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ONE HORIZON GROUP, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion provides information which management believes is relevant to an assessment and understanding of our results of operations and financial condition. The discussion should be read along with our unaudited condensed consolidated financial statements for the three and six months ended June 30, 2014 and 2013 and notes thereto contained elsewhere in this Report, and our annual report on Form 10-K for the twelve months ended December 31, 2013 and 2012 including the consolidated financial statements and notes thereto. The following discussion and analysis contains forward-looking statements, which involve risks and uncertainties. Our actual results may differ significantly from the results, expectations and plans discussed in these forward-looking statements. See "Cautionary Note Concerning Forward-Looking Statements." Overview Business We develop and license software to telecommunications operators through our wholly-owned subsidiaries Horizon Globex GmbH and Abbey Technology GmbH, each incorporated under the laws of Switzerland ("Horizon Globex" and "Abbey Technology," respectively). Specifically, Horizon Globex and Abbey Technology develop software application platforms that optimize mobile voice, instant messaging and advertising communications over the internet, collectively, the "Horizon Platform." Our proprietary software techniques ("SmartPacket™") use internet bandwidth more efficiently than other techniques that are unable to provide a low-bandwidth solution. The Horizon Platform is a bandwidth-efficient Voice over Internet Protocol ("VoIP") platform for smartphones and tablets, and also provides optimized data applications including multi-media messaging and mobile advertising. Using our SmartPacket™ platform, we have been able to significantly improve the efficiency by which voice signals are transmitted by radio over the Internet resulting in a 10X reduction in mobile spectrum required to transmit a VoIP call. We license our software solutions to telecommunications network operators and service providers in the mobile, fixed line, cable TV and satellite communications markets. We are an ISO 9001 and ISO 20000-1 certified company with assets and operations in Switzerland, Ireland, the United Kingdom, China, India, Russia, Singapore and Hong Kong. The Horizon Platform delivers a turnkey mobile VoIP solution to telecommunications operators. We believe that the technology underlying SmartPacket™ is the world's most bandwidth-efficient VoIP technology. Our VoIP platform allows voice calls over the Internet that use as little as 4kbps of data compared to around 48kbps offered by other optimized VoIP platforms, thereby enabling voice communications over limited bandwidth and congested cellular telecom data networks including 2G, 3G and 4G. The kbps rates above include bi-directional voice communication including IP overhead. We believe that emerging markets represent a key opportunity for Horizon Call because there are significant markets with high population density, high penetration of mobile phones, congested mobile cellular networks and high growth in the adoption of smartphones. These factors will put increased pressure on mobile operators to manage their network availability. In this context, the Company is forming a number of joint ventures with local partners in the regions of interest to seize upon this opportunity. We expect to form joint ventures when local regulations prevent us from accessing a particular market directly. As of the date of this report, we have formed joint ventures in India, Russia and China. We plan to fund this proposed expansion through debt financing, cash from operations and potential equity financing. However, we may not be able to obtain additional financing at acceptable terms, or at all, and, as a result, our ability to continue to improve and expand our software products and to expand our business could be adversely affected. Recent developments During the six months ended June 30, 2014, we expanded our Irish software development team with the addition of a new senior software developer at our recently opened software research and development office at the Nexus Innovation Center on the campus of the University of Limerick. As part of this process, we signed an agreement with the Industrial Development Agency (IDA) Ireland whereby IDA granted certain financial assistance toward the cost of establishing and carrying a service undertaking for a software development center in Ireland in connection with our VoIP software platform. The software development center is intended to give employment of 25 persons and could allow us to more quickly increase the size of this research and development team. We believe that the further expansion of our Irish development team will allow the further advance of our unique mobile VoIP solutions. 