Net Element, Inc.
Q1 2017 Earnings Call Transcript

Published: 16 May 2017

[Operator:]

Good day, ladies and gentlemen. Thank you for standing by. Welcome to the Net Element 2017 First Quarter Financial Results and Business Update Conference Call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. [Operator Instructions] I'd like to remind listeners that during the call, management's prepared remarks may contain forward-looking statements which are subject to risks and uncertainties. Management may make additional forward-looking statements in response to your questions today. Therefore, the Company claims protection under Safe Harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995. Actual results may differ from results discussed today and therefore we refer you to a more detailed discussion of these risks and uncertainties in the Company's filings with the SEC. Any projections as to the Company's future performance represented by management include estimates today, as of May 16, 2017, and the Company assumes no obligation to update these projections in the future as market conditions change. The recording and certain financial information provided during the call is available at www.netelement.com, on the Investor Relations page. At this time, I would like to turn the call over to Oleg Firer, CEO. Oleg, please go ahead.

[Oleg Firer:]

Good morning, everyone. Thanks to everyone for joining our call today to discuss first quarter 2017 operational and financial results as well as give an opportunity for those of you listening in to ask questions during the Q&A session. I would like to begin today's conference call by highlighting our accomplishments during the first quarter of 2017. For the three months ended March 31, 2017, net revenues increased 20% to $13.6 million, as compared to $11.3 million in the prior year. The $2.3 million increase in net revenues is primarily due to organic growth in our North America Transaction Solutions segment, which demonstrated net revenues increase of 40% as compared to the prior year. North America Transaction Solutions segment, there was a continued organic growth of SMB merchants in this segment with emphasis on value-added offerings. Revenues for this segment continue to lead the growth for three months ended March 31, 2017 with $11 million, a 40% increase over the prior year. Online Solutions segment, there was continued organic growth in global online payments acceptance services with emphasis on value-added offerings. Revenues for this segment for three months ended March 31, 2017 were $1.7 million, a 23% increase over the prior year. Mobile Solutions segment; revenues for this segment were $857,000, a 57% decrease over the prior year. We continue to explore financing options for this business as well as expansion to markets that do not require us to advance capital to content providers prior to getting paid from mobile network operators. During the first quarter of 2017, we expanded our service offerings to several new markets, which included continued expansion of our Direct Carrier Billing services to Poland and Turkey through integration of our proprietary Trinity Platform with all major operators in the region, including T-Mobile and Orange, allowing access to 113.5 million mobile users in these markets. During the first quarter, we announced new client relationships. Unified Payments launched payment acceptance for ReservHotel, a leading provider of travel distribution and booking solutions for hotels worldwide. First quarter was a record quarter for new SMB merchants in North American Transactional Payment segment. During the quarter, we signed over 1,500 new merchants in the U.S. PayOnline launched payment acceptance for Sutochno.ru, the leading C2C short-term accommodation booking service in Russia. First quarter was also a busy quarter for new product launches. During the quarter, we launched Multi Currency Processing to allow online merchants to price their goods and services in over 90 local currencies and expand their global reach. Unified Payments announced a comprehensive Point-of-Sale program during its 2017 launch series at the annual Northeast Acquirers Association conference in Boston, Massachusetts. Digital Provider announced partnership programs targeting content providers, mobile network operators and mobile application developers at Mobile World Congress 2017 in Barcelona, Spain. PayOnline launched Apple Pay support in Russia. PayOnline is well-positioned to capitalize on this growing trend in mobile payments acceptance by enabling and supporting mobile and e-commerce merchants to accept Apple Pay. PayOnline launched Instant Credit, an innovative microcredit solution available to online consumers that can help increase conversion rates and merchants' revenues. The first quarter of this year is typically one of the slowest quarters of the year for processing and we remain focused on continued growth and innovation to differentiate our product offerings and provide superior products and services to our expanding customer base. As it relates to decline in our Mobile Solutions segment, we are undertaking several strategic changes which should yield results in the third quarter of this year. Now I would like to introduce Jonathan New, Net Element's Chief Financial Officer, who will provide comments on our financials. Jon, please proceed.

