UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2015
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____________________to _________________________
Commission file number: 000-31671
Intellinetics, Inc.
(Exact name of registrant as specified in its charter)
Nevada | 87-0613716 | |
(State or Other Jurisdiction of Incorporation or | (I.R.S. Employer Identification No.) | |
Organization) |
2190 Dividend Drive | ||
Columbus, Ohio | 43228 | |
(Address of Principal Executive Offices) | (Zip Code) |
(614) 388-8909 | ||
(Registrant’s telephone number, including area code) |
(Former name and former address, if changed since last report) |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨ | Accelerated filer ¨ | |||
Non-accelerated filer ¨ | (Do not check if a smaller reporting company) | Smaller reporting company x |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act): Yes ¨ No x
As of November 11, 2015, there were 7,123,074 shares of the issuer’s common stock outstanding.
2
INTELLINETICS, INC. and SUBSIDIARY
Condensed Consolidated Balance Sheets
Unaudited | ||||||||
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
ASSETS | ||||||||
Current assets: | ||||||||
Cash | $ | 172,021 | $ | 184,081 | ||||
Accounts receivable, net | 274,554 | 99,061 | ||||||
Prepaid expenses and other current assets | 53,332 | 45,668 | ||||||
Total current assets | 499,907 | 328,810 | ||||||
Property and equipment, net | 23,919 | 28,671 | ||||||
Other assets | 17,049 | 27,809 | ||||||
Total assets | $ | 540,875 | $ | 385,290 | ||||
LIABILITIES AND STOCKHOLDERS' DEFICIT | ||||||||
Current liabilities: | ||||||||
Accounts payable and accrued expenses | $ | 800,445 | $ | 633,053 | ||||
Deferred revenues | 583,947 | 563,998 | ||||||
Deferred compensation | 215,012 | 215,012 | ||||||
Notes payable - current | 600,072 | 1,071,708 | ||||||
Notes payable - related party - current | 1,835,994 | 1,234,871 | ||||||
Total current liabilities | 4,035,470 | 3,718,642 | ||||||
Long-term liabilities: | ||||||||
Notes payable - net of current portion | 861,623 | 544,322 | ||||||
Notes payable - related party | 136,380 | 216,772 | ||||||
Deferred interest expense | 124,043 | 103,242 | ||||||
Other long-term liabilities - related parties | 151,150 | 56,021 | ||||||
Total long-term liabilities | 1,273,196 | 920,357 | ||||||
Total liabilities | 5,308,666 | 4,638,999 | ||||||
Stockholders' deficit: | ||||||||
Common stock, $0.001 par value, 50,000,000 shares authorized; 7,123,074 shares issued and outstanding at September 30, 2015 and December 31, 2014 | 14,124 | 14,124 | ||||||
Additional paid-in capital | 5,780,269 | 5,189,178 | ||||||
Accumulated deficit | (10,562,184 | ) | (9,457,011 | ) | ||||
Total stockholders' deficit | (4,767,791 | ) | (4,253,709 | ) | ||||
Total liabilities and stockholders' deficit | $ | 540,875 | $ | 385,290 |
See Notes to these condensed consolidated financial statements
3
INTELLINETICS, INC. and SUBSIDIARY
Condensed Consolidated Statements of Operations
(Unaudited)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | |||||||||||||||
2015 | 2014 | 2015 | 2014 | |||||||||||||
Revenues: | ||||||||||||||||
Sale of software | $ | 136,459 | $ | 25,990 | $ | 474,219 | $ | 38,486 | ||||||||
Software as a service | 64,817 | 52,582 | 182,322 | 133,052 | ||||||||||||
Software maintenance services | 239,506 | 216,310 | 700,116 | 638,832 | ||||||||||||
Professional services | 152,169 | 11,805 | 327,189 | 88,579 | ||||||||||||
Third Party services | 29,023 | 10,075 | 109,073 | 43,348 | ||||||||||||
Total revenues | 621,974 | 316,762 | 1,792,919 | 942,297 | ||||||||||||
Cost of revenues: | ||||||||||||||||
Sale of software | 23,650 | 4,073 | 90,876 | 11,777 | ||||||||||||
Software as a service | 14,097 | 6,909 | 36,771 | 20,779 | ||||||||||||
Software maintenance services | 32,943 | 31,274 | 95,402 | 94,096 | ||||||||||||
Professional services | 41,670 | 4,486 | 85,781 | 24,824 | ||||||||||||
Third Party services | 18,334 | 12,989 | 57,846 | 40,218 | ||||||||||||
Total cost of revenues | 130,694 | 59,731 | 366,676 | 191,694 | ||||||||||||
Gross profit | 491,280 | 257,031 | 1,426,243 | 750,603 | ||||||||||||
Operating expenses: | ||||||||||||||||
General and administrative | 390,841 | 474,301 | 1,548,096 | 1,385,848 | ||||||||||||
Sales and marketing | 191,325 | 344,690 | 622,990 | 585,915 | ||||||||||||
Depreciation | 2,589 | 5,915 | 8,640 | 19,655 | ||||||||||||
Total operating expenses | 584,755 | 824,906 | 2,179,726 | 1,991,418 | ||||||||||||
Loss from operations | (93,475 | ) | (567,875 | ) | (753,483 | ) | (1,240,815 | ) | ||||||||
Other income (expense) | ||||||||||||||||
Interest expense, net | (160,078 | ) | (70,734 | ) | (351,690 | ) | (174,330 | ) | ||||||||
Total other income (expense) | (160,078 | ) | (70,734 | ) | (351,690 | ) | (174,330 | ) | ||||||||
Net loss | $ | (253,553 | ) | $ | (638,609 | ) | $ | (1,105,173 | ) | $ | (1,415,145 | ) | ||||
Basic and diluted net loss per share: | $ | (0.04 | ) | $ | (0.09 | ) | $ | (0.16 | ) | $ | (0.21 | ) | ||||
Weighted average number of common shares outstanding - basic and diluted | 7,123,074 | 6,769,812 | 7,123,074 | 6,767,238 |
See Notes to these condensed consolidated financial statements
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INTELLINETICS, INC. and SUBSIDIARY
Condensed Consolidated Statement of Stockholders' Deficit
For the Nine Months Ended September 30, 2015
(Unaudited)
Common Stock | Additional Paid-in | Accumulated | ||||||||||||||||||
Shares | Amount | Capital | Deficit | Total | ||||||||||||||||
Balance, December 31, 2014 | 7,123,074 | $ | 14,124 | $ | 5,189,178 | $ | (9,457,011 | ) | $ | (4,253,709 | ) | |||||||||
Beneficial Conversion of convertible notes | 170,091 | 170,091 | ||||||||||||||||||
Stock Option Compensation | 421,000 | 421,000 | ||||||||||||||||||
Net loss | - | - | - | (1,105,173 | ) | (1,105,173 | ) | |||||||||||||
Balance, September 30, 2015 | 7,123,074 | $ | 14,124 | $ | 5,780,269 | $ | (10,562,184 | ) | $ | (4,767,791 | ) |
See Notes to these condensed consolidated financial statements
5
INTELLINETICS, INC. and SUBSIDIARY
Condensed Consolidated Statements of Cash Flows
(Unaudited)
For the Nine Months Ended September 30, | ||||||||
2015 | 2014 | |||||||
Cash flows from operating activities: | ||||||||
Net loss | $ | (1,105,173 | ) | $ | (1,415,145 | ) | ||
Adjustments to reconcile net loss to net cash used in operating activities: | ||||||||
Depreciation and amortization | 8,640 | 19,655 | ||||||
Bad debt expense | 16,123 | 44,963 | ||||||
Amortization of deferred financing costs | 10,761 | 8,036 | ||||||
Amortization of beneficial conversion option | 133,549 | 4,250 | ||||||
Stock options compensation | 421,000 | - | ||||||
Gain on disposal of property and equipment | (4,234 | ) | ||||||
Stock issued for services | 200,000 | |||||||
Changes in operating assets and liabilities: | ||||||||
Accounts receivable | (191,616 | ) | 53,970 | |||||
Prepaid expenses and other current assets | (7,664 | ) | (6,011 | ) | ||||
Accounts payable and accrued expenses | 185,141 | 63,525 | ||||||
Other long-term liabilities - related parties | 77,377 | 72,922 | ||||||
Deferred interest expense | 20,802 | 9,326 | ||||||
Deferred revenues | 19,949 | 63,215 | ||||||
Total adjustments | 694,062 | 529,617 | ||||||
Net cash used in operating activities | (411,111 | ) | (885,528 | ) | ||||
Cash flows from investing activities: | ||||||||
Proceeds for property and equipment | - | 9,060 | ||||||
Purchases of property and equipment | (3,888 | ) | (4,583 | ) | ||||
Net cash used in investing activities | (3,888 | ) | 4,477 | |||||
Cash flows from financing activities: | ||||||||
Proceeds from notes payable | $ | - | $ | 45,000 | ||||
Proceeds from notes payable - related parties | 582,000 | 805,000 | ||||||
Repayment of notes payable | (155,813 | ) | (200,224 | ) | ||||
Repayment of notes payable - related parties | (23,248 | ) | (15,000 | ) | ||||
Net cash provided by financing activities | 402,939 | 634,776 | ||||||
Net increase (decrease) in cash | (12,060 | ) | (246,275 | ) | ||||
Cash - beginning of period | 184,081 | 260,560 | ||||||
Cash - end of period | $ | 172,021 | $ | 14,285 | ||||
Supplemental disclosure of cash flow information: | ||||||||
Accrued interest refinanced in notes payable - related parties | $ | - | $ | 31,068 | ||||
Discount on notes payable for beneficial converion feature | - | 3,125 | ||||||
Discount on notes payable - related parties for beneficial converion feature | 170,092 | 33,000 | ||||||
Notes payable - related parties issued for debt financing costs | - | 10,800 | ||||||
Cash paid during the period for interest and taxes | 18,851 | 55,073 | ||||||
$ | 188,943 | $ | 133,066 |
See Notes to these condensed consolidated financial statements
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1. Business Organization and Nature of Operations
Intellinetics, Inc. (“Intellinetics”) is a Nevada holding company incorporated in 1997, with a single operating subsidiary, Intellinetics, Inc. (“Intellinetics”), together the (“Company”). On February 10, 2012 (the “Closing Date”), Intellinetics entered into a Securities Exchange Agreement (the “Exchange Agreement”) by and between itself and Intellinetics. Pursuant to the terms of the Exchange Agreement, all of the former shareholders of Intellinetics transferred to Intellinetics all of their shares of Intellinetics in exchange for shares of common stock (“Share Exchange”) of Intellinetics. Prior to the Share Exchange, Intellinetics was a non-operating public shell company. As a result of the Share Exchange, Intellinetics became a wholly-owned subsidiary of Intellinetics. The Share Exchange was accounted for as a reverse merger and recapitalization of Intellinetics (See Note 4 – Corporate Actions). The Company is an enterprise content management (ECM) software development, sales and marketing company serving both the public and private sectors. In the public sector, the Company’s products, services and process models serve, principally, the critical needs of law enforcement and compliance agencies within the state and local government establishment. Intellinetics was formed in December 1996 as a corporation in the state of Ohio.
