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ALYI > SEC Filings for ALYI > Form 10-K on 15-Apr-2013All Recent SEC Filings

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Form 10-K for ALTERNET SYSTEMS INC


15-Apr-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our consolidated audited financial statements and the related notes that appear elsewhere in this annual report. The following discussion contains forward-looking statements that reflect our plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward looking statements. Factors that could cause or contribute to such differences include, but are not limited to those discussed below and elsewhere in this annual report, particularly in the section entitled "Risk Factors".

Our consolidated audited financial statements are stated in United States Dollars and are prepared in accordance with United States Generally Accepted Accounting Principles.

Overview

Alternet Systems Inc competes in two distinct industries, mobile financial services and mobile security. In mobile financial services, the Company has unique features in its product offerings and is considered a global pioneer and market leader, consistently ranked by independent surveys amongst the top three in the world. The Company's technology has been developed and improved over numerous years and provides clients with a complete suite of applications and functionality that addresses all current market applications and usage. The Company is geographically focused on the entire Western Hemisphere (North, Central and South America and the Caribbean), it is the market leader in terms of deployments.

Mobile Financial Services

In 2010, the Company launched its mobile financial and mobile commerce suite of services, which it offers in equity partnership with the leading mobile financial services software developer, Utiba. Utiba Americas enjoys exclusive rights to the Utiba software platform for the Americas region, sold as a software license, or as a hosted service, also known as Software as a Service (SaaS).


Demand for our mobile financial transaction services is driven by the widespread adoption of mobile phone service and the existence of large segments of the global population which possess a mobile phone, but do not possess a bank account. The global mobile commerce industry is in its early growth and adoption stages and several successful initiatives have been launched worldwide by our competitors. We believe that as wireless usage expands, the demand for our services will grow.

Since launching in 2010, the Company has implemented mobile financial service solutions in Bolivia, Colombia, Ecuador, Guatemala, and Honduras. Revenue will come from organic growth of its existing operations, primarily from its hosted service, and the Company's robust sales pipeline with many qualified opportunities throughout the region. The Company also benefits from its name recognition and reputation, being one of the leading names in mobile financial services.

Sales and marketing is accomplished through the Company's existing sales staff, who contact potential clients directly, and through agent sales, channel partners, trade shows, and industry associations. Marketing materials such as brochures, web sites, and technical specifications are continuously updated with an increased emphasis being placed on its offerings for specific vertical industries, specifically the telecom, financial, government and utilities sectors.

The Company has been successful in capturing a leading market share in regional deployments and is widely recognized as having among the broadest and most robust product offerings. In 2012 the Company was awarded a multi country license sale agreement with Digicel Group, with an initial launch in Haiti, as well as the sale of a license to Astra Holdings, S.A. a Central America mobile payment service provider, that initially launched in Honduras and will expand in 5 Central America countries. It also successfully launched in January 2013, the electronic top up platform for Corporación Digitel S.A. a mobile network operator in Venezuela.

The SaaS product offering has successfully garnered key clients in Guatemala, Bolivia, México and Latin America. The Company is currently working in several other projects with a regional player with a multi country reach, and is continuing to receive widespread interest as it is currently negotiating several SaaS proposals with regional banks and mobile payment service providers.

In 2013, the Company expects to leverage its market leadership and regional footprint to garner additional profitable business and market share and aggressively replicate the SaaS business model throughout the region.

In 2012 the company entered into strategic alliances with complimentary players in the industry. The strategic partnership with Spindle, Inc. , a United States based mobile payments processor and technology developers allows ATS to enter this market and leverages Spindle's merchant acquisition suite into the existing Utiba mobile commerce offering. This partnership will expand as the companies are seeking additional technological and commercial integration. It also signed an MOU with i2C, Inc., a payments processor based in Redwood City, California to leverage their payment processing, card management and prepaid platform into a Utiba's converging payment offering. This initiative follows the MasterCard global partnership signed by Utiba Pte. Ltd. in October 2011, and the announcements made in 2012 on our expansion into the physical payments markets, as described in our Converging Payments offering.