21 -------------------------------------------------------------------------------- We also completed the development and continued to refine the Horizon billing system. The completion of the Horizon Billing System software add-on package allows one Horizon to deliver an additional turn-key element to our customers that will allow our customers to invoice their customers and enterprise on a postpaid monthly basis. This adds greater flexibility and reach to the Horizon platform as offered by our customers to those subscribers that wish to utilize the service on a post paid basis. We also expanded our software development capabilities for China by hiring 4 new junior software developers in our Horizon Nanjing JV, known as Horizon Network Technology Co. Ltd.. We believe that the expansion of our software development team at our Chinese joint venture will support the company's strategy of continuing to develop our products in areas with high population density, high penetration of mobile phones, congested mobile cellular networks and high growth in the adoption of smartphones while working within the constraints of local regulations. During the first half of our 2014 fiscal year, Chongqing Leixin Network Technology ("Leixin"), a joint venture with Leiqiang Telecommunications Co. Ltd ("Leiqiang") through a PRC entity controlled by us delivering the 95131 area code to smartphones throughout China, commenced the first phase of its infrastructure rollout in five cities in China: Tianjin, Beijing, Chongqing, Changchun and Shijiazhuang. These initial five locations will connect the 95131 to the national telephone network to commence the commissioning of the Leixin VoIP service in China. To date, we have successfully installed eight servers in support of Leixin smart phone app The Leixin smart phone app will be able to provide various optimized internet value added services to its mobile subscribers including but not limited to voice and social media services including text, picture, video and geo-location messaging. These value added services are made possible through the creation of a "Virtual SIM" that utilizes the 95131 area code number range and One Horizon's proprietary communication software, an industry first. The "Virtual SIM" will be deployed via a Leixin-branded smart phone app that will also make use of the One Horizon on-line payment service to enable the purchase of call and message credits as well as the purchase and sharing of Stickers, Emojis & Emoticons. Combined with One Horizon's location aware mobile advertising services, the Leixin branded smart phone app is expected to drive multiple revenue streams from the supply of its value-added services. Leixin will seek to acquire 100 million new app subscribers for the Leixin branded smartphone app over a three-year period and expects to achieve industry average revenues per user (ARPU) for similar social media apps. During the three months ended June 30, 2014, we continued building up the LeiXin core network rollout. The Global Exchange (network control center) was placed in a high availability Data Center in Shanghai and eight (8) Horizon line servers were connected to the telecommunications network. This level of rollout allowed us to issue a preliminary Android Application (App) to a group of Chinese students in Nanjing for them to evaluate the user Interface and the core features of our optimized smartphone App. Based on this feedback the research and development teams in Ireland and China made some adjustments to the Application look and feel service to accommodate this target user community. During the second quarter of 2014, we signed a global exchange agreement with a second tier telecommunication company that targets US citizens traveling overseas by providing the Horizon VoIP application in a new configuration called "RoamFrii" that allows customers to eliminate certain roaming charging while traveling internationally. Going forward, we plan to work with our partner to expand this offering to other international travelers. In the first half year of 2014, we continued our research and development of the Horizon product platform. The Swiss based team made significant strides towards the next generation of the product suite with particular emphasis going to the User Interface (UI) re-engineering. Further to the UI the Research and Development for version 2.0, our Irish based team made progress on the latest multi-core solution with a view to releasing this software in the third quarter of 2014. The software team in China is pushing ahead with integrating the user feedback garnered from Chinese students using our Application on the smartphone and also working on a new and exciting method for Direct Inward Dial number rental for the Chinese marketplace. 