[Jonathan New:]

Thank you, Oleg. Let's walk through the financial results for the quarter. We reported a net loss attributable to stockholders of $2.5 million or $0.15 a share for the three months ended March 31, 2017, as compared to a net loss of $1.9 million or $0.16 per share for the three months ended March 31, 2016. This resulted in an increase in our net loss attributable to stockholders of $600,000 primarily as a result of higher general and administrative expenses, non-cash compensation expense, and those two things were offset by an improved gross margin driven by North American production. Eliminating the effects of non-cash compensation, on a non-GAAP basis, net loss attributable to Net Element was $1.9 million or $0.11 a share for the three months ended March 31, 2017 as compared to an adjusted non-GAAP net loss attributable to Net Element, Inc. stockholders of $1.5 million or $0.13 per share for the three months ended March 31, 2016. Net revenues were $13.6 million for the three months ended March 31 as compared to $11.2 million for the three months ended March 31, 2016. The increase in net revenues is primarily due to organic growth of merchants in North American Transaction Solutions segment, which resulted in an increase to the North American Transaction Solutions revenue of $3 million or 40% over the three months ended March 31, 2016. Increases in our North American Transaction Solutions segment revenue were primarily due to continued growth of our SMB merchants with emphasis on value-added offerings. This was partially offset by a $1.1 million or 57% decrease in our Mobile Solutions segment, as we continue to seek capital needed to prepay for content delivered through our platform as well as to diversify to post-paid markets. Our Online Solutions segment revenue increased $300,000 or 23% from $1.4 million for the three months ended March 31, 2016, to $1.7 million for the three months ended March 31, 2017, primarily due to favorable exchange rates. Cost of revenues for the three months ended March 31, 2017 were $11.5 million as compared to $9.4 million for the three months ended March 31, 2016. The $2 million increase in cost of revenue was primarily due to $2.8 million in North America Transaction Solutions segment due to increased volume. There was also a $270,000 increase resulting from Online, also due to increased volume and FX. This was offset by almost $1 million decrease in Mobile Solutions segment cost of revenues. As we discussed, the revenues are down and the costs are down correspondingly. Gross margin for the three months ended March 31, 2017 was $2.1 million or 15% of net revenue, as compared to $1.9 million or 17% of net revenue for the three months ended March 31, 2016. The $226,000 increase in gross margin was due to the increased volume of processing in North American Transaction Solutions offset by a decrease of $139,000 in Mobile Solutions margin caused from a decrease in business. Total operating expenses were $4.4 million for the three months ended March 31, 2017 versus total operating expenses of $3.6 million for the three months ended March 31, 2016. General and administrative expenses were $2.8 million of that versus $2.1 million for the three months ended March 31, 2016. This $700,000 variance was primarily due to higher salaries in Corporate and Online Solutions. General and administrative expenses consisted of operating expenses not otherwise delineated in our financial statements and they include salaries and benefits, professional fees, rent, travel, transaction gains, office expense, communication, and other expenses required to run our business. Getting into the specifics of that, salaries, benefits and contractor payments were $1.4 million for the three months ended March 31, 2017 as compared to $1.2 million for the three months ended March 31, 2016. The increase in salaries of $489,000 was due primarily to the increase in the Corporate expense for a $300,000 discretionary bonus payable to our CEO and approved by the Board of Directors for prior periods, for prior year's performance. The bonus is payable when cash flow to business can support the payment. Additionally, North American Transaction Solutions segment salaries increased $87,000 due to an increase in headcount and sales incentives for key employees, as we continue to grow that business. We saw an increase of $109,000 and $16,000 respectively in Online and Mobile, which were primarily due to ruble exchange rate, and to a lesser extent some salary increases. Professional fees were $674,000 as compared to $524,000 for the three months ended March 31, 2016. Fee increased $149,000 primarily due to Online Solutions segment consulting fees which increased $133,000 of that $149,000 mainly due to an increase in management consulting for portfolio. Non-cash compensation from share-based compensation was almost $600,000 for the three months ended March 31, as compared to almost $361,000 for the three months ended March 31, 2016. The majority of these expenses were for employee and consultant incentives in both periods. We recorded bad debt of $280,000 for the three months ended March 31, 2017 as compared to $251,000 for the three months ended March 31, 2016. Of that $279,000 in this quarter, $287,000 of it was ACH rejects. We had a recovery from Russian operations of $7,000 in the three months ended March 31, 2016. We recorded a loss, again which was primarily ACH rejects, $264,000, offset by $12,000 recovery in Russian operations. Depreciation and amortization expense consist primarily of the amortization of merchant portfolios purchased plus depreciation expense on fixed assets, client acquisition costs, capitalized software expenses, domain names and employee non-compete agreements. Depreciation and amortization expense was $657,000 for the three months ended March 31, 2017 as compared to $888,000 for the three months ended March 31, 2016, as we have almost fully amortized the purchased portfolio portion of the amortization. Interest expense was $270,000 for the quarter, as compared to $150,000 for the three months ended March 31, increase of $119,000 due to an increase primarily in loan fees and related party interest. Net loss attributable to non-controlling interest amounted to $51,000 for the three months, as compared to $38,000 for the three months ended March 31, 2016. This concludes our formal remarks. I'd now like to ask the operator to open the call for questions please.