The Company provides its software solutions principally through (i) the direct licensing of its software installed on customer computer platforms and (ii) providing the applications as a service, accessible through the internet. The Company’s comprehensive solutions include services that range from pre-installation assessment, project scoping, implementation, consulting and ongoing software maintenance and customer support.
2. Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“U.S. GAAP”) for interim financial information and the instructions to Form 10-Q and Article 8.03 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP. In the opinion of management, all adjustments (consisting of normal accruals) considered for a fair presentation of the consolidated financial position of the Company as of September 30, 2015 and the consolidated results of its operations and cash flows for the three and nine months ended September 30, 2015 and 2014, have been included. The Company has evaluated subsequent events through the issuance of this Form 10-Q. Operating results for the three and nine months ended September 30, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015 or any other interim or future period. For further information, refer to the consolidated financial statements and footnotes thereto for the year ended December 31, 2014 included in the Company’s Form 10-K filed with the Securities and Exchange Commission on March 31, 2015.
3. Liquidity and Management’s Plans
Through September 30, 2015, the Company has incurred an accumulated deficit since inception of $10,562,184. At September 30, 2015, the Company had a cash balance of $172,021.
From the Company’s inception, it has generated revenues from the sales and implementation of its internally generated software applications.
The Company’s plan is to increase its sales and market share by developing an expanded network of resellers through which the Company will sell its expanded software product portfolio. The Company expects that this marketing initiative will require that it hire and develop an expanded sales force and enhance its product marketing efforts, all of which will require additional capital.
Based on current quarterly revenues, our operating cash flows before working capital changes are insufficient by approximately $125,000 per quarter. In addition, our operating payables currently exceed our accounts receivable by approximately $530,000. Accordingly, unless our revenues increase from current levels, our operating cash flows over the next 12 months will be insufficient by approximately $1,050,000 to $1,250,000 requiring additional capital or debt financing to support operations. During 2014 and the nine months ended September 30, 2015, we used the proceeds from convertible note issuances to fund our operating cash flow deficits. Debt obligations due within the next 12 months approximate $2,436,000. We intend to enter into negotiations to extend maturities, defer payments or convert obligations to equity. We also plan to continue our marketing and sales strategies to increase our revenues while controlling operating costs. There are no assurances that our plans as discussed above will materialize and/or that we will have sufficient liquidity to fund operations. These factors, among others, raise substantial doubt about our ability to continue as a going concern.
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Since inception, the Company’s operations have primarily been funded through a combination of operating margins, state business development loans, bank loans, convertible loans and loans from friends and family, and the sale of securities. Although management believes that the Company has access to capital resources, there are currently no commitments in place for new financing at this time and there is no assurance that the Company will be able to obtain funds on commercially acceptable terms, if at all.
During the nine months ended September 30, 2015, the Company raised $582,000 in net new funds through the issuance of ten convertible promissory notes to two accredited investors who are associated with each other. The proceeds from these notes were used to fund the Company’s working capital needs and debt repayment.
The Company’s financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should it be unable to continue as a going concern.
4. Corporate Actions
On February 10, 2012, Intellinetics Ohio was acquired by Intellinetics (formerly known as “GlobalWise Investments, Inc.”), pursuant to a reverse merger, with Intellinetics Ohio remaining as a wholly-owned subsidiary of Intellinetics.
On September 1, 2014, the Company changed its name from GlobalWise Investments, Inc., to Intellinetics, Inc. and effected a seven (7)-to-one (1) reverse stock split of the Company’s common stock. All share and per share amounts herein have been adjusted to reflect the reverse stock split.
In April, 2015, the board of directors granted 768,000 non-qualified stock options to two directors of the Company.
5. Summary of Significant Accounting Policies
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions. Such estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses. Actual results could differ from estimated amounts.
Significant estimates and assumptions include valuation allowance related to receivables, the recoverability of long-term assets, depreciable lives of property and equipment, percentage of completion estimates for revenue recognition, deferred taxes and related valuation allowances. The Company’s management monitors these risks and assesses its business and financial risks on a quarterly basis.
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Concentrations of Credit Risk
The Company maintains its cash with high credit quality financial institutions. At times, the Company’s cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit.
The number of customers that comprise the Company’s customer base, along with the different industries, governmental entities and geographic regions, in which the Company’s customers operate, limits concentrations of credit risk with respect to accounts receivable. The Company does not generally require collateral or other security to support customer receivables; however, the Company may require its customers to provide retainers, up-front deposits or irrevocable letters-of-credit when considered necessary to mitigate credit risk. The Company has established an allowance for doubtful accounts based upon facts surrounding the credit risk of specific customers and past collections history. Credit losses have been within management’s expectations. At September 30, 2015 and December 31, 2014, the Company allowance for doubtful accounts was $13,138 and $2,015, respectively.
Property and Equipment
Property and equipment and leasehold improvements are stated at cost less accumulated depreciation and amortization. Depreciation and amortization is computed over the estimated useful lives of the related assets on a straight-line basis. Furniture and fixtures, computer hardware and purchased software are depreciated over 3 to 7 years. Leasehold improvements are amortized over the life of the lease or the asset, whichever is shorter, generally 7 to 10 years. Upon retirement or other disposition of these assets, the cost and related accumulated depreciation and amortization of these assets are removed from the accounts and the resulting gains and losses are reflected in the results of operations.
Impairment of Long-Lived Assets
The Company accounts for the impairment and disposition of long-lived assets in accordance with Accounting Standards Codification (“ASC”) Topic 360, “Property, Plant, and Equipment.” The Company tests long-lived assets or asset groups, such as property and equipment, for recoverability when events or changes in circumstances indicate that their carrying amount may not be recoverable.
Circumstances which could trigger a review include, but are not limited to: significant adverse changes in the business climate or legal factors; current period cash flow or operating losses combined with a history of losses or a forecast of continuing losses associated with the use of the asset; and a current expectation that the asset will more likely than not be sold or disposed of before the end of its estimated useful life.
Recoverability is assessed based on comparing the carrying amount of the asset to the aggregate pre-tax undiscounted cash flows expected to result from the use and eventual disposal of the asset or asset group. Impairment is recognized when the carrying amount is not recoverable and exceeds the fair value of the asset or asset group. The impairment loss, if any, is measured as the amount by which the carrying amount exceeds fair value, which for this purpose is based upon the discounted projected future cash flows of the asset or asset group.
Share Based Compensation
The Company accounts for stock-based payments to employees in accordance with ASC 718, “Stock Compensation” (“ASC 718”). Stock-based payments to employees include grants of stock that are recognized in the consolidated statement of operations based on their fair values at the date of grant.
The Company accounts for stock-based payments to non-employees in accordance with ASC 718 and AC 505-50, “Equity-Based Payments to Non-Employees,” which requires that such equity instruments are recorded at their fair value on the measurement date, with the measurement of such compensation being subject to periodic adjustment as the underlying equity instruments vest. Both employee and non-employee grants of stock are fully vested at their respective date of grants.
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The grant date fair value of stock option awards is recognized in earnings as share-based compensation cost over the requisite service period of the award using the straight-line attribution method. The Company estimates the fair value of the stock option awards using the Black-Scholes-Merton option pricing model. The exercise price of options is specified in the stock option agreements. The expected volatility is based on the historical volatility of the Company’s stock for the previous period equal to the expected term of the options. The expected term of options granted is based on the midpoint between the vesting date and the end of the contractual term. The risk-free interest rate is based upon a U.S. Treasury instrument with a life that is similar to the expected term of the options. The expected dividend yield is based upon the yield expected on date of grant to occur over the term of the option.
Software Development Costs
Software development costs for software to be sold or otherwise marketed incurred prior to the establishment of technological feasibility are expensed as incurred. The Company defines establishment of technological feasibility as the completion of a working model. Software development costs incurred subsequent to the establishment of technological feasibility through the period of general market availability of the product are capitalized, if material. To date, all software development costs for software to be sold or otherwise marketed have been expensed as incurred. In accordance with ASC 350-40, the Company capitalizes purchase and implementation costs of internal use software. No such costs were capitalized during the periods presented.
Recent Accounting Pronouncement
In May 2014, the FASB issued Accounting Standards Update (ASU) No. 2014-09, Revenue from Contracts with Customers. The core principle of ASU 2014-09 is built on the contract between a vendor and a customer for the provision of goods and services. It attempts to depict the exchange of rights and obligations between the parties in the pattern of revenue recognition based on the consideration to which the vendor is entitled. To accomplish this objective, ASU 2014-09 requires five basic steps: (i) identify the contract with the customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, (v) recognize revenue when (or as) the entity satisfies a performance obligation. Entities will generally be required to make more estimates and use more judgment than under current guidance, which will be highlighted for users through increased disclosure requirements. ASU 2014-09 is effective for public entities for annual periods beginning after December 15, 2016, including interim periods therein. Three basic transition methods are available – full retrospective, retrospective with certain practical expedients, and a cumulative effect approach. Early adoption is prohibited. Management is in the process of evaluating the impact that adoption of ASU 2014-09 will have on the consolidated financial statements and has not yet determined the method by which the Company will adopt the standard.
Revenue Recognition
a) Sale of Software
The Company recognizes revenues in accordance with ASC Topic 985-605, “Software Revenue Recognition” (“ASC 985-605”).
The Company records revenues from the sale of software licenses when persuasive evidence of an arrangement exists, the software product has been installed, there are no significant uncertainties surrounding product acceptance by the customer, the fees are fixed and determinable, and collection is considered probable. Revenues included in this classification typically include sales of additional software licenses to existing customers and sales of software to the Company’s Resellers (See section h) – Reseller Agreements, below).
The Company assesses whether payment terms are customary or extended in accordance with normal practice relative to the market in which the sale is occurring. The Company’s sales arrangements generally include standard payment terms. These terms effectively relate to all customers, products, and arrangements regardless of customer type, product mix or arrangement size.
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If an undelivered element for the arrangement exists under the license arrangement, revenues related to the undelivered element are deferred based on Vendor Specific Objective Evidence (“VSOE”) of the fair value of the undelivered element. Often, multiple-element sales arrangements include arrangements where software licenses and the associated post-contract customer support (“PCS”) are sold together. The Company has established VSOE of the fair value of the undelivered PCS element based on the contracted price for renewal PCS included in the original multiple element sales arrangement, as substantiated by contractual terms and the Company’s significant PCS renewal experience, from the Company’s existing customer base.
The Company records the revenues for the sales of software with professional services as prescribed by ASC 985-605, in accordance with the contract accounting guidelines in ASC 605-35, “Revenue Recognition: Construction-Type and Production-Type Contracts” (“ASC 605-35”), after evaluating for separation of any non-ASC 605-35 elements in accordance with the provisions of ASC 605-25, “Revenue Recognition: Multiple-Element Arrangements,” as updated. The Company accounts for these contracts on a percentage of completion basis, measured by the percentage of labor hours incurred to date to estimated total labor hours for each contract, or on a completed contract basis when dependable estimates are not available. Prior to the second quarter ended September 30, 2015, the Company had recognized these contracts exclusively on the completed contract basis. With improvements in internal processes the Company now has the ability to make more dependable estimates. Had the Company continued to exclusively use the completed contract method for the nine months ended September 30, 2015, revenues would have been $33,174 lower than recorded.
