HeartCore Enterprises, Inc. — Q1 2023 Form 10-Q
Reporting period: Three months ended March 31, 2023; unaudited consolidated financial statements. Comparisons are with Q1 2022 unless otherwise noted. The company operates software businesses in Japan and the United States and provides IPO-related consulting to Japanese companies.
Financial highlights
| Metric | Q1 2023 | Q1 2022 / prior balance |
|---|---|---|
| Revenue | $8.734 million | $2.276 million |
| Gross profit / margin | $5.633 million / 64.5% | $1.221 million / 53.6% |
| Operating income (loss) | $2.300 million | $(1.562) million |
| Net income (loss), consolidated | $1.808 million | $(1.578) million |
| Net income (loss) attributable to HeartCore | $1.882 million | $(1.578) million |
| Basic and diluted EPS | $0.10 | $(0.09) |
| Operating cash flow | $(1.048) million | $(2.394) million |
| Cash and cash equivalents | $5.210 million | $7.177 million at Dec. 31, 2022 |
| Working capital | $3.541 million | $4.887 million at Dec. 31, 2022 |
At March 31, total assets were $24.670 million and total liabilities were $10.824 million. Long-term debt had $2.139 million of aggregate principal outstanding ($2.131 million net carrying amount, including current and non-current portions). In addition, the company reported $173,582 outstanding under a recourse factoring arrangement, $352,518 of insurance premium financing, and $2.602 million of operating lease liabilities. Financing activities used $134,296; investing activities used $722,364, including $724,910 net cash paid for the Sigmaways acquisition.
Material changes and business developments
- Revenue rose 283.7%, primarily from $5.193 million of IPO consulting revenue and $1.632 million of customized software development revenue added through Sigmaways. On-premise software revenue fell $444,680, which management attributed primarily to losing a significant CMS customer.
- Q1 revenue from on-premise software was $356,921 versus $801,601; maintenance and support was $701,474 versus $845,339; SaaS was $171,044 versus $126,654; software development and miscellaneous services was $680,341 versus $502,407. Customized development and IPO consulting were new reported categories, at $1.632 million and $5.193 million, respectively.
- Gross margin increased to 64.5% from 53.6%, while operating expenses rose 19.8% to $3.333 million. G&A was $2.685 million, including acquisition-related increases and higher stock-based compensation, partly offset by lower listing expenses. Stock-based compensation totaled $915,228.
- The company acquired 51% of Sigmaways on February 1, 2023 for $1.0 million cash and 2.5 million HeartCore shares valued at $3.15 million. The purchase accounting recorded $5.1 million of customer-relationship intangible assets, $3.276 million of goodwill, and $3.190 million of non-controlling interest. Sigmaways contributed $1.632 million revenue and a $151,534 net loss from acquisition through March 31.
- IPO consulting generated substantial noncash warrant consideration: warrants received were valued at $4.009 million, with a further $193,365 fair-value gain. Warrant investments were carried at approximately $4.203 million at quarter-end and valued using a Level 3 Black-Scholes model.
Liquidity, outlook, risks and unusual items
- Despite the return to profitability, operating cash flow remained negative. The company attributed cash use partly to noncash warrant consideration, bonus payments and a decrease in deferred revenue; cash fell by $1.967 million during the quarter.
- Management reported no specific numerical financial guidance or forecast. It said IPO consulting revenue helped offset lower CX and DX sales. As of May 22, 2023, HeartCore reported consulting agreements with ten companies, generally involving fees of $350,000 to $900,000 plus warrants or acquisition rights tied to 1% to 4% of client fully diluted shares.
- Revenue concentration is notable: two customers represented 28.9% and 18.8% of Q1 2023 revenue. Three vendors represented 38.5%, 29.6% and 18.4% of purchases. Accounts receivable was $2.380 million, with no allowance for credit losses recorded.
- Insurance premium financing bears 16.04% annual interest. Sigmaways factoring is with recourse and had $173,582 outstanding. Long-term debt payments total $2.139 million of principal, including $464,705 scheduled for the remainder of 2023.
- Disclosure controls and procedures were reported as ineffective as of March 31, 2023, for the same reason disclosed in the 2022 Form 10-K. No material changes in internal control were identified during the quarter. The filing reports no material pending legal proceedings, no material payment defaults, and no off-balance-sheet arrangements.
- Subsequent events: on May 2, 2023, the company entered into an agreement to provide ZEROSPO with a $300,000 note investment, bearing 8% interest and generally due within 180 days; default interest is 12%. The note is an asset/investment of HeartCore, not borrowing by HeartCore.
Important facts for investors to verify
- How much of Q1 growth and profit is recurring software or services versus IPO consulting, warrant consideration and Sigmaways consolidation; also verify the timing and collectability of consulting fees.
- The terms, valuation assumptions and liquidity of the approximately $4.203 million warrant portfolio, including the impact of future fair-value changes on earnings.
- Sigmaways acquisition economics, final purchase-price allocation, ownership and non-controlling-interest effects, and the reconciliation of acquisition-related share and warrant issuances described in the filing.
- Customer and vendor concentration, receivable collection experience, and the implications of recording no credit-loss allowance.
- Cash runway and scheduled debt, lease and high-interest insurance-financing obligations, given negative operating cash flow.
- Remediation plans and progress for the ineffective disclosure controls and procedures.