Intercloud Systems Inc. (ICLDD) did a reverse split on July 12, 2017 and after a brief move up in relief of the split incessant selling hit the stock.  The company has convertible sellers active in the market that were in arrears a couple of interest payments due to the delays in the reverse which prevented the company or transfer agent from delivering more shares to the noteholder to satisfy their obligations.  Since FINRA is required to review the reverse split contemplated and approved by shareholder the delay seemed to created pent up selling pressure by the convertible note holder.  This noteholder has violently sold into the market before only to have the stock rebound on a short squeeze created by all the naked shorts forced to cover when the noteholder was unable to get any more shares to sell.

The question on investor’s minds is focused on when will this convertible note holder stop?  The answer lies in the filings.  The company was close to maxed out on their authorized in April 2017.  So they are potentially 3 monthly payments in arrears with their convertible noteholders.  One of the key noteholders in question seems to be the assignee of the Tim Hannibal Note.  Before we look at the details let’s look at the progress they have made in cleaning up their debt year over year.  In FY 2015 their total debt was $34.045 mil and in the course of a year their ending debt in FY 2016 was $23.007 mil.  That represents a reduction of $11.038 mil or 32.4%.  In Q1 2017 they sold off a division and reduced their debt by $2.216 mil.

There were a many conversions last quarter.  Here is the summary.  As you can see from the chart below the company dramatically increased the share count by 374,535,985 which represents a 332% increase in outstanding shares.  The silver lining to this is the $7.324 mill of equity that was essentially raised in the quarter.

Here is a chart detailing the reduction of debt to the note holders

The asterisked note amounts are the active sellers.   The note holder, Tim Hannibal highlighted in red type assigned his note to a third party as disclosed in the 2017 10-Q.  Based on the selling pattern it appears that this new noteholder entered the market.  Based on interest payments due and assuming the noteholder completely liquidated his position it appears that the dilution is over.  In the past 7 trading days the share count has risen by 29,879,316 as verified by the transfer agent on 7/20/17.  The total number of short volume per OTC short volume is approximately 36 mil.  Using the closing data multiplied by the short volume it closely matches the size of the $1.215 mil convertible note that was assigned.  Based on the chart pattern and tailing volume today it appears that the dilution may be over.

Notes Rate 3 months
117,000 0.12 4% 4680
3,170,000 0.0467 2% 49346
155,000 0.0467 2% 2413
449,000 0.0467 2% 6989
493,000 0.12 4% 19720
435,000 0.0467 2% 6772
Receivables 47000
Total 136920
Tim Hannibal note 1215000
1351920
Selling Based off OTC Short Volume Transfer
Vol (mil) Short Vol (mil) Closing Price Agent
7/12/2017 11.8 3 0.06 0.18 125,000,000
7/13/2017 44.4 10 0.034 0.34
7/14/2017 24.8 8 0.036 0.288
7/17/2017 9.8 2.5 0.0365 0.09125
7/18/2017 11.2 2 0.0332 0.0664
7/19/2017 30.3 5.5 0.0245 0.13475
7/20/2017 19 5 0.021 0.105 154,879,316
36 1.2054 29,879,316

The current market capitalization of ICLDD is $3.28 million assuming 154.88 million shares outstanding.  OTC markets has the Outstanding Share count of 329,426,039 as of Jul 20, 2017.  When reorganizations happen it’s not uncommon for OTC Market to not have the most updated information.  It seems reasonable that this dramatic rise in share count has spooked investors but applying a little common sense and you will see that roughly 151 million shares have traded over the past 7 days since the split and if ever share was sold and you add that to the 125 million shares left from the reverse it would equal 276 million shares far short of what OTC markets has reported.

When declines like this happen it’s important for investors to look at asset valuations.   At the end of Q1 2017 they had current assets of over $15.3 million including AR of $11.6 million.  They had $14.0 million in revenue for the quarter on pace with a $56.0 million annual run rate.  The company’s cash flow is slightly negative in operations and under pressure but any sizeable contract awards would be profitable.  The interesting point about their cash flow is that their receivables do not seem to be fully pledged which may allow them to get a factoring facility in the future allowing them to take on more business.  This company is likely to produce over $50 mil in sales and has 24% gross margin so any improvement in margin or sales could tip the company toward profitability.  As an investor you have to ask does it make sense if a company with $50 million in annual sales in an industry with above average growth that is in merger and acquisition mode will stay at a $3.28 million valuation very long.  Trading at .06 sales while its peers are trading a multiples to sales seem a little unvalued in such a hot market sector.

When company’s do reverse stock splits nothing fundamentally has changed in the company.  The market capitalization remains the same and the share count decreases.  In this particular scenario one party with a convertible note seemed to be anxious to liquidate their position but could not do so because the company was at its maximum authorized share count.  Once the split was completed and the authorized shares reduced the transfer agent was able to issue more shares pursuant to the convertible note.  If you were an existing shareholder of ICLDD on the date of the reverse the only way to sell your shares would have been to call it in to your broker.  Electronic access would have been denied until the reorganization work was completed.  Once the stock opened for trading on July 12, 2017 there was almost an immediate free fall in price.  The only party with stock to sell right after the bell would have been a convertible noteholder that had been waiting months to convert his stock.     So when a stock loses $10 million in market capitalization in 7 days and nothing fundamentally has changed with the company and the selling shareholder seems to be done it might be time for value investors to step up and scoop up shares at extremely discounted valuations.

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