[Operator:]

[Operator Instructions] Our first question comes from [Nery Rodriguez] [ph]. Your line is now open.

[Nery Rodriguez:]

I'm an investor, Oleg. I have a quick question for you. When do you expect PayOnline to be in the U.S.? And also I have a second follow-up question actually. What is your strategy for staying NASDAQ compliant? I think last year we effected a reverse split. That didn't go so well. So what strategy do we have in place now that will prevent that from happening again?

[Oleg Firer:]

With respect to PayOnline, we are in the final stages of certifying in the United States. So we project that PayOnline will be live in U.S. probably within next 30 days, 30 to 45 days. We are in the final stages of testing certifications. With respect to compliance, we have until I believe July 1 or end of June, July 1, to get compliance with NASDAQ. We will explore all other options and one of the options is to ask NASDAQ for an extension. We have already began those conversations with NASDAQ. So we hope that NASDAQ will grant us a six-month extension.

[Nery Rodriguez:]

Awesome, thank you, and again, great job increasing revenues for the quarter, really impressive.

[Operator:]

Our next question comes from Lisa Thompson from Zacks Investment. Your line is now open.

[Lisa Thompson:]

Let me just follow up on the PayOnline question for starters. What are your plans for that in the U.S., how are you going to market that and who do you think the customers will be?

[Oleg Firer:]

So, there are several strategies to PayOnline. First one, we are currently using third-party gateways for our business. By bringing PayOnline, we project lower costs for the transactions by not going to foreign gateways and by having our own, hence the reason why we are certifying the platforms that we have most of the business on. Second is we are focused on integrated payments. We are doing a lot of IP based transactions through POS systems and such, and PayOnline will be a driving force behind it. We work with a lot of value-added resellers and developers that develop products currently on the foreign gateways that we use. So we hope to have a centralized platform which will allow single onboarding and single integration for our partners to be able to not only to process domestically but to process internationally, and we believe there are significant business opportunities in U.S. for that.

[Lisa Thompson:]

So is that something where you just turn a switch on and switch your U.S. system onto that system?

[Oleg Firer:]

Yes, it's all of our – we have full control of our merchants and ones that are using foreign gateways today, with switching over to ours. There are some merchants that use vaulting for their transactions, and it will take a while for those to switch over, but the bulk of the merchants that we have will be very easy to convert over to us.

