Business context and reporting period
Netcapital Inc. (formerly ValueSetters, Inc.) filed this unaudited Form 10-Q for the quarter ended October 31, 2020, covering the three- and six-month periods ended that date. This corresponds to the second quarter of fiscal 2021; the request metadata’s “2019 Q2” does not match the filing. The company provides consulting, subscription, advertising, and digital services, with a focus on capital-raising support for early-stage businesses.
Financial performance
| Metric | Six months ended Oct. 31, 2020 | Six months ended Oct. 31, 2019 | Three months ended Oct. 31, 2020 | Three months ended Oct. 31, 2019 |
|---|---|---|---|---|
| Revenue | $2,493,486 | $835,725 | $731,164 | $716,993 |
| Gross profit | $1,779,262 | $830,877 | $447,959 | $714,511 |
| Gross margin | 71.3% | 99.4% | 61.3% | 99.7% |
| Operating income | $106,855 | $576,540 | $54,360 | $547,332 |
| Net income | $60,893 | $566,926 | $30,022 | $542,451 |
| Basic and diluted EPS | $0.15 | $1.43 | $0.07 | $1.31 |
Six-month revenue rose 198%, while quarterly revenue increased 2%. Profitability declined sharply in both comparisons as costs of revenue and operating expenses rose. Revenue included $2,314,532 recognized for equity received for services in the first six months, making reported revenue substantially noncash. Two customers contributed 82% of six-month revenue and 75% of quarterly revenue.
Six-month operating cash flow was negative $1,941,012, versus positive $16,432 a year earlier; the primary offset was noncash equity revenue. SBA loan proceeds of $2,385,800 supported financing cash flow, and cash increased to $455,994 from $11,206 at April 30, 2020. No investing cash flow or capital expenditures were reported.
Financial position, debt, and material changes
- At October 31, 2020, total assets were $4,756,311, total liabilities $3,996,299, and stockholders’ equity $760,012. Investments carried at cost totaled $3,721,514.
- Total debt was $3,442,984, including $2,385,800 in SBA loans. Current liabilities were $2,875,018; the balance sheet classifies $1,121,281 of SBA debt as long-term. The company’s related-party secured $1 million loan matured October 31, 2020 without payment; its maturity was extended to January 31, 2021, and its rate increased from 1.25% to 8% starting November 1.
- Management reports negative working capital of $1,867,687 and short-term debt exceeding $2.3 million. However, the balance sheet’s current assets less current liabilities equals negative $2,004,123; the filing does not explain this difference.
- Six-month wages and payroll expense was $1,296,333, compared with none in the prior-year period; stock-based compensation was $259,909 versus $108,531.
- The company recorded a $22,398 income tax expense and reported a deferred tax asset of $157,602, down from $180,000 at April 30, 2020.
Outlook, risks, and unusual items
- Going concern: Management concluded substantial doubt exists about the company’s ability to continue as a going concern within one year after issuance. It said available cash may not cover debt service and working capital needs, and that without debt forgiveness its plans are not likely to alleviate the uncertainty. Plans include seeking SBA loan forgiveness or renegotiated terms, pursuing combinations with incubated companies, and continuing consulting services.
- Merger and corporate changes: After quarter-end, the company changed its name and completed a 1-for-2,000 reverse split, effective November 5, 2020. It also issued 1,666,360 shares to NetCapital Systems LLC in connection with an agreement to combine with its funding portal subsidiary. The filing describes the transaction and purchase accounting as provisional; acquired intangible asset values remain subject to final valuation. The company expects the deal to expand its Reg CF funding-portal business.
- Business outlook: Management viewed SEC changes to exempt-offering rules, including raising the Reg CF offering cap to $5 million, as potentially beneficial. A new issuer reportedly raised $1.07 million on the portal in November 2020. The filing provides no quantified company revenue or earnings guidance.
- Other risks: The company depends heavily on a small number of customers, receives significant consideration in equity whose value may be uncertain, and may be unable to obtain financing on acceptable terms. Disclosure controls were deemed ineffective due to insufficient written accounting and SEC-reporting procedures. Management reported no material litigation and no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether the SBA loans or other debt are forgiven, refinanced, or repaid, and the status of the $1 million related-party loan after its January 31, 2021 maturity.
- The value, liquidity, and impairment risk of the $3.72 million investment portfolio, particularly equity received as consulting revenue.
- The customer concentration and the durability of revenue from the two largest customers, including related-party customer Zelgor.
- The final terms, share-count effects, acquisition accounting, and valuation of intangible assets from the NetCapital Systems transaction.
- The discrepancy between reported negative working capital and the amount implied by the balance sheet, and progress in remediating ineffective disclosure controls.