Professional Diversity Network, Inc. quarterly report, Q2 FY2014

Professional Diversity Network, Inc. — Q2 2014 Form 10-Q

Reporting period: Three and six months ended June 30, 2014. Unaudited interim results. The company operates online professional networks and recruitment, advertising, and career-event services for diverse professionals and employers.

Financial performance

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Revenue	$1.032 million	$0.977 million	$2.270 million	$1.897 million
Operating loss	$(0.792) million	$(0.434) million	$(1.344) million	$(0.681) million
Net loss	$(0.488) million	$(0.133) million	$(0.751) million	$(0.615) million
Basic and diluted loss per share	$(0.08)	$(0.02)	$(0.12)	$(0.12)

Revenue increased 5.7% in Q2 and 19.7% for the first half. Recruitment services contributed $585,000 and $1.401 million, respectively; consumer advertising and marketing contributed $447,000 and $868,000.
Calculated gross margin (revenue less cost of services) was approximately 61.7% in Q2 versus 74.7% a year earlier, and 66.4% for the first half versus 74.4%. Operating loss widened as expenses grew faster than revenue.
Sales and marketing expense rose 32.5% in Q2 and 51.1% in the first half; cost of services increased 60.2% and 56.8%, respectively. Direct sales and events activity contributed to growth as well as higher costs.
First-half operating cash flow was $(1.116) million, compared with $0.867 million provided a year earlier. Investing cash outflow was $11.986 million, largely reflecting purchases of short-term investments; financing used $26,000. Cash declined by $13.127 million.
At June 30, cash and equivalents were $5.609 million and short-term investments were $11.876 million. Working capital was $17.344 million; current liabilities were $2.466 million. The balance sheet reports no debt at period-end. The warrant liability was $71,689.
Total assets were $22.214 million and stockholders’ equity was $19.748 million. The filing reports a $512,589 deferred tax benefit for the first half, materially reducing the reported net loss.

Material changes and business developments

The LinkedIn reseller agreement ended March 29, 2014. It had provided fixed payments of $500,000 per quarter, in addition to possible commissions. LinkedIn revenue was zero in Q2 2014 versus $500,000 in Q2 2013, and $494,444 for the first half versus $1.0 million. LinkedIn represented 22% of first-half revenue, but none of Q2 revenue.
The company says it is now free to pursue former restricted accounts and is seeking direct renewals from customers previously served through LinkedIn. Direct sales revenue from businesses, excluding LinkedIn and Apollo, was approximately $682,000 in Q2 and $1.075 million in the first half, compared with $92,000 and $158,000, respectively, in 2013. Direct bookings were not the same as revenue recognized.
Customer concentration remains significant: Apollo represented 34% of Q2 revenue and 31% of first-half revenue, and 32% of accounts receivable at June 30. The Apollo agreement, renewed in February 2014, provides a fixed monthly fee of $116,667 and expires February 28, 2015 unless renewed.
The company reported approximately 3.17 million registered users at June 30, adding more than 523,000 in the first half. It had 26 sales and marketing professionals and over 500 companies using its products and services.

Outlook, risks, and unusual items

Management expects available funds and operating cash flow to meet working-capital needs for the next 12 months, but cautions that LinkedIn’s termination will materially affect near-term revenue and operating cash flow. No quantified revenue or earnings guidance is provided.
Management’s plan emphasizes direct selling, access to the approximately 1,000 formerly restricted accounts, demand it expects from updated OFCCP requirements, and possible recruitment-industry acquisitions. The company notes that historical hiring seasonality typically makes demand lower in the first half and higher in the second half.
On July 11, 2014, after quarter-end, the company signed a merger agreement to acquire NAPW. Proposed consideration includes 6,309,845 company shares, $3.45 million cash, a $550,000 promissory note, options and warrants; the filing says recipients would own 50% of the company on a fully diluted basis. Completion was subject to the merger agreement’s terms. The proposed transaction would significantly dilute existing holders and require substantial cash and other consideration.
On June 30, the company entered licensing and sales-representation agreements with AudioEye. It agreed to pay $450,000 in aggregate license fees and royalties of 12% of related revenue; AudioEye agreed to pay the company a $450,000 non-refundable service fee plus commissions. The balance sheet includes a $450,000 accrued license fee.
Management concluded disclosure controls and procedures were ineffective at June 30 and identified a material weakness involving segregation of duties and application of complex accounting principles. Remediation steps were underway, but management said successful operation of controls would need to be demonstrated over several quarters.
The filing reports no legal proceedings and says market-risk disclosure was not applicable. The share repurchase program expired May 30, 2014; the company repurchased 6,182 shares for $25,862 during the first half.

Key facts for investors to verify

Whether direct-sales growth and bookings convert into recurring recognized revenue sufficient to replace LinkedIn’s fixed payments.
Renewal terms and continued revenue contribution from Apollo, and the company’s exposure to customer concentration.
The merger’s closing status, final consideration, cash and financing requirements, and resulting dilution; the agreement was a subsequent event, not a completed transaction as of June 30.
Liquidity and cash use after the substantial short-term-investment purchases, including the impact of ongoing operating losses and the AudioEye arrangements.
Progress in remediating the disclosed material weakness and whether disclosure controls become effective.