ATS also continues to actively work with MasterCard operations in Latin America, developing a joint offering leveraging the brands strength and Utiba's market presence. Management expects several of these offers to close in 2013 in several key markets, specifically launching payments services to the unbanked markets in Latin America and the Caribbean.

The Company also expects to pursue potential opportunities to grow through mergers and acquisitions. Several opportunities have been identified and the Company has initiated initial discovery processes.

Digital and Mobile Security Software and Services

International Mobile Security (IMS) finalized the acquisition of proprietary technology in early 2011 and was positioned to offer software and security products in the global market segments of law enforcement, corporate, and consumer sales. Sales efforts have been conducted in house and through value added resellers. Drivers of demand include smart phones and the newly arrived mobile tablet computers.

IMS has entered into an agreement to develop opportunities with Delma MSS Ltd. ("Delma"), a company based in the United Kingdom developing location and tracking technologies. As part of the agreement, Delma will develop and enhance some of the IMS products, with the intent to develop joint business opportunities and products. The relationship with Delma will allow IMS to expand its sales reach into the Middle East and Asian markets.

Results of Operations:

Results of Operations are for the year ended December 31, 2012 compared to the year ended December 31, 2011.

The Company's results, on a consolidated basis, reflect its own results consolidated with its subsidiaries. For the remainder of this part, the term "Company" refers to both the Company and its wholly owned and two majority owned subsidiaries, International Mobile Security, Inc. ("IMS") and Alternet Transactions Systems, Inc. ("ATS") doing business as Utiba Americas. Alternet has a controlling interest in both subsidiaries.


Net Sales

For the year ending December 31, 2012, the Company had net sales of $1,229,674 versus $1,210,766, for the prior year, effectively flat. While the Company signed two license sales contracts in the fourth quarter of 2012, only one sale was recorded in the year. ATS has experienced continued challenges in closing other large complex projects, due to their scope and size. The Company accrues these sales on a performance basis, so additional revenues will be recorded as they are deemed delivered.

The other transaction, given its underlying financing structure, is being recognized over the term of the contract. Projects continue to take significant time and effort to close due to the complexity, the required participation of multiple parties, differing levels of expertise and experience amongst parties and, at times, shifting regulatory conditions.

As a result sales are below expectations. SaaS revenue, the Company's preferred product offering and pricing structure, is rapidly getting traction, while license sales have experienced a deceleration. ATS is actively engaged in final discussions and contract negotiations, with the largest clients in the market and expects to sign major projects in 2013.

IMS continues to underperform and management is reviewing various options, including divestiture, reorganization or merger opportunities. Based on its limited success, it is evident that IMS' product offering requires further development and additional investment to keep them up to date with current market expectations and requirements. In light of the results to date, management is reticent in continuing directing resources to the endeavor, and is actively evaluating different scenarios.

Accordingly, the Company may focus entirely on Mobile Financial Transaction Services and ancillary businesses within this space, such as Mobile Remittances, Consumer Analytics, Mobile Advertising Monetization and integration of its Mobile Commerce suit to Social Media opportunities.

Cost of Sales and Gross Margin

The Company has cost of sales of $656,542 and a gross margin of $573,132 for the year ending December 31, 2012 as compared to cost of sales of $1,122,536 and a gross margin of $88,230 for the year ending December 31, 2011. The decrease in the cost of sales is due to the prior year including a one time charge of $421,000 from Utiba Pte for additional support services performed during the year and prior years.

Selling, General and Administrative Expenses

The operating and administrative expenses for the year ended December 31, 2012
totaled $3,834.404 as compared to $2,996,392 for the year ended December 31,
2011. The table below details the major changes in administrative expenditures
for the year ended December 31, 2012 as compared to the corresponding year ended
December 31, 2011.

