Intellinetics, Inc. — Q2 2015 Form 10-Q
Business and period: Intellinetics develops, sells and supports enterprise content management software for public- and private-sector customers. It offers installed software and cloud-based software-as-a-service (SaaS), with sales increasingly focused on reseller and other channel partners. This unaudited report covers the quarter and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods.
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $587,170; up 80% from $326,352 | $1,170,945; up 87% from $625,535 |
| Gross profit / margin | $464,725 / 79%; margin unchanged year over year | $934,963 / 80%, versus $493,572 / 79% |
| Operating expenses | $1,011,756, up 76% from $574,939 | $1,594,951, up 37% from $1,166,512 |
| Operating loss | $547,031, versus $317,122 | $659,988, versus $672,940 |
| Interest expense, net | $95,711, versus $55,592 | $191,611, versus $103,596 |
| Net loss | $642,742, versus $372,714; loss per share $0.09 | $851,599, versus $776,536; loss per share $0.12 |
Revenue growth included software sales of $147,723 for Q2 versus $4,496 a year earlier, SaaS revenue of $60,966 (up 49%), and maintenance revenue of $231,939 (up 9%). Six-month SaaS revenue rose 46% to $117,505. Management reported cloud-based delivery at 10% of revenue, compared with 13% a year earlier.
At June 30, cash was $98,752, accounts receivable net was $228,967, current assets were $379,586, and total assets were $422,257. Current liabilities were $4,167,283, producing a working-capital deficit of $3,754,289. Total liabilities were $5,035,899; stockholders’ deficit was $4,613,642. The company reported $2,636,455 of current notes payable, including related-party notes, and approximately $2.636 million of debt obligations due within 12 months.
Six-month operating cash use was $334,024, compared with $540,224 in 2014; investing cash flow was zero. Financing provided $248,695, including $360,000 of related-party convertible-note proceeds, partly offset by repayments. Cash declined by $85,329 from year-end.
Changes versus the prior comparable period
- Q2 revenue and gross profit grew substantially, while Q2 net loss widened 72%. For the six months, revenue growth was accompanied by a 10% increase in net loss.
- Operating expenses rose, including higher sales and marketing costs associated with additional sales staff and channel-partner development. General and administrative expense also included $395,000 of stock-option compensation recognized during the six months. Interest expense increased with higher average debt.
- In Q2, the company began recognizing certain software contracts using percentage of completion when estimates were dependable; previously it used completed-contract accounting for these contracts. The filing says Q2 revenue would have been $81,306 lower had the prior method continued.
- Accounts receivable increased from $99,061 at December 31, 2014 to $228,967 at June 30, 2015, while cash decreased from $184,081.
Outlook, risks and unusual items
- Going concern and funding: Management says operating cash flows before working-capital changes are short by about $390,000 per quarter. It estimates a $1.05–$1.25 million operating funding shortfall over the next 12 months absent revenue growth, in addition to approximately $2.636 million of debt obligations due in that period. The company says it plans to negotiate extensions, deferrals or conversion of obligations and pursue additional financing, but has no committed new financing and gives no assurance these efforts will succeed. The filing states these conditions raise substantial doubt about the company’s ability to continue as a going concern.
- Strategy and execution: Management intends to expand reseller channels, sales capacity and marketing, and expects cloud services to become more significant. It cautions that sales cycles can last 18–24 months and results may fluctuate with project timing, customer renewals, collections and channel-partner performance.
- Debt and covenant exposure: Convertible notes issued during 2014 and the first half of 2015 generally mature by December 31, 2015, with interest rates of 6%–10% and conversion rights at varying prices. The Ohio State Development Authority increased the rate on one loan from 6% to 7% after an employment covenant was not met; the company also disclosed employment requirements on another loan and prior covenant non-compliance.
- Concentration and other risks: Government contracts represented 39% of Q2 revenue and 43% of six-month revenue. Two customers represented 22% and 11% of gross receivables at June 30. The filing also identifies risks involving government contracts, data privacy and security, intellectual property, third-party software, litigation and access to capital. No legal proceedings or material capital-expenditure commitments were reported. Management concluded disclosure controls were effective as of June 30, 2015.
- Equity compensation: The company granted directors 768,000 options at $0.75 per share; 464,000 were exercisable at June 30. The filing reports approximately 6.673 million shares reserved for warrants and options, in addition to 7,123,074 common shares outstanding.
- Reporting inconsistencies to note: The financial statements show Q2 professional-services revenue of $92,782, while the MD&A gives $97,782. The July 15, 2015 subsequent-note terms also differ between disclosures: the footnote describes $50,000 of notes maturing October 14 at 10%, while the MD&A describes a July 15 issuance maturing August 15 at 6%.
Most important facts for investors to verify
- Whether the company obtained financing or successfully extended, deferred or converted the substantial near-term debt maturities after June 30, 2015.
- Whether revenue growth—particularly software-license and reseller sales—translated into sustainable cash generation, and whether the change to percentage-of-completion recognition affected reported revenue timing.
- The precise terms and subsequent status of the July 2015 convertible notes, given the conflicting disclosures, and the potential dilution from outstanding conversion rights, options and warrants.
- Collection of receivables and exposure to customer concentration, government-contract dependence and lender covenant requirements.