Business context and reporting period
Intellinetics, Inc. develops and sells document-management software and related services to public- and private-sector customers. This unaudited Form 10-Q covers the three months ended March 31, 2017, compared with the first quarter of 2016. The company is pursuing growth through channel partners and a shift toward cloud-based software; cloud revenue, including hosting, represented 19% of revenue versus 18% a year earlier.
Financial results and position
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Revenue | $710,394 | $603,391 |
| Gross profit / margin | $503,514 / 71% | $429,634 / 71% |
| Operating expenses | $819,420 | $826,731 |
| Operating loss | $(315,906) | $(397,097) |
| Net loss | $(448,709) | $(535,765) |
| Basic and diluted loss per share | $(0.03) | $(0.03) |
| Cash from operating activities | $(548,062) | $(548,961) |
Revenue increased 18%; gross profit rose 17%, while the gross margin was unchanged. Software-license revenue increased 79% to $162,984, SaaS revenue rose 20% to $132,308, maintenance revenue was nearly flat at $249,922, and professional-services revenue increased 10% to $107,604. Cost of revenue rose 19% to $206,880. General and administrative expense fell 9% to $579,837, partly offset by a 26% increase in sales and marketing expense to $236,577. Net loss narrowed 16%; net interest expense was $132,803.
Cash was $494,935 at March 31, down from $689,946 at year-end. Investing activities used $6,429; financing activities provided $359,480, including $560,000 of note proceeds, offset by debt repayments and financing costs. Current assets were $1.073 million versus current liabilities of $1.896 million, a working-capital deficiency of $822,582. Total liabilities were $3.129 million and stockholders’ deficit was $2.023 million. Balance-sheet carrying amounts for notes payable, including related-party notes, totaled approximately $1.475 million; significant maturities fall in 2018 and 2019. The company reported $215,012 of deferred founder compensation.
Material changes, outlook, and risks
Management said increased software-license sales were driven mainly by demand for on-premise solutions, particularly from state and local governments; SaaS growth primarily reflected new customers. The company plans to expand its reseller network, reseller training, software integration and customization capabilities, and cloud offering. It provided no specific revenue or earnings guidance.
Management estimated cash needs exceed available operating cash flow by approximately $91,000 per month and stated that, without improved operating cash flow or additional financing, funds would not be sufficient for planned operations and current debt obligations over the next 12 months. The filing identifies substantial doubt about the company’s ability to continue as a going concern. Management reported no committed new financing and no assurance that additional funding would be available on acceptable terms.
During the quarter, the company raised $560,000 in convertible-note proceeds as part of a $1.25 million offering issued across December 2016 and January 2017. The notes carry 12% annual interest, are convertible at $0.65 per share, and mature December 31, 2018; unpaid interest and post-maturity rates may increase. The company also recorded a $248,523 beneficial conversion feature in equity. Key risks include recurring losses and financing dependence, short-term liquidity and debt obligations, loan-covenant compliance, long sales cycles, reliance on resellers and government-related revenue, and customer concentration. The two largest customers represented 12% and 8% of first-quarter revenue; government contracts accounted for approximately 36%, down from 56% a year earlier.
Disclosure controls were reported ineffective because of a material weakness in technical accounting knowledge and GAAP training. The company had hired a controller in November 2016, who became CFO in December, but said insufficient time had passed to determine that the weakness was resolved. No legal proceedings were reported.
Important facts for investors to verify
- Whether revenue growth, reseller expansion, and cloud adoption can improve operating cash flow enough to address the stated monthly funding shortfall and going-concern uncertainty.
- Availability and terms of additional financing, and the company’s ability to meet debt maturities and comply with loan covenants.
- Potential dilution: 17,376,012 common shares were outstanding at March 31, 2017, and 8,947,540 shares were reserved for warrants, convertible notes, options, and the equity plan as of May 12, 2017.
- Progress in remediating the material weakness in financial reporting controls and the effect of customer concentration and government-contract exposure.