Expenses           Increase / Decrease in         Explanation for Change -
                          Expenses            Year Ended December 31, 2012 as
                                          Compared to Year Ended December 31, 2011
Bad debts          Increase of $174,549   Collection of the remaining balance on
                                          one contract and one note receivable was
                                          determined to be uncertain.
Depreciation       Increase of $67,936    Additional assets were acquired during
                                          the year.
Investor relations Increase of $14,885    More activity during the year in respect
                                          to financing transactions.
Management and     Increase of $500,861   Increased number of consultants hired
consulting                                during the year to assist with the
                                          customization required to complete the
                                          increased number of contracts the
                                          Company signed during the year.
Professional fees  Increase of $71,243    Increase due to lawyers reviewing more
                                          customer contracts in the current year.
Rent               Increase of $41,924    The Company moved offices at the end of
                                          2011.
Salaries           Increase of $11,327    Increased cost of new employees filling
                                          open positions.
Telephone and      Increase of $27,551    Increased usage of long-distance
utilities                                 telephone calls to increase customer
                                          sales
Travel             Decrease of $72,318    Decreased amount of travel required to
                                          more stringent travel policy and use of
                                          remote conferencing.

Interest and Other Expenses


The Company's interest expense increased to $457,283 for the year ended December 31, 2012 compared to $45,143 the previous year due to 1) the increase in loans received by the Company during the year, 2) the recording of financing costs of $66,905 relating to convertible debentures, and 3) the estimation of potential tax penalties.

Net Loss

For the year ending December 31, 2012, the Company had a net loss of $4,703,334 or ($0.04) per share and total comprehensive loss of $3,263,407 or ($0.04) per share, an increase of 52% and 34%, respectively, when compared to corresponding year December 31, 2011 which had a net loss of $3,095,376 or $(0.04) per share and a total comprehensive loss of $2,444,395 or ($0.04) per share. The increased loss is primarily attributable to higher Other Items, consisting of the aforementioned interest expense ($457,283), foreign exchange loss ($404,736) and loss on debt settlement ($579,375), up $1,252,293 from the prior year. The foreign exchange loss is attributable to the devaluation of the Venezuelan Bolivar.

Liquidity and Capital Resources

As of December 31, 2012, the Company had $5,751 cash in the bank and accounts receivable of $1,249,447. At December 31, 2012, the Company had a working capital deficiency of $3,165,793. The Company is currently pursuing financing, and has engaged an investment bank to raise additional capital to fund ongoing operations. The Company's ability to continue as a going concern will be negatively affected if it is unsuccessful.

Accounts payable were $1,457,054 at December 31, 2012 compared to accounts payable of $1,778,876 at December 31, 2011. Accounts receivable decreased to $1,249,447 for 2012 versus $2,215,586 for 2011. Both items reflect the timing impact of sales closed at the end of the year.

As of December 31, 2012, the Company holds an accounts receivable of $789,565 (VEF 6,674,709) with a related company that has been outstanding for longer than one year. Due to the relationship with this Company, management is certain the funds will be collected.

Plan of Operation

Over the next 12 months, the Company will continue selling mobile financial services, in the form of software licenses and, increasingly more given market demand, as a service, commonly referred to as Software as a Services (SaaS), through its subsidiary Alternet Transaction Systems (dba Utiba Americas). The Company is in advanced negotiations with various clients to roll out single market, multi-market and regional mobile financial services, primarily under the SaaS product offering. SaaS transactions are multi-year in nature and are priced based on active wallets, transactions or a combination thereof. The Company is also in discussions for the sale of additional licenses and/or expansions.

As for International Mobile Security (IMS), provider of mobile security solutions, management is currently reviewing the strategic fit of the subsidiary within the Company's overall vision and business focus. While the market for IMS' products, primarily the government, law enforcement and, to a lesser degree, corporate segments, appears to be large and growing, IMS' product offering needs further refinement and development. Similarly, significantly more management time will be required to address the current challenges and well as additional resources, which may distract from the Company's primary focus.


