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NETE > SEC Filings for NETE > Form 10-Q on 19-Aug-2013All Recent SEC Filings

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Form 10-Q for NET ELEMENT INTERNATIONAL, INC.


19-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read and evaluated in conjunction with the unaudited condensed consolidated financial statements and notes thereto contained in this Report and with the discussion under "Forward-Looking Statements" on page 2 at the beginning of this Report and the Risk Factors set forth in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2012 and in Part II, Item 1A of our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2013.

Overview; Recent Developments

We have two reportable business segments, consisting of (i) mobile commerce and payment processing, and (ii) entertainment and culture Internet destinations. During the three months and six months ended June 30, 2012, we had only one reportable business segment: entertainment and culture Internet destinations.

The Company's subsidiary TOT Group, Inc. (formerly known as TOT, Inc.) ("TOT Group") is a multinational, mobile payments and transaction processing holding company, which provides a range of flexible online and offline payment solutions. Clients include wireless carriers, content providers and merchants. TOT Group delivers comprehensive, end-to-end payment solutions to enable merchants to reliably accept cashless transactions at the point of sale ("POS"). From processing electronic payments at the POS to processing mobile commerce transactions to managing merchant terminals and providing information management services, TOT Group through its proprietary technology offers innovative solutions which allow its merchants to streamline their payments resources. Through TOT Group, the Company generates revenues from transaction fees, service fees, percentage of the dollar amount of each transaction and other fees associated with processing of cashless transactions at the points of sale. The Company serves merchants primarily in the retail, restaurant, supermarket, petroleum and hospitality sectors. In addition, TOT Group (through its subsidiary OOO TOT Money ("TOT Money")) operates the Company's provider of carrier-integrated mobile payments solutions. TOT Money's relationships with mobile operators give the Company substantial geographic coverage, a strong capacity for innovation in mobile payments and messaging, and the ability to offer customers In-App, P-SMS and Online and Carrier Billing solutions in over 49 countries.

During the third quarter of 2012, our subsidiary, TOT Money, launched operations as a provider of carrier-integrated mobile payments solutions in Russia. Since then, TOT Money has continued seeking to expand its carrier-integrated mobile payments business primarily in the Commonwealth of Independent States (CIS) countries (comprised of participating states of the former Soviet Union) and other emerging markets. During the second half of 2012, TOT Money entered into contracts with the three largest mobile phone operators in Russia, Mobile TeleSystems OJSC, MegaFon OJSC and OJSC VimpelCom, to facilitate payments using SMS and MMS for their mobile phone subscribers in Russia.

On April 16, 2013, certain subsidiaries of TOT Group acquired substantially all of the business assets of Unified Payments, LLC, a Delaware limited liability company. Unified Payments provides comprehensive turnkey, payment-processing solutions to small and medium size business owners (merchants) and independent sales organizations across the United States. For additional information, see Note 4 to the accompanying notes to unaudited condensed consolidated financial statements.

In addition to our payment processing operations, we continue to pursue a strategy to develop and acquire technology and applications for use in the online media industry. In furtherance of this strategy, we acquired Openfilm, LLC on December 14, 2010 and Motorsport, LLC and Music1, LLC on February 1, 2011. On February 8, 2013, in connection with our termination of Music1's employment of Stephen Strother, we transferred and assigned to Mr. Strother our 97% interest in A&R Music Live, LLC, the internet domain name www.arlive.com and related intellectual property rights.

Our subsidiary, LegalGuru LLC, has been developing a video-centric, legal information portal (legalguru.com) intended to allow licensed attorneys (or Gurus) to brand themselves by posting relevant information content related to each attorney's respective practice concentration. We launched a beta test version of legalguru.com in May 2012 and, in the first quarter of 2013, indefinitely discontinued all development and marketing efforts for LegalGuru pending receipt of additional financing, if any.

Our subsidiary, Yapik LLC, was developing, and in the fourth quarter of 2011 launched a beta test version of, Yapik, a peer-to-peer communication and bartering application and service for mobile devices operating within and around colleges and universities in the United States. Upon completion of the beta tests, we decided to discontinue development efforts for Yapik and focus on developing a similar application called Komissionka for use in the Russian market. The Komissionka application was introduced in Russia in the second quarter of 2012 on a pre-loaded smartphone sold by the mobile phone carrier MegaFon.

Since our inception, we have incurred significant operating losses (for additional information, see "Liquidity and Capital Resources" below). If we fail to maintain our relationships with merchants, mobile phone providers, content providers, lenders and other business partners, or fail to expand our base of advertisers or generate and maintain high quality content on our websites, it could harm our prospects. We face all of the risks inherent in a new business, including the need for significant additional capital, management's potential underestimation of initial and ongoing costs, and potential delays and other problems in connection with developing our technologies, Internet websites and applications and our operations.

Results of Operations for the Three Months Ended June 30, 2013 and 2012

We reported a net loss of $20,231,697 or $(0.72) per share, for the three months ended June 30, 2013 versus a net loss of $2,573,263 (as restated), or $(0.13) per share, for the three months ended June 30, 2012. Basic and diluted weighted average shares outstanding were 28,133,699 and 19,115,616 for the three months ended June 30, 2013 and 2012, respectively.