22 -------------------------------------------------------------------------------- On July 2, 2014, we received approval by NASDAQ's Listing Qualifications Department to list our common stock on the NASDAQ Capital Market. Our common stock commenced trading on the NASDAQ Capital Market on July 9, 2014 under the same ticker symbol "OHGI". On July 21, 2014, we closed a private placement of $1,000,000 for a total of 10 units at a purchase price of $100,000 per Unit, each consisting of, (i) 17,094 shares of the Company's Series A Redeemable Convertible Preferred Stock, par value $0.0001 per share, initially convertible into 17,094 shares of the Company's common stock, par value $0.0001 per share, and (ii) 10,000 Class B Warrants, each exercisable to purchase 1 share of Common Stock at an exercise price of $4.00 per share. The Financings were completed in reliance upon the exemption from securities registration afforded by Regulation S ("Regulation S") as promulgated under the Securities Act of 1933. On July 28, 2014, we appointed Brian Collins, Vice President and the Chief Technology officer of the Company, the Chief Executive Officer of the Company, following our former CEO, Mark White's resignation. Mr. Collins is the co-inventor of the Horizon Platform, and has over 20 years' experience in the technology sector with a background in software engineering. Mr. Collins brings experience in founding and operating technology companies along with his extensive knowledge of software engineering. Results of Operations Comparison of three months ended June 30, 2014 and 2013 The following table sets forth key components of our results of operations for the periods indicated. (All amounts, other than percentages, in thousands of U.S. dollars) Three Months Ended June 30, Change Increase/ Percentage 2014 2013 (decrease) Change Revenue $ 1,304 $ 1,253 $ 51 4.1 % Cost of revenue 549 885 (336) (40.0) Gross margin 755 368 387 105.1 Operating expenses: General and administrative 1,190 2,221 (1,031 ) (46.2 ) Depreciation 46 39 7 17.9 Total operating expenses 1,236 2,260 (1,024 ) (45.3 ) Loss from operations (481 ) (1,892 ) 1,411 Other income (expense) (64 ) (57 ) Income (Loss) before income taxes (545 ) (1,949 ) 1,404 Income taxes (recovery) - - - - Net Loss for period (545 ) (1,949 ) 1,404 Net loss attributable to non-controlling interest (22 ) (44 ) 22 Net loss attributable to One Horizon Group, Inc. (523 ) (1,905 ) (1,382 ) 23-------------------------------------------------------------------------------- Revenue: Our revenue for the three months ended June 30, 2014 was approximately $1.304 million as compared to approximately $1.253 million for the three months ended June 30, 2013, an increase of roughly $51,000, or 4.1%. The increase was primarily due to increase in sales of user licenses The Company expects sales to continue to increase going forward and that sales will begin to grow more quickly as more companies have signed up for the Horizon Platform. As of June 30, 2014, the following table sets forth the value of all existing contracts as it related to master licenses and the amount of revenue recognized to date as well as the revenue recognized during the three months ended June 30, 2014. This table represents the contract value for the sale of the master license, excluding other revenues recognized under the terms of the contract for maintenance, user licenses, and other sales. Master License Customer Type Balance Revenue Revenue to be recognized for 3 months Contract Value recognized to date ending 6/30/2014 Tier 1 $ 13,425,000 $ 9,512,500 $ 3,912,500 $ - Tier 2 52,000,000 46,861,419 5,138,581 500,000 Total $ 65,425,000 $ 56,373,919 $ 9,051,081 $ 500,000 In addition to the above revenue recognized from Master Licenses of approximately $500,000, the Company also recognized approximately $804,000 from the sale of hardware, user licenses, consultancy and maintenance services during the three months ended June 30, 2014. Cost of Revenue: Cost of revenue was approximately $549,000 or 42% of sales for the three months ended June 30, 2014, compared to cost of revenue of $885,000 or 71% of sales for the three months ended June 30, 2013. Our cost of sales is primarily composed of the amortization of software development costs. In addition, when a customer requires ancillary hardware, there are costs relating to the provision of that hardware. The decrease in cost of sales was mainly attributed to a reduction in sales of ancillary hardware and the associated cost of sale during the three months ended June 30, 2014 as compared to the same quarter in 2013. Gross Profit: Gross profit for the three months ended June 30, 2014 was approximately $0.76 million as compared to $0.37 million for the three months ended June 30, 2013, an increase of approximately 105%. The main reason for the increase in gross profit was the reduction in hardware costs described above herein. Management expects that gross profit shall increase withthe growth in business and the smartphone market globally, as well as the Company's ability to capitalize on market opportunities by entering areas with high population density, high penetration of mobile phones, congested mobile cellular networks and high growth in the adoption of smartphones. Operating Expenses: Operating expenses, including general and administrative expenses and depreciation were approximately $1.24 million and $2.26 million during the three months ended June 30, 2014 and 2013, respectively. The reduction arose from reduced accounting and legal costs incurred in 2014. We had relatively higher level of accounting and legal costs in the comparative period in 2013 compared to the same period in 2013 following the share exchange between and among Intelligent Communication Enterprise Corp. and One Horizon Group PLC closed on November 20, 2012. The reduced operating expenses were also due to our reduced staff costs during the three months ended June 30, 2014 as we transited certain development positions from Switzerland to Ireland and China. In addition, during the comparative period in 2013, we recognized a non-cash expenditure of more than $500,000 in connection with the issuance of certain shares to our advisors while we did not record such non-cash expenditure in the same period in 2014. 