BINI 10-Q Quarter ended Sept. 30, 2018

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

OR

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to __________

Commission file number: 001-34887

Net Element, Inc.

(Exact name of registrant as specified in its charter)

Delaware	90-1025599
(State or other jurisdiction of incorporation	(I.R.S. Employer
or organization)	Identification No.)

3363 NE 163rd Street, Suite 705
North Miami Beach, Florida	33160
(Address of principal executive offices)	(Zip Code)

(305) 507-8808

(Registrant’s telephone number, including area code)

Not applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  ☒  No  ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☐	Accelerated filer ☐
Non-accelerated filer ☐	Smaller reporting company ☒
	Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

The number of outstanding shares of common stock, $.0001 par value, of the registrant as of November 14, 2018 was 3,863,019

Net Element, Inc.

Quarterly Report on Form 10-Q

For the Three and Nine Months Ended September 30, 2018

Table of Contents

		Page
		No.
	PART I — FINANCIAL INFORMATION
Item 1.	Financial Statements	4
	Unaudited Condensed Consolidated Balance Sheets – at September 30, 2018 and December 31, 2017	4
	Unaudited Condensed Consolidated Statements of Operations and Comprehensive Loss – for the Three and Nine Months Ended September 30, 2018 and 2017	5
	Unaudited Condensed Consolidated Statements of Cash Flows – for the Nine Months Ended September 30, 2018 and 2017	6
	Notes to Unaudited Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	32
Item 4.	Controls and Procedures	32
	PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	33
Item 1A.	Risk Factors	33
Item 6.	Exhibits	33
	Signatures	35

		September 30, 2018				December 31, 2017
ASSETS
Current assets:
Cash		$	2,563,104			$	11,285,669
Accounts receivable, net			4,970,697				5,472,856
Prepaid expenses and other assets			1,679,092				2,282,614
Total current assets, net			9,212,893				19,041,139
Equipment, net			34,267				58,268
Intangible assets, net			5,354,237				3,127,760
Goodwill			9,643,752				9,643,752
Other long term assets			603,110				460,511
Total assets			24,848,259				32,331,430
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable			5,407,971				6,785,459
Accrued expenses			2,247,101				3,212,438
Deferred revenue			1,173,802				1,712,591
Notes payable (current portion)			484,490				2,493,973
Due to related parties			441,606				461,992
Total current liabilities			9,754,970				14,666,453
Notes payable (net of current portion)			5,072,396				4,521,449
Total liabilities			14,827,366				19,187,902
STOCKHOLDERS' EQUITY
Series A Convertible Preferred stock ($.0001 par value, 1,000,000 shares authorized, no shares issued and outstanding at September 30, 2018 and December 31, 2017)			-				-
Common stock ($.0001 par value, 100,000,000 shares authorized and 3,858,813 and 3,853,100 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively)			385				385
Paid in capital			183,223,732				183,119,222
Accumulated other comprehensive loss			(2,315,394	)			(2,530,238	)
Accumulated deficit			(170,781,062	)			(167,356,070	)
Stock Subscriptions Receivable			-				(50,585	)
Non-controlling interest			(106,768	)			(39,186	)
Total stockholders' equity			10,020,893				13,143,528
Total liabilities and stockholders' equity		$	24,848,259			$	32,331,430

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		Three Months Ended September 30								Nine Months Ended September 30
		2018				2017				2018				2017
Net revenues
Service fees		$	17,242,758			$	14,901,131			$	49,689,870			$	43,263,217
Branded content			-				-				-				1,340,896
Total Revenues			17,242,758				14,901,131				49,689,870				44,604,113
Costs and expenses:
Cost of service fees			14,559,808				12,756,627				41,992,150				36,232,170
Cost of branded content			-				-				-				1,302,841
Selling, general and administrative			2,346,809				2,357,729				7,292,785				7,788,068
Non-cash compensation			22,500				111,277				127,011				836,218
Bad debt expense			611,897				319,690				1,611,068				1,465,311
Depreciation and amortization			463,384				630,020				1,829,447				1,860,401
Total costs and operating expenses			18,004,398				16,175,343				52,852,461				49,485,009
Loss from operations			(761,640	)			(1,274,212	)			(3,162,591	)			(4,880,896	)
Interest expense, net			(215,935	)			(302,813	)			(694,910	)			(894,553	)
Other income (expense)			41,507				(92,904	)			364,930				(148,099	)
Net (loss) income before income taxes			(936,068	)			(1,669,929	)			(3,492,571	)			(5,923,548	)
Income taxes			-				-				-				-
Net loss			(936,068	)			(1,669,929	)			(3,492,571	)			(5,923,548	)
Net (income) loss attributable to the non-controlling interest			25,654				(32,607	)			67,582				93,175
Net loss attributable to Net Element, Inc. stockholders			(910,414	)			(1,702,536	)			(3,424,989	)			(5,830,373	)
Foreign currency translation			145,867				92,191				214,845				(41,809	)
Comprehensive loss attributable to common stockholders		$	(764,547	)		$	(1,610,345	)		$	(3,210,144	)		$	(5,872,182	)
Loss per share - basic and diluted		$	(0.23	)		$	(0.90	)		$	(0.88	)		$	(3.29	)
Weighted average number of common shares outstanding - basic and diluted			3,901,218				1,891,023				3,870,134				1,770,947

