Intellinetics, Inc. — Q2 2019 Form 10-Q
Business context and reporting period. Intellinetics develops and sells document-management software and related services to public- and private-sector customers. This unaudited report covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. The company is shifting its focus from on-premise licenses toward cloud-based software as a service (SaaS).
Financial performance and position
| Metric | Three months ended June 30 | Six months ended June 30 |
|---|---|---|
| Revenue | $640,608; up 17% from $549,678 | $1,155,993; up 8% from $1,075,052 |
| Gross profit / margin | $510,504 / 80%; prior-year margin 71% | $883,424 / 76%; prior-year margin 71% |
| Operating loss | $234,315, versus $450,098 | $671,021, versus $879,624 |
| Net loss / loss per share | $473,662 / $0.03, versus $669,451 / $0.04 | $1,143,515 / $0.06, versus $1,307,960 / $0.07 |
| Interest expense, net | $239,347, versus $219,353 | $472,494, versus $428,336 |
| Cash used in operating activities | Not presented separately for the quarter | $648,124, versus $817,592 |
For the six months, SaaS revenue increased 21% to $429,165 and professional-services revenue increased 74% to $194,405. Software-license revenue fell 88% to $8,852. Maintenance revenue rose 3% to $505,349. Management attributed revenue growth to SaaS adoption, customer expansion, and professional-services projects; lower license sales reflected the strategic shift and project timing. Cost of revenue declined 11%, supporting improved gross margin.
At June 30, cash was $412,224, down from $1,088,630 at December 31, 2018. Current assets were $729,693 and current liabilities were $1,066,746, a working-capital deficit of $337,053. Total liabilities were $6,330,471 and stockholders’ deficit was $5,461,987. Notes payable included $3,242,445 of long-term notes and $1,075,703 of long-term related-party notes, plus $24,014 current related-party notes; reported carrying values reflect discounts and financing costs. The company reported $5,489 of capital expenditures for the first half. Lease adoption in January 2019 resulted in a $117,894 right-of-use asset and $122,238 of lease liabilities at quarter-end.
Material changes versus the prior comparable period
- Revenue grew, with SaaS and professional services more than offsetting the sharp decline in software-license sales and lower third-party services revenue.
- Gross margins improved from 71% to 80% for Q2 and from 71% to 76% for the first half. Operating and net losses narrowed, partly as operating expenses declined.
- Interest expense increased 10% for the six-month period, primarily due to interest and debt-issuance-cost amortization on convertible notes issued in September 2018.
- Operating cash outflow improved year over year but remained substantial. Cash fell by $676,406 during the first half.
- Shares outstanding increased to 18,524,878 from 17,729,421 at year-end, including stock issued to directors and an employee. As of June 30, 37,187,116 shares were reserved for warrants, convertible notes, and the equity plan.
Outlook, risks, and unusual items
Management said it expects capital needs over the next 12 months to exceed cash flows from operations, including amounts needed for operating costs, debt service, and growth. The company states that existing cash and operating cash flow are insufficient to fund planned operations and debt obligations without improved cash generation or additional financing. It has no committed new financing arrangements, and the filing says these conditions raise substantial doubt about its ability to continue as a going concern. Management plans to pursue revenue growth through targeted vertical markets, direct sales, reseller expansion, marketing, and product development, but provides no quantified revenue or earnings guidance.
The company’s debt is primarily convertible notes bearing stated interest rates generally between 8% and 12%; several note maturities were extended to December 31, 2020. Additional debt or equity financing may be unavailable or costly, and conversion of notes and exercise of warrants could materially dilute shareholders. Other disclosed risks include fluctuating sales and sales-cycle timing, customer renewals and collections, dependence on channel partners, government-customer termination or compliance risks, data security and privacy, competition, and product-development execution.
Customer concentration is notable: the two largest customers represented 19% of Q2 revenue combined; government contracts represented 36% of Q2 revenue and 33% of first-half revenue. The company reported no legal proceedings and no material change to the risk factors in its 2018 Form 10-K. Management concluded disclosure controls were effective at quarter-end. Stock options were repriced in March 2019, including replacement of options covering 1.66 million shares at a $0.13 exercise price.
Key facts investors should verify
- Whether Intellinetics can secure financing or increase operating cash flow sufficiently to address the going-concern uncertainty and near-term funding needs.
- Debt principal, accrued interest, payment terms, and the consequences of the convertible-note maturities and potential conversions.
- Whether SaaS growth and improved gross margins can continue to offset declining license sales and sustain overall revenue growth.
- The scale of potential dilution from 37.2 million shares reserved for outstanding warrants, convertible debt, and equity-plan awards compared with 18.5 million shares outstanding.
- Customer and government-contract concentration, as well as collection trends and the ability to renew maintenance and SaaS agreements.