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LENCO MOBILE INC. - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) Statements in this annual report on Form 10-K, including this Management's Discussion and Analysis of Financial Condition and Results of Operations, which are not historical are "forward-looking statements" and are based on management's present expectations about future events. Although we believe the expectations reflected in these forward-looking statements are reasonable, such statements are inherently subject to risk and we can give no assurances that our expectations, estimates, forecasts and projections will prove to be correct. Actual results could differ from those described in this report because of numerous factors, many of which are beyond our control. These factors include, without limitation: our ability to obtain future financing or funds when needed; financial risk due to fluctuations in foreign currencies against the U.S. dollar; our ability to control operating costs and successfully implement our current business plan; our ability to successfully establish and maintain relationships with wireless carriers to deliver our mobile messaging solutions on a cost-effective basis; our ability to attract and retain new customers; our ability to respond to new developments in technology and new applications of existing technology in a timely and effective manner; and our ability to manage risks associated with acquisitions, business combinations, strategic partnerships, divestitures, and other significant transactions which may involve additional uncertainties. We undertake no obligation to update these forward-looking statements to reflect events or circumstances after the date of this report or to reflect actual outcomes. Please see "Special Note Regarding Forward Looking Statements" at the beginning of this report. The following discussion of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other financial information appearing elsewhere in this report. Overview We are a global provider of proprietary mobile engagement solutions to large enterprises. Historically our core operations have been conducted in South Africa through our subsidiary Archer Mobile South Africa Pty Ltd (formerly Capital Supreme (Pty) Ltd. and referred to herein as "Archer South Africa"). In December 2011, we acquired iLoop Mobile Inc. (since renamed Archer USA Inc. and referred to herein as "Archer USA"), a U.S. based mobile engagement platform and services provider. Our strategy is to focus on selling our mobile solutions to large enterprises worldwide. We are an early stage business in a rapidly changing mobile industry. We were incorporated in 1999 in Delaware under the name of Shochet Holdings Corporation. Prior to 2008, Shochet Holdings Corporation completed an initial public offering, underwent several changes of control and was engaged in several different businesses, which included discount brokerage, financial services, mortgage banking and apparel; ultimately we were operating as a shell company seeking a combination with another operating company. The shell company and its predecessors had generated losses of approximately $15.8 million which are reflected in our accumulated deficit. Our strategy is to focus on selling our mobile solutions to large enterprises worldwide and to increase the use of MMS messaging across existing and new customers in the US and internationally. There are approximately 6.8 billion mobile device subscribers globally. This represents almost 98% of the world's population. Our business is based on our core belief that the most effective way for a business to communicate with its customers is through mobile devices. Thus, our mission is to combine unique technology and comprehensive services to enable our customers to use mobile solutions to build and strengthen relationships with their customers. Our technology includes messaging - simple and rich media messaging - and mobile web technology. We also provide technology that enables measurement and analysis of mobile initiatives and provide strategic and technical services. Matters Affecting Comparability Our financial performance over the past few years has been affected by a variety of factors, principally acquisitions, the general economic conditions within our global markets, fluctuations in the relationship of foreign currencies to the U.S. dollar, the availability of capital, product and project mix and the impact of restructuring initiatives. These key factors have impacted the comparability of our results of operations in the past and are likely to affect them in the future. 27 Subsequent Events As discussed elsewhere, the Company has received notices from seven shareholders of Series A Preferred Stock that each of them has elected to have the Company redeem the Series A Preferred Stock held by them. As of April 15, 2014, the total amount that would be required to redeem all of the shares of Series A Preferred Stock held by these seven shareholders is approximately $2.4 million. The Company is not legally able to redeem any shares at this time. On March 20, 2014, the Company received notice that the Supreme Court of Denmark had declined to hear an appeal filed by Archer USA relating to a judgment entered by the Eastern High Court of Denmark. As discussed elsewhere, Archer USA was a party in a proceeding in Copenhagen, Denmark captioned Cirkelselskabet af 16. Juli 2008 in bankruptcy v. iLoop Mobile, Inc., Vedrorende sag 3, afd. B-1040-12: (Deres j.nr. 1013836). This matter was filed in the Copenhagen City Court by the trustee for Cirkelselskabet, formerly iLoop Mobile ApS ("ApS"). ApS was a Danish subsidiary of Archer USA that was declared bankrupt in July 2008. As a result of the Supreme Court of Denmarks decision not to review Archer USA's appeal, Archer USA has no further opportunities for appeal in Denmark. The judgment entered against Archer USA in Denmark is for $2,549,794, plus interest of approximately $1,292,047, plus fees of approximately $168,000. If Archer USA did pay this judgment, the trustee would owe Archer USA approximately $3,000,000 as of March 31, 2014. We believe that it is not probable that Archer USA will pay any amounts as a result of this judgment. We believe the proceedings in the Danish courts suffered from serious violations of United States public policy and due process requirements. In addition, we believe