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		Nine Months Ended September 30,
		2018				2017
Cash flows from operating activities
Net loss attributable to Net Element, Inc. stockholders		$	(3,424,989	)		$	(5,830,373	)
Adjustments to reconcile net loss to net cash used in operating activities
Non-controlling interest			(67,582	)			(93,175	)
Share based compensation			127,011				836,218
Deferred revenue			(536,041	)			(159,228	)
Depreciation and amortization			1,829,447				1,860,401
Non cash interest			49,000				98,774
Changes in assets and liabilities							-
Accounts receivable			379,601				3,421,265
Prepaid expenses and other assets			457,806				(352,551	)
Accounts payable and accrued expenses			(2,087,416	)			(2,390,495	)
Net cash used in operating activities			(3,273,163	)			(2,609,164	)
Cash flows from investing activities
Purchase of portfolios and client acquisition costs			(3,851,596	)			(1,380,661	)
Purchase of equipment and changes in other assets			(115,041	)			77,430
Net cash used in investing activities			(3,966,637	)			(1,303,231	)
Cash flows from financing activities
Proceeds from sale of common stock			-				1,150,098
Proceeds from indebtedness			-				3,239,033
Repayment of indebtedness			(1,458,536	)			(273,360	)
Related party advances			(39,265	)			77,587
Net cash (used in) provided by financing activities			(1,497,801	)			4,193,358
Effect of exchange rate changes on cash			15,036				19,504
Net (decrease) increase in cash			(8,722,565	)			300,467
Cash at beginning of period			11,285,669				621,635
Cash at end of period		$	2,563,104			$	922,102
Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest		$	645,910			$	795,779
Taxes		$	44,932			$	86,942

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NOTE 1. BASIS OF PRESENTATION

The accompanying September 30, 2018 interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and note disclosures normally included in the annual financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to those rules and regulations, but we believe the disclosures made are adequate to make the information presented not misleading. In the opinion of management, all adjustments, consisting of normal and recurring adjustments, necessary for a fair presentation have been included in the condensed consolidated financial statements included herein. These statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our 2017 Annual Report on Form 10-K. The results of operations for the periods presented are not necessarily indicative of results to be expected for the full fiscal year or any other periods.

The condensed consolidated unaudited financial statements contained in this report include the accounts of Net Element, Inc., and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.

NOTE 2. BUSINESS OPERATIONS AND LIQUIDITY

Net Element, Inc. (collectively with its subsidiaries, “Net Element”, “we”, “us”, “our” or the “Company”) is a financial technology-driven group specializing in payment acceptance and value-added solutions across multiple channels in the United States and selected international markets. We are differentiated by our proprietary technology which enables us to provide a broad suite of payment products and end-to-end transaction processing services. Our transactional services business enables merchants to accept credit cards as well as other forms of payment, including debit cards, checks, gift cards, loyalty programs and alternative payment methods in traditional card-present or swipe transactions, as well as card-not-present transactions, such as those conducted over the phone or through the Internet or a mobile device. During the three and nine months ended September 30, 2018, we operated in two reportable business operating segments: (i) North American Transaction Solutions, and (ii) International Transaction Solutions. In the fourth quarter of 2017, we combined our online and mobile payments operations into one segment, International Transaction Solutions. Prior to that we had operated in three segments.

