Business context and reporting period
GlobalWise Investments, Inc. (the public parent of operating subsidiary Intellinetics, Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2014. The company develops and sells enterprise content management software and related services to public- and private-sector customers. Its sales strategy emphasizes cloud services and reseller/channel partners. Cloud revenue was 13% of total revenue in the first half of 2014, compared with 8% in the prior-year period.
Key financial results
Amounts in U.S. dollars.
| Metric | Q2 2014 | Q2 2013, restated | Six months 2014 | Six months 2013, restated |
|---|---|---|---|---|
| Revenue | $326,352 | $471,174 | $625,535 | $826,046 |
| Gross profit | $257,817 | $288,811 | $493,572 | $464,197 |
| Gross margin | 79% | 61% | 79% | 56% |
| Operating expenses | $574,939 | $766,481 | $1,166,512 | $1,567,755 |
| Operating loss | $(317,122) | $(477,670) | $(672,940) | $(1,103,558) |
| Net loss | $(372,714) | $(518,897) | $(776,536) | $(1,190,694) |
| Basic and diluted loss per share | $(0.01) | $(0.01) | $(0.02) | $(0.03) |
For the six months, operating cash flow was $(540,224), investing cash flow $(3,519), and financing cash flow $664,275; cash increased by $120,532 to $381,092. At June 30, total assets were $725,088, total liabilities $4,342,817, and stockholders’ deficit $(3,617,729). Notes payable were $2,457,435, plus $255,415 of related-party notes. Current assets were $657,316 and current liabilities $2,569,090.
Material changes versus prior comparable periods
- Revenue declined 31% in Q2 and 24% in the first half, primarily because software-license sales fell sharply: 97% in Q2 and 93% year to date. Management attributed the decline in part to redirecting effort toward building its reseller channel.
- SaaS revenue grew 20% in Q2 and 16% in the first half; maintenance revenue declined 1% and 3%, respectively. First-half professional-services revenue fell 35%, mainly because a large prior-year customer project had been completed.
- First-half gross profit rose 6% despite lower revenue, and gross margin increased to 79% from 56%, which management attributed primarily to revenue mix. Operating expenses fell, particularly sales and marketing costs, which were down 50% in both comparisons, and general and administrative costs.
- Interest expense was $55,592 in Q2, up 35%; first-half interest expense was $103,596, approximately level with the prior-year period.
- The 2013 comparative results were restated for a $109,990 overstatement of revenue on one customer contract: $90,000 of software revenue and $19,990 of professional-services revenue. The company said the correction had no effect on full-year 2013 results or six-month 2013 operating cash flow.
Outlook, risks, contingencies and unusual items
- Liquidity and going concern: Management disclosed substantial doubt about the company’s ability to continue as a going concern. It estimated an operating cash shortfall of about $180,000 per month and stated that $2.16 million to $2.56 million of additional funding could be needed over the next 9–12 months if operating cash flow did not improve. Management said no commitment for additional financing was in place. The filing’s MD&A reports a working-capital deficiency of $1,927,774; the balance-sheet current assets and liabilities imply a deficiency of $1,911,774, a difference to verify.
- The company raised $840,000 in net new funds through notes during the first half, including related-party borrowings, and used proceeds for working capital and debt repayment. The notes carry interest, some are convertible at $0.08 per share, and certain agreements require shareholder approval to increase authorized shares. In July, the company exchanged specified earlier convertible notes for new notes totaling $701,067, including accrued interest. A private offering of $500,000 also involved an 8% placement-agent commission paid in a convertible note and warrants for 168,750 shares. These terms and subsequent transactions warrant review.
- In June, payment schedules on both Ohio State Development Authority loans were modified to defer a portion of principal and interest payments until June 1, 2015. The company reported current covenant compliance but disclosed past non-compliance and risk of higher rates or accelerated repayment upon default. Employment-related loan covenants also apply.
- Sales are uneven because software projects and sales cycles can take many months, and software revenue is often recognized on completion. The company cited reliance on channel partners, competition, financing needs, customer renewals and collections, government-contract risks, and data security/privacy among factors that could affect results. Two customers contributed 26% of Q2 revenue; government contracts represented approximately 55% of Q2 revenue.
- MarketCommand, the reseller program for dealers in the print and imaging channel, had five resellers in Q2. By July, 24 subscriptions had been sold. Management expected limited impact on 2014 revenue because the $500 base subscription is recognized over 12 months. No formal revenue or earnings guidance was provided.
- After quarter-end, shareholders approved a company-name change to Intellinetics, Inc. and a 7-for-1 reverse split; the filing said the amendments would become effective when filed. The ticker changed to INLX on August 1, 2014. Legal proceedings: none reported. Management said disclosure controls were effective as of June 30, 2014.
Important facts for investors to verify
- Whether the company can secure the additional capital management estimated it needs, and the timing and terms of any financing.
- The working-capital-deficit discrepancy between MD&A and the balance-sheet figures.
- The maturity, conversion, interest, authorized-share and dilution terms of outstanding and subsequently refinanced notes, including placement-agent compensation and related-party transactions.
- Progress converting reseller and SaaS activity into material recurring revenue, given the steep decline in software-license sales and the stated long sales cycle.
- The effects of the 2013 revenue restatement, customer concentration, loan covenants, and the approved reverse split and corporate-name change.