the judgment rendered by the Danish courts is not supported by and offends bankruptcy law and principles of both Denmark and the United States. We intend to vigorously contest the validity and enforceability of this judgment in the United States and to vigorously dispute any attempt made to enforce this judgment or collect these amounts. Liquidity and Capital Resources We have historically experienced recurring operating losses and negative cash flows from operations and have maintained our financial position through strategic management of our resources, including the sale of equity securities, borrowings and debt instruments. At December 31, 2013, we had total cash and cash equivalents of approximately $0.5 million and working capital deficit of $25.3 million. To date, we have funded our operations primarily through sales of our common stock, convertible preferred stock, and debt financing arrangements. Management is continuing its efforts to improve quarterly profits by increasing revenue generation and managing the Company's cost structure, while at the same time ensuring the Company has the resources to meet demand from its customers. In February 2013, the Company issued Bridge Notes to certain lenders in an aggregate principal amount of $600,000. Certain Lenders elected to convert amounts owed to them under the Bridge Notes in exchange for 5,500 shares of Series A 1 Preferred stock. The remaining Bridge Note in the amount of $100,000 is currently past the maturity date and we are reviewing options for settlement. In June 2013, the Company entered into a Note Purchase and Security Agreements with certain lenders pursuant to which the Lenders purchased from the Company the 2013 Senior Notes in an aggregate principal amount of $2.0 million. For the years ended December 31, 2013 and 2012, net losses from operations were approximately $26.6 million and $19.4 million, respectively. For the fiscal year ended December 31, 2013, we had negative operating cash flows of $4.1 million. We anticipate we will continue to incur significant losses for the foreseeable future. Our ability to generate positive cash flows from operations and net income is dependent, among other things, on the acceptance of our products in the marketplace, market conditions, cost control, and our ability to raise capital on acceptable terms. We may need to raise additional capital to fund our working capital requirements, capital expenditures and operations. Our ability to fund our capital needs will depend on many factors, including our future operating performance, our ability to successfully realign our costs and strategic path, the effect of any strategic and financing alternatives we may pursue, and our ability to meet financial covenants under current and any future indebtedness. Financing, if available, may be on terms that are significantly dilutive to our stockholders, and the prices at which investors would be willing to purchase our securities may be lower than the current price of our common stock. The holders of new securities may also receive rights, preferences or privileges that are senior to those of existing holders of our common stock. If new sources of financing are required but are insufficient or unavailable, we would be required to modify our growth and operating plans accordingly. The uncertainties relating to our ability to successfully execute our 2014 operating plan, combined with our inability to implement further meaningful cost containment measures that do not jeopardize our growth plans and the difficult financing environment, raise substantial doubt about our ability to continue as a going concern. Our consolidated financial statements for the years ended December 31, 2013 and 2012 have been prepared assuming that we will continue as a going concern, which contemplates realization of assets and the satisfaction of liabilities in the normal course of business for a reasonable period following the date of such financial statements. The consolidated financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classifications of liabilities that could result should we be unable to continue as a going concern. 28 Revenue Generation We generate revenues through the provision of our mobile engagement solutions. We operate under a number of different contractual relationships and generate revenue from a number of different sources, including the following: Managed Service contracts: Many of our customers pay us fixed monthly fees for the right to use our technology and services. We typically enter into 12 month contracts to provide mobile access gateways, back-end connectivity, MMS and SMS messaging connectivity, monitoring, quality assurance and support in exchange for a monthly retainer. Revenues from these arrangements are generally recognized ratably over the term of the contract. These services are accounted for as a single unit of accounting as they do not meet the criteria for segregation into multiple deliverable units for purposes of revenue recognition. Program contracts: We enter into certain program contracts with customers, under which we provide a defined service for a fixed fee per transaction. For example, our Mobile Statement products are used by some of our customer to deliver monthly statements to the mobile phones to their respective subscribers or consumers. We typically earn a fixed fee for each statement sent to a mobile phone. Revenues from these contracts are recognized upon provision of such services. Transaction fees: In certain instances, we earn revenues on a transaction basis. For example, under the terms of our agreements with wireless carriers and enterprises, we earn transaction fees when a wireless subscriber downloads content into a mobile phone via one of our servers. Transaction fees are recognized as revenue in the period in which the transaction giving rise to the fee occurs. Licenses of mobile platform: We earn royalties from the license of our platform to wireless carriers and enterprises. Our platform is connected to the wireless carriers' data centers, and we earn fees ratably over the time period that services are provided to the wireless carrier or on a per message charge, depending on the individual agreement with the wireless carrier. With agreements that are based on a period of time in which the wireless carrier utilized the platform, revenues from the licenses are generally recognized ratably