Intellinetics, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017; balance-sheet comparisons are with December 31, 2016. Intellinetics develops and sells document-management software and related services, serving public- and private-sector customers through on-premise, SaaS, maintenance, professional-services, and reseller channels.
Financial performance and liquidity
| Metric | Q2 2017 | Q2 2016 | Six months 2017 | Six months 2016 |
|---|---|---|---|---|
| Revenue | $737,354 | $636,749 | $1,447,748 | $1,240,140 |
| Gross profit / margin | $524,220 / 71% | $433,374 / 68% | $1,027,735 / 71% | $863,008 / 70% |
| Operating expenses | $685,319 | $811,226 | $1,505,447 | $1,637,957 |
| Operating loss | $(161,099) | $(377,852) | $(477,712) | $(774,949) |
| Interest expense, net | $(138,183) | $(24,112) | $(270,278) | $(162,781) |
| Net loss | $(299,282) | $(401,964) | $(747,990) | $(937,730) |
- Revenue rose 16% in Q2 and 17% for the first half. SaaS revenue increased 28% and 24%, respectively; professional-services revenue increased 189% and 93%. Q2 software-license revenue fell 24%, maintenance was down 2%, and third-party services fell 74%.
- Gross margin improved, which management attributed mainly to product mix. Operating expenses declined 16% in Q2 and 8% in the first half, including lower sales and marketing costs and reduced professional fees. Higher interest expense, primarily associated with recent convertible-note financing, partly offset operating improvement.
- At June 30, cash was $305,617, total current assets were $813,697, and current liabilities were $1,912,251; the reported working-capital deficit was $1,098,554. Total assets were $843,407 and stockholders’ deficit was $2,284,587.
- Six-month operating cash use was $638,533, investing cash use was $6,428, and financing provided $260,632. Cash declined by $384,329 from year-end 2016.
- Notes payable carrying amounts on the balance sheet totaled approximately $1.46 million, including related-party notes. Note disclosures show approximately $1.58 million of principal across non-related and related-party notes before unamortized financing costs; accrued interest and fees are additional obligations. Significant maturities include Authority loans due August 2018 and convertible notes due December 2018.
Changes, outlook, and risks
- Management is shifting toward cloud delivery and sales through resellers/channel partners. SaaS represented 20% of Q2 revenue versus 18% a year earlier. The company expects cloud-based delivery to become increasingly important but gives no quantified revenue or earnings guidance.
- Management estimated cash requirements exceeded available operating cash flow by approximately $73,000 per month. It warned that, absent improved operating cash flow or additional financing, it would not have sufficient funds for planned operations and current debt obligations over the next six months. No new financing commitments were in place, and management stated that substantial doubt existed about the company’s ability to continue as a going concern.
- The company raised $560,000 of convertible notes in January 2017 as part of a $1.25 million offering completed across December 2016 and January 2017. The notes carry 12% annual interest before maturity, have conversion features, and mature December 31, 2018. Management reported that funds supported working capital, general corporate purposes, and debt reduction.
- Customer and execution risks include long sales and implementation cycles, reliance on resellers, government-contract exposure, renewal and collection risk, and the need for additional capital to expand reseller training and product capabilities. Government contracts accounted for about 45% of Q2 revenue. The two largest Q2 customers represented 10% and 9% of revenue.
- Disclosure controls were judged ineffective at quarter-end due to a material weakness: insufficient technical accounting knowledge and GAAP training relative to reporting complexity. The company had hired a Controller who became CFO in December 2016, but stated that more time was needed to determine whether the weakness was resolved.
- Other notable obligations include $215,012 of deferred founder compensation, an office lease extending to December 2021, and Ohio Development Authority loan covenants. The company reported a prior employment-level covenant breach that increased one loan’s rate; it reported compliance with other covenants at the filing date. No legal proceedings were reported.
Key facts investors should verify
- Whether Intellinetics obtained sufficient financing or improved cash generation to address the stated monthly shortfall, working-capital deficit, and going-concern uncertainty.
- Actual cash burn, debt-service requirements, accrued interest and fees, and the company’s ability to meet 2018 maturities and loan covenants.
- Whether SaaS and channel-partner growth can continue, and whether professional-services growth is sustainable at acceptable margins.
- Potential dilution: 17,376,012 common shares were outstanding as of August 9, 2017; approximately 8.94 million additional shares were reserved for warrants, convertible notes, options, and the equity plan.
- Progress in remediating the material weakness in internal control over financial reporting and the accuracy of future financial disclosures.