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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2021

 

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 Organization)

 

(I.R.S. Employer

Identification No.)

 

2190 Dividend Drive    
Columbus, Ohio   43228
(Address of Principal Executive Offices)   (Zip Code)

 

(614) 921-8170

(Registrant’s telephone number, including area code)

 

 

(Former name and former address, if changed since last report)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol(s)   Name of each exchange on which registered
None.   N/A   N/A

 

Securities registered pursuant to Section 12(g) of the Act: Common stock, $0.001 par value.

 

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 ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer (Do not check if a smaller reporting company) Accelerated filer
Non-accelerated filer   Smaller reporting company
Emerging growth company      

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ☐ No

 

As of August 12, 2021, there were 2,823,072 shares of the issuer’s common stock outstanding, each with a par value of $0.001 per share.

 

 

 

 
 

 

INTELLINETICS, INC.

Form 10-Q

June 30, 2021

TABLE OF CONTENTS

 

   

Page

No.

PART I    
     
FINANCIAL INFORMATION 5
     
ITEM 1. Financial Statements. 5
     
  Condensed Consolidated Balance Sheets as of June 30, 2021 (Unaudited) and December 31, 2020 5
     
  Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2021 and 2020 (Unaudited) 6
     
  Condensed Consolidated Statement of Stockholders’ Equity for the three and six months ended June 30, 2021 and 2020 (Unaudited) 7
     
  Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2021 and 2020 (Unaudited) 8
     
  Notes to Condensed Consolidated Financial Statements (Unaudited) 9
     
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. 27
     
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk. 37
     
ITEM 4. Controls and Procedures. 37
     
PART II    
     
OTHER INFORMATION 38
     
ITEM 1. Legal Proceedings. 38
     
ITEM 1A. Risk Factors. 38
     
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds. 38
     
ITEM 3. Defaults Upon Senior Securities. 38
     
ITEM 4. Mine Safety Disclosures. 38
     
ITEM 5. Other Information. 38
     
ITEM 6. Exhibits. 38
     
SIGNATURES 39

 

2
 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This Quarterly Report on Form 10-Q and the documents incorporated into this report by reference contain forward-looking statements. In addition, from time to time we may make additional forward-looking statements in presentations, at conferences, in press releases, in other reports and filings and otherwise. Forward-looking statements are all statements other than statements of historical facts, including statements that refer to plans, intentions, objectives, goals, targets, strategies, hopes, beliefs, projections, prospects, expectations or other characterizations of future events or performance, and assumptions underlying the foregoing. The words “may,” “could,” “should,” “would,” “will,” “project,” “intend,” “continue,” “believe,” “anticipate,” “estimate,” “forecast,” “expect,” “plan,” “potential,” “opportunity,” “scheduled,” “goal,” “target,” and “future,” variations of such words, and other comparable terminology and similar expressions and references to future periods are often, but not always, used to identify forward-looking statements. Examples of forward-looking statements include, among other things, statements about the following:

 

  the ongoing effect of the novel coronavirus pandemic (“COVID-19”), including its macroeconomic effects on our business, operations, and financial results; and the effect of governmental lockdowns, restrictions and new regulations on our operations and processes;
     
  our prospects, including our future business, revenues, expenses, net income, earnings per share, margins, profitability, cash flow, cash position, liquidity, financial condition and results of operations, backlog of orders and revenue, our targeted growth rate, our goals for future revenues and earnings, and our expectations about realizing the revenues in our backlog and in our sales pipeline;
     
  the effects on our business, financial condition and results of operations of current and future economic, business, market and regulatory conditions, including the current economic and market conditions and their effects on our customers and their capital spending and ability to finance purchases of our products, services, technologies and systems;
     
  our expectation that the shift from an offline to online world will continue to benefit our business;
     
  our ability to integrate our two recent acquisitions and any future acquisitions, grow their businesses and obtain the expected financial and operational benefits from those businesses;
     
  the effects of fluctuations in sales on our business, revenues, expenses, net income, earnings per share, margins, profitability, cash flow, capital expenditures, liquidity, financial condition and results of operations;
     
  our products, services, technologies and systems, including their quality and performance in absolute terms and as compared to competitive alternatives, their benefits to our customers and their ability to meet our customers’ requirements, and our ability to successfully develop and market new products, services, technologies and systems;
     
  our markets, including our market position and our market share;
     
  our ability to successfully develop, operate, grow and diversify our operations and businesses;
     
  our business plans, strategies, goals and objectives, and our ability to successfully achieve them;
     
  the sufficiency of our capital resources, including our cash and cash equivalents, funds generated from operations, availability credit and financing arrangements and other capital resources, to meet our future working capital, capital expenditure, lease and debt service and business growth needs;
     
  the value of our assets and businesses, including the revenues, profits and cash flow they are capable of delivering in the future;

 

3
 

 

  the amount and timing of revenue recognition from customer contracts with commitments for performance obligations, including our estimate of the remaining amount of commitments and when we expect to recognize revenues;
     
  industry trends and customer preferences and the demand for our products, services, technologies and systems; and
     
  the nature and intensity of our competition, and our ability to successfully compete in our markets.