Net revenues consist of payment processing fees, advertising fees, license fees and membership fees. Net revenues for the three months ended June 30, 2013 were $5,615,719, of which $5,607,599 were payment processing fees from our subsidiary TOT Group, Inc. This consisted of $4,601,830 from its subsidiary TOT Payments (which consists of the former operations of Unified Payments, which we acquired on April 16, 2013), $1,005,248 from its subsidiary TOT Group Russia (which owns TOT Money, our mobile commerce payment processing operations in Russia) and $520 from Aptito. Additionally, we earned $5,928 from our Motorsport web businesses. Net revenues for the three months ended June 30, 2012 were $37,818, which were primarily comprised of fees generated by our subsidiaries Music1 ($16,364), Motorsport ($12,666) and Openfilm ($8,248). Music1 revenues are primarily services fees while Motorsport revenues are primarily advertising revenue. As of February 8, 2013, A&R Music Live is no longer owned by Music1, so our results of operations in future periods will no longer include service fees generated by A&R Music Live. Openfilm revenues are a mix of license fees, advertising and subscription fees. The increase in net revenues in the three months ended June 30, 2013 compared to the three months ended June 30, 2012 is primarily a result of the Unified Payments acquisition and the launch of our mobile commerce payment processing operations in Russia during the third quarter of 2012 through TOT Money. Our results of operations for the three months ended June 30, 2012 include only the operations of our online media products (websites and mobile applications).

Operating expenses totaled $25,578,342 for the three months ended June 30, 2013 versus $2,663,219 (as restated) for the three months ended June 30, 2012, representing an increase of $22,915,123. The primary reason for the increase in operating expenses is our acquisition of the operations of Unified Payments on April 16, 2013, which resulted in a $3,785,617 increase in cost of revenues, and $11,200,000 of goodwill impairment charge. In addition, we recorded a $5,792,487 provision for unrecoverable advances and we incurred $1,364,526 of increased general and administrative expenses and $506,309 of increased depreciation and amortization expenses in the three months ended June 30, 2013, which contributed to our increased operating expenses as compared to the three months ended June 30, 2012. Each of these expense items is discussed further below.

Cost of revenues represents direct costs of generating revenues, including commissions, purchases of short numbers, content acquired and created and certain payroll expense that is directly related to revenue creation. Cost of revenues for the three months ended June 30, 2013 was $4,151,955 as compared to $100,154 for the three months ended June 30, 2012, which represents an increase of $4,051,801 as detailed below.

                             Qtr End      Qtr Ended      Increase /
Entity or Web Property     6/30/2013      6/30/2012      (Decrease)
TOT GROUP                $ 4,124,494     $        -     $ 4,124,494
Nete Russia              $    16,568     $        -     $    16,568
Nete Element             $         -     $    3,098     $    (3,098 )
Yapik                              -            587     $      (587 )
LegalGuru                          -            956     $      (956 )
Openfilm                           -         19,794         (19,794 )
Motorsport                    10,893         56,687         (45,794 )
Music                              -         19,032         (19,032 )
                         $ 4,151,955     $  100,154     $ 4,051,801

The increase in cost of revenues is primarily attributable to $4,124,494 in cost of revenues from TOT Group, Inc. due to the Unified Payments acquisition and operations of TOT Money. Of the $4,124,494, TOT Payments (which owns the business operations acquired from Unified Payments) accounted for $3,785,617. The primary costs are $2,980,959 of interchange fees, $186,638 of VisaŽ and MasterCardŽ charges, $521,631 of outside sales commissions and $79,215 in processing costs. The primary difference between $4,124,494 and $3,785,617 belongs to TOT Money (which first began operations in the third quarter of 2012) for the purchase of short numbers to facilitate creation of payment processing revenues. The increase in cost of revenues was partially offset by $89,261 decline in cost of revenues in Motorsport, Openfilm and other web properties due to decreased revenues of those properties.

Effective January 1, 2013, we ceased development efforts for the Yapik application in the United States, and are instead focused on developing a similar application called Komissionka for use in the Russian market. In the first quarter of 2013, we indefinitely discontinued all development and marketing efforts for LegalGuru pending receipt of additional financing, if any. On February 8, 2013, in connection with the termination of Music1's employment of Stephen Strother, we transferred and assigned to Mr. Strother our 97% interest in A&R Music Live, LLC (which previously was owned by Music1), the internet domain name www.arlive.com and related intellectual property rights. As a result of the foregoing, our results of operations in future periods will no longer include the operations of Yapik or A&R Music Live and we expect that our results of operations will not include the operations of LegalGuru for the foreseeable future.

General and administrative expenses were $3,807,913 for the three months ended June 30, 2013 as compared to $2,443,387 (as restated) for the three months ended June 30, 2012, representing an increase of $1,364,526, or 55.8%. General and administrative expenses for the three months ended June 30, 2013 and 2012 consisted of operating expenses not otherwise delineated in our Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss, including certain salaries, benefits, taxes, professional fees, travel, rent, Internet expenses and other expenses required to run our business. General and administrative expenses for the three months ended June 30, 2013 and 2012 were attributable to:

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