Conclusion

The Company has positioned itself as the regional go-to, if not preferred, provider of mobile financial services and solutions and is confident in the future demand for its products and services. However, there can be no assurance that sales will increase in the future. The Company is expected to remain dependent upon debt or equity financing unless revenues from operations grow significantly.

Critical Accounting Policies

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with the accounting principles generally accepted in the United States of America. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, and expenses. These estimates and assumptions are affected by management's application of accounting policies. We believe that understanding the basis and nature of the estimates and assumptions involved with the following aspects of our financial statements is critical to an understanding of our financial statements.

Basis of Presentation and Consolidation

These consolidated financial statements and related notes are presented in accordance with accounting principles generally accepted in the United States, and are expressed in United States dollars. These financial statements include the accounts of the Company and its wholly owned and majority owned subsidiaries. Our fiscal year-end is December 31.

Use of Estimates and Assumptions

The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our company regularly evaluates estimates and assumptions. Our company bases its estimates and assumptions on current facts, historical experience and various other factors that it believes to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities and the accrual of costs and expenses that are not readily apparent from other sources. The actual results experienced by our Company may differ materially and adversely from our Company's estimates. To the extent there are material differences between the estimates and the actual results, future results of operations will be affected.

Accounts Receivable and Allowance for Doubtful Accounts

Trade accounts receivable are stated at the amount the Company expects to collect. The Company maintains allowances for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Management considers the following factors when determining the collectability of specific customer accounts: customer credit-worthiness, past transaction history with the customer, current economic industry trends, and changes in customer payment terms. Past due balances over 90 days and other higher risk amounts are reviewed individually for collectability. If the financial condition of the Company's customers were to deteriorate, adversely affecting their ability to make payments, additional allowances would be required. Based on management's assessment, the Company provides for estimated uncollectible amounts through a charge to earnings or customer deposits depending on whether the corresponding income has been recognized by the Company, and a credit to a valuation allowance. Balances that remain outstanding after the Company has used reasonable collection efforts are written off through a charge to the valuation allowance and a credit to accounts receivable.


Foreign Currency Translation

The Company's functional currency and its reporting currency is the United States Dollar. Foreign denominated monetary assets and liabilities are translated to their United States dollar equivalents using foreign exchange rates which prevailed at the balance sheet date. Revenue and expenses are translated at average rates of exchange during the year. Related translation adjustments are reported as a separate component of stockholders' equity (deficit), whereas gains or losses resulting from foreign currency transactions are included in the results of operations.

Refer to the Risk Management section for further discussions on foreign exchange exposure.

Long-Lived Assets Including Other Acquired Intellectual Property

Management monitors the recoverability of long-lived assets and intangibles based on estimates using factors such as current market value, future asset utilization, and future undiscounted cash flows expected to result from its investment or use of the related assets. The Company's policy is to record any impairment loss in the period when it is determined that the carrying amount of the asset may not be recoverable. Any impairment loss is calculated as the excess of the carrying value over estimated realizable value. The Company did not record any significant impairments during 2012 and 2011.

Intangible assets deemed to have an indefinite life are not amortized but are subject to impairment tests at each reporting date. The Company assesses the impairment of intangible assets on a quarterly basis or whenever events or changes in circumstances indicate that the fair value is less than its carrying value. If the carrying amount of the intangible asset exceeds its fair value, the intangible asset is considered impaired and the second step of the test is performed to determine the amount of impairment loss, if any. The Company did not recognize any impairment charges related to indefinite lived intangible assets during 2012 and 2011.