[Lisa Thompson:]

And now is that for 100% of your U.S. revenues or just the ones that have foreign transactions?

[Oleg Firer:]

No, it's not 100%. Right now I would say it's about 15% of our U.S. business, but we are actively marketing to that channel. So we believe that on a go forward basis, there will be significant opportunity for U.S. business. As we develop value-added services for small to medium-sized businesses and as we work with developers that develop such services, we will need a platform to allow merchants to work on that we control, and PayOnline is that platform.

[Lisa Thompson:]

Okay.

[Oleg Firer:]

It's not only for online, it's not just for online business, it's for online and IP based business. So PayOnline is not just going to be using U.S. as purely an online platform, it will also be a platform to be used for IP-based transactions. And most of the terminals that we deploy today are IP-based terminals, like the Poynt's smart payment terminal and other terminals that we deploy or POS integrations that we do, they are all IP-based transactions and that would also fall into this platform. So it's not purely online, it's going to be online and IP-based transactions.

[Lisa Thompson:]

Okay, that sounds good. So, I'm looking at the numbers and I'm trying to figure out where you spent all the extra money compared to last year. Now it looks like a lot of it went into Online in Russia. Is that all currency or are you actually doing something over there that's costing a bunch of money?

[Jonathan New:]

It is all currency. The ruble went from like 79 to 54, something like that. So we've had a big currency change, and so that affected the revenues and the expenses. So, basically you're dealing with flat cost in Russia. It would be slightly decreased on a ruble basis if you look at it.

[Lisa Thompson:]

And so if we took all the currency out of the quarter, how much would it have been since it would have gone up?

[Jonathan New:]

The Russian would have been flat basically or slightly down. So you can back that out. And then the U.S. went up because of one-time bonus accrual and compensation, non-cash comp primarily.

[Lisa Thompson:]

Okay, because there is a theory that the more revenues you have, the less your [indiscernible] are supposed to be. It's just not working out like that. Is that [indiscernible]?

[Oleg Firer:]

But that's not correct because we have not incurred [expenses] [ph]. It's all, like Jon just said, it's all non-cash based. We have not, and it's all catching up from the previous periods, it's not like we awarded anybody for like in Russia for doing a job that goes on. So it's really previous stuff, it's historical stuff. And with respect to expenses, it's flat or down. So we are not incurring any extra cash expenses.

[Jonathan New:]

I mean the growth was about $88,000 in salaries quarter on quarter to support the North American Transaction, and then the bonus accrual $300,000 and then the change in non-cash.

[Lisa Thompson:]

Okay. So are you still burning around $1 million a quarter?

[Jonathan New:]

Yes.

[Lisa Thompson:]

Okay, so that hasn't changed.

[Jonathan New:]

No.

[Oleg Firer:]

But also, Lisa, it's also very important to underline, our North American business has experienced a significant growth in this quarter with respect to new merchants. We signed up over 1,500 new merchants. And even though we are saying that we are losing about $1 million a quarter, that's less than we lost last year because we have redeployed cash to sign up new merchants. So that cash that we lost includes incentives to bring, to onboard over 1,500 new merchants in the quarter, which is more than we've ever done. So, if we are looking, comparing side-by-side, a big part of the burn is to attract new merchants. And if we slowdown, obviously it could improve, but we have a momentum and we want to bring in as much as we can and we believe our distribution channel is expanding rapidly.

[Lisa Thompson:]

Okay, great. And another question, have you introduced Aptito in Russia, is that out there for sale yet and who is selling it?

[Oleg Firer:]

Right, so we have introduced it last year and then the rules in Russia changed, and actually they changed really twice, with the new one that we need to make certain adjustments to it to be compliant with their federal rules integrations, so we do not have significant activations in Russia as of yet because we need to re-comply with the new regulations that were effective as of beginning of this year. And once that's going to be done, we are going to be selling it through the PayOnline distribution channel.

