INTELLINETICS, INC. quarterly report, Q2 FY2012

Business context and reporting period

Globalwise Investments, Inc. (which operates through wholly owned Intellinetics, Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. Intellinetics develops and sells enterprise content management software and related implementation, consulting, maintenance, and cloud services. On February 10, 2012, Globalwise acquired Intellinetics in a reverse merger; the comparative operating results reflect Intellinetics.

Financial results and position

• Second-quarter revenue growth came mainly from modified software licenses, consulting, and maintenance. SaaS revenue declined 35% for the quarter and 23% year to date.
• Operating expenses rose substantially: first-half general and administrative expense was $1,169,198, including $676,668 of share-exchange and public-company legal, consulting, and professional costs; sales and marketing expense increased to $645,333 as the company expanded its sales team and promotional activity.
• Net cash used in operating activities was $914,267 for the first half, compared with $295,954 in 2011. Investing activities used $48,178; financing activities provided $839,540, principally through borrowings. Cash fell from $140,271 at year-end to $17,366 at June 30.
• At June 30, current assets were $462,369 and current liabilities were $3,480,581, a working-capital deficit of $3,018,212. Total liabilities were $5,582,563. Notes payable were $2,802,232, excluding $576,707 of related-party notes.
• Accounts receivable were $400,168 and deferred revenue was $745,975. Stockholders’ deficit was $5,006,682. The prior-year mandatory-redemption obligation was eliminated following termination of the stockholder agreement and the share exchange; this accounting reclassification did not represent an operating recovery.

Changes, outlook, and risks

• Management is shifting toward reseller and channel-partner sales, aiming to expand into new markets and increase sales of a broader product portfolio. It also expects SaaS to become a more important revenue source. Management says the sales cycle has historically been long, and project revenue and margins can vary considerably by quarter.
• The company stated that cash and operating margins were insufficient to cover existing obligations and that it required external funding. Management targeted raising at least $2 million during 2012–2013 and expected growth and public-company costs to consume substantially all anticipated operating cash flows over the next 10–16 months. No commitment for new financing was in place; the filing cites substantial doubt about the company’s ability to continue as a going concern.
• If financing is unavailable, contemplated cash-preservation steps include limiting hiring, reducing staff, deferring key-employee compensation, extending vendor payment terms, and encouraging early customer payments.
• Financing risk is significant: many notes mature within the following year, several maturities were extended, and related-party borrowing increased. Ohio development loans had covenant noncompliance waived in February 2012; failure to meet specified Ohio employment requirements could increase their interest rates to 10%.
• Revenue and receivables are concentrated. Tiburon and Lexmark, both resellers, represented approximately 39% and 11% of second-quarter revenue, respectively; together they represented approximately 33% and 12% of first-half revenue. Government contracts accounted for about 32% of second-quarter and 35% of first-half revenue.
• After quarter-end, holders converted $130,000 of contingently convertible notes into 162,063 common shares on July 20. A JMJ note dated August 7 had a stated principal amount of $400,000, but only $100,000 had been funded as of the filing; conversion terms reference the lower of $1.50 or 70% of the lowest trade price in a prior 25-trading-day period. The note also provides for an 18% default rate and significant default penalties.
• Management reported disclosure controls and procedures were effective at a reasonable-assurance level as of June 30. The filing reported no legal proceedings and no defaults upon senior securities.

Important facts for investors to verify

• Whether the company secured the targeted financing, on what terms, and whether funds were sufficient to meet near-term obligations.
• Subsequent cash balances, note maturities and extensions, related-party financing, and the amount actually funded under the JMJ note.
• Whether reseller-led sales growth persisted, customer concentration changed, and SaaS revenue recovered.
• Progress toward the Ohio loan employment requirements and ongoing compliance with debt covenants.
• The effect of share conversions and any further equity or convertible-debt issuance on common-share dilution.