The fair value of any undelivered elements in multiple-element arrangements in connection with the sales of software licenses with professional services are deferred based upon VSOE.
b) Sale of Software as a Service
Sale of Software as a Service consists of revenues from arrangements that provide customers the use of the Company’s software applications, as a service, typically billed on a monthly or annual basis. Advance billings of these services are not recorded to the extent that the term of the arrangement has not commenced and payment has not been received. Revenue on these services is recognized ratably over the term of the underlying arrangement.
c) Sale of Software Maintenance Services
Software maintenance services revenues consist of revenues derived from arrangements that provide PCS to the Company’s software license holders. These revenues are recognized ratably over the term of the contract. Advance billings of PCS are not recorded to the extent that the term of the PCS has not commenced and payment has not been received
d) Sales of Professional Services
Professional services consist principally of revenues from consulting, advisory services, training and customer assistance with management and uploading of data into the Company’s applications. When these services are provided on a time and material basis, the Company records the revenue as the services are rendered, since the revenues from services rendered through any point in time during the performance period are not contingent upon the completion of any further services. Where the services are provided under a fixed priced arrangement, the Company records the revenue on a proportional performance method, since the revenues from services rendered through any point in time during the performance period are not contingent upon the completion of any further services.
e) Sale of Third Party Services
Sale of third party services consist principally of third party software and/or equipment as a pass through of software and equipment purchased from third parties at the request of customers.
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f) Deferred revenues
The Company records deferred revenue primarily related to software maintenance support agreements, when the customer pays for the contract prior to the time the services are performed. Substantially all maintenance agreements have a one-year term that commences immediately following the delivery of the maintained products or on the date of the applicable renewal period.
g) Rights of return and other incentives
The Company does not generally offer rights of return or any other incentives such as concessions, product rotation, or price protection and, therefore, does not provide for or make estimates of rights of return and similar incentives. The Company, from time to time, may discount bundled software sales with PCS services. Such discounts are recorded as a component of the software sale and any revenue related to PCS is deferred over the PCS period based upon appropriate VSOE of fair value.
h) Reseller agreements
The Company executes certain sales contracts through resellers and distributors (collectively, “Resellers”). The Company recognizes revenues relating to sales through Resellers when all the recognition criteria have been met—in other words, persuasive evidence of an arrangement exists, delivery has occurred in the reporting period, the fee is fixed and determinable, and collectability is probable. In addition, the Company assesses the credit-worthiness of each Reseller, and if the Reseller is undercapitalized or in financial difficulty, any revenues expected to emanate from such Resellers are deferred and recognized only when cash is received and all other revenue recognition criteria are met.
Advertising
The Company expenses the cost of advertising as incurred. Advertising expense for the three and nine months ended September 30, 2015 and 2014 amounted to approximately $12 and $1,879 and $0 and $3,430, respectively.
Earnings (Loss) Per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. The company has outstanding stock options which have not been included in the calculation of diluted net loss per share because to do so would be anti-dilutive. As such, the numerator and the denominator used in computing both basic and diluted net loss per share for each period are the same.
Income Taxes
The Company and its subsidiary file a consolidated federal income tax return. The provision for income taxes is computed by applying statutory rates to income before taxes.
Deferred income taxes are recognized for the tax consequences in future years of temporary differences between the financial reporting and tax bases of assets and liabilities as of each period-end based on enacted tax laws and statutory rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. A 100% valuation allowance has been established on deferred tax assets at September 30, 2015 and December 31, 14, due to the uncertainty of our ability to realize future taxable income.
The Company accounts for uncertainty in income taxes in its financial statements as required under ASC 740, Accounting for Uncertainty in Income Taxes. The standard prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The standard also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods, disclosure and transition accounting. Management determined there were no material uncertain positions taken by the Company in its tax returns.
Statement of Cash Flows
For purposes of reporting cash flows, cash includes cash on hand and demand deposits held by bank.
Reclassifications
Certain accounts in the prior year condensed consolidated financial statements have been reclassified for comparative purposes to conform to the presentation in the current year condensed consolidated financial statements.
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6. Property and Equipment
Property and equipment are comprised of the following:
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
Computer hardware and purchased software | $ | 301,129 | $ | 297,242 | ||||
Leasehold improvements | 221,666 | 221,666 | ||||||
Furniture and fixtures | 88,322 | 88,322 | ||||||
611,117 | 607,230 | |||||||
Less: accumulated depreciation and amortization | (587,198 | ) | (578,559 | ) | ||||
Property and equipment, net | $ | 23,919 | $ | 28,671 |
Total depreciation expense on the Company’s property and equipment for the three months and nine months ended September 30, 2015 and 2014 amounted to $2,589 and $8.640, and $5,915 and $19,655, respectively.
7. Notes Payable
The Company evaluated the terms of its convertible notes payable in accordance with ASC 815 – 40, Derivatives and Hedging - Contracts in Entity’s Own Stock and determined that the underlying common stock is indexed to the Company’s common stock. The Company determined that the conversion feature did not meet the definition of a liability and therefore did not bifurcate the conversion feature and account for it as a separate derivative liability. The Company evaluated the conversion feature for a beneficial conversion feature. The effective conversion price was compared to the market price on the date of each note. If the conversion price was deemed to be less than the market value of the underlying common stock at the inception of the note, then the Company would recognize a beneficial conversion feature resulting in a discount on the note payable, upon satisfaction of the contingency. The beneficial conversion features are amortized to interest expense over the life of the respective notes, starting from the date of recognition.
On July 17, 2009, the Company issued a note payable to the Ohio State Development Authority in the amount of $1,012,500, bearing interest at a rate of 6.00% per annum (“Authority Loan No. 1”). Pursuant to the terms of the loan, the Company was required to pay only interest through September 30, 2010 and then monthly principal and interest payments of $23,779 each through September 1, 2015. The note is secured by a senior secured interest on all business assets financed with loan proceeds, as well as a second secured interest in all business assets. Upon maturity, by acceleration or otherwise, the Company shall pay a loan participation fee of $101,250, which is accounted for as a loan premium, accreted monthly, utilizing the interest method, over the term of the loan. In June, 2014, Intellinetics and the Ohio State Development Authority entered into a Notice and Acknowledgement of Modification to Payment Schedule relating to Authority Loan No.1, deferring a portion of the principal and interest payment until June 1, 2015. On September 25, 2015 Intellinetics and the Ohio State Development Authority entered into a Third Amendment to the Loan Agreement related to Authority Loan No. 1, deferring a portion of the principal payment until October 1, 2016 and extending the maturity date until August 1, 2018. As of September 30, 2015, the principal amount outstanding under Authority Loan No.1 was $523,373.
On June 3, 2011, the Company issued a note payable to the Ohio State Development Authority in the amount of $750,000, bearing interest at a rate of 1% per annum for the first 12 months, then interest at rate of 7% per annum for the second 12 months (“Authority Loan No. 2”). The Company was not obligated to remit payments of principal until September 1, 2013. The monthly principal and interest payments, beginning on the third anniversary of the loan origination, are $14,850 and are payable on a monthly basis through August 1, 2018. The note is secured by a senior secured interest on all business assets financed with loan proceeds, as well as a second secured interest in all business assets. Upon maturity, by acceleration or otherwise, the Company shall pay a loan participation fee of $75,000 , which is accounted for as a loan premium, accreted monthly utilizing the interest method, over the term of the loan. The interest rate of 1% during the first 12 months of this loan was considered to be below market for that period. The Company further determined that over the life of the loan, the effective interest rate was 5.6% per annum. Accordingly, during the first 12 months of the loan, the Company recorded interest expense at the 5.6% rate per annum. The difference between the interest expense accrual at 5.6% and the stated rate of 1% over the first 12 months is credited to deferred interest. The deferred interest amount that is accumulated over the first 12 months of the loan term will be amortized as a reduction to interest expense over the remaining term of the loan. At September 30, 2015 and December 31, 2014 deferred interest of $124,043 and $103,242, respectively, was reflected within long-term liabilities on the accompanying condensed consolidated balance sheets. In June, 2014, Intellinetics and the Ohio State Development Authority entered into a Notice and Acknowledgement of Modification to Payment Schedule, deferring a portion of the principal and interest payment until June 1, 2015. On September 25, 2015 Intellinetics and the Ohio State Development Authority entered into a Third Amendment to the Loan Agreement related to Authority Loan No. 2, deferring a portion of the interest payment until October 1, 2016. As of September 30, 2015, the principal amount outstanding under Authority Loan No. 2 was $578,250.
The Authority Loans were granted to the Company in connection with the State of Ohio’s economic development programs. The proceeds from these loans were used by the Company to support its efforts in developing software solutions for its customers.
These Authority Loans are subject to certain covenants and reporting requirements. Intellinetics is required to, within three years of the respective loan origination dates of each of the Authority Loans, have created and/or retained an aggregate of 19, as amended, full time jobs in the State of Ohio. Should Intellinetics not attained these employment levels by the respective dates, then the interest rates on the Authority Loans shall increase to 10% per annum. In July, 2014, the Company informed the State of Ohio that it would not meet the employment level of 15 new full-time employees as well as retain 10 existing full-time employees. As a result of this non-compliance with a covenant of Authority Loan No. 1, the Development Services Agency exercised its right to increase the interest rate from 6.0% to 7.0%, effective October 1, 2014. The approximate impact of this increase is to raise the Company’s balloon payment by $6,000 on Authority Loan No. 1, which is due, as amended, on August 1, 2018. We have had past instances of non-compliance with certain of the loan covenants. We are currently in compliance with the all other loan covenants. There can be no assurance that we will not become non-compliant with one or more of these covenants in the future.
13
Between May 18, 2014 and July 10, 2014, the Company issued convertible promissory notes in an aggregate amount of $350,000 (the “Notes in an Aggregate Amount of $350,000”) to accredited investors who are associated with each other (the accredited investors collectively referred to as the (“$350,000 Investors”). The Convertible Notes mature on December 31, 2015 (the “Maturity Date”) and bear interest at an annual rate of interest of 10 percent until maturity, with interest payable quarterly. The Note Investors have a right, in their sole discretion, to convert the Convertible Notes into shares of Common Stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.56 per Share. The Company recognized a beneficial conversion feature in the amount of $4,125. Interest expense recognized on the amortization of the beneficial conversion feature was $728 and $2,181 for the three and nine months ended September 30, 2015. If the Convertible Notes have not been fully repaid by the Company by the Maturity Date or converted into shares at the election of the Convertible Note Investors prior to the Maturity Date, then such Convertible Notes will accrue interest at the annual rate of 12% from the Maturity Date until the date the Convertible Notes are repaid in full. Any interest not paid quarterly will also accrue interest at the annual rate of 12%. The Company used the proceeds of the Convertible Note for working capital, general corporate purposes, and debt repayment. As of September 30, 2015 the Note had accrued interest of $47,193.