 

Any forward-looking statements we make are based on our current plans, intentions, objectives, strategies, projections and expectations, as well as assumptions made by and information currently available to management. Forward-looking statements are not guarantees of future performance or events, but are subject to and qualified by substantial risks, uncertainties and other factors, which are difficult to predict and are often beyond our control. Forward-looking statements will be affected by assumptions and expectations we might make that do not materialize or that prove to be incorrect and by known and unknown risks, uncertainties and other factors that could cause actual results to differ materially from those expressed, anticipated or implied by such forward-looking statements. These risks, uncertainties and other factors include, but are not limited to, those described in Part I, Item 1A, “Risk Factors,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2020, filed on March 30, 2021, as well as other risks, uncertainties and factors discussed elsewhere in this Quarterly Report, in documents that we include as exhibits to or incorporate by reference in this report, and in other reports and documents we from time to time file with or furnish to the Securities and Exchange Commission (the “SEC”). In light of these risks and uncertainties, you are cautioned not to place undue reliance on any forward-looking statements that we make.

 

Any forward-looking statements contained in this report speak only as of the date of this report, and any other forward-looking statements we make from time to time in the future speak only as of the date they are made. We undertake no duty or obligation to update or revise any forward-looking statement or to publicly disclose any update or revision for any reason, whether as a result of changes in our expectations or the underlying assumptions, the receipt of new information, the occurrence of future or unanticipated events, circumstances or conditions or otherwise.

 

As used in this Quarterly Report, unless the context indicates otherwise:

 

  the terms “Intellinetics,” “Company,” “the company,” “us,” “we,” “our,” and similar terms refer to Intellinetics, Inc., a Nevada corporation, and its subsidiaries;
  “Intellinetics Ohio” refers to Intellinetics, Inc., an Ohio corporation and a wholly-owned subsidiary of Intellinetics; and
  “Graphic Sciences” refers to Graphic Sciences, Inc., a Michigan corporation and a wholly-owned subsidiary of Intellinetics.

 

4
 

 

PART I – FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

INTELLINETICS, INC. and SUBSIDIARIES

Condensed Consolidated Balance Sheets

 

   2021   2020 
   (unaudited)     
   June 30,   December 31, 
   2021   2020 
         
ASSETS          
Current assets:          
Cash  $1,140,631   $1,907,882 
Accounts receivable, net   1,001,625    792,380 
Accounts receivable, unbilled   512,075    523,522 
Parts and supplies, net   60,922    79,784 
Prepaid expenses and other current assets   252,661    162,166 
Total current assets   2,967,914    3,465,734 
           
Property and equipment, net   1,010,312    698,752 
Right of use assets   3,832,916    2,641,005 
Intangible assets, net   1,076,733    1,184,971 
Goodwill   2,322,887    2,322,887 
Other assets   27,284    31,284 
Total assets  $11,238,046   $10,344,633 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY          
           
Current liabilities:          
Accounts payable  $163,869   $141,823 
Accrued compensation   458,567    271,889 
Accrued expenses, other   152,370    131,685 
Lease liabilities - current   606,350    518,531 
Deferred revenues   942,947    996,131 
Deferred compensation   100,828    100,828 
Earnout liabilities - current   923,109    877,522 
Accrued interest payable - current   -    5,941 
Notes payable - current   -    580,638 
Total current liabilities   3,348,040    3,624,988 
           
Long-term liabilities:          
Notes payable - net of current portion   1,649,324    1,802,184 
Lease liabilities - net of current portion   3,304,366    2,196,951 
Earnout liabilities - net of current portion   643,369    1,566,478 
Total long-term liabilities   5,597,059    5,565,613 
Total liabilities   8,945,099    9,190,601 
           
Stockholders’ equity:          
Common stock, $0.001 par value, 25,000,000 shares authorized; 2,823,072 and 2,810,865 shares issued and outstanding at June 30, 2021 and December 31, 2020, respectively   2,823    2,811 
Additional paid-in capital   24,251,172    24,147,488 
Accumulated deficit   (21,961,048)   (22,996,267)
Total stockholders’ equity   2,292,947    1,154,032 
Total liabilities and stockholders’ equity  $11,238,046   $10,344,633 

 

See Notes to these Condensed Consolidated financial statements

 

5
 

 

INTELLINETICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Operations

(Unaudited)

 

   2021   2020   2021   2020 
  

For the Three Months Ended

June 30,

  

For the Six Months Ended

June 30,

 
   2021   2020   2021   2020 
                 
Revenues:                    
Sale of software  $5,598   $9,674   $15,192   $103,774 
Software as a service   376,154    248,693    699,880    474,687 
Software maintenance services   335,073    314,111    675,519    575,354 
Professional services   1,897,780    1,045,679    3,550,243    1,605,709 
Storage and retrieval services   295,041    218,025    604,031    290,322 
Total revenues   2,909,646    1,836,182    5,544,865    3,049,846 
                     