[Lisa Thompson:]

Okay. And can they just sell it with the people they have there?

[Oleg Firer:]

Yes, that's why I said, we're going to be using the same distribution, we're going to employ the same strategy that we are employing in United States, we use the same distribution channel rather than reinvesting into a distribution, because one of our assets is distribution channel and we want to put as many products as possible through that distribution channel.

[Lisa Thompson:]

And how long do you think it will take till it's available?

[Oleg Firer:]

I would say it will take a while, I would say probably another three months.

[Lisa Thompson:]

Okay And how are you competitive there, are you way ahead of the curve or is there a lot of [indiscernible]?

[Oleg Firer:]

We're still very competitive in the region, and hence the reason why we are signing up new merchants, we are signing up some main merchants in the region. So not only are we very competitive in our offerings, we have some products and services that do not have any competition to us in that region, hence the reason why we are able to sign up larger merchants that we signed up in North American segment.

[Lisa Thompson:]

So that implies it's not more at restaurants, it's going to be more retail or [indiscernible]?

[Oleg Firer:]

If we are talking about Aptito, Aptito in Russia we are seeing more focus on the restaurants than retail. That's where we see a void in the product in our region. Retail, there is lot of retail packages are available and retail is a little bit more competitive. On the restaurant side, there is still lot of opportunities.

[Lisa Thompson:]

All right, that sounds great, something to look forward to. And so back to Mobile, I mean it looks like that that's got very low margins, it's losing you money, why are you even bothering, why don't you just shut it down and put the money into PayOnline?

[Oleg Firer:]

Right, we have not been putting any money into Mobile, hence the reason why it's slowed down. It's a business that historically we used credit facilities to finance and we do not have credit facility available to finance the business, hence the situation that we are in. We are focused on areas where we don't have to advance capital and we are doing a lot of repositioning or restructuring our business, which as I said in my opening remarks, that we hope we will see the results in the third quarter of this year, and we are making changes and we are considering all options.

[Lisa Thompson:]

Okay, great.

[Oleg Firer:]

But we are not investing in that business, we have not been investing in the Mobile business.

[Lisa Thompson:]

So I mean you are paying rent and you got employees and…

[Oleg Firer:]

Right, but if we are to lose money – we don't want to lose money, so we are scaling down for that reason. So you're not going to see increased overhead, you're going to see decreased overhead as we restructure this.

[Lisa Thompson:]

Okay, great, that sounds good. All right, so what's your feeling about how the second quarter is going? Is North America still just as strong?

[Oleg Firer:]

Yes, North America is going to be phenomenal.

[Lisa Thompson:]

It is because of the new people you signed up, right?

[Oleg Firer:]

It's because of the expanded distribution strategy, it's we believe that this coming quarter will be another record quarter for new merchant sign-ups. We have a new BIN relationship, new acquiring relationship with Esquire, hence the reason why you saw slight decline in the margin, is because we have some one-time expenses associated with it. The new BIN relationship will allow us for increased margin because we'll have lower costs for processing transactions. We are already putting on merchants onto Esquire BIN relationship and that's growing. So we believe that we are working on all cylinders in North America.

[Lisa Thompson:]

All right, so we'll see less losses this quarter, right?

[Oleg Firer:]

I believe so.

[Lisa Thompson:]

Okay, great. Thank you. That's all my questions.

[Operator:]

I'm showing no further questions at this time. I'd like to turn the call back over to management for closing remarks.

[Oleg Firer:]

Again, I want to thank everyone for participating in our call today. Please do not hesitate to contact me or Jon with any follow-up questions. Thank you.

[Operator:]

Ladies and gentlemen, that does conclude the Net Element 2017 First Quarter Financial Results Conference Call. Thank you for your participation. You may now disconnect. Everyone have a great day.