors’ general perception of us and our industry; |
● | changes in general economic and market conditions; |
● | changes in industry conditions; and |
● | changes in regulatory and other dynamics. |
In addition, if the market for stocks in our industry, or the stock market in general, experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition or results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose us to lawsuits that, even if successfully defended, could be costly to defend and a distraction to management.
Our Common Stock mayWe are a “smaller reporting company,” and we cannot be delisted from The NASDAQ Capital Market, which could affect its market price and liquidity.certain if the reduced disclosure requirements applicable to smaller reporting companies will make our common stock less attractive to investors.
We are requireda “smaller reporting company,” as defined in Rule 12b-2 of the Exchange Act. As a smaller reporting company, we have relied on exemptions from certain disclosure requirements that are applicable to continually meet the listing requirements of The NASDAQ Capital Market (includingother public companies that are not smaller reporting companies. These exemptions include reduced financial disclosure and reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements. We may continue to rely on such exemptions for so long as we remain a minimum bid price forsmaller reporting company under applicable SEC rules and regulations. Accordingly, we cannot predict if investors will find our common stock of $1.00 per share) to maintain the listing ofless attractive because we rely on these exemptions. If some investors find our common stock on The NASDAQ Capital Market. On November 14, 2016, the bid priceless attractive as a result of our common stock fell below $1.00 and stayed below $1.00 for 30 consecutive business days. On December 28, 2016, we received a letter from NASDAQ providing us 180 days (until June 26, 2017) to regain compliance. To regain compliance, our stock closing bid price must remain above $1.00 for 10 consecutivereduced disclosures, there may be less active trading days. If we do not regain compliance with the minimum closing bid price requirement, the NASDAQ Capital Market will provide written notice that our securities are subject to delisting. At such time, we would be entitled to appeal the delisting determination to a NASDAQ Listing Qualifications Panel. We cannot provide any assurance that our stock price will recover within the permitted grace period.
Any delisting of our common stock from The NASDAQ Capital Market could adversely affect our ability to attract new investors, reduce the liquidity of our outstanding shares of common stock, reduce our flexibility to raise additional capital, reduce the price at which our common stock trades and increase the transaction costs inherent in trading such shares with overall negative effects for our stockholders. In addition, delisting of our common stock could deter broker-dealers from making a market in or otherwise seeking or generating interest in our common stock and might deter certain institutions and persons from investing in our securities at all. For these reasons and others, delisting could adversely affect our business, financial condition and results of operations.stock price may be more volatile.
Item 1B. Unresolved Staff Comments.
Not applicable.
OnNorth American Transaction Solutions
During May 10, 2013, we entered into a lease agreement, which is dated as of May 1, 2013, for approximately 4,7164,101 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.
On September 12, 2016, this The lease was extended for a period of five years commencing JanuaryAugust 1, 2017 and expiring DecemberJuly 31, 20212022 with equal monthly base rent increasing each year from 20,421 per month beginning January 1, 2017installments of $14,354 ($245,046172,248 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 larger space.plus sales tax.
NetLabs Systems, LLC, through its Russian representative office,Net Element Software, our subsidiary, currently leases 1,654 square feet of office space in Yekaterinburg, Russia, where it conducts certainwe develop value added services, andmobile applications, smart terminals applications, sales central CRMERP system development and marketing activities, at an annual rent of approximately $24,300. The currentlease was renewed on same terms and the lease term expires on June 1, 2017.2019.
International Transaction Solutions
PayOnline Systems leasesleased approximately 5,0904,675 square feet of office space in Moscow, Russia at an annual rent of $141,867. The current lease term for the office$84,457 which expired on September 30, 2018. This space expires on July 15, 2017. PayOnline leases approximately 276was reduced to 3,385 square feet of office space in Ekaterinburg, Russiaand renewed at an annual rent of $3,328. As a 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$56,000 expiring on August 16, 2017.31, 2019.
We believe that our current 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 if necessary,move to locate substitutenew facilities on acceptable terms.
Litigation
Aptito.com, Inc.For a discussion of legal proceedings, see “Litigation” in Note 10 to the Consolidated Financial Statements, which is incorporated by reference herein.
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 soon hold a hearing on the motion to interplead. 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 21, 2017, Aptito.com, Inc. filed several counterclaims against Aptito, LLC and us, which we are disputing and will defend.
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 and the injunction order prohibiting Zell from making further defamatory posts remains in place. We intend to protect our 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.
Item 4. Mine Safety Disclosures.
Not applicable.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information
Our common stock began trading on The NASDAQ Capital Market under the symbol “NETE” on October 3, 2012. From October 22, 2010 through October 2, 2012, our ordinary shares (then known as Cazador Acquisition Corporation Ltd.) traded on The NASDAQ Capital Market under the symbol “CAZA.” For the periods indicated, the following table sets forth the high and low intraday sales prices per share of our common equity.
| Fiscal 2016 | Fiscal 2015 | |||||||||||||||
| Quarter Ended | High | Low | High | Low | ||||||||||||
| March 31, | $ | 4.50 | $ | 1.50 | $ | 1.43 | $ | 1.03 | ||||||||
| June 30, | 4.60 | 1.71 | 1.30 | 0.38 | ||||||||||||
| September 30, | 2.55 | 1.03 | 0.63 | 0.12 | ||||||||||||
| December 31, | 1.38 | 0.70 | 0.43 | 0.05 | ||||||||||||
Holders
As of December 31, 2016,2018, our common stock was held by approximately 348 stockholders208 registered shareholders of record. The number of record holders was determined from the records of our transfer agent and does not include beneficial owners of common stock whose shares are held in the names of various securities brokers, dealers and registered clearing agencies. Our transfer agent is Continental Stock Transfer & Trust Company.
Dividends
We have not declared any dividends during the two most recent fiscal years. We have no present intention of paying any cash dividends on our common stock in the foreseeable future, as any earnings will be used to help generate growth. The decision on the payment of dividends in the future rests within the discretion of the Board of Directors and will depend upon, among other things, our earnings, capital requirements and financial condition, as well as other relevant factors. There are no restrictions in our certificate of incorporation or bylaws that restrict us from declaring dividends.
Securities Authorized for Issuance Under Equity Compensation Plans
The information included under Item 12 of Part III of this Report is hereby incorporated by reference into this Item 5 of Part II of this Report.
Recent Sales of Unregistered Securities
None.The Company did not sell any securities during the fiscal year ended December 31, 2018 that were not registered under the Securities Act of 1933, as amended, and that have not previously been included in a Quarterly Report on Form 10-Q or in a Current Report on Form 8-K.
Issuer Purchases of Equity Securities
None.For the years ended December 31, 2018 and 2017, we did not repurchase any shares of our common stock.
Item 6. Selected Financial Data.
Not Applicable.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
TheYou should read the following discussion should be read in conjunctionand analysis of our financial condition and results of operations together with the Consolidated Financial Statementsour audited financial statements and Notes to Consolidated Financial Statements containedrelated notes included elsewhere in this ReportReport. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward- looking statements as a result of many factors, including but not limited to those under the discussion under “Forward-Looking Statements” on page 2 at the beginning of this Report and the Risk Factors set forthheading “Risk Factors” in Part I, Item 1A of this Report. Certain amounts in this section may not foot due to rounding.
Overview
Net Element isWe are a global financial technologytechnology-driven group specializing in payment acceptance and value-added solutions groupacross multiple channels in the United States and selected international markets. We are differentiated by our proprietary technology which enables us to provide a broad suite of payment products, end-to-end transaction processing services and superior client support. We are able to deliver our services across multiple points of access, or “multi-channel,” including brick and mortar locations, software integration, e-commerce, mobile operator billing, mobile and tablet-based solutions. In the United States, via our U.S. based subsidiaries, we generate revenues from transactional services and value-added payment technologies for small and medium-sized businesses. Through PayOnline, we provide transactional services, mobile payment transactions, online payment transactions and other payment technologies in selected international markets, the Russian Federation, Eurasian Economic Community (“EAEC”), Europe and Asia.
Our transactional services business enables merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards, loyalty programs and alternative payment methods in traditional card-present or swipe transactions, as well as card-not-present transactions, such as those conducted over the phone or through the Internet or a mobile device. We market and sell our services through both independent sales groups (“ISGs”), which are non-employee, external sales organizations and other third-party resellers of our products and services, and directly to merchants through electronic media, telemarketing and other programs, including utilizing partnerships with other companies that supports companiesmarket products and services to local and international merchants. We have agreements with several banks that sponsor us for membership in accepting electronicthe Visa ®, MasterCard ®, American Express ® and Discover ® card brands and settle card transactions for our merchants. These agreements allow us to use the banks’ identification numbers, referred to as Bank Identification Numbers (BIN) for Visa® transactions and Interbank Card Association (ICA) number for MasterCard® transactions. The principal sponsoring banks through which we process the majority of our transaction in the United States include Citizens Bank, Esquire Bank, N.A. and Wells Fargo Bank, N.A. From time to time, we may enter into agreements with additional banks. We perform core functions for merchants such as application processing, underwriting, number account set-up, risk management, fraud detection, merchant assistance and support, equipment deployment, chargeback services and offer our own dedicated BIN and ICA for various types of specialty merchants.
Netevia, our future-ready payments and merchant management platform acts as a framework and core for a number of value-added services that connect merchants and consumers directly utilizing disruptive emerging technologies while increasing the economic efficiency of all transactions being made within the ecosystem. Specifically, Netevia delivers end-to-end payment processing through easy-to-use APIs and complements the Company’s ability to perform in an omni-channela multi-channel environment, that spans acrossincluding point-of-sale (“POS”)(POS), e-commerce and mobile devices and will enable the Company to perform as a hub for disruptive emerging technology solutions.
Our mobile payments business, previously provided through Digital Provider, has been combined with PayOnline to provide contracts with mobile operators that give us the ability to offer our clients in-app, premium SMS (short message services, which is a text messaging service), Wireless Application Protocol (WAP)-click, one click and other carrier billing services. We have substantially reorganized this business, and currently we are not generating revenues from new mobile content. We have not yet been able to find or solidify an acceptable joint venture partner or other arrangement that provides sufficient profit potential and operating benefit for our mobile payments operations.
PayOnline provides flexible, high-tech payment solutions to companies doing business on the Internet or in the mobile environment. PayOnline specializes in integration and customization of payment solutions for websites and mobile apps. In particular, PayOnline arranges payment on the website of any commercial organization, which increases the convenience of using the website and helps maximize the number of successful transactions. In addition, PayOnline is focused on providing online and mobile payment acceptance services to the travel industry through direct integration with leading Global Distribution Systems (“GDS”), which include Amadeus® and Sabre®. Key geographic regions that PayOnline serves include Eastern Europe, Central Asia, Western Europe, North America and Asia major sub regions. PayOnline offices are located in Moscow, Russia.
Aptito is a proprietary, cloud-based payments platform for the hospitality industry, which creates an online consumer experience in offline commerce environments via tablet, mobile and all other cloud-connected devices. We operateAptito’s easy to use point-of-sale (“POS”) system makes things easier by providing a comprehensive solution to the hospitality industry to help streamline management and operations. Orders placed tableside by customers directly speed up the ordering process and improve overall efficiency. Aptito’s mobile POS system provides portability to the staff while performing all the same functions as a traditional POS system.
Recent Developments
During the year ended December 31, 2018 we acquired the following recurring cash flow portfolios. There were no recurring cash flow portfolios acquired during the year ended 2017.
Acquisitions of Recurring Cash Flow Portfolios
From time to time, the Company acquires future recurring revenue streams from sales agents in exchange for an upfront cash payment. This results in an increase in net cash flow to the Company. The acquisitions of recurring cash flows are treated as asset acquisitions, resulting in recording a recurring cash flow portfolio intangible asset, at cost, on the date of acquisition. These assets are amortized over a straight-line period of approximately four years and is included in intangible assets on the accompanying consolidated balance sheets (See Note 6 - item labeled “Portfolio and Clients Lists”, on the accompanying consolidated audited financial statements).
Universal Partners, LLC
On July 30, 2018, our subsidiary, Unified Portfolio Acquisitions, LLC (the “Purchaser”), entered into an Advance and Residual Purchase Agreement (the “Agreement”) with Universal Partners, LLC (“Universal”). Pursuant to the Agreement, the Purchaser acquired certain transactional services portfolios (“cash flow assets”) from Universal and Payment Club, LLC (together with Universal, the “Seller”) for $2,700,000 (the “Advance Amount”). The cash flow assets consist of residuals (the “Residuals”) that the Sellers are entitled to receive pursuant to certain agreements (the “Combined Marketing Agreements”) with TOT Payments, LLC (doing business as Unified Payments), our subsidiary, or any other agreements pursuant to which the Seller is entitled to residuals.
The Advance Amount is to be repaid to the Purchaser whereby each and every month, commencing from July 1, 2018 (the “Effective Date”) and for a period of 24 months thereafter, terminating on June 30, 2020 (the “Advance Period”), the Purchaser is entitled to a certain amount of the Residuals. Such Residuals due to the Purchaser are secured by certain of the Seller’s property as collateral.
At the end of the Advance Period (the “Transfer Date”), the Purchaser and the Seller have agreed to create a new static portfolio pool of mutually agreed residual income from Seller portfolios comprising merchant accounts boarded by the Seller under the Combined Marketing Agreements that on the Transfer are generating at least $120,000 per month in net cash flow income (the “Portfolio Residuals”). From and after the Transfer Date, the Purchaser and Seller will share/split the Portfolio Residuals with the Purchaser owning an 80% interest in the Portfolio Residuals and the Seller owning a 20% interest in the Portfolio Residuals.
Argus Merchant Services, LLC
On December 26, 2018, Unified Portfolio Acquisitions, LLC (the “Purchaser”), a subsidiary of Net Element, Inc. (the “Company”), entered into an Advance and Residual Purchase Agreement (the “Agreement”) with Argus Merchant Services, LLC ("Argus") and Treasury Payments, LLC ("Treasury"); Argus and Treasury are collectively referred to herein as the (“Seller”). Pursuant to the Agreement, the Purchaser acquired certain transactional services portfolios (“cash flow assets”) from the Seller for a total purchase consideration of $1,426,000. The cash flow assets consist of residuals (the “Residuals”) that the Seller is entitled to receive pursuant to certain agreements (including any amendments of such agreements, the “Combined Marketing Agreements”) with TOT Payments, LLC (doing business as Unified Payments, a subsidiary of the Company).
On December 27, 2018, the Purchaser paid to Seller $1,150,000 (the “Advance Amount”). The Advance Amount and the balance of the purchase consideration is to be repaid to the Purchaser from Residuals due to the Seller, whereby each and every month, commencing from January 2019 (the “Effective Date”) and for a period of 24 months (the “Advance Period”), the Purchaser will be entitled to a certain amount of the Seller’s Residuals. Such Residuals due to the Purchaser are secured by certain of the Seller’s property as collateral.
At the end of the Advance Period (the “Transfer Date”), the Purchaser will receive an ownership interest in a portfolio of cash flow assets by creating with the Seller, a new static portfolio pool of mutually agreed residual income from Seller portfolios comprising merchant accounts boarded by the Seller under the Combined Marketing Agreements.
Also, we entered into a memorandum of understanding during the third quarter of 2018 with Bank Sputnik (“Sputnik”), located in Russia, to launch a technology platform expected to provide a suite of frictionless payment acceptance services for financial institutions and value-added providers. This new payment processing center would integrate Sputnik’s expertise in enabling secure globally inter-operable financial transactions with our expertise in developing frictionless value-added payment acceptance services. In addition, this payment processing center was expected to accelerate the delivery of payment acceptance services in this market, combining banking services and bill payments in a multi-channel environment. This joint venture with Sputnik was subject to approval of the shareholders of Sputnik and the regulators in Russia. Sputnik’s shareholders approved the transaction; however Sputnik, did not obtain regulatory approval, as they declined below the required paid in capital reserves. PayOnline continues to be committed to the payment processing center business plan. Accordingly, PayOnline entered into an agreement with each of MOBI.Money CJSC (“MOBI.Money”), and VTB Bank, both financial institutions, as sponsoring and transaction clearing banks. This new arrangement received regulatory approval in Russia. During the first quarter of 2019, PayOnline has entered into a financial services agreement for transaction clearing services with MOBI.Money and amended its agreement with VTB Bank, allowing for greater scalability and sponsorship of PayOnline to Card Brands. Card Brands have initiated projects for registration of PayOnline as a third-party payment processor, following successful registration, PayOnline plans to further implement direct integrations with international payment networks (“IPNs”). In order to achieve its business plan, PayOnline has identified several investors for financing a proposed venture. The executive team continues to work diligently to select the most capable financial partner for this venture.
Operating Segments
Prior to the fourth quarter of 2017, we had three reportable business operating segments: (i) North AmericaAmerican Transaction Solutions, (ii) Mobile Solutions and (iii) Online Solutions. For additionalManagement determines the reportable segments based on the internal reporting information about our business segments, see “Business Segments” under Part I, Item 1 of this Report.
We enable merchants of all sizesnecessary to acceptevaluate performance and process over 100 different payment optionsto assess where to allocate resources. In addition, management considers certain other factors, such as, the increased growth in more than 40 currencies, including credit, debit and prepaid payments. We also provide merchants with value-added services and technologies including integrated payment technologies, POS solutions, security solutions, fraud management, information solutions and analytical tools.
Total transactions processed during 2016 were 187 million compared to 161 million for 2015. The increase in transactions processed came primarily from our North AmericaAmerican Transactions Solutions segment and the consolidation of our mobile solutions business with our online solutions business, which sawhas changed how management evaluates performance and allocates resources. We now have two reportable business segments (i) North American Transaction Solutions and (ii) International Transaction Solutions.
Our 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, in distinct geographic locations, with different delivery and service processes.
North American Transaction Solutions
Our North American Transaction Solutions 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 70% increase from 51.5 million in 2015provider of comprehensive turnkey, payment processing solutions to 87.5 million transactions in 2016. small and medium size business owners (merchants) and independent sales organizations across the United States.
In April 2013, we acquired 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.
International Transaction Solutions
Our OnlineInternational Transaction Solutions segment experiencedconsists of PayOnline, which also now includes our mobile payments operations, primarily located in Russia. PayOnline provides a 36% increase from 19.5 million in 2015secure online payment processing system to 26.5 million transactions in 2016, while our Mobile Solutions segment processed 73.3 million in 2016 compared to 90 million transactions in 2015, which represented a 19% decrease. Growth in the North America Transactions Solutionsaccept bank card payments for goods and Online Solutions segments was organic.services.
Total transaction dollars processed during 2016 was $2.45 billion compared to $1.75 billion for 2015. The increase in transaction dollars processed came primarily from our North America Transactions Solutions segment, which saw a 60% increase from $1.0 billion in 2015 to $1.6 billion processed in 2016. Our Online Solutions segment experienced a 24% increase from $333 million in 2015 to $412 million processed in 2016, while our Mobile Solutions processed $36 million in transactions for 2016 compared to $90 million in 2015, which represented a 60% decrease. Growth in the North America Transactions Solutions and Online Solutions segments was organic.
Critical Accounting Policies and Estimates
Our significant accounting policies are described more fully in Note 13 of the accompanying Notesnotes to Consolidated Financial Statements. our audited consolidated financial statements.
The preparation of these consolidated financial statements in conformity with accounting principles generally accepted inrequires the United States requires managementCompany to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosuredisclosures of contingent assets and liabilities at the date of the consolidated financial statements as well asand the reported amounts of revenues and expenses duringfor the reporting period. Such estimates include, but are not limited to, the value of purchase consideration paid and identifiable assets acquired and assumed in acquisitions, goodwill and asset impairment review, valuation reserves for accounts receivable, valuation of acquired or current merchant portfolios, incurred but not reported claims, revenue recognition for multiple element arrangements, loss reserves, assumptions used in the calculation of equity-based compensation and in the calculation of income taxes, and certain tax assets and liabilities, as well as, the related valuation allowances. Actual results could differ materially from those estimates.
In applyingBelow is a summary of the Company’s critical accounting policies and estimates management uses itsfor which the nature of management’s assumptions are material due to the levels of subjectivity and judgment necessary to determineaccount for highly uncertain matters or the appropriatesusceptibility of such matters to change, and for which the impact of the estimates and assumptions to be used in the determination of certain estimates. Those estimates are based on our historical experience, terms of existing contracts, the observance of trends in our industries, information provided by outside sources, trade journals and other sources, as appropriate.financial condition or operating performance is material.
Revenue.
We recognize revenue when all of the following four basic criteria have beenare met: (1) the parties to the contract have approved the contract and are committed to perform their respective obligations, (2) we can identify each party’s rights regarding the goods or services to be transferred, (3) we can identify the payment terms for the goods or services to be transferred, (4) the contract has commercial substance, and (5) it is probable that we will collect substantially all of the consideration to which we will be entitled in exchange for the goods or services that will be transferred to the customer. The Company considers persuasive evidence of a sales arrangement exists; (2) performance of services has occurred, (3) the sales price is fixed or determinable, and (4) collectability is reasonably assured. We consider persuasive evidence of a merchant processing sales arrangement to be the receipt of a billable transaction from aggregators, signed contract or the processing of a signed contract.
Revenue for access to branded content is recognized monthly as the mobile subscribers purchase access to content. Service fee revenue from the Aptito SaaS fees is recognized when billed unless collectability is considered an issue.
credit card transaction. Collectability is assessed based on a number of factors, including transaction history with the customer and the credit worthiness of the customer. If it is determined that the collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. We record cash received in advance of revenue recognition as deferred revenue. Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services and is recognized as revenue during the period the transactions are processed or when the related services are performed.
The majority of our revenues is derived from volume-based payment processing fees ("discount fees”) and other related fixed transaction or service fees. Discount fees represent a percentage of the dollar amount of each credit or debit transaction processed. Discount fees are recognized at the time the merchants’ transactions are processed. Generally, where we have control over merchant pricing, merchant portability, credit risk and ultimate responsibility for the merchant relationship, revenues are reported at the time of sale on a gross basis equal to the full amount of the discount charged to the merchant. This amount includes interchange fees paid to card issuing banks and assessments paid to payment card networks pursuant to which such parties receive payments based primarily on processing volume for particular groups of merchants. Revenues generated from merchant portfolios where we do not have control over merchant pricing, liability for merchant losses or credit risk or rights of portability are reported net of interchange and other fees.
Revenues are also derived from a variety of fixed transaction or service fees, including authorization fees, convenience fees, statement fees, annual fees, and fees for other miscellaneous services, such as handling chargebacks. Revenues derived from service fees are recognized at the time the services are performed and there are no further performance obligations. Revenue from the sale of equipment is recognized upon transfer of ownership and delivery to the customer, after which there are no further performance obligations.
We primarily report revenues gross as a principal versus net as an agent. Although some of our processing agreements vary with respect to specific terms, the transactional processing service fees collected from merchants generally are recognized as revenue on a gross basis as we are the principal in the delivery of the managed payments solutions to the sellers. The gross fees we collect are intended to cover the interchange, assessments and other processing and non-processing fees which are included and are part of our gross margin.
Accounts Receivable and Credit Policies
Accounts receivable consist primarily of uncollateralized credit card processing residual payments due from processing banks requiring payment within thirty days following the end of each month. Accounts receivable also include amounts due from the sales of our technology solutions to our customers. The carrying amount of accounts receivable is reduced by an allowance for doubtful accounts, if necessary, which reflects management’s best estimate of the amounts that will not be collected. The allowance is estimated based on management’s knowledge of its customers, historical loss experience and existing economic conditions. Accounts receivable and the allowance are written-off when, in management’s opinion, all collection efforts have been exhausted.
ReserveGoodwill
Our goodwill represents the excess of the purchase price over the fair value of the net identifiable assets acquired in business combinations. The goodwill generated from the business combinations is primarily related to the value placed on the employee workforce and expected synergies. Judgment is involved in determining if an indicator or change in circumstances relating to impairment has occurred. Such changes may include, among others, a significant decline in expected future cash flows, a significant adverse change in the business climate, and unforeseen competition.
We have the option of performing a qualitative assessment of impairment to determine whether any further quantitative testing for Loan Losses. We monitor all accounts receivable, notes receivableimpairment is necessary. The option of whether or not to perform a qualitative assessment is made annually and transactions with mobile operatorsmay vary by reporting unit. Factors we consider in the qualitative assessment include general macroeconomic conditions, industry and aggregators on a quarterly basis to ensure collectability andmarket conditions, cost factors, overall financial performance of our reporting units, events or changes affecting the adequacycomposition or carrying amount of loss provisions. Considerations include payment history, business volume history, financial statementsthe net assets of borrower, projections of borrowerits reporting units, sustained decrease in its share price, and other standard credit review documentation. Management usesrelevant entity specific events. If we determine on the basis of qualitative factors that the fair value of the reporting unit is more likely than not less than the carrying value, then we perform a quantitative test for that reporting unit. The fair value of each reporting unit is compared to the reporting unit’s carrying value, including goodwill. Subsequent to the adoption on January 1, 2017 of Accounting Standards Update (“ASU”) No. 2017-04, Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment, if the fair value of a reporting unit is less than its best judgmentcarrying value, we recognize an impairment equal to adequately reserve for future losses after all available information is reviewed. During 2016 and 2015, Digital Provider recovered approximately $0.1 millionthe excess carrying value, not to exceed the total amount of advances previously reserved. goodwill allocated to that reporting unit.
During 2016At December 31, 2018, our management determined that an impairment charge of approximately $636,000 was necessary to reduce the goodwill relating to the acquisition of PayOnline. The impairment charge was primarily related to a decrease in projected sales for 2019, which is the base year utilized for determining the future discounted cash flows.
How We Assess Our Business
Technology Enabling Payment Solutions
Our technology provides comprehensive payment solutions to small and 2015,medium size businesses and organizations. Our merchant services includes third-party integrated payment solutions as well as traditional payment services across our strategic vertical markets.
Proprietary Software and Payments
Our proprietary software and payments services, Aptito, delivers embedded payment solutions to our clients through company-owned software and we recognized $1,274,671also provide the traditional merchant processing model.
Corporate Expenses and $754,162Eliminations
Ourcorporate expenses and eliminations category includes corporate overhead expenses, when presenting reportable segment information. For additional information on our segments, see Note 15 of our accompanying audited consolidated financial statements.
Key Operating Metrics
We evaluate our performance through key operating metrics, including:
the dollar volume of payments our clients process through us (“payment volume”);
the portion of our payment volume that is produced by integrated transactions; and
period-to-period payment volume attrition.
Our payment volume for net ACH rejects that occurredthe years ended December 31, 2018 and 2017 was $3.3 billionand $2.8 billion, respectively, representing a period- to-period growth rate of 18%. We focus on volume, because it reflects the scale and economic activity of our client base and because a significant part of our revenue is derived as a percentage of our clients’ dollar volume receipts. Payment volume reflects the addition of new clients and same store payment volume growth of existing clients, partially offset by client attrition during the period.
Total transactions processed during 2018 were 143 million compared to 154 million for 2017.
Our International Transaction Solutions segment saw a decrease during 2018 due to the loss of a material contract and reorganization and combination of the mobile solutions business. Growth in the normal course of business.
Deferred Taxes. Estimates of deferred income taxes and items giving rise to deferred tax assets and liabilities reflect management’s assessment of actual future taxes to be paid on items reflected in the financial statements, giving consideration to both timing and the probability of their realization. Actual income taxes could vary from these estimates for a variety of reasons, including changes in tax law, operating results that vary from budget or the review of our tax returns by the IRS.North American Transactions Solutions segment during 2018 was primarily organic.
Results of Operations for the Year Ended December 31, 20162018 Compared to the Year Ended December 31, 20152017
We reported a net loss attributable to common stockholders of $13,487,537approximately $4.9 million or ($1.03)1.28) loss per share for the year ended December 31, 20162018 as compared to a net loss of $14,838,704approximately $9.9 million or ($2.32)5.04) loss per share for the year ended December 31, 2015. Our2017. This resulted in a decrease in net loss from operations for the years ended December 31, 2016attributable to stockholders of approximately 50% primarily due to an increase in revenues and 2015 primarily resulted from our non-cash compensation, depreciation and amortization, andother income, combined with selling, general and administrative expenses, as discussed further below.and non-cash compensation, which was partially offset by an increase in bad debt expense.
The following table sets forth our sources of revenues, cost of revenues and gross margins for the years ended December 31, 20162018 and 2015.2017.
Gross Margin Analysis:
| Twelve | Twelve | |||||||||||||||||||
| Months Ended | Months Ended | Increase / | ||||||||||||||||||
| Source of Revenues | December 31, 2016 | Mix | December 31, 2015 | Mix | (Decrease) | |||||||||||||||
| North American Transaction Solutions | $ | 42,130,901 | 78 | % | $ | 27,388,598 | 68 | % | $ | 14,742,303 | ||||||||||
| Mobile Solutions | 5,933,281 | 11 | % | 9,043,705 | 22 | % | (3,110,424 | ) | ||||||||||||
| Online Solutions | 6,222,677 | 11 | % | 3,803,059 | 10 | % | 2,419,618 | |||||||||||||
| Total | $ | 54,286,859 | 100 | % | $ | 40,235,362 | 100 | % | $ | 14,051,497 | ||||||||||
| Twelve | Twelve | |||||||||||||||||||
| Months Ended | % of | Months Ended | % of | Increase / | ||||||||||||||||
| Cost of Revenues | December 31, 2016 | revenues | December 31, 2015 | revenues | (Decrease) | |||||||||||||||
| North American Transaction Solutions | $ | 36,342,465 | 86 | % | $ | 23,497,808 | 86 | % | $ | 12,844,657 | ||||||||||
| Mobile Solutions | 5,287,960 | 89 | % | 8,124,763 | 90 | % | (2,836,803 | ) | ||||||||||||
| Online Solutions | 4,077,816 | 66 | % | 2,354,644 | 62 | % | 1,723,172 | |||||||||||||
| Total | $ | 45,708,241 | 84 | % | $ | 33,977,215 | 84 | % | $ | 11,731,026 | ||||||||||
| Twelve | Twelve | |||||||||||||||||||
| Months Ended | % of | Months Ended | % of | Increase / | ||||||||||||||||
| Gross Margin | December 31, 2016 | revenues | December 31, 2015 | revenues | (Decrease) | |||||||||||||||
| North American Transaction Solutions | $ | 5,788,436 | 14 | % | $ | 3,890,790 | 14 | % | $ | 1,897,646 | ||||||||||
| Mobile Solutions | 645,321 | 11 | % | 918,942 | 10 | % | (273,621 | ) | ||||||||||||
| Online Solutions | 2,144,861 | 34 | % | 1,448,415 | 38 | % | 696,446 | |||||||||||||
| Total | $ | 8,578,618 | 16 | % | $ | 6,258,147 | 16 | % | $ | 2,320,471 | ||||||||||
Twelve | Twelve | |||||||||||||||||||
Months Ended | Months Ended | Increase / | ||||||||||||||||||
Source of Revenues | December 31, 2018 | Mix | December 31, 2017 | Mix | (Decrease) | |||||||||||||||
North American Transaction Solutions | $ | 59,138,552 | 89.9 | % | $ | 51,138,327 | 85.1 | % | $ | 8,000,225 | ||||||||||
International Transaction Solutions | 6,648,265 | 10.1 | % | 8,926,497 | 14.9 | % | (2,278,232 | ) | ||||||||||||
Total | $ | 65,786,817 | 100.0 | % | $ | 60,064,824 | 100.0 | % | $ | 5,721,993 | ||||||||||
Twelve | Twelve | |||||||||||||||||||
Months Ended | % of | Months Ended | % of | Increase / | ||||||||||||||||
Cost of Revenues | December 31, 2018 | revenues | December 31, 2017 | revenues | (Decrease) | |||||||||||||||
North American Transaction Solutions | $ | 50,545,759 | 85.5 | % | $ | 44,265,264 | 86.6 | % | $ | 6,280,495 | ||||||||||
International Transaction Solutions | 5,071,412 | 76.3 | % | 6,971,948 | 78.1 | % | (1,900,536 | ) | ||||||||||||
Total | $ | 55,617,171 | 84.5 | % | $ | 51,237,212 | 85.3 | % | $ | 4,379,959 | ||||||||||
Twelve | Twelve | |||||||||||||||||||
Months Ended | % of | Months Ended | % of | Increase / | ||||||||||||||||
Gross Margin | December 31, 2018 | revenues | December 31, 2017 | revenues | (Decrease) | |||||||||||||||
North American Transaction Solutions | $ | 8,592,793 | 14.5 | % | $ | 6,873,063 | 13.4 | % | $ | 1,719,730 | ||||||||||
International Transaction Solutions | 1,576,853 | 23.7 | % | 1,954,549 | 21.9 | % | (377,696 | ) | ||||||||||||
Total | $ | 10,169,646 | 15.5 | % | $ | 8,827,612 | 14.7 | % | $ | 1,342,034 | ||||||||||
Net revenues consist primarily of service fees from transaction processing. Net revenues were $54,286,859approximately $65.8 million for the year ended December 31, 20162018 as compared to $40,235,362approximately $60.1 million for the year ended December 31, 2015.2017. The increase in net revenues is primarily due to continued organic growth of North American merchants with emphasis on value-added offerings and the acquisition of a recurring cash flow portfolio in our North America Transaction Solutions segment. This was partially offset byJuly 2018. The net increase also is reflective of the following factors which consisted of a $3,110,424$2 million decrease primarily from our Mobile Solutions branded content. We acquired and began consolidatingin net revenues from our OnlineInternational Transaction Solutions segment consisting of PayOnline, which was acquired in May of 2015. Additionally,as we began generating revenues for branded content inexperienced increased competition, and reorganizing assignments from our MobileInternational Transaction Solutions segment duringand approximately $1.9 million reduction in gross revenues, due to the quarter ending September 30, 2015. Branded content revenues are presented gross versus net fees recorded for all other business. Branded content amounted to $5,502,004 and $9,030,491 foradoption of ASC 606. For the twelve monthsyear ended December 31, 2016 and 2015 respectively. The Mobile Solutions non-branded content2017, approximately $2.2 million was $431,277 and $13,214 for the twelve months ended December 31, 2016 and 2015 respectively and reportedincluded in service fees.gross revenues that would have been excluded under ASC 606.