over the term of the contract in which the platform will be utilized. For those wireless carriers that pay on a per message basis, we recognize revenue in the period in which the transaction giving rise to the revenue occurs. Advisory and service fees: We earn consulting and service fees when enterprises hire us to assist in the design and execution of a mobile advertising campaign. We provide services from the initial conceptualization through the creation of the content, mobile website development, database design/development, and other related services to successfully implement the mobile campaign, including final product dissemination to consumers and measurement of success rates. Fees for these services are recognized as revenue when the services have been performed. Each of these services are priced, billed and recorded as revenue separately in the period in which the service is performed. Operating Results The discussion below pertains only to our results of operations on a consolidated basis for the periods presented. The period-to-period comparison of financial results is not necessarily indicative of future results. Revenues. For the year ended December 31, 2013, revenues were approximately $15.3 million compared to $15.9 million in 2012. The year over year decrease of 16% in the value of the South African Rand against the U.S. dollar decreased revenue by approximately $1.6 million. Had the exchange rate remained constant, revenue would have grown approximately $1.0 million. Cost of Sales. Cost of sales are fees that we pay to wireless carriers and various wireless aggregators for messaging services It also includes third-party data center costs where we host our messaging platform. Certain third-party creative services related to our customers' campaigns are also included. As our revenues increase and thus message volumes increase, we generally can negotiate improved message costs. For the year ended December 31, 2013, cost of sales was $6.6 million compared to $6.3 million for the year ended December 31, 2013. Our cost of sales varies depending on the change in product mix, including the mix among types of messaging, and the cost of delivering messages through different aggregators and carriers. 29 Gross Profit. For the year ended December 31, 2013, gross profit as a percentage of revenues was 57% compared to 60% for the year ended December 31, 2012. Our revenue mix in 2013 consisted of more SMS messaging than in 2012. Further, we do not pay messaging fees when our largest customer, Vodacom (Pty.) Ltd., utilizes our messaging products and services for its own use, which results in 100% gross profit when Vodacom is a customer. Revenue from Vodacom, as a customer, as a percentage of total revenue continued to decrease in 2013, resulting in a decrease in our overall 2013 gross profit. Gross profit varies depending on the change in product mix between the type of messaging and the wireless carrier network over which the messages are sent. As a result, period to period comparisons of our gross profit may not provide meaningful information concerning expected future trends. Sales and Marketing Expenses. Our sales and marketing expenses are marketing and promotional expenditures and include direct costs attributable to our sales and marketing activities, such as conference and seminar hosting and attendance, travel, entertainment and advertising expenses. In order to continue to grow our business, we expect to continue to commit resources to our sales and marketing efforts. Sales and marketing expenses for the year ended December 31, 2013 were approximately $4.1 million compared to $4.3 million in 2012. Sales and marketing costs decreased in 2013 due to reduced head-count and less travel cost in the U.S. General and Administrative Expenses. Our general and administrative, or G&A, expenses primarily consist of personnel costs for all employees, except those engaged in research and development and sales and marketing. Additional G&A expenses include consulting and professional fees and other corporate and travel expenses. G&A expenses for the year ended December 31, 2013 were approximately $5.8 million compared to $7.2 million for 2012. Our G&A expenses for 2013 decreased from prior year as a result of aggressive expense management. Research and Development. Research and development, or R&D, expenses consist primarily of personnel-related expenses, including payroll expenses and engineering costs related principally to the design of new products and services. R&D expenses decreased from $5.4 million in 2012 to $4.4 million in 2013 due primarily to significant deduction in personnel related to our operations in Poland. Impairment Loss. In December 2013, we completed an impairment review of all our property and equipment, intangible assets and goodwill. Based on this review, we determined that approximately $17.1 million of goodwill and intangible assets related to the purchase of Archer USA do not provide substantial, foreseeable value to the Company and thus were impaired and included in "Impairment Loss" for the year ended December 31, 2013. In December 2012, we completed an impairment review of all our property and equipment, intangible assets and goodwill. Based on this review, we determined that approximately $9.5 million of goodwill and intangible assets related to the purchase of Archer USA do not provide substantial, foreseeable value to the Company and thus were impaired and included in "Impairment Loss" for the year ended December 31, 2012. Other Income (Expense). As of December 31, 2013 the fair value of the shares in excess of the authorized shares was approximately $2.5 million which resulted in a charge to other income for the twelve months ended December 31, 2013 of approximately $0.5 million. 