Cost of revenues:                    
Sale of software   2,122    5,357    6,359    43,659 
Software as a service   91,781    71,281    168,121    143,796 
Software maintenance services   22,272    31,569    46,660    78,085 
Professional services   861,267    514,036    1,695,505    811,132 
Storage and retrieval services   118,137    42,546    209,249    56,537 
Total cost of revenues   1,095,579    664,789    2,125,894    1,133,209 
                     
Gross profit   1,814,067    1,171,393    3,418,971    1,916,637 
                     
Operating expenses:                    
General and administrative   1,058,061    844,657    2,097,087    1,688,860 
Change in fair value of earnout liabilities   7,261    -    77,211    - 
Significant transaction costs   -    175,673    -    636,440 
Sales and marketing   341,595    229,873    631,906    473,562 
Depreciation and amortization   101,432    86,750    196,316    114,842 
                     
Total operating expenses   1,508,349    1,336,953    3,002,520    2,913,704 
                     
Income (loss) from operations   305,718    (165,560)   416,451    (997,067)
                     
Other income (expense)                    
Gain on extinguishment of debt   -    -    845,083    287,426 
Interest expense, net   (113,271)   (116,796)   (226,315)   (407,226)
                     
Total other income/expense   (113,271)   (116,796)   618,768    (119,800)
                     
Income (loss) before income taxes   192,447    (282,356)   1,035,219    (1,116,867)
                     
Income tax benefit   -    -    -    188,300 
                     
Net income/loss  $192,447   $(282,356)  $1,035,219   $(928,567)
                     
Basic and diluted net income (loss) per share:  $0.07   $(0.10)  $0.37   $(0.46)
Diluted net income (loss) per share:  $0.06   $(0.10)  $0.33   $(0.46)
                     
Weighted average number of common shares outstanding - basic and diluted   2,823,072    2,810,865    2,822,870    1,998,356 
Weighted average number of common shares outstanding - diluted   3,104,334    2,810,865    3,105,602    1,998,356 

 

See Notes to these Condensed Consolidated financial statements

 

6
 

 

INTELLINETICS, INC. and SUBSIDIARIES

Condensed Consolidated Statement of Stockholders’ Equity

For the Three and Six Months Ended June 30, 2021 and 2020

(Unaudited)

 

   Shares   Amount   Capital   Deficit   Total 
   Common Stock   Additional Paid-in   Accumulated     
   Shares   Amount   Capital   Deficit   Total 
                     
Balance, March 31, 2020   2,810,865   $2,811   $24,100,291   $(21,442,277)  $2,660,825 
                          
Stock Option Compensation   -    -    7,110    -    7,110 
                          
Net Loss   -    -    -    (282,356)   (282,356)
                          
Balance, June 30, 2020   2,810,865   $2,811   $24,107,401   $(21,724,633)  $2,385,579 
                          
Balance, March 31, 2021   2,823,072    2,823    24,228,074    (22,153,495)   2,077,402 
                          
Stock Option Compensation   -    -    23,098    -    23,098 
                          
Net Income   -    -    -    192,447    192,447 
                          
Balance, June 30, 2021   2,823,072   $2,823   $24,251,172   $(21,961,048)  $2,292,947 

 

   Common Stock   Additional Paid-in   Accumulated     
   Shares   Amount   Capital   Deficit   Total 
                     
Balance, December 31, 2019   370,497   $371   $14,419,437   $(20,796,066)  $(6,376,258)
                          
Stock Issued to Directors   16,429    16    57,484    -    57,500 
                          
Stock Option Compensation   -    -    18,683    -    18,683 
                          
Stock Issued   955,000    955    3,819,045    -    3,820,000 
                          
Stock Issued for Convertible Notes   1,468,939    1,469    5,728,566    -    5,730,035 
                          
Equity Issuance Costs   -    -    (307,867)   -    (307,867)
                          
Note Offer Warrants   -    -    372,053    -    372,053 
                          
Net Loss   -    -    -    (928,567)   (928,567)
                          
Balance, June, 2020   2,810,865   $2,811   $24,107,401   $(21,724,633)  $2,385,579 
                          
Balance, December 31, 2020   2,810,865    2,811    24,147,488    (22,996,267)   1,154,032 
                          
Stock Issued to Directors   12,207    12    57,488    -    57,500 
                          
Stock Option Compensation   -    -    46,196    -    46,196 
                          
Net Income   -    -    -    1,035,219    1,035,219 
                          
Balance, June 30, 2021   2,823,072   $2,823   $24,251,172   $(21,961,048)  $2,292,947 

 

See Notes to these Condensed Consolidated financial statements

 

7
 

 

INTELLINETICS, INC. and SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(Unaudited)

 

