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ALTERNET SYSTEMS INC - 10-Q - MANAGEMENT DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:(Edgar Glimpses Via Acquire Media NewsEdge) 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 interim 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), and 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 American 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 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. 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. -------------------------------------------------------------------------------- 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. 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. Results of Operations: Results of Operations are for the quarter ended March 31, 2013 compared to the similar prior year quarter ended March 21, 2012. 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 quarter ending March 31, 2013, the Company had net sales of $436,976 versus $59,285, an increase of $377,691, primarily reflecting the sale of a license expansion. -------------------------------------------------------------------------------- Cost of Sales and Gross Margin The Company has cost of sales of $316,698 and a gross profit of $120,278 for the quarter ending March 31, 2013 as compared to cost of sales of $37,967 and a gross profit of $21,318 for the quarter ending March 31, 2012. The increase in the cost of sales is due to the commensurate higher revenue for the period when compared to the prior year. Timing of expense recognition reflecting delays in the receipt invoices and supporting documentation from foreign vendors also impacts these items. Selling, General and Administrative Expenses The operating and administrative expenses for the quarter ended March 31, 2013 totaled $730,981 as compared to $825,279 for the similar prior year quarter. The table below details the major changes in administrative expenditures for the quarter ended March 31, 2013 as compared to the corresponding quarter ended March 31, 2012. Expenses Increase / Decrease in Explanation for Change - Expenses Quarter Ended March 31, 2013 as Compared to Quarter Ended March 31, 2012 Depreciation Increase of $10,457 Additional capital assets versus prior year quarter. Management and Decrease of $20,172 Lower staffing at corporate level and consulting operating subsidiary than prior year quarter.Office and general Decrease of $27,694 Lower marketing expenses as 2012 included global Mobile Conference wherein company was presenter, decreased telephone usage attributable to greater use of free services/internet and lower staffing.Professional fees Increase of $13,051 Increased legal fees incurred defending lawsuit. Salaries Decrease of $54,282 Lower staffing levels than prior year quarter. Travel Decrease of $16,058 Decreased amount of travel required due to more stringent travel policy and use of remote conferencing and staffing. Interest and Other Expenses The Company's interest expense increased to $122,456 for the quarter ended March 31, 2013 compared to $14,639 the previous year quarter due to the increase in loans outstanding during the period, reflecting greater relative use of debt financing versus stock financing. Net Loss For the quarter ending March 31, 2013, the Company had a net and comprehensive loss of $503,785 or ($0.01) per share, a decrease of 51% when compared to the corresponding period of March 31, 2012 which had a net loss of $1,027,410 or $(0.01) per share. The lower loss is primarily attributable to lower Other Items, consisting of debt settlement losses which are down $528,174, and lower Operating expenses of $94,298. Last year's debt settlement loss reflected the accounting loss, not a cash outlay, attributable to the assigned value of shares received by a lender on the settlement of a convertible note. The settlement coincided with a spike in the share price. -------------------------------------------------------------------------------- Liquidity and Capital Resources As of March 31, 2013, the Company had $39,730 cash in the bank and accounts receivable of $1,115,314. At March 31, 2013, the Company had a working capital deficiency of $3,743,476. 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 $1,416,143 at March 31, 2013 compared to accounts payable of $1,457,054 at December 31, 2012. Accounts receivable decreased to $1,144,564 for March 2013 versus $1,249,447 at year ended 2012. As of March 31, 2013, 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 as 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 the first quarter of 2013. 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 the first quarter of 2013. 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. During the three months ended March 31, 2013, the largest customer accounted for 86% of sales. Two other customers accounted for 69% and 25% of accounts receivable. During the three months ended March 31, 2012, the two largest customers accounted for 48% and 25% of sales and 76% and 0% of accounts receivable, respectively. 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. Recent Accounting Pronouncements Other recent accounting pronouncements issued by the FASB (including its Emerging Issues Task Force), the American Institute of Certified Public Accountants, and the SEC did not, or are not believed by management to, have a material impact on the Company's present or future financial position, results of operations or cash flows. |