Revenue Recognition

The Company derives its revenues from the sale of licenses of software, implementation services, support services, and telecommunication services. Revenues are recognized when title transfers or services are rendered, as follows:

a) Revenue from the sale of licenses is recognized when the title of the license transfers to the customer.
b) Revenue from implementation services performed is recognized upon completion of the service.
c) Revenue from support services is recognized as earned.
d) Revenue from telecommunications and hosted services are recognized when billed, which occurs in the month the services are provided.

The Company invoices 100% of the implementation services and requires customers to pay a non-refundable deposit prior to any services being performed. The Company recognizes the customer deposit as unearned revenue until either completion of the implementation or upon the contract being cancelled at which time the revenue is recognized. The uncollected portion of the implementation invoice is recorded when collection has occurred, implementation services have been completed, or the contract has been cancelled.

The Company invoices support services at the beginning of the term and recognizes the revenue over the term of the agreement.


Deferred Income

The Company recognizes revenues as earned. Amounts billed in advance of the period in which service is rendered are recorded as a liability under ''Deferred income.''

Debt with Conversion Options

The Company accounts for convertible debentures in accordance with ASC Topic 470-20, Debt with Conversion and Other Options, which applies to all convertible debt instruments that have a ''net settlement feature,'' which means instruments that by their terms may be settled either wholly or partially in cash upon conversion. Accordingly, the liability and equity components of convertible debt instruments that may be settled wholly or partially in cash upon conversion should be accounted for separately in a manner reflective of their issuer's nonconvertible debt borrowing rate. Conversion features determined to be beneficial to the holder are valued at fair value and recorded to additional paid in capital. Any discount derived from determining the fair value to the debenture conversion features is amortized to interest expense over the life of the debenture. The unamortized costs, if any, upon the conversion of the debentures is expensed to interest immediately.

Financial Instruments

The carrying value of our company's financial instruments, consisting of cash, accounts receivable, accounts payable and accrued liabilities, wages payable, accrued taxes, customer deposits, deferred income, other loans payable, and due to related parties, approximate their fair value due to the relatively short maturity of these instruments.

Stock-Based Compensation

The Company accounts for its share-based compensation plans in accordance with the fair value recognition provisions of ASC 718 Compensation-Stock Compensation. The Company utilizes the Black-Scholes option pricing model as its method for determining the fair value of stock option grants. ASC 718 requires the fair value of all share-based awards that are expected to vest to be recognized in the statements of operations over the service or vesting period of each award. The Company uses the straight-line method of attributing the value of share-based compensation expense for all stock option grants over the requisite service period.

Risk Management

The Company is exposed to credit risk through accounts receivable and therefore, the Company maintains adequate provisions for potential credit losses. The Company, given the relative size of a typical contract, the number of clients, timing of sales and the revenue recognition of said sales, will have an inherent concentration of sales. The Company is cognizant of such concentration and takes steps to mitigate such risks via accelerated and/or progress payment structures and contractual legal recourse. The tables below demonstrate the level of concentration in the two prior periods:

                2012 Sales Concentration
                Client Description              Rank     Percentage
                Global Mobile Operator           1          34%
                Local Mobile Operator            2          33%
                Global Mobile Operator           3          18%
                Local Mobile Service Provider    4           9%
                Total                                       94%


                   2011 Sales Concentration
                   Client Description         Rank     Percentage
                   Local Mobile Operator       1          87%
                   Global Mobile Operator      2           9%
                   Total                                  96%

The Company's functional currency is the United States dollar. The Company operates in foreign jurisdictions, giving rise to exposure to market risks from changes in foreign currency rates. The financial risk to the Company's operations arises from fluctuations in foreign exchange rates and the degree of volatility of these rates. Currently, the Company does not use derivative instruments to reduce its exposure to foreign currency risk.

The Company also operates in countries with strict foreign exchange controls,
i.e. Venezuela, which limit access and convertibility to US dollars. While the Company is familiar with such restrictions and the programs available in each country to access foreign exchange, when available, is exposed to government vagary and fiat. Management actions are limited in such cases.

. . .

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