   2021   2020 
   For the Six Months Ended June 30, 
   2021   2020 
         
Cash flows from operating activities:          
Net income (loss)  $1,035,219   $(928,567)
Adjustments to reconcile net income (loss) to net cash used in operating activities:          
Depreciation and amortization   196,316    114,842 
Bad debt (recovery) expense   (11,453)   44,705 
Parts and supplies reserve change   9,000    6,000 
Amortization of deferred financing costs   51,869    65,222 
Amortization of beneficial conversion option   -    11,786 
Amortization of debt discount   53,333    35,555 
Amortization of right of use asset   292,051    160,290 
Stock issued for services   57,500    57,500 
Stock options compensation   46,196    18,683 
Note conversion stock issue expense   -    141,000 
Warrant issue expense   -    236,761 
Interest on converted debt   -    176,105 
Amortization of original issue discount on notes   -    18,296 
Gain on extinguishment of debt   (845,083)   (287,426)
Change in fair value of earnout liabilities   77,211    - 
Changes in operating assets and liabilities:          
Accounts receivable   (197,792)   804,874 
Accounts receivable, unbilled   11,447    (150,846)
Parts and supplies   9,862    1,676 
Prepaid expenses and other current assets   (86,495)   (53,400)
Accounts payable and accrued expenses   229,409    (399,261)
Lease liabilities, current and long-term   (288,728)   (154,257)
Deferred compensation   -    (16,338)
Accrued interest, current and long-term   442    2,236 
Deferred revenues   (53,184)   (37,723)
Total adjustments   (448,099)   796,280 
Net cash used in operating activities   587,120   (132,287)
           
Cash flows from investing activities:          
Cash paid to acquire business, net of cash acquired   -    (4,017,816)
Purchases of property and equipment   (399,638)   (21,927)
Net cash used in investing activities   (399,638)   (4,039,743)
           
Cash flows from financing activities:          
Payment of earnout liabilities   

(954,733

)   

-

 
Proceeds from issuance of common stock   -    3,167,500 
Offering costs paid on issuance of common stock   -    (307,867)
Payment of deferred financing costs   -    (175,924)
Proceeds from notes payable   -    3,008,700 
Repayment of notes payable - related parties   -    (47,728)
Net cash provided by financing activities   

(954,733

)   5,644,681 
           
Net increase in cash   (767,251)   1,472,651 
Cash - beginning of period   1,907,882    404,165 
Cash - end of period  $1,140,631   $1,876,816 
           
Supplemental disclosure of cash flow information:          
Cash paid during the period for interest  $121,339   $85,949 
Cash paid during the period for income taxes  $2,088   $- 
           
Supplemental disclosure of non-cash financing activities:          
Accrued interest notes payable converted to equity  $-   $796,074 
Accrued interest notes payable related parties converted to equity   -    238,883 
Discount on notes payable for beneficial conversion feature   -    320,000 
Discount on notes payable for warrants   -    135,292 
Notes payable converted to equity   -    3,421,063 
Notes payable converted to equity - related parties   -    1,465,515 
Right-of-use asset obtained in exchange for operating lease liability   

1,483,962

    

-

 
           
Supplemental disclosure of non-cash investing activities relating to business acquisitions:          
Cash  $-   $17,269 
Accounts receivable   -    1,122,737 
Accounts receivable, unbilled   -    276,023 
Parts and supplies   -    91,396 
Prepaid expenses   -    73,116 
Other current assets   -    5,954 
Right of use assets   -    2,885,618 
Property and equipment   -    735,885 
Intangible assets   -    1,361,000 
Accounts payable   -    (169,289)
Accrued expenses   -    (163,168)
Lease liabilities   -    (2,947,684)
Federal and state taxes payable   -    (168,900)
Deferred revenues   -    (195,448)
Deferred tax liabilities, net   -    (149,900)
Net assets acquired in acquisition   -    2,774,609 
Total goodwill acquired in acquisition   -    2,319,676 
Total purchase price of acquisition   -    5,094,285 
Purchase price of business acquisition financed with earnout liability   -    (889,200)
Purchase price of business acquisition financed with installment payments   -    (170,000)
Cash used in business acquisition  $-   $4,035,085 

 

See Notes to these Condensed Consolidated financial statements

 

8
 

 

INTELLINETICS, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(Unaudited)

 

1. Business Organization and Nature of Operations

 

Intellinetics, Inc., formerly known as GlobalWise Investments, Inc. (“Intellinetics” or the “Company” or “we” or “us”), is a Nevada corporation incorporated in 1997, with two subsidiaries: Intellinetics, Inc., an Ohio corporation that is wholly-owned by the Company (“Intellinetics Ohio”), and Graphic Sciences, Inc., a Michigan corporation that is also wholly-owned by the Company (“Graphic Sciences”). Intellinetics Ohio was incorporated in 1996, and on February 10, 2012, Intellinetics Ohio became the sole operating subsidiary of the Company as a result of a reverse merger and recapitalization. On March 2, 2020, the Company purchased all the outstanding capital stock of Graphic Sciences.