Cost of revenues represents direct costs of generating revenues, including commissions, mobile operator fees, purchases of short numbers, interchange expense, processing and processingnon-processing fees. Cost of revenues for the twelve monthsyear ended December 31, 20162018 were $45,708,241approximately $55.6 million as compared to $33,977,215approximately $51.2 million for the twelve monthsyear ended December 31, 2015.2017. The year over year increase in cost of revenues in 2018 as compared to 2017 of $11,731,026approximately $4.4 million was because of a $12,844,657primarily driven by the increase directly due to continued increasedin North AmericaAmerican Transaction Solutions volume. There was also a $1,723,172 increaserevenues and expenses associated with new Sponsoring Bank relationships. Approximately $1.9 million reduction in cost of revenues resulting from Online Solutions segment (PayOnline) operations (acquired May 20, 2015). This was offset by a $2,836,803 decrease in Mobile Solutions costsdue to the adoption of revenues. Cost of revenues for Mobile Solutions branded content costs amounted to $5,187,005 and $8,119,117ASC 606 for the twelve monthsyear ended December 31, 2016 and 2015 respectively. The Mobile Solutions non-branded content costs were $100,955 and $5,646 for2018. For the twelve monthsyear ended December 31, 2016 and 2015, respectively and reported2017, approximately $2.2 million was included in costcosts of service fees.revenues that would have been excluded under ASC 606.
Gross Margin for the twelve monthsyear ended December 31, 20162018 was $8,578,618,approximately $10.2 million, or 16%15.5% of net revenue, as compared to $6,258,147,approximately $8.8 million, or 16%14.7% of net revenue, for the twelve monthsyear ended December 31, 2015.2017. The primary reasons margin percentages stayedreason for the same was an increase in net revenue from ourthe gross margin percentage was the result of North American Transaction Solutions segment processing of transactions utilizing our self-designated BIN/ICA and Online Solutions segments. This was offsetfurther acceptance of value-added services by a $273,621 decrease in Mobile Solutions net revenues. Mobile Solutions branded content gross margin amounted to $314,999 (6%) and $911,374 (10%) for the twelve months ended December 31, 2016 and 2015 respectively. The Mobile Solutions non-branded content gross margins were $330,322 (77%) and $7,568 (58%) for the twelve months ended December 31, 2016 and 2015 respectively.merchants.
Operating Expenses Analysis:
Total operating expenses were $17,416,066approximately $14.5 million for the year ended December 31, 2016,2018, as compared to total operating expenses of $16,779,514approximately $17.4 million for the year ended December 31, 2015.2017. Total operating expenses for the year ended December 31, 20162018 consisted of selling, general and administrative expenses of $8,797,883,approximately $9.8 million, non-cash compensation of $3,463,435, aapproximately $142,000, bad debt provisionexpense of $1,688,237approximately $2.1 million, and depreciation and amortization expense of $3,466,511.approximately $2.5 million. For the year ended December 31, 2015,2017, total operating expenses consisted of general and administrative expenses of $9,310,477,approximately $10.6 million, non-cash compensation of $4,306,304, aapproximately $2.9 million, bad debt provisionexpense of $649,571,approximately $1.3 million, and depreciation and amortization expense of $2,513,162.approximately $2.5 million.
The components of our selling, general and administrative expenses are discussedreflected in the table below.
GeneralSelling, general and administrative expenses for the years ended December 31, 20162018 and 20152017 consisted of operating expenses not otherwise delineated in ourthe accompanying audited consolidated statements of operations and comprehensive loss, as follows:
Twelve months ended December 31, 2018 | ||||||||||||||||
Category | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Total | ||||||||||||
Salaries, benefits, taxes and contractor payments | $ | 1,431,806 | $ | 1,205,885 | $ | 2,760,334 | $ | 5,398,025 | ||||||||
Professional fees | 350,100 | 346,084 | 1,556,497 | 2,252,681 | ||||||||||||
Rent | - | 90,456 | 204,143 | 294,599 | ||||||||||||
Business development | 134,862 | 4,636 | 14,961 | 154,459 | ||||||||||||
Travel expense | 151,098 | 12,789 | 138,316 | 302,203 | ||||||||||||
Filing fees | - | - | 49,339 | 49,339 | ||||||||||||
Transaction (gains) losses | - | 94,573 | - | 94,573 | ||||||||||||
Office expenses | 307,593 | 35,646 | 51,997 | 395,236 | ||||||||||||
Communications expenses | 112,510 | 162,444 | 107,475 | 382,429 | ||||||||||||
Insurance expense | - | - | 136,643 | 136,643 | ||||||||||||
Other expenses | 2,842 | 18,244 | 277,415 | 298,501 | ||||||||||||
Total | $ | 2,490,811 | $ | 1,970,757 | $ | 5,297,120 | $ | 9,758,688 | ||||||||
Twelve months ended December 31, 2017 | ||||||||||||||||
Category | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Total | ||||||||||||
Salaries, benefits, taxes and contractor payments | $ | 1,970,860 | $ | 1,696,245 | $ | 2,082,294 | $ | 5,749,399 | ||||||||
Professional fees | 505,383 | 819,184 | 1,312,271 | 2,636,838 | ||||||||||||
Rent | - | 245,539 | 245,186 | 490,725 | ||||||||||||
Business development | 53,011 | 32,072 | 3,569 | 88,652 | ||||||||||||
Travel expense | 331,299 | 32,397 | 130,198 | 493,894 | ||||||||||||
Filing fees | - | - | 72,035 | 72,035 | ||||||||||||
Transaction (gains) losses | 742 | (41,200 | ) | 1,642 | (38,816 | ) | ||||||||||
Office expenses | 303,586 | 98,961 | 120,103 | 522,650 | ||||||||||||
Communications expenses | 47,878 | 130,046 | 79,288 | 257,212 | ||||||||||||
Insurance expense | - | 5,401 | 135,386 | 140,787 | ||||||||||||
Other expenses | 38,788 | 14,715 | 162,894 | 216,397 | ||||||||||||
Total | $ | 3,251,547 | $ | 3,033,360 | $ | 4,344,866 | $ | 10,629,773 | ||||||||
Variance | ||||||||||||||||
Category | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Total | ||||||||||||
Salaries, benefits, taxes and contractor payments | $ | (539,054 | ) | $ | (490,360 | ) | $ | 678,040 | $ | (351,374 | ) | |||||
Professional fees | (155,283 | ) | (473,100 | ) | 244,226 | (384,157 | ) | |||||||||
Rent | - | (155,083 | ) | (41,043 | ) | (196,126 | ) | |||||||||
Business development | 81,851 | (27,436 | ) | 11,392 | 65,807 | |||||||||||
Travel expense | (180,201 | ) | (19,608 | ) | 8,118 | (191,691 | ) | |||||||||
Filing fees | - | - | (22,696 | ) | (22,696 | ) | ||||||||||
Transaction (gains) losses | (742 | ) | 135,773 | (1,642 | ) | 133,389 | ||||||||||
Office expenses | 4,007 | (63,315 | ) | (68,106 | ) | (127,414 | ) | |||||||||
Communications expenses | 64,632 | 32,398 | 28,187 | 125,217 | ||||||||||||
Insurance expense | - | (5,401 | ) | 1,257 | (4,144 | ) | ||||||||||
Other expenses | (35,946 | ) | 3,529 | 114,521 | 82,104 | |||||||||||
Total | $ | (760,736 | ) | $ | (1,062,603 | ) | $ | 952,254 | $ | (871,085 | ) | |||||
The total decrease of approximately $0.9 million in selling, general and administrative expenses for the year ended December 31, 2018 as compared to the prior year was primarily due to the Company’s continued monitoring of operations and the labor costs necessary to maintain or increase revenues, and the reorganization of assignments in the International Transaction Solutions segment, which resulted in a decrease of approximately $351,000. These objectives were also responsible for the decrease of approximately $384,000 in professional fees associated with operations.
The following table represents salaries, benefits, taxes and contractor payments by operating segment and the category corporate expenses and eliminations for the years ended December 31, 2018 and 2017.
Segment | Salaries and benefits for the twelve months ended December 31, 2018 | Salaries and benefits for the twelve months ended December 31, 2017 | Increase / (Decrease) | |||||||||
North American Transaction Solutions | $ | 1,431,806 | $ | 1,970,860 | $ | (539,054 | ) | |||||
International Transaction Solutions | 1,205,885 | 1,696,245 | (490,360 | ) | ||||||||
Corporate Expenses & Eliminations | 2,760,334 | 2,082,294 | 678,040 | |||||||||
Total | $ | 5,398,025 | $ | 5,749,399 | $ | (351,374 | ) | |||||
The following table represents professional fees by operating segment and the category corporate expenses and eliminations for the years ended December 31, 2018 and 2017.
Twelve months ended December 31, 2018 | ||||||||||||||||
Professional Fees | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Total | ||||||||||||
General Legal | $ | 12,553 | $ | 39,503 | $ | 206,684 | $ | 258,740 | ||||||||
SEC Compliance Legal Fees | - | - | 152,168 | 152,168 | ||||||||||||
Accounting and Auditing | - | 7,815 | 390,000 | 397,815 | ||||||||||||
Tax Compliance and Planning | - | - | 25,500 | 25,500 | ||||||||||||
Consulting | 337,547 | 298,766 | 782,145 | 1,418,458 | ||||||||||||
Total | $ | 350,100 | $ | 346,084 | $ | 1,556,497 | $ | 2,252,681 | ||||||||
Twelve months ended December 31, 2017 | ||||||||||||||||
Professional Fees | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Total | ||||||||||||
General Legal | $ | 33,480 | $ | 38,386 | $ | 80,724 | $ | 152,590 | ||||||||
SEC Compliance Legal Fees | - | - | 275,112 | 275,112 | ||||||||||||
Accounting and Auditing | - | 15,433 | 412,943 | 428,376 | ||||||||||||
Tax Compliance and Planning | - | - | 55,400 | 55,400 | ||||||||||||
Consulting | 471,903 | 765,365 | 488,092 | 1,725,360 | ||||||||||||
Total | $ | 505,383 | $ | 819,184 | $ | 1,312,271 | $ | 2,636,838 | ||||||||
Variance | ||||||||||||||||
Professional Fees | North American Transaction Solutions | International Transaction Solutions | Corporate Expenses & Eliminations | Increase / (Decrease) | ||||||||||||
General Legal | $ | (20,927 | ) | $ | 1,117 | $ | 125,960 | $ | 106,150 | |||||||
SEC Compliance Legal Fees | - | - | (122,944 | ) | (122,944 | ) | ||||||||||
Accounting and Auditing | - | (7,618 | ) | (22,943 | ) | (30,561 | ) | |||||||||
Tax Compliance and Planning | - | - | (29,900 | ) | (29,900 | ) | ||||||||||
Consulting | (134,356 | ) | (466,599 | ) | 294,053 | (306,902 | ) | |||||||||
Total | $ | (155,283 | ) | $ | (473,100 | ) | $ | 244,226 | $ | (384,157 | ) | |||||
Other Income and Expenses Delineated in the Condensed Consolidated Statements of Operations and Comprehensive Loss, including non-cashLoss:
Non-cash Compensation Analysis:
Non-cash compensation expense salaries and benefits, professional fees, rent, filing fees and other expenses required to run our business, as follows:
| Twelve months ended December 31, 2016 | ||||||||||||||||||||
| Category | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & Eliminations | Total | |||||||||||||||
| Salaries, benefits, taxes and contractor payments | $ | 1,302,547 | $ | 450,306 | $ | 637,181 | $ | 2,012,655 | $ | 4,402,689 | ||||||||||
| Professional fees | 542,681 | 10,835 | 888,174 | 1,273,150 | 2,714,840 | |||||||||||||||
| Rent | - | 3,996 | 140,789 | 421,548 | 566,333 | |||||||||||||||
| Business development | 36,923 | 4,966 | 123,046 | 13,354 | 178,289 | |||||||||||||||
| Travel expense | 191,848 | 11,435 | 23,606 | 119,904 | 346,793 | |||||||||||||||
| Filing fees | - | - | - | 82,560 | 82,560 | |||||||||||||||
| Transaction (gains) losses | 49 | (408,425 | ) | 44,738 | (376,906 | ) | (740,544 | ) | ||||||||||||
| Other expenses | 529,281 | (52,189 | ) | 145,854 | 623,977 | 1,246,924 | ||||||||||||||
| Total | $ | 2,603,329 | $ | 20,924 | $ | 2,003,388 | $ | 4,170,242 | $ | 8,797,883 | ||||||||||
| Twelve months ended December 31, 2015 | ||||||||||||||||||||
| Category | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & Eliminations | Total | |||||||||||||||
| Salaries, benefits, taxes and contractor payments | $ | 904,447 | $ | 405,910 | $ | 332,961 | $ | 2,172,923 | $ | 3,816,241 | ||||||||||
| Professional fees | 465,680 | 12,326 | 789,197 | 2,296,682 | 3,563,885 | |||||||||||||||
| Rent | 3,438 | 3,439 | 74,945 | 393,986 | 475,808 | |||||||||||||||
| Business development | 31,661 | 780 | 77,074 | - | 109,515 | |||||||||||||||
| Travel expense | 170,578 | 23,806 | 24,844 | 102,928 | 322,156 | |||||||||||||||
| Filing fees | - | - | - | 100,001 | 100,001 | |||||||||||||||
| Transaction (gains) losses | - | 68,713 | (69,480 | ) | (76,327 | ) | (77,094 | ) | ||||||||||||
| Other expenses | 507,002 | 523,451 | 46,231 | (76,719 | ) | 999,965 | ||||||||||||||
| Total | $ | 2,082,806 | $ | 1,038,425 | $ | 1,275,772 | $ | 4,913,474 | $ | 9,310,477 | ||||||||||
Salaries, benefits, taxes and contractor payments were $4,402,689was $142,000 for the year ended December 31, 20162018 as compared to $3,816,241approximately $2.9 million for the year ended December 31, 2015, representing an increase2017. A summary of $586,448 as2018 and 2017 non-cash compensation activity follows:
| Segment | Salaries and benefits for the twelve months ended December 31, 2016 | Salaries and benefits for the twelve months ended December 31, 2015 | Increase / (Decrease) | |||||||||
| North America Transaction Solutions | $ | 1,302,547 | $ | 904,447 | $ | 398,100 | ||||||
| Mobile Solutions | 450,306 | 405,910 | 44,396 | |||||||||
| Online Solutions | 637,181 | 332,961 | 304,220 | |||||||||
| Corporate Expenses & Eliminations | 2,012,655 | 2,172,923 | (160,268 | ) | ||||||||
| Total | $ | 4,402,689 | $ | 3,816,241 | $ | 586,448 | ||||||
2018 Non-Cash Compensation Activity:
# of Shares | # of Options | |||||||||||
Amount | Issued | Issued | ||||||||||
Board of Directors and Employee stock and Options | $ | 142,017 | 9,919 | - | ||||||||
Stock issued for consulting | - | - | - | |||||||||
Stock issued for acquisitions | - | - | - | |||||||||
Total for 2018 | $ | 142,017 | 9,919 | - | ||||||||
The increase in salaries of $586,448 was due primarily to the increase of corporate salaries of $398,100 due to an increase in North America Transactions Solutions’ headcount and sales incentives given to our key segment managers. Also, $304,220 of our Online Solutions segment salaries increased due to the May 20, 2015 acquisition and consolidation of PayOnline expenses were for a partial year in 2015.2017 Non-Cash Compensation Activity:
# of Shares | # of Options | |||||||||||
Amount | Issued | Issued | ||||||||||
Board of Directors and Employee stock and Options | $ | 2,827,200 | 242,324 | 45,106 | ||||||||
Stock issued for consulting | 7,258 | 896 | - | |||||||||
Stock issued for acquisitions | 105,966 | 13,082 | - | |||||||||
Total for 2017 | $ | 2,940,424 | 256,302 | 45,106 | ||||||||
ProfessionalBad Debt Expense:
We reflected a bad debt expense on the accompanying consolidated statements of operations, which represents uncollected fees were $2,714,840of approximately $2.1 million for the year ended December 31, 2016 as2018, compared to $3,563,885bad debt expense, representing uncollected fees of approximately $1.3 million for the year ended December 31, 2015, representing a decrease2017. The increase of $849,045 as follows:
| Twelve months ended December 31, 2016 | ||||||||||||||||||||
| Professional Fees | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & | Total | |||||||||||||||
| General Legal | $ | 43,257 | $ | 274 | $ | 4,403 | $ | 194,814 | $ | 242,748 | ||||||||||
| SEC Compliance Legal Fees | 120,000 | - | - | 55,000 | 175,000 | |||||||||||||||
| Accounting and Auditing | - | - | 578 | 420,686 | 421,264 | |||||||||||||||
| Tax Compliance and Planning | - | - | - | 44,200 | 44,200 | |||||||||||||||
| Consulting | 379,424 | 10,561 | 883,193 | 558,450 | 1,831,628 | |||||||||||||||
| Total | $ | 542,681 | $ | 10,835 | $ | 888,174 | $ | 1,273,150 | $ | 2,714,840 | ||||||||||
| Twelve months ended December 31, 2015 | ||||||||||||||||||||
| Professional Fees | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & | Total | |||||||||||||||
| General Legal | $ | 62,163 | $ | 1,732 | $ | 10,533 | $ | 557,355 | $ | 631,783 | ||||||||||
| SEC Compliance Legal Fees | 77,304 | - | - | 118,695 | 195,999 | |||||||||||||||
| Accounting and Auditing | 850 | 7,899 | 76,949 | 542,355 | 628,053 | |||||||||||||||
| Tax Compliance and Planning | - | - | - | 38,425 | 38,425 | |||||||||||||||
| Consulting | 325,363 | 2,697 | 701,714 | 1,039,851 | 2,069,625 | |||||||||||||||
| Total | $ | 465,680 | $ | 12,328 | $ | 789,196 | $ | 2,296,681 | $ | 3,563,885 | ||||||||||
| Variance | ||||||||||||||||||||
| Professional Fees | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & | Increase / (Decrease) | |||||||||||||||
| General Legal | $ | (18,906 | ) | $ | (1,458 | ) | $ | (6,130 | ) | $ | (362,541 | ) | $ | (389,035 | ) | |||||
| SEC Compliance Legal Fees | 42,696 | - | - | (63,695 | ) | (20,999 | ) | |||||||||||||
| Accounting and Auditing | (850 | ) | (7,899 | ) | (76,371 | ) | (121,669 | ) | (206,789 | ) | ||||||||||
| Tax Compliance and Planning | - | - | - | 5,775 | 5,775 | |||||||||||||||
| Consulting | 54,061 | 7,864 | 181,479 | (481,401 | ) | (237,997 | ) | |||||||||||||
| Total | $ | 77,001 | $ | (1,493 | ) | $ | 98,978 | $ | (1,023,531 | ) | $ | (849,045 | ) | |||||||
The most significant decreasesapproximately $800,000 from the prior year primarily resulted from an increase of approximately 15.6% in professional fees were attributable to general legalgross revenues from our North American Transaction Solutions segment, which in the normal course of $389,035, accounting/auditing fees of $206,789business, resulted in an increase in net ACH rejects and consulting services of $237,997. The primary reason for a $389,035 decrease in general legal expenses was due to less litigation activity in our corporate expenses duringuncollectible non-processing fees. For the year ended December 31, 2016 versus2018, total gross ACH reject were approximately $4 million of which $1.9 million were subsequently collected. We were able to pass through to independent sales organizations (“ISO's), via a reduction in commissions, $949,000 from the total gross ACH rejects.
For the year ended December 31, 2015. Corporate accounting fees decreased $121,669, due2017, total gross ACH rejects were approximately $3.7 million of which $2.4 million were subsequently collected. We were able to PayOnline’s acquisition which required additional accounting costspass through to ISO's, via a reduction in 2015 related to its valuation and separate financial statement audit prior to purchase. Online Solutions’ accounting fees also decreased $76,371 during 2016 becausecommissions, $603,000 from the PayOnline required increased accounting costs for its purchase in May 20, 2015 to prepare for its annual audit and to provide accurate financials for its valuation. Consulting fees decreased $237,997 primarily resulting from a corporate decrease of $481,401. This decrease occurred because of a transition of consultants into permanent positions as well as decreased investor relations costs and valuation fees. This was primarily offset by Online Solutions consulting costs which increased $181,479 as result of PayOnline’s being consolidated for a full year in 2016 versus 2015’s consolidation being effective May 20, 2015.total gross ACH rejects.
Transaction gains and losses represent changes in exchange rates between our functional currency and the foreign currency in which the transaction is denominated.
Other general and administrative expenses were $1,246,924 forDuring the year ended December 31, 2016 as compared2018, approximately $300,000 of the $4 million in gross ACH rejects was attributable to $999,965 formerchant processing losses, while the remaining $3.7 million was related to non-processing fees billed to merchants. Approximately $200,000 of the merchant processing losses were passed on to ISOs. This resulted in net processing losses of $100,000 or .004% of total volume.
During the year ended December 31, 2015, representing an increase2017, approximately $400,000 of $246,959. The differences consisted primarilythe $3.7 million in gross ACH rejects is attributable to merchant processing losses, while the remaining $3.3 million was related to non-processing fees billed to merchants. Approximately $323,000 of an $83,131 increase in office expenses, $64,805 increase in communications, a $42,409 increase in insurance, and a $31,921 increase in taxes. The increase in office expenses was attributedmerchant processing losses were passed on to North America Transaction Solutions ($44,294) and Online Solutions ($41,297). The increase to communications was primarily due to Online Solutions ($65,555), and corporate expenses ($41,502), offset by a decrease in North America Transaction Solutions ($20,573) and a decrease in Mobile Solutions ($21,678). The increase in insurance was due to our corporate, primarily as a result of our Directors and Officers policy. The increase in taxes was primarily due to an increase in corporate ($206,157), which primarily due to an $180,000 franchise tax for the State of Delaware, offset by a $166,926 decrease in Mobile Solutions taxes.
Non-cash compensation expense was $3,463,435 for the year ended December 31, 2016 as compared to 4,306,304 for the year ended December 31, 2015. A summary of 2016 and 2015 non-cash compensation activity was as follows:
| 2016 Non-Cash Compensation Activity | ||||
| $ Amount | ||||
| Board of directors & employee stock and options | $ | 3,184,608 | ||
| Options provided for financing | 78,827 | |||
| Stock issued in legal settlement | 200,000 | |||
| Total for 2016 | $ | 3,463,435 | ||
| 2015 Non-Cash Compensation Activity | ||||
| $ Amount | ||||
| Board of directors & employee stock and options | $ | 3,402,082 | ||
| Options provided for financing | 904,222 | |||
| Total for 2015 | $ | 4,306,304 | ||
We recorded a provision for bad debt in the amount of $1,688,237 for the year ended December 31, 2016, compared to provision for bad debts of $649,571 for the year ended December 31, 2015. For the twelve months ended December 31, 2016 we recorded a loss provision which was primarily comprised of $1,274,671ISOs.This resulted in net ACH rejects, attributable to the normal courseprocessing losses of our North America Transaction Solutions segment, and a $413,565 loss, which was primarily to reserve for potential accounts receivable losses from our Mobile Solutions business. For the twelve months ended December 31, 2015 we recorded a loss provision which was primarily comprised$101,000 or .004% of $754,162 in ACH rejects, attributable to the normal course of our North America Transaction Solutions segment, offset by $100,868 bad debt recovery from our Mobile Solutions segment.total volume.
During the years ended December 31, 2016Depreciation and 2015, we did not recognize any goodwill impairment.Amortization Expense:
Depreciation and amortization expense consists primarily of the amortization of merchant portfolios trademarks and domain names plusin connection with residual buyout arrangements, depreciation expense on fixed assets,equipment, client acquisition costs, capitalized software expenses, trademarks, domain names and employee non-compete agreements.
Depreciation and amortization expense was $3,466,511approximately $2.5 million for each of the years ended December 31, 2018 and, 2017.
Interest Expense:
Interest expense was approximately $847,000 for the year ended December 31, 20162018 as compared to $2,513,162approximately $1.2 million for the year ended December 31, 2015. The primary reason for the $953,349 increase is an $834,395 increase attributed to Online Solutions segment,2017, representing a decrease of approximately $340,000 primarily because we took a full year’s depreciation as we purchased PayOnline in May 2015. In addition, we had a $313,191 increase in North American Transaction Solutions due to increased customer acquisition costs, offset by $138,621 decrease because manypayoffs to the MBF and RBL notes in the normal course of our merchant portfolios became fully amortized in 2015.business.
Funding Source | Twelve months ended December 31, 2018 | Twelve months ended December 31, 2017 | Increase / (Decrease) | |||||||||
MBF Notes | $ | 10,359 | $ | 76,591 | $ | (66,232 | ) | |||||
RBL Notes | 597,440 | 772,777 | (175,337 | ) | ||||||||
PPS Note | 169,501 | 168,233 | 1,268 | |||||||||
Other | 69,879 | 172,021 | (102,142 | ) | ||||||||
Total | $ | 847,179 | $ | 1,189,622 | $ | (342,443 | ) | |||||
Interest expense was $1,463,833Other Income (Expenses):
Other income for the year ended December 31, 2016 as compared2018 of approximately $792,000 consisted primarily of a gain recorded on the transfer of Digital Provider's net assets to $3,575,698PayOnline (approximately $198,000), net gain in connection with the review and analysis of accounts receivable and accounts payable aging (approximately $856,000), gain on the write-off of TOT Group Russia (approximately $312,000), gain on the reversal of stock price guarantees in connection with the purchase of PayOnline that expired (approximately $313,000), partially offset by costs associated with common stock purchase agreement with ESOUSA Holdings, LLC (approximately $(227,000)), and approximately $(332,000) in miscellaneous other expenses.
Other income and expenses for the year ended December 31, 2015, representing a decrease of $2,111,865 as follows:
| Funding Source | Twelve months ended 2016 | Twelve months ended 2015 | Increase / (Decrease) | |||||||||
| Convertible Notes Payable | $ | - | $ | 3,027,354 | $ | (3,027,354 | ) | |||||
| MBF Notes | 61,325 | - | 61,325 | |||||||||
| RBL Notes | 1,282,439 | 513,994 | 768,445 | |||||||||
| Other | 120,069 | 34,350 | 85,719 | |||||||||
| Total | $ | 1,463,833 | $ | 3,575,698 | $ | (2,111,865 | ) | |||||
Interest for 2016 was primarily attributed to RBL Notes. Of the $1,282,439 in interest attributable to the RBL Notes, $789,357 was attributed to discounts on common stock provided in exchange for debt, as compared the market value on the day of issuance. In addition, $40,479 resulted from the amortization of related loan costs and $452,609 resulted from the payment of interest on the notes. Other interest2017 consisted primarily of $125,887 dueapproximately $117,000 of foreign taxes and other expenses attributed to a third partyour International Transaction Solutions segment, as a result of delayed payment installments onwell as approximately $48,000 in miscellaneous other expenses in the PayOnline stock price guarantee obligation, offset by interest earned by our MobileNorth American Transaction Solutions segment.
Interest for 2015 was primarily attributed to corporate of which $3,027,354 was dueNet Loss Attributable to the accretion of interest on the debt discounts attributed to the Convertible notes payable that were extinguished during the fourth quarter of 2015. Additionally, $513,994 was for our RBL Notes.
During 2016, we recorded a $3,722,142 loss from stock value guarantee and other charges from PayOnline acquisition, related to Online Solutions segment. This loss includes a stock price guarantee charge in the amount of $2,288,667, due to a make-whole provision arising from a decrease in the stock value purchase consideration paid and a reserve for merchant liabilities assumed in the amount of $1,433,475 pursuant to an amendment to the PayOnline acquisition agreement. Included in other income was a gain of $450,000, from the transfer and settlement of merchant reserves.
During 2015, we recorded a loss on the change in fair value on the beneficial conversion derivative related to convertible preferred stock and the related note payable in the amount of $26,932,496. During the fourth quarter, we extinguished the note payable and convertible preferred stock and recognized a $27,743,980 gain on these extinguishments which were attributable to our corporate expenses.
There was no intangible asset impairment during 2016 and 2015.Non-Controlling Interest:
The net incomeloss attributable to non-controlling interests amounted to $128,539approximately $87,000 and $74,314$110,000 for 2016the years ended December 31, 2018 and 2015,2017, respectively. The incomeloss was attributed to our North AmericaAmerican Transaction Solutions segment which represents 10%their 20% non-controlling interest in Aptito. The non-controlling interest reflects the results of operations of subsidiaries that are allocable to minority equity owners.
Since our inception, we have incurred significant operating losses. We incurred net losses totaling $13.6 million and $13.3 million for the years ended December 31, 2016 and 2015, respectively. We had a working capital deficit of approximately $6.3 million and an accumulated deficit of $157 million at December 31, 2016. These conditions raise substantial doubt about our ability to continue as a going concern. The independent auditors’ report on our consolidated financial statements for the year ended December 31, 2016 contains an explanatory paragraph expressing substantial doubt as to our ability to continue as a going concern. The accompanying consolidated financial statements do not include any adjustments that might be necessary if we are unable to continue as a going concern. See also “Liquidity and Capital Resources” below.
Liquidity and Capital Resources
Our totalTotal assets at December 31, 20162018 were $23.3approximately $25.8 million compared to $22.9approximately $32.3 million at December 31, 2015.2017. The year over year changeprimary reasons for the net decrease in total assets is primarily attributablewas the result of cash utilized to the $0.9 million increase in our North America Transaction Solutions receivables,fund operations, complete acquisitions, and a $0.4 million increase in mobile services receivables,pay down notes payable, which was partially offset by a decreasean increase in our intangibles of $1.3 million primarily from amortization throughintangible assets in connection with the year ended December 31, 2016 compared toportfolio acquisitions which occurred during the year ended December 31, 2015.year.
At December 31, 2016,2018 we had total current assets of $9.2approximately $9.7 million including $0.6as compared to approximately $19.0 million at December 31, 2017. The primary reason for the decrease in current assets was the utilization of cash $7.1 million of accounts receivable, and $1.5 million of prepaid expenses and other assets. At December 31, 2015, we had total current assets of $7.3 million including $1.0 million of cash, $5.2 million of accounts receivable, and $1.1 million of prepaid expenses and other assets.
As of the filing date of this Report with the SEC, management expects that our cash flows from operations will not be sufficienton hand to fund our current operations, through 2017. We will require additional capitalpay expenses in order to continue our existingthe normal course of business operations and to fund our obligations.for the purchase of recurring cash flow portfolios and client acquisition costs.
We currently believe that we will require an additional $4.8$3.3 million to finance our continuing operations, as currently conducted over the next 12 months. We also are obligatedmonths, although we may need additional capital in order to make a $1.8fund business expansion or future acquisitions.
To fund our operating cash needs, we may need to borrow additional capital from our current credit facilities or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financings. The Company has been successful in restructuring its current debt facilities with commercially acceptable terms that ensures the continued operation of its business for the foreseeable future. As of December 31, 2018 the Company had approximately $10.8 million payment in May 2017 relating to our obligations under the PayOnline acquisition. Weavailable credit facilities.
Additional funds may raise additional fundsbe 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 prospectsprospects.
Since our inception, we have incurred significant operating losses. We incurred net losses approximating $5 million and $10 million for the years ended December 31, 2018 and 2017, respectively. We have negative working capital of approximately $1.5 million and an accumulated deficit of $172 million at December 31, 2018. We have a cash balance at December 31, 2018 of approximately $1.7 million. We estimate we will need $3.3 million to cover our anticipated cash flow shortfall over the next 12 months. Although we do not have adequate cash balances to support our cash flow requirements, we do have the available credit facilities in place to provide adequate funding to support our cash needs for this period. We may raise additional funds 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 or re-financing is another possibility in the future and debt must be repaid regardless of whether we generate revenues or cash flows from operations and may ultimately require usbe secured by substantially all of our assets. Any equity financing or debt financing that requires the issuance of equity securities or warrants to suspendthe 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 cease operations, which could cause investorsprivileges senior to lose the entire amountthose of their investment.existing stockholders.
Operating activities used approximately $3.3 million of cash for the twelve months ended December 31, 20162018 as compared to using $1.7approximately $5.0 million of cash for the twelve months ended December 31, 2015.2017. Negative operating cash flow for the twelve months ended December 31, 20162018 was primarily due to a $13.5 millionsupporting the company’s loss adjusted for non-cash expenses and working capital items.an increase in the company’s payables, offset by an increase accounts payable and accrued expenses.
Investing activities used $1.5approximately $5.5 million of cash for the year ended December 31, 20162017 as compared to using $4.4approximately $1.8 million of cash for the year ended December 31, 2015.2017. The decreaseincrease in cash used by investing activities for the year ended December 31, 20162017 was primarily attributable to the $3.2 million of cash to purchase PayOnline in 2015, partially offset by a $0.4$3.6 million increase in portfolio purchases as we continue to acquire recurring cash flows and client acquisition costs in our North America Transaction Solutions segment during 2016.improve margins.