The Company expects to fund its operating cash needs for the next twelve months, including debt service requirements, operating expenses in the normal course of business, capital expenditures, and possible future acquisitions, with cash flow from its operating activities, potential sales of equity securities, and current and future borrowings.

To fund our operating cash needs, we may need to raise additional capital through loans or additional sales of equity securities. The Company continues to investigate the capital markets for sources of funding, which could take the form of additional debt, the restructuring of our current debt, or additional equity financings. The Company cannot provide any assurance that it will be successful in securing new financing or restructuring its current debt or that it will secure such future financing with commercially acceptable terms. If the Company is unable to raise additional capital, it may need to delay certain technology capital improvements, limit its planned level of capital expenditures and future growth plans, or explore other alternatives.

NOTE 3. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Significant accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. The Company’s significant accounting policies are described below.

Use of Estimates

The preparation of these financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the condensed consolidated unaudited financial statements and the reported amounts of revenues and expenses for the reporting period. Significant estimates include valuation reserves for accounts receivable, valuation of acquired or current merchant portfolios, incurred but not reported claims, and the valuation of goodwill and other intangible assets. We believe that our estimates are reasonable. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications of prior year amounts have been made to conform to the 2018 presentation. These reclassifications had no effect on net loss or loss per share as previously reported.

Cash

We maintain our U.S. dollar-denominated cash in several non-interest bearing bank deposit accounts. All U.S. non-interest bearing transaction accounts are insured up to a maximum of $250,000 at FDIC insured institutions. The bank balances exceeded FDIC limits by approximately $0.9 million and $10.6 million at September 30, 2018 and December 31, 2017, respectively. The increase in the balance which exceeded FDIC limits at December 31, 2017 was the result of proceeds received from the issuance of common stock. We maintained approximately $51,000 and $186,000 in uninsured bank accounts in Russia and the Cayman Islands at September 30, 2018 and December 31, 2017, respectively.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable are stated net of an allowance for doubtful accounts. We estimate an allowance for doubtful accounts based on experience with our service providers and judgment as to the likelihood of their ultimate payment. We also consider collection experience and make estimates regarding collectability based on payout trends of the customers. The allowance for doubtful accounts was approximately $213,000 at September 30, 2018 and $257,000 at December 31, 2017.

Other Current Assets

We maintain an inventory of point-of-sale ("POS") terminals which we use to service both merchants and independent sales agents ("ISG"). Often, we will provide the terminals as an incentive for merchants and independent sales agents to enter into a merchant contracts with us. The term of these contracts has an average length of three years and the cost of the terminal plus any setup fees will be amortized over the contract period. If the merchants terminate their contract with us early, they are obligated to either return the terminal or pay for the terminal. The Company has approximately $539,000 and $507,000 in terminals, iPads ® and related equipment as of September 30, 2018 and December 31, 2017, respectively, of which approximately $531,000 and $501,000 had been placed with merchants as of September 30, 2018 and December 31, 2017, respectively.

Goodwill and Other Intangible Assets

Intangible assets acquired, either individually or with a group of other assets (but not those acquired in a business combination), are initially recognized and measured based on fair value. Goodwill acquired in business combinations is initially computed as the amount paid in excess of the fair value of the net assets acquired.

The cost of internally developing, maintaining and restoring intangible assets (including goodwill) that are not specifically identifiable, that have indeterminate lives, or that are inherent in a continuing business and related to an entity are recognized as an expense when incurred.

An intangible asset (including goodwill) that is not subject to amortization shall be tested for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. If the carrying amount of an intangible asset exceeds its fair value, an impairment loss shall be recognized in an amount equal to that excess. Goodwill is not amortized. It is the Company’s policy to test for impairment no less than annually, by considering qualitative factors to determine whether it is more likely than not that the Company’s goodwill carrying value is greater than its fair value. The Company’s intangible assets, which consist of goodwill of approximately $9.6 million recorded in connection with the Company's various acquisitions in prior years.  There was no goodwill impairment charge during the nine months ending September 30, 2018 and 2017.

Capitalized Customer Acquisition Costs, Net

Capitalized customer acquisition costs consist of up-front cash payments made to ISGs for the establishment of new merchant relationships. Capitalized customer acquisition costs represent incremental, direct customer acquisition costs that are recoverable through gross margins associated with merchant contracts. The up-front cash payment to the ISG is based on the estimated gross margin for the first year of the merchant contract. The deferred customer acquisition cost asset is recorded at the time amounts are receivable but not yet earned and the capitalized acquisition costs are amortized on a straight-line basis over a period of approximately four years.