 

Our products and services are provided through two reporting segments: Document Management and Document Conversion. Our Document Management segment, which includes the CEO Imaging Systems, Inc. (“CEO Image”) asset acquisition in April 2020, consists primarily of solutions involving our software platform, allowing customers to capture and manage their documents across operations such as scanned hard-copy documents and digital documents including those from Microsoft Office 365, digital images, audio, video and emails. Our Document Conversion segment, which includes and primarily consists of the Graphic Sciences acquisition, provides assistance to customers as a part of their overall document strategy to convert documents from one medium to another, predominantly paper to digital, including migration to our software solutions, as well as long-term storage and retrieval services. Our solutions create value for customers by making it easy to connect business-critical documents to the people who need them by making those document easy to find and access, while also being secure and compliant with the customers’ audit requirements. Solutions are sold both directly to end-users and through resellers.

 

2. Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles (“GAAP”).

 

The financial statements presented in this Quarterly Report on Form 10-Q are unaudited. However, in the opinion of management, these unaudited condensed consolidated financial statements include all adjustments, consisting solely of normal recurring adjustments, necessary to present fairly the financial position, results of operations and cash flows for the periods presented in conformity with GAAP applicable to interim periods. The financial data and other financial information disclosed in these notes to the accompanying condensed consolidated financial statements are also unaudited. As such, certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to applicable rules and regulations thereunder.

 

Operating results for the interim periods presented are not necessarily indicative of the results that may be expected for the full fiscal year ending December 31, 2021 or any other future period.

 

These unaudited interim condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 filed with the SEC filed on March 30, 2021.

 

3. Liquidity and Management’s Plans

 

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. Since 2012, we have raised a total of approximately $18.6 million in cash through issuances of debt and equity securities. As of June 30, 2021, we had $1,140,631 in cash and cash equivalents, net working capital deficit of $380,126, and an accumulated deficit of approximately $22 million. In June 2021, we paid $954,733 in annual earnout liabilities.

 

In 2020, we engaged in several actions that significantly improved our liquidity and cash flows, including:

 

  acquiring Graphic Sciences and CEO Image, resulting in increased cash flow from operations,
     
  receiving aggregate gross proceeds of $3.5 million from the private placement of our common stock,
     
  converting all of the outstanding principal and accrued interest payable on our then-existing convertible debt in the approximate amount of $6.0 million into shares of common stock at a conversion price of $4.00 per share,

 

9
 

 

  receiving $2.0 million in proceeds from the issuance of 12% subordinated promissory notes due February 28, 2023, which we refer to as the 2020 Notes, and
     
  obtaining the loan under the Paycheck Protection Program through PNC Bank in the principal amount of $838,700 (the “PPP loan”), the principal and interest on which was forgiven in its entirety by the U.S. Small Business Administration (the “SBA”) by notice we received on January 20, 2021.

 

Overall, we reduced our outstanding debt by approximately $3 million during 2020 and have not incurred any new debt in 2021.

 

Our ability to meet our capital needs in the future will depend on many factors, including maintaining and enhancing our operating cash flow, successfully managing the transition of our recent acquisitions of Graphic Sciences and CEO Image, successfully retaining and growing our client base in the midst of general economic uncertainty, and managing the continuing effects of the COVID-19 pandemic on our business. We will need to successfully manage our cash flows to support potential future earnout commitments and debt service commitments.

 

Based on our current plans and assumptions, we believe our capital resources, including our cash and cash equivalents, along with funds expected to be generated from our operations, will be sufficient to meet our anticipated cash needs arising in the ordinary course of business for at least the next 12 months, including to satisfy our expected working capital needs, earnout obligations and capital and debt service commitments.

 

4. Summary of Significant Accounting Policies

 

Principles of Consolidation

 

The condensed consolidated financial statements accompanying these notes include the accounts of Intellinetics and the accounts of all its subsidiaries in which it holds a controlling interest. Under GAAP, consolidation is generally required for investments of more than 50% of the outstanding voting stock of an investee, except when control is not held by the majority owner. We have two subsidiaries: Intellinetics Ohio and Graphic Sciences. We consider the criteria established under Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Topic 810, “Consolidations” in the consolidation process. All significant intercompany balances and transactions have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of condensed consolidated financial statements in conformity with 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 condensed consolidated financial statements and the reported amounts of revenues and expenses. By their nature, these estimates and assumptions are subject to an inherent degree of uncertainty. The impact of COVID-19 has significantly increased economic and demand uncertainty. Because future events and their effects cannot be determined with precision, actual results could differ significantly from estimated amounts.

 

Significant estimates and assumptions include valuation allowances related to receivables, accounts receivable -unbilled, allowance for obsolescence or slow-moving parts and supplies inventory, the recoverability of long-term assets, depreciable lives of property and equipment, purchase price allocations for acquisitions, fair value for goodwill and intangibles, the lease liabilities, estimates of fair value deferred taxes and related valuation allowances. Our management monitors these risks and assesses our business and financial risks on a quarterly basis.