The Company retained Taglich Brothers, Inc. (the “Placement Agent”) as a placement agent for the sale of the Convertible Notes, which sale concluded a private offering of debt in the amount of $500,000. (the “Offering”). In connection with the Offering, on July 8, 2014, the Company paid the Placement Agent in the form of a convertible note with a principal amount of $10,800 (with terms identical to the Convertible Notes set forth above), which represented an 8% commission of the gross proceeds. In addition, the Placement Agent earned warrants to purchase 21,107 shares of Common Stock, which represented 10% of the shares of Common Stock into which the Convertible Notes the placement agent sold in the offering could be converted into a $0.56 per share of Common Stock, will be exercisable for a period of four years, contain customary cashless exercise and anti-dilution protection and are entitled to registration rights. No beneficial conversion feature was recognized. The Company recorded deferred financing charges in the amount of $10,800, which are being amortized over the life of the promissory note. During the three and nine months ending September 30, 2015, the Company amortized $1,800 and $5,400, respectively, of the financing expense related to this note. As of September 30, 2015, the note had accrued interest of $1,329.
The table below reflects all notes payable at September 30, 2015 and December 31, 2014, respectively, with the exception of related party notes disclosed in Note 8 - Notes Payable - Related Parties.
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
Authority Loan No. 1, due August 1, 2018 | $ | 523,373 | $ | 600,429 | ||||
Authority Loan No. 2, due August 1, 2018 | 578,250 | 657,006 | ||||||
The $10,800 Taglich Brothers Note | 10,800 | 10,800 | ||||||
Notes payable due December 31, 2015 | 349,272 | 347,795 | ||||||
Total notes payable | $ | 1,461,695 | $ | 1,616,030 | ||||
Less current portion | (600,072 | ) | (1,071,708 | ) | ||||
Long-term portion of notes payable | $ | 861,623 | $ | 544,322 |
Future minimum principal payments of these notes payable with the exception of the related party notes in Note 8 - Notes Payable - Related Parties, as described in this Note 7 are as follows:
For the Twelve-Month | ||||
Period Ended September 30, | Amount | |||
2016 | $ | 600,072 | ||
2017 | 354,768 | |||
2018 | 506,855 | |||
Total | $ | 1,461,695 |
14
As of September 30, 2015 and December 31, 2014, accrued interest for these notes payable with the exception of the related party notes in Note 8 - Notes Payable - Related Parties, was $431,074 and $341,827, respectively, and was reflected within accounts payable and accrued expenses on the consolidated balance sheets. As of September 30, 2015 and December 31, 2014, accrued loan participation fees were $163,855 and $155,044, respectively, and reflected within accounts payable and accrued expenses on the consolidated balance sheets. As of September 30, 2015 and December 31, 2014, deferred financing costs were $4,963 and $10,324, respectively, and were reflected within other assets on the consolidated balance sheets.
With respect to all notes outstanding (other than the notes to related parties), for the three and nine months ended September 30, 2015, and 2014, interest expense, including the amortization of deferred financing costs, accrued loan participation fees, original issue discounts, deferred interest and related fees and the embedded conversion feature was $34,804 and $82,907, and $50,712 and $94,786, respectively.
8. Notes Payable - Related Parties
On March 2, 2009, the Company issued an unsecured promissory note payable to Ms. Chretien, in the amount of $80,000 due January 1, 2014 and bearing interest at 5% per annum, with the principal and interest to be paid at maturity. On December 27, 2013 the $80,000 promissory note was extended under the same terms, with a maturity date of January 1, 2015. On December 31, 2014 the $80,000 promissory note was extended under the same terms, with a maturity date of January 1, 2016. During the nine months ended September 30, 2015, the Company paid no principal to Ms. Chretien related to this note. As of September 30, 2015 the note had a principal balance of $15,000 and accrued interest of $4,215.
On December 29, 2001, the Company issued an unsecured promissory note payable to A. Michael Chretien, a Founder of the Company, in the amount of $55,167, with any unpaid principal and interest due on January 1, 2014. During 2013, the Company paid $11,250 in accrued interest to A. Michael Chretien. On December 27, 2013, the note was extended, under the same terms, with a maturity of January 12, 2015. On December 31, 2014, the note was extended under the same terms, with a maturity of January 1, 2016. As of September 30, 2015, the note had a principal balance of $40,415 and accrued interest of 6,544.
On March 29, 2012, the Company issued an unsecured note payable to Ramon Shealy a then -director of the Company, who subsequently resigned from the Board of Directors on December 17, 2012, for personal reasons, in the amount of $238,000 , bearing interest at a rate of 10% for the term of the note. All principal and interest was due and payable on September 27, 2012, but was later extended to November 24, 2012. On April 16, 2012, the Company issued a note payable to Mr. Shealy, in the amount of $12,000, bearing interest at a rate of 10% per quarter. All principal and interest was due on July 15, 2012, but was later extended to November 24, 2012. On November 24, 2012 the two notes were combined into a $250,000 promissory note, under the same terms, with a maturity date of January 1, 2014. On December 24, 2013 the $250,000 promissory note, was extended under the same terms, with a maturity date of January 1, 2015. On March 13, 2013, the Company paid $100,000 of the principal amount of the $250,000 promissory note to Mr. Shealy. On December 31, 2014, the Company and Ramon Shealy agreed to cancel the previous notes and extensions set forth above, and issue a new single promissory note with accrued interest of $43,453, to a total principal and interest in the amount of $193,453, payable in ninety monthly installments beginning January 31, 2015, with a maturity date of January 1, 2020. Interest will accrue at 10% on the outstanding balance until paid in full. All other provisions of the original Promissory Note shall prevail unless specifically set forth herein or otherwise agreed in writing by the parties. As of September 30, 2015 this Note had a principal balance of $170,205 and $0 accrued interest.
15
Between May 9, 2014 an May 12, 2014 the Company issued convertible promissory notes in an aggregate amount of $110,000, (the “Notes in an Aggregate Amount of $110,000”) to accredited investors who are associated with each other and are shareholders of the Company, (the accredited investors collectively referred to as the (“$110,000 Investors”). The Convertible Notes mature on December 31, 2015 (the “Maturity Date”) and bear interest at an annual rate of interest of 10 percent until maturity, with interest payable quarterly. The Note Investors have a right, in their sole discretion, to convert the Convertible Notes into shares of Common Stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.56 per Share. Any interest not paid quarterly will also accrue interest at the annual rate of 12%. The Company used the proceeds of the Convertible Note for working capital, general corporate purposes, and debt repayment. At September 30, 2015, the notes had accrued interest of $15,053.
On May 12, 2014, the Company issued a convertible promissory note in an aggregate amount of $30,000 (the “Note in an Aggregate Amount of $30,000”) to Robert Schroeder, a director of the Company. The Convertible Notes mature on December 31, 2015 (the “Maturity Date”) and bear interest at an annual rate of interest of 10 percent until maturity, with interest payable quarterly. Robert Schroeder has a right, in his sole discretion, to convert the Convertible Note into shares of Common Stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.56 per Share. No beneficial conversion feature was recognized. If the Convertible Notes have not been fully repaid by the Company by the Maturity Date or converted into shares at the election of the Convertible Note Investors prior to the Maturity Date, then such Convertible Notes will accrue interest at the annual rate of 12% from the Maturity Date until the date the Convertible Notes are repaid in full. Any interest not paid quarterly will also accrue interest at the annual rate of 12%. The Company used the proceeds of the Convertible Note for working capital, general corporate purposes, and debt repayment. As of September 30, 2015, the note had accrued interest of $4,184.
16
On June 6, 2014, the Company issued a convertible promissory note in an aggregate amount of $10,000 (the “Note in an Aggregate Amount of $10,000”) to Matthew L. Chretien, President, CEO and a director of the Company. The Convertible Notes mature on December 31, 2015 (the “Maturity Date”) and bear interest at an annual rate of interest of 10 percent until maturity, with interest payable quarterly. Matthew L. Chretien has a right, in his sole discretion, to convert the Convertible Note into shares of Common Stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.56 per Share. No beneficial conversion feature was recognized. If the Convertible Notes have not been fully repaid by the Company by the Maturity Date or converted into shares at the election of the Convertible Note Investors prior to the Maturity Date, then such Convertible Notes will accrue interest at the annual rate of 12% from the Maturity Date until the date the Convertible Notes are repaid in full. Any interest not paid quarterly will also accrue interest at the annual rate of 12%. The Company used the proceeds of the Convertible Note for working capital, general corporate purposes, and debt repayment. As of September 30, 2015, the note had accrued interest of $1,318.
On July 10, 2014, the Company exchange convertible promissory notes issued on November 12, 2013, December 27, 2013, February 4, 2014 in the aggregate amount of $670,000 plus accrued interest of $31,068 in exchange for a new convertible promissory note in an aggregate amount of $701,068, (the “Note in an Aggregate Amount of $701,068”). The Convertible Notes mature on December 31, 2015(the “Maturity Date”) and bear interest at 10% until maturity. The note holders have a right, at their sole discretion, to convert the notes into equity under certain circumstances at a price stated on each original note as discussed above. The Company recognized a beneficial conversion feature in the amount of $32,000. Interest expense recognized on the amortization of the beneficial conversion feature was $5,647 and $16,941 for the three and nine months ended September 30, 2015. If the notes are not paid off by the Company, with the consent of the investors, by the maturity date or converted in to equity at the election of the investors prior to the maturity date, the note will accrue interest in the amount of 15% from the maturity date until the note is paid in full. As of September 30, 2015 the note had accrued interest of $85,856.
On October 9, 2014, the Company issued three convertible promissory notes in the amounts of $80,000, $80,000, and $15,000, (the “Notes in the Aggregate Amount of $175,000”) to three accredited investors. Robert C. Schroeder, a director of the Company, purchased the note in the amount of $15,000, and Robert Taglich and Michael Taglich, each beneficial owners of 10% of the Company, each purchased notes in the amount of $80,000. The notes mature on December 31, 2015, and bear interest at an annual rate of interest of 6% until maturity, with interest payable quarterly. The note investors have a right, in their sole discretion, to convert the notes into shares of Common Stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.30 per Share. No beneficial conversion feature was recognized. If the convertible notes have not been fully repaid by the Company by the maturity date or converted into shares at the election of the note investors prior to the maturity date, then such notes will accrue interest at the annual rate of 12% from the maturity date until the date the notes are repaid in full. Any interest not paid quarterly will also accrue interest at the annual rate of 12%. The Company used the proceeds of the notes for working capital, general corporate purposes, and debt repayment. As of September 30, 2015 the notes had accrued interest of $10,241.
On December 17, 2014, the Company issued two convertible promissory notes in a principal amounts of $100,000 each (the “Notes in the Aggregate Amount of $200,000) to Robert Taglich and Michael Taglich, each beneficial owners of 10% of the Company. The notes mature on December 31, 2015, and bear interest at an annual rate of interest of 6% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.30 per share. No beneficial conversion feature was recognized. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital and general corporate purposes, and debt repayment. As of September 30, 2015 the notes had accrued interest of $9,436.
17
On February 10, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $100,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on December 31, 2015, and bear interest at an annual rate of interest of 6% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.30 per share. The Company recognized a beneficial conversion feature in the amount of $26,667. Interest expense recognized on the amortization of the beneficial conversion feature was $7,273 and $19,394 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital, general corporate purposes and debt repayment. As of September 30, 2015, the notes had accrued interest of $3,814.