Net Loss per Share

Basic net loss per common share is computed by dividing net loss applicable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares issuable upon exercise of common stock options or warrants. In periods when losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents because their inclusion would have an anti-dilutive effect. At September 30, 2018, we had warrants outstanding to purchase 728,583 of common stock and 234,219 of stock options issued and outstanding, and at September 30, 2017, we had warrants outstanding to purchase 89,389 shares of common stock and 228,256 shares of stock options issued and outstanding, that are anti-dilutive in effect .

Accrued Residual Commissions

The Company records commissions as a cost of revenues in the accompanying condensed consolidated unaudited statement of operations and comprehensive loss. We pay agent commissions to ISGs and independent sales agents based on the processing volume of the merchants enrolled. The commission obligations are based on varying percentages of the volume processed by us on behalf of the merchants. Percentages vary based on the program type and transaction volume of each merchant.

Foreign Currency Transactions

We are subject to exchange rate risk in our foreign operations in Russia, the functional currency of which is the Russian ruble, where we generate service fee revenues, interest income or expense, incur product development, engineering, website development, and selling, general and administrative costs and expenses. Our Russian subsidiaries pay a majority of their operating expenses in their local currencies, exposing us to exchange rate risk.

Recently Issued Accounting Guidance

In February 2016, the Financial Accounting Standards Board ("FASB") issued ASU 2016-02, “Leases” which, for operating leases, requires a lessee to recognize a right-of-use asset and a lease liability, initially measured at the present value of the lease payments, in its balance sheet. The standard also requires a lessee to recognize a single lease cost, calculated so that the cost of the lease is allocated over the lease term, on a generally straight-line basis. The ASU is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We are in the process of collecting data and designing processes and controls to account for our leases in accordance with the new guidance. We expect that the adoption of ASU 2016-02 may result in management’s recognition of right of use assets and related obligations on our consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this update changed how companies measure and recognize credit impairment for many financial assets. The new expected credit loss model will require companies to immediately recognize an estimate of credit losses expected to occur over the remaining life of the financial assets (including trade receivables) that are within the scope of the update. The update also made amendments to the current impairment model for held-to-maturity and available-for-sale debt securities and certain guarantees. The guidance will become effective for us on January 1, 2020. Early adoption is permitted for periods beginning on or after January 1, 2019. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04 “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment”. This update simplifies the subsequent measurement of goodwill by eliminating Step 2 from the goodwill impairment test. Under this updated standard, an entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value, but the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. An entity also should consider income tax effects from any tax-deductible goodwill on the carrying amount of the reporting unit when measuring the goodwill impairment loss, if any. This guidance is effective prospectively and is effective for interim and annual periods beginning after December 15, 2019 with early adoption permitted. We do not expect the adoption of this guidance to have a material impact on our consolidated financial statements.

NOTE 4 . REVENUES

We recognize revenue when all of the following criteria are met: (1) the parties to the contract have approved the contract and are committed to perform their respective obligations, (2) we can identify each party’s rights regarding the goods or services to be transferred (3) we can identify the payment terms for the goods or services to be transferred, (4) the contract has commercial substance, and (5) it is probable that we will collect substantially all of the consideration to which we will be entitled in exchange for the goods or services that will be transferred to the customer. The Company considers persuasive evidence of a sales arrangement to be the receipt of a billable transaction from aggregators, signed contract or the processing of a credit card transaction. Collectability is assessed based on a number of factors, including transaction history with the customer and the credit worthiness of the customer. If it is determined that the collection is not reasonably assured, revenue is not recognized until collection becomes reasonably assured, which is generally upon receipt of cash. We record cash received in advance of revenue recognition as deferred revenue. Revenue consists primarily of fees generated through the electronic processing of payment transactions and related services and is recognized as revenue during the period the transactions are processed or when the related services are performed.

We work directly with payment card networks and banks so that our merchants do not need to manage the complex systems, rules, and requirements of the payments industry. We satisfy our performance obligations and therefore recognize the transactional processing service fees as revenue upon authorization of a transaction by the merchant’s customer’s bank.