 

10
 

 

Revenue Recognition

 

In accordance with ASC 606, “Revenue From Contracts With Customers,” we follow a five-step model to assess each contract of a sale or service to a customer: identify the legally binding contract, identify the performance obligations, determine the transaction price, allocate the transaction price, and determine whether revenue will be recognized at a point in time or over time. Revenue is recognized when a performance obligation is satisfied and the customer obtains control of promised goods and services. The amount of revenue recognized reflects the consideration to which we expect to be entitled to receive in exchange for these goods and services. In addition, ASC 606 requires disclosures of the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers.

 

We categorize revenue as software, software as a service, software maintenance services, professional services, and storage and retrieval services. We earn the majority of our revenue from the sale of professional services, followed by the sale of software maintenance services and software as a service. We apply our revenue recognition policies as required in accordance with ASC 606 based on the facts and circumstances of each category of revenue. More detail regarding each category of revenue is contained in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 filed with the SEC filed on March 30, 2021

 

Contract balances

 

When the timing of our delivery of goods or services is different from the timing of payments made by customers, we recognize either a contract asset (performance precedes contractual due date) or a contract liability (customer payment precedes performance). Customers that prepay are represented by deferred revenue until the performance obligation is satisfied. Contract assets represent arrangements in which the good or service has been delivered but payment is not yet due. Our contract assets consisted of accounts receivable, unbilled, which are disclosed on the condensed consolidated balance sheets. Our contract liabilities consisted of deferred (unearned) revenue, which is generally related to software as a service or software maintenance contracts. We classify deferred revenue as current based on the timing of when we expect to recognize revenue, which are disclosed on the condensed consolidated balance sheets.

 

The following table present changes in our contract assets and liabilities during the six months ended June 30, 2021 and 2020:

   Balance at
Beginning of Period
   Addition
from
acquisition
(Note 5)
   Revenue
Recognized in
Advance of
Billings
   Billings   Balance at
End of
Period
 
Six months ended June 30, 2021                         
Contract assets: Accounts receivable, unbilled  $523,522   $-   $1,944,919   $(1,956,366)  $512,075 
                          
Six months ended June 30, 2020                         
Contract assets: Accounts receivable, unbilled  $23,371   $276,023   $208,404   $(57,558)  $450,240 

 

 

Deferred revenue

 

Amounts that have been invoiced are recognized in accounts receivable, deferred revenue or revenue, depending on whether the revenue recognition criteria have been met. Deferred revenue represents amounts billed for which revenue has not yet be recognized. Deferred revenues typically relate to maintenance and software-as-a-service agreements which have been paid for by customers prior to the performance of those services, and payments received for professional services and license arrangements and software-as-a-service performance obligations that have been deferred until fulfilled under our revenue recognition policy.

 

11
 

 

Remaining performance obligations represent the transaction price from contracts for which work has not been performed or goods and services have not been delivered. We expect to recognize revenue on approximately 95% of the remaining performance obligations over the next 12 months, with the remainder recognized thereafter. As of June 30, 2021, the aggregate amount of the transaction price allocated to remaining performance obligations for software as a service and software maintenance contracts with a duration greater than one year was $48,454. As of December 31, 2020, the aggregate amount of the transaction price allocated to remaining performance obligations for software as a service and software maintenance contracts with a duration greater than one year was $45,323. This does not include revenue related to performance obligations that are part of a contract whose original expected duration is one year or less.

 

   Balance at
Beginning
of Period
   Addition
from
acquisition
(Note 5)
   Billings   Recognized
Revenue
   Balance at
End of
Period
 
Six months ended June 30, 2021                         
Contract liabilities: Deferred revenue  $996,131   $-   $2,141,905   $(2,195,089)  $942,947 
                          
Six months ended June 30, 2020                         
Contract liabilities: Deferred revenue  $754,073   $195,448   $1,482,894   $(1,520,617)  $911,798 

 

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Parts and Supplies

 

Parts and supplies are valued at the lower of cost or net realizable value. Costs are determined using the first-in, first-out method. Parts and supplies are used for scanning and document conversion services. A provision for potentially obsolete or slow-moving parts and supplies inventory is made based on parts and supplies levels, future sales forecasted and management’s judgment of potentially obsolete parts and supplies. We recorded an allowance of $24,000 and $15,000 at June 30, 2021 and December 31, 2020, respectively.

 

Property and Equipment

 

Property, 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 three to seven years. Leasehold improvements are amortized over the life of the lease or the asset, whichever is shorter, generally seven to ten 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. Construction in progress represents warehouse racking for document storage and retrieval purposes. No depreciation is provided for construction in progress until it is completed and placed into service.