24-------------------------------------------------------------------------------- Net Loss:Net Loss for the three months ended June 30, 2014 was approximately $545,000 as compared to net loss of approximately $1.95 million for the same period in 2013. The decrease in net loss reflected a slight increase in revenue coupled with a reduction in operating expenses for reasons set out above herein. Management believe the net loss will continuously decrease and eventually become net income going forward with our growth in the sales and operations; provided that we are able to successfully sell Horizon Platform solution to new telecommunications companies globally. Non-Controlling Interest: The non-controlling interest holders in our Chinese subsidiary Horizon Network Technology Co Ltd were attributed their 25% share of the net loss of the Company in the amount of $22,000 for the three months ended June 30, 2014. The remaining portion of net loss of $523,000 for the three months ended June 30, 2014 was attributable to the stockholders of the Company. Going forward, management believes the Company will continue to grow the business and increase profitability if we are successful in selling the Horizon Platform solution to new telecommunications company customers globally. Comparison of six months ended June 30, 2014 and 2013 The following table sets forth key components of our results of operations for the periods indicated above. (All amounts, other than percentages, in thousands of U.S. dollars) Six Months Ended June 30, Change Increase/ Percentage 2014 2013 (decrease) Change Revenue $ 2,489 $ 3,172 $ (683 ) (21.5 )% Cost of revenue 1,097 1,338 (241) (18.0 ) Gross margin 1,392 1,834 (442 ) (24.1 ) Operating expenses: General and administrative 2,318 694 (1,376 ) (37.2 ) Depreciation 94 75 (19 ) (25.3 ) Total operating expenses 2,412 3,769 (1,357 ) (36.0 ) Loss from operations (1,020 ) (1,935 ) 717 Other income (expense) (112 ) (112 ) Income (Loss) before income taxes (1,132 ) (2,047 ) 717 Income taxes (recovery) (156) - - - Net Loss for period (976 ) (2,047 ) 1,071 Net loss attributable to non-controlling interest (65 ) (44 ) (21 ) Net loss attributable to One Horizon Group, Inc. (911 ) (2,003 ) 1,092 25-------------------------------------------------------------------------------- Revenue: Our revenue for the six months ended June 30, 2014 was approximately $2.49 million as compared to approximately $3.17 million for the six months ended June 30, 2013, a decrease of roughly $0.68 million, or 21.5%. The decrease was primarily due to revenue generated in 2013 for the maintenance of a banking software which is now no longer supported by One Horizon, and licenses for a customer booked in January 2013 which were due for renewal in December 2013 and consequently issued and invoiced in December 2013, two of which accounted for approximately $700,000 in revenue. . The total effect of these two items was a reduction in revenue of roughly $700,000. The Company expects revenue to increase as we have new companies signed up for Horizon Platform. The following table sets forth the value of all existing contracts as it related to master licenses and the amount of revenue recognized as of June 30, 2014 as well as the revenue recognized during the 6 months ended June 30, 2014. This table represents the contract value for the sale of the master license, excluding other revenues recognized under the terms of the contract for maintenance, user licenses, and other sales. Master License Customer Type Balance Revenue Revenue to be recognized for 6 months Contract Value recognized to date ending 6/30/2014 Tier 1 $ 13,425,000 $ 9,512,500 $ 3,912,500 $ 500,000 Tier 2 52,000,000 46,861,419 5,138,581 660,000 Total $ 65,425,000 $ 56,373,919 $ 9,051,081 $ 1,160,000 In addition to the revenue recognized from Master Licenses of approximately $1,160,000, we also recognized an amount of approximately $1,329,000 from the sale of user licenses, consultancy and maintenance services for the six months ended June 30, 2014. Cost of Revenue: Cost of revenue was approximately $1.1 million for the six months ended June 30, 2014, or 44% of sales, compared to cost of revenue of $1.34 million, or 42% of sales for the six months ended June 30, 2013. Our cost of sales is primarily composed of the amortization of software development costs. In addition, we recognize costs relating to the provision of hardware when a customer requires such ancillary hardware. Gross Profit: Gross profit for the six