On March 11, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $100,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on December 31, 2015, and bear interest at an annual rate of interest of 6% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.30 per share. The Company recognized a beneficial conversion feature in the amount of $16,667. Interest expense recognized on the amortization of the beneficial conversion feature was $5,000 and $11,667 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital general corporate purposes, and debt repayment. As of September 30, 2015, the note had accrued interest of $3,336.
On May 20, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $40,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on August 15, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.60 per share. The Company recognized a beneficial conversion feature in the amount of $13,334. Interest expense recognized on the amortization of the beneficial conversion feature was $8,889 and $13,333 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital general corporate purposes., and debt repayment. As of September 30, 2015, the note had accrued interest of $1,552.
On June 3, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $20,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on September 2, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.60 per share. The Company recognized a beneficial conversion feature in the amount of $6,666. Interest expense recognized on the amortization of the beneficial conversion feature was $4,444 and $6,666 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital general corporate purposes., and debt repayment. As of September 30, 2015, the note had accrued interest of $682.
On June 17, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $100,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on September 16, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.60 per share. The Company recognized a beneficial conversion feature in the amount of $33,334. Interest expense recognized on the amortization of the beneficial conversion feature was $22,222 and $33,334 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital general corporate purposes and debt repayment. As of September 30, 2015, the note had accrued interest of $2,954.
18
On July 15, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $50,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on October 14, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.54 per share. The Company recognized a beneficial conversion feature in the amount of $16,666. Interest expense recognized on the amortization of the beneficial conversion feature was $11,111 and $11,111 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital, general corporate purposes, and debt repayment. As of September 30, 2015, the notes had accrued interest of $1,054.
On August 26, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $72,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature on November 22, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.60 per share. The Company recognized a beneficial conversion feature in the amount of $24,000. Interest expense recognized on the amortization of the beneficial conversion feature was $8,000 and $8,000 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital, general corporate purposes, and debt repayment. As of September 30, 2015, the notes had accrued interest of $690.
On September 22, 2015, the Company issued two convertible promissory notes in a maximum aggregate principal amount of $100,000 to Robert and Michael Taglich (10% beneficial owners). The notes mature December 21, 2015 and bear interest at an annual rate of interest of 10% until maturity. Each note holder has a right, in their sole discretion, to convert the notes into shares of common stock, par value $0.001 per share, of the Company under certain circumstances at a conversion rate of $0.58 per share. The Company recognized a beneficial conversion feature in the amount of $32,759. Interest expense recognized on the amortization of the beneficial conversion feature was $10,920 and $10,920 for the three and nine months ended September 30, 2015. If either note has not been fully repaid by the Company by the maturity date or converted into shares at the election of the note holders prior to the maturity date, then such note will accrue interest at the annual rate of 12% from the maturity date until the date the convertible note is repaid in full. The Company used the proceeds of the convertible notes for working capital, general corporate purposes, and debt repayment. As of September 30, 2015, the notes had accrued interest of $220.
The table below reflects Notes payable due to related parties at September 30, 2015 and December 31, 2014, respectively
September 30, | December 31, | |||||||
2015 | 2014 | |||||||
The $80,000 Jackie Chretien Note | $ | 15,000 | $ | 15,000 | ||||
The $55,167 A. Michael Chretien Note | 40,415 | 40,415 | ||||||
The $250,000 Shealy Note | 170,205 | 193,453 | ||||||
Notes in the Aggregate Amount of $110,000 | 110,000 | 110,000 | ||||||
Notes in the Aggregate Amount of $701,068 | 695,421 | 677,776 | ||||||
The $30,000 Robert C. Schroeder Convertible Promissory Note | 30,000 | 30,000 | ||||||
The $10,000 Matthew L. Chretien Convertible Promissory Note | 10,000 | 10,000 | ||||||
Notes in the Aggregate Amount of $175,000 | 175,000 | 175,000 | ||||||
Notes in the Aggregate Amount of $200,000 | 200,000 | 200,000 | ||||||
Notes in the Aggregate Amount of $100,000 | 92,727 | - | ||||||
Notes in the Aggregate Amount of $100,000 | 95,000 | - | ||||||
Notes in the Aggregate Amount of $40,000 | 40,000 | - | ||||||
Notes in the Aggregate Amount of $20,000 | 20,000 | - | ||||||
Notes in the Aggregate Amount of $100,000 | 100,000 | - | ||||||
Notes in the Aggregate Amount of $50,000 | 44,444 | - | ||||||
Notes in the Aggregate Amount of $72,000 | 56,000 | - | ||||||
Notes in the Aggregate Amount of $100,000 | 78,162 | - | ||||||
Total notes payable - related party | $ | 1,972,374 | $ | 1,451,643 | ||||
Less current portion | (1,835,994 | ) | (1,234,871 | ) | ||||
Long-term portion of notes payable-related party | $ | 136,380 | $ | 216,772 |
Future minimum principal payments of these notes payable as described in this Note 8 are as follows:
For the Twelve Months Ended September 30, | Amount | |||
2016 | $ | 1,835,994 | ||
2017 | 37,368 | |||
2018 | 41,280 | |||
2019 | 45,603 | |||
2020 | 12,129 | |||
TOTAL | $ | 1,972,374 |
With respect to all related party notes, for the three and nine months ended September 30, 2015 and 2014, interest expense and the embedded conversion feature was $125,274 and $268,783 and $4,880 and $8,810, respectively.
9. Commitments and Contingencies
Employment Agreements
The Company has entered into employment agreements with four of its key executives. Under their respective agreements, the executives serve at will and are bound by typical confidentiality, non-solicitation and non-competition provisions.
Operating Leases
On January 1, 2010, the Company entered into an agreement to lease 6,000 rentable square feet of office space in Columbus, Ohio at a monthly rent of $3,375. The lease commenced on January 1, 2010 and, pursuant to a lease extensions through August 14, 2014, the lease expires on December 31, 2016.
19
Future minimum lease payments under this operating lease are as follows:
For the Twelve Months Ending | ||||
September 30, | Amount | |||
2016 | $ | 40,500 | ||
2017 | 10,125 | |||
Total | $ | 50,625 |
Rent expense charged to operations for the three months and nine months ended September 30, 2015 and 2014 amounted to $10,125 and $30,375, respectively.
10. Stockholders’ Equity
Description of Authorized Capital
The Company is authorized to issue up to 50,000,000 shares of common stock with $0.001 par value. The holders of the Company’s common stock are entitled to one vote per share. The holders of common stock are entitled to receive ratably such dividends, if any, as may be declared by the Board of Directors out of legally available funds. However, the current policy of the Board of Directors is to retain earnings, if any, for the operation and expansion of the business. Upon liquidation, dissolution or winding-up of the Company, the holders of common stock are entitled to share ratably in all assets of the Company that are legally available for distribution.
11. Share-Based Compensation
On April 30, 2015, the Company entered into a Non-qualified Stock Option Agreement with Sophie Pibouin, a director of the Company. The agreement granted options to purchase 128,000 shares of the Company prior to the expiration date of April 29, 2025 at an exercise price of $0.75. The options granted will vest on a graded scale over a period of time through October 31, 2015. The unvested options will not be exercisable on or after the director’s termination of continuous service, as defined in the agreement.
On April 30, 2015, the Company entered into a Non-qualified Stock Option Agreement with Murray Gross, a director of the Company. The agreement granted options to purchase 640,000 shares of the Company prior to the expiration date of April 29, 2025 at an exercise price of $0.75. 400,000 of the options granted are immediately vested on the date of grant, and the remaining 240,000 options granted will vest upon the date at which the Company first reports two consecutive fiscal quarters with revenues of One Million Dollars ($1,000,000) each. The unvested options will not be exercisable on or after the director’s termination of continuous service, as defined in the agreement.
The fair values of these director stock option grants were based on estimates at the date of grant as follows:
Risk-free interest rate | 1.43 | % | ||
Weighted average expected term | 5 years | |||
Expected volatility | 143.10 | % | ||
Expected dividend yield | 0.00 | % |
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A summary of stock option activity during the 9 months ended September 30, 2015 under our stock option agreements is as follows:
Weighted- | ||||||||||||||
Weighted- | Average | |||||||||||||
Shares | Average | Remaining | Aggregate | |||||||||||
Under | Exercise | Contractual | Intrinsic | |||||||||||
Option | Price | Life | Value | |||||||||||
Outstanding at January 1, 2015 | - | |||||||||||||
Granted | 768,000 | $ | 0.75 | |||||||||||
Exercised | - | |||||||||||||
Forfeited and expired | - | |||||||||||||
Outstanding at September 30, 2015 | 768,000 | $ | 0.75 | 10 years | $ | 115,200 | ||||||||
Exercisable at September 30, 2015 | 464,000 | $ | 0.75 | 10 years | $ | 69,600 |
The weighted-average grant date fair value of options granted during the 9 months ended September 30, 2015 was $0.81.
As of September 30, 2015, there was $204,000 of total unrecognized compensation costs related to stock options granted under our stock option agreements. $9,000 of the unrecognized compensation cost is expected to be recognized over a weighted-average period of four months. $195,000 of the unrecognized compensation cost will be recognized upon satisfaction of the vesting contingency. The total fair value of stock options that vested during the 3 and 9 months ended September 30, 2015 was $26,000 and $421,000, respectively.
No stock options were exercised during the 3 or 9 months ended September 30, 2015.
12. Concentrations
Revenues from the Company’s services to a limited number of customers have accounted for a substantial percentage of the Company’s total revenues. For the three months ended September 30, 2015, the Company’s two largest customers, Washington State Patrol (“WSP”) , a direct client and Tiburon (“Tiburon”), a reseller, accounted for approximately 9% and 8%, respectively, of the Company’s total revenue for that period. For the three months ended September 30, 2014, the Company’s two largest customers, Tiburon (“Tiburon”), a Reseller, and Alabama Department of Insurance (“ALDOI”), a direct client, accounted for 16% and 10%, respectively, of the Company’s total revenue for that period. For the nine months ended September 30, 2015, the Company’s two largest customers, Tiburon and WSP accounted for approximately 11% and 5%, respectively, of the Company’s total revenues for that period. For the nine months ended September 30, 2014, the Company’s two largest customers, Tiburon, and WSP, accounted for approximately 14% and 7%, respectively, of the Company’s total revenues for that period.
For the three months ended September 30, 2015 and 2014, government contracts represented approximately 42% and 50% of the Company’s total revenues, respectively. A significant portion of the Company’s sales to Tiburon and Lexmark represent ultimate sales to government agencies. For the nine months ended September 30, 2015 and 2014 government contracts represented approximately 42% and 49%, respectively, of the Company’s total revenue.
As of September 30, 2015, accounts receivable concentrations from the Company’s two largest customers were 17% and 17% of gross accounts receivable, respectively, and as of September 30, 2014, accounts receivable concentrations from the Company’s three largest customers were 45%, 16% and 11% of gross accounts receivable, respectively. Accounts receivable balances form the Company’s three largest customers at September 30, 2015 have been partially collected.