 

13
 

 

Purchase Accounting Related Fair Value Measurements

 

We allocate the purchase price, including contingent consideration, of our acquisitions to the assets and liabilities acquired, including identifiable intangible assets, based on their respective fair values at the date of acquisition. Such fair market value assessments are primarily based on third-party valuations using assumptions developed by management that require significant judgments and estimates that can change materially as additional information becomes available. The purchase price allocated to intangibles is based on unobservable factors, including but not limited to, projected revenues, expenses, customer attrition rates, a weighted average cost of capital, among others. The weighted average cost of capital uses a market participant’s cost of equity and after-tax cost of debt and reflects the risks inherent in the cash flows. The approach to valuing the initial contingent consideration associated with the purchase price also uses similar unobservable factors such as projected revenues and expenses over the term of the contingent earnout period, discounted for the period over which the initial contingent consideration is measured, and volatility rates. We finalize the purchase price allocation once certain initial accounting valuation estimates are finalized, and no later than 12 months following the acquisition date.

 

Software Development Costs

 

We design, develop, test, market, license, and support new software products and enhancements of current products. We continuously monitor our software products and enhancements to remain compatible with standard platforms and file formats. In accordance with ASC 985-20 “Costs of Software to be Sold, Leased or Otherwise Marketed,” we expense software development costs, including costs to develop software products or the software component of products to be sold, leased, or marketed to external users, before technological feasibility is reached. Once technological feasibility has been established, certain software development costs incurred during the application development stage are eligible for capitalization. Based on our software development process, technical feasibility is established upon completion of a working model. Technological feasibility is typically reached shortly before the release of such products. No such costs were capitalized during the periods presented in this report.

 

14
 

 

In accordance with ASC 350-40, “Internal-Use Software,” we capitalize purchase and implementation costs of internal use software. Once an application has reached development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon complete of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable that the expenditure will result in additional functionality. No such costs were capitalized during the periods presented in this report.

 

For the three and six months ended June 30, 2021 and 2020, our expensed software development costs were $95,374 and $197,569, respectively, and $80,854 and $168,749, respectively.

 

Recently Issued Accounting Pronouncements Not Yet Effective

 

Financial Instruments – Credit Losses

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), which requires entities to measure all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost. ASC 2016-16 is effective for annual reporting periods beginning after December 15, 2023, including interim reporting periods within those annual reporting periods. Early adoption is permitted. The Company is currently evaluating the impact of the new guidance on its condensed consolidated financial statements and related disclosures.

 

Reference Rate Reform

 

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting” which provides optional relief through specific exceptions and practical expedients for transitioning away from reference rates that are expected to be discontinued. The relief generally applies to eligible modifications of contractual terms that change (or have the potential to change) the amount or timing of contractual cash flows related to replacement of a reference rate. The relief allows such modifications to be accounted for as continuations of existing contracts without additional analysis. The optional relief is available from March 2020 through December 31, 2022. The Company is currently evaluating the impact of this ASU.

 

15
 

 

No other Accounting Standards Updates that have been issued but are not yet effective are expected to have a material effect on the Company’s future condensed consolidated financial statements.

 

Advertising

 

We expense the cost of advertising as incurred. Advertising expense for the three and six months ended June 30, 2021 and 2020 amounted to $366 and $1,041, respectively, and 1,691 and $3,680, respectively.

 

Earnings (Loss) Per Share

 

Basic income or loss per share is computed by dividing net income or loss by the weighted average number of shares of common stock outstanding during the period. Diluted income or loss per share is computed by dividing net income or loss by the diluted weighted average number of shares of common stock outstanding during the period. The diluted weighted average number of shares gives effect to all dilutive potential common shares outstanding during the period using the treasury stock method. Diluted earnings per share exclude all diluted potential shares if their effect is anti-dilutive, including warrants or options which are out-of-the-money and for those periods with a net loss. The three and six months ended June 30, 2021 reported net income, while the three and six months ended June 30, 2020 reported net losses.

 

We have outstanding stock options which have not been included in the calculation of diluted net loss per share for the three and six months ended June 30, 2020 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

 

We file a consolidated federal income tax return with our subsidiaries. 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 June 30, 2021 and December 31, 2020, due to the uncertainty of our ability to realize future taxable income.

 

We account for uncertainty in income taxes in our financial statements as required under ASC 740, “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 us in our tax returns.

 

Segment Information

 

Operating segments are defined in the criteria established under the FASB ASC Topic 280 as components of public entities that engage in business activities from which they may earn revenues and incur expenses for which separate financial information is available and which is evaluated regularly by our chief operating decision maker (“CODM”) in deciding how to assess performance and allocate resources. Our CODM assesses performance and allocates resources based on two operating segments: Document Management and Document Conversion. These segments contain individual business components that have been combined on the basis of common management, customers, solutions offered, service processes and other economic characteristics. We currently have no intersegment sales. We evaluate the performance of our segments based on gross profits.

 

The Document Management Segment provides cloud-based and premise-based content services software. Its modular suite of solutions complements existing operating and accounting systems to serve a mission-critical role for organizations to make content secure, compliant, and process-ready. This segment conducts its primary operations in the United States. Markets served include highly regulated, risk and compliance-intensive markets in healthcare, K-12 education, public safety, other public sector, risk management, financial services, and others. Solutions are sold both directly to end-users and through resellers.