months ended June 30, 2014 was approximately $1.39 million as compared to $1.83 million for the six months ended June 30, 2013, a decrease of roughly 24%. The decrease was mainly due to the reduced revenue as set forth above herein. However, management anticipate gross profit to increase with the growth of our business and the global smartphone market as well as our established expansion plan of entering into markets with high population density, high penetration of mobile phones, congested mobile cellular networks and high adoption of smartphones. Operating Expenses: Operating expenses including general and administrative expenses and depreciation were approximately $2.41 million and $3.77 million during the six months ended June 30, 2014 and 2013, respectively. The decrease was mainly due to reduced accounting and legal costs for the six months ended June 30, 2014. For the same period in 2013, we incurred higher accounting and legal costs following the share exchange between and among Intelligent Communication Enterprise Corp. and One Horizon Group PLC closed on November 20, 2012. The decrease was also partially due to reduced staff cost in 2014 as we transited certain development positions from Switzerland to Ireland and China. In addition, for the comparative period in 2013 we incurred non cash expenditure in respect of shares given to our advisors of over $500,000 which hasn't been incurred for the same period in 2014. Net Loss:Net Loss for the six months ended June 30, 2014 was approximately $976,000 as compared to net loss of approximately $2.0 million for the same period in 2013. The decrease in net loss reflected a reduction in operating expenses for reasons set out above herein. We showed a breakeven position when adjusted for non cash items of depreciation and amortization. Management believes that the net loss will continuously decrease with our business growth; provided that we can successfully sell the Horizon Platform solution to new telecommunications company customers globally. 26 -------------------------------------------------------------------------------- Non-Controlling Interest: The non-controlling interest holders in our Chinese subsidiary were attributed their 25% share of the net loss of the Company in the amount of $65,000 for the six months ended June 30, 2014. The remaining portion of net loss of $911,000 for the six months ended June 30, 2014 was attributable to the stockholders of the Company. Going forward, management believes the Company will continue to grow the business and increase profitability if we are successful in selling the Horizon Platform solution to new telecommunications company customers globally. Foreign Currency Translation Adjustment: Our reporting currency is the U.S. dollar. Our local currencies, Swiss Francs and British pounds, are our functional currencies. Results of operations and cash flow are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by http://www.oanda.com/currency/historical-rates/ at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of shareholders' equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. Currency translation adjustments resulting from this process are included in accumulated other comprehensive income in the consolidated statement of shareholders' equity and amounted to approximately $19,000 for the six months ended June 30, 2014. Liquidity and Capital Resources Six Months Ended June 30, 2014 and June 30, 2013 The following table sets forth a summary of our approximate cash flows for the periods indicated: For the Six Months Ended June 30 (in thousands) 2014 2013 Net cash provided by (used in) operating activities (859 ) (1,728 ) Net cash (used in) investing activities (686 ) (629 ) Net cash provided by (used in) financing activities (30 ) 3,602 Net cash used by operating activities was approximately $859,000 for the six months ended June 30, 2014 as compared to net cash used of approximately $1.73 million for the same period in 2013. The decrease in cash used by operations was primarily due to the reduced loss incurred for the period. Net cash used in investing activities was approximately $686,000 and $629,000 for the six months ended June 30, 2014 and 2013, respectively. Net cash used in investing activities was primarily focused on acquisitions of intangible assets and property and equipment. Net cash used in financing activities was $30,000 for the six months ended June 30, 2014 as compared to net cash provided by financing activities amounted to $3.6 million for the six months ended June 30, 2013. Cash used by financing activities in 2014 was primarily due to repayment in long term bank borrowing. Cash provided by financing activities in 2013 was primarily due to the advances from related parties. Our working capital as of June 30, 2014 was approximately $3.6 million. Our working capital as of December 31, 2013, was approximately $4.1 million. The reduction in working capital was due primarily to the loss incurred during the six months as well as the reduction in long-term liabilities. 27-------------------------------------------------------------------------------- |