TM Editors' Note: This article discusses a microcap penny stock. Such stocks are easily manipulated; do your own careful due diligence.

Earlier this year, I published this piece focusing on social media sponsorship microcap Izea, Inc. (OTCQB:IZEA). I pointed out that it looked like what might turn out to be a rewarding speculative allocation as part of a wider, balanced portfolio. Since the article's publication there have been a number of developments associated with Izea , with one in particular related to its financial structure that could impact the company going forward. In light of this, I feel it is worth addressing these developments to identify what effect, positive or negative; each might have on an early-stage investor's decision to pick up shares.

Our approach

Here's an outline of our approach. First, for those who did not catch the initial piece, I will introduce Izea and its market. Next, I will take a look at the company's latest financials, and see how Izea's performance compares to previous periods. After the financial analysis, I will address the financial development to which I alluded already, and try to ascertain the impact of this development on both a short and a longer-term timeframe. Finally, I will finish with an analysis of the risks associated with the company. Our conclusion will put forward our interpretation of the latest developments, and highlight whether any of them change our previously published thesis on Izea and its prospects.

An introduction

So, what is Izea? Izea is a social media sponsorship company. When it started out back in 2006, the company offered a limited number of platforms through which users from a range of social media platforms could connect with advertisers to initiate promotional campaigns. As a crude example, a cosmetics company may contact an influential fashion and beauty blogger, and pay them a fee to publish a tweet that (often subtly) promotes an item of makeup. This was back in 2006, and in the decade since, Izea has expanded to operate what it now calls its IZEAx platform, which is essentially a consolidation of its previous platforms that brings users the ability to conduct campaigns across a wide range of social media networks from one central system. The premise remains the same - advertiser pays publisher to promote, while IZEA takes a fee for facilitating the transaction through its platform - but has now matured to include video, blog and image-based promotion. How does this differ from a sponsored post on Facebook, or a promoted tweet on Twitter, Inc. (NYSE:TWTR)? Well, when a company pays for a promoted tweet, it creates the content itself and posts on Twitter under its brand name. Take Gillette for example. If Gillette wants to promote a new type of razor, it may pay Twitter to promote a tweet that contains a link to a particular section of its website that describes this razor's features. What Gillette is paying for here is for the tweet to appear at a particular frequency, or towards a particular demographic. Sticking with the same example, but adapting it to the Izea model, Gillette would use IZEAx to connect with an influential men's health blogger or sports personality and pay them to publish the content. The difference being that they are essentially paying for access to this influencers network of followers, not for a pre-calculated exposure rate as would be the case with Twitter on, say, a CPM arrangement (with CPM here standing for cost per thousand impressions).

The industry

Another thing I mentioned in the previous article, but something worth running through again, is the benefit of Izea addressed in our previous IZEA coverage.  To bring new readers to speed, I outlined that traditional banner advertising has become less and less effective over time and concepts such as the banner blindness phenomenon has led advertisers to seek alternative methods of promotion online. One that is proving the most effective is native advertising, which seeks to integrate promotional content with a website's standard content. Also worth pointing out is that the shift to mobile device internet access has fueled the native advertising industry, as display real estate diminishes with a reduction in screen size. Business Insider published a report on the native advertising space towards the end of 2014, and with it, and number of takeaways that feed into Izea's business model. First, that by 2018 the native advertising industry across both desktop and mobile displays will be worth $21 billion. Of this $21 billion, social native (promoted tweets, etc.) and sponsorship native (sponsored blog content) will account for $15.3 billion. Social native will account for the majority of this $15.3 billion, totaling $11.9 billion by 2018. Further, the report highlighted that native mobile advertising's have a 1% click through rate ("CTR") which does not sound that high initially, but compared to the average display banner CTR of 0.06%, look superior. The industry forecast data is represented graphically in the image below:

US Native Advertising Revenue 2013-18E (Source)

