Information Analysis Inc (OTC:IAIC)

Monday, August 17, 2020

Research

Information Analysis Inc (OOTC:IAIC) (Information Technology Services):  Classic information arbitrage in Q2 hints that the company could be on the cusp of sustained revenue growth and profitability for the first time in its history.

IAIC has been struggling to consistently grow profitably for years.

  REV EPS
2019 $10.10 ($0.06)
2018 $8.90 $0.00
2017 $10.60 $0.02
2016 $6.70 $0.05
2015 $6.20 $0.01
2014 $5.70 $0.00
2013 $7.40 ($0.01)
2012 $7.00 $0.01
2011 $7.80 $0.01
2010 $6.90 $0.01
2009 $6.70 $0.01
2008 $6.70 ($0.03)

We first disclosed a long position in IAIC on January 17, 2018 at $0.49 based on a strong Q3 2017 financial report and our belief that the company would see a meaningful long-awaited uptick in project work where it performs upgrades to  outdated computer database infrastructures for various departments of the U.S. government.  We also concurrently added the stock to our “Run To One” Model Portfolio.

Unfortunately, the stock basically went straight down from the time we bought shares, hitting a low of $0.08 in October 2019.  Project delays and a delay of a major government contract award were the culprits. We’ve come to realize that project pipeline uncertainty is a risk when dealing with the government.

Well, late Friday, IAIC reported breakeven 2020 Q2 results vs. a loss of $0.02, on revenue of $4.8 million vs. $3.7 million. The Q2 results were disclosed in the company’s SEC quarterly filing with no associated press release. So naturally, we wanted to read the filling for the presence of Information Arbitrage disclosures related to project or government award change status.

Recall that in our weekly wrap up email in early April, we discussed that potential revenue from a subcontract award that the company won, displacing the previous firm that had been awarded this contract in prior years, would be very material for IAIC. Specifically, in its 2019 10K  IAIC commented that the award could generate in excess of $5 million annually and help the company achieve profitability. Given that the company had been generating annual revenue ranging between $5 million and $10 million for several years, we surmised that this award could be a big deal.

One thorn in the side of IAIC had been that the incumbent firm protested IAIC’s displacement of them from the contract. As a result, IAIC could not perform any work under the award until the matter was resolved.

However, we decided to dig into the company’s 2020 Q1 and Q2 filings and found that the incumbent withdrew their protest as of IAIC’s 2020 Q1 filing. This, along with the resumption of revenue that has been delayed due to COVID-19, is likely the reason for the company’s strong Q2 revenue numbers, which are actually the highest quarterly revenues since 1998.

Q2 filings indicate that project work is recommencing:

“IAI has been experiencing prolonged delays in the commencement of new professional fees contracts and subcontracts due to protests and now coronavirus. The largest of these contracts, originally delayed due to protest and subsequently delayed due to indirect effects related to coronavirus, commenced on June 1, 2020.

In April 2020, we were made aware that the incumbent withdrew its subsequent protest, thereby confirming the initial contract award to our prime contractor. The coronavirus pandemic indirectly impacted the commencement of services under this contract for a few months, but we finally commenced providing services under this seven-year subcontract award on June 1, 2020.  We anticipate net income in the third quarter due to the increase of our professional fee revenue we are experiencing under the commencement of new contracts.

The details surrounding these events have only been disclosed in SEC financial filings, hence the Information Arbitrage.

With this issue behind them, the contract could lead to improved results for years to come and may be why shares have quietly risen over the past few months. 

While this new development is encouraging, we need be cognizant of the following:

  • We estimate that IAIC would reach a quarterly profit at about $7 million in revenue. So, they are not quite there, yet.
  • The company’s base business can be volatile. So, we need to perform some research on the likelihood that the base business or potential new business will be able to provide the revenue to enable the company to reach profitability.
  • A good deal of the company’s business is very low margin.  For example, the company has two sources of revenue – third party software license revenue and professional fee revenue. The gross margin on the software revenue is minimal, but the professional fee revenues are respectable.  From a cursory glance, it appears that professional fees comprise somewhere between 25% to 40% of revenue. Therefore, net income can be greatly impacted by this revenue mix. However, the company gave us a clue that the 3rd quarter of 2020 will include some additional professional fee revenue. On this note, it’ll be important for us to determine to which extent professional fees will be associated with the software revenue tied to the new contract the company just won.

Please note that the stock is extremely illiquid.

As for valuation the stock is selling at

  • P/E: NA losing money
  • Price to ttm Sales: 0.29
  • Enterprise Value to ttm Sales: 0.21
  • Tangible Book Value per share: 0.09
  • Cash per share: $0.09
  • Debt: Zero

Given the possibility the company may be close to achieving consistent profitability we think IAIC could be particularly cheap down here.

We are considering the possibility that IAIC may now have become an acquisition target, maybe by the company it displaced in the recent contract dispute? However, we still need to dig into who the incumbent was.