For the year ended December 31, 2016,2018 we did not have any equity financing activities provided cash of $4.4and approximately $2.1 million primarily from $3.2 million fromwas proceeds from indebtedness during the year ending December 31, 2016, $0.3 million in cash paid for stock and warrants and $1 million from related party advances from our CEO and board member.
borrowings. For the year ended December 31, 2015,2017, financing activities provided $6.5cash of approximately $17.6 million, dollars, primarily from $5.5 million in the issuance of preferred stock, later converted to common stock during the year ending December 31, 2015, $0.7approximately $14.9 million from equity financing and approximately $3.7 million was proceeds from issuance of notes payable to RBL and $0.3 million in related party loans from our CEO.
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 RBL Loan Agreement, we may borrow up to $10,000,000 from RBL during the period of 18 months 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. Borrowings from the line of credit in the amounts of $3,315,000, $400,000 and $250,000 were converted into term loans. At December 31, 2016 and 2015 we had $10,955,944 and $6,035,000 available on our RBL credit line. On May 2, 2016, we renewed our credit facility with RBL, increasing the facility from $10 million to $15 million, and extended the term through February 2018.
On May 2, 2016, we entered into a Master Exchange Agreement with Crede CG III, Ltd (“Crede”), an entity that purchased a portion our previously issued notes held by RBL. Pursuit to the Master Exchange Agreement, we have the right to direct Crede to exchange up to $3,965,000 of the RBL promissory notes acquired for shares of our common stock.
Effective December 20, 2016, we entered into a $4,044,055 term note with RBL. This note effectively refinanced certain previously issued RBL notes. The term note provides for interest-only payments at 14.15% through May 20, 2017 in the amount of $47,686. From June 20, 2021 through May 20, 2021, we are obligated to make monthly interest and principal payments of $110,814. The promissory note also provides for a $20,000 front end refinancing fee, due upon the execution of the loan and a $104,600 back end fee due at the final payment on May 20, 2021.
Effective March 28, 2016, we entered into a $75,000 term loan note with MBF Merchant Capital, LLC (“MBF”). The loan provides for interest-only payments at 14% through May 28, 2016. From June 28, 2016 through March 28, 2017, we are obligated to make monthly interest and principal payments of $7,990. The loan also provides for a 6% back end fee due at the final payment of the loan. As of December 31, 2016, the balance of the note was $23,420.borrowings.
Effective April 19, 2016, we entered into a $300,000 promissory loan note with MBF. The loan 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 monthly interest and principal paymentsTable of $14,617. The loan also provides for a 6% back end fee due at the final payment of the loan. As of December 31, 2016, the balance of the note was $221,826.
Effective July 1, 2016, our subsidiary, TOT Group, Inc., entered into a $353,500 promissory loan note with MBF. The loan 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 monthly interest and principal payments of $17,224. The loan also provides for a 1% front end fee and a 6.6% back end fee due at the final payment of the loan. As of December 31, 2016, the remaining balance of the note was $275,056.
Off-balance sheet arrangements
At December 31, 2016,2018, we did not have any off-balance sheet arrangements as defined in Item 303(a) (4) of Regulation S-K.
Recently Issued Accounting Pronouncements
In May 2014,The information contained in Note 3 to our Consolidated Financial Statements concerning a description of recent accounting pronouncements, including our expected dates of adoption and the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2014-09, “Revenue from Contracts with Customers,” which supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” and requires entities to recognize revenue in a way that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In August 2015, the FASB issued ASU 2015-14, which defers by one year the effective date of ASU 2014-09. Accordingly, this guidance is effective for interim and annual periods beginning after December 15, 2017 with early adoption permitted for interim and annual periods beginning after December 15, 2016. We are evaluating theestimated effects that the adoption of ASU 2014-9 will have on our consolidated financial statements, and do not expect a material impact on our financial position, results of operations or cash flows.
and financial condition, is incorporated by reference herein.
In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. This ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is permitted. We adopted this ASU, which had no impact on our financial position, results of operations or cash flows.
In February 2016, the FASB issued ASU 2016-02, “Leases” which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the effects that the adoption of ASU 2016-02 will have on our consolidated financial statements, and expect an increase in Assets and Liabilities associated with the recognition of right-of-use office leases.
In March 2016, the FASB issued Accounting Standards Update 2016-08 Revenue from Contracts with Customers (Topic 606) to clarify implementation guidance on principal versus agent considerations (for reporting revenue on a gross or net basis). The ASU is an amendment to Topic 606, clarifies the implementation guidance, and requires an entity to account for revenue as an agent when another entity controls the specified good or service before that good or service is transferred to the customer. This ASU is effective for annual periods beginning after December 15, 2017. We currently are preparing analyses, across all business lines and customers, to determine the effect of the new revenue recognition standard. While our study is not yet complete, we believe that a portion of our revenue recognized for branded content in our Mobile Solutions business segment may no longer meet the conditions for gross reporting upon adoption of this ASU in 2018.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
Not Applicable.
Item 8. Financial Statements and Supplementary Data.
The Consolidated Financial Statements and notes thereto and the reports of the independent registered public accounting firm set forth on pages F-2 through F-31F-24 are filed as part of this Report and incorporated herein by reference.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A. Controls and Procedures.
OurEvaluation of Disclosure Controls and Procedures
We maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) that are designed to provide reasonable assuranceensure that information required to be disclosed in ourthe reports filedthat we file or submittedsubmit under the Exchange Act is recorded, processed, summarized and reported within the time periodsperiod specified in the Commission’sSEC's rules and forms, and that such information is accumulated and communicated to our management, including to our chief executive officerChief Executive Officer and chief financial officer,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 required by Rule 13a-15 under the Exchange Act, our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the end of the period covered by this Report, our management conducted an evaluation, under the supervisiondesign and with the participation of our chief executive officer and chief financial officer, of the effectivenessoperation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and Rule 15d-15(e) under the Exchange Act).as of December 31, 2018. Based on that evaluation, our chief executive officerChief Executive Officer and chief financial officerChief Financial Officer concluded that as of December 31, 2018, 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’sbelow.
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
ManagementThe 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). Internalreporting. The Company's internal control over financial reporting is a process designed to provide reasonable, but not absolute, 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 becauseBecause 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 andor procedures may deteriorate.
Management of the Company conducted an assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016, 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 December 31, 2016.
Management is aware of the following material weaknesses (aA 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’sCompany's annual or interim financial statements will not be prevented or detected and corrected on a timely basis) inbasis.
The management of the Company’sCompany assessed the effectiveness of the Company's internal control over financial reporting: reporting as of December 31, 2018, and this assessment identified the following material weaknesses in the Company's internal control over financial reporting.
Control Environment:We identified a material weakness in our risk assessment process, which we determined was not operating adequately to identify and address the risks to our business and to establish appropriate control objectives given the environment in which we operate and the decentralized structure used to manage our operating activities in connection with our international operations. This material weakness in our risk assessment process was a factor contributing to the other material weaknesses which we have further described below.
We have identified a material weakness in our review of key accounting policies and procedures as of December 31, 2018. We have determined that although such policies and procedures exist, they are generally not formalized. Additionally, management has assessed certain policies and procedures as inadequate regarding their design adequacy, including a lack of formalized evidence of their effective operation.
We have identified a material weakness in that due to the lack of formalized documentation as to the adequacy of design and effective operation of both preventative and detective controls, management’s ability to monitor the effective operation of these internal controls is limited. Accordingly, management’s ability to timely detect, prevent and remediate deficiencies and potential fraud risks has been assessed as inadequate.
In making its assessment of internal control over financial reporting, management used the criteria issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control—Integrated Framework (2013). Because of the material weaknesses described in the preceding paragraphs, management concluded that, as of December 31, 2018, the Company's internal control over financial reporting was not effective based on those criteria.
This annual report does not include an attestation report of the Company's registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by the Company's registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management's report in this annual report.
Remediation Plan
As of December 31, 2018, the material weaknesses disclosed in previous years have not yet been fully remediated; however, significant progress has been made during 2018 in remediating certain material weaknesses. Several steps taken in improving and remediating internal controls over financial reporting have included retaining a financial reporting manager, the formation of a disclosure committee, as well as, formal education and training of our Board members. Remediation activities for our material weaknesses include:
● | Risk Assessment. We are in the process of designing and | |
Control Activities
Information and Communication
Monitoring
These material weaknesses impede the ability of management to adequately oversee our internal control over financial reporting on a timely basis. Management intends to continue focusing its remediation efforts in the near term on providing best practices training to our audit committee. In addition, we will endeavor to design 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 additional review and monitoring procedures. We plan to periodically assess the need for additional accounting resources as business develops and resources permit. Management also is committed to taking further action by implementing enhancements or improvements as resources permit. We recognize that, due to the size and global nature of our business, implementation of additional measures may take considerable time.
Notwithstanding the material weaknesses discussednoted above, our management has concluded thatand allocate appropriate resources to department heads in the financial statements includedcourse of the next nine to twelve months.
We expect to maintain continuous monitoring and implement changes to existing controls, as deemed necessary, to mitigate or remediate the material control weaknesses, where applicable.
Changes 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.Internal Control Over Financial Reporting
Except as specifically described above in this Item 9A, there was no change in our internal control over financial reporting during our fourth fiscal quarter of 20162018 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
None.
Item 10. Directors, Executive Officers and Corporate Governance.
The directors and executive officers of the Company and their respective ages, and positions with the Company and certain business experience as of March 30, 2017the date of this Report are set forth below. There are no family relationships among any of the directors or executive officers.
There are no material legal proceedings to which any director or executive officer of the Company, or any associate of any director or executive officer of the Company, is a party adverse to the Company or any of its subsidiaries or has a material interest adverse to the Company or any of its subsidiaries.
Name | Age | Position | ||
Oleg Firer | 41 | Executive Chairman and Chief Executive Officer | ||
Steven Wolberg | 59 | Chief Legal Officer | ||
Jeffrey Ginsberg | 53 | Chief Financial Officer | ||
Drew Freeman | 61 | Director | ||
Howard Ash | 60 | Director | ||
Jon Najarian | 61 | Director | ||
Jonathan Fichman | 48 | Director | ||
Each of our directors will hold office until our next annual meeting of shareholders at which directors are elected or until his successor is duly elected and qualified. Executive officers serve at the discretion of our Board of Directors.
Oleg Firer, Executive Chairman and Chief Executive Officer and Director. Mr. Firer has served as Executive Chairman since November 27, 2018 and Chief Executive Officer and a director of the Company since April 16, 2013. Previously, Mr. Firer served as Executive Chairman of Unified Payments, LLC from January 2011 until its acquisition by the Company’s subsidiary, TOT Group, Inc., on April 16, 2013.2013 and has served as the Executive Chairman since November 2018. From July 2004 until December 2012, Mr. Firer served as President, Chief Executive Officer and Secretary (and from May 2006 until December 2012 as Treasurer and from May 2008 until December 2012 as Chief Financial Officer) of Acies Corporation, a provider of payment processing solutions to small and medium size merchants across the United States. Mr. Firer also served as a director of Acies Corporation from May 2005 until December 2012. Mr. Firer served as the President of GM Merchant Solution, Inc. (from August 2002) and Managing Partner of GMS Worldwide, LLC (from August 2003) until their assets were acquired by Acies Corporation in June 2004. From November 2002 to December 2003, Mr. Firer served as the Chief Operating Officer of Digital Wireless Universe, Inc. From December 2001 to November 2002, Mr. Firer served as the Managing Partner of CELLCELLCELL, LLC. From March 1998 to December 2001, Mr. Firer served as Vice President of SpeedUS Corp. Mr. Firer studied Computer Science at New York Technical College from 1993 to 1995. Mr. Firer currently serves as a member of Star Capital Management, LLC and Star Equities, LLC, Florida-based investment group. In addition, Mr. Firer serves as a Chairman of the Supervisory Board of the Eastern Caribbean Blockchain Association, a board member of InList, RealConnexProgressive Care, Inc. and Star Development Ltd as well as a member of the Advisory Board of the E2Exchange, the Institute of Entrepreneurs and several non-for-profit organizations. Advisory Board member of CoinBoost, Inc. and several other private technology companies. Mr. Firer supports the initiatives of the Firer Family Charitable Foundation, the charitable family fund focused on helping families and children in need. In addition, Mr. Firer serves on various committees of Electronic Transaction Association (ETA). Mr. Firer holds a diplomatic rank of the Extraordinary and Plenipotentiary Ambassador. The Company believes that Mr. Firer’s leadership roles in various payment processing companies make him qualified to serve as a director of the Company.
Steven Wolberg, Chief Legal Officer and Secretary. Mr. Wolberg has beenserved as Chief Legal Officer and Secretary of the Company since April 16, 2013. Previously, Mr. Wolberg served in various capacities with Acies Corporation from approximately January 2009 until December 2012, including as a consultant from approximately January 2009 until October 2009, as a director from October 30, 2009 until December 2012 and as Chief Strategy Officer from March 1, 2010 until December 2012. Mr. Wolberg currently operates a solo law practice in Newton, Massachusetts, Attorney Steven Wolberg, which he has operated since January 1997. Mr. Wolberg served as Chief Counsel and Vice President of Corporate Development for Mascot Networks in Cambridge, Massachusetts from January 2000 to September 2001. Since September 1996, Mr. Wolberg has served as president of Oakland Properties, Inc., a real estate development company. From February 1993 to December 1994, Mr. Wolberg served as an attorney in the real estate and corporate divisions of Brown and Rudnick in Boston, Massachusetts. From March 1988 to November 1991, Mr. Wolberg was a partner with the law firm of Jordaan and Wolberg in Johannesburg, South Africa. From January 1986 to February 1988, Mr. Wolberg was employed as an attorney with Goodman and North in Johannesburg, South Africa. Mr. Wolberg also currently owns and serves as the Managing Member of Prime Portfolios, LLC, which holds a private investment portfolio of merchants, receiving payment processing services. Mr. Wolberg received his Bachelor of Arts from the University of Witwatersrand in Johannesburg, South Africa, his Bachelors of Laws from the University of Witwatersrand, in Johannesburg, South Africa, and his Juris Doctorate from the New England School of Law in Boston, Massachusetts. Mr. Wolberg is a member of the Massachusetts Bar Association.
Jonathan New,Jeffrey Ginsberg, Chief Financial OfficerOfficer.. Mr. NewGinsberg has beenserved as Chief Financial Officer of the Company since October 2, 2012.July 9, 2018. Previously, Mr. New was Chief Financial OfficerGinsberg served as the Vice President of Finance and Controller of the Company’s predecessor, Net Element, from March 10, 2008 until October 2, 2012. From 2001 to 2003, Mr. New was Chief Operating OfficerCompany since April 16, 2013, responsible for financial operations management, maintenance of Ener1, Inc. From 2004 until it was sold in 2006, Mr. New ownedaccounting records and operated Wholesale Salon Furniture Corp.com, which importedmaintenance of consolidated financial statements for the Company and distributed salon equipment. Thereafter, until joining Net Element, Mr. New provided services to public companies on a variety of corporate accounting, reporting and audit related issues.its subsidiaries. Prior to joining Ener1, Inc.his employment with the Company, Mr. Ginsberg was a Vice President of Finance and Controller of Unified Payments from June 2011 until acquisition by the Company in 2001,April 2013. Prior to Unified Payments, Mr. New held finance manager and chief financial officer positionsGinsberg was a Partner at Strombeck Consulting CPA from December 2009 to April 2013. He is a graduate of Queens College with companies including Häagen-Dazs, Virtacon (a web development company), RAI Credit Corporation (private label credit card company) and Prudentiala Bachelors of Florida. Mr. New obtained his BSArts degree in Accounting from Florida State University and began his career with Accenture.Accounting. He is a member of the Florida Institute of Certified Public Accountants and the American Institute of Certified Public Accountants.
Kenges Rakishev, Director. Mr. Rakishev has been a director
William Healy, Director. Mr. Healy is an accomplished financial services industry veteran with more than 24 years of merchant financing and electronic payments industry experience. Since 2006, Mr. Healy has served as the President of Funds4Growth, a leading investment firm focused on financing of payment service providers in the United States. Since launching Funds4Growth, Mr. Healy has successfully structured and financed in excess of $150 million in merchant base loans. Prior to his tenure at Funds4Growth, Mr. Healy founded MBF Leasing, LLC in November of 2003, where he was responsible for strategic planning along with the financial and operational management of MBF Leasing. Prior to that, Mr. Healy spent 13 years with the CIT Group, Inc., where he was the President of CIT’s Lease Finance Group out of Chicago, Illinois, overseeing more than 150 employees involved in over 225,000 leasing transactions, and in excess of $125 million in merchant base financings. Prior to joining CIT, Mr. Healy held several senior level positions with NewCourt Financial, including Chief Operating Officer of the Specialty Finance Division. He is a graduate of the University of Notre Dame with a Bachelor’s degree in Accounting. We believe that Mr. Healy’s extensive knowledge in the payments industry qualifies him to serve as a director of the Company.
James Caan, Director. Mr. Caan has been a director of the Company since October 2, 2012. Mr. Caan served as a director of the Company’s predecessor, Net Element, from January 1, 2011 until October 2, 2012. Mr. Caan is an actor and director, having worked in the film and television industries for over 40 years, and he is one of the entertainment industry’s most renowned talents, having starred in over 80 films. We believe that Mr. Caan’s tenure working as an actor and director in the film and television industry, qualifies him to serve as a director of the Company.
Drew J. Freeman, Director. Mr. Freeman has been a director of the Company since May 21, 2014. Mr. Freeman is an accomplished industry veteran with more than 30 years of electronic payments industry experience. Since June 2007, Mr. Freeman has served as the President of Freeman Consulting, Inc., a payments consulting firm that works with private equity and ISOs. Concurrent and prior to that, Mr. Freeman served as President of Merchant Data Systems from 2009 to 2013, Group Executive at Chase Paymentech from 2006 to 2007, and Executive Vice President at JP Morgan Chase-First Data JV (Chase Merchant Services) from 2000 to 2006. Mr. Freeman earned a business degree from the University of Miami in 1980. We believe that Mr. Freeman’s extensive knowledge in the payments industry qualifies him to serve as a director of the Company.
Howard Ash, Director.Director . Mr. Ash has been a director of the Company since June 13, 2016. Mr. Ash is an accomplished executive who served as CEO, COO and CFO to a variety of high profile, international companies. Mr. Ash currently serves as Chairman of Claridge Management since 2000. Mr. Ash served as Chief Operating Officer of BioCard Corporation from 1997 to 2007. Mr. Ash served as Chief Operating Officer of CITA Americas, Inc. from 1996 to 1997. Mr. Ash served as Chief Executive Officer of IEDC Marketing, Inc. from 1992 to 1996. Mr. Ash held a CFO/Financial Planning/Investment position at Abrams, Ash & Associates from 1990 to 1992. Mr. Ash currently serves on the Star Telemed Board, functioning initially as the Liaison to the Cuban Government through the Government of Grenada. Mr. Ash currently serves on the Advisory Board of the E2Exchange, the Institute of Entrepreneurs, in the United Kingdom as the only non-UK citizen. Mr. Ash continues to serve since 2009 in a senior development and strategic capacity for One Laptop Per Child, a global NGO created to provide educational opportunities for the world's poorest children by providing each child with a rugged, low-cost, low-power, internet connected laptop with content and software. Prior Chairmanships include the 2009 through 2012 term for the Sturge Weber Foundation, a non-profit organization dedicated to curing this rare but fatal syndrome that affects children. Previously, Mr. Ash was an Advisory Board Member to Edge Global Investment Limited which forged a strategic partnership with the Africa Forum, consisting of 37 former Heads of State and Government to pave the way for a new approach on nutrition and food supplements as part of a comprehensive strategy to fight the HIV and AIDS pandemic. Mr. Ash started an interest-free micro-loan society in 1987 that has provided more than $15 million in micro-loans throughout the United States and Israel. In 1999, Mr. Ash founded the Circle of Life Resource Center, Inc., a food bank in Miami, Florida that feeds several hundred families per week. Mr. Ash earned a Bachelor of Commerce degree, with Honors in Accounting and Law from the University of Witwatersrand (South Africa) in 1980. We believe that Mr. Ash’s extensive experience as a business and finance executive and member of multiple oversight bodies, provides him with the necessary skills to be qualified to serve as a director of the Company.
Jon Najarian, Director. Mr. Najarian has been a director of the Company since March 8, 2018. Mr. Najarian is an accomplished financial industry veteran with more than 37 years of financial and capital markets industry experience. Mr. Najarian is also well-versed in cryptocurrency and blockchain technologies. Mr. Najarian is a professional investor, money manager and media analyst. He is a co-founder of Investitue, LLC, the industry leading options education firm, which recently launched “Crypto Basics,” a new educational course that covers the basics of cryptocurrency, blockchain technology, altcoins and Initial Coin Offerings (ICOs). He is also a host of the International ICO Channel, a part of CoinBoost, whose goal is to bridge the divide between blockchain and mainstream media by offering distribution to traditional financial media outlets. In 2016, Mr. Najarian and his brother Pete co-founded Najarian Advisors, a company advising institutional investors on options strategies. The brothers invest in and work with start-ups via Rebellion Partners, a venture consulting firm they launched in 2015. Mr. Najarian is a cast member of CNBC’s “Halftime Report” and the “Fast Money” show. He is also the feature of the “DRJ Report” on CBOE-TV popular webcast. Mr. Najarian was a linebacker for the Chicago Bears before he focused his attention to trading on the Chicago Board Options Exchange (“CBOE”). He became a member of the CBOE, NYSE, CME and CBOT and worked as a floor trader for 25 years. In 1990, he founded Mercury Trading, a market-making firm at the CBOE, which he sold in 2004 to Citadel, one of the world’s largest hedge funds. In 2005, Mr. Najarian co-founded optionMONSTER and tradeMONSTER and negotiated a partnership with General Atlantic Partners in 2014 resulting ultimately in a sale to E*Trade for $750 million in September of 2016. Mr. Najarian developed and patented trading applications and algorithms used to identify unusual activity in stock, options, futures and cryptocurrency markets. optionMONSTER, an options news and education site, was described by Securities Industry News as “content king of the options business.” Mr. Najarian is a graduate of Gustavus Adolphus College with a BA degree. We believe that Mr. Najarian’s experience in the financial and capital markets industry provides him with the necessary skills to be qualified to serve as a director of the Company.
Jonathan Fichman, Director. Mr. Fichman has been a director of the Company since March 23, 2018. Mr. Fichman is an accomplished financial industry veteran with more than 20 years of domestic and international finance experience. His experience includes FinTech, payments, blockchain, wealth management and banking. Mr. Fichman holds a Six Sigma Black Belt accreditation and serves on multiple for profit and nonprofit boards. Since 2013, Mr. Fichman has served as a managing director of C-Anax Ventures & Advisory, where he assists early-stage companies with corporate strategy, streamlining operations, and financial analysis. Mr. Fichman is also an adjunct professor at the Florida International University where he teaches in the Business School with a focus on international management and entrepreneurship. From 2005 to 2015, Mr. Fichman served as a senior vice president of International Business Strategy & Initiatives at Bank of America Merrill Lynch. From 2003 to 2004, he served as a director of Operations, Procurement and Insurance at the Township of Cherry Hill, New Jersey. From 1999 to 2003, Mr. Fichman was a vice president of Strategic Initiatives at Actrade Financial Technologies, where he helped create B2B banking products that were at the forefront of commercial payments. From 1997 to 1999, he was a senior analyst consultant with Carson Group. Mr. Fichman received his MBA in Finance and Management from the University of Miami School of Business and Bachelor of Arts in Criminal Justice from the George Washington University. We believe that Mr. Fichman’s experience in the financial and capital markets industry provides him with the necessary skills to be qualified to serve as a director of the Company.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Exchange Act requires our directors and officers and persons who beneficially own more than ten percent of a registered class of our equity securities to file with the Commission initial reports of ownership and reports of change in ownership of common stock and other equity securities of the Company. Directors, officers and greater than ten percent stockholders are required by Commission regulations to furnish us with copies of all Section 16(a) forms they file. To our knowledge, the following persons have failed to file on a timely basis the identified reports required by Section 16(a) of the Exchange Act during the most recent fiscal year:
| Name and Relationship | Number of late reports | Transactions not timely reported | Known failures to file a required form | |||
| Jonathan New, Chief Financial Officer | 1 | 1 | 0 | |||
| Steven Wolberg, Chief Legal Officer and Secretary | 1 | 1 | 0 |
Name and Relationship | Number of late reports | Transactions not timely reported | Known failures to file a required form | ||||||
James Caan, former Director | 1 | 1 | - | ||||||
Kenges Rakishev, former Director | 1 | 1 | - | ||||||
Howard Ash, Director | 1 | 1 | - | ||||||
Drew Freeman, Director | 1 | 1 | - | ||||||
Jonathan Fichman, Director | 1 | 1 | - | ||||||
Jon Najarian, Director | 2 | 2 | - |
Code of Ethics
We have adopted a Code of Ethics and Business Conduct that applies to all of our directors, officers and employees, including our principal executive officer and our principal financial and accounting officer. A copy of our Code of Ethics and Business Conduct has been posted to the "Investors—Corporate Governance" section of our Internet website at http://www.netelement.com. We will provide a copy of our Code of Ethics and Business Conduct to any person without charge, upon written request to our Secretary at 3363 NE 163rd Street, Suite 705, North Miami Beach, Florida 33160, fax number (305) 508-5497, e-mail address investors@netelement.com.
Audit Committee
Our Board of Directors has a separately-designated standing audit committee established in accordance with Section 3(a)(58)(A) of the Exchange Act, which is currently comprised of Howard Ash (audit committee chairman), Drew FreemanJonathan Fichman and William Healy.Jon Najarian. Our Board of Directors has determined that Howard Ash is financially sophisticated as described in NASDAQ Listing Rule 5605(c)(2) and qualifies as an "audit committee financial expert" as defined in Item 407(d)(5) of Regulation S-K. We believe that the audit committee's current member composition satisfies the rules of NASDAQ that govern audit committee composition, including the requirement that audit committee members all be "independent directors" as that term is defined by NASDAQ Listing Rule 5605(a)(2).
Item 11. ExecutiveCompensation.
Summary Compensation Table
The following table sets forth information for the fiscal years ended December 31, 20162018 and 20152017 with respect to all compensation paid to or earned by each of our “named executive officers” (as defined by Item 402(m)(2) of the Regulation S-K).
| Stock | Option | All Other | ||||||||||||||||||||||||
| Name and Principal Position | Year | Salary ($) | Bonus ($) | Awards ($) | Awards ($) | Compensation ($) | Total ($) | |||||||||||||||||||
| Oleg Firer, Chief | 2016 | $ | 300,000 | $ | 300,000 | $ | 3,614,273 | $ | - | $ | 29,734 | $ | 4,244,007 | |||||||||||||
| Executive Officer of Net Element | 2015 | $ | 300,000 | $ | 300,000 | $ | 3,442,934 | (1) | $ | - | $ | 29,729 | $ | 4,072,663 | (1) | |||||||||||
| Steven Wolberg, Chief Legal Officer and | 2016 | $ | 200,000 | $ | - | $ | 245,500 | $ | 290,743 | $ | 11,734 | $ | 747,977 | |||||||||||||
| Secretary of Net Element | 2015 | $ | 200,000 | $ | - | $ | 180,000 | (2) | $ | 252,000 | (3) | $ | 11,734 | $ | 643,734 | |||||||||||
Stock | Option | All Other | ||||||||||||||||||||||||
Name and Principal Position | Year | Salary ($) | Bonus ($) | Awards ($)(1) | Awards ($)(1) | Compensation ($) | Total ($) | |||||||||||||||||||
Oleg Firer, Chairman and Chief Executive Officer of Net Element | 2018 | 300,000 | 600,000 | - | - | 55,868 | (3) | 955,868 | ||||||||||||||||||
| 2017 | 300,000 | 600,000 | 1,144,899 | - | 25,849 | 2,070,748 | |||||||||||||||||||
Steven Wolberg, Chief Legal Officer and Secretary of Net Element | 2018 | 230,000 | - | - | - | 11,734 | 241,734 | |||||||||||||||||||
| 2017 | 230,000 | - | 194,997 | 85,050 | 33,287 | 543,334 | |||||||||||||||||||
Jeffrey Ginsberg, Chief Financial Officer of Net Element (2) | 2018 | 123,500 | - | - | - | 7,589 | 131,089 | |||||||||||||||||||
(1) AnThe amounts disclosed generally reflect the grant date fair value computed in accordance with FASB ASC Topic 718. Grant date fair value for each award of 954,172 restricted shareswas determined based on the date approved by the Compensation Committee of the Company’s commonBoard of Directors and by the closing stock to Oleg Firer (consisting of 579,172 shares in lieu of and in satisfaction of accrued and unpaid compensation due to him in the amount of $1,042,509 and 375,000 shares as performance bonus) was grantedprice on December 3, 2015.such date.
(2) An award of 100,000 restricted shares ofMr. Ginsberg began serving as the Company’s common stock to Steven Wolberg was granted on December 3, 2015.Company's Chief Financial Officer effective July 9, 2018.
(3) Not reflecting a rescission, effective on April 12, 2016 (i.e., subsequent to the fiscal year ended December 31, 2015), of award of 120,000 ISOs (with a fair market value of $216,000 as of the grant date).This amount is primarily for automobile reimbursement expense in connection with his employment agreement.
Outstanding Equity Awards at Fiscal Year End
The following table sets forth information with respect to outstanding equity awards at the end of the Company’s fiscal year 20162018 for the “named executive officers”:
| OPTION AWARDS | SHARE AWARDS | OPTION AWARDS | SHARE AWARDS | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Name | Number of securities underlying unexercised options(#) exercisable | Number of securities underlying unexercised options (#) unexercisable | Equity incentive plan awards: Number of securities underlying unexercised unearned options (#) | Option exercise price ($) | Option Expiration Date | Number of shares or units of stock that have not vested(#) | Market value of shares of units of stock that have not vested($) | Equity incentive plan awards: Number of unearned shares, units or other rights that have not vested (#) | Equity incentive plan awards: Market or payout value of unearned shares, units or other rights that have not vested ($) | Number of | Number of securities | Equity incentive | Option exercise price | Option Expiration | Number of shares or | Market value of units of have not | Equity incentive | Equity incentive | |||||||||||||||||||||||||||||||||||||||||||||||||
| Steven Wolberg | 200,000 | - | - | $ | 0.24 | December 7, 2025 | - | $ | - | - | $ | - | 2,000 | - | - | 24.00 | October 3, 2025 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||
| Steven Wolberg | 137,143 | - | - | $ | 2.12 | June 13, 2026 | - | $ | - | - | $ | - | 13,714 | - | - | 21.20 | June 13, 2026 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||
Steven Wolberg | 10,500 | 1,500 | - | 8.10 | February 28, 2027 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Jeffrey Ginsberg | 483 | 44 | 439 | 13.40 | December 10, 2024 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Jeffrey Ginsberg | 503 | - | 503 | 21.20 | June 13, 2026 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Jeffrey Ginsberg | 2,000 | - | 2000 | 24.00 | December 3, 2025 | - | - | - | - | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
(1) These stock options for Mr. Wolberg and Mr. Ginsberg are fully vested.