The numbers

So now to the numbers. In the middle of May, Izea reported its latest 10 Q detailing the company's Q1 2015 financials. For the three months ended March 31, 2015, the company generated revenues of $4.13 million - a 111% increase over the $1.95 million reported during the same period in 2014. Of the Q1 2015 revenues, sponsored revenue accounted for $2.69 million and content revenue for $1.36 million. Sponsored revenue was up 93% on the same period a year earlier, while content revenue does not have a comparable figure as it results from the company's acquisition of Ebyline, which I addressed in the previous piece. Cost of sales for Q1 2015 came in at $1.18 million, up from 600,000 reported a year earlier, and content revenue at $1.23 million for Q1 2015. Both the increase in sponsored revenue and the costs associated with the generating of this revenue came as a result of an expansion in the company's sales force, and in turn, the ability for IZEA to focus on managed campaigns (from which IZEA draws a larger fee) and repeat custom. More specifically, IZEA increased its sales team by 71%, at an extra cost of just under $500,000 quarterly. Gross profit for the period came in at $1.69 million - 29.6% increase compared to the same period during 2014. Gross profit as a percentage of revenue came in at 41% - a decrease on the 67% reported last year. This decline arose primarily from the content generated revenues that came about as a result of the Ebyline acquisition, for which the company generates revenue at a gross profit 10%. Also affecting margins is the company's white label IZEAx platform. White label partners earn a percentage of each transaction generated through their own system, and this eat away at IZEAs margin figure. All told, as a result of both the Ebyline acquisition and the white labeling of IZEAx, the company expects revenues to increase by an as yet uncertain amount, and margins to decrease to within a range of between 30% and 35%.

That's where things stood last quarter. But what can we expect during this quarter, and what does the company's balance sheet look like? Let's first address the former. Izea announced its Q2 2015 bookings figure on July 7, 2015. The company uses net bookings as a leading indicator, with the figure representing sales orders minus any cancellations or refunds on a given period. Bookings generally become recognized as revenue within 90 days of their initiation. During the first quarter of this year, the company recorded $4.3 million net bookings. In July, the company announced Q2 2015 bookings of $6.2 million, with sponsored sales revenue of $3.9 million. Izea's bookings growth between 2011 and a projected 2015 is illustrated in the image below:

IZEA Bookings 2011-15E (Source)

What about operating expenses and balance sheet situation? At the end of March this year, the company reported $3.9 million in cash and cash equivalents - down from $6.5 million in cash at the end of December 2014. The acquisition of Ebyline accounted for $1.2 million of the $2.5 million decline between December and March, and the remainder went on the funding of the company's operating losses. From a credit perspective, the company has an as yet untapped facility at Bridge Bank (NASDAQ:BBNK) (the same one I mentioned in the previous piece) of $5 million. So, to summarize up to this point, the company is generating revenues and has both cash in the bank (albeit a relatively small amount) and the credit facility that could fund operations through to the end of the year at its current burn rate.

Upcoming warrant exercise

There is one more thing I should mention that strengthens the company from a financially attractive investment perspective in a couple of ways. On July 20, 2015, the company announced that it had received signed commitments from holders of more than 70% of its outstanding warrants issued during 2013 and 2014 that sees these holders exercise their warrants for cash. Total proceeds should come in at around $11 million, including $2.8 million in proceeds from a 100% exercising of the company's board of directors warrant Holdings from the same period. To summarize, the company is offering a 25% discount on warrant exercise prices to investors holding warrants issued in 2013 private placement, and 26% discount on a similar placement in 2014. As the primary benefit, this gives Izea a way to strengthen its balance sheet through raising additional capital, without having to dilate the holdings of current IZEA investors. In our last coverage of IZEA, I highlighted dilution as a potential risk factor. For the medium-term, however, this warrant exercise should mitigate some of the risk of dilution. An additional benefit of this $11 million capital injection is its effect on IZEA's potential uplisting. CEO of Izea Ted Murphy has highlighted the company's target of a Nasdaq listing a few times over the last couple of years, and I need not highlight the benefits of an uplisting for a currently over-the-counter traded company in this piece. However, a Nasdaq listing involves minimum shareholder equity requirements. Current requirements for a listing on the Nasdaq Capital Market - the tier of Nasdaq that IZEA will likely go for initially - is between $4 million and $5 million depending which standard the company targets. In other words, the $11 million capital raised through warrant exercise will inflate IZEA's balance sheet and help bring it in line with Nasdaq listing shareholder equity requirements, as cash holdings contribute to the calculation, whereas unexercised warrants do not.

HR additions

While on the topic, the company also recently announced two new changes to its management structure - the addition of Ruby Tuesday Chief Financial Officer Jill Golder to its board of directors and the appointment of Chris Staymates as Vice President of Engineering. The first of these, Jill Golder, looks to be a direct play at working towards a NASDAQ listing. Listing rule 5605 (NYSE:B) states that before qualifying for a NASDAQ listing, a "company's board of directors is required to have a majority of independent directors."

