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ONE HORIZON GROUP, INC. - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

May 20, 2014

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 ended March 31, 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 region 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 20

-------------------------------------------------------------------------------- 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 first quarter of our 2014 fiscal year, 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. We believe that the further expansion of our Irish development team will allow the further advance our unique mobile VOIP solutions.



We also completed the development of 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. In March 2014, we 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 three months ended March 31, 2014, Chongqing Leixin Network Technology ("Leixin"), a joint venture with Leiqiang Telecommunications Co. Ltd ("Leiqiang") and Ishuo Network Information Co., Ltd. (a PRC entity controlled by us) that is 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. As of March 2014, 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. 21 --------------------------------------------------------------------------------



Results of Operations

Comparison of Three Months Ended March 31, 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 March 31, Change Increase/ Percentage 2014 2013 (decrease) Change Revenue $ 1,185$ 1,919$ (734 ) (38.3 )% Cost of revenue 498 453 45 10.0 Gross margin 687 1,466 (779 ) (53.9 ) Operating expenses: General and administrative 1,178 1,473 (295 ) (20.1 ) Depreciation 48 36 12 33.3 Total operating expenses 1,226 1,509 (283 ) (18.8 ) Income (loss) from operations (539 ) (43 ) (496 ) Other income (expense) Interest expense (48 ) (55 ) (7 ) 12.7 Income (Loss) before income taxes (587 ) (98 )



(489 )

Income taxes (recovery) - deferred (156 ) - - - Net income (loss) for period (431 ) (98 )



333

Net income (loss) attributable to non-controlling interest (43 )



(43 )

Net income (loss) attributable to One Horizon Group, Inc. (388 ) (98 ) 290 22

-------------------------------------------------------------------------------- Revenue: Our revenue for the three months ended March 31, 2014 was approximately $1.19 million as compared to approximately $1.92 million for the three months ended March 31, 2013, a decrease of $0.73 million, or 38%. When compare to the same quarter in 2013, the reduction in Revenue 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 were due for renewal in December 2013 and as a consequence were issued and invoiced in December 2013. The total effect of these two items was a reduction in revenue of roughly $700,000. The Company expects sales trend to reverse going forward and that sales will begin to grow as more companies sign up for the Horizon Platform. As of March 31, 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 3 months ended March 31, 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 Contract Balance Revenue Revenue Value to be recognized for 3 months recognized to date ending 3/31/2014 Tier 1 $ 13,425,000$ 9,512,500$ 3,912,500 $ 500,000 Tier 2 49,000,000 44,361,419 4,638,581 160,000 Total $ 62,425,000$ 53,873,919$ 8,551,081 $ 660,000



In addition to the above revenue recognized from Master Licenses of approximately $660,000, the Company also recognized approximately $525,000 from the sale of user licenses, consultancy and maintenance services.

Cost of Revenue: Cost of revenue was approximately $498,000 for the three months ended March 31, 2014, or 42% of sales, compared to cost of revenue of $453,000, or 24% of sales for the three months ended March 31, 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. Gross Profit: Gross profit for the three months ended March 31, 2014 was approximately $0.69 million as compared to $1.47 million for the three months ended March 31, 2013, an decrease of roughly 54%. The main reason for the decrease in gross profit was the reduction in revenue as described above. Management expects this trend to reverse and gross profit to increase going forward due to the 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 $1.2 million and $1.5 million in the three month periods ended March 31, 2014 and 2013. The $1.2 million in operating expenses was in excess of sales for the three months ended March 31, 2014 as compared to 79% of sales for the same period in 2013. The reduction in expenditure arose from reduced accounting and legal costs incurred from the high level incurred in 2013 following the reverse takeover by One Horizon Group of Intelligent Communications Enterprise together with reduced staff costs following a transition of certain development positions from Switzerland to Ireland and due to recognition of certain development work as being commercially viable and therefore eligible under GAAP to be capitalized. Net Loss: Net Loss for the three months ended March 31, 2014 was approximately $388,000 as compared to net loss of approximately $98,000 for the same period in 2013. The increase in net loss reflected a reduction in revenue offset partly by a reduction in operating expenses for reasons set out above. Despite the reduction in revenue, when compared to the same quarter in 2013, the Company showed a breakeven position when adjusted for non cash items of depreciation and amortization. In addition the group had incurred other non cash expenditure of $194,060 due to the issue of 15,000 shares to Newport Coast Securities and issue of staff options. Management believe that the net loss will be reduced going forward due to future growth in the business and sales. Going forward, management believes the Company will continue to grow the business and increase sales if we are successful in selling the Horizon Platform solution to new telecommunications company customers globally. Management also expects profitability to increase as revenue is expected to increase more than new operating costs related to public company expenses. Non-Controlling Interest: The non-controlling interest holders in our China joint venture were attributed their 25% share of the net loss of the joint venture in the amount of $43,000 for the three months ended March 31, 2014. The remaining portion of net loss of $388,000 for the three months ended March 31, 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 $23,000 for the three months ended March 31, 2014. 23

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Liquidity and Capital Resources

Three Months Ended March 31, 2014 and March 31, 2013

The following table sets forth a summary of our approximate cash flows for the periods indicated: For the Three Months Ended March 31 (in thousands) 2014 2013 Net cash (used in) operating activities (821 ) (470 ) Net cash (used in) investing activities (398 ) (257 ) Net cash provided by (used in) financing activities (15 )



488

Net cash used by operating activities was approximately $821,000 for the three months ended March 31, 2014 as compared to net cash used of $470,000 for the same period in 2013. The increase in cash used by operations was primarily due to the increase in cash used for other assets and accounts payable and accrued expenses. Net cash used in investing activities was approximately $398,000 and $257,000 for the three months ended March 31, 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 $15,000 for the three months ended March 31, 2014 as compared to net cash provided by financing activities amounted to $488,000 for the three months ended March 31, 2013. Cash used by financing activities in 2013 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 March 31, 2014 was approximately $3.8 million. Our working capital, as of December 31, 2013 was approximately $4.1 million

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have, or are reasonably likely to have, a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to the Company.


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