Director Compensation
The following table further summarizes the compensation paid to the Company's non-employee directors for service as a director during 2016:2018:
| Fees earned or | ||||||||||||
| Director Name | paid in cash ($) | Stock awards ($) | Total ($) | |||||||||
| Kenges Rakishev | $ | - | $ | 4,650 | $ | 4,650 | ||||||
| David P. Kelley II | $ | 27,500 | $ | 2,133 | $ | 29,633 | ||||||
| James Caan | $ | - | $ | 4,650 | $ | 4,650 | ||||||
| William Healy | $ | 21,250 | $ | 4,650 | $ | 25,900 | ||||||
| Drew J. Freeman | $ | 6,354 | $ | 4,650 | $ | 11,004 | ||||||
| Howard Ash | $ | 18,958 | $ | 2,520 | $ | 21,478 | ||||||
Fees earned or | ||||||||||||
Director Name | paid in cash ($) | Stock awards ($) | Total ($) | |||||||||
Kenes Rakishev, former Chairman | - | 11,797 | 11,797 | |||||||||
Howard Ash | 47,500 | 15,549 | 63,049 | |||||||||
Drew Freeman | 22,500 | 15,549 | 38,049 | |||||||||
James Caan, former Director | - | 11,797 | 11,797 | |||||||||
Jonathan Fichman | 10,000 | 15,549 | 25,549 | |||||||||
Jon Najarian | 10,000 | 15,549 | 25,549 | |||||||||
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The table below contains information regarding the beneficial ownership of our Common Stock as of March 21, 201729, 2019 by (i) each person who is known to us to beneficially own more than 5% of our Common Stock, (ii) each of our directors, (iii) each of our named executive officers and (iv) all of our directors and executive officers as a group. Except as otherwise noted below, each person or entity named in the following table has the sole voting and investment power with respect to all shares of our Common Stock that he, she or it beneficially owns. Unless otherwise indicated, the address of each beneficial owner listed below is c/o Net Element, Inc., 3363 NE 163rd Street, Suite 705, North Miami Beach FL 33160.
| Name and address of beneficial owner | Amount and nature of beneficial ownership (number of shares of Common Stock beneficially owned) | Percent of class (1) | ||||||
| Kenges Rakishev c/o SAT & Company 241 Mukanova Street Almaty Kazakhstan 050008 | 3,132,961 | (2) | 16.61 | % | ||||
| Oleg Firer c/o Net Element, Inc. 3363 NE 163rd Street, Suite 705, North Miami Beach, Florida 33160 | 1,815,730 | (3) | 8.64 | % | ||||
| Steven Wolberg c/o Net Element, Inc. 3363 NE 163rd Street, Suite 705, North Miami Beach, Florida 33160 | 508,091 | (4) | 2.76 | % | ||||
| James Caan 2791 Hutton Drive Beverly Hills, CA 90210 | 18,764 | 0.11 | % | |||||
| Jonathan New c/o Net Element, Inc. 3363 NE 163rd Street, Suite 705, North Miami Beach, Florida 33160 | 150,160 | (5) | 0.83 | % | ||||
| Howard Ash 4233 Sheridan Avenue Miami Beach, Florida 33140 | 812 | 0.01 | % | |||||
| William Healy 16W281 83rd Street, Suite B Burr Ridge, IL 60527 | 178,599 | (6) | 0.97 | % | ||||
| Drew Freeman 2542 Nassau Lane Fort Lauderdale. FL 33312 | 3,875 | 0.02 | % | |||||
| All directors and executive officers as a group (8 persons) | 5,808,992 | 29.95 | % | |||||
Name and address of beneficial owner | Amount and nature of beneficial | Percent | ||||||
Oleg Firer | 339,747 | (2) | 8.7 | % | ||||
Steven Wolberg | 71,133 | (3) | 1.83 | % | ||||
Jeffrey Ginsberg c/o Net Element, Inc. | 8,355 | (4) | 0.22 | % | ||||
Howard Ash c/o Net Element, Inc. | 1,313 | 0.03 | % | |||||
Drew Freeman c/o Net Element, Inc. | 7,800 | 0.20 | % | |||||
Jon Najarian | 2,403 | 0.06 | % | |||||
Jonathan Fichman | 2,403 | 0.06 | % | |||||
All directors and executive officers as a group (7 persons) | 433,354 | 10.55 | % | |||||
(1) | Applicable percentage ownership is based on |
(2) | |
| The | |
(3) | |
The shares held directly by |
(4) | Comprised of 8,355 shares of Common Stock issuable upon exercise of the options granted as part of the Company’s incentive compensation awards. |
Equity Compensation Plan Table
The following table summarizes our equity compensation plan information as of December 31, 2016.2018. Information is included for equity compensation plans approved by our stockholders and equity compensation plans not approved by our stockholders
| Plan Category | (a) Number of securities to be issued upon exercise of outstanding options, warrants and rights | (b) Weighted-average exercise price per share of outstanding options, warrants and rights | (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | (a) Number of securities to be issued upon exercise of outstanding options, warrants and rights | (b) Weighted-average exercise price per share of outstanding options, warrants and rights | (c) Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | ||||||||||||||||||
| Equity compensation plans approved by stockholders | 333,956 | $ | 2.60 | 1,280,258 | 74,004 | $ | 15.50 | 225,234 | ||||||||||||||||
| Equity compensation plans not approved by stockholders | - | $ | - | - | - | - | - | |||||||||||||||||
| Total | 333,956 | $ | 2.60 | 1,280,258 | 74,004 | $ | 15.50 | 225,234 | ||||||||||||||||
Item 13. Certain Relationships and Related Transactions, and Director Independence.
Certain Relationships and Related Transactions
On September 17, 2014, Digital Provider (formerly TOT Money) entered intoSince the Supplement Agreement No. 14 andbeginning of fiscal 2017, the Supplement Agreement No. 15 with Alfa-Bank (“Amendment No. 15”),Company did not have any transactions to which renewed and amendedit has been a participant that involved amounts that exceeded or will exceed the previously expired Factoring Credit Facility with Alfa-Bank. Pursuant to such amendments, the Factoring Credit Facility was renewed until June 30, 2016, the maximum aggregate limitlesser of financing (secured by Digital Provider’s accounts receivable) to be provided by Alfa-Bank to Digital Provider under the Factoring Credit Facility was increased to 415 million Russian rubles (approximately US $10,814,614 based on the currency exchange rate on September 17, 2014), Alfa-Bank’s compensation fees (commissions) for providing financing to Digital Provider was amended to be computed as a financing rate that ranged from 13.22% to 14.50%(i) $120,000 or (ii) one percent of the amounts borrowed, depending upon the number of days in the period from the date financing is provided until the date the applicable account receivable is paid, and the maximum amount of financing on account of the monetary claim assigned by Digital Provider to debtor was increased from 80% to 100% of the assigned amount of monetary claim against which the financing is affected. Digital Provider’s obligations under the Factoring Credit Facility were secured by a guarantee given by AO SAT & Company. AO SAT & Company is an affiliate of Kenges Rakishev, who is the Chairman of our Board of Directors of the Company and a significant shareholder. Prior to the expiration of the amended Factoring Credit Facility on June 30, 2016, we did not draw any funds under such credit facility.
In November 2014, Digital Provider entered into a factoring services agreement (together with related and ancillary agreements, collectively, the “Bank Otkritie Agreement”) with Bank Otkritie Financial Corporation. Oleg Firer, our Chief Executive Officer and director, personally guaranteed this loan. No funds were drawn under the Bank Otkritie Agreement, which was terminated on August 31, 2015.
On March 31, 2015, Star Equities, LLC provided an advance to the Company in the amount of $125,000 to pay the invoices from the Company’s investor relations consultant. Such loan was repaid in May 7, 2015. Oleg Firer, our Chief Executive Officer and director, is the chairman and managing member of Star Equities, LLC.
In addition, we received advances on each of July 16, 2015 and July 29, 2015 for $150,000, an advance on August 25, 2015 for $200,000, an advance on September 30, 2015 for $125,000, an advance on October 1, 2015 for $85,712, an advance on December 28, 2015 for $35,000, an advance on February 26, 2016 for $55,924 and an advance on July 1, 2016 for $61,735, each from Star Equities, LLC. All such advances were non-interest bearing and were used to fund current operating expenses. As of December 31, 2016, $290,924 remains outstanding.
On September 11, 2015, the Company entered into the Letter Agreement with certain accredited investors, including Star Equities, LLC, Steven Wolberg, our Chief Legal Officer and Secretary, William Healey, a member of our Board of Directors, and Kenges Rakishev, Chairman of our Board of Directors and a significant shareholder (together, the “Investors”). Oleg Firer, our Chief Executive Officer and director, is the chairman and managing member of Star Equities, LLC. Pursuant to the Letter Agreement, the Investors purchased from the Company an aggregate of (i) 11,357,143 restricted shares of Common Stock (the “Restricted Shares”) to be issued in the future and (ii) options to purchase 11,357,143 restricted shares of Common Stock, (the “Restricted Options”). The per share purchase price of each Restricted Share was $0.14 for an aggregate purchase price of $1,590,000. The Restricted Options expire on the fifth (5th) annual anniversary of the date of the Letter Agreement. Prior to expiration, each Restricted Options is exercisable into one Restricted Share at the exercise price equal 110% of the closing trading price per one share of Common Stock reported on The NASDAQ Capital Market on the date of the Letter Agreement. Each Investor may elect to exercise it or his Amended Restricted Option through a cashless exercise.
On October 7, 2015, the Investors and the Company entered into an agreement to modify certain terms of the Letter Agreement relating to the Restricted Shares. Pursuant to such agreement, the parties agreed that the Restricted Shares would not be issued to the Investors until the Company’s stockholders approved the issuance of the Restricted Shares. In addition, on October 7, 2015, certain of the Investors and the Company entered into an agreement to modify the terms of the Restricted Options. Pursuant to such agreement, the parties agreed that the Restricted Options cannot be exercised by the Investors until the Company’s stockholders approve the issuance of common stock in connection with any such exercise. Such stockholder approval was obtained at a special meetingaverage of the Company’s stockholders on November 14, 2015.
On January 21, 2016, the Company entered into a Second Additional Letter Agreement, as amended on April 14, 2016 (the “Second Additional Agreement”) with Kenges Rakishev. The Second Additional Agreement further modified the terms of the Letter Agreement, as amended. The Second Additional Agreement providedtotal assets at year-end for the secondlast two completed fiscal years, and final round of $910,000 equity financing to the Company contemplated by the Letter Agreement in consideration for the issuance by the Company on June 13, 2016 to Kenges Rakishev of (i) 466,428 restricted shareswhich any of the Company’s common stock based on $1.95 per share price and (ii) options to purchase 466,428 restricted sharesdirectors, executive officers or any other “related person” as defined in Item 404(a) of the Company’s common stock withRegulation S-K had or will have a strike price of $2.15 and a 5 year life.direct or indirect material interest, other than:
We issued the following notes payable to MBF Merchant Capital, LLC (MBF)(“MBF”), which is owned by William Healy, a former member of our boardBoard of directors.Directors.
Effective March 28, 2016, we entered into a $75,000 promissory loan note with MBF Merchant Capital, LLC (“MBF”). The loan provides for interest only payments at 14% through May 28, 2016. From June 28, 2016 through March 28, 2017, we are obligated to make interest and principal payments of $7,990. The loan also provided a 6% backend fee due at the final payment of the loan. As of December 31, 2016, $23,420 remains outstanding.
● | Effective March 28, 2016, we entered into a $75,000 promissory loan note with MBF. The loan 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 loan also provided a 6% backend fee due at the final payment of the loan. This loan was paid off in March 2017. |
Effective April 19, 2016, we entered into a $300,000 promissory loan note with MBF. The loan 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 loan also provided a 6% back end fee due at the final payment of the loan. As of December 31, 2016, $221,826 remains outstanding.
● | Effective April 19, 2016, we entered into a $300,000 promissory loan note with MBF. The loan provided for interest only payments at 15.5% through May 28, 2016. From June 28, 2016 through May 28, 2018, we were obligated to make interest and principal payments of $14,617. The loan also provided a 6% back end fee due at the final payment of the loan. This loan was paid off in 2018. |
● | Effective July 1, 2016, our subsidiary, TOT Group, Inc., entered into a $353,500 promissory loan note with MBF. The loan provided for interest only payments at 15.5% through June 28, 2016. From July 28, 2016 through June 28, 2018, we were obligated to make interest and principal payments of $17,224. The loan also provided a 1% front end fee and a 6.6% back end fee due at the final payment of the loan. This loan was paid off in 2018. |
Effective July 1, 2016, our subsidiary, TOT Group, Inc., entered into a $353,500 promissory loan note with MBF. The loan 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 loan also provided a 1% front end fee and a 6.6% back end fee due at the final payment of the loan. As of December 31, 2016, $275,056 remains outstanding.
● | On August 29, 2017, our subsidiary, TOT Group, Inc., entered into a $275,000 promissory note with MBF. The principal amount of the loan carried an interest rate 13.95% per annum, with ten monthly interest and principal payments of $29,289. The promissory note required payment of a 2% front-end fee at issuance and a 4% back-end fee due at final payment. This loan was paid off in 2018. |
On March 1, 2017, we entered into a Promissory Notepromissory note with Star Equities, LLC, an entity which our CEO is the managing member, in the principal amount of $348,083 (the “Note”“Star Equities Note”). Pursuant to the Note,The Star Equities LLC previously lent $348,083 to the Company that is now being repaid with interest under this agreement. The note providesNote provided for 18 monthly interest payments of $3,481 through September 30, 2018 followed by one interest and balloon principle payment on October 1, 2018. The principal balance of the Note outstanding shall bear interest2018 at the rate of 12% per annum. In the event of any capital raise byOn October 20, 2017, the Company not in the ordinary course of businessentered into and that results in fundingconsummated a letter agreement with Star Equities, LLC (the “Exchange Agreement”). Pursuant to the Exchange Agreement, the entire outstanding amount (including the principal amount of $348,083 and accrued and unpaid interest) of $374,253 under the Star Equities Note was exchanged into 67,312 restricted shares of common stock of the Company in excess of $5 million (a “Liquidity Event”),based on such shares’ consolidated closing bid price on The NASDAQ Stock Market on the Maturity Date will be accelerated to coincide with the closing date of such Liquidity Event. Oleg Firer, our Chief Executive Officer and director, is Chairman and the managing member of Star Equities, LLC.Exchange Agreement.
At December 31, 2018 and 2017, we had accrued expenses of approximately $388,000 and $462,000, respectively, which consisted primarily of various travel, professional fees, and other expenses paid and charged for by our CEO on his personal credit cards. This is reflected as due to related party on the accompanying consolidated balance sheets.
Director Independence
Our Board of Directors currently includes four non-employee independent members: William Healy, Drew Freeman, Howard Ash, Jon Najarian and James Caan.Jonathan Fichman. Each of Messrs. Healy, Freeman, Ash, Najarian and CaanFichman is an "independent director" as defined under NASDAQ Listing Rule 5605(a)(2). A majority of our Board members are independent directors, as four out of the sixfive members of the Board qualify as independent under the NASDAQ listing standards and the rules of the Commission. No director is considered independent unless our Board of Directors affirmatively determines that the director has no relationship with us (directly, or as a partner, shareholder or officer of an organization that has a relationship with us) that would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. Also, all members of our Board of Director’s audit committee, compensation committee and nominating and governance committee are independent directors.directors under applicable NASDAQ and SEC rules and regulations.
Item 14. Principal Accountant Fees and Services.
Audit Fees. The aggregate fees, including expenses, billed by our principal accountant for the audit of our annual financial statements and review of financial statements included in our quarterly reports on Form 10-Q and other services that are normally provided in connection with statutory and regulatory filings or engagements during each of the fiscal years ended December 31, 20162018 and 20152017 were $375,000 and $370,000, respectively.$390,000.
Audit-Related Fees. The aggregate fees, including expenses, billed by our principal accountant for assurance and related services that are reasonably related to the performance of the audit or review of our financial statements not reported under “Audit Fees” above during the fiscal years ended December 31, 20162018 and 20152017 were $43,623 and $117,129, respectively.$ 0.
Tax Fees. The aggregate fees, including expenses, billed by our principal accountant for services rendered for tax compliance, tax advice and tax planning during the fiscal years ended December 31, 20162018 and 20152017 were $0.$25,500 and $55,400, respectively.
All Other Fees. The aggregate fees, including expenses, billed for all other products and services provided by our principal accountant during the fiscal years ended December 31, 20162018 and 20152017 were $0.
Audit Committee Pre-Approval Policy
Our audit committee is responsible for approving in advance the engagement of our principal accountant for all audit services and non-audit services, based on independence, qualifications and, if applicable, performance, and approving the fees and other terms of any such engagement. The audit committee may in the future establish pre-approval policies and procedures pursuant to which our principal accountant may provide certain audit and non-audit services to us without first obtaining the audit committee’s approval, provided that such policies and procedures (i) are detailed as to particular services, (ii) do not involve delegation to management of the audit committee’s responsibilities described in this paragraph and (iii) provide that, at its next scheduled meeting, the audit committee is informed as to each such service for which the principal accountant is engaged pursuant to such policies and procedures. In addition, the audit committee may in the future delegate to one or more members of the audit committee the authority to grant pre-approvals for such services, provided that the decisions of such member(s) to grant any such pre-approval must be presented to the audit committee at its next scheduled meeting.
All audit and audit-related services performed by our principal accountant during the fiscal years ended December 31, 20162018 and 20152017 were pre-approved by our audit committee.
Item 15. Exhibits and Financial Statement Schedules.
Documents filed as part of this Report.
1. | The following consolidated financial statements of Net Element, Inc. and subsidiaries and notes thereto and the reports of the independent registered public accounting firms thereon are set forth on pages F-2 through | |
| Reports of Independent Registered Public Accounting Firms | ||
| Audited Consolidated Balance Sheets | ||
| Audited Consolidated Statements of Operations and Comprehensive Loss for the years ended December 31, | ||
| 2017, Audited Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, | ||
| 2017, and Audited Consolidated Statements of Cash Flows for the years ended December 31, | ||
| Notes to Consolidated Financial Statements |
2. | Exhibits. |
A list of the exhibits filed as a part of this Report is set forth on the Exhibit Index that immediately precedes the signature pages to this Report and is incorporated herein by reference.
EXHIBIT INDEX
Exhibit No. | Description of Exhibit | |
2.1 | ||
2.2 | ||
2.3 | ||
2.4 | ||
2.5 | ||
2.6 | ||
2.7 | ||
3.1 | ||
3.2 | ||
3.3 | ||
3.4 | ||
3.5 |
3.6 | ||
3.7 | ||
3.8 | ||
3.9 | ||
3.10 |
3.11 | ||
3.12 | ||
3.13 | ||
4.1 | ||
4.2 | ||
4.3 | ||
4.4 | ||
4.5 | ||
4.6 | ||
4.7 |
4.8 | ||
4.9 | ||
4.10 | ||
4.11 | ||
4.12 | ||
10.1 | ||
10.2 | ||
10.3 |
10.4 | ||
10.5 | ||
10.6 | ||
10.7 | ||
10.8 | ||
10.9 |
10.10# | ||
10.11 | ||
10.12 | ||
10.13 | ||
10.14 | ||
10.15 | ||
10.16 | ||
10.17 |
10.18 | ||
10.19 | ||
10.20 |
10.21 | ||
10.22 | ||
10.23 | ||
10.24 | ||
10.25 | ||
10.26 | ||
10.27 | ||
10.28 | ||
10.29 | ||
10.30 | ||
10.31 | ||
10.32 |
10.33# | ||
10.34# |
10.35# | ||
10.36 | ||
10.37 | ||
10.38 | ||
10.39 | ||
10.40 | ||
10.41 | ||
10.42 | ||
10.43 | ||
10.44 | ||
10.45 |
10.46 | ||
10.47 | ||
10.48 | ||
10.49 | ||
10.50 | ||
10.51 |
10.52 | ||
10.53 | ||
10.54 | ||
10.55 | ||
10.56 | ||
10.57 | ||
10.58 | ||
10.59 |
10.60 | ||
10.61 | ||
10.62 | ||
10.63 | ||
10.64 | ||
10.65 | ||
10.66 | ||
10.67 | ||
10.68# |
10.69# | ||
10.70# | ||
10.71 | ||
10.72 | ||
10.73 |
10.74 | ||
10.75 | ||
10.76 | ||
10.77 | ||
10.78 | ||
10.79 | ||
10.80 | ||
10.81 | ||
10.82 | ||
10.83 | ||
10.84 | ||
10.85 |
10.86 |
10.87 | ||
10.88# | ||
10.89 | ||
10.90 | ||
10.91 | ||
10.92 | ||
| 10.93* | ||
| 10.94*# | Amendment to 2013 Equity Incentive Plan approved on November 27, 2018 (incorporated by reference to Appendix “A” to the Company’s Definitive Proxy Statement on Schedule 14A filed with the Commission on October 10, 2018) | |
| 10.95 | Advance and Residual Purchase Agreement, dated December 26, 2018, among Unified Portfolio Acquisitions, LLC, Argus Merchant Services, LLC and Treasury Payments, LLC (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with the Commission on December 28, 2018) | |
21.1* | ||
23.1* | Consent of Independent Registered Public Accounting Firm (Daszkal Bolton LLP) | |
31.1* | ||
31.2* | ||
32.1* | Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. § 1350 | |
101* | The following financial information from the Annual Report on Form 10-K for the fiscal year ended December 31, 2018, formatted in XBRL (eXtensible Business Reporting Language), is filed electronically herewith: (i) Consolidated Balance Sheets as |
# Indicates management contract or compensatory plan or arrangement.
* Filed herewith (furnished herewith with respect to Exhibit 32.1).
None.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Net Element, Inc. | ||||
April 1, 2019 | By: | /s/ Oleg Firer | ||
Oleg Firer | ||||
Executive Chairman and Chief Executive Officer | ||||
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
April 1, 2019 | By: | /s/ Oleg Firer |
Oleg Firer | ||
Executive Chairman and Chief Executive Officer | ||
April 1, 2019 | By: | /s/ |
Jeffrey Ginsberg | ||
Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | ||
April 1, 2019 | By: | |
/s/ Drew Freeman | ||
Drew Freeman | ||
Director | ||
April 1, 2019 | By: | /s/ Howard Ash |
Howard Ash | ||
Director | ||
April 1, 2019 | By: | /s/ |
Jon Najarian | ||
Director | ||
April 1, 2019 | By: | /s/ |
Jonathan Fichman | ||
Director |
Item 8. Financial Statements and Supplementary Data
NET ELEMENT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page | ||
F-2 | ||
Consolidated Balance Sheets at December 31, | F-3 | |
F-4 | ||
F-5 | ||
Consolidated Statements of Cash Flows for the Years Ended December 31, | F-6 | |
F-7 |
F-1 |
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Stockholders of Net Element, Inc.
Miami, Florida
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Net Element, Inc. (the “Company”) at December 31, 20162018 and 2015,2017, and the related consolidated statements of operations, and comprehensive loss, changes in stockholders’ equity, and cash flows for each of the years then ended. The Company’s management is responsible for thesein the two-year period ended December 31, 2018, and the related notes (collectively referred to as the financial statements). In our opinion, the consolidated financial statements.statements present fairly, in all material respects, the financial position of the Company and subsidiaries at December 31, 2018 and 2017, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2018, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on thesethe Company’s consolidated financial statements based on our audit. audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included considerationAs part of our audits we are required to obtain an understanding of internal control over financial reporting, as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the company’sCompany’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence supportingregarding the amounts and disclosures in the consolidated financial statements. An auditOur audits also includes assessingincluded evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statement presentation.statements. We believe that our audit providesaudits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Net Element, Inc. at December 31, 2016 and 2015, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As described in Note 3 to the consolidated financial statements, the Company has sustained recurring losses from operations and has working capital and accumulated deficits that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are described in Note 3. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Our opinion is not modified with respect to this matter.
/s/ Daszkal Bolton LLP
We have served as the Company’s auditor since 2015.
Fort Lauderdale, Florida
March 31, 2017April 1, 2019
F-2 |
CONSOLIDATED BALANCE SHEETS
| December 31, 2016 | December 31, 2015 | December 31, 2018 | December 31, 2017 | |||||||||||||
| ASSETS | ||||||||||||||||
| Current assets: | ||||||||||||||||
| Cash | $ | 621,635 | $ | 1,025,747 | $ | 1,645,481 | $ | 11,285,669 | ||||||||
| Accounts receivable, net | 7,126,429 | 5,198,993 | 6,290,412 | 5,472,856 | ||||||||||||
| Prepaid expenses and other assets | 1,467,897 | 1,106,016 | 1,749,221 | 2,282,614 | ||||||||||||
| Total current assets, net | 9,215,961 | 7,330,756 | 9,685,114 | 19,041,139 | ||||||||||||
| Fixed assets, net | 117,295 | 162,123 | ||||||||||||||
Equipment, net | 25,335 | 58,268 | ||||||||||||||
| Intangible assets, net | 3,589,850 | 5,423,880 | 6,441,743 | 3,127,760 | ||||||||||||
| Goodwill | 9,643,752 | 9,643,752 | 9,007,752 | 9,643,752 | ||||||||||||
| Other long term assets | 742,810 | 353,050 | 604,070 | 460,511 | ||||||||||||
| Total assets | 23,309,668 | 22,913,561 | $ | 25,764,014 | $ | 32,331,430 | ||||||||||
| LIABILITIES AND STOCKHOLDERS' EQUITY | ||||||||||||||||
| Current liabilities: | ||||||||||||||||
| Accounts payable | 7,510,113 | 5,858,837 | $ | 6,368,444 | $ | 6,785,459 | ||||||||||
| Accrued expenses | 5,518,823 | 2,975,066 | 2,535,947 | 3,212,438 | ||||||||||||
| Deferred revenue | 1,355,972 | 743,910 | 1,495,849 | 1,712,591 | ||||||||||||
| Notes payable (current portion) | 808,976 | 518,437 | 433,448 | 2,493,973 | ||||||||||||
| Due to related parties | 299,004 | 329,881 | ||||||||||||||
Due to related party | 387,814 | 461,992 | ||||||||||||||
| Total current liabilities | 15,492,888 | 10,426,131 | 11,221,502 | 14,666,453 | ||||||||||||
| Notes payable (net of current portion) | 3,755,383 | 3,446,563 | 5,946,046 | 4,521,449 | ||||||||||||
| Total liabilities | 19,248,271 | 13,872,694 | 17,167,548 | 19,187,902 | ||||||||||||
| STOCKHOLDERS' EQUITY | ||||||||||||||||
| Series A Convertible Preferred stock ($.0001 par value, 1,000,000 shares authorized, no shares issued and outstanding at December 31, 2016 and December 31, 2015) | - | - | ||||||||||||||
| Common stock ($.0001 par value, 400,000,000 shares authorized and 15,353,494 and 11,261,959 shares issued and outstanding at December 31, 2016 and December 31, 2015 | 1,535 | 1,126 | ||||||||||||||
Series A Convertible Preferred stock ($.0001 par value, 1,000,000 shares authorized, no shares issued and outstanding at December 31, 2018 and December 31, 2017) | - | - | ||||||||||||||
Common stock ($.0001 par value, 100,000,000 shares authorized and 3,863,019 and 3,853,100 shares issued and outstanding at December 31, 2018 and December 31, 2017, respectively) | 386 | 385 | ||||||||||||||
| Paid in capital | 163,918,685 | 154,361,694 | 183,246,232 | 183,119,222 | ||||||||||||
| Accumulated other comprehensive loss | (2,486,616 | ) | (1,565,822 | ) | (2,232,163 | ) | (2,530,238 | ) | ||||||||
| Accumulated deficit | (157,442,585 | ) | (143,955,048 | ) | (172,292,252 | ) | (167,356,070 | ) | ||||||||
| Noncontrolling interest | 70,378 | 198,917 | ||||||||||||||
Stock subscriptions receivable | - | (50,585 | ) | |||||||||||||
Non-controlling interest | (125,737 | ) | (39,186 | ) | ||||||||||||
| Total stockholders' equity | 4,061,397 | 9,040,867 | 8,596,466 | 13,143,528 | ||||||||||||
| Total liabilities and stockholders' equity | $ | 23,309,668 | $ | 22,913,561 | $ | 25,764,014 | $ | 32,331,430 | ||||||||
See Notes to the Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
Twelve Months Ended December 31, | ||||||||
2018 | 2017 | |||||||
Net revenues | ||||||||
Service fees | $ | 65,786,817 | $ | 58,723,928 | ||||
Branded content | - | 1,340,896 | ||||||
Total Revenues | 65,786,817 | 60,064,824 | ||||||
Costs and expenses: | ||||||||
Cost of service fees | 55,617,171 | 49,934,371 | ||||||
Cost of branded content | - | 1,302,841 | ||||||
Selling, general and administrative | 9,758,688 | 10,629,773 | ||||||
Non-cash compensation | 142,017 | 2,940,424 | ||||||
Bad debt expense | 2,145,425 | 1,320,848 | ||||||
Depreciation and amortization | 2,454,637 | 2,533,985 | ||||||
Total costs and operating expenses | 70,117,938 | 68,662,242 | ||||||
Loss from operations | (4,331,121 | ) | (8,597,418 | ) | ||||
Interest expense | (847,179 | ) | (1,189,622 | ) | ||||
Other income (expense) | 791,567 | (236,009 | ) | |||||
| Impairment charge relating to goodwill | (636,000 | ) | - | |||||
Net loss from continuing operations before income taxes | (5,022,733 | ) | (10,023,049 | ) | ||||
Income taxes | - | - | ||||||
Net loss from continuing operations | (5,022,733 | ) | (10,023,049 | ) | ||||
Net loss attributable to the non-controlling interest | 86,551 | 109,564 | ||||||
Net loss attributable to Net Element, Inc. stockholders | (4,936,182 | ) | (9,913,485 | ) | ||||
Foreign currency translation | 298,075 | (43,623 | ) | |||||
Comprehensive loss attributable to common stockholders | $ | (4,638,107 | ) | $ | (9,957,108 | ) | ||
Loss per share - basic and diluted | $ | (1.28 | ) | $ | (5.04 | ) | ||
Weighted average number of common shares outstanding - basic and diluted | 3,868,324 | 1,967,676 | ||||||
See Notes to the Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
Common Stock | Paid in | Stock | Comprehensive | Non-controlling | Accumulated | Equity (Deficiency) | ||||||||||||||||||||||||||
Shares | Amount | Capital | Subscription | Income | interest | Deficit | in Assets | |||||||||||||||||||||||||
Balance December 31, 2016 | 1,535,350 | $ | 154.00 | $ | 163,920,066 | $ | - | $ | (2,486,616 | ) | $ | 70,378 | $ | (157,442,585 | ) | $ | 4,061,397 | |||||||||||||||
Shares issued in connection with reverse stock split | 3,117 | 0.31 | 1 | - | - | - | - | 1 | ||||||||||||||||||||||||
Share based compensation | 242,324 | 24.00 | 2,850,155 | - | - | - | - | 2,850,179 | ||||||||||||||||||||||||
Shares issued for acquisitions | 13,082 | 1.00 | 105,965 | - | - | - | - | 105,966 | ||||||||||||||||||||||||
Shares issued to settle merchant liabilities | 30,759 | 3.00 | 252,220 | - | - | - | - | 252,223 | ||||||||||||||||||||||||
Shares issued for consulting services | 19,896 | 2.00 | 228,416 | (50,585 | ) | - | - | - | 177,833 | |||||||||||||||||||||||
Shares issued in connection with debt restructuring | 127,406 | 13.00 | 758,181 | - | - | - | - | 758,194 | ||||||||||||||||||||||||
Shares issued under ESOUSA/Cobblestone agreements | 1,881,165 | 188.00 | 15,004,217 | - | - | - | - | 15,004,405 | ||||||||||||||||||||||||
Net loss | - | - | - | - | - | (109,564 | ) | (9,913,485 | ) | (10,023,049 | ) | |||||||||||||||||||||
Comprehensive loss - foreign currency translation | - | - | - | - | (43,622 | ) | - | - | (43,622 | ) | ||||||||||||||||||||||
Balance December 31, 2017 | 3,853,100 | $ | 385.31 | $ | 183,119,222 | $ | (50,585 | ) | $ | (2,530,238 | ) | $ | (39,186 | ) | $ | (167,356,070 | ) | $ | 13,143,528 | |||||||||||||
Share based compensation | 9,919 | 0.99 | 127,010 | - | - | - | - | 127,011 | ||||||||||||||||||||||||
Shares issued for consulting services | - | - | - | 50,585 | - | - | - | 50,585 | ||||||||||||||||||||||||
Net loss | - | - | - | - | - | (86,551 | ) | (4,936,182 | ) | (5,022,733 | ) | |||||||||||||||||||||
Comprehensive gain - foreign currency translation | - | - | - | - | 298,075 | - | - | 298,075 | ||||||||||||||||||||||||
Balance December 31, 2018 | 3,863,019 | $ | 386.30 | $ | 183,246,232 | $ | - | $ | (2,232,163 | ) | $ | (125,737 | ) | $ | (172,292,252 | ) | $ | 8,596,466 | ||||||||||||||
See Notes to the Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
Twelve Months Ended December 31, | ||||||||
2018 | 2017 | |||||||
Cash flows from operating activities: | ||||||||
Net loss attributable to Net Element, Inc. stockholders | $ | (4,936,182 | ) | $ | (9,913,485 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Non-controlling interest | (86,551 | ) | (109,564 | ) | ||||
Share based compensation | 142,017 | 2,940,424 | ||||||
Deferred revenue | (216,742 | ) | 356,619 | |||||
| Net Non cash items in other income | (1,202,201 | ) | - | |||||
| Impairment for Goodwill | 636,000 | - | ||||||
Provision for bad debt | 16,238 | - | ||||||
Depreciation and amortization | 2,454,637 | 2,533,985 | ||||||
Non cash interest | 73,442 | 114,802 | ||||||
| Changes in assets and liabilities: | ||||||||
Accounts receivable | (1,503,755 | ) | 3,002,425 | |||||
Prepaid expenses and other assets | 384,403 | (1,047,811 | ) | |||||
Accounts payable and accrued expenses | 971,202 | (2,943,154 | ) | |||||
Net cash used in operating activities | (3,267,492 | ) | (5,065,759 | ) | ||||
Cash flows from investing activities: | ||||||||
Purchase of portfolios and client acquisition costs | (5,413,264 | ) | (1,885,098 | ) | ||||
Receipt of excess deposits | - | 149,826 | ||||||
Purchase of equipment and changes in other assets | (114,931 | ) | (103,341 | ) | ||||
Net cash used in investing activities | (5,528,195 | ) | (1,838,613 | ) | ||||
Cash flows from financing activities: | ||||||||
Proceeds from sale of common stock | - | 14,884,435 | ||||||
Proceeds from indebtedness | 2,131,500 | 3,678,824 | ||||||
Repayment of indebtedness | (2,785,134 | ) | (998,780 | ) | ||||
Net cash (used in) provided by financing activities | (653,634 | ) | 17,564,479 | |||||
Effect of exchange rate changes on cash | (34,399 | ) | (20,899 | ) | ||||
Net (decrease) increase in cash | (9,483,720 | ) | 10,639,208 | |||||
Cash and restricted cash at beginning of year | 11,733,271 | 1,094,063 | ||||||
Cash and restricted cash at end of year | $ | 2,249,551 | $ | 11,733,271 | ||||
Supplemental disclosure of cash flow information | ||||||||
Cash paid during the period for: | ||||||||
Interest | $ | 773,737 | $ | 1,074,820 | ||||
Taxes | $ | 61,871 | $ | 86,942 | ||||
| Shares issued for redemption of indebtedness | $ | - | $ | 379,874 | ||||
| Shares issued in settlement of related party debt | $ | - | $ | 378,253 | ||||
See accompanying notes to the consolidated financial statements
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
| Twelve months ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Net revenues | ||||||||
| Service fees | $ | 48,784,855 | $ | 31,204,871 | ||||
| Branded content | 5,502,004 | 9,030,491 | ||||||
| Total revenues | 54,286,859 | 40,235,362 | ||||||
| Costs and expenses: | ||||||||
| Cost of service fees | 40,521,236 | 25,858,098 | ||||||
| Cost of branded content | 5,187,005 | 8,119,117 | ||||||
| General and administrative | 8,797,883 | 9,310,477 | ||||||
| Non-cash compensation | 3,463,435 | 4,306,304 | ||||||
| Bad debt expense | 1,688,237 | 649,571 | ||||||
| Depreciation and amortization | 3,466,511 | 2,513,162 | ||||||
| Total costs and operating expenses | 63,124,307 | 50,756,729 | ||||||
| Loss from operations | (8,837,448 | ) | (10,521,367 | ) | ||||
| Interest expense, net | (1,463,833 | ) | (3,575,698 | ) | ||||
| Loss on change in fair value and settlement of beneficial conversion derivative | - | (26,932,496 | ) | |||||
| Loss from stock value guarantee and other charges from PayOnline acquisition | (3,722,142 | ) | - | |||||
| Gain on debt extinguishment | - | 27,743,980 | ||||||
| Gain on asset disposal | - | 40,369 | ||||||
| Other income (expense), net | 407,347 | (82,714 | ) | |||||
| Net loss before income taxes | (13,616,076 | ) | (13,327,926 | ) | ||||
| Income taxes | - | - | ||||||
| Net loss | (13,616,076 | ) | (13,327,926 | ) | ||||
| Net loss attributable to the noncontrolling interest | 128,539 | 74,314 | ||||||
| Net loss attributable to Net Element, Inc. stockholders | (13,487,537 | ) | (13,253,612 | ) | ||||
| Dividends for the benefit of preferred stockholders | - | (1,585,092 | ) | |||||
| Net loss attributable to Net Element, Inc. common stockholders | (13,487,537 | ) | (14,838,704 | ) | ||||
| Foreign currency translation | (920,794 | ) | (314,361 | ) | ||||
| Comprehensive loss attributable to common stockholders | $ | (14,408,331 | ) | $ | (15,153,065 | ) | ||
| Loss per share - basic and diluted | $ | (1.03 | ) | $ | (2.32 | ) | ||
| Weighted average number of common shares outstanding - basic and diluted | 13,058,009 | 6,391,120 | ||||||
See accompanying notes to the consolidated financial statements
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
| Preferred Stock | Common Stock | Paid in | Stock | Comprehensive | Non-controlling | Accumulated | Equity | |||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | Capital | Subscription | Income | interest | Deficit | in Assets | |||||||||||||||||||||||||||||||