 

16
 

 

The Document Conversion Segment provides services for scanning and indexing, converting images from paper to digital, paper to microfilm, and microfiche to microfilm, as well as long-term physical document storage and retrieval. This segment conducts its primary operations in the United States. Markets served include business and federal, county, and municipal governments. Solutions are sold both directly to end-users and through a reseller distributor.

 

Information by operating segment is as follows:

 

   For the three months ended June 30,   For the six months ended June 30, 
   2021   2020   2021   2020 
Revenues                
Document Management  $791,004   $622,865   $1,526,822   $1,240,916 
Document Conversion   2,118,642    1,213,317    4,018,043    1,808,930 
Total revenues  $2,909,646   $1,836,182   $5,544,865   $3,049,846 
                     
Gross profit                    
Document Management  $638,169   $486,127   $1,225,700   $920,832 
Document Conversion   1,175,898    685,266    2,193,271    995,805 
Total gross profit  $1,814,067   $1,171,393   $3,418,971   $1,916,637 
                     
Capital additions, net                    
Document Management  $-   $4,717   $38,116   $7,911 
Document Conversion   165,455    12,981    361,522    17,529 
Total capital additions, net  $165,455   $17,698   $399,638   $25,440 

 

   As of June 30, 
   2021   2020 
Total assets          
Document Management  $1,562,655   $2,295,165 
Document Conversion   9,675,391    8,049,468 
Total assets  $11,238,046   $10,344,633 

 

Statement of Cash Flows

 

For purposes of reporting cash flows, cash includes cash on hand and demand deposits held by banks.

 

Reclassifications

 

Certain amounts reported in prior filings of the condensed consolidated financial statements have been reclassified to conform to current period presentation.

 

5. Business Acquisitions – Earnout Liability

 

On March 2, 2020, we acquired all of the issued and outstanding stock of Graphic Sciences. The purchase price paid for Graphic Sciences was $3,906,253 in cash plus potential contingent, or earnout, payments of up $833,000 annually over a three year period based on a gross profit level achieved by Graphic Sciences on an annual basis, for maximum total earnout payments over a three year period of $2,500,000, and with no minimum earnout payments. At the time of this acquisition, management estimated a fair value of the contingent liability—earnout (“earnout liability”) of $686,200 based on the terms of the earnout, and accordingly, recorded this amount as our earnout liability at the acquisition date in accordance with GAAP. For the three and six months ended June 30, 2021 we recorded a change in fair value of our earnout liabilities in the amount of $0 and $69,950, respectively. On June 8, 2021, we paid $769,733 for the first annual period. At June 30, 2021, our condensed consolidated balance sheets reflected an earnout liability for Graphic Sciences in the amount of $1,410,217. See Note 7 for the estimated fair value of the earnout liability as of June 30, 2021.

 

On April 21, 2020, we acquired substantially all of the assets of CEO Image. The purchase price paid for the assets of CEO Image consisted of $128,832 in cash, $170,000 in installment payments paid during 2020, and potential contingent, or earnout, payments of up $185,000 annually over a two year period based on a sales revenue level achieved by certain customers of CEO Image on an annual basis, for maximum total earnout payments over a two year period of $370,000, and with no minimum earnout payments. At the time of this acquisition, management estimated a fair value of the contingent liability—earnout (“earnout liability”) of $203,000 based on the terms of the earnout, and accordingly, recorded this amount as our earnout liability at the acquisition date in accordance with GAAP. For the three and six months ended June 30, 2021 we recorded a change in fair value of our earnout liabilities in the amount of $7,261. On June 10, 2021, we paid $185,000 for the first annual period. At June 30, 2021, our condensed consolidated balance sheets reflected an earnout liability for CEO Image in the amount of $156,261. See Note 7 for the estimated fair value of the earnout liability as of June 30, 2021.

 

17
 

 

The following unaudited pro forma information presents a summary of the condensed consolidated results of operations for the Company as if the acquisitions of Graphic Sciences and CEO Image had occurred on January 1, 2020.

 

For the six months ended June 30, 2020  (unaudited) 
   June 30, 2020 
Total revenues  $4,482,809 
      
Net loss  $(721,755)
      
Basic and diluted net loss per share  $(0.26)

 

The unaudited pro forma consolidated results are based on the Company’s historical financial statements and those of Graphic Sciences and CEO Image and do not necessarily indicate the results of operations that would have resulted had the acquisition actually been completed at the beginning of the applicable period presented. The pro forma financial information assumes that the companies were combined as of January 1, 2020.

 

The following tables present the amounts of revenue and earnings of the acquirees since the acquisition date included in the condensed consolidated income statement for the reporting period.

 

   For the three months ended June 30,   For the six months ended June 30, 
   2021   2020   2021   2020 
Graphic Sciences:                    
Total revenues  $2,028,798   $1,192,164   $3,872,019   $1,843,221 
Net income   279,374   $61,984   $497,895   $141,326 

 

   For the three months ended June 30,   For the six months ended June 30, 
   2021   2020    2021   2020 
CEO Image:                    
Total revenues  $139,591   $64,519   $272,196