We primarily report revenues gross as a principal versus net as an agent. Although some of the Company’s processing agreements vary with respect to specific terms, the transactional processing service fees collected from merchants generally are recognized as revenue on a gross basis as we are the principal in the delivery of the managed payments solutions to the sellers. The gross fees we collect are intended to cover the interchange, assessments and other processing and non-processing fees which are included and are part of our gross margin.

We have primary responsibility for providing end-to-end payment processing services for our clients. Our clients contract us for all credit card processing services, including transaction authorization, settlement, dispute resolution, data/transmission security, risk management, reporting, technical support and other value-added services. We have concluded that we are the principal because we control the services before delivery to the merchant, and are primarily responsible for the delivery of the services, have discretion in setting prices charged to merchants, and responsible for losses. We also have pricing latitude and can provide services using several different network options.

Adoption of ASC 606, Revenue from Contracts with Customers

On January 1, 2018, the Company adopted ASC 606 using the modified retrospective method applied to those contracts which were not completed as of January 1, 2018. Results for reporting periods beginning January 1, 2018 are presented under ASC 606, while prior period amounts are not adjusted and continue to be reported in accordance with the Company’s historic revenue recognition methodology under ASC 605, Revenue Recognition.

The cumulative impact of adopting ASC 606 resulted in no changes to retained earnings at January 1, 2018. The impact of adoption of ASC 606 on the Company’s condensed consolidated statement of operations was as follows:

Three months ended September 30, 2018:

Nine months ended September 30, 2018:

There was no impact on our condensed consolidated balance sheets.

NOTE 5 . NOTES PAYABLE

Notes payable consist of the following:

RBL Capital Group, LLC

Effective June 30, 2014, TOT Group, Inc. and its subsidiaries as co-borrowers, TOT Payments, LLC, TOT BPS, LLC, TOT FBS, LLC, Process Pink, LLC, TOT HPS, LLC and TOT New Edge, LLC (collectively, the “co-borrowers”), entered into a Loan and Security Agreement (“Credit Facility”) with RBL Capital Group, LLC (“RBL”), as lender (the “RBL Loan Agreement”). The original terms provided us with an 18-month, $10 million credit facility with interest at the higher of 13.90% per annum or the prime rate plus 10.65%. Interest on drawn amounts outstanding after November 30, 2015 carry interest at an additional three percent per annum until repaid in full, with other amounts, obligations or payments due carrying an annual default rate not to exceed the lesser of (i) the prime rate plus 13% per annum and (ii) 18.635% per annum. On May 2, 2016, we renewed our Credit Facility with RBL, increasing the facility from $10 million to $15 million and extending the term through February 2019.  At September 30, 2018, we had approximately $10.5 million available under the Credit Facility.  This Credit Facility is for general working capital purposes or to support the growth of the co-borrowers, subject to the terms and conditions, as defined. We expect that this Credit Facility will be extended under similar terms and conditions.

The co-borrowers’ obligations to RBL pursuant to the RBL Loan Agreement are secured by a first priority security interest in all of the co-borrowers’ tangible and intangible assets, including but not limited to their merchants, merchant contracts and proceeds thereof, and all right title and interest in co-borrowers’ processing contracts, contract rights, and portfolio cash flows with all processors of the co-borrowers.

Borrowings from the Credit Facility in the amounts of $3,315,000, $400,000 and $250,000 were previously converted into RBL term notes.  Effective March 20, 2018, we entered into a single note with a principal balance of $4,544,087 with RBL to effectively refinance all previously issued outstanding RBL notes, including certain additional term notes entered into with RBL through August 2017. The refinanced and combined note provides for four (4) interest-only payments at 14.19%, with monthly interest and principal payments of $85,634 from August 2018 through June 2021, with a balloon payment of $3,170,967 in July 2021. The back-end fees from prior notes in the amount of $133,600 have been rolled into this note and also are due in July 2021.

Priority Payment Systems LLC

Effective May 18, 2017, we entered into a loan agreement and security agreement with Priority Payment Systems LLC (“PPS”) and issued a promissory note dated May 18, 2017. Pursuant to the loan agreement and the note, we borrowed $2,000,000. Prior to maturity of the loan, the principal amount of the loan will carry a floating interest rate of prime rate plus 6% per annum. The interest rate was 11% and 10.25% at September 30, 2018 and December 31, 2017, respectively. We may prepay the loan in whole or in part at any time. The loan is repayable in monthly installments consisting of principal plus interest. The loan matures and becomes due and payable in full on May 20, 2019 to the extent not repaid earlier.