| Balance December 31, 2014 | - | - | 4,588,152 | $ | 459 | $ | 136,693,759 | $ | (1,111,130 | ) | $ | (1,251,461 | ) | $ | 269,762 | $ | (129,116,344 | ) | $ | 5,485,045 | ||||||||||||||||||||
| Share based compensation | - | - | 401,532 | 39 | 4,306,264 | - | - | - | - | 4,306,303 | ||||||||||||||||||||||||||||||
| Preferred shares issued | 5,500 | 5,287,082 | - | - | - | - | - | - | - | - | ||||||||||||||||||||||||||||||
| Preferred shares converted to common shares | (5,500 | ) | (5,287,082 | ) | 3,376,045 | 338 | 9,035,746 | - | - | - | - | 9,036,084 | ||||||||||||||||||||||||||||
| Preferred share dividends paid | - | - | 612,891 | 61 | 1,585,031 | 1,585,092 | ||||||||||||||||||||||||||||||||||
| Shares issued in connection with debt restructuring | - | - | 420,805 | 42 | 1,346,606 | - | - | - | - | 1,346,648 | ||||||||||||||||||||||||||||||
| Shares issued in exchange for warrants | - | - | 250,000 | 25 | (2,679,885 | ) | (2,679,861 | ) | ||||||||||||||||||||||||||||||||
| Shares issued and issuable for acquisitions | - | - | 476,821 | 48 | 3,599,952 | - | - | - | - | 3,600,000 | ||||||||||||||||||||||||||||||
| Repurchase of non-controlling interest | - | - | - | - | (3,489 | ) | - | - | 3,469 | - | (20 | ) | ||||||||||||||||||||||||||||
| Shares issued for insider financing | - | - | 1,135,713 | 114 | 1,588,840 | - | - | - | - | 1,588,954 | ||||||||||||||||||||||||||||||
| Write-off of stock subscription receivable | - | - | - | - | (1,111,130 | ) | 1,111,130 | - | - | - | - | |||||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | - | - | (74,314 | ) | (14,838,704 | ) | (14,913,018 | ) | |||||||||||||||||||||||||||
| Comprehensive loss - foreign currency translation | - | - | - | - | - | - | (314,361 | ) | - | - | (314,361 | ) | ||||||||||||||||||||||||||||
| Balance December 31, 2015 | - | - | 11,261,959 | $ | 1,126 | $ | 154,361,694 | $ | - | $ | (1,565,822 | ) | $ | 198,917 | $ | (143,955,048 | ) | $ | 9,040,867 | |||||||||||||||||||||
| Share based compensation | - | - | 1,214,418 | 121 | 4,426,996 | - | - | - | - | 4,427,117 | ||||||||||||||||||||||||||||||
| Shares issued and issuable for acquisitions | - | - | 65,430 | 7 | 134,088 | - | - | - | 134,095 | |||||||||||||||||||||||||||||||
| Shares issued in connection with reverse stock split | - | - | 1,801 | 0 | - | - | - | - | 0 | |||||||||||||||||||||||||||||||
| Shares issued for insider financing | - | - | 466,428 | 47 | 988,781 | - | - | - | - | 988,828 | ||||||||||||||||||||||||||||||
| Shares issued in connection with debt restructuring | - | - | 1,663,401 | 166 | 3,288,670 | - | - | - | - | 3,288,836 | ||||||||||||||||||||||||||||||
| Shares issued under ESOUSA agreement | - | - | 680,057 | 68 | 718,456 | - | - | - | - | 718,524 | ||||||||||||||||||||||||||||||
| Net loss | - | - | - | - | - | - | - | (128,539 | ) | (13,487,537 | ) | (13,616,076 | ) | |||||||||||||||||||||||||||
| Comprehensive loss - foreign currency translation | - | - | - | - | - | - | (920,794 | ) | - | - | (920,794 | ) | ||||||||||||||||||||||||||||
| Balance December 31, 2016 | - | - | 15,353,494 | $ | 1,535 | $ | 163,918,685 | $ | - | $ | (2,486,616 | ) | $ | 70,378 | $ | (157,442,585 | ) | $ | 4,061,397 | |||||||||||||||||||||
See accompanying notes to the consolidated financial statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31, | ||||||||
| 2016 | 2015 | |||||||
| Cash flows from operating activities | ||||||||
| Net loss attributable to Net Element, Inc. stockholders | $ | (13,487,537 | ) | $ | (13,253,612 | ) | ||
| Adjustments to reconcile net loss to net cash used in operating activities | ||||||||
| Noncontrolling interest | (128,539 | ) | (74,309 | ) | ||||
| Share based compensation | 3,463,435 | 4,306,304 | ||||||
| Gain on change in fair value and settlement of beneficial conversion derivative | - | 26,932,495 | ||||||
| Depreciation and amortization | 3,466,510 | 2,513,162 | ||||||
| Non-cash interest | 852,408 | - | ||||||
| Amortization of deferred revenue | (1,221,177 | ) | - | |||||
| Amortization of debt discount | - | 3,027,354 | ||||||
| Provision bad debt expense | 500,000 | - | ||||||
| Amortization of prepaid costs | 967,313 | |||||||
| Gain on disposal of fixed asset | - | (40,369 | ) | |||||
| Gain on debt extinguishment | - | (27,743,980 | ) | |||||
| Changes in assets and liabilities | ||||||||
| Accounts receivable | (2,751,144 | ) | (1,492,183 | ) | ||||
| Deferred revenue | 1,833,239 | 271,428 | ||||||
| Prepaid expenses and other assets | (570,582 | ) | 291,631 | |||||
| Accounts payable and accrued expenses | 3,797,753 | 3,571,307 | ||||||
| Net cash used in operating activities | (3,278,321 | ) | (1,690,772 | ) | ||||
| Cash flows from investing activities | ||||||||
| Purchase of portfolio and client acquisition costs | (1,319,820 | ) | (878,085 | ) | ||||
| Sale of portfolio | - | 300,000 | ||||||
| Acquisition of PayOnline assets, net of cash received | - | (3,195,452 | ) | |||||
| Purchase of fixed and other assets | (187,089 | ) | (579,209 | ) | ||||
| Net cash used in investing activities | (1,506,909 | ) | (4,352,746 | ) | ||||
| Cash flows from financing activities | ||||||||
| Proceeds from issuance of preferred stock | - | 5,500,000 | ||||||
| Proceeds from indebtedness | 3,170,540 | 650,000 | ||||||
| Repayment of indebtedness | (71,700 | ) | - | |||||
| Cash received for issuance of shares and warrants | 300,000 | |||||||
| Related party advances | 1,027,874 | 331,273 | ||||||
| Net cash provided by financing activities | 4,426,714 | 6,481,273 | ||||||
| Effect of exchange rate changes on cash | (45,596 | ) | 84,649 | |||||
| Net (decrease) increase in cash | (404,112 | ) | 522,404 | |||||
| Cash at beginning of year | 1,025,747 | 503,343 | ||||||
| Cash at end of year | $ | 621,635 | $ | 1,025,747 | ||||
| Supplemental disclosure of cash flow information | ||||||||
| Cash paid during the year for: | ||||||||
| Interest | $ | 611,625 | $ | 548,344 | ||||
| Taxes | $ | 94,718 | $ | 74,563 | ||||
| Non-cash activities: | ||||||||
| Stock issued in exchange for warrants | $ | - | $ | 2,679,861 | ||||
| Preferred dividends paid in common stock | $ | - | $ | 1,585,092 | ||||
| Common share issuance for settlement of unpaid compensation | $ | 1,042,509 | $ | - | ||||
| Common shares issued for redemption of indebtedness | $ | 2,499,481 | $ | 1,346,648 | ||||
| Common shares issued in settlement of advances from board member | $ | 909,285 | $ | - | ||||
| Common shares issued for acquisition | $ | - | $ | 3,600,000 | ||||
| Common shares issued upon redemption of preferred shares | $ | - | $ | 9,036,084 | ||||
See accompanying notes to the consolidated financial statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016 AND 2015
NOTE 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization and Basis of Presentation
OrganizationORGANIZATION AND OPERATIONS
Net Element, Inc. (“We”(collectively with its subsidiaries, “Net Element”, “we”, “us”, “our” or the “Company”) is a financial technology-driven group specializing in mobile paymentspayment acceptance and other transactional services in emerging countries andvalue-added solutions across multiple channels in the United States. We have three reportable segments: (i) North America Transaction Solutions for electronic commerce, (ii) Mobile Solutions which primarily serves the Russian FederationStates and Commonwealth of Independent States (“CIS”) and (iii) Online Solutions.selected international markets. We are differentiated by our proprietary technology which enables us to provide a broad suite of payment products and end-to-end transaction processing services. Our transactional services business enables merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards, loyalty programs and superior client support. alternative payment methods in traditional card-present or swipe transactions, as well as card-not-present transactions, such as those conducted over the phone or through the Internet or a mobile device. For the year ended December 31, 2018, we operated in two reportable business operating segments: (i) North American Transaction Solutions, and (ii) International Transaction Solutions. During the fourth quarter of 2017, we combined our online and mobile payments operations into one segment, International Transaction Solutions. Prior to that we had operated in three segments.
We are able to deliver theseour services across multiple points of access, or “multi-channel,” including brick and mortar locations, software integration, e-commerce, mobile operator billing, mobile and tablet-based solutions. In the United States, via our U.S. based subsidiaries, we generate revenues from transactional services and other payment technologies for small and medium-sized businesses. Through TOT Group Russia and Net Element Russia,PayOnline, we provide transactional services, mobile payment transactions, online payment transactions and other payment technologies in emerging countries in the Russian Federation, CIS,Eurasian Economic Community ("EAEC"), Europe and Asia.
Business
Our transactional services business enables merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards, loyalty programs and alternative payment methods in traditional card-present or swipe transactions, as well as card-not-present transactions, such as those conducted over the phone or through the Internet or a mobile device. We market and sell our services through both independent sales groups (“ISGs”), which are non-employee, external sales organizations and other third-party resellers of our products and services, and directly to merchants through electronic media, telemarketing and other programs, including utilizing partnerships with other companies that market products and services to local and international merchants. We have agreements with several banks that sponsor us for membership in the Visa ® , MasterCard® , American Express ® and Discover ® card associations and settle card transactions for our merchants. The principalSponsoringThese sponsoring banks include Citizens Bank, through which we processed the majority of our transaction in the United States during 2016 was BMO Harris Bank, N.A. On November 1, 2016, we moved all of our processing from BMO Harris Bank, N.A. to Merrick Bank, N.A. In addition, in February 2016, we entered into a bank identification (“BIN”) sponsorship agreement with Esquire Bank, N.A. As a result of our settlement with First Data, in 2016, we entered into a sponsoring agreement withand Wells Fargo Bank, N.A. From time to time, we may enter into agreements with additional banks. We perform core functions for merchants such as application processing, underwriting, account set-up, risk management, fraud detection, merchant assistance and support, equipment deployment and chargeback services.
Our Mobile Solutions business, Digital Provider, LLC (f/k/a Tot Money, LLC) (“Digital Provider”)PayOnline, provides carrier-integrated mobile payments solutions. Our relationships and contracts with mobile operators givethat gives us substantial geographic coverage, a strong capacity for innovation in mobile payments and messaging, and the ability to offer our clients in-app, premium SMS wap click,(short message services, which is a text messaging service), Wireless Application Protocol (WAP)-click, one click and other carrier billing services. We also markethad marketed our own branded content as a separate line of business for our mobile commerce business.
business from offices in Russia and Kazakhstan. In August 2017, we substantially reorganized this business, and combined its operations into PayOnline and TOT Group Russia. We currently are not generating revenues from new mobile content and we continue to explore partnership opportunities that can monetize our relationships and contracts with mobile operators. PayOnline provides flexible high-tech payment solutions to companies doing business on the Internet or in the mobile environment. PayOnline specializes in integration and customization of payment solutions for websites and mobile apps. In particular, PayOnline arranges payment on the website of any commercial organization, which increases the convenience of using the website and helps maximize the number of successful transactions. In addition, PayOnline is focused on providing online and mobile payment acceptance services to the travel industry through direct integration with leading Global Distribution Systems (“GDS”), which includesinclude Amadeus® and Sabre®. Key geographic regions ofthat PayOnline are the CIS,serves include Eastern Europe, Central Asia, Western Europe, North America and Asia major sub regions. PayOnline offices are located in Russia, Kazakhstan and in the Republic of Cyprus. We included the results of PayOnline starting in May 20, 2015.
Also part of our transactional services business, Aptito is a proprietary, next-generation, cloud-based payments platform for the hospitality industry, which creates an online consumer experience in offline commerce environments via tablet, mobile and all other cloud-connected devices. Aptito’s easy to use point-of-sale (“POS”) system makes things easier by providing a comprehensive solution to the hospitality industry to help streamline management and operations. Orders placed tableside by customers directly speed up the ordering process and improve overall efficiency. Aptito's mobile POS system provides portability to the staff while performing all the same functions as a traditional POS system,system.
NOTE 2. LIQUIDITY
We expect to fund our operating cash needs for the next twelve months, including debt service requirements, operating expenses in the normal course of business, capital expenditures, and more. possible future acquisitions, with cash flow from its operating activities, potential sales of equity securities, and current and potential future borrowings.
The Company is continuing with its plan to further fund, grow and expand its payment processing operations through organic growth and acquisition of profitable residual buyouts (See Note 4).
To fund our operating cash needs, we may need to borrow additional capital from our current credit facilities or additional sales of equity securities. Further, we continue to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financings. Historically, we have been successful to date in restructuring our current debt facilities with commercially acceptable terms that supports the continued operation of our business for the foreseeable future. However, we cannot be sure that any additional financing will be available when needed, or that, if available, financing will be obtained on terms favorable to us or our stockholders. As of December 31, 2018 we have approximately $10.8 million in available credit facilities for use in funding general working needs and potential acquisitions.
F-7 |
NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Significant accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s significant accounting policies are described below.
Basis of Presentation
UseThe accompanying consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of EstimatesAmerica (“GAAP”) and pursuant to the reporting and disclosure rules and regulations of the Securities and Exchange Commission (“SEC”).
The preparationPrinciples of Consolidation
These consolidated financial statements include the accounts of Net Element, Inc and our subsidiary companies. All significant intercompany accounts and transactions have been eliminated in conformity with U.S. generally accepted accounting principles (“U.S. GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities as of the balance sheet date and the reported amounts of expenses for the period presented. Actual results could differ from those estimates.
Significant estimates include (i) the valuation of acquired merchant portfolios, (ii) the collectability of accounts receivable (iii) the recoverability of indeterminate-lived assets, (iv) the remaining useful lives of long-lived assets, and (v) the sufficiency of merchant, aggregator, legal, and other reserves. On an ongoing basis, we evaluate the sufficiency and accuracy of our estimates. Actual results could differ from those estimates.consolidation.
Reclassifications
Certain reclassifications of prior year amounts have been made to the comparative period amounts to conform to our current periodthe 2018 presentation. These reclassifications had no impacteffect on net loss or loss per share as previously presented financial condition or results of operations.reported.
Cash and Cash Equivalents
We maintain our U.S. dollar-denominated cash in several non-interest bearing bank deposit accounts. All U.S. non-interest bearing transaction accounts are insured up to a maximum of $250,000 at FDIC insured institutions. The bank balances did not exceedexceeded FDIC limits by approximately $0.6 million and $10.6 million at December 31, 2018 and December 31, 2017, respectively. The higher balance which exceeded FDIC limits at December 31, 20162017 was the result of proceeds received from the issuance of common stock. We maintained approximately $74,000 and 2015.
We maintain $498,308 and $922,062$186,000 in uninsured bank accounts in Russia and the Cayman Islands at December 31, 20162018 and 20152017, respectively.
Restricted Cash
Restricted cash represents funds held-on-deposit with processing banks pursuant to agreements to cover potential merchant losses. It is presented as other long-term assets on the accompanying consolidated balance sheets since the related agreements extend beyond the next twelve months. Following the adoption of ASU 2016-18, StatementofCashFlows:RestrictedCash(Topic 230), the Company includes restricted cash along with the cash balance for presentation in the consolidated statements of cash flows. The reconciliation between the consolidated balance sheet and the consolidated statement of cash flows is as follows:
December 31, 2018 | December 31, 2017 | |||||||
Cash on consolidated balance sheet | $ | 1,645,481 | $ | 11,285,669 | ||||
Restricted cash | 604,070 | 447,602 | ||||||
| $ | 2,249,551 | $ | 11,733,271 | |||||
Accounts Receivable and Allowance for Doubtful Accounts Credit Policies
Accounts receivable are stated netconsist primarily of allowance for doubtful accounts. We estimateuncollateralized credit card processing residual payments due from processing banks requiring payment within thirty days following the end of each month. Accounts receivable also include amounts due from the sales of our technology solutions to its customers. The carrying amount of accounts receivable is reduced by an allowance based on experience with our service providers and judgment as to the likelihood of their ultimate payment. We also consider collection experience and make estimates regarding collectability based on payout trends of the customers. In Russia, the service providers are subsidiaries of large telecommunication companies and we do not reserve for these receivables given their financial backing and our historical experience with such companies. The allowance for doubtful accounts, was $603,031 at December 31, 2016if necessary, which reflects management’s best estimate of the amounts that will not be collected. The allowance is estimated based on management’s knowledge of its customers, historical loss experience and $103,031 December 31, 2015, respectively.existing economic conditions. Accounts receivable and the allowance are written-off when, in management’s opinion, all collection efforts have been exhausted.
Inventories
Other Current Assets
We maintain an inventoryInventories consist of POS terminalspoint-of-sale equipment which we use to service both merchants and independent sales agents. If the terminals are sold for a fee, we expense the cost of these terminals, plus any setup fees at the time of the sale.agents ("ISG"). Often, we will provide the terminalsequipment as an incentive for merchants and independent sales agents to enter into a merchant contracts with us. The term of these contracts havehas an average length of three years and the cost of the terminalequipment plus any setup fees will be amortized over the contract period. If the merchants early terminate their contract with us early, they are obligated to either return the terminalequipment or pay for the terminal. The Company has $311,206it. We have approximately $526,000 and $345,459$507,000 in terminals, iPads ® and related equipment as ofat December 31, 20162018 and 2015,2017, respectively, of which $308,582 and $268,501 hasare included within prepaid expenses and other current assets on the accompanying consolidated balance sheets. Approximately $727,000 and $501,000 had been placed with merchants during 2016at December 31, 2018 and 2015,2017, respectively.
Amortization of these terminals amounted to $126,643 and $110,182expense for the equipment placed in service for the years ended December 31, 20162018 and 2015, respectively.
Fixed Assets
We depreciate our furniture2017 was approximately $296,000 and equipment over a term of three to ten years. Computers and software are depreciated over terms between two and five years. Leasehold improvements are depreciated over the shorter of the economic life or term of each lease. All of our assets are depreciated on a straight-line basis for financial statement purposes.
Expenditures for repairs and maintenance are charged to operating expense as incurred. Expenditures that increase the value or productive capacity of assets are capitalized. At the time of retirements, sales, or other dispositions of property and equipment, the original cost and related accumulated depreciation are removed from the respective accounts, and the gains or losses are presented as other expenses.$189,000, respectively
Intangible Assets
IncludedIntangible assets acquired, either individually or with a group of other assets (but not those acquired in oura business combination), are initially recognized and measured based on fair value. Goodwill acquired in business combinations is initially computed as the amount paid in excess of the fair value of the net assets acquired. We did not acquire any businesses during the years ended December 31, 2018 and 2017.
The cost of internally developing, maintaining and restoring intangible assets (including goodwill) that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business and related to an entity are recognized as an expense when incurred.
Intangible assets include acquired merchant relationships, recurring cash flow portfolios, whichreferral agreements, trademarks, tradenames, website development costs and non-compete agreements. Merchant relationships represent the net bookfair value of customer relationships purchased by us. Recurring cash flow portfolios give us the right to retain a greater share of the cash flow, in the form of paying less commissions to an acquired merchant customer base, andindependent sales agent, related to certain future transactions with the agent referred sales partners. Referral agreements represent the right to exclusively obtain referrals from a partner for their customers' credit card processing services.
We amortize definite lived identifiable intangible assets using a method that reflects the pattern in which the economic benefits of the intangible asset are amortizedexpected to be consumed or otherwise utilized. The estimated useful lives of our customer-related intangible assets approximate the expected distribution of cash flows on a straight-line basis over their respectivefrom each asset. The useful lives generally threeof contract-based intangible assets are equal to five years. Merchant portfolios are assessedthe terms of the agreement.
Management evaluates the remaining useful lives and carrying values of long-lived assets, including definite lived intangible assets, at least annually, or when events and circumstances warrant such a review, to determine whether significant events or changes in circumstances indicate that a change in the useful life or impairment in value may have occurred. There were no impairment charges during the years ended December 31, 2018 and 2017.
Goodwill
In accordance with ASC 350, Intangibles—GoodwillandOther, we test goodwill for impairment iffor each reporting unit on an annual basis, or when events or circumstances indicate that their respectivethe fair value of a reporting unit is below its carrying values are not recoverable from the future anticipated undiscounted net cash flows attributable to such assets. In such cases, the amount of any potential impairment would be measured asvalue.
Our goodwill represents the excess if any, of carrying valuethe purchase price over the fair value of such assets.
We capitalize direct expenses associated with filing of patents and patent applications and amortize the capitalized intellectual property costs over five years beginning when the patent is approved.
Additionally, we capitalize the fair value of intangiblenet identifiable assets acquired in business combinations. We perform valuations of assets acquiredThe goodwill generated from the business combinations is primarily related to the value placed on the employee workforce and liabilities assumed on each acquisition accounted for asexpected synergies. Judgment is involved in determining if an indicator or change in circumstances relating to impairment has occurred. Such changes may include, among others, a significant decline in expected future cash flows, a significant adverse change in the business combinationclimate, and allocates the purchase price of each acquired business to its respective net tangible and intangible assets. Acquired intangible assets include: merchant portfolios, trade names, non-compete agreements, customer relationships and technology.
Impairment of Long-Lived Assetsunforeseen competition.
We review our long-lived assetshave the option of performing a qualitative assessment of impairment to determine whether any further quantitative testing for impairment wheneveris necessary. The option of whether or not to perform a qualitative assessment is made annually and may vary by reporting unit. Factors we consider in the qualitative assessment include general macroeconomic conditions, industry and market conditions, cost factors, overall financial performance of our reporting units, events or changes indicate thataffecting the composition or carrying amount of the net assets of its reporting units, sustained decrease in its share price, and other relevant entity specific events. If the management determines on the basis of qualitative factors that the fair value of the reporting unit is more likely than not less than the carrying value, then we perform a quantitative test for that reporting unit. The fair value of each reporting unit is compared to the reporting unit’s carrying value, including goodwill. Subsequent to the adoption on January 1, 2017 of Accounting Standards Update (“ASU”) No. 2017-04, Intangibles—Goodwill and Other: Simplifying the Test for Goodwill Impairment, if the fair value of a reporting unit is less than its carrying value, we recognize an asset or groupimpairment equal to the excess carrying value, not to exceed the total amount of assets may not be recoverable. Duringgoodwill allocated to that reporting unit.
At December 31, 2018, our management determined that an impairment charge of approximately $636,000 was necessary to reduce the twelve monthsgoodwill relating to the acquisition of PayOnline. The impairment charge was primarily related to a decrease in projected sales for 2019, which is the base year utilized for determining the discounted cash flows.
For a discussion of the estimate methodology and the significance of various inputs, please see the subheading below titled “Use of Estimates.”
We have determined that we have two reporting units, North American Transaction Solutions and International Transaction Solutions. For each of the years ended December 31, 20162018 and 2015,2017 we did not recognize any chargesperformed a quantitative assessment for impairmenteach of goodwill or intangible assets.its reporting units. The Company determined that none of the reporting units were impaired.
Capitalized Customer Acquisition Costs, Net
Capitalized customer acquisition costs consist of up-front cash payments made to Independent Sales Groups (“ISG’s”)ISG’s for the establishment of new merchant relationships. Capitalized customer acquisition costs represent incremental, direct customer acquisition costs that are recoverable through gross margins associated with merchant contracts. The up-front cash payment to the ISG is based on the estimated gross margin for the first year of the merchant contract. The deferred customer acquisition cost asset is recorded at the time of paymentamounts are receivable but not yet earned and the capitalized acquisition costs are primarily amortized on a straight-line basis over a period of threeapproximately four years.
Management evaluates the These capitalized customer acquisition cost for impairment at each balance sheet date by comparing, on a pooled basis by vintage monthcosts, net of origination, the expected future net undiscounted cash flows from underlying merchant relationships to the carrying amount of capitalized customer acquisition costs. If the estimated future net cash flowsamortization expense, are lower than the recorded carrying amount, indicating an impairment of the carrying value of the capitalized customer acquisition costs, the impairment loss is charged to operations.
During the years ended December 31, 2016 and 2015, we recorded $1,319,820 and $878,085, respectively, in additional capitalized customer acquisition costs, and $670,543 and $356,757, respectively, in related additional amortization. The balance of customer acquisition costs was $1,697,337 and $1,048,060 at December 31, 2016 and 2015, respectively, and is reflectedincluded in intangible assets inon the accompanying consolidated balance sheets.sheets (See Note 6 – item labeled “Client Acquisition Costs”).
Accrued Residual Commissions
We report commission paymentsrecord commissions as a cost of revenues in the accompanying consolidated statement of operations and comprehensive loss. We pay agent commissions to ISGs and independent sales agents based on the processing volume of the merchants enrolled. The commission paymentsobligations are based on varying percentages of the volume processed by us on behalf of the merchants. Percentages vary based on the program type and transaction volume of each merchant. We report commission payments as a cost of revenues in the accompanying consolidated statement of operations and comprehensive loss.
At December 31, 2016 and 2015 the residual commissions payable to ISGs and independent sales agents were $1,347,352 and $1,205,751, respectively.
We pay agent commission on annual fees between January and April of each year. We amortize the annual fees paid in equal monthly amounts from date of payment to end of year. We pay our agent commissions for annual fees in advance of recognizing the associated revenue. We deferred $863,604 and $483,090 of agent commissions paid for annual fees at December 31, 2016 and 2015, respectively. Prepaid agent commissions for annual fees are included in prepaid expenses and other assets, and commissions payable are included in accounts payable in the accompanying condensed consolidated balance sheets.
Financial Instruments
Convertible securities containing detachable warrants where the conversion price of the security and/or the exercise price of the warrants are affected by the current market price of our common stock are accounted for as derivative financial instruments when the exercise and conversion prices are not considered to be indexed to our stock.
For such issuances of convertible securities with detachable warrants, we initially record both the warrant and the beneficial conversion feature (“BCF”) at fair value, using option pricing models commonly used by the financial services industry (Black-Scholes-Merton options pricing model) using inputs generally observable in the financial services industry. These derivative financial instruments are marked-to-market each reporting period, with unrealized changes in value reflected in earnings as a gain or loss on change in fair value and settlement of beneficial conversion derivative.
For discounts arising from issuances of instruments embedded in a debt security, the discount is presented on the consolidated balance sheets as a discount to the principal amount of the related note payable. For discounts arising from issuances of instruments embedded in an equity security, the discount is presented as a reduction to additional paid-in-capital.
The resulting discounts arising from the initial recording of the warrants and BCF are amortized over the term of the host security. The classification of the amortization is based on the nature of the host instrument. In this respect, amortization of discounts associated with debt issuances are classified as interest expense, whereas amortization of discounts associated with preferred stock issuances are classified as preferred stock dividends.
At the time a warrant or BCF is exercised or cancelled, the fair value of the derivative financial instrument at the time of exercise/cancellation is calculated, and a realized gain or loss on conversion is determined and reported as a gain or loss on change in fair value and settlement of beneficial conversion derivative on the Statement of Operations and Comprehensive Loss.
Fair Value Measurements
Our financial instruments consist primarily of cash, accounts receivables, merchant portfolios, notes receivable, trade payables and debt instruments.accounts payables. The carrying values of cash and cash equivalents, accounts receivable and trade payablesthese financial instruments are considered to be representative of their respective fair values due to the short-term nature of these instruments. The carrying amount of the long-term debt of $4.6approximately $6.4 million and $7.0 million at December 31, 20162018 and 2017, respectively, approximates fair value because current borrowing rate does not materially differ from market rates for similar bank borrowings. The long-term debt is classified as a Level 2 item within the fair value hierarchy.
We measure certain nonfinancial assets and liabilities at fair value on a nonrecurring basis. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-level fair value hierarchy to prioritize the inputs used to measure fair value and maximizes the use of observable inputs and minimizes the use of unobservable inputs. The three levels of inputs used to measure fair value are as follows:
Level 1 — Quoted market prices in active markets for identical assets or liabilities as of the reporting date
Level 2 — Observable market based inputs or unobservable inputs that are corroborated by market data
Level 3 — Unobservable inputs that are not corroborated by market data
These non-financial assets and liabilities include intangible assets and liabilities acquired in a business combination as well as impairment calculations, when necessary. The fair value of the assets acquired and liabilities assumed in connection with the PayOnline acquisition, as discussed in Note 4, were measured at fair value by us at the acquisition date. The fair values of our merchant portfolios are primarily based on Level 3 inputs and are generally estimated based upon independent appraisals that include discounted cash flow analyses based on our most recent cash flow projections, and, for years beyond the projection period, estimates based on assumed growth rates. Assumptions are also made regarding appropriate discount rates, perpetual growth rates, and capital expenditures, among others. In certain circumstances, the discounted cash flow analyses are corroborated by a market-based approach that utilizes comparable company public trading values, and, where available, values observed in private market transactions. The inputs used by management for the fair value measurements include significant unobservable inputs, and therefore, the fair value measurements employed are classified as Level 3. The goodwillGoodwill impairment wasis primarily based on observable inputs using company specific information and is classified as Level 3.
Concentrations
See Note 11 for full concentration disclosure.
Foreign Currency Transactions
We are subject to exchange rate risk in our foreign operations in Russia, the functional currency of which is Russian Ruble, where we generate service fee revenuesRevenue Recognition and interest income and incurs product development, engineering, website development, and general and administrative costs and expenses. The Russian engineering operations pay a majority of their operating expenses in their local currencies, exposing us to exchange rate risk.
We do not engage in any currency hedging activities.
Deferred Revenue Recognition
We recognize revenue when all of the following four basic criteria have beenare met: (1) persuasive evidencethe parties to the contract have approved the contract and are committed to perform their respective obligations, (2) we can identify each party’s rights regarding the goods or services to be transferred, (3) we can identify the payment terms for the goods or services to be transferred, (4) the contract has commercial substance, and (5) it is probable that we will collect substantially all of a sales arrangement exists; (2) performance ofthe consideration to which we will be entitled in exchange for the goods or services has occurred, (3)that will be transferred to the sales price is fixed or determinable, and (4) collectability is reasonably assured.customer. We consider persuasive evidence of a sales arrangement to be the receipt of a billable transaction from aggregators, signed contract or the processing of a credit card transaction. Collectability is assessed based on a number of factors, including transaction history with the customer and the credit worthiness of the customer. If it is determined that the collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. We record cash received in advance of revenue recognition as deferred revenue. Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services and is recognized as revenue during the period the transactions are processed or when the related services are performed.
