Intellinetics, Inc. — Q1 2016 Form 10-Q
Business context and period: Intellinetics develops and sells enterprise content management software and related services, including premises-based licenses and cloud software-as-a-service (SaaS), serving public- and private-sector customers. This unaudited report covers the three months ended March 31, 2016; comparisons are with Q1 2015 unless otherwise noted.
Financial performance and position
| Metric | Q1 2016 / March 31, 2016 | Comparable period / December 31, 2015 |
|---|---|---|
| Revenue | $603,391 | $583,775 |
| Gross profit and margin | $453,931; 75% | $470,238; 81% |
| Operating expenses | $851,028 | $583,195 |
| Operating loss | $(397,097) | $(112,957) |
| Net loss | $(535,765); $(0.03) per share | $(208,857); $(0.03) per share |
| Cash from operations | $(548,961) | $(248,749) |
| Cash | $1,004,441 | $1,117,118 |
| Working capital | $(427,266) | Not stated as a comparable figure |
| Total assets / liabilities | $1,381,797 / $2,736,512 | $1,413,555 / $3,232,992 |
| Stockholders’ deficit | $(1,354,715) | $(1,819,437) |
Gross margin fell six percentage points. Gross profit less operating expenses resulted in a $397,097 operating loss. Cash declined by $112,677 during the quarter; financing activities provided $436,284, including $559,285 of reported net proceeds from common-stock sales and $126,501 of debt repayments. Investing cash flow was zero.
At March 31, outstanding note principal was approximately $1.15 million, including $993,034 of non-related-party notes and $153,714 owed to a related party. The balance sheet also reports $144,276 of deferred interest expense. Current liabilities were $1,779,131, versus current assets of $1,351,865.
Material changes versus Q1 2015
- Revenue rose 3%. Software-license revenue declined 52% to $90,874, while SaaS revenue increased 95% to $110,156. SaaS represented 18% of revenue, compared with 10% a year earlier.
- Maintenance revenue increased 8% to $246,596; professional-services revenue rose 19% to $98,176; and third-party-services revenue rose 119% to $57,589.
- Cost of revenue increased 32% to $149,460, which management attributed principally to labor costs. Management attributed lower gross margin mainly to revenue mix, particularly professional services.
- Operating expenses rose $267,833. General and administrative expense increased 81% to $660,564, driven principally by warrant expense related to convertible-note conversion, stock-option compensation, director fees and stock compensation. Sales and marketing expense fell 12% to $187,508.
- Net loss increased by $326,908 to $535,765. Interest expense, net, increased 45% to approximately $138,700, principally reflecting warrant-related expense associated with the note conversion.
- During the quarter, $135,000 of convertible notes and $35,038 of accrued interest were converted into 303,912 common shares and warrants. The company also issued 1,013,198 shares in a private placement, issued director stock, and recorded warrant and option compensation. Shares outstanding increased to 16,794,992 from 14,908,439 at year-end.
Outlook, risks and notable disclosures
- Going concern and financing: Management said cash needs exceed available resources by approximately $70,000 per month and that growth, public-company costs and debt service are expected to consume substantially all operating cash flows over the next 12 months. The filing states that these conditions raise substantial doubt about the company’s ability to continue as a going concern. Additional financing was not committed, and management gave no assurance it could be obtained on acceptable terms.
- Strategy: Management plans to expand reseller/channel-partner sales, develop its sales force and marketing, and grow SaaS and its product portfolio. The company described cloud delivery as a future strategic focus, while noting that customer migration was at an early stage. No numerical revenue or earnings guidance was provided.
- Debt and covenants: Ohio State Development Authority loans remain outstanding, with principal maturities extending through 2018. The company disclosed prior covenant noncompliance related to employment levels that increased the rate on one loan from 6% to 7%; management said it was then in compliance with other covenants but could not assure future compliance.
- Concentration and operating risks: Two resellers accounted for 10% and 9% of Q1 revenue. Government contracts represented approximately 56% of revenue, versus 45% in Q1 2015. Management cited long sales cycles, customer renewals and collections, channel-partner dependence, competition, capital access, and government-contract and data-security risks.
- Controls: Management concluded disclosure controls were ineffective because of a material weakness in technical accounting knowledge and GAAP training. The filing says adjustments related to the stock-and-warrant offering and convertible-debt conversion had been identified during the 2015 audit; management was evaluating additional expertise and possible consultant support.
- Other: The company reported no legal proceedings, no defaults upon senior securities, and no material capital-expenditure commitments. A reseller agreement signed in April 2016, with an April 1 effective date, was disclosed as a subsequent development.
Important facts for investors to verify
- Whether operating cash burn and the stated monthly funding shortfall improve, and whether additional financing is secured.
- The company’s ability to meet debt payments and loan covenants, and the terms and potential dilution of future equity or debt financing.
- Whether SaaS and channel-partner growth can offset declining software-license revenue while maintaining gross margins.
- Progress remediating the material weakness in financial reporting controls and the reliability of subsequent financial statements.
- Customer and government-contract concentration, receivable collections, and the commercial performance of the April 2016 reseller arrangement.