Pursuant to the security agreement, the loan is secured by collateral consisting of accounts, cash or cash equivalents, residuals related to the merchants originated by us and processed by PPS. The loan agreement, the note and the security agreement contain customary representations, warranties, events of default, remedies and affirmative and negative covenants, as well as the right of first refusal and the right related to the merchants.

Effective May 17, 2017, we entered into a corporate guaranty in favor of PPS, pursuant to which we unconditionally guaranteed the full and prompt payment of each present and future liability, debt and obligation under the loan agreement, the note, the security agreement and other related documents.

On June 27, 2017, we entered into an amendment to the loan agreement with PPS pursuant to which:

	(i)	The original term loan was modified into a multi - draw loan with an increase of the borrowing limit to $2,500,000 and;
	(ii)	The loan maturity was extended to May 20, 2021.

Scheduled Notes Payable Principal Repayment at September 30, 2018 is as follows:

NOTE 6 . CONCENTRATIONS

Credit card processing revenues are from merchant customer transactions, which were processed primarily by two third-party processors (greater than 5%) and our own dedicated bank identification number ("BIN")/Interbank Card Association ("ICA") number during the three and nine months ended September 30, 2018 and one third-party processors (greater than 5%) during the three and two nine months ended September 30, 2017.

For the three months ended September 30, 2018, we processed 59% of our total revenue with PPS, 21% from our own dedicated BIN/ICA number, and 6% from First Data Corp. For the three months ended September 30, 2017, we processed 82% of our total revenue with PPS.

For the nine months ended September 30, 2018, we processed 64% of our total revenue with PPS, 16% from our own dedicated BIN/ICA, and 5% from First Data Corp. For the nine months ended September 30, 2017, we processed 77% of our total revenue with PPS and 5% of our total revenue with Vantiv, Inc. (f/k/a National Processing Company (NPC).

NOTE 7 . COMMITMENTS AND CONTINGENCIES

Advance and Residual Purchase Agreement

On July 30, 2018, our subsidiary, Unified Portfolio Acquisitions, LLC (the “Purchaser”), entered into an Advance and Residual Purchase Agreement (the “Agreement”) with Universal Partners, LLC (“Universal”). Pursuant to the Agreement, the Purchaser acquired certain transactional services portfolios (“cash flow assets”) from Universal and Payment Club, LLC (together with Universal, the “Seller”) for $2,700,000 (the “Advance Amount”). The cash flow assets consist of residuals (the “Residuals”) that the Sellers are entitled to receive pursuant to certain agreements (the “Combined Marketing Agreements”) with TOT Payments, LLC (doing business as Unified Payments), our subsidiary, or any other agreements pursuant to which the Seller is entitled to residuals.

The Advance Amount is to be repaid to the Purchaser whereby each and every month, commencing from July 1, 2018 (the “Effective Date”) and for a period of 24 months thereafter, terminating on June 30, 2020 (the “Advance Period”), the Purchaser is entitled to a certain amount of the Residuals. Such Residuals due to the Purchaser are secured by certain of the Seller’s property as collateral.

At the end of the Advance Period (the “Transfer Date”), the Purchaser and the Seller have agreed to create a new static portfolio pool of mutually agreed residual income from Seller ISO codes comprising merchant accounts boarded by the Seller under the Combined Marketing Agreements that on the Transfer are generating at least $120,000- per month in net residual income (the “Portfolio Residuals”). From and after the Transfer Date, the Purchaser and Seller will share/split the Portfolio Residuals with the Purchaser owning an 80% interest in the Portfolio Residuals and the Seller owning a 20% interest in the Portfolio Residuals.

Leases

North American Transaction Solutions

During May 2013, we entered into a lease agreement, for approximately 4,101 square feet of office space located at 3363 N.E. 163rd Street, Suites 705 through 707, North Miami Beach, Florida 33160. The term of the lease agreement was from May 1, 2013 through December 31, 2016, with monthly rent increasing from $16,800 per month at inception to $19,448 per month (or $233,377 per year) for the period from January 1, 2016 through December 31, 2016.  The lease was extended for a period of five years commencing August 1, 2017 and expiring July 31, 2022 with equal monthly base rent installments of $14,354 ($172,248 per year) plus sales tax.