Our revenues for the years ended December 31, 2016 and 2015 are principally derived from the following sources:
Transactional Processing Fees: Transactionaltransactional processing fees are generated primarily from TOT Payments doing business as Unified Payments, which is our North AmericaAmerican Transaction Solutions segment, PayOnline, which is our Russian online transaction processing company, consolidated effective May 20, 2015 when we obtained control of PayOnline. See “PayOnline” in Note 4 for additional more information and Aptito, which is our point of sale solution for restaurants.
Our
We work directly with payment card networks and banks so that our merchants do not need to manage the complex systems, rules, and requirements of the payments industry. We satisfy our performance obligations and therefore recognize the transactional processing companies deriveservice fees as revenue upon authorization of a transaction by the merchant’s customer’s bank.
The majority of our revenues primarilyis derived from the electronicvolume-based payment processing of services including: credit, debit, electronic benefits transfer and alternative payment methods card processing authorized and captured through proprietary and third party networks, electronic gift certificate processing, and equipment sales. These revenues are recorded as bankcardfees ("discount fees”) and other processing transactions when processed. In addition to generatingrelated fixed transaction or service fees. Discount fees Aptito earns monthly license fees for use of its platform.
Typically, fees charged to merchants for these processing services are based onrepresent a variable percentage of the dollar amount of each credit or debit transaction and in some instances, additionalprocessed. Discount fees are recognized at the time the merchants’ transactions are processed. Generally, where we have control over merchant pricing, merchant portability, credit risk and ultimate responsibility for the merchant relationship, revenues are reported at the time of sale on a gross basis equal to the full amount of the discount charged to the merchant. This amount includes interchange fees paid to card issuing banks and assessments paid to payment card networks pursuant to which such parties receive payments based primarily on processing volume for each transaction. Merchant customersparticular groups of merchants. Revenues generated from merchant portfolios where we do not have control over merchant pricing, liability for merchant losses or credit risk or rights of portability are reported net of interchange and other fees.
Revenues are also may be charged miscellaneousderived from a variety of fixed transaction or service fees, including authorization fees, convenience fees, statement fees, annual fees, monthly minimum fees, fees for handling chargebacks, gateway fees, and fees for other miscellaneous services, such as handling chargebacks. Revenues derived from service fees are recognized at the time the services are performed and there are no further performance obligations. Revenue from the sale of equipment is recognized upon transfer of ownership and delivery to the customer, after which there are no further performance obligations.
We primarily report revenues gross as a principal versus net as an agent. Although some of our processing agreements vary with respect to specific terms, the transactional processing service fees collected from merchants generally are recognized as revenue on a gross basis as we are the principal in the delivery of the managed payments solutions to the sellers. The gross fees we collect are intended to cover the interchange, assessments and other processing and non-processing fees which are included and are part of our gross margin.
We have primary responsibility for providing end-to-end payment processing services for our clients. Our clients contract us for all credit card processing services, including transaction authorization, settlement, dispute resolution, data/transmission security, risk management, reporting, technical support and other value-added services. We have concluded that we are the principal because we control the services before delivery to the merchant, and are primarily responsible for the delivery of the services, have discretion in setting prices charged to merchants, and responsible for losses. We also have pricing latitude and can provide services using several different network options.
Adoption of ASC 606, Revenue from Contracts with Customers
On January 1, 2018, we adopted ASC 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with our historic revenue recognition methodology under ASC 605-45 Revenue Recognition-Principal Agent Considerations in determining its merchant processing services.
Generally, we (i) are the primary obligorThe cumulative impact of adopting ASC 606 resulted in our arrangements with our merchant customers, (ii) have latitude in establishing the priceno changes to retained earnings at January 1, 2018. The impact of our services, (iii) have the ability to change the product and perform partsadoption of the services, (iv) have discretion in supplier selection, (v) have latitude in determining the product and service specifications to meet the needs ofASC 606 on our merchant customers, and (vi) assume credit risk. In such cases, we report revenues as gross of fees deducted by our sponsoring member banks, as well as fees deducted from card-issuing member banks and card associations (Visa® and MasterCard®) on behalf of our sponsoring member banks for interchange and assessments. These fees charged by the card associations to process the credit card transactions are recorded separately as cost of revenue and interchange fees in the accompanying condensed consolidated statement of operations and comprehensive loss.was as follows:
Service Fees: Service fees are generated primarily from mobile payment processing services provided to third party content aggregators by Digital Provider. Service fees for services provided for content providers were recorded net of mobile operator fees during 2014 and the first half of 2015. In July of 2015, TOT Money began to offer its branded content to customers and changed its name to “Digital Provider”. Digital Provider’s revenues for the access of branded content are recorded at the amounts charged to the mobile subscriber. A corresponding charge to cost of sales for mobile operator and content fees is recorded for branded content. Revenues for access to branded content are recorded on the income statement as branded content revenues.
With | Before | |||||||||||
Implementation | Implementation | Effect of | ||||||||||
of ASC 606 | of ASC 606 | Implementation | ||||||||||
Revenue | $ | 65,786,817 | $ | 67,726,298 | $ | (1,939,481 | ) | |||||
Costs | (55,617,171 | ) | (57,556,652 | ) | $ | 1,939,481 | ||||||
Net effect of ASC 606 implementation | $ | - | ||||||||||
Mobile payment processing revenues for third party content providers continue to be accounted for as service fees and presented net of aggregator and mobile operator paymentsThere was no impact on theour consolidated financial statements as these revenues are considered to be agency fees.
Cost of revenues for Digital Provider is comprised primarily of mobile operator fees, content provider fees and fees for short numbers paid to mobile operators. Additionally, penalties and penalty recoveries are recorded as cost of sales. Service revenues for mobile payment processing services are presented net as these revenues are considered to be agency fees.
Subscription revenues for our branded content are recognized when a content subscriber initiates the purchase of our access to content using WAP-click, Internet-click, or a SMS-to-short number registered to us.
Digital Provider’s subscription revenues are recorded at the amounts charged to the third party customer. Cost of revenues for Digital Provider branded content includes fees due to mobile operators and marketing partners, as well as short number fees.
Cost of revenues for TOT Payments, Aptito and PayOnline is comprised primarily of processing fees paid to third parties attributable to providing transaction processing and service fees for POS system usage by our merchant customers. Interchange fees and cost of services are recognized as incurred, which generally occurs in the same period in which the corresponding revenue is recognized. Interchange fees are set by the card networks, and are paid to the card-issuing bank. Interchange fees are calculated as a percentage of the dollar volume processed plus a per transaction fee. We also pay Visa® and MasterCard® network dues.
We have multiple element arrangements that include bundled transactions with merchants encompassing annual PCI (payment card industry) fees, annual membership fees, and monthly processing fees.
We adopted Accounting Standard Update No 2009-13, “Multiple–Deliverable Revenue Arrangements” (ASU 2009-13). ASU 2009-13 requires the use of the relative selling price method of allocating total consideration to units of accounting in a multiple element arrangement and eliminates the residual method. This accounting principle requires an entity to allocate revenue in an arrangement using estimated selling price deliverables if it does not have vendor specific objective evidence (VSOE) or third party evidence (TPE) of selling price.
VSOE is the price charged when the same or similar product or service is sold separately. We define VSOE as a median price of recent stand-alone transactions that are priced within a narrow range. TPE is determined based on the prices charged by our competitors for a similar deliverable when sold separately.
We evaluate each deliverable in its arrangements to determine whether it represents a separate unit of accounting. A deliverable constitutes a separate unit of accounting when it has stand-alone value to our customers. Our products (i.e., terminals) and services qualify as separate units of accounting under ASU 2009-13.
Our payment processing division derives revenues primarily from the electronic processing of services including credit, debit and electronic benefits transfer card processing authorized and captured through third party networks, check conversion and guarantee, electronic gift certificate processing, and equipment leasing and sales. These revenues are recorded as bankcard and other processing transactions when processed.
Typically, fees charged to merchants for these processing services are based on a variable percentage of the dollar amount of each transaction and in some instances, additional fees are charged for each transaction. Merchant customers may also be charged miscellaneous fees, including statement fees, annual fees, monthly minimum fees, fees for handling chargebacks, gateway fees, and fees for other miscellaneous services.
The fair value for annual fees is based on the annual contract renewal price and is deemed to represent stand-alone selling price based upon VSOE. The fair value for processing is based on prices charged by our competitors for similar deliverables when sold separately and is deemed to represent stand-alone selling price based upon TPE.
Deferred revenue represents primarily amounts received in advance for annual fee billings and are recognized on a pro rata basis over the service period.
Generally, we (i) are the primary obligor in its arrangements with its merchant customers, (ii) have latitude in establishing the price of its services, (iii) have the ability to change the product and perform parts of the services, (iv) have discretion in supplier selection, (v) have latitude in determining the product and service specifications to meet the needs of its merchant customers, and (vi) assume credit risk. In such cases, we report revenues as gross of fees deducted by its sponsoring member banks, as well as fees deducted from card-issuing member banks and card associations (Visa/MasterCard) on behalf of its sponsoring member banks for interchange and assessments. These fees charged by the card associations to process the credit card transactions are recorded separately as cost of sales and interchange fees in the accompanying consolidated statement of operations.balance sheets.
Net Loss per Share
Basic net loss per common share is computed by dividing net loss applicable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares issuable upon exercise of common stock options or warrants. In periods when losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents because their inclusion would have an anti-dilutive effect. At both December 31, 2015 and 2016, respectively, we had warrants outstanding to purchase 893,890 shares of common stock, and we had 1,464,369 and 1,936,099 stock options issued and outstanding that are anti-dilutive in effect.
ImpairmentTable of Long-Lived Assets
We review our long-lived assets for impairment whenever events or changes indicate that the carrying amount of an asset or group of assets may not be recoverable. During the year ended December 31, 2016 and 2015, there was no impairment of goodwill and intangible assets.
Income Taxes
We account for income taxes under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statements and tax basis of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.
We recognize net deferred tax assets to the extent that we believe these assets are more likely than not to be realized. In making such a determination, we consider all available positive and negative evidence, including future reversals of existing taxable temporary differences,projected future taxable income, tax-planning strategies, and results of recent operations. If we determine that we would be able to realize our deferred tax assets in the future in excess of their net recorded amount, we would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes.
We account for uncertainty in income taxes using a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. We classify the liability for unrecognized tax benefits as current to the extent we anticipate payment (or receipt) of cash within one year. Interest and penalties related to uncertain tax positions are recognized and recorded as necessary in the provision for income taxes. Our evaluation of uncertain tax positions was performed for the tax years ended December 31, 2012 and forward, the tax years which remain subject to examination at December 31, 2016. Please see Note 16 for discussion of our uncertain tax positions.2018.
RecentlyInterchange, Network Fees and Other Cost of Services
Interchange and network fees consist primarily of fees that are directly related to discount fee revenue. These include interchange fees paid to issuers and assessment fees payable to card associations, which are a percentage of the processing volume we generate from Visa and Mastercard, AMEX, and Discover, as well as fees charged by card-issuing banks. Other costs of services include costs directly attributable to processing and bank sponsorship costs, which may not be based on a percentage of volume. These costs also include related costs such as residual payments to sales groups, which are based on a percentage of the net revenues generated from merchant referrals. In certain merchant processing bank relationships we are liable for chargebacks against a merchant equal to the volume of the transaction. Losses resulting from chargebacks against a merchant are included in other cost of services or as a bad debt expense, determined on the timing and nature of the specific transaction, on the accompanying consolidated statement of operations. We evaluate the risk for such transactions and our potential loss from chargebacks based primarily on historical experience and other relevant factors.
Advertising and Promotion Costs
Advertising and promotion costs are expensed as incurred. Advertising expense was approximately $154,000 and $89,000 for the years ended December 31, 2018 and 2017, respectively, and is included in selling, general and administrative expenses in the accompanying consolidated statements of operations and comprehensive loss.
Equity-based Compensation
We account for grants of equity awards to employees in accordance with ASC 718, Compensation—StockCompensation. This standard requires compensation expense to be measured based on the estimated fair value of the share-based awards on the date of grant and recognized as expense on a straight-line basis over the requisite service period, which is generally the vesting period.
Equity-based compensation was approximately $100,000 and $2.9 million for the years ended December 31, 2018 and 2017, respectively, and is reflected on the accompanying consolidated statements of operations and comprehensive loss.
Foreign Currency Transactions
We are subject to exchange rate risk in our foreign operations in Russia, the functional currency of which is the Russian ruble, where we generate service fee revenues, interest income or expense, incur product development, engineering, website development, and selling, general and administrative costs and expenses. Our Russian subsidiaries pay a majority of their operating expenses in their local currencies, exposing us to exchange rate risk.
Use of Estimates
The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses for the reporting period. Such estimates include, but are not limited to, the value of purchase consideration paid and identifiable assets acquired and assumed in acquisitions, goodwill and asset impairment review, valuation reserves for accounts receivable, valuation of acquired or current merchant portfolios, incurred but not reported claims, revenue recognition for multiple element arrangements, loss reserves, assumptions used in the calculation of equity-based compensation and in the calculation of income taxes, and certain tax assets and liabilities, as well as, the related valuation allowances. Actual results could differ from those estimates.
Below is a summary of the Company’s critical accounting estimates for which the nature of management’s assumptions are material due to the levels of subjectivity and judgment necessary to account for highly uncertain matters or the susceptibility of such matters to change, and for which the impact of the estimates and assumptions on financial condition or operating performance is material.
Goodwill
The Company tests goodwill for impairment using a fair value approach at least annually, absent some triggering event that would require an interim impairment assessment.
Significant estimates and assumptions are used in our goodwill impairment review and include the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units and determining the fair value of each reporting unit. Our assessment of qualitative factors involves significant judgments about expected future business performance, general market conditions, and regulatory changes. In a quantitative assessment, the fair value of each reporting unit is determined based largely on the present value of projected future cash flows, growth assumptions regarding discount rates, estimated growth rates and our future long-term business plans. Changes in any of these estimates or assumptions could materially affect the determination of fair value and the associated goodwill impairment charge for each reporting unit.
Recently Issued Accounting Pronouncements
In May 2014,January 2017, the Financial Accounting Standards Board (“FASB”("FASB") issued Accounting Standard Update (“ASU”) 2014-09, “RevenueASU 2017-04 “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. This update simplifies the subsequent measurement of goodwill by eliminating Step 2 from Contracts with Customers,” which supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition” and requires entities togoodwill impairment test. Under this updated standard, an entity should recognize revenue in a way that depictsan impairment charge for the transfer of promised goods or services to customers in an amount that reflects the consideration toby which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity expects to be entitled in exchange for those goods or services. In August 2015,also should consider income tax effects from any tax-deductible goodwill on the FASB issued ASU 2015-14, which defers by one yearcarrying amount of the reporting unit when measuring the goodwill impairment loss, if any. This guidance is effective date of ASU 2014-09. Accordingly, this guidanceprospectively and is effective for interim and annual periods beginning after December 15, 20172019 with early adoption permitted for interim and annual periods beginning after December 15, 2016.permitted. We are evaluating the effects thatdo not expect the adoption of ASU 2014-9 willthis guidance to have a material impact on our consolidated financial statements
In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this update changed how companies measure and recognize credit impairment for many financial assets. The new expected credit loss model will require companies to immediately recognize an estimate of credit losses expected to occur over the remaining life of the financial assets (including trade receivables) that are within the scope of the update. The update also made amendments to the current impairment model for held-to-maturity and available-for-sale debt securities and certain guarantees. The guidance will become effective for us on January 1, 2020. Early adoption is permitted for periods beginning on or after January 1, 2019. We do not expect the adoption of this guidance to have a material impact on our consolidated financial position, results of operations or cash flows.
In November 2015, the FASB issued ASU No. 2015-17, “Balance Sheet Classification of Deferred Taxes,” which requires entities to present deferred tax assets and deferred tax liabilities as noncurrent in a classified balance sheet. As a result, each jurisdiction will now only have one net noncurrent deferred tax asset or liability. This ASU is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, and early adoption is permitted. We adopted this ASU, which had no impact on our financial position, results of operations or cash flows.statements.
In February 2016, the FASB issued ASU 2016-02, “Leases” which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are currently evaluatingin the effectsprocess of collecting data and designing processes and controls to account for our leases in accordance with the new guidance. We expect that the adoption of ASU 2016-02 will haveresult in the recognition of right of use assets and related obligations on our consolidated financial statements, and expect an increase in Assets and Liabilities associated with the recognition of right-of-use office leases.statements.
In March 2016, the FASB issued Accounting Standards Update 2016-08 Revenue from Contracts with Customers (Topic 606) to clarify implementation guidance on principal versus agent considerations (for reporting revenue on a gross or net basis). The ASU is an amendment to Topic 606, clarifies the implementation guidance, and requires an entity to account for revenue as an agent when another entity controls the specified good or service before that good or service is transferred to the customer. This ASU is effective for annual periods beginning after December 15, 2017. We currently are preparing analyses, across all business lines and customers, to determine the effect of the new revenue recognition standard. While our study is not yet complete, we believe that a portion of our revenue recognized for branded content in our Mobile Solutions business segment may no longer meet the conditions for gross reporting upon adoption of this ASU in 2018.
NOTE 2. BASIS OF PRESENTATION AND PRINCIPLES OF CONSOLIDATIONNote 4. ACQUISITIONS
On May 25, 2016, we completed a one-for-ten reverse stock split of our common stock. Our condensed consolidated financial statements give retrospective effect for this change in capital structure.
Following the consolidation principles promulgated by U.S. GAAP, our consolidated financial statements include the assets, liabilities, results of operations, and cash flows of the following subsidiaries:
(1) TOT Group, Inc., a 100% owned subsidiary formed in Delaware; (2) Netlab Systems, LLC, a wholly owned subsidiary formed in Florida; (3) NetLab Systems IP, LLC, a wholly owned subsidiary formed in Florida; (4) OOO Net Element Russia (“Net Element Russia”), a wholly owned subsidiary formed in Russia; and (5) Net Element Services, LLC, a wholly owned subsidiary formed in Florida.
The subsidiaries listed above are the parent companies of several other subsidiaries, which hold our underlying investments or operating entities.
TOT Group is the parent company of TOT Payments, LLC (“TOT Payments”) doing business as Unified Payments, a wholly owned subsidiary formed in Florida, Aptito, LLC, an 80% owned subsidiary formed in Florida (acquired June 18, 2013), TOT Group Europe LTD, a wholly owned subsidiary formed in the United Kingdom, Unified Portfolios, LLC, a wholly owned subsidiary formed in Florida and OOO TOT Group Russia, a wholly owned subsidiary formed in Russia.
All material intercompany accounts and transactions have been eliminated in consolidation.
NOTE 3. LIQUIDITY AND GOING CONCERN CONSIDERATIONS
Our consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. We sustained a net loss of $13.6 million forDuring the year ended December 31, 2016 and have2018 we acquired the following residual buyout arrangements. There were no residual buyout arrangements acquired during the year ended 2017.
Acquisitions of Recurring Cash Flow Portfolios
From time to time, the Company acquires future recurring revenue streams from sales agents in exchange for an accumulated deficitupfront cash payment. This results in an increase in net cash flow to the Company. The acquisitions of $157 million andrecurring cash flows are treated as asset acquisitions, resulting in recording a negative working capitalrecurring cash flow portfolio intangible asset, at cost, on the date of $6.3 million at December 31, 2016. In addition, we haveacquisition. These assets are amortized over a payment obligationstraight-line period of approximately $1.8 million duefour years and is included in intangible assets on May 20, 2017 associated with our PayOnline acquisition. These conditions raise substantial doubt about our ability to continue as a going concern.the accompanying consolidated balance sheets (See Note 6 - item labeled “Portfolio and Clients Lists”, on the accompanying consolidated audited financial statements).
FailureUniversal Partners, LLC
On July 30, 2018, our subsidiary, Unified Portfolio Acquisitions, LLC, entered into an Advance and Residual Purchase Agreement (the “Agreement”) with Universal Partners, LLC (“Universal”). Pursuant to successfully continue developingthe Agreement, we acquired certain transactional services portfolios (“cash flow assets”) from Universal and Payment Club, LLC (together with Universal, the “Seller”) for $2,700,000 (the “Advance Amount”). The cash flow assets consist of residuals (the “Residuals”) that the Sellers were entitled to receive pursuant to certain agreements (the “Combined Marketing Agreements”) with TOT Payments, LLC (doing business as Unified Payments), our payment processing operationssubsidiary, or any other agreements pursuant to which the Seller was entitled to residuals.
The Advance Amount is to be repaid to us whereby each and maintain contracts with merchants, mobile phone carriersevery month, commencing from July 1, 2018 (the “Effective Date”) and content providersfor a period of 24 months thereafter, terminating on June 30, 2020 (the “Advance Period”), we are entitled to use TOT Group’s services could harm our revenues and materially adversely affect our financial condition and results of operations. We face alla certain amount of the risks inherentResiduals. Such Residuals due to the Purchaser are secured by certain of the Seller’s property as collateral.
At the end of the Advance Period (the “Transfer Date”), we and the Seller have agreed to create a new static portfolio pool of mutually agreed residual income from Seller portfolios comprising merchant accounts boarded by the Seller under the Combined Marketing Agreements that on the Transfer are generating at least $120,000 per month in net residual income (the “Portfolio Residuals”). From and after the Transfer Date, we and Seller will share/split the Portfolio Residuals with us owning an 80% interest in the Portfolio Residuals and the Seller owning a 20% interest in the Portfolio Residuals.
During 2018, cash paid in connection for this Agreement approximated $2.5 million.
Argus Merchant Services, LLC
On December 26, 2018, our subsidiary, Unified Portfolio Acquisitions, LLC, entered into an Advance and Residual Purchase Agreement (the “Agreement”) with Argus Merchant Services, LLC ("Argus") and Treasury Payments, LLC ("Treasury"); Argus and Treasury are collectively referred to herein as the (“Seller”). Pursuant to the Agreement, we acquired certain transactional services portfolios (“cash flow assets”) from the Seller for a total purchase consideration of $1,426,000. The cash flow assets consist of residuals (the “Residuals”) that the Seller is entitled to receive pursuant to certain agreements (including any amendments of such agreements, the “Combined Marketing Agreements”) with TOT Payments, LLC (doing business as Unified Payments, our subsidiary).
On December 27, 2018, we paid to Seller $1,150,000 (the “Advance Amount”). The Advance Amount and the balance of the purchase consideration is to be repaid to us from Residuals due to the Seller, whereby each and every month, commencing from January 2019 (the “Effective Date”) and for a period of 24 months (the “Advance Period”), we will be entitled to a certain amount of the Seller’s Residuals. Such Residuals due us are secured by certain of the Seller’s property as collateral.
At the end of the Advance Period (the “Transfer Date”), we will receive an ownership interest in a portfolio of cash flow assets by creating with the Seller, a new business, includingstatic portfolio pool of mutually agreed residual income from Seller portfolios comprising merchant accounts boarded by the need for significant additional capital, management’s potential underestimation of initial and ongoing costs, and potential delays and other problemsSeller under the Combined Marketing Agreements.
During the 2018, cash paid in connection with developing our technologies and operations.this residual buyout agreement approximated $1.2 million.
Referral Agreements
Our company is continuing with its planFrom time to further grow and expand our payment processing operations in emerging markets, particularly in Russia and surrounding countries, and seek sources of capital to expand and pay our contractual obligations as they come due. Management believes that its current operating strategy will provide the opportunity for us to continue as a going concern as long as we are able to obtain additional financing; however, there is no assurance this will occur. The accompanying consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
We are required to continually meet the listing requirements of The NASDAQ Capital Market (including a minimum bid price for our common stock of $1.00 per share) to maintain the listing of our common stock on The NASDAQ Capital Market. On November 14, 2016, the bid price of our common stock fell below $1.00 and stayed below $1.00 for 30 consecutive business days. On December 28, 2016, we received a letter from NASDAQ providing us 180 days (until June 26, 2017) to regain compliance. To regain compliance, our stock closing bid price must remain above $1.00 for 10 consecutive trading days. If we do not regain compliance with the minimum closing bid price requirement, the NASDAQ Capital Market will provide written notice that our securities are subject to delisting. At such time, we would be entitledenter into referral agreements with ISG’s or other organizations (“referral partner”). Under these agreements, the referral partner exclusively refers its customers to appeal the delisting determination to a NASDAQ Listing Qualifications Panel. We cannot provide any assurance that our stock price will recover within the permitted grace period.
Any delisting of our common stock from The NASDAQ Capital Market could adversely affect our ability to attract new investors, reduce the liquidity of our outstanding shares of common stock, reduce our flexibility to raise additional capital, reduce the price at which our common stock trades and increase the transaction costs inherent in trading such shares with overall negative effectsus for our stockholders. In addition, delisting of our common stock could deter broker-dealers from making a market in or otherwise seeking or generating interest in our common stock, and might deter certain institutions and persons from investing in our securities at all. Forcredit card processing services. Consideration paid for these reasons and others, delisting could adversely affect our business, financial condition and results of operations.
The independent auditors’ reports on our consolidated financial statementsagreements for the years ended December 31, 20162018 and 2015 contain explanatory paragraphs expressing substantial doubt2017 was approximately $1.6 million and $1.8 million, respectively, all of which was settled with cash on hand. Because we pay an up-front fee to compensate the referral partner, the amount is treated as to our ability to continue asan asset acquisition in which we have acquired an intangible stream of referrals. This asset is amortized over a going concern.straight-line period of approximately four years and is included in intangible assets on the accompanying consolidated balance sheets (See Note 6 – item labeled “Client Acquisition Costs”).
NOTE 4. ACQUISITION OF PAYONLINE5. ACCOUNTS RECEIVABLE
On May 20, 2015, our subsidiaries TOT Group Europe, Ltd.Accounts receivable, net of allowance for doubtful accounts, consist of amounts due from merchant service providers and TOT Group Russia LLC, entered into an agreement with Maglenta Enterprises Inc.to a lesser extent Russian mobile operator intermediaries. Net accounts receivable amounted to approximately $6.3 million and Champfremont Holding Ltd. (together,$5.5 million at December 31, 2018 and 2017, respectively. Net accounts receivable consisted primarily of $6.2 million and $5.4 million for North American Transaction Solutions and $74,000 and $58,000, attributed to International Transaction Solutions for credit card processing receivables at December 31, 2018 and 2017, respectively.
Our allowance for doubtful accounts was approximately $214,000 and $257,000 as of December 31, 2018 and 2017, respectively. Actual write-offs may exceed estimated amounts.
NOTE 6. INTANGIBLE ASSETS
The Company had approximately $6.4 and $3.1 million in intangible assets, net of amortization, at December 31, 2018 and 2017, respectively. Shown below are the “Sellers”) to acquire alldetails of the assets and liabilitiescomponents that comprise PayOnline. PayOnline’s business includes the operation of a protected payment processing system to accept bank card payments for goods and services.represent these balances.
Purchase considerationIntangible assets consisted of a combinationthe following as 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 determinationDecember 31, 2018
Cost | Accumulated Amortization | Carrying Value | Amortization Life and Method | ||||||||||
IP Software | $ | 2,309,291 | $ | (2,139,891 | ) | $ | 169,400 | 3 years - straight-line | |||||
Portfolios and Client Lists | 7,576,665 | (4,333,866 | ) | 3,242,799 | 4 years - straight-line | ||||||||
Client Acquisition Costs | 6,370,124 | (3,340,581 | ) | 3,029,544 | 4 years - straight-line | ||||||||
PCI Certification | 449,000 | (449,000 | ) | - | 3 years - straight-line | ||||||||
Trademarks | 703,586 | (703,586 | ) | - | 3 years - straight-line | ||||||||
Domain Names | 437,810 | (437,810 | ) | - | 3 years - straight-line | ||||||||
| $ | 17,846,476 | $ | (11,404,732 | ) | $ | 6,441,743 | |||||||
Intangible assets consisted of the valuefollowing as 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.December 31, 2017
Cost | Accumulated Amortization | Carrying Value | Amortization Life and Method | ||||||||||
IP Software | $ | 2,274,693 | $ | (2,171,803 | ) | $ | 102,890 | 3 years - straight-line | |||||
Portfolios and Client Lists | 5,213,911 | (4,939,857 | ) | 274,054 | 3 years - straight-line | ||||||||
Client Acquisition Costs | 4,812,474 | (2,377,139 | ) | 2,435,335 | 3 years - straight-line | ||||||||
PCI Certification | 449,000 | (361,694 | ) | 87,306 | 3 years - straight-line | ||||||||
Trademarks | 702,192 | (570,383 | ) | 131,809 | 3 years - straight-line | ||||||||
Domain Names | 435,956 | (339,590 | ) | 96,366 | 3 years - straight-line | ||||||||
| $ | 13,888,226 | $ | (10,760,466 | ) | $ | 3,127,760 | |||||||
On October 25, 2016, we entered into a settlement agreement which incorporated the above charge of $2,162,861 and an additional charge of $125,806 to adjust the accrual relating to the stock price guarantee obligation to the agreed upon amount of $2,288,667 plus 10% per annum interest accrued from May 20, 2016, payable in installments with a balloon payment of $1.8 million due in May 2017. As a result, forDuring the year ended December 31, 2016,2018, we recognized $125,887removed fully amortized portfolio and client lists, approximating $1.4 million, relating to our PayOnline acquisition.
Amortization expense for the related interest.intangible assets was approximately $2.1 million and $2.3 million for the years ended December 31, 2018 and 2017, respectively.
The following table presents the estimated aggregate future amortization expense of intangible assets:
2019 | $ | 1,561,829 | ||
2020 | 1,561,829 | |||
2021 | 1,561,829 | |||
2022 | 1,505,362 | |||
2023 | 250,894 | |||
Balance December 31, 2018 | $ | 6,441,743 |
NOTE 7. ACCRUED EXPENSES
At December 31, 2018 and December 31, 2017, accrued expenses amounted to approximately $2.5 and $3.2 million, respectively. Accrued expenses represent expenses that are owed at the end of the period or are estimates of services provided that have not been billed by the provider or vendor. The following table reflect the balances outstanding as of December 31, 2018 and December 31, 2017.
December 31, 2018 | December 31, 2017 | |||||||
Accrued professional fees | $ | 174,915 | $ | 241,281 | ||||
PayOnline accrual | 1,126,273 | 1,438,900 | ||||||
Accrued interest | 108,202 | 145,264 | ||||||
Accrued bonus | 1,157,556 | 1,249,852 | ||||||
Accrued foreign taxes | (45,952 | ) | 137,141 | |||||
Other accrued expenses | 14,953 | - | ||||||
| $ | 2,535,947 | $ | 3,212,438 | |||||
On October 25, 2016, we entered into an amendment to the PayOnline acquisition agreement with the Sellers,sellers, in which we agreed to assume $1,433,475 of certain refundable merchant deposit reserves. These reserves, are expected to be repaid duringand accordingly, recorded the first half of 2017 and we have recorded a charge in this amount forliability. During the year the ended December 31, 2016.
The following table summarizes the fair value of consideration paid and the allocation of purchase price to the fair value of tangible and intangible assets acquired and liabilities assumed:
Assuming the acquisition of PayOnline occurred on January 1, 2015, Net Revenues and Net Loss from operations for the year ended December 31, 2015 would have been $42,725,207 and $12,240,344, respectively.
NOTE 5. ACCOUNTS RECEIVABLE
Accounts receivable (net) consist of amounts due from processors and Russian mobile operator intermediaries. Total net accounts receivable amounted to $7,126,429 and $5,198,993 at December 31, 2016 and 2015, respectively. Net accounts receivable consisted primarily of $2,391,646 and $1,764,087 of amounts due from Russian mobile operators, $185,650 and $211,019 due to PayOnline business and $4,549,133 and $3,223,287 of credit card processing receivables at December 31, 2016 and 2015 respectively.
Total allowance for doubtful accounts was $603,031 and $103,031 at December 31, 2016 and 2015, respectively. For the year ended December 31, 2016,2017, we recorded a provision of $500,000 for potentially uncollectible accounts receivable in our mobile payments business.
NOTE 6. FIXED ASSETS
Fixed assets are stated at acquired cost less accumulated depreciation and amortization as follows:
| Useful life (in years) | December 31, 2016 | December 31, 2015 | ||||||||
| Furniture and equipment | 3 - 10 | $ | 185,301 | $ | 174,133 | |||||
| Computers | 2 - 5 | 168,942 | 141,692 | |||||||
| Total | 354,243 | 315,825 | ||||||||
| Less: Accumulated depreciation | (236,948 | ) | (153,702 | ) | ||||||
| Total fixed assets, net | $ | 117,295 | $ | 162,123 | ||||||
Depreciation expense for the years ended December 31, 2016 and 2015 was $83,245 and $129,343, respectively.