Prior to the Golder higher, Izea's board of directors comprised six members, three of which were independent. The Golder hire now weights the board towards independent directors 4-3, bringing it in line with rule 5605 .

Twitter firehose partnership

Finally, let's consider a recent development announced by IZEA on June 25, 2015. On this day, the company announced that it had reached a deal with Twitter whereby IZEA can augment twitters data to provide analytics info for its clients through the IXEAx platform. It was big news last year when IZEA withdrew firehose access to data analytics companies, and acquired Gnip, an entity that was previously in the business of reselling Titter's firehouse, with the assumed goal being to bring the selling and distribution of its data in-house. I have seen a couple of examples of this strategy hit press so far, with the first being a deal with IBM, reported during the back end of 2014, and the second being this IZEA agreement. Exact terms of the deal remain uncertain - both Twitter and IZEA were pretty tightlipped in the reporting of the partnership - but I can assume that IZEA intends to use its (limited) access to the Twitter firehose as leverage when forming partnerships with potential clients. To offer some perspective on what this means for IZEA, Twitter used offer its data for free for packaging and reselling by companies such as Datasift and Topsy. These companies built an industry based around the inherent value in historic Tweet data, and so it is reasonable to assume that there is plenty of value in Izea's access.

Analyst coverage

Since the latest financial results hit markets, we have seen to coverage initiations on the company. The first came on March 20, 2015, when Craig-Hallum reported an updated analysis alongside a buy rating of one dollar per share, and a financial year 2016 estimated revenue figure at $37.3 million. In addition, the company also slated 2016 as the year IZEA will turn profitable, with an EPS of $0.01 on full year revenues.

Next, on April 24, 2015, Ladenburg Thalmann released a report titled "Pure Play in the Escalating Medium of Sponsored Social Advertising", and stamped a $1.20 price target on IZEA. Revenue estimates came in similar to the Craig-Hallum figures, with 2016 full-year financials of $38 million revenues and a $0.01 earnings per share.

Some inherent risks

With all this noted, then, has our bias towards IZEA has changed? Well, in the last piece, we concluded that while very much under the radar at present, IZEA might be positioned to take advantage of rapid growth in the native advertising industry. The large social media platforms currently dominate the space, but IZEA offers advertisers an alternative to these companies from a market targeting perspective, and if it can continue to grow at the rate I are seeing in its ongoing financial reports, it could be a rewarding allocation for early stage investors. Having said this, before I drew this conclusion back in May, I highlighted IZEA's tiny market capitalization and current over-the-counter listing as potentially serious obstacles. I noted that the necessitating of an expanded personnel expense might put pressure on the company's burn rate, and could lead to the company struggling to fund its growth. I have seen an expansion of this personnel expense, and as the company targets higher revenues, its sales team payroll is likely to increase further. The $11 million capital injection through the warrant exercise eases the pressure somewhat, but does not mitigate the risk entirely. Further, the competition mentioned previously will remain as having the potential to redirect advertising revenues from IZEA towards their own operations, and IZEA must maintain and upgrade head technology (in particular, the IZEAx platform) in order to keep ahead of its competitors. This, again, will likely be a large expense going forward, and as to the risk of ongoing concern, as would any reasonably sized expense for a company not yet generating income.

Finally, but worth noting as potential risk factors going forward, the company has only paid a small portion of the costs associated with its Ebyline acquisition to date. While the initial cash expense totaled $1.2 million, IZEA stands to shell out a further $7.65 million, the majority of which is rooted in three end of year installments during December 2015, 2016 and 2017. Ebyline must meet certain targets in order to receive these payments in full, but since IZEA continues to generate a net loss, its liability to the meeting of these payments must be considered a risk going forward.
 

Conclusion

All said, in our opinion, the next 12 months will be crucial. I will look for further expansion in revenues, and while I do not expect IZEA to report a net profit for the foreseeable future (this is relatively standard for a growth stage tech company) I will look to any steps towards a potential NASDAQ listing as likely drivers of upside market revaluation. At time of writing, the company remains under the radar and offers us an alternative social media exposure not without risks, but in the right industry at what looks to be the right time, with plenty of upside potential.