Net Element Software, our subsidiary, currently leases 1,654 square feet of office space in Yekaterinburg, Russia, where we develop value added services, mobile applications, smart terminals applications, sales central ERP system development and marketing activities, at an annual rent of approximately $24,300. The lease was renewed on same terms and the lease term expires on June 1, 2019.

International Transaction Solutions

PayOnline Systems leased approximately 4,675 square feet of office space in Moscow, Russia at an annual rent of $84,457 which expired on September 30, 2018.  This space was reduced to 3,385 square feet and renewed at an annual rent of $56,000 expiring on August 31, 2019.

We believe that our current facilities are suitable and adequate for our present purposes, and we anticipate that we will be able to extend our existing leases on terms satisfactory to us or move to new facilities on acceptable terms.

Future maturities of lease agreements are as follows:

Litigation , Claims, and Assessments :

Aptito.com, Inc.

On August 6, 2014, our subsidiary (Aptito, LLC) filed a lawsuit against Aptito.com, Inc. and the shareholders of Aptito.com, Inc., in state court in the 11th Judicial Circuit in and for Miami-Dade County. This is an interpleader action in regards to 125,000 shares of our stock. Aptito, LLC acquired Aptito.com, Inc. in exchange for, among other things, 125,000 shares of our stock. There has been disagreement among the Aptito.com, Inc. shareholders as to proper distribution of the 125,000 shares. To avoid any liability in regards to improper distribution, Aptito, LLC filed the interpleader action so as to allow the Defendants to litigate amongst themselves as to how the shares should be distributed. Aptito.com, Inc. opposed the motion to interplead and filed counterclaims relative to Aptito, LLC for non-delivery of the 125,000 shares.

On July 18, 2017, the Court granted Aptito LLC’s motion to interplead and also indicated that Aptito, LLC could not be held liable for any alleged damages relative to the purported non-delivery of the 125,000 shares after the interpleader action was filed on August 6, 2014.

In March 2018, a new Judge in the case ruled that Aptito.com, Inc. was entitled to receive 125,000 newly issued shares of our common stock, but indicated that the Judge was not ruling that we were required to issue such shares. We plan to appeal this ruling, and our legal counsel is addressing the counterclaims filed by Aptito.com, Inc. in this matter.

In July 2018, our counsel Waldman Barnett P.L was disqualified due to a conflict of interest.  We engaged the Law Offices of Anthony Accetta PA to represent our ongoing interests in this case.

Gene Zell

In June 2014, we, as plaintiff, commenced an action in the Miami-Dade Circuit Court, Florida against Gene Zell for defamation of our Company and CEO and tortious interference with our business relationships. In October 2014, the court granted a temporary injunction against Zell enjoining him from posting any information about our Company and CEO on any website and enjoining him from contacting our business partners or investors. Zell violated the Court Order and the Court granted a Motion imposing sanctions against Zell. We continue to seek enforcement of the Court Order.

On April 13, 2015, Zell filed a Motion to set aside the Court Order alleging he was unaware of the Court Proceedings. The Court, on August 26, 2015, dismissed Zell’s Motion to dissolve the injunction. In March 2017 the Court dismissed another Motion brought by Zell to dissolve the injunction. A further appeal from Zell to dissolve the injunction was heard in November 2018 and dismissed by the Court.  Accordingly, the injunction order prohibiting Zell from making further defamatory posts remains in place. The Company intends to vigorously protect its interests by enforcing the injunctive relief granted by the Court.

Other Legal Matters

During December 2017, we entered into a letter of intent with Bunker Capital (“Bunker”) for the development of block-chain technology-based solutions, and we made a prepayment of 19,000 shares of our common stock. On February 26, 2018, we terminated the relationship with Bunker as the parties did not reach a definitive agreement, and, as part of such termination, we asked Bunker to return such shares of our common stock. The value of these shares were recorded as other expense for approximately $221,000 during the first quarter of 2018. Subsequent to September 30, 2018, we reached a settlement with Bunker, whereby we received a cash payment of $50,000.

We may from time to time be involved in certain legal proceedings and claims which arise in the ordinary course of business. At this time, in our opinion, based on consultations with outside counsel, the results of any of these matters, individually and/or in the aggregate, are not expected to have a material adverse effect on our consolidated financial statements. As more information becomes available, and management determines that an unfavorable outcome is probable and such that the claim is reasonably estimable, we will record a reserve.