NOTE 7. INTANGIBLE ASSETS
The Company had $3,589,850 and $5,423,880 in intangible assets at December 31, 2016 and 2015, respectively. Shown below are the details at December 31, 2016 and 2015:
| IP Software | Portfolios and Client Lists | Client Acquisition Costs | PCI Certification | Trademarks | Domain Names | Covenant Not to Compete | Total | |||||||||||||||||||||||||
| Balance at December 31, 2014 | $ | 520,924 | $ | 1,082,731 | $ | 526,728 | $ | - | $ | - | $ | - | $ | 361,667 | $ | 2,492,050 | ||||||||||||||||
| Additions due to Payonline purchase | 1,328,000 | 1,410,000 | - | 449,000 | 708,062 | 429,939 | - | 4,325,001 | ||||||||||||||||||||||||
| Other additions | 163,129 | 878,085 | 1,041,214 | |||||||||||||||||||||||||||||
| Amortization | (463,452 | ) | (842,806 | ) | (356,753 | ) | (93,542 | ) | (146,290 | ) | (90,793 | ) | (280,000 | ) | (2,273,636 | ) | ||||||||||||||||
| Divested | - | (160,750 | ) | - | - | - | - | - | (160,750 | ) | ||||||||||||||||||||||
| Balance at December 31, 2015 | $ | 1,548,601 | $ | 1,489,175 | $ | 1,048,060 | $ | 355,458 | $ | 561,772 | $ | 339,146 | $ | 81,667 | $ | 5,423,880 | ||||||||||||||||
| Additions | 102,689 | - | 1,319,820 | 83 | 1,422,592 | |||||||||||||||||||||||||||
| Amortization | (1,271,226 | ) | $ | (704,184 | ) | (670,543 | ) | (149,668 | ) | (234,064 | ) | (145,270 | ) | (81,667 | ) | (3,256,622 | ) | |||||||||||||||
| Balance at December 31, 2016 | $ | 380,064 | $ | 784,991 | $ | 1,697,337 | $ | 205,790 | $ | 327,708 | $ | 193,959 | $ | - | $ | 3,589,850 | ||||||||||||||||
Amortization expense for the year ended December 31, 2016 was $3,383,265 of which $3,256,622 is described in the table above and $126,643 was for the amortization of terminal inventory placed for free. The inventory and its associated amortization are included in prepaid and other expenses, and is not included in the table above.
Amortization expense for the year ended December 31, 2015 was $2,383,818 of which $2,273,636 is described in the table above and $110,182 was for the amortization of terminal inventory placed with merchants without charge. The inventory and its associated amortization are included in prepaid and other expenses, and is not included in the table above.
The following table presents the estimated aggregate future amortization expense of other intangible assets:
| Year | Amortization Expense | |||
| 2017 | $ | 1,196,616 | ||
| 2018 | 1,196,617 | |||
| 2019 | 1,196,617 | |||
| 2020 | - | |||
| 2021 | - | |||
| Total | $ | 3,589,850 | ||
As a result of the PayOnline acquisition in 2015, we recognized certain intangible assets with a fair market value of $4,325,001. This consisted of software ($1,328,000), client lists ($1,410,000), PCI certification ($449,000), trademarks ($708,062) and Domain names ($429,939). Amounts are included in table above and amortized accordingly.
Software
We capitalized software development costs that add value to or extend the useful of the related software it develops for internal use and licensing. Costs for routine software updates are expensed as incurred. Capitalized costs are amortized over 36 months on a straight-line basis. Impairment is reviewed quarterly to ensure only viable active costs are capitalized.
During the twelve months ended December 31, 2016 and 2015, we capitalized $102,689 and $163,129 of development costs as follows:
For the twelve months ended December 31, 2016, amortization was $1,271,226. For twelve months ended December 31, 2015, amortization was $463,452.
Merchant Portfolios
Merchant Portfolios consisted of purchased portfolios that earn future streams of income for the foreseeable future. The remaining useful lives of these portfolios range from 15 months to 36 months at the time of acquisition. At December 31, 2016 and 2015 the net value of these portfolios was $784,991 and $1,489,175 respectively.
The useful lives of merchant portfolios represent management’s best estimate over which the Company will recognize the economic benefits of these intangible assets.
Trademarks and Domain Names
During 2015, we acquired certain trademarks with a $708,062 fair market value and domain names with a $429,939 fair market value at the date of acquisition. At December 31, 2016 and December 31, 2015, the net book values of these trademarks were $327,708 and $561,772, respectively, and the net book value of the domain names were $193,959 and $339,146, respectively.
For the twelve- months ended December 31, 2016, amortization for trademarks was $234,064. For the twelve months ended December 31, 2015, amortization was $146,290.
For the twelve months ended December 31, 2016, amortization for domain names was $145,270. For the twelve months ended December 31, 2015, amortization was $90,793.
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 December 31, 2016 and December 31, 2015, the net book valuerepaid $252,223 of this certification was $205,790 and $355,458, respectively.
For the twelve-months ended December 31, 2016, amortization for this certification was $149,668. For the twelve months ended December 31, 2015, amortization for this certification was $93,542.
Non-Compete Agreements
In connection with our acquisition of Unified Payments, LLC in 2013, two key executives signed covenants not to compete. These covenants had a three-year life with a net book value $0 and $81,667 at December 31, 2016 and December 31, 2015, respectively.
NOTE 8. ACCRUED EXPENSES
At December 31, 2016 and December 31, 2015, accrued expenses amounted to $5,518,823 and $2,975,066 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 as of December 31, 2016 and December 31, 2015.
| December 31, 2016 | December 31, 2015 | |||||||
| Accrued professional fees | $ | 220,140 | $ | 220,140 | ||||
| PayOnline Accrual | 3,784,451 | 618,500 | ||||||
| Accrued interest | 183,778 | - | ||||||
| Accrued payroll | - | 79,653 | ||||||
| Accrued bonus | 774,485 | 1,635,816 | ||||||
| Accrued franchise taxes | 180,000 | - | ||||||
| Accrued foreign taxes | 131,810 | 79,691 | ||||||
| Short term loan advances | 174,376 | 200,000 | ||||||
| Other accrued expenses | 69,783 | 141,266 | ||||||
| $ | 5,518,823 | $ | 2,975,066 | |||||
liability. The accrual for PayOnline at December 31, 20162018 and 2017, respectively, 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, it includes a $1.4approximately $1.1 million obligation for refundable merchant reserves assumed pursuant to anthis amendment to the PayOnline acquisition agreement. See Note 11 for additional information.
Accrued performance bonuses were $774,485Included in accrued bonus are non-discretionary compensation due to our Chairman and $1,635,816CEO, approximating $866,000 and $1.0 million at December 31, 20162018 and 2015, respectively. At December 31, 2015, the bonus accrual consisted of bonuses that were owed at the date of the Unified Payments acquisition, plus additional bonus accruals from date of acquisition to December 31, 2015.
Accrued interest2017, respectively, and approximately $291,000 and $244,000 at December 31, 2016 is comprised of loan costs associated with RBL notes in the amount of $134,180 as a result of the issuance of additional RBL notes2018 and interest payable of $49,598 associated with the PayOnline settlement agreement.2017 for discretionary performance bonuses due to certain employees.
We were required to pay $180,000 to the state of Delaware on March 1, 2017, for franchise taxes relating to 2016. As such we recognized an accrual at December 31, 2016. In addition, we owed $131,810 in foreign taxes, which primarily consist of VAT and payroll taxes related to our Mobile and Online segments at December 31, 2016.NOTE 8. NOTES PAYABLE
NOTE 9. SHORT TERM LOANS
Term Loan
On April 14, 2015, Revere Wealth Management, LLC provided a $200,000 term loan with an annual interest rate of 12% due May 31, 2015. Terms of the loan provided for fees of $2,500 and required that the first $65,000 of the loan proceeds be used to fund expenses associated with our convertible preferred stock transaction and convertible senior notes and warrants transaction. This loan was repaid in May 2015.
Senior Convertible Notes and Warrants
On April 30, 2015, we entered into a $5,000,000 Securities Purchase Agreement (the “Debt SPA”) for the issuance of (i) senior convertible notes in the aggregate principal amount of $5,000,000 (the “Notes”), convertible into shares of our common stock and (ii) 2,709,360 warrants (the “Warrants”) to purchase shares of our common stock.
The investors had the right to purchase additional Notes and Warrants, up to $10,000,000.
The notes accrued interest at 7% (default rate 18%) per year on the full face amount of $5,000,000, with accelerated interest and principal payments, payable in five (5) monthly installments in cash and/or shares of our common stock, and mature on April 30, 2018. The Notes were convertible into shares of our common stock at an initial price of $1.62 per share, subject to market adjustments and “down round” reductions in the conversion price arising from future stock issuances at prices less than the conversion price.
The Warrants had a term of three years from issuance and were immediately exercisable to purchase shares of our common stock at an initial exercise price of $1.74 per share, subject to market adjustments and “down round” reductions in the conversion price arising from future stock issuances at prices less than the exercise price. Under certain circumstances, the holder of the Warrants may have elected a cashless exercise.
Pursuant to a letter agreement dated August 4, 2015, (i) all Notes became automatically (i.e., without any further action by us or the investors) null and void on October 11, 2015, (ii) the investors' right to purchase, and our obligation to issue, Additional Notes and Additional Warrants became automatically null and void on October 11, 2015.
On December 1, 2015, the warrants previously issued to the Series A Preferred stock investors were terminated and cancelled in exchange for 250,000 unrestricted shares of our common stock.
NOTE 10. LONG TERM DEBT
Long term debt consistsconsist of the following:
| December 31, 2016 | December 31, 2015 | |||||||
| RBL Capital Group, LLC | $ | 4,044,056 | $ | 3,965,000 | ||||
| MBF Merchant Capital, LLC | 520,303 | - | ||||||
| Less Current Portion | (808,976 | ) | (518,437 | ) | ||||
| Long Term Debt | $ | 3,755,383 | $ | 3,446,563 | ||||
December 31, 2018 | December 31, 2017 | |||||||
RBL Capital Group, LLC | $ | 6,512,268 | $ | 4,544,087 | ||||
Priority Payments Systems LLC | - | 2,238,511 | ||||||
MBF Merchant Capital, LLC | - | 341,804 | ||||||
Subtotal | 6,512,268 | 7,124,402 | ||||||
Less: deferred loan costs | (132,774 | ) | (108,980 | ) | ||||
Subtotal | 6,379,494 | 7,015,422 | ||||||
Less: current portion | (433,448 | ) | (2,493,973 | ) | ||||
Long term debt | $ | 5,946,046 | $ | 4,521,449 | ||||
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 (collectively, the “co-borrowers”), entered into a Loan and Security Agreement (“Credit Facility”) with RBL Capital Group, LLC (“RBL”), as lender (the “RBL Loan Agreement”). Pursuant to theThe 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 theprovided us with an 18-month, $10 million credit facility will carry a fixedwith interest rate ofat 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,Interest on drawn amounts outstanding after November 30, 2015 carry interest at an additional three percent per annum would be added to such interest rate, and for anyuntil repaid in full, with other amounts, obligations or payments due to RBL,carrying 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. At December 31, 2016 and 2015 we had $10,955,944 and $6,035,000 available on our RBL credit line. On May 2, 2016, we renewed our credit facilityCredit Facility with RBL, increasing the facility from $10 million to $15 million and extendedextending the term through February 2018.2019. At December 31, 2018, we had approximately $10.5 million available under the Credit Facility. This Credit Facility is for general working capital purposes or to support the growth of the co-borrowers, subject to the terms and conditions, as defined.
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,
Borrowings from the Credit Facility in the amounts of $3,315,000, $400,000 and $250,000 were previously converted into RBL term notes. Effective March 20, 2018, we entered into a $3,315,000 promissorysingle note with RBL. Net proceeds from the promissorya principal balance of $4,544,087 with RBL to effectively refinance all previously issued outstanding RBL notes, including certain additional term notes entered into with RBL through August 2017. The refinanced and combined note were used to repay a $3.0 million note previously due to MBF in addition to approximately $239,000provides for working capital. The promissory note required interest onlyfour (4) interest-only payments at 13.90% interest through January 2015 commencing on August 20, 2014 followed by14.19%, with monthly interest and principal payments of $90,421$85,634 from August 2018 through January 2019.July 2021, with a balloon payment of $3,170,967 in July 2021. The promissory note balance reducedback-end fees from prior notes in the amount available under our RBL credit line. The note also provided for a 2% front end fee due at execution of the$133,600 have been rolled into this note and a 4% backend feealso are due at the final payment of the note. At December 31, 2016, the promissory note balance was $0. 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 is $0.
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.
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.
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 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 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 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 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 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 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 December 31, 2016.2021.
On December 15, 2016,28, 2018, in connection with an addendum to that certain term loan made by TOT Group, Inc.in favor of RBL, the Credit Facility referred to above, we entered into a $325,000 term note with RBL. The term note provided forreceived funding of $2,131,500, bearing 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 paymentsan annual rate 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.14%. On December 20, 2016,2019 we are required to make one (1) payment of interest only for $18,804, followed by eleven (11) payments of interest only for $24,867. Effective January 20, 2020, we are required to make thirty-six (36) monthly payments, which includes principal and interest for $72,850, until December 20, 2022 the date this note was refinanced into another term note and its balance was $0 at December 31, 2016.loan matures.
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 provides for a $20,000 front end refinancing fee, due upon the execution of the loan and a $104,600 back end fee due at the final paymentCredit Facility that was renewed on May 20, 2021.2, 2016, allows the Company to have access to approximately $8.3 million for general working capital purposes.
MBF Merchant Capital, LLC
We issued the following notesnote payable to MBF, Merchant Capital, LLC (MBF), which isan entity owned by William Healy, a former member of our boardBoard of directors.
On March 28, 2016, we entered into a $75,000 promissory note with MBF. The promissory note provides for interest only payments at 14% through May 28, 2016. From June 28, 2016 through March 28, 2017, we are obligated to make interest and principal payments of $7,990. The promissory note also provides for a 6% backend fee due at the final payment of the promissory note. As of December 31, 2016, the balance of the note was $23,420.Directors.
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 December 31, 2016, the balance of the note was $221,826.
On July 1, 2016,August 29, 2017, our subsidiary, TOT Group, Inc., entered into a $353,500$275,000 promissory note with MBF. The promissory note provides forprincipal amount of the loan carries an interest only payments at 15.5% through June 28, 2016. From July 28, 2016 through June 28, 2018, we are obligated to makerate 13.95% per annum, with ten monthly interest and principal payments of $17,224.$29,289. The promissory note also provides forrequired payment of a 1% front end2% front-end fee at issuance and for a 6.6% back end4% back-end fee due at the final payment of the loan. At December 31, 2016 the remaining balance of thepayment. This note was $275,056.paid-off in 2018.
Crede CG III, Ltd.Priority Payment Systems LLC
OnEffective May 2, 2016,18, 2017, we entered into a Master Exchange Agreementloan agreement and security agreement with Crede CG III, LtdPriority Payment Systems LLC (“Crede”PPS”), an entity that purchased and issued a portion our previously issued promissory notes held by RBL.note dated May 18, 2017. Pursuant to the Master Exchange Agreement,loan agreement and the note, we haveborrowed $2,000,000. Prior to maturity of the loan, the principal amount of the loan will carry a floating interest rate of prime rate plus 6% per annum. The interest rate was 10.25% at December 31, 2018 and 2017, respectively. We may prepay the loan in whole or in part at any time. The loan is repayable in monthly installments consisting of principal plus interest. The loan matures and becomes due and payable in full on May 20, 2019 to the extent not repaid earlier.
Pursuant to the security agreement, the loan is secured by collateral consisting of accounts, cash or cash equivalents, residuals related to the merchants originated by us and processed by PPS. The loan agreement, the note and the security agreement contain customary representations, warranties, events of default, remedies and affirmative and negative covenants, as well as the right of first refusal and the right related to request exchanges upthe merchants.
Effective May 17, 2017, we entered into a corporate guaranty in favor of PPS, pursuant to $3,965,000which we unconditionally guaranteed the full and prompt payment of RBL promissory notes purchasedeach present and future liability, debt and obligation under the loan agreement, the note, the security agreement and other related documents.
On June 27, 2017, we entered into an amendment to the loan agreement with PPS pursuant to which:
(i) | The original term loan was modified into a multi - draw loan with an increase of the borrowing limit to $2,500,000 and; |
(ii) | The loan maturity was extended to May 20, 2021. |
The draw-down period was extended to coincide with the loan maturity date of May 20, 2021.
Scheduled Notes Payable Principal Repayment at December 31, 2018 is as follows:
2019 | $ | 433,448 | ||
2020 | 1,113,323 | |||
2021 | 4,154,137 | |||
2022 | 811,360 | |||
2023 | - | |||
Balance December 31, 2018 | $ | 6,512,268 |
NOTE 9. CONCENTRATIONS
Credit card processing revenues are from merchant customer transactions, which were processed primarily by Crede for shares ofone third-party processor (greater than 5%) and our common stock. Also, see Note 18. Subsequent Events.own dedicated bank identification number ("BIN")/Interbank Card Association ("ICA") number during the years ended December 31, 2018 and 2017.
For the year ended December 31, 2016,2018, we exchanged 1,663,402 sharesprocessed 61% 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 $1.68. The exchanges also settled current interest and loan fees of $302,294 and a non-cash exchange premium of $487,064. A summary of these exchanges for the year ended December 31, 2016 is as follows:
| Date | Shares Issued | Exchange Price | Principal Reduction | Interest, Fees & Fair Value Charges | ||||||||||||
| May 2, 2016 | 97,857 | $ | 2.87 | $ | 250,000 | $ | 63,142 | |||||||||
| May 9, 2016 | 91,744 | 2.72 | 237,367 | 56,214 | ||||||||||||
| May 16, 2016 | 66,405 | 2.57 | 162,633 | 36,581 | ||||||||||||
| June 9, 2016 | 99,025 | 2.02 | 148,341 | 83,378 | ||||||||||||
| June 23, 2016 | 57,663 | 1.73 | 88,479 | 28,000 | ||||||||||||
| June 30, 2016 | 62,596 | 1.60 | 85,050 | 30,123 | ||||||||||||
| July 8, 2016 | 125,220 | 1.60 | 178,650 | 56,762 | ||||||||||||
| July 22, 2016 | 164,603 | 1.82 | 284,567 | 79,200 | ||||||||||||
| August 4, 2016 | 52,791 | 1.89 | 80,671 | 34,939 | ||||||||||||
| August 9, 2016 | 104,942 | 1.91 | 182,012 | 50,961 | ||||||||||||
| August 12, 2016 | 103,617 | 1.93 | 184,114 | 50,059 | ||||||||||||
| August 31, 2016 | 156,546 | 1.28 | 177,893 | 61,619 | ||||||||||||
| September 9, 2016 | 90,138 | 1.11 | 86,749 | 28,629 | ||||||||||||
| September 16, 2016 | 194,175 | 1.03 | 181,825 | 82,253 | ||||||||||||
| November 8, 2016 | 98,040 | 1.02 | 81,363 | 28,441 | ||||||||||||
| November 14, 2016 | 98,040 | 1.02 | 89,767 | 19,057 | ||||||||||||
| Totals | 1,663,402 | $ | 1.76 | $ | 2,499,481 | $ | 789,358 | |||||||||
Cayman Invest, S.A.
On April 21, 2014, we had a Stock Subscription Receivable from Cayman Invest, S.A. (“CI”) associated with the issuance of a secured convertible senior promissory note. During 2015, we wrote off $1,111,130 for amounts that were not funded by CI.
Scheduled Debt Principal Repayment
Scheduled principal maturities on indebtedness at December 31, 2016 is as follows:
| 2017 | $ | 808,976 | ||
| 2018 | 1,046,973 | |||
| 2019 | 1,010,396 | |||
| 2020 | 1,163,015 | |||
| 2021 | 534,999 | |||
| Balance December 31, 2016 | $ | 4,564,359 |
NOTE 11. CONCENTRATIONS
The Company’s total revenue was $54,286,859 and $40,235,362 for the years ended December 31, 2016 and 2015 respectively.
Of the $54,286,859 in 2016 revenues, $48,784,854 (which also includes its newly acquired PayOnline Systems) was derived from processing of Visa®, MasterCard®, Discover® and American Express® card transactions and $5,502,004 was derived from providing branded content during 2016.
Of the $40,235,362 in 2015 revenues, $31,204,871 (which also includes its newly acquired PayOnline Systems) was derived from processing of Visa®, MasterCard®, Discover® and American Express® card transactions and $9,030,491 was derived from providing branded content during 2015.
The credit card processing revenues were from merchant customer transactions, which are processed primarily by two third-party processors (greater than 5%) during 2016 and two “third-party” processors (greater than 5%) during 2015. For the twelve months ended December 31, 2016, the Company processed 69% of its total revenue with Priority DataPayment Systems, and 6% of its total revenue20% from our own dedicated BIN/ICA with National Processing Company (NPC) and during 2015, and 51% of its total revenue was processed with Priority Data, and 10% was processed with National Processing Company (NPC).
Esquire Bank.
Mobile electronic payment revenues are generated from merchant customer transactions which are processed primarily by two mobile operators during the twelve months ended December 31, 2016 and during the twelve months ended December 31, 2015. For the year ended December 31, 2016, the Company2017, we processed 4%77% of itsour total revenue with Mobile Internet SolutionsPriority Payment Systems and 3%5.2% from our own dedicated BIN/ICA with Esquire Bank.
NOTE 10. COMMITMENTS AND CONTINGENCIES
Minimum Processing Commitments
We have non-exclusive agreements with HelpLine. Duringseveral processors to provide services related to transaction processing and transmittal, transaction authorization and data capture, and access to various reporting tools. Certain of these agreements require us to submit a minimum monthly number of transactions for processing. If we submit a number of transactions that is lower than the twelve months endedminimum, we are required to pay to the processor the fees it would have received if we had submitted the required minimum number of transactions. As of December 31, 2015, the Company processed 9% of its total revenue with Beeline (OJSC Vimpelcom) and 5% of its total revenue with MTS (Mobile TeleSystems OJSC).2018, such minimum fee commitments were as follows:
2019 | $ | 558,700 | ||
2020 | 614,300 | |||
2021 | 670,730 | |||
2022 | 60,000 | |||
2023 | 70,000 | |||
Thereafter | 80,000 | |||
Total | $ | 2,053,730 |
Leases
NOTE 12. COMMITMENTS AND CONTINGENCIESNorth American Transaction Solutions
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 and a balloon payment of $1.8 million in May 2017. As a result, for the twelve month period ended December 31, 2016, we recorded an additional charge of $125,806 to adjust the accrual relating to the stock price guarantee obligation to the amount agreed to in such settlement agreement and a charge of $125,887 for the related interest. In addition, 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 during the first half of 2017, and we have recorded a charge in this amount.
Leases
InDuring May 2013, we entered into a lease agreement, for approximately 4,7164,101 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 The lease was extended for a period of five years commencing JanuaryAugust 1, 2017 and expiring DecemberJuly 31, 20212022 with equal monthly base rent increasing each year from $20,421 per month beginning January 1, 2017installments of $14,354 ($245,046172,248 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.plus sales tax.
NetLabs Systems, LLC, through its Russian representative office,Net Element Software, our subsidiary, currently leases 1,654 square feet of office space in Yekaterinburg, Russia, where it conducts Value Added Serviceswe develop value added services, mobile applications, smart terminals applications, sales central ERP system development and Sales Central CRM developmentmarketing activities, at an annual rent of approximately $24,300. The currentlease was renewed on same terms and the lease term expires inon June 1, 2017.2019.
International Transaction Solutions
PayOnline Systems leasesleased approximately 5,0904,675 square feet of office space in Moscow, Russia at an annual rent of $141,867. The current lease term for the office$84,457 which expired on September 30, 2018. This space expires on July 15, 2017. For the first regional office, PayOnline leases approximately 276was reduced to 3,385 square feet of office space in Ekaterinburg, Russiaand renewed at an 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. $56,000 expiring on August 31, 2019.
We believe that theseour current facilities are suitable and adequate for our anticipated needs.present purposes, and we anticipate that we will be able to extend our existing leases on terms satisfactory to us or move to new facilities on acceptable terms.
Net Element Russia leases approximately 2,033 square feetFuture maturities of office spacelease agreements are as follow:
| 2019 | $ | 238,548 | ||
2020 | 172,248 | |||
2021 | 172,248 | |||
2022 | 100,478 | |||
Total | $ | 683,522 |
Litigation, Claims, and Assessments
With respect to all legal, regulatory and governmental proceedings, and in Moscow, Russia at annual rentaccordance with ASC 450-20, Contingencies—LossContingencies, we consider the likelihood of $73,960, as well as one corporate apartment at annual renta negative outcome. If we determine the likelihood of $22,600. The current lease terma negative outcome with respect to any such matter is probable and the amount of the loss can be reasonably estimated, we record an accrual for the office space expires on January 31, 2018estimated amount of loss for the expected outcome of the matter. If the likelihood of a negative outcome with respect to material matters is reasonably possible and we expectare able to renew this lease at that time. The current lease term fordetermine an estimate of the corporate apartment expiresamount of possible loss or a range of loss, whether in excess of a related accrued liability or where there is no accrued liability, we disclose the estimate of the amount of possible loss or range of loss. However, management in some instances may be unable to estimate an amount of possible loss or range of loss based on August 16, 2017. We believe thatthe significant uncertainties involved in, or the preliminary nature of, the matter, and in these facilitiesinstances we will disclose the nature of the contingency and describe why we are adequate for our anticipated needs.unable to determine an estimate of possible loss or range of loss.
LitigationIn addition, we are involved in ordinary course legal proceedings, which include all claims, lawsuits, investigations and proceedings, including unasserted claims, which are probable of being asserted, arising in the ordinary course of business and otherwise not described below. We have considered all such ordinary course legal proceedings in formulating our disclosures and assessments.
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 our stock. Aptito, LLC acquired Aptito.com, Inc. in exchange for, among other things, 125,000 shares (prior to adjustment for two one-for-ten reverse stock splits) of Net Element, Inc.our stock. There has been disagreementdisagreements among the Aptito.com, Inc. shareholders as to proper distribution of the 125,000 shares.shares (prior to adjustment for two one-for-ten reverse stock splits). To avoid any liability in regards to improper distribution, Aptito, LLC filed the interpleader action so as to allow the defendantsDefendants to litigate amongst themselves as to how the shares (prior to adjustment for two one-for-ten reverse stock splits) should be distributed. Aptito.com, Inc. opposesopposed the motion to interplead and has filed counterclaims relative to Aptito, LLC for non-delivery of the 125,000 shares. shares (prior to adjustment for two one-for-ten reverse stock splits) .
On February 10,July 18, 2017, the Court held a hearing on Aptito.com, Inc.’sgranted Aptito LLC’s motion to dismiss the complaintinterplead 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 soon holdAptito, LLC could not be held liable for any alleged damages relative to the purported non-delivery of the 125,000 shares after the interpleader action was filed on August 6, 2014.
In March 2018, a hearing onnew Judge in the motioncase ruled that Aptito.com, Inc. was entitled to interplead. Ifreceive 125,000 newly issued shares of our common stock, but indicated that he was not ruling that we were required to issue such shares. We plan to appeal this ruling, and our legal counsel is addressing the motioncounterclaims filed by Aptito.com, Inc. in this matter.
In July 2018, our counsel was disqualified due to interpleada conflict of interest. We engaged a new law firm to represent our ongoing interests in this case. Since that time, there have been multiple Motions and claims brought by Aptito.com, Inc., including the request for rescission of the asset purchase agreement that gave rise to the share issuance obligation. All of these Motions and claims are being vigorously defended. There is granted, ita court ordered mediation conference that 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 21, 2017, Aptito.com, Inc. filed several counterclaims against Aptito, LLC and us, which we are disputing and will defend.held sometime in April 2019.
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 andinjunction. 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.
In 2018, the Company filed a motion to enforce the injunction and contempt orders against Zell. The court upheld the injunction and the Company continues to vigorously protect its interests.
OVHA Patent Claim
On January 15, 2019, OVHA, Inc. filed a lawsuit against Unified Payments, LLC, a previous subsidiary of the Company that is no longer operating. The lawsuit which is most likely intended against our subsidiary TOT Payments, LLC dba Unified Payments (“Unified”) alleges that Unified’s Mobile POS infringes upon a patent held by OVHA. The alleged infringing part of the POS equipment is produced by a 3rd party vendor. We intendhave engaged Intellectual Property counsel to protect our rights by ongoing enforcement of the Injunction.interests in this matter.
Other Legal ProceedingsMatters
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 13. RELATED PARTY TRANSACTIONS
On March 31, 2015, Star Equities, LLC (“Star”) provided a $125,000 advance to pay certain expenses. The loan was repaid in May 7, 2015. In addition, we received non-interest bearing advances from Star Equities, LLC, in the aggregate approximately $745,000 in 2015 and $117,000 in 2016. Oleg Firer, our CEO, is the Chairman and managing member of Star.
Effective March 28, 2016,During December 2017, we entered into a $75,000letter of intent with Bunker Capital (“Bunker”) for the development of block-chain technology-based solutions, and we made a prepayment of 19,000 shares of our common stock. On February 26, 2018, we terminated the relationship with Bunker as the parties did not reach a definitive agreement, and, as part of such termination, we asked Bunker to return such shares of our common stock. The value of these shares were recorded as other expense for approximately $221,000 during the first quarter of 2018. During the fourth quarter of 2018, we reached a settlement in-full satisfaction with Bunker, whereby we received a cash payment of $50,000.
NOTE 11. RELATED PARTY TRANSACTIONS
We and our subsidiary, TOT Group, Inc., previously entered into certain term loan notenotes with MBF, Merchant Capital, LLC (“MBF”("MBF"), which were paid off during the year ended December 31, 2018 (See Note 8). The loan provides for interest only payments at 14% through May 28, 2016. From June 28, 2016 through March 28, 2017, we are obligated to make interest and principal payments of $7,990. The loan also providedMBF is a 6% backend fee due at the final payment of the loan. MBF of whichcompany owned by William Healy, a former member of our Board of Directors, is the sole member. As of December 31, 2016, $23,420 remains outstanding.Directors.
Effective April 19, 2016,On March 1, 2017, we entered into a $300,000 term loanpromissory note with MBF.Star Equities, LLC, an entity which our Chairman and CEO is the managing member, in the principal amount of $348,083 (the “Star Equities Note”). The loanStar Equities Note provides for 18 monthly interest only payments (bearing interest at 15.5%12% annually) of $3,481 through May 28, 2016. From June 28, 2016 through May 28,September 30, 2018 we are obligated to makefollowed by one interest and principal payments of $14,617. The loan also providedprinciple payment on October 1, 2018. On October 20, 2017, the Company entered into and consummated a 6% back end fee due atletter agreement with Star Equities, LLC (the “Exchange Agreement”). Pursuant to the final paymentExchange Agreement, the entire outstanding amount including accrued and unpaid interest totaling $374,253 was exchanged into 67,312 restricted shares of the loan. As of December 31, 2016, $221,826 remains outstanding.
Effective July 1, 2016, our subsidiary, TOT Group, Inc., entered into a $353,500 term loan note with MBF.Company’s common stock, based on such shares’ consolidated closing bid price on The loan 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 loan also provided a 1% front end fee and a 6.6% back end fee due atNASDAQ Stock Market on the final paymentdate of the loan. As of December 31, 2016, $275,056 remains outstanding.Exchange Agreement (See Note 12).
During 2015the years ended December 31, 2018 and 2016, indirect2017, agent commissions resulting from merchant processing of $108,567approximately $72,000 and $98,000, respectively, were paid to Prime Portfolios, LLC, an entity owned by Oleg Firer, our Chairman and CEO, and Steven Wolberg, our Chief Legal Officer. In addition, key members of management owned companies received similar commissions and/or reimbursement for equipment purchased on the company’s behalf, amounted to approximately $739,000 and $346,000 for the years ended December 31, 2018 and 2017, respectively.
At December 31, 2018 and 2017, we had accrued expenses of approximately $388,000 and $462,000, respectively, which consisted primarily of various travel, professional fees, and other expenses paid and charged for by our CEO on his personal credit cards. This is reflected as due to related party on the accompanying consolidated balance sheets.
NOTE 14.12. STOCKHOLDERS’ EQUITY
On May 25, 2016,October 5, 2017, we effected aan one-for-ten reverse stock split of our common stock. Our condensed consolidated financial statements and disclosures reflect for this changethese changes 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. On October 2, 2017, our shareholders approved a 300,000,000 decrease in our authorized common stock to 100,000,000.
Convertible Preferred Stock, Series AAgreement with Cobblestone
On April 30, 2015, weJuly 5, 2017, the Company entered into a $5,500,000 Securitycommon stock purchase agreement (the “Cobblestone Purchase Agreement forAgreement”) with Cobblestone Capital Partners LLC (“Cobblestone Capital”) which provided that, upon the issuanceterms and subject to the conditions and limitations set forth therein, Cobblestone Capital was committed to purchase up to an aggregate of 5,500 shares$10 million of Series A Convertible Preferred Stock. The Series A Convertible Preferred Stock paid dividends at 9% (default rate 18%) per year on the full face amount of $5,500,000, and required accelerated principal redemption and dividends payments to be made monthly in cash and/or shares of our common stock through October, 2015, and maturedover the 30-month term of the Cobblestone Purchase Agreement. In consideration for entering into the Cobblestone Purchase Agreement, we were obligated to issue to Cobblestone Capital such number of shares of common stock that would have a value equivalent to $200,000 calculated using the average of volume weighted average price for the common stock during the 3 trading days period immediately preceding the date of issuance of such shares. Accordingly, on April 20, 2017. The Series A Convertible Preferred Stock initially was convertible intoAugust 3, 2017, we issued to Cobblestone Capital 45,676 shares of common stock based on a price of $4.38 per share. In connection with this Cobblestone Purchase Agreement, we issued approximately 1.3 million shares of our common stock during 2017 for an approximate amount of $6.2 million, at $1.74an average price of $4.71 per share, subject to market adjustments and “down round” reductions in the conversion price arising from future stock issuances at prices less than the conversion price.share.