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ITEM 2 MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following management’s discussion and analysis of financial conditions and results of operations of the Company for the three and nine months ended September 30, 2015, and 2014 should be read in conjunction with our financial statements and the notes to those financial statements that are included elsewhere in this Form 10-Q. References in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” to “the Company,” “us,” “we,” “our,” and similar terms refer to Intellinetics, Inc., a Nevada corporation (“Intellinetics”), and its sole operating subsidiary, Intellinetics, Inc., an Ohio corporation (“Intellinetics Ohio”), unless we state otherwise or the context indicates otherwise.
This discussion includes forward-looking statements, as that term is defined in the federal securities laws, based upon current expectations that involve risks and uncertainties, such as plans, objectives, expectations and intentions. Actual results and the timing of events could differ materially from those anticipated in these forward-looking statements as a result of a number of factors. Words such as “anticipate,” “estimate,” “plan,” “continuing,” “ongoing,” “expect,” “believe ,” “intend,” “may,” “will,” “should,” “could,” and similar expressions are used to identify forward-looking statements.
We caution you that these statements are not guarantees of future performance or events and are subject to a number of uncertainties, risks and other influences, many of which are beyond our control, which may influence the accuracy of the statements and the projections upon which the statements are based. Factors that may affect our results include, but are not limited to, the risk factors that are included in Part I, Item IA of our 2014 Form 10-K. Any one or more of these uncertainties, risks and other influences could materially affect our results of operations and whether forward-looking statements made by us ultimately prove to be accurate. Our actual results, performance and achievements could differ materially from those expressed or implied in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether from new information, future events or otherwise.
Our Management’s Discussion and Analysis of Financial Condition and Results of Operations section discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. On an on-going basis, we evaluate our estimates and judgments, including those related to revenue recognition accrued expenses, financing operations, contingencies and litigation. We base our estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The most significant accounting estimates inherent in the preparation of our financial statements include estimates as to the appropriate carry value of certain assets and liabilities which are not readily apparent from other sources. These accounting policies are described at relevant sections in this discussion and analysis and in the notes to the financial statements included in this report for the three months ended September 30, 2015.
Company Overview
The Company is an Enterprise Content Management (“ECM”) software development, sales and marketing company serving both the public and private sectors. The Company provides its software solutions principally through (i) the direct licensing of its software installed on customer computer platforms and (ii) providing the applications as a service, accessible through the internet. The latter delivery model is what is referred to as a “cloud-based” or “software as a service” (“SaaS”) model.
The Company’s software products allow customers to manage “enterprise content” (unstructured data such as hard-copy scanned documents, Word documents, Excel spreadsheets, JPEG files, images, pictures, faxes, audio/video files, emails, and PowerPoint presentations) through the complete document life cycle for that organization. The Company’s platform, Intellivue™, improves and enhances business operations for clients by making document and content management simple, accessible and affordable. Our approach to deploying templates for specific business processes is designed to empower clients to affordably manage their documents entirely within the Intellivue™ platform.
To date, most of our software customers install our software onto computers at their location (premises-based). In time, the Company anticipates that the provision of “cloud” application services, or software as a service (SaaS), will become a more significant part of its software sales business. We anticipate that cloud-based services will become the principal part of our software sales business and a primary source of revenues for us, because this model allows customers to avoid significant upfront costs for hardware and installation services required for a premises-based delivery. That said, we are just beginning to see our customers migrate to such cloud-based services. Our revenues from cloud-based delivery of our software, for the nine months ended September 30, 2015 and September 30, 2014, were $182,322 and $133,052, respectively, an increase of $49,720 or 37%.
Our current sales strategy is to focus our sales efforts toward a much greater percentage of sales through intermediaries, such as software resellers and multi-function device resellers, rather than through direct sales. We have developed marketing programs with resellers that facilitate their selling and support of our software solutions. We refer to these resellers as our “channel partners.” We believe that our channel partner strategy improvements have increased the competitive strength of our platform of products. In addition, we have established a set of business solutions templates that provide base software configurations which we believe will facilitate our delivery and installation of software to our customers. We believe that these advancements, in the aggregate, will allow us to license and sell our products to a broader customer base, shortening our sales cycle, making margins more consistent, and allowing us to expand our sales through new channel partnerships. In 2014 and 2015, we devoted significant efforts, in both development and marketing, in bringing about this change in core strategic focus for the Company.
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Revenues
Revenues are generated from the licensing, subscription and maintenance of our enterprise software products and from professional services fees in connection with the implementation and integration of software applications. Our revenues, especially our license revenues, are impacted by the competitive strength of our software products, as well as general economic and industry conditions.
For our sales of software, our customer base has traditionally been made up of customers with larger projects that can take as much as nine months to two years to complete. During the second quarter ending June 30, 2015, the Company changed from the completed contract basis to the percentage of completion basis, measured by the percentage of labor hours incurred to date to estimated total labor hours for each contract, or on a completed contract basis when dependable estimates are not available. Prior to the second quarter ended June 30, 2015, the Company had recognized these contracts exclusively on the completed contract basis. With our improvements in internal processes the Company now has the ability to make more dependable estimates.
Cost of Revenues
We maintain a staff of software design engineers, developers, installers and customer support personnel, dedicated to the development and implementation of customer applications, customer support and maintenance of deployed software applications. While the total costs related to these personnel are relatively consistent from period to period, the cost of revenues categories to which these costs are charged may vary depending on the type of work performed by our staff.
Costs of revenues also include the costs of server hosting and Software as a Service applications, as well as certain third-party costs and hardware costs incurred. Third-party and hardware costs may vary widely from quarter to quarter.
In addition, while revenues are recognized upon the completion of software and consulting projects, the related costs are recognized when incurred, resulting in gross margins which may vary widely from period to period for these revenue categories.
Sales and Marketing Expenses
Sales expenses consist of compensation and overhead associated with the development and support of our channel sales network, as well as our direct sales efforts. Marketing expenses consist primarily of compensation and overhead associated with the development and production of product marketing materials, as well as promotion of the Company’s products through the trade and industry.
General and Administrative Expenses
General and administrative expenses consist of the compensation and overhead of administrative personnel and professional services firms performing administrative functions, including management, accounting, finance and legal services, plus expenses associated with infrastructure, including depreciation, information technology, telecommunications, facilities and insurance.
Interest, Net
Interest, net, consists primarily of interest expense associated with our notes payable. See Results of Operations – Interest Expense – Net, for additional information.
How We Evaluate our Business Performance and Opportunities
Major Quantitative and Qualitative Factors we Consider in the Evaluation of our Business
The major qualitative and quantitative factors we consider in the evaluation of our operating results include the following:
¨ | Our current strategy is to focus upon cloud-based delivery of our software products through channel partners. Historically, our revenues have mostly resulted from premise-based software licensing revenue and professional services revenue. Our observation of industry trends leads us to anticipate that cloud-based delivery will become our principal software business and a primary source of revenues for us, but we are just beginning to see our customers migrate to cloud-based services. Accordingly, when we evaluate our results, we assess whether our cloud-based software revenues are increasing, relative to prior periods and relative to other sources of revenue. Additionally, we assess whether our sales resulting from relationships with channel partners are increasing, relative to prior periods and relative to direct sales to customers. Finally, we consider the number of channel partners with which we have a contract or other relationship to be an indicator of our performance and future results. |
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¨ | Our customer engagements often involve the development and licensing of customer-specific software solutions and related consulting and software maintenance services. When analyzing whether to undertake a particular customer engagement, we often consider all of the following factors as part of our overall strategy to grow the business: (i) the profit margins the project may yield, (ii) whether the project will allow us to enter a new geographic market, (iii) whether the project would enable us to demonstrate our capabilities to large national resellers, or (iv) whether the project would help to develop new product and service features that we could integrate into our suite of products, resulting in an overall product portfolio that better aligns with the needs of our target customers. As a result of this pipeline analysis, we may take on projects with a lower project margin if we determine that the project is valuable to our business for the other reasons discussed. |
¨ | Our sales cycle is long, sometimes lasting 18-24 months. Even when a project begins, we often perform pre-installation assessment, project scoping, and implementation consulting. Our revenue and profit in any particular period is significantly influenced by sales efforts and preliminary project work conducted in prior periods but not completed and recognized until the current period. Therefore, when we plan our business and evaluate our results, we consider the revenue we expect to recognize from projects in our late-stage pipeline. |
¨ | Our research and development efforts and expenses to create new software products are critical to our success. When developing new products or product enhancements, our developers collaborate with our own employees across a wide variety of job functions. We also gather in-depth feedback from our customers and channel partners. We evaluate new products and services to determine their likelihood of market success and their potential profitability. |
¨ | We monitor our costs and capital needs to ensure efficiency as well as an adequate level of support for our business plan. |
Uncertainties, Trends, and Risks that can cause Fluctuations in our Operating Results
Our operating results have fluctuated significantly in the past and are expected to continue to fluctuate in the future due to a variety of factors. Factors that affect our operating results include the following:
¨ | our capital needs, and the costs at which we are able to obtain capital; |
¨ | general economic conditions that affect the amount our customers are spending on their software needs, the cost at which we can provide software products and services, and the costs at which we can obtain capital; |
¨ | the development of new products, requiring development expenses, product rollout, and market acceptance; |
¨ | the length of our sales cycle; |
¨ | the fact that many of our customers are governmental organizations, exposing us to the risk of early termination, audits, investigations, sanctions, and other penalties not typically associated with private customers; |
¨ | our relationships with our channel partners, for purposes of product delivery, introduction to new markets and customers, and for feedback on product development; |
¨ | our need to increase expenses at the beginning of a customer project, while associated revenue is recognized over the life of the project; |
¨ | the potential effect of security breaches, data center infrastructure capacity, our use of open-source software, and governmental regulation and litigation over data privacy and security; |
¨ | whether our clients renew their agreements and timely remit our accounts receivable; |
¨ | whether we can license third-party software on reasonable terms; |
¨ | our ability to protect and utilize our intellectual property; and |
¨ | the effects of litigation, warranty claims, and other claims and proceedings. |
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Due to all these factors and the other risks discussed in “Part I, Item IA of our 2014 Form 10-K”, our results of operations should not be relied upon as an indication of our future performance. Comparisons of our operating results with prior periods is not necessarily meaningful or indicative of future performance.
Results of Operations
Overview
We reported net losses of $253,553 and $638,609 for the three months ended September 30, 2015 and 2014, respectively, representing a decrease in net loss of $385,056 or 60%. We reported gross profit of $491,280 and $257,031 for the three months ended September 30, 2015 and 2014, respectively, representing an increase in gross profit of $234,249, or 91%. The increase in gross profit was from the increase in total revenues, as the overall gross margins were 79% and 81% for the three months ending September 30, 2015 and 2014, respectively. We reported operating expenses of $584,755 and $824,906 for the three months ended September 30, 2015 and 2014, respectively, representing a decrease in operating expenses of $240,151. The decrease in operating expenses was principally related to the decrease in consulting expenses incurred for the three months ending September 30, 2015. We reported net losses of $1,105,173 and $1,415,145 for the nine months ended September 30, 2015 and 2014, respectively, representing a decrease in net loss of $309,972 or 22%. We reported gross profit of $1,426,243 and $750,603 for the nine months ended September 30, 2015 and 2014, respectively, representing an increase in gross profit of $675,640, or 90%. The increase in gross profits was directly related to the increase in revenues, as gross margins were 80% for the nine months ended September 30, 2015 and 2014, respectively. We reported operating expenses of $2,179,726 and $1,991,418 for the nine months ending September 30, 2015 and 2014, respectively, representing an increase of $188,308 or 9%. The increase in operating expenses was principally related to stock option compensation, an increase in sales and marketing personnel offset by a decrease in consulting expenses.