NOTE 8 . RELATED PARTY TRANSACTIONS

We and our subsidiary, TOT Group, Inc., previously entered into certain term loan notes with MBF, Merchant Capital, LLC ("MBF"), which were paid off during the three months ended June 30, 2018 (See Note 5).  MBF is a company owned by William Healy, a former member of our Board of Directors.

During the nine months ended September 30, 2018 and 2017, agent commissions resulting from merchant processing of $54,000 and $67,000, respectively, were paid to Prime Portfolios, LLC, an entity owned by Oleg Firer, our CEO, and Steven Wolberg, our Chief Legal Officer. In addition, key members of management owned companies that received similar commissions amounting to approximately $352,000 and $143,000 for the nine months ended September 30, 2018 and 2017, respectively.

At December 31, 2017, we had accrued expenses in the amount of $461,992, which consisted primarily of various travel, professional and other expenses paid for by our CEO and charged on his personal credit cards and not yet paid. During the year, we reclassified such accrued expenses as related party loans. The amount of related party liabilities at September 30, 2018 is $441,606 which is primarily comprised of $478,763, which is due to our CEO.

NOTE 9 . STOCKHOLDERS’ EQUITY

On October 5, 2017, we effected one-for-ten reverse stock splits of our common stock. Our condensed consolidated financial statements and disclosures reflect these changes in capital structure for all periods presented.

On June 12, 2015 and June 13, 2016, our shareholders approved 100,000,000 increases in our authorized common stock to 300,000,000 and 400,000,000, respectively. On October 2, 2017, our shareholders approved a 300,000,000 decrease in our authorized common stock to 100,000,000.

Equity Incentive Plan Activity

On December 5, 2013, our shareholders approved the Net Element International, Inc. 2013 Equity Incentive Plan (the “2013 Plan”). Awards under the 2013 Plan may be granted in any one or all of the following forms: (i) incentive stock options meeting the requirements of Section 422 of the Internal Revenue Code of 1986, as amended; (ii) non-qualified stock options (unless otherwise indicated, references to “Options” include both Incentive Stock Options and Non-Qualified Stock Options); (iii) stock appreciation rights, which may be awarded either in tandem with Options or on a stand-alone basis; (iv) shares of common stock that are restricted; (v) units representing shares of common stock; (vi) units that do not represent shares of common stock but which may be paid in the form of common stock; and (vii) shares of common stock that are not subject to any conditions to vesting. The maximum aggregate number of shares of common stock available for award under the 2013 Plan at September 30, 2018 and December 31, 2017 was 240,996. The 2013 Plan is administered by the compensation committee.

2013 Equity Incentive Plan - Unrestricted Shares and Stock Options

During the three and nine months ended September 30, 2018, we issued common stock pursuant to the 2013 Plan to the members of our Board of Directors and recorded a compensation charge of $22,500 and $67,500, respectively.

At September 30, 2018 and December 31, 2017, we had 74,004 incentive stock options outstanding with a weighted average exercise price of $15.52 and a weighted average remaining contract term of 8.02 years and 8.77 years, respectively. All of the stock options were anti-dilutive at September 30, 2018 and December 31, 2017.

NOTE 10 . WARRANTS AND OPTIONS

Options

At September 30, 2018 and December 31, 2017, we had fully vested options outstanding to purchase 234,218 shares of common stock at exercise prices ranging from $8.10 to $134.00 per share.

Due to the high level of volatility in the stock price of our common stock, our management determined the grant date fair value of the options granted during the nine months ended September 30, 2018 and 2017 using the then quoted stock price at the grant date.

Warrants

At September 30, 2018 and December 31, 2017, we had warrants outstanding to purchase 728,583 shares of common stock. At September 30, 2018, the warrants had a weighted average exercise price of $6.18 per share purchased and a weighted average remaining contractual term of 4.25 years. At December 31, 2017, the warrants had a weighted average exercise price of $6.18 per share purchased and a weighted average remaining contractual term of 5.00 years.

Non-Incentive Plan Options

At September 30, 2018 and December 31, 2017, we had 160,214 non-incentive options outstanding with a weighted-average exercise price of $21.84. The non-incentive options have a remaining contract term of 2.17 years at September 30, 2018. These options were out of the money at September 30, 2018 and December 31, 2017 and had no intrinsic value.

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