The conversion rights embedded in the Series A Convertible Preferred Stock were at a conversion price below-market, and subject to further market price adjustments and “down round” provisions. As a result, the beneficial conversion feature (“BCF”) was accounted for as a derivative financial instrument and was valued at date of issuance using the Black- Scholes-Merton options pricing model, resulting in a recorded value of $212,918 at the time of issuance.
During the year ended December 31, 2015, the holders of Series A Convertible Preferred Stock converted their 5,500 shares for 3,988,935 shares of our common stock. Pursuant to the agreement, we issued an additional 420,805 shares of our common stock resulting in a $1,346,648 charge for the value of the shares issued. Additionally, we recorded preferred stock dividends of $1,585,092 for this transaction.
Equity Incentive Plan Activity
On December 5, 2013, our shareholders approved the Net Element International, Inc. 2013 Equity Incentive Plan (the(as amended to date, the “2013 Plan”). Awards under the 2013 Plan may be granted in any one or all of the following forms: (i) incentive stock options (“Incentive Stock Options”) meeting the requirements of Section 422 of the Internal Revenue Code of 1986, as amended (the “Code”);amended; (ii) non-qualified stock options (“Non-Qualified Stock Options”) (unless otherwise indicated, references to “Options” include both Incentive Stock Options and Non-Qualified Stock Options); (iii) stock appreciation rights, (“Stock Appreciation Rights”), which may be awarded either in tandem with Options (“Tandem Stock Appreciation Rights”) or on a stand-alone basis (“Nontandem Stock Appreciation Rights”);basis; (iv) shares of common stock that are restricted (“Restricted Shares”);restricted; (v) units representing shares of common stock (“Performance Shares”);stock; (vi) units that do not represent shares of common stock but which may be paid in the form of common stock (“Performance Units”);stock; and (vii) shares of common stock that are not subject to any conditions to vesting (“Unrestricted Shares”). vesting.
On November 27, 2018, our shareholders approved an amendment to the 2013 Plan to increase the number of shares of the Company’s common stock available for issuance by 178,900 shares resulting in the aggregate of 773,000 shares authorized for issuance under the 2013 Plan, which represents in the aggregate approximately 20% of our issued and outstanding stock as of December 31, 2018.
The maximum aggregate number of shares of common stock available for award under the 2013 Plan at December 31, 20162018 and 2017 was 1,280,258, subject to adjustment as provided for in the 2013 Plan.323,498 and 168,374, respectively. The 2013 Plan is administered by the compensation committee.
On December 10, 2014, the Compensation Committee of the Board of Directors of the Company approved and authorized the issuance of 1,807,921 restricted shares of common stock and 119,194 incentive stock options to various employees for services performed during 2013 – 2015 and recorded a compensation charge of $1,684,534 for the 2013 – 2014 portions of these grants. An additional $897,800 of non-cash compensation expense was recognized during 2015.
2013 Equity Incentive Plan - Unrestricted Shares and Stock Options
During the twelve monthsyears ended December 31, 20162018 and 2015,2017, we issued common stock pursuant to the Net Element International, Inc. 2013 Equity Incentive Plan (as amended, the “2013 Plan”) to the members of our Board of Directors and recorded compensation charges of $7,363 and $87,000, respectively.
On June 13, 2016, we issued 475,000 shares of our common stock to named executives as additional compensation. We recorded a compensation charge of $1,007,000 for the fair value of shares provided.
2013 Equity Incentive Plan - Stock Options
On December 8, 2015, we issued 316,735 incentive stock options with an exercise price of $2.40 per share. The options have a 10-year life$85,786 and we recorded compensation expense of $996,598 at time of issuance for the Black-Scholes value of options provided.
On April 12, 2016, the compensation committee of the Board of Directors rescinded previously granted incentive stock options to purchase approximately 1.6 million shares of our common stock, as the amounts granted were inadvertently in excess of individual grant limitations set forth in the 2013 Plan documents.
On June 13, 2016, we issued 182,408 incentive stock options pursuant to the 2013 Plan to key management. The option strike price is $2.12 and the term of the option is 10 years. We recorded a non-cash compensation charge of $386,705 in connection with this issuance.
In September, 2016, we issued 70,310 shares as incentive compensation to employees and recorded a non-cash compensation charge of $532,701.$130,499, respectively.
At December 31, 2016,2018 and 2017, we had 333,95674,004 incentive stock options outstanding with a weighted average exercise price of $2.60$15.52 and a weighted average remaining contract term of 9.18 years.7.77 years and 8.77 years, respectively. All of the stock options were out-of-the-money and had no intrinsic valueanti-dilutive at December 31, 2016.
See Note 18. Subsequent Events, for awards granted after December 31, 2016.
Equity Issuances – Insider Financing2018 and 2017.
On September 11, 2015,February 28, 2017, the Company entered into the Letter Agreement with certain accredited investors, including Star Equities, LLC, of which our Chief Executive Officer, Oleg Firer is managing member and chairman of the board, Steven Wolberg, our Chief Legal Officer and Secretary, William Healey, a memberCompensation Committee of our Board of Directors approved and Kenges Rakishev, Chairmanauthorized grants of the following equity awards to our employees and consultants of the Company pursuant to the 2013 Plan:
(i) | 45,105 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) | 62,668 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). |
On December 28, 2017, the Compensation Committee of our Board of Directors approved and authorized grants for 134,161 fully vested, incentive equity awards to our employees, directors and consultants pursuant to the 2013 Plan.
Agreement with Crede CG III, Ltd.
On May 2, 2016, we entered into a significant shareholder (together, the “Investors”Master Exchange Agreement with Crede (the “Master Exchange Agreement”)., an entity that purchased a portion our previously issued notes held by RBL. Pursuant to the LetterMaster Exchange Agreement, we have the Investors purchased fromright to request that Crede exchange up to $3,965,000 of the Company an aggregate of (i) 11,357,143 restrictedRBL promissory notes for shares of Common Stock (the “Restricted Shares”)our common stock. On March 3, 2017, we entered into an Amendment to be issued inMaster Exchange Agreement with Crede, which extended the future and (ii) options to purchase 11,357,143 restricted shares of Common Stock, (the “Restricted Options”). The per share purchase price of each Restricted Share was $0.14 for an aggregate purchase price of $1,590,000. The Restricted Options will expire on the fifth (5th) annual anniversary of theexpiration date of the Letter Agreement. Prior to expiration, each Restricted Options is exercisable into one Restricted Share at the exercise price equal 110% of the closing trading price per one share of Common Stock reported on The NASDAQ Capital Market on the date of the Letter Agreement. Each Investor may elect to exercise it or his Amended Restricted Option through a cashless exercise.
On October 7, 2015, the Investors and the Company entered into an agreement to modify certain terms of the LetterMaster Exchange Agreement relating to the Restricted Shares. Pursuant to such agreement, the parties agreed that the Restricted Shares would not be issued to the Investors until the Company’s stockholders approved the issuance of the Restricted Shares. In addition, on October 7, 2015, certain of the Investors and the Company entered into an agreement to modify the terms of the Restricted Options. Pursuant to such agreement, the parties agreed that the Restricted Options cannot be exercised by the Investors until the Company’s stockholders approve the issuance of common stock in connection with any such exercise. Such stockholder approval was obtained at a special meeting of the Company’s stockholders on November 14, 2015.
On January 21, 2016, the Company entered into a Second Additional Letter Agreement, as amended on April 14, 2016 (the “Second Additional Agreement”) with Kenges Rakishev. The Second Additional Agreement further modified the terms of the Letter Agreement, as amended. The Second Additional Agreement provided for the second and final round of $910,000 equity financing to the Company contemplated by the Letter Agreement in consideration for the issuance by the Company on June 13,from December 31, 2016 to Kenges Rakishev of (i) 466,428 restrictedAugust 31, 2017. Accordingly, this extended the time to which we had the right to request Crede to exchange previously issued RBL promissory notes for shares of the Company’s common stock based on $1.95 per share pricethe terms and (ii) options to purchase 466,428 restrictedconditions as set forth in the Master Exchange Agreement.
For the year ended December 31, 2017, we exchanged 60,944 shares of the Company’sour common stock with a strikeCrede for an aggregate of $330,969 of the original $3,315,000 RBL promissory note partially purchased by Crede, based on an average per share exchange price of $2.15 and$6.83. The exchange included a 5 year life.non-cash exchange premium $52,972.
Share Issuances -Agreements 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”), in which provides that ESOUSA is committed to purchase up to an aggregate of $10 million of our shares of common stock over the 30- month30-month term of the Purchase Agreement. In consideration for entering into the Purchase Agreement, we paidissued shares of our common stock with a value equivalent to $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,
In connection with the aforementioned ESOUSA Purchase Agreement, we issued 131,171the 168,266 shares of our common stock at an average per share price of $8.45 to ESOUSA based onduring the price of $1.52 per share.year ended December 31, 2017. There were no shares issued in connection with this Purchase Agreement for the year ended December 31, 2018.
On September 15, 2016,December 29, 2017, we issued 454,546entered into, and consummated a unit purchase agreement with ESOUSA. Pursuant to the unit purchase agreement, we sold to ESOUSA (i) 350,553 shares of our common stock, par value $0.0001, at a purchase price of $11.12 per share (i.e., a price equal to ESOUSA forthe our consolidated closing bid price per share as reported by the Nasdaq); (ii) an aggregate price of $500,000, or $1.10 per share in accordance with the Purchase Agreement. On October 25, 2016, we issued 94,340404,676 five-year warrants to purchase shares of our common stock to ESOUSA forat a purchase price of $0.125 per share and exercise price of $11.12 per share; and (iii) an aggregate price of $100,000, or $1.06 per share in accordance with the Purchase Agreement.
See Note 18. Subsequent Events, for equity issuances323,907 five-year pre-paid warrants to ESOUSA after December 31, 2016.
Share Issuances - Crede CG III, Ltd.
On May 2, 2016, we entered into a Master Exchange Agreement with Crede CG III, Ltd., an entity that purchased a portion our previously issued notes held by RBL. 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 forpurchase shares of our common stock.stock with exercise price of $0.01 per share. The aggregate purchase price for the securities was approximately $7.6 million.
DuringOther Stock Issuances
On July 19, 2017, we issued 30,759 shares for a $252,223 partial settlement of our $1.4 million reserve liability assumed with the PayOnline acquisition (See Note 7).
On February 28, 2017, the Compensation Committee of our board of directors awarded to Oleg Firer, our Chairman and Chief Executive Officer, 47,139 restricted shares of our common stock as a performance bonus, which shareholders approved October 2017. The share award was made outside the 2013 Plan and these shares were issued in October 2017. In addition, the Compensation Committee approved a $300,000 discretionary cash performance bonus to Oleg Firer which was paid in March, 2018.
On October 20, 2017, the Company entered into and consummated the Exchange Agreement with Star Equities, LLC relating to the Star Equities Note (see Note 11). Pursuant to the Exchange Agreement, the entire outstanding amount of the Star Equities Note including accrued and unpaid interest totaling $374,253 was exchanged into 67,312 restricted shares of the Company’s common stock, based on such shares’ consolidated closing bid price on The NASDAQ Stock Market on the date of the Exchange Agreement.
NOTE 13. WARRANTS AND OPTIONS
Options
In February 28, 2017, we granted options to acquire 45,106 shares of common stock at an exercise price of $8.10 per share over a 10-year term.
At December 31, 2018 and 2017, we had fully vested options outstanding to purchase 234,218 shares of common stock, net of 4,497 options which have expired, at exercise prices ranging from $8.10 to $134.00 per share. The remaining contractual life of these options range from 8.17 to 1.70 years as of December 31, 2018.
Due to the high level of volatility in the stock price of our common stock, our management determined the grant date fair value of the options granted during the year ended December 31, 2016, we exchanged $2,801,776 of outstanding RBL promissory notes and associated fees for 1,663,402 shares of our common2017 using the then quoted stock (See Note 10).price at the grant date. There were no options granted during 2018.
Other Share IssuancesWarrants
On January 25, 2016, we issued 42,565 shares of our common stock in connection with the earn-out provisions of our acquisition of PayOnline. See Note 18. Subsequent Events, for additional earn-out shares issued after December 31, 2016.
On August 15, 2016, we issued 95,694 shares of our common stock and recorded a $200,000 charge in connection with the Orkin litigation settlement (see Note 12. Commitments and Contingencies)
NOTE 15. 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 894,00089,400 shares (reverse split adjusted) of common stock in connection with its private placement and initial public offering. offering (the “Prior Warrants”). These Prior Warrants expired on October 1, 2017.
In connection with the aforementioned unit purchase agreement with ESOUSA, on December 29, 2017 we issued (i) an aggregate of 404,676 five-year warrants to purchase shares of Company common stock at a purchase price of $0.125 per share and exercise price of $11.12 per share; and (ii) an aggregate of 323,907 five-year pre-paid warrants to purchase shares of Company common stock with an exercise price of $0.01 per share.
At December 31, 20162018 and 2015,2017, we had warrants outstanding to purchase 893,890728,583 shares of common stock.stock, net of 89,389 warrants that have expired. At December 31, 2016, the2018, these warrants havehad a weighted average exercise price of $75.00$6.18 per share purchased and a weighted average remaining contractual term of 0.75 years (1.75 years at December 31, 2015). These4 years. There were no warrants are “out-of-the-money” and have no intrinsic value at December 31, 2016 and 2015. 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.granted during 2018.
On April 30, 2015, in connection with our issuance
Non-Incentive Plan Options
At December 31, 2016,2018 and 2017, we had 1,602,142323,498 non-incentive options outstanding with ana weighted-average exercise price of $2.18 and$21.84. The non-incentive options have a remaining contract term of 3.92 years.1.92 years at December 31, 2018. These options were out of the money at December 31, 20162018 and 2017 and had no intrinsic value.
NOTE 16.14. INCOME TAXES
The components of income (loss) before income tax provision are as follows:
| December 31, | December 31, | December 31, | December 31, | |||||||||||||
| 2016 | 2015 | 2018 | 2017 | |||||||||||||
| United States | $ | (11,615,285 | ) | $ | (11,748,447 | ) | $ | (11,214,581 | ) | $ | (7,865,421 | ) | ||||
| Foreign | (2,000,791 | ) | (1,579,479 | ) | 7,206,912 | (2,157,628 | ) | |||||||||
| $ | (13,616,076 | ) | $ | (13,327,926 | ) | $ | (4,007,669 | ) | $ | (10,023,049 | ) | |||||
There was no current U.S. income tax or deferred income tax provision for years ended December 31, 20162018 and December 31, 2015.2017. There were current foreign tax provisions of $49,375$67,002 and $79,000$70,033 for the years ended December 31, 20162018 and December 31, 2015 respectively.2017, respectively, which are included as part of accrued expenses.
The following is a reconciliation of the effective income tax rate with the U.S. federal statutory income tax rate at December 31, 2015 and December 31, 2016:at:
| December 31, | December 31, | December 31, | December 31, | |||||||||||||
| 2016 | 2015 | 2018 | 2017 | |||||||||||||
| U. S. Federal statutory income tax rate | 34.0 | % | 34.0 | % | 21.00 | % | 34.00 | % | ||||||||
| State income tax, net of federal tax benefit | 4.1 | % | 4.1 | % | 5.10 | % | 4.10 | % | ||||||||
| Debt Extinguishment | 0.0 | % | 0.0 | % | ||||||||||||
| Currency translation adjustment | -0.9 | % | 3.9 | % | 5.20 | % | (2.20 | %) | ||||||||
| Stock based compensation related permanent differences | 0.0 | % | -5.9 | % | ||||||||||||
| Dividend on preferred stock related permanent differences | 0.0 | % | -3.6 | % | ||||||||||||
| Foreign taxes | -0.4 | % | -0.5 | % | ||||||||||||
Foreign income tax | 1.70 | % | (0.90 | %) | ||||||||||||
| Difference in foreign tax rates | 3.4 | % | 0.1 | % | (2.10 | %) | 5.20 | % | ||||||||
| Change in valuation allowance | -40.5 | % | -32.7 | % | (29.20 | %) | (28.90 | %) | ||||||||
Change in tax rates | - | (12.20 | %) | |||||||||||||
| Effective income tax rate | -0.4 | % | -0.5 | % | 1.7 | % | (0.90 | %) | ||||||||
The effective tax rate on operations of -0.3%1.7% at December 31, 20162018 varied from the statutory rate of 34%21%, primarily due to the permanent difference related to difference in foreign tax rates and the increase in our valuation allowance. The effective rate on operations of -0.6%-0.9% at December 31, 20152017 varied from the statutory rate of 34% primarily due to dividends paid on preferred stock, stock based compensationthe permanent difference related to difference in foreign tax rates and the increase in our valuation allowance.
On December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act” (TCJA) that significantly reformed the Internal Revenue Code of 1986, as amended. The TCJA, among other things, reduces the corporate tax rate to 21 percent beginning with years starting January 1, 2018. Because a change in tax law is accounted for in the period of enactment, the deferred tax assets and liabilities have been adjusted to the newly enacted U.S. corporate rate, and the related impact to the tax expense has been recognized in the current year.
A new federal tax on Global Intangible Low – Taxed Income (GILTI) was enacted for the tax year beginning after December 31, 2017. The GILTI rules require US corporations to include in taxable income current year net earnings of their foreign subsidiaries that are controlled foreign corporations.
Significant components of our deferred tax assets and liabilities as of December 31, 2016 and December 31, 2015 are as follows:
| December 31, | December 31, | December 31, | December 31, | |||||||||||||
| 2016 | 2015 | 2018 | 2017 | |||||||||||||
| Deferred tax assets: | ||||||||||||||||
| Net operating loss carry forwards | $ | 19,556,555 | $ | 17,086,460 | $ | 15,657,776 | $ | 14,800,451 | ||||||||
| Stock based compensation | 906,087 | 572,004 | (356,049 | ) | 741,275 | |||||||||||
| Contingent legal expenses | 0 | 235,259 | ||||||||||||||
| Basis difference in goodwill | 2,604,306 | 3,038,988 | 1,161,577 | 1,471,976 | ||||||||||||
| Basis difference in fixed assets | 19,899 | 62,710 | - | 8,792 | ||||||||||||
| Basis difference in intangible assets | 1,714,761 | 1,447,782 | 1,564,483 | 1,313,547 | ||||||||||||
Allowance for bad debt (US) | - | - | ||||||||||||||
| Stock price guarantee adjustment | 1,416,870 | 0 | - | - | ||||||||||||
| Valuation allowance for deferred tax assets | (26,218,478 | ) | (22,443,203 | ) | (18,027,787 | ) | (18,336,041 | ) | ||||||||
| Total deferred tax assets | - | - | - | - | ||||||||||||
| Deferred tax liabilities: | ||||||||||||||||
Basis difference in goodwill | - | - | ||||||||||||||
| Basis difference in fixed assets | - | - | - | - | ||||||||||||
| Basis difference in intangible assets | - | - | - | - | ||||||||||||
| Total deferred tax liabilities | - | - | - | - | ||||||||||||
| Net deferred taxes | $ | - | $ | - | $ | - | $ | - | ||||||||
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts of assets and liabilities used for income tax purposes. According to the GILTI rules, the income from foreign corporations reduce the net operating losses (‘NOLs”). At December 31, 2016, we had cumulative federal and state net operating losses (“NOLs”) carry forwards of approximately $51.4 million. At December 31, 2015,2018, we had cumulative federal and state NOLs carry forwards of approximately $44.9$67.3 million. At December 31, 2017, we had cumulative federal and state NOLs carry forwards of approximately $56.8 million. We also have $11.9$6.8 million and $10.4$14.0 million in foreign NOLs as of December 31, 20162018 and 2015,2017, respectively. The valuation allowance was increased by $3.6$0.3 million in fiscal year 2016.2018. The fiscal 20162018 increase was primarily related to additional operating loss incurred, and difference in tax and book basis of goodwill and other intangible assets. We have considered all the evidence, both positive and negative, that the NOLs and other deferred tax assets may not be realized and have recorded a valuation allowance for $26$17.8 million. The federal NOLs begin to expirearising in the tax year beginning before January 1, 2018 can be carried back two years and forward twenty years. The NOLs arising in the tax year beginning after December 2025 while31, 2017 can only offset 80% of taxable income in any given tax year, but the foreign NOLs begin to expire in 2023.remaining can be carried forward indefinitely.
The timing and manner in which we will be able to utilize some of its 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 usthe Company at the rate of $2.4 million per year. Any unused losses can be carried forward, subject to their original carryforward limitation periods. In the year 2016,2018, approximately $2.4 million in the pre-change losses was released from the Section 382 loss limitation. WeSince the ownership change, the cumulative amount of NOLs released from Section 382 was approximately 10.9 million. The Company can still fully utilize the NOLs generated after the change of the ownership, which was approximately $11.1$20.6 million. Thus, the total of approximately $15.2$31.5 million as of December 31, 20162018 is available to offset future income.
The open United States tax years subject to examination with respect to our operations are 2015, 2016 and 2017.
NOTE 17.15. OTHER INCOME
Included in net other income for the year ended December 31, 2018, in the accompanying statement of operations and comprehensive loss, is approximately $675,000 for a reversal of an accounts payable recorded by the Company in a previous year not deemed to be payable, per statutory requirements.
NOTE 16. SEGMENT INFORMATION
Prior to the fourth quarter of 2015,2017, we had a singlethree reportable business segment: payment processing for electronic commerce. On May 20, 2015, we obtained financial and operational control of PayOnline, a provider of online payment processing of online transactions in emerging markets for services fees. Additionally, we rebranded our Mobile Solutions business to Digital Provider and began reporting gross revenues for mobile payments where we provide access to branded content. Given the size of assets and revenues from PayOnline and Digital Provider, we began reporting segment information for three operating segments.
Our three reportable segments include:segments: (i) North AmericaAmerican Transaction Solutions, for electronic commerce (ii) Mobile Solutions (primary Russian(Russia Federation and CIS) and (iii) Online Solutions, which started up with our acquisition of PayOnline Solutions on May 20, 2015.Solutions. Management determines the reportable segments based on the internal reporting used by our Chief Operating Decision Makerinformation necessary to evaluate performance and to assess where to allocate resources. DuringIn addition, management considers certain other factors, such as, the twelve months ending December 31, 2016,increased growth in our North American Transactions Solutions segment and the principal revenue stream for allconsolidation of our mobile solutions business with our online solutions business, which has changed how management evaluates performance and allocates resources. We now have two reportable business segments came from services fees(i) North American Transaction Solutions and branded content. During the twelve months ending December 31, 2015 the revenue stream for all segments was service fees.
Factors management used to identify the entity’s reportable segments(ii) International Transaction Solutions.
Our 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, in distinct geographic locations, with different delivery and service processes.
North America Transaction Solutions
Our US payment processingNorth American Transaction Solutions 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 basedcloud-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
International Transaction Solutions
Our RussianInternational Transaction Solutions segment consists of PayOnline, which includes our mobile andpayments operations, primarily located in Russia. PayOnline provides a secure online payment processing segment consists of Digital Provider which operates primarily in Russia.system to accept bank card payments for goods and services.
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, During 2017 we acquiredcombined Digital Provider into PayOnline. There was no branded content provided during 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.year ended 2018.
Segment Summary Information
Geographic Summary Information
| 2016 Revenues | 2016 Long- Lived Assets | 2015 Revenues | 2015 Long- Lived Assets | 2018 Revenues | 2018 Long- Lived Assets | 2017 Revenues | 2017 Long- Lived Assets | |||||||||||||||||||||||||
| North America | $ | 42,130,901 | $ | 9,468,105 | $ | 27,388,598 | $ | 9,152,499 | $ | 59,138,552 | $ | 13,672,169 | $ | 51,138,327 | $ | 9,778,888 | ||||||||||||||||
| Russia and CIS | 12,155,958 | 4,625,602 | 12,846,764 | 6,430,306 | 6,648,265 | 2,406,732 | 8,926,497 | 3,511,403 | ||||||||||||||||||||||||
The following tables present financial information of our reportable segments at and for the years ended December 31, 2016.2018 and 2017. The “corporate and eliminations” column includes all corporate expenses and intercompany eliminations required for consolidation. consolidated purposes.
| Twelve months ended December 31, 2016 | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & Eliminations | Total | |||||||||||||||||||||||||||||||
Twelve months ended December 31, 2018 | North American Transaction Solutions | International Transaction Solutions | Corp Exp & Eliminations | Total | ||||||||||||||||||||||||||||||||
| Net revenues | 42,130,901 | 5,933,281 | 6,222,677 | - | $ | 54,286,859 | $ | 59,138,552 | $ | 6,648,265 | $ | - | $ | 65,786,817 | ||||||||||||||||||||||
| Cost of revenues | 36,342,465 | 5,287,960 | 4,077,816 | - | 45,708,241 | 50,545,759 | 5,071,412 | - | 55,617,171 | |||||||||||||||||||||||||||
| Gross Margin | 5,788,436 | 645,321 | 2,144,861 | - | 8,578,618 | 8,592,793 | 1,576,853 | - | 10,169,646 | |||||||||||||||||||||||||||
| Gross margin % | 14 | % | 11 | % | 34 | % | - | 16 | % | 15 | % | 24 | % | - | 15 | % | ||||||||||||||||||||
| General, administrative, and asset disposal | 2,603,329 | 20,924 | 2,003,388 | 4,170,242 | 8,797,883 | |||||||||||||||||||||||||||||||
General and administrative | 2,490,811 | 1,970,757 | 5,297,120 | 9,758,688 | ||||||||||||||||||||||||||||||||
| Non-cash compensation | - | - | - | 3,463,435 | 3,463,435 | - | - | 142,017 | 142,017 | |||||||||||||||||||||||||||
| Provision (recovery) for bad debt | 1,173,815 | 511,772 | 2,760 | (110 | ) | 1,688,237 | ||||||||||||||||||||||||||||||
Provision for bad debt | 2,121,131 | 24,294 | - | 2,145,425 | ||||||||||||||||||||||||||||||||
| Depreciation and amortization | 1,201,268 | 18,970 | 1,837,709 | 408,564 | 3,466,511 | 1,898,784 | 555,853 | - | 2,454,637 | |||||||||||||||||||||||||||
| Interest expense (income), net | 555,212 | (42,760 | ) | (28,670 | ) | 980,051 | 1,463,833 | 833,494 | (33,944 | ) | 47,629 | 847,179 | ||||||||||||||||||||||||
| Loss from stock value guarantee | - | - | - | 3,722,142 | 3,722,142 | |||||||||||||||||||||||||||||||
| Other expenses (income) | 4,118 | (446,592 | ) | 32,950 | 2,177 | (407,347 | ) | |||||||||||||||||||||||||||||
Impairment charge relating to goodwill | - | 636,000 | - | 636,000 | ||||||||||||||||||||||||||||||||
Other (income) expense | (647,040 | ) | (8,248,059 | ) | 8,103,532 | (791,567 | ) | |||||||||||||||||||||||||||||
| Net (loss) income for segment | $ | 250,694 | $ | 583,007 | $ | (1,703,276 | ) | $ | (12,746,501 | ) | $ | (13,616,076 | ) | $ | 1,895,613 | $ | 6,671,952 | $ | (13,590,298 | ) | $ | (5,022,733 | ) | |||||||||||||
| Segment assets | $ | 14,934,000 | $ | 2,685,674 | $ | 5,125,140 | $ | 564,854 | $ | 23,309,668 | ||||||||||||||||||||||||||
| Twelve months ended December 31, 2015 | North America Transaction Solutions | Mobile Solutions | Online Solutions | Corporate Expenses & Eliminations | Total | |||||||||||||||||||||||||||||||
| Net revenues | $ | 27,388,598 | $ | 9,043,705 | $ | 3,803,059 | $ | - | 40,235,362 | |||||||||||||||||||||||||||
| Cost of revenues | 23,497,808 | 8,124,763 | 2,354,644 | - | 33,977,215 | |||||||||||||||||||||||||||||||
| Gross Margin | 3,890,790 | 918,942 | 1,448,415 | - | 6,258,147 | |||||||||||||||||||||||||||||||
| Gross margin % | 14 | % | 10 | % | 38 | % | - | 16 | % | |||||||||||||||||||||||||||
| General, administrative, and asset disposal | 2,038,833 | 1,043,187 | 1,349,970 | 4,878,487 | 9,310,477 | |||||||||||||||||||||||||||||||
| Non-cash compensation | - | - | - | 4,306,304 | 4,306,304 | |||||||||||||||||||||||||||||||
| Provision (recovery) for bad debt | 749,952 | (100,868 | ) | - | 487 | 649,571 | ||||||||||||||||||||||||||||||
| Depreciation and amortization | 1,212,266 | 20,625 | 971,830 | 308,442 | 2,513,163 | |||||||||||||||||||||||||||||||
| Interest expense (income), net | 538,994 | - | 773 | 3,035,931 | 3,575,698 | |||||||||||||||||||||||||||||||
| Loss on change in fair value and settlement of beneficial conversion derivative | - | - | - | 26,932,496 | 26,932,496 | |||||||||||||||||||||||||||||||
| Gain on debt extinguishment | - | - | - | (27,743,980 | ) | (27,743,980 | ) | |||||||||||||||||||||||||||||
| Gain on asset disposal | - | - | - | (40,369 | ) | (40,369 | ) | |||||||||||||||||||||||||||||
| Other expenses (income) | 3,715 | 4,762 | 74,198 | 38 | 82,714 | |||||||||||||||||||||||||||||||
| Net (loss) income for segment | $ | (652,971 | ) | $ | (48,764 | ) | $ | (948,357 | ) | $ | (11,677,836 | ) | $ | (13,327,926 | ) | |||||||||||||||||||||
| Segment assets | $ | 7,673,944 | $ | 1,848,574 | $ | 7,531,767 | $ | 5,859,226 | 22,913,561 | |||||||||||||||||||||||||||
Goodwill | 6,671,750 | 2,336,002 | - | 9,007,752 | ||||||||||||||||||||||||||||||||
Other segment assets | 16,431,351 | 324,910 | - | 16,756,261 | ||||||||||||||||||||||||||||||||
Total segment assets | $ | 23,103,101 | $ | 2,660,912 | $ | - | $ | 25,764,013 | ||||||||||||||||||||||||||||
NOTE 18. SUBSEQUENT EVENTS
Twelve months ended December 31, 2017 | North American Transaction Solutions | International Transaction Solutions | Corp Exp & Eliminations | Total | ||||||||||||
Net revenues | $ | 51,138,327 | $ | 8,926,497 | $ | - | $ | 60,064,824 | ||||||||
Cost of revenues | 44,265,264 | 6,971,948 | - | 51,237,212 | ||||||||||||
Gross Margin | 6,873,063 | 1,954,549 | - | 8,827,612 | ||||||||||||
Gross margin % | 13 | % | 22 | % | - | 15 | % | |||||||||
General and administrative | 3,251,547 | 3,033,360 | 4,344,866 | 10,629,773 | ||||||||||||
Non-cash compensation | - | - | 2,940,424 | 2,940,424 | ||||||||||||
Provision for bad debt | 1,408,908 | (89,260 | ) | 1,200 | 1,320,848 | |||||||||||
Depreciation and amortization | 1,480,603 | 1,053,382 | - | 2,533,985 | ||||||||||||
Interest expense (income), net | 997,429 | (34,776 | ) | 226,969 | 1,189,622 | |||||||||||
Other income | 48,549 | 178,576 | 8,884 | 236,009 | ||||||||||||
Net loss for segment | $ | (313,973 | ) | $ | (2,186,733 | ) | $ | (7,522,343 | ) | $ | (10,023,049 | ) | ||||
Goodwill | 6,671,750 | 2,972,002 | - | 9,643,752 | ||||||||||||
Other segment assets | 21,563,571 | 1,124,107 | - | 22,687,678 | ||||||||||||
Total segment assets | $ | 28,235,321 | $ | 4,096,109 | $ | - | $ | 32,331,430 | ||||||||
On March 3, 2017, we entered into an Amendment to Master Exchange Agreement dated as of May 2, 2016 with Crede CG III, Ltd. The Amendment extended the expiration date from December 31, 2016 to August 31, 2017, which extends the time prior to which we have the right to request Crede to exchange the promissory notes for shares of the Company’s common stock on the terms and conditions set forth in the Agreement.F-24
In connection with the ESOUSA Purchase Agreement (see Note 14 for additional information), we issued the following shares of our common stock to ESOUSA subsequent to December 31, 2016:
| 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 23, 2017 | 103,790 | 87,132 | 0.84 | |||||||||
| Totals | 1,682,667 | $ | 1,437,132 | $ | 0.85 | |||||||
On March 1, 2017, we entered into a Promissory Note with Star in the principal amount of $348,083 (the “Note”). Pursuant to the Note, previously advanced $348,083 to us that is now being repaid with interest under this agreement. 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.
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 provided for interest-only payments at 14.4% interest through May 20, 2017. From June 20, 2017 through June 20, 2021 (maturity date), we were obligated to make interest and principal payments of $2,753 per month. We paid $2,000 in costs related to this loan at its inception and another $4,000 of costs is due at the maturity of the note.
Awards Under the 2013 Equity Incentive Compensation Plan, as amended
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 our 2013 Equity Incentive Compensation Plan, as amended:
Awards Outside the 2013 Equity Incentive Compensation Plan, as amended
On February 28, 2017, the Compensation Committee of our board of directors awarded to Oleg Firer, our Chief Executive Officer, 471,388 restricted shares of our common stock as performance bonus subject to shareholder approval. In addition, the Committee approved a $300,000 cash performance bonus to Oleg Firer, payable when we have sufficient capital to pay such cash bonus and cover the Company’s on-going monthly operations.
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 in March 2017.
EXHIBIT INDEX
| ||
| ||
| ||
# Indicates management contract or compensatory plan or arrangement.
* Filed herewith.