30 Provision for Income Taxes. For the years ended December 31, 2013 and 2012, we did not record any tax benefit for the income before tax losses incurred in the U.S., as we recorded a 100% valuation allowance on the potential benefit. If our U.S. operations achieve consistent profitability from a tax-reporting perspective we will record the tax benefits of U.S. pre-tax losses including any allowable tax benefit from historical losses. Preferred stock dividend and accretion of beneficial conversion feature. We determined that the Series A Preferred Stock issued in September 2010 contained an embedded beneficial conversion feature and we recorded a preferred stock discount of $10.0 million which will be treated as a deemed dividend and amortized over 24 months to accumulated deficit. In addition, the holders of the Series A Preferred Stock are entitled to cumulative dividends at the rate per share (as a percentage of the stated value per share) of 6.0% per annum. For the years ended December 31, 2013 and 2012, we amortized approximately $0.0 million and $3.9 million, respectively, as accretion of the beneficial conversion feature. In addition, for the years ended December 31, 2013 and 2012, we recorded dividends of approximately $1.9 and $1.1 million, respectively, for the dividends payable to holders of the Series A Preferred Stock. Net loss attributable to the Company. For the year ended December 31, 2013 and 2012, net loss attributable to the Company was $26.6 million and $19.4 million, respectively. Off-Balance Sheet Arrangements As of December 31, 2013, we did not have any off-balance sheet arrangements that have or are reasonably likely to have current or future effect on our financial condition, revenues or expenses, results of operations, liquidity or capital resources that are material to investors. In accordance with our normal business practices, we indemnify our officers and directors. We also have contractual indemnification obligations to our customers relating to third-party content and operating systems that we provide to our customers. Recent Accounting Pronouncements There are no future accounting pronouncements which will impact 2014. Critical Accounting Policies and Estimates Our discussion and analysis of our financial condition and results of operations is based upon the consolidated financial statements accompanying this report, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires us to make certain assumptions and estimates about future events, and apply judgments that affect the reported amount of assets and liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities at the date of our consolidated financial statements. We base our assumptions, estimates, and judgment on historical experience, current trends and other factors which management believes to be relevant and appropriate at the time our consolidated financial statements are prepared. On a regular basis, management reviews its assumptions, estimates, and judgments to ensure that our consolidated financial statements are presented fairly. However, because future events cannot be determined with certainty, actual results may differ from our assumptions and estimates, and such differences could be material. Our significant accounting policies are summarized in Note 1 - "Organization and Significant Accounting Policies" of the Notes to the Consolidated Financial Statements included in Item 8 of this report. Management identifies its most critical accounting policies as those that are the most pervasive and important to the portrayal of our financial position and results of operations, and that require the most difficult, subjective and/or complex judgments by management regarding estimates that are inherently uncertain. 31 Currency Conversion. The business of our mobile services and solutions segment has historically been conducted in the South African Rand. All assets and liabilities are translated from foreign currencies into U.S. dollars at the exchange rates prevailing at the balance sheet dates, and all income and expenditure items are translated at the average rates for each of the periods presented. Revenue Recognition. We generate revenue from a variety of transactions, including retainers, program contracts, transaction fees, licenses of mobile platforms, and advisory and service fees. See the discussion under "Revenue Generation" above. Revenue recognition varies depending on the type of transaction, and may involve recognizing revenues over the term of a contract in the period in which services are performed or at the time a transaction occurs, to ensure revenue recognition for multiple deliverables is accounted for appropriately in our financial statements. Because a significant portion of our sales may be tied to large advertising campaigns ordered from time to time, the timing of when the revenue is recognized may have a significant impact on results of operations for any quarterly or annual period. Accounts Receivable and Allowance for Doubtful Accounts. Management exercises its judgment in establishing allowances for doubtful accounts receivable. This judgment is based on historical write-off percentages and information collected from individual customers. We have traditionally experienced high customer concentration, resulting in large accounts receivable from individual customers. The determination of the creditworthiness of these customers and whether or not an allowance is appropriate could have a significant impact on our results of operations for any quarter. Goodwill impairment. We review our goodwill for impairment annually in the fourth quarter at the reporting unit level. We also analyze whether any indicators of impairment exist each quarter. A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators may include a sustained, significant decline in our share price and market capitalization, a decline in our expected future cash flows, a significant adverse change in legal factors or in the business climate, unanticipated competition, the testing for recoverability of our long-lived assets, and/or slower growth rates, among others Contingencies. At any time, we may be involved in legal proceedings or other claims and assessments arising in the normal course of business. Our policy is to routinely assess the likelihood of any adverse judgments or outcomes related to these matters, as well as ranges of probable losses. A determination of the amount of the reserves required, if any, for these contingencies is based on historical experience and/or after analysis of each known issue. We record reserves related to those matters for which it is probable that a loss has been incurred and the range of such loss can be estimated. With respect to other matters, management has concluded that a loss is only reasonably possible or remote and, therefore, no liability is recorded. Management discloses the facts regarding material matters assessed as reasonably possible and potential exposure, if determinable. Costs incurred defending claims are expensed as incurred. |