Revenues
We reported total revenues of $621,974 and $316,762 for the three months ended September 30, 2015 and 2014, respectively, representing an increase of $305,212 or 96%. For the nine months ended September 30, 2015 and 2014, respectively, revenues were $1,792,919 and $942,297, representing an increase of $850,622 or 90%. The increase in total revenues is attributable to several factors as described below.
Sale of Software
Revenues from the sale of software principally consist of sales of additional or upgraded software licenses and applications to existing customers and sales of software to our resellers. These software revenues were $136,459 and $25,990, for the three months ended September 30, 2015 and 2014, respectively, representing an increase of $110,469, or 425%. The increase was due to our efforts to close new customers in our direct sales and an increase in our sales of software through our resellers. Software revenues were $474,219 and $38,486 for the nine months ended September 30, 2015 and 2014, respectively, representing an increase of $435,733, or 1,132%. The increase was again due to closing new customers through direct sales and our sales of software to our resellers.
Sale of Software as a Service
For those customers that wish to avoid the upfront costs of typical premises-based software installations, we provide access to our software as a service, accessible through the internet. Our customers typically enter into our software as a service agreement for periods in excess of one year. Under these agreements, we generally provide access to the applicable software, data storage and related customer assistance and support. Our software as a service revenues were $64,817 and $52,582, for the three months ended September 30, 2015 and 2014, respectively, representing an increase of $12,235, or 23%. Our software as a service revenues were $182,322 and $133,052, for the nine months ended September 30, 2015 and 2014, respectively, representing an increase of $49,270 or 37%. The increase in revenue year-over-year was primarily the result of new customers and relationships with channel partners.
Sale of Software Maintenance Services
Software maintenance services revenues consist of fees for post contract customer support services provided to license holders. These agreements allow our customers to receive technical support, enhancements and upgrades to new versions of our software products when and if available. A substantial portion of these revenues were generated from customers to whom we sold software in prior years who have continued to renew their maintenance agreements. The support and maintenance agreements typically have a term of 12 months. Our software maintenance support revenue was $239,506 and $216,310, for the three months ended September 30, 2015 and 2014, respectively, representing an increase of $23,196, or 11%. For the nine months ending September 30, 2015 and 2014, the software maintenance support revenue was $700,116 and $638,832 respectively, representing an increase of $61,284 or 10%. The increase in revenue was primarily the result of new accounts from the sale of software.
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Sale of Professional Services
Professional services revenues consist of revenues from consulting, discovery, training, and advisory services to assist customers with document management needs. These revenues include those arrangements where we do not sell software licenses as an element of the overall arrangement. Professional services revenues were $152,169 and $11,805 for the three months ended September 30, 2015 and 2014, respectively, an increase of $140,364, or 1,189%. For the nine months ended September 30, 2015 and 2014, respectively, professional services revenues were $327,189 and $88,579 respectively, and increase of $238,610, or 269%. The increase in revenue primarily resulted from partner fees received from new channel partners and software applications sold to existing customers.
Sale of Third Party Services
Third party services consist of third party vendor software, hardware and/or services purchases as requested by our customers as needed in conjunction with Intellinetics core software or services.
Cost of Revenues
The cost of revenues during the three months ended September 30, 2015 and 2014 were $130,694 and $59,731, respectively, representing an increase of $70,963, or 119%. For the nine months ended September 30, 2015 and 2014, respectively, the cost of revenues were $366,676 and $191,694, representing an increase of $174,982 or 91%. The increase in cost of revenue for the three and nine month period ended September 30, 2015 is primarily due to the increase in revenues as compared with the three and nine month period ending September 30, 2014.
Gross Margins
Overall gross margin for the three months ended September 30, 2015 and 2014 were 79% and 81%, respectively. For the nine months ended September 30, 2015 and 2014, the gross margins were 80% and 80%.
Operating Expenses
General and Administrative Expenses
General and administrative expenses were $390,841 during the three months ended September 30, 2015 as compared to $474,301 during the three months ended September 30, 2014, representing a decrease of $83,460, or 18%. For the nine months ended September 30, 2015 and 2014, general and administrative expenses were $1,548,096 and $1,385,848, respectively, an increase of $162,248 or 12%. The increase was primarily due to stock option compensation offset by decrease in expenses operating as a public company.
Sales and Marketing Expenses
Sales and marketing expenses decreased to $191,325 during the three months ended September 30, 2015 as compared to $344,690 during the three months ended September 30, 2014, representing a decrease of $153,365 or 44%. The decrease was primarily related to the expense of sales consultants in the quarter ending September 30, 2014. For the nine months ended September 30, 2015 and 2014, sales and marketing expenses were $622,990 and $585,915, respectively, representing an increase of $37,075 or 6%. The increase was related to the hiring of additional sales personnel in the nine months ended September 30, 2015, which also increased our marketing and travel expenses in obtaining new channel partners offset by the decrease in sales consultants expenses recognized in the nine months ending September 30, 2014.
Depreciation and Amortization
Depreciation and amortization was $2,589 for the three months ended September 30, 2015, as compared to $5,915 for the three months ended September 30, 2014, representing a decrease of $3,326 or approximately 56%. For the nine months ended September 30, 2015 and 2014, depreciation and amortization were $8,640 and $19,655, respectively, representing a decrease of $11,015 or 56%. The decrease was the result of no assets being acquired and assets that are becoming fully depreciated.
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Interest Expense, Net
Interest expense, net, was $160,078 during the three months ended September 30, 2015 as compared to $70,734 during the three months ended September 30, 2014, representing an increase of $89,344 or 126%. For the nine months ended September 30, 2015 and 2014, interest expense was $351,690 and $174,330, respectively, an increase of $177,360 or 102%. The increase resulted primarily from an increase in the average debt balance outstanding during the three and nine months ending September 30, 2015.
Liquidity and Capital Resources
We have financed our operations primarily through a combination of cash on hand, cash generated from operations, borrowings from third parties and related parties, and proceeds from private sales of equity. As of September 30, 2015, our major liquidity indicators are:
¨ | Cash $172,021, |
¨ | Working Capital Deficiency $(3,535,563), |
¨ | Through September 30, 2015 we have incurred cumulative net losses since inception of $10,562,184. |
From the Company’s inception, it has generated revenues from the sales and implementation of our internally generated software applications. Our plan is to increase our sales and market share by developing an expanded network of resellers through which we expect to sell our expanded software product portfolio. We expect that this marketing initiative will require us to develop an expanded sales force and enhance our product marketing efforts, all of which will require additional capital.
Based on current quarterly revenues, our operating cash flows before working capital changes are insufficient by approximately $125,000 per quarter. In addition, our operating payables currently exceed our accounts receivable by approximately $530,000. Accordingly, unless our revenues increase from current levels, our operating cash flows over the next 12 months will be insufficient by approximately $1,050,000 to $1,250,000 requiring additional capital or debt financing to support operations. During 2014 and the nine months ended September 30, 2015, we used the proceeds from convertible note issuances to fund our operating cash flow deficits. Debt obligations due within the next 12 months approximate $2,436,000. We intend to enter into negotiations to extend maturities, defer payments or convert obligations to equity. We also plan to continue our marketing and sales strategies to increase our revenues while controlling operating costs. There are no assurances that our plans as discussed above will materialize and/or that we will have sufficient liquidity to fund operations. These factors, among others, raise substantial doubt about our ability to continue as a going concern.
Since inception, our operations have primarily been funded through a combination of operating margins, state business development loans, bank loans and loans from friends and family. Although management believes that we may have access to capital resources, there are currently no commitments in place for new financing, and there is no assurance that we will be able to obtain funds on commercially acceptable terms, if at all.
During the nine months ended September 30, 2015, we raised $582,000 in net new funds through the issuance of contingently convertible notes. The proceeds from these notes were used to fund our working capital needs and debt repayment.
Assuming that we are successful in our growth plans and development efforts, we believe that we will be able to raise additional funds through sales of our common stock, issuance of debt or some other financing source. There is no guarantee that we will be able to raise these additional funds or do so on acceptable terms.
Our financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary should we be unable to continue as a going concern.
Liquidity and Capital Resource - Equity Capital Resources
Shares Issued and Outstanding and Shares Reserved for Exercise of Warrants
As of September 30, 2015 the Company has 7,123,074 shares of common stock issued and outstanding; and approximately 7,045,000 shares reserved for issuance upon the exercise of outstanding warrants and stock options.
Our shares are available for quotation on the Over-the-Counter Bulletin Board, and we believe this is important for raising capital to finance our growth plan. We intend to deploy any future capital we may raise to expand our sales and marketing capabilities, develop ancillary software products, enhance our internal infrastructure, support the accounting, auditing and legal costs of operating as a public company, and provide working capital.
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Liquidity and Capital Resource - Debt Capital Resources
Deferral of Interest Payment Relating to Notes Payable Issued by Intellinetics Ohio to the Ohio State Development Authority
Intellinetics Ohio has issued two notes payable to the Ohio State Development Authority. In June 2014, Intellinetics Ohio and the Ohio State Development Authority entered into a Notice and Acknowledgement of Modification to Payment Schedule on both of the loans, deferring a portion of the interest payments until June 1, 2015. On September 25, 2015 both notes payable were amended as discussed below.
Both of these notes are subject to certain covenants and reporting requirements, with the Company. In July, 2014 the Company informed the Ohio State Development Authority that the employment requirement was not in compliance in relation to the Authority Loan No. 1. As a result of this noncompliance, the Company’s interest rate effective October 1, 2014 went from 6.00% to 7.00%. The impact of this increase is to raise the Company’s balloon payment by $6,000, and will be waived if the Company fulfills all of its other loan commitments, including satisfying the balloon payment. On September 25, 2015, this $1,012,500 note was amended and restated, setting forth the amount of principal, interest payable under the Note. The interest rate is changed to six percent 6% per annum until paid, with principal and interest payments according to a new amortization schedule, which reduces principal payments and defers interest payment until October 1, 2016. This note matures on August 1, 2018.
On August 14, 2014, the Company entered into a Second Amendment to Loan Agreement to the $750,000 note payable in which the Company is to provide employment of 19 full-time jobs and create an estimated twelve new full-time jobs and employment opportunities by December 31, 2015. If the Company fails, for reasons other than market conditions, to retain and create an aggregate of at least 25 such jobs and employment opportunities, the interest rate on the outstanding balance of the loan could increase to 10%. On September 25, 2015, the Company entered into a Third Amendment to Loan Agreement to the $750,000 note payable, to create and/or maintain nineteen full-time jobs for each month beginning on October 1, 2016. Additionally, a new amortization schedule will reduce the principal payments and defer interest payments until October 1, 2016, at which time the payments will restate the monthly principal and interest payments through the maturity date of August 1, 2018.
