Intellinetics, Inc. — Q3 2015 Form 10-Q
Business and period: The company develops and sells enterprise content management software, delivered through installed licenses and software-as-a-service (SaaS), with implementation, maintenance and related services. This unaudited report covers the three and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods.
Financial performance and position
- Revenue: Q3 revenue was $621,974, up 96% from $316,762. Nine-month revenue was $1,792,919, up 90% from $942,297. Growth included software-license revenue of $474,219 for nine months (versus $38,486) and SaaS revenue of $182,322 (up 37%).
- Profit and margins: Q3 gross profit was $491,280, with a 79% gross margin, versus $257,031 and 81%. Nine-month gross profit was $1,426,243, with an 80% margin, unchanged from 2014. Operating losses were $93,475 for Q3 and $753,483 for nine months. Net losses were $253,553 and $1,105,173, respectively; nine-month loss narrowed 22% year over year. Interest expense rose to $351,690 for nine months from $174,330.
- Cash flow: Nine-month operating cash use was $411,111, compared with $885,528 in 2014. Investing cash use was $3,888; financing provided $402,939, including $582,000 of related-party note proceeds. Cash declined $12,060 from year-end to $172,021.
- Liquidity and debt: Current assets were $499,907 and current liabilities $4,035,470, a reported working-capital deficit of $3,535,563. Total liabilities were $5,308,666; stockholders’ deficit was $4,767,791. Notes payable totaled approximately $3.43 million, including $1.97 million payable to related parties. Management estimated approximately $2.436 million of debt obligations due within 12 months.
- Other metrics: Accounts receivable, net, was $274,554, compared with $99,061 at year-end 2014; deferred revenue was $583,947. Common shares outstanding were 7,123,074. The company reported 768,000 options granted in 2015 and $421,000 of nine-month stock-option compensation expense.
Changes versus 2014
- Revenue increased sharply across software licenses, professional services, SaaS and maintenance. Management attributed growth principally to new customers, reseller/channel-partner activity and sales to existing customers.
- Q3 operating expenses fell 29% to $584,755, principally due to lower consulting expense. Nine-month operating expenses rose 9% to $2,179,726, including stock-option compensation and higher sales and marketing costs, partly offset by lower consulting expense.
- Management began recognizing qualifying software-and-services contracts using percentage of completion when estimates were dependable, rather than exclusively using completed-contract accounting. It stated that nine-month 2015 revenue would have been $33,174 lower under the prior method.
- Nine-month operating cash use improved, but cash remained low and financing depended on new borrowing. Interest expense increased substantially with higher average debt.
Outlook, risks and unusual items
- Going concern: Management stated that, absent revenue growth, operating cash flows over the next 12 months would be insufficient by approximately $1.05 million to $1.25 million. It said the company needed additional capital or debt financing, with no new financing commitments in place, and that these conditions raised substantial doubt about its ability to continue as a going concern.
- Management planned to grow revenue through an expanded reseller network, sales force and product marketing while controlling costs. It intended to negotiate extensions, payment deferrals or equity conversions for debt obligations. There is no assurance these plans or financing efforts will succeed; the filing provides no quantified revenue or earnings guidance.
- Convertible notes issued during 2015 and earlier carry maturities concentrated in 2015, with conversion prices and interest rates varying by note. Certain notes provide for higher default interest after maturity. Related-party investors include significant shareholders, directors and executives, creating potential dilution and governance considerations.
- Ohio State Development Authority loans were amended in September 2015 to defer payments and revise amortization. The filing also describes prior employment-covenant noncompliance and an interest-rate increase on one loan. The loan terms and rate disclosures should be checked against the amendments, as the filing text describes both a prior increase and a later amended rate.
- Customer concentration remains a risk: the two largest customers represented 17% each of gross receivables at September 30, 2015. Government contracts accounted for approximately 42% of nine-month revenue. Management cited long sales cycles, reliance on channel partners, customer renewals and collections, capital availability, and data security/privacy among risks.
- The company reported no legal proceedings, no defaults upon senior securities, and no material change in risk factors from its 2014 Form 10-K. Management concluded disclosure controls were effective as of September 30, 2015, with no material quarter change in internal control over financial reporting.
Important facts for investors to verify
- Whether the company obtained financing or successfully extended, deferred or converted obligations due in late 2015 and within the following 12 months—and the resulting liquidity and going-concern position.
- The exact debt balances, maturities, accrued interest, conversion terms and post-maturity rates, particularly for related-party notes; reconcile the stated $2.436 million near-term obligation estimate with the debt schedules.
- The September 2015 Ohio loan amendments, applicable interest rates, employment covenants and current compliance status.
- Whether reported revenue growth and reseller/channel activity continued, and how the percentage-of-completion estimates affected reported results and future revenue timing.
- Collection of receivables, customer concentration, and any dilution from convertible notes, warrants or stock options.