- Headline Profitability Number $5.2 million
- Dilution Slowing but Still Problematic
- 37% Growth in Profit Margins Indicate Potential Turnaround
InterCloud Systems, Inc. (ICLD) has been the poster child of toxic financing but may have finally turned the corner. On May 22, 2018, it announced an unbelievably profitable first quarter in the press release. $5.2 million in net income is so high that investors are finding it hard to believe. Based on 16,211,816 shares issued and outstanding that would represent a quarterly earnings of $.32/sh. Some multibillion dollar Software as a Service (SaaS) companies don’t have earnings this robust. The issue that investors have to reconcile is that there was no formal earning conference call to go over the quarterly release. Investors don’t know if that was an actual number off their core business or if it was engineered from the restructuring that was completed at the end of 2017. What investors do have to go off of is their past track record. The company has done an exemplary job of announcing significant sales wins and purchase orders. On the converse the company has done a horrible job letting investors understand how the toxic financing worked. So we hope to dissect the report and give investors some clarity.
Rebranding Taking Hold
On the latest press release CEO Mark Munro said “We continue to secure new purchase orders and scale back on expenses. We achieved our goal of profitability in the first quarter. We are focused on driving profitable next – gen Wi-Fi and DAS business as well as adding customers to our SDN Wan and SDN Orchestration platforms throughout the year.” These statement echo the statements from the open letter to shareholders in December last year where he said “X-Barrier and NFVgrid are part of a suite of network management and automation products for Next-Gen Software Defined Networks (SDN) and traditional network environments. In 2018, we expect a restructured ICLD will bring these new products to market with associated strong margins.” Investors should focus on the part about the strong margins. Investors should focus on the strong margins. They were indeed strong for Q1 coming in at 37% but fall far short of what SaaS companies have been able to post. Killer application companies can see upwards of 60% gross margins so there is room for growth.
Q1 Earning Summary
Revenue for the quarter came in at $4.765 million down from $5.487 million year over year. The large decline in revenue was likely attributable to the product mix but the rise in margins offset any loss in profitability. Last year gross margin were 27% and improved to 37% representing a 37% increase in gross margins year over year. The company did record a profit from operation of $159,000. The bulk of the profits however were from one time charges of $6.3 million from the changes in the fair value of the derivative instruments. They were able to extinguish debt and interest expenses regarding their convertible notes. Investors need to keep in mind that most of this “profitability” was due to the value of the convertible notes tanking in price after they were issued. In the accounting realm that is considered a profitable transaction.
SEC Litigation Closed
On April 2, 2018 the SEC closed its investigation regarding stock promotion and manipulation charges that date back to May 2014 when the SEC was looking into Galena Biopharma, Inc. And also in connection with the SEC investigation opened in May 2015 where the company officers were charged with possible violations regarding market manipulation. The SEC closed these investigations and didn’t recommend enforcement action against the company.
Dilution Continues Despite Comments on the Shareholder Update
Although the dilution of ICLD is not happening on an epic scale as investors have seen in the past the company still appears to be diluting shareholder interests. In just the past year ICLD had 2 stock splits (7/7/17 split 1:4 and 2/22/18 split 1:100) and recalibrated the company but the adjusted post-split share count has grown from 9,338,286 to 16,211,816 in just one quarter. This represents 73.6% dilution in just one quarter. The question on investor’s minds is will this toxic like dilution continue?
All investors have to do is look at the diluted EPS to see how many shares could be brought to bear. These shares are likely in the hands of “friendlies” but in the past any friend of the company has been an enemy of equity holders. The company still has convertible debt and a lot of it. In December 2017 they had $23.051 million and reduced it to $21.228 in the latest quarter so they are making progress but it’s more like baby steps. The balance of preferred stock is still sitting at $14.887 million.
Investment Summary
ICLD could be on the cusp of a massive turnaround but investors really need to be cautious and the large spike on the news seems to be a knee jerk reaction to a nice juicy headline profitability number. For ICLD to put in a profitable quarter on operations is really a big milestone and I hate to throw cold water on it but they have to stop diluting. Management spent so much time and effort to get rid of the derivative action lawsuit but they never really told investors how much it cost. The intangible cost was deafening because they should have been able to refinance their receivables but chose convertible debt as the preferred method of cash flowing the business. This is a big black mark on management. It’s also impossible to figure out how the convertible notes work and what their terms look like. Furthermore, it’s alarming for them to enter into any new note financing’s like they did in Q1. That is the wrong way to finance the company. ICLD is in the right space at the right time but their mistreatment of shareholders in the past in regards to dilution and transparency is going to keep this shadow of doubt hovering over them until the balance sheet is completely cleaned up. The key to investing in this company is to see a growth in revenue quarterly and a continued creep in gross margin. Investors need to be very cognizant of the dilution risk, but if the company delivers consistent contract awards and purchase orders this could be the start of a turnaround ICLD investors have been waiting for. Only then will a true bottom be in place.
Disclosure/Disclaimer: PSInvestor has NOT been compensated for the above opinion, and holds NO position in the above mentioned company, to read our full disclaimer, click here.