Promissory Notes
On December 31, 2014, the Company and Ramon M. Shealy converted their previous promissory notes, whose total principal balance and unpaid interest was $193,453 into a new single promissory note, with a maturity date of January 1, 2020. For more information, please see Note 8 to the Consolidated Financial Statements, titled Notes Payable – Related Parties.
On December 31, 2014, Intellinetics Ohio and Jackie M. Chretien, who is related to the Secretary and director of the Company, and who is also related to the President, CEO, and director of the Company extended their original promissory note, with a maturity of January 1, 2015, by a Promissory Note Extension Agreement, with the maturity date of January 1, 2016, without changing any other terms of that promissory note.
On December 31, 2014, Intellinetics Ohio and A. Michael Chretien, who is the Secretary of the Company, extended a promissory note with a maturity date of January 1, 2015, into a promissory note maturity of January 1, 2016. Without changing any other terms of that promissory note.
Issuance of Convertible Notes.
Throughout 2014 and through the nine months ending September 30, 2015, the Company issued new convertible promissory notes as a source of debt liquidity. The total principal balance of such notes issued was $1,807,000. The note investors have a right, in their sole discretion, to convert the convertible notes into shares of common stock, par value $0.001 per share, of the Company at various conversion rates ranging from $0.30 to $0.56 per share. The annual rate of interest on such notes ranges from 6% to 10%, with all notes maturing by December 31, 2015. For more information, please see Note 7 and 8 to the Consolidated Financial Statements.
Summary of Current Outstanding Indebtedness
The Company’s outstanding indebtedness at September 30, 2015 is as follows:
· | Promissory note held by Ohio State Development Authority, dated July 17, 2009, with an original principal balance of $1,012,500, and current principal balance of $523,373. |
· | Promissory note held by Ohio State Development Authority, dated July 3, 2011,with an original principal balance of $750,000, and current principal balance of $578,250. |
· | Convertible notes held by accredited investors, dated between May 18, 2014 and July 10, 2014, with an aggregate original principal balance of $350,000, current principal balance of $350,000 with a current discount for the beneficial conversion feature of $727, and accrued interest of $47,193. |
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· | Promissory note held by Jackie Chretien, dated March 2, 2009, with an original principal balance of $80,000, current principal balance of $15,000, and accrued interest of $4,215. |
· | Promissory note held by A. Michael Chretien, dated December 29, 2001, with an original principal balance of $55,167, current principal balance of $40,415, and accrued interest of $6,544. |
· | Promissory note held by Ramon Shealy, dated December 31, 2014, with an original principal balance of $250,000, current principal balance of $170,205, and accrued interest of $0. |
· | Convertible notes held by accredited investors, dated between May 18, 2014 to July 10, 2014, with an aggregate original principal balance of $350,000, current principal balance of $350,000, with a current discount for the beneficial conversion feature of $353, and accrued interest of $47,193. |
· | Convertible note held by Robert Schroeder, a director of the company, dated May 12, 2014, with an aggregate original principal balance of $30,000, current principal balance of $30,000, and accrued interest of $4,184. |
· | Convertible note held by Matthew L. Chretien, dated June 6, 2014, with an aggregate original principal balance of $10,000, current principal balance of $10,000, and accrued interest of $1,318. |
· | Convertible notes held by two accredited investors, dated July 10, 2014, with an aggregate original principal balance of $701,068, current principal balance of $701,068 with a current discount for the beneficial conversion feature of $5,647, and accrued interest of $85,856. |
· | Convertible note held by Taglich Brothers, dated July 8, 2014, with an original principal balance of $10,800, current principal balance of $10,800 and accrued interest of $1,329. |
· | Convertible notes held by three accredited investors, dated October 9, 2014, with an aggregate original principal balance of $175,000, current principal balance of $175,000, and accrued interest of $10,682. |
· | Convertible notes held by two accredited investors, dated December 17, 2014, with an aggregate original principal balance of $200,000, current principal balance of $200,000 and accrued interest of $9,436. |
· | Convertible notes held by two accredited investors, dated February 10, 2015, with an aggregate original principal balance of $100,000, current principal balance of $100,000 with a current discount for the beneficial conversion feature of $7,273, and accrued interest of $3,814. |
· | Convertible notes held by two accredited investors, dated March 11, 2015, with an aggregate original principal balance of $100,000, current principal balance of $100,000 with a current discount for the beneficial conversion feature of $5,000 and accrued interest of $3,336. |
· | Convertible notes held by two accredited investors, dated May 20, 2015, with an aggregate original principal balance of $40,000, current principal balance of $40,000 with a current discount for the beneficial conversion feature of $0, and accrued interest of $1,552. |
· | Convertible notes held by two accredited investors, dated June 3, 2015, with an aggregate original principal balance of $20,000, current principal balance of $20,000 with a current discount for the beneficial conversion feature of $0, and accrued interest of $682. |
· | Convertible notes held by two accredited investors, dated June 17, 2015, with an aggregate original principal balance of $100,000, current principal balance of $100,000 with a current discount for the beneficial conversion feature of $0, and accrued interest of $2,954. |
· | Convertible notes held by two accredited investors, dated July 15, 2015, with an aggregate original principal balance of $50,000, current principal balance of $50,000 with a current discount for the beneficial conversion feature of $5,556, and accrued interest of $1,054. |
· | Convertible notes held by two accredited investors, dated August 26, 2015, with an aggregate original principal balance of $72,000, current principal balance of $72,000 with a current discount for the beneficial conversion feature of $16,000, and accrued interest of $690. |
· | Convertible notes held by two accredited investors, dated September 22, 2015, with an aggregate original principal balance of $100,000, current principal balance of $100,000 with a current discount for the beneficial conversion feature of $21,389, and accrued interest of $220. |
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There were no material commitments for capital expenditures at September 30, 2015.
Cash Flows
Operating Activities
Net cash used in operating activities for the nine months ended September 30, 2015 and 2014 was $411,111 and $885,528, respectively. During the nine months ended September 30, 2015, the net cash used in operating activities was primarily attributable to the net loss adjusted for non- cash expenses of $590,073 and an increase in net operating liabilities of $103,989. During the nine months ended September 30, 2014, the net cash used in operating activities was primarily attributable to the net loss adjusted for non- cash expenses of $272,670 and an increase in net operating liabilities of $256,947.
Investing Activities
Net cash used in investing activities for the nine months ended September 30, 2015 amounted to $3,888 and was related to the purchase of property and equipment. Net cash provided by investing activities for the nine months ended September 30, 2014 amounted to $4,477 and was related to the disposition of property and equipment.
Financing Activities
Net cash provided by financing activities for the nine months ended September 30, 2015 amounted to $402,939. The net cash provided by financing activities resulted from new borrowings. New borrowings of $582,000 were partially offset by $179,061 of notes payable repayments, of which $23,248 was repaid to related parties.
Net cash provided by financing activities for the nine months ended September 30, 2014 amounted to $634,776. The net cash provided by financing activities resulted from new borrowings. New borrowings of $850,000 were partially offset by $215,224 of notes payable repayments, of which $15,000 was repaid to related parties.
Critical Accounting Policies and Estimates
There have been no significant changes during the three months ended September 30, 2015 to the items that we disclosed as our critical accounting policies and use of estimates in our “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2014 Form 10-K.
Liquidity, Going Concern and Management’s Plans
We have incurred substantial recurring losses since our inception. The accompanying financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities and commitments in the normal course of business. During the years 2012, 2013, 2014 and the nine months ended September 30, 2015, we raised a total of $5,226,077 through issuance of debt and equity securities. We are also in the process of exploring strategies to increase our existing revenues. We believe we will be successful in these efforts; however, there can be no assurance we will be successful in raising additional debt or equity financing or finding any other financing source to fund our operations on terms agreeable to us. These matters raise substantial doubt about our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if we were unable to continue as a going concern.
Use of Estimates
The preparation of our consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to exercise its judgment. We exercise considerable judgment with respect to establishing sound accounting policies and in making estimates and assumptions that affect the reported amounts of our assets and liabilities, our recognition of revenues and expenses, and other financial information.
On an ongoing basis, we evaluate our estimates and judgments. Areas in which we exercise significant judgment include, but are not necessarily limited to, our valuation of accounts receivable and income taxes.
We base our estimates and judgments on a variety of factors, including our historical experience, knowledge of our business and industry, current and expected economic conditions, and the attributes of our products and services. We periodically re-evaluate our estimates and assumptions with respect to these judgments and modify our approach when circumstances indicate that modifications are necessary.
While we believe that the factors we evaluate provide us with a meaningful basis for establishing and applying sound accounting policies, we cannot guarantee that the results will always be accurate. Since the determination of these estimates requires the exercise of judgment, actual results could differ from such estimates.
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A description of significant accounting policies that require us to make significant estimates and assumptions in the preparation of our consolidated financial statements is the allowance for doubtful accounts and valuation allowance for deferred tax assets.
We establish allowances for doubtful accounts based on certain percentages of accounts ninety days or more past due and when available information causes us to believe that credit loss is probable. Due to historical losses, a full valuation allowance is recognized on deferred tax assets.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Not applicable to smaller reporting companies.
Item 4. Controls and Procedures.
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
Under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as defined under Exchange Act Rule 13a-15(e)), as of September 30, 2015. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of September 30, 2015.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting during the quarter ended September 30, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
None.
Our business and operating results are subject to many risks, uncertainties and other factors. If any of these risks were to occur, our business, affairs, assets, financial condition, results of operations, cash flows and prospects could be materially and adversely affected. These risks, uncertainties and other factors include the information discussed elsewhere in this report as well as the risk factors set forth in “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, which have not materially changed as of the date of this report.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
There have been no securities sold by the registrant during the period covered by this Quarterly Report on Form 10-Q that have not previously been included on a Form 8-K.
ITEM 3. DEFAULT UPON SENIOR SECURITIES.
None.
ITEM 4. MINE SAFETY DISCLOSURES.
Not Applicable.
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None.
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTELLINETICS, INC. | ||
Dated: November 16, 2015 | ||
By: | /s/ Matthew L. Chretien | |
Matthew L. Chretien | ||
President and Chief Executive Officer (Principal Executive Officer) | ||
Dated: November 16, 2015 | ||
By: | /s/ Kendall D. Gill | |
Kendall D. Gill | ||
Chief Financial Officer |
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The following is a list of exhibits filed as part of this Quarterly Report on Form 10-Q.
Exhibit No. | Description of Exhibit | |
31.1* | Certification of Principal Executive Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. | |
31.2* | Certification of Principal Financial Officer pursuant to Section 302 of The Sarbanes-Oxley Act of 2002. | |
32.1* | Certification of Principal Executive Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. | |
32.2* | Certification of Principal Financial Officer pursuant to Section 906 of The Sarbanes-Oxley Act of 2002. |
101. INS XBRL Instance Document.*
101. SCH XBRL Taxonomy Schema.*
101. CAL XBRL Taxonomy Extension Calculation Linkbase.*
101. DEF XBRL Taxonomy Extension Definition Linkbase.*
101. LAB XBRL Taxonomy Extension Label Linkbase.*
101. PRE XBRL Taxonomy Extension